1 EXHIBIT INDEX ON PAGE 25 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q - - [XX] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended: SEPTEMBER 30, 1998 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________________ to _____________________ Commission File Number: 1-11954 VORNADO REALTY TRUST - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) MARYLAND 22-1657560 - -------------------------------------------------------------------------------- (State or other jurisdiction of incorporation (I.R.S. Employer or organization) Identification Number) PARK 80 WEST, PLAZA II, SADDLE BROOK, NEW JERSEY 07663 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (201) 587-1000 - -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) N/A - -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No As of October 23, 1998 there were 84,222,096 common shares outstanding. Page 1
2 VORNADO REALTY TRUST INDEX <TABLE> <CAPTION> Page Number ----------- <S> <C> PART I. FINANCIAL INFORMATION: Item 1. Financial Statements: Consolidated Balance Sheets as of September 30, 1998 and December 31, 1997............................................... 3 Consolidated Statements of Income for the Three and Nine Months Ended September 30, 1998 and September 30, 1997................. 4 Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 1998 and September 30, 1997................. 5 Notes to Consolidated Financial Statements...................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....................................... 14 Item 3. Quantitative and Qualitative Disclosures About Market Risks..... 21 PART II. OTHER INFORMATION: Item 1. Legal Proceedings............................................... 22 Item 6. Exhibits and Reports on Form 8-K................................ 23 Signatures................................................................... 24 Exhibit Index................................................................ 25 </TABLE> Page 2
3 Page 3 PART I. FINANCIAL INFORMATION VORNADO REALTY TRUST CONSOLIDATED BALANCE SHEETS (AMOUNTS IN THOUSANDS EXCEPT SHARE AMOUNTS) <TABLE> <CAPTION> SEPTEMBER 30, DECEMBER 31, 1998 1997 ----------- ----------- <S> <C> <C> ASSETS: Real estate, at cost: Land $ 686,049 $ 436,274 Buildings and improvements 2,316,218 1,118,334 Leasehold improvements and equipment 10,471 9,485 ----------- ----------- Total 3,012,738 1,564,093 Less accumulated depreciation and amortization (208,943) (173,434) ----------- ----------- Real estate, net 2,803,795 1,390,659 Cash and cash equivalents, including U.S. government obligations under repurchase agreements of $17,275 and $8,775 140,853 355,954 Restricted cash 37,412 27,079 Marketable securities 91,687 34,469 Investment in and advances to partially-owned entities, including investments in and advance to Alexander's of $103,456 and $108,752 840,986 482,787 Due from officers 15,414 8,625 Accounts receivable, net of allowance for doubtful accounts of $2,457 and $658 32,785 16,663 Mortgage loans receivable 10,625 88,663 Deposits in connection with real estate acquisitions 19,996 47,275 Receivable arising from the straight- lining of rents 41,847 24,127 Other assets 92,320 47,788 ----------- ----------- TOTAL ASSETS $ 4,127,720 $ 2,524,089 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY: Notes and mortgages payable $ 1,234,314 $ 586,654 Revolving credit facility 683,250 370,000 Accounts payable and accrued expenses 76,213 36,538 Officer's deferred compensation payable 34,664 25,000 Deferred leasing fee income 9,868 9,927 Other liabilities 2,735 3,641 ----------- ----------- 2,041,044 1,031,760 ----------- ----------- Minority interest 302,549 178,567 ----------- ----------- Commitments and contingencies Shareholders' equity: Preferred shares of beneficial interest: no par value per share; authorized, 20,000,000 shares; liquidation preference $50.00 per share; issued 5,789,239 and 5,789,315 shares 282,039 279,884 Common shares of beneficial interest: $.04 par value per share; authorized, 100,000,000 shares; issued 84,222,096 and 72,164,654 shares 3,369 2,887 Additional capital 1,623,877 1,146,385 Accumulated deficit (107,375) (109,561) ----------- ----------- 1,801,910 1,319,595 Unrealized loss on securities available for sale (2,429) (840) Appreciation of securities held in officer's deferred compensation trust (10,464) -- Due from officers for purchase of common shares of beneficial interest (4,890) (4,993) ----------- ----------- Total shareholders' equity 1,784,127 1,313,762 ----------- ----------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 4,127,720 $ 2,524,089 =========== =========== </TABLE> See notes to consolidated financial statements. Page 3
4 VORNADO REALTY TRUST CONSOLIDATED STATEMENTS OF INCOME (amounts in thousands except per share amounts) <TABLE> <CAPTION> FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED --------------------------- --------------------------- SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, 1998 1997 1998 1997 --------- --------- --------- --------- <S> <C> <C> <C> <C> Revenues: Property rentals $ 118,197 $ 49,882 $ 299,924 $ 113,353 Expense reimbursements 20,210 10,763 53,000 25,924 Other income (including fee income from related parties of $450 and $592 and $1,635 and $1,236) 2,265 1,223 6,482 2,550 --------- --------- --------- --------- Total revenues 140,672 61,868 359,406 141,827 --------- --------- --------- --------- Expenses: Operating 58,607 21,899 144,214 48,557 Depreciation and amortization 16,210 6,611 41,605 15,040 General and administrative 6,775 3,460 18,792 8,208 Amortization of officer's deferred compensation expense -- 6,249 -- 18,747 --------- --------- --------- --------- Total expenses 81,592 38,219 204,611 90,552 --------- --------- --------- --------- Operating income 59,080 23,649 154,795 51,275 Income (loss) applicable to Alexander's (2,340) 1,344 806 4,186 Income from partially owned entities 11,195 669 20,871 1,471 Interest and other investment income 5,230 6,086 18,067 17,744 Interest and debt expense (34,034) (13,622) (80,536) (30,972) Net gain from insurance settlement and condemnation proceeding 9,649 -- 9,649 -- Minority interest (3,698) (2,500) (10,767) (4,600) --------- --------- --------- --------- Net Income 45,082 15,626 112,885 39,104 Preferred stock dividends (including accretion of issuance expenses of $719 and $719 and $2,157 and $1,198) (5,423) (5,241) (16,268) (10,096) --------- --------- --------- --------- Net Income applicable to common shares $ 39,659 $ 10,385 $ 96,617 $ 29,008 ========= ========= ========= ========= Net Income per common share - basic $ .47 $ .20 $ 1.22 $ .56 ========= ========= ========= ========= Net income per common share - diluted $ .46 $ .19 $ 1.19 $ .54 ========= ========= ========= ========= Dividends per common share $ .40 $ .32 $ 1.20 $ .96 ========= ========= ========= ========= </TABLE> See notes to consolidated financial statements. Page 4
5 VORNADO REALTY TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS (amounts in thousands) <TABLE> <CAPTION> FOR THE NINE MONTHS ENDED ------------------------------- SEPTEMBER 30, SEPTEMBER 30, 1998 1997 ----------- ----------- <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 112,885 $ 39,104 Adjustments to reconcile net income to net cash provided by operations: Depreciation and amortization (including debt issuance costs) 41,605 16,012 Amortization of officer's deferred compensation expense -- 18,747 Straight-lining of rental income (14,977) (4,947) Minority interest 10,767 4,600 Equity in (income) loss of Alexander's, including depreciation of $675 in each period (806) 497 Equity in net income of partially-owned entities (14,593) (553) Gain on marketable securities (1,530) (911) Net gain from insurance settlement and condemnation proceeding (9,649) -- Changes in operating assets and liabilities (23,817) (8,532) ----------- ----------- Net cash provided by operating activities 99,885 64,017 ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisitions of real estate and other (855,800) (548,790) Investments in partially-owned entities (308,800) (19,215) Investment in mortgage loans receivable (6,562) (67,663) Repayment of mortgage loans receivable 67,663 -- Cash restricted for tenant improvements (6,133) (27,571) Additions to real estate (67,392) (4,080) Purchases of securities available for sale (73,773) (3,436) Proceeds from sale or maturity of securities available for sale 14,903 -- Real estate deposits and other 51,135 -- ----------- ----------- Net cash used in investing activities (1,184,759) (670,755) ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from borrowings 1,423,953 523,000 Repayments of borrowings (883,043) (151,177) Debt issuance costs (6,533) (3,038) Proceeds from issuance of common shares 445,282 -- Proceeds from issuance of preferred stock -- 276,000 Repayment of borrowings on U.S. Treasury obligations -- (9,636) Dividends paid on common shares (94,430) (50,091) Dividends paid on preferred shares (16,268) (10,096) Exercise of stock options 812 447 ----------- ----------- Net cash provided by financing activities 869,773 575,409 ----------- ----------- Net decrease in cash and cash equivalents (215,101) (31,329) Cash and cash equivalents at beginning of period 355,954 89,696 ----------- ----------- Cash and cash equivalents at end of period $ 140,853 $ 58,367 =========== =========== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash payments for interest $ 75,305 $ 29,983 =========== =========== NON-CASH TRANSACTIONS: Financing assumed in acquisitions $ 497,300 $ 215,000 Minority interest in connection with acquisitions 140,000 177,000 Unrealized (loss) gain on securities available for sale (1,589) 2,019 </TABLE> See notes to consolidated financial statements. Page 5
6 VORNADO REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION Vornado Realty Trust ("Vornado") is a fully-integrated real estate investment trust ("REIT"). In April 1997, Vornado transferred substantially all of its assets to Vornado Realty L.P., a Delaware limited partnership (the "Operating Partnership"). As a result, Vornado now conducts its business through, and substantially all of its interests in properties are held by, the Operating Partnership. Vornado is the sole general partner of the Operating Partnership and owns a 91.5% limited partnership interest in the Operating Partnership at September 30, 1998. All references to "Vornado" in these financial statements refer to Vornado Realty Trust; all references to the "Operating Partnership" refer to Vornado Realty L.P. and all references to the "Company" refer to Vornado and its consolidated subsidiaries, including the Operating Partnership. 2. BASIS OF PRESENTATION The consolidated balance sheet as of September 30, 1998, the consolidated statements of income for the three and nine months ended September 30, 1998 and September 30, 1997 and the consolidated statements of changes in cash flows for the nine months ended September 30, 1998 and September 30, 1997 are unaudited. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position, results of operations and changes in cash flows have been made. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in Vornado's 1997 Annual Report to Shareholders. The results of operations for the three and nine month periods ended September 30, 1998 are not necessarily indicative of the operating results for the full year. The accompanying unaudited consolidated condensed financial statements include the accounts of Vornado Realty Trust and its majority-owned subsidiary, Vornado Realty L.P. All significant intercompany amounts have been eliminated. Equity interests in partially-owned entities include partnerships, joint ventures and preferred stock affiliates (corporations in which the Company owns all of the preferred stock and none of the common equity) and are accounted for under the equity method of accounting as the Company exercises significant influence over such entities. These investments are recorded initially at cost and subsequently adjusted for equity in net income (loss) and cash contributions and distributions. Ownership of the preferred stock entitles the Company to substantially all of the economic benefits in the preferred stock affiliates. The common stock of the preferred stock affiliates are owned by officers and trustees of Vornado. Certain prior period amounts have been reclassified to conform to the September 30, 1998 financial statement presentation. 3. ACQUISITIONS AND FINANCINGS: ACQUISITIONS: Westport On January 29, 1998, the Company acquired the Westport Corporate Office Park from a limited partnership that included members of the Mendik Group, a related party. The purchase price was approximately $14 million consisting of $6 million of cash and an $8 million mortgage loan. One Penn Plaza On February 9, 1998, the Company acquired a long-term leasehold interest in One Penn Plaza, a Manhattan office building. The purchase price was approximately $410 million consisting of $317 million of cash and a $93 million bridge mortgage loan. Page 6
7 VORNADO REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 150 East 58th Street On March 9, 1998, the Company acquired 150 East 58th Street (the "Architects and Design Center"), a Manhattan office building, for a cash purchase price of approximately $118 million. The Merchandise Mart Properties On April 1, 1998, the Company acquired a real estate portfolio from the Kennedy Family for approximately $630 million, consisting of $187 million in cash, $116 million in Operating Partnership Units, $77 million in existing debt and $250 million of newly issued debt. The acquired real estate assets consist of a portfolio of properties used for office, retail and trade showroom space which aggregate approximately 5.4 million square feet and include the Merchandise Mart in Chicago. The transaction also includes the acquisition of Merchandise Mart Properties, Inc. which manages the properties and trade shows. Following is a summary of the notes and mortgages payable, collateralized by the Merchandise Mart Properties (amounts in thousands): <TABLE> <S> <C> Merchandise Mart mortgage payable, due in 1999, non-amortizing with interest at LIBOR plus 1.35% (7.00% at September 30, 1998) (prepayable without penalty) $250,000 Washington Office Center mortgage payable, due in 2004, amortization based on a 25 year term, with interest at 6.80% (prepayable with yield maintenance) 51,537 Washington Design Center mortgage payable, due in 2000, amortization based on a 25 year term, with interest at LIBOR plus 3.00% (8.59% at September 30, 1998) (prepayable without penalty) 24,335 -------- $325,872 ======== </TABLE> 888 Seventh Avenue and 40 Fulton Street On June 2, 1998, the Company entered into an agreement to acquire the leasehold interest in 888 Seventh Avenue, a 46 story office building containing approximately 847,000 square feet located in midtown Manhattan, and simultaneously acquired 40 Fulton Street, a 29 story office building containing approximately 234,000 square feet located in downtown Manhattan. The aggregate consideration for both buildings is approximately $154.5 million. The acquisition of 888 Seventh Avenue is expected to be completed in the first quarter of 1999 and is subject to customary closing conditions. 770 Broadway On July 24, 1998, the Company acquired 770 Broadway, a 1,000,000 square foot Manhattan office building, for approximately $149 million, including $18 million of Operating Partnership Units. Page 7
8 VORNADO REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Capital Trust On July 28, 1998, the Company purchased $50 million of Capital Trust's 8.25% Step Up Convertible Trust Preferred Securities. The preferred securities are convertible at any time by the holder into common shares of Capital Trust at a price of $11.70 per share. The preferred shares have a 20-year maturity and are non-callable for five years. Capital Trust is a fully integrated, self-managed specialty finance company focused on the commercial real estate industry. Steven Roth, Chairman and Chief Executive Officer of Vornado joined Capital Trust's Board of Trustees. 689 Fifth Avenue On August 12, 1998, the Company acquired 689 Fifth Avenue, a 84,000 square foot Manhattan specialty building for approximately $33 million. OTHER FINANCINGS: Sale of Common Shares On April 15, 1998, the Company completed the sale of 10,000,000 common shares pursuant to an effective registration statement with net proceeds to the Company of approximately $401,000,000. On April 29, 1998, the Company sold 1,132,420 common shares to a unit investment trust, which were valued for the purpose of the trust at $41.06 per share, resulting in net proceeds of approximately $44,000,000. One Penn Plaza On June 15, 1998, the Company completed a $275,000,000 refinancing of its One Penn Plaza office building and borrowed $170,000,000 pursuant thereto. In the third quarter of 1998, the Company borrowed the remaining $105,000,000. The debt matures in June 2002, is prepayable at anytime, and bears interest at LIBOR + 1.25% (currently 6.91%). This debt replaced the $93,000,000 bridge-mortgage loan financing put in place when the property was acquired. See "Investments in and Advances to Partially Owned Entities" for other acquisitions and financing activities of partially owned entities. PRO FORMA INFORMATION The unaudited pro forma condensed consolidated statements of income for Vornado for the nine months ended September 30, 1998 and 1997 are presented as if the acquisitions described above and those included in Investments in and Advances to Partially Owned Entities and the financings attributable thereto had occurred on January 1, 1997. Condensed Consolidated Pro Forma Income Statements <TABLE> <CAPTION> Pro Forma ------------------------------------------ Nine Months Ended ------------------------------------------ September 30, 1998 September 30, 1997 ------------------ ------------------ (amounts in thousands, except per share amounts) <S> <C> <C> Revenues $ 479,700 $ 449,500 ========= ========= Net income $ 126,100 $ 93,700 Preferred stock dividends (16,300) (15,200) --------- --------- Net income applicable to common shares $ 109,800 $ 78,500 ========= ========= Net income per common share - basic $ 1.30 $ .93 ========= ========= Net income per common share - diluted $ 1.27 $ .91 ========= ========= </TABLE> Page 8
9 VORNADO REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 4. INVESTMENTS IN AND ADVANCES TO PARTIALLY-OWNED ENTITIES: The Company's investments in and advances to partially-owned entities and income recognized from such investments is as follows: INVESTMENTS AND ADVANCES: <TABLE> <CAPTION> September 30, 1998 December 31, 1997 ------------------ ----------------- (amounts in thousands) <S> <C> <C> Cold Storage Companies $445,901 $243,846 Alexander's 103,456 108,752 Charles E. Smith Commercial Realty L.P. 61,554 60,437 Hotel Pennsylvania 46,789 20,152 Newkirk Joint Ventures 55,913 -- Mendik Partially-Owned Office Buildings 79,391 37,209 Vornado Management Corp., Mendik Management Company, Merchandise Mart Properties, Inc. and other 47,982 12,391 -------- -------- $840,986 $482,787 ======== ======== </TABLE> INCOME: <TABLE> <CAPTION> Three Months Ended Nine Months Ended ---------------------------------------- ----------------------------------------- September 30, 1998 September 30, 1997 September 30, 1998 September 30, 1997 ------------------ ------------------ ------------------ ------------------ (amounts in thousands) <S> <C> <C> <C> <C> Income Applicable to Alexander's $ (2,340) $ 1,344 $ 806 $ 4,186 ======== ======== ======== ======== Other Partially-Owned Entities: Cold Storage Companies $ 5,008 $ -- $ 8,172 $ -- Charles E. Smith Commercial Realty L.P. 1,054 -- 3,405 -- Hotel Pennsylvania 1,361 -- 2,750 -- Newkirk Joint Ventures 1,006 -- 1,006 -- Mendik Partially-Owned Office Buildings 959 271 2,181 553 Vornado Management Corp., Mendik Management Company, Merchandise Mart Properties Inc. and other 1,807 398 3,357 918 -------- -------- -------- -------- $ 11,195 $ 669 $ 20,871 $ 1,471 ======== ======== ======== ======== </TABLE> Alexander's Alexander's is managed by and its properties are leased by the Company pursuant to agreements with a one-year term which are automatically renewable. Subject to the payments of rents by Alexander's tenants, the Company is due $3,221,000 under its leasing agreement with Alexander's which amount is included in Investments in and Advances to Alexander's. Included in Income from Vornado Management Corp. is management fee income from Alexander's of $1,563,000 and $4,688,000 in each of the three and nine months ended September 30, 1998 and 1997, respectively. On June 18, 1998, Alexander's increased its interest in the Kings Plaza Mall to 100% by acquiring Federated Department Store's ("Federated") 50% interest. The purchase price was approximately $28,000,000, which was paid in cash. In addition, Alexander's has agreed to pay Federated $15,000,000 to renovate its Macy's store in the mall in exchange for certain modifications to the Kings Plaza Operating Agreement. In connection with the acquisition, Alexander's has completed a $90 million three-year mortgage loan with Union Bank of Switzerland. Page 9
10 VORNADO REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Cold Storage Companies On April 23, 1998, the Cold Storage Companies completed a $550,000,000 non-recourse ten-year loan secured by 58 of its warehouses. The loan bears interest at 6.89%. The net proceeds from the loan together with working capital were used to repay $607,000,000 of bridge financing, which replaced high yield debt assumed at the date of acquisition. On June 15, 1998, a partnership in which Vornado owns a 60% interest through a preferred stock affiliate acquired the assets of Freezer Services, Inc., consisting of nine cold storage warehouses in the central United States for approximately $133 million, including $107 million in cash and $26 million in indebtedness. On July 1, 1998, the Carmar Group cold storage warehouse business was similarly acquired for approximately $158 million, including $144 million in cash and $14 million in indebtedness. Carmar owns and operates five cold storage distribution warehouses in the midwest and southeast United States. Hotel Pennsylvania On May 1, 1998, the Company acquired an additional 40% interest in the Hotel Pennsylvania increasing its ownership to 80%. The Company purchased the additional 40% interest from Hotel Properties Limited (one of its joint venture partners) for approximately $70 million, including $48 million of existing debt. Newkirk Joint Ventures On July 8, 1998, the Company invested $47 million for a 30% share in joint ventures with affiliates of Apollo Real Estate Investment Fund III, L.P., collectively Newkirk Joint Ventures ("Newkirk"). Newkirk owns various equity and debt interests relating to 120 limited partnerships which own real estate primarily net leased to credit rated tenants. An additional $9 million was invested prior to September 30, 1998 and the Company has issued a $15.6 million letter of credit in connection with these joint ventures. Mendik Partially-Owned Office Buildings On April 20, 1998, the Company increased its interest from 5.6% to approximately 50% in 570 Lexington Avenue, a 49 story office building located in midtown Manhattan containing approximately 435,000 square feet. The Company purchased the additional interest for approximately $37.2 million, including $4.9 million of existing debt. On August 4, 1998, the Company sold a 40% interest in a $27,000,000 mortgage on 20 Broad Street to one of the owners of the property for $10,800,000. On August 5, 1998, as part of a related transaction, the Company acquired the Mendik Group's 60% interest in the property for approximately $600,000 of Vornado Operating Partnership Units. 5. OTHER RELATED PARTY TRANSACTIONS The Company lent Mr. Fascitelli, the President of the Company, $3,500,000 on March 2, 1998 and $2,600,000 on April 30, 1998, in accordance with the terms of his employment agreement. The loans have a five-year term and bear interest, payable quarterly, at a rate of 5.47% and 5.58%, respectively (based on the mid-term applicable federal rate provided under the Internal Revenue Code). The Company currently manages and leases the real estate assets of Interstate Properties pursuant to a management agreement. Management fees earned by the Company pursuant to the management agreement were $184,000 and $470,000 for the three months ended September 30, 1998 and 1997 and $956,000 and $847,000 for the nine months ended September 30, 1998 and 1997. Page 10
11 VORNADO REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Mendik Group owns an entity which provides cleaning and related services and security services to office properties including the Company's Manhattan office properties acquired subsequent to September 30, 1997. The Company was charged fees for these services of $7,356,000 and $18,580,253 for the three and nine months ended September 30, 1998 and $3,292,000 for the three months ended September 30, 1997 and $5,899,000 for the period from April 15, 1997 to September 30, 1997. A portion of these fees is expected to be reimbursed to the Company by its tenants. 6. NET GAIN FROM INSURANCE SETTLEMENT AND CONDEMNATION PROCEEDINGS In April 1997, the Company's Lodi shopping center was destroyed by a fire. In the third quarter of 1998, the Company and its insurer agreed that the estimated cost to reconstruct the shopping center is approximately $9,012,000 and the Company recorded a gain of $7,955,000 (the agreed upon amount, net of the carrying value of the shopping center of $1,057,000). The insurance carrier had previously advanced $5,550,000 to the Company. The reconstruction of the shopping center is expected to be completed in 1999. On September 1, 1998, Atlantic City condemned the Company's vacant property. In the third quarter of 1998, the Company recorded a gain of $1,694,000, (which reflects the condemnation award of $3,100,000, net of the carrying value of the building of $1,406,000). The Company is contesting the amount of the award. 7. COMMITMENTS AND CONTINGENCIES At September 30, 1998, in addition to the $683,250,000 balance outstanding under the Company's revolving credit facility, the Company had utilized approximately $100,218,000 of availability under the facility for letters of credit and guarantees primarily related to pending acquisitions. In January 1997, two individual investors in Mendik Real Estate Limited Partnership ("RELP"), the publicly held limited partnership that indirectly owns a 60% interest in the Two Park Avenue Property, filed a purported class action against NY Real Estate Services 1, Inc. ("NY Real Estate"), Mendik RELP Corp., B&B Park Avenue, L.P. (an indirect subsidiary of the Company which acquired the remaining 40% interest in Two Park Avenue) and Bernard H. Mendik in the Supreme Court of the State of New York, County of New York, on behalf of all persons holding limited partnership interests in RELP. The complaint alleges that, for reasons which include purported conflicts of interest, the defendants breached their fiduciary duty to the limited partners, that the then proposed transfer of the 40% interest in Two Park Avenue would result in a burden on the operation and management of Two Park Avenue and that the transfer of the 40% interest violates RELP's right of first refusal to purchase the interest being transferred and fails to provide limited partners in RELP with a comparable transfer opportunity. Shortly after the filing of the complaint, another limited partner represented by the same attorneys filed an essentially identical complaint in the same court. Both complaints seek unspecified damages, an accounting and a judgment requiring either the liquidation of RELP and the appointment of a receiver or an auction of Two Park Avenue. In August 1997, a fourth limited partner, represented by separate counsel, commenced another purported class action in the same court by serving a complaint essentially identical to the complaints in the two previously commenced actions. These lawsuits have since been consolidated. On June 2, 1998, the parties entered into a Stipulation and Agreement of Compromise, Settlement and Release (the "Settlement"). The Settlement provides, among other things: (i) for Vornado to purchase the Partnership's interest in Two Park Avenue for approximately $34.6 million, which will be paid in cash, or at Vornado's election, in any combination of cash or shares of Vornado stock, plus the assumption of $39 million in existing debt; and (ii) for Vornado to purchase the Partnership's interest in 550-600 Mamaroneck Avenue, Harrison, New York and 330 West 34th Street, New York, NY for an aggregate price of $30 million in cash. On October 14, 1998, the Supreme Court of the State of New York for New York County approved the proposed settlement. On November 6, 1998, the Court's judgment became final. It is expected that the transaction will close within the next 30 days. Page 11
12 VORNADO REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8. EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share: <TABLE> <CAPTION> Three Months Ended Nine Months Ended ----------------------------------------- ---------------------------------------- September 30, 1998 September 30, 1997 September 30, 1998 September 30, 1997 ------------------ ------------------ ------------------ ------------------ (amounts in thousands except per share amounts) <S> <C> <C> <C> <C> Numerator: Net income $ 45,082 $ 15,626 $ 112,885 $ 39,104 Preferred stock dividends (5,423) (5,241) (16,268) (10,096) --------- --------- --------- --------- Numerator for basic and diluted earnings per share - income applicable to common shares $ 39,659 $ 10,385 $ 96,617 $ 29,008 ========= ========= ========= ========= Denominator: Denominator for basic earnings per share -- weighted average shares 83,755 52,195 79,407 52,194 Effect of dilutive securities: Employee stock options 1,673 1,768 2,075 1,454 --------- --------- --------- --------- Denominator for diluted earnings per share - adjusted weighted average shares and assumed conversions 85,428 53,963 81,482 53,648 ========= ========= ========= ========= Net income per common share - basic $ .47 $ .20 $ 1 .22 $ .56 ========= ========= ========= ========= Net income per common share - diluted $ .46 $ .19 $ 1.19 $ .54 ========= ========= ========= ========= </TABLE> 9. COMPREHENSIVE INCOME AND ACCOUNTING FOR DEFERRED COMPENSATION ARRANGEMENTS In June 1997, the Financial Accounting Standards Board issued Statement No. 130, "Reporting Comprehensive Income" (SFAS 130). SFAS 130 establishes standards for reporting and display of comprehensive income and its components. The statement, which requires disclosure of net income including unrealized gains and losses recognized in the equity section of the balance sheet, was adopted by the Company in the first quarter of 1998. Page 12
13 VORNADO REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In addition, at September 30, 1998, the Company adopted Emerging Issues Task Force (EITF) Issue No. 97-14, "Accounting for Deferred Compensation Arrangements Where Amounts Earned are Held in a Rabbi Trust and Invested". This EITF provides the framework for the accounting for changes in the value of investments held in a Rabbi Trust and the effects of such changes on compensation expense. The Company's comprehensive income was $34,766,000 and $11,408,000 for the three months ended September 30, 1998 and 1997 and $95,028,000 and $31,027,000 for the nine months ended September 30, 1998 and 1997. 10. SUBSEQUENT EVENTS Vornado Operating Company On October 16, 1998, the Company completed its spin-off of Vornado Operating Company. Holders of Vornado Realty Trust common shares and the Operating Partnership's Class A, Class C and Class D units ("Units") received one share of common stock, par value $.01 per share of Vornado Operating Company ("Common Stock") for every 20 common shares or units held of record on October 9, 1998. The conversion price of the Company's $3.25 Series A Convertible Preferred Shares was adjusted from $36.38 to $36.10 to reflect the distribution. The Company has capitalized Vornado Operating Company with an equity contribution of $25 million. In addition, the Company has agreed to enter into a $75 million revolving credit agreement with Vornado Operating Company. Las Catalinas Mall On October 29, 1998, Vornado completed its acquisition of K Mart's 50% interest in the Las Catalinas Mall located in Caguas, Puerto Rico (adjacent to San Juan). In addition, Vornado acquired 75% and Vornado's partner in the Mall acquired 25% of K Mart's anchor store. Vornado's purchase price of $38 million was fully financed with 15 year non-recourse debt. The Las Catalinas Mall, which opened in 1997 contains 485,000 square feet, including a 123,000 square foot K Mart and a 146,000 square foot Sears. Page 13
14 VORNADO REALTY TRUST MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Certain statements contained herein constitute forward-looking statements as such term is defined in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Certain factors could cause actual results to differ materially from those in the forward-looking statements. Factors that might cause such a material difference include, but are not limited to, (a) changes in the general economic climate, (b) local conditions such as an oversupply of space or a reduction in demand for real estate in the area, (c) conditions of tenants, (d) competition from other available space, (e) increased operating costs and interest expense, (f) the timing of and costs associated with property improvements, (g) changes in taxation or zoning laws, (h) government regulations, (i) failure of Vornado to continue to qualify as a REIT, (j) availability of financing on acceptable terms, (k) potential liability under environmental or other laws or regulations, (l) general competitive factors and (m) the impact of the Year 2000 issue, including the effect of third parties' failure to address the Year 2000 issue as well as the Company's own readiness. RESULTS OF OPERATIONS The Company's revenues, which consist of property rentals, tenant expense reimbursements and other income were $140,672,000 in the quarter ended September 30, 1998, compared to $61,868,000 in the prior year's quarter, an increase of $78,804,000. Revenues were $359,406,000 for the nine months ended September 30, 1998, compared to $141,827,000 in the prior year's nine months, an increase of $217,579,000. These increases included $70,522,000 and $201,586,000 of revenues from properties acquired which are not reflected in operations for all or a portion of the prior year's periods presented. Property rentals were $118,197,000 in the quarter ended September 30, 1998, compared to $49,882,000 in the prior year's quarter, an increase of $68,315,000. Property rentals were $299,924,000 for the nine months ended September 30, 1998, compared to $113,353,000 in the prior year's nine months, an increase of $186,571,000. These increases resulted from: <TABLE> <CAPTION> Three Months Nine Months Date of Ended Ended Acquisitions: Acquisition September 30, 1998 September 30, 1998 ------------- ----------- ------------------ ------------------ <S> <C> <C> <C> 20 Broad Street August 1998 $1,800,000 $1,800,000 689 Fifth Avenue August 1998 472,000 472,000 770 Broadway July 1998 2,935,000 2,935,000 40 Fulton Street June 1998 1,504,000 1,993,000 Merchandise Mart Properties April 1998 27,477,000 54,364,000 150 E. 58th Street March 1998 3,978,000 9,128,000 One Penn Plaza February 1998 14,859,000 39,468,000 Westport January 1998 661,000 1,778,000 Green Acres Mall December 1997 5,404,000 16,367,000 640 Fifth Avenue December 1997 1,796,000 4,407,000 Riese June 1997 -- 486,000 90 Park Avenue May 1997 -- 13,889,000 Mendik April 1997 -- 24,949,000 Montehiedra Shopping Center April 1997 -- 2,203,000 ----------- ------------ 60,886,000 174,239,000 Leasing Activity and Step-Ups in Leases: Shopping centers 1,656,000 4,736,000 Office buildings 5,773,000 7,596,000 ----------- ------------ $68,315,000 $186,571,000 =========== ============ </TABLE> Page 14
15 VORNADO REALTY TRUST MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Tenant expense reimbursements were $20,210,000 in the quarter ended September 30, 1998, compared to $10,763,000 in the prior year's quarter, an increase of $9,447,000. Tenant expense reimbursements were $53,000,000 for the nine months ended September 30, 1998, compared to $25,924,000 in the prior year's nine months, an increase of $27,076,000. These increases included $9,450,000 and $27,590,000 from tenants at properties acquired which are not reflected in operations for all or a portion of the prior year's periods presented. Operating expenses were $58,607,000 in the quarter ended September 30, 1998, as compared to $21,899,000 in the prior year's quarter, an increase of $36,708,000. Operating expenses were $144,214,000 for the nine months ended September 30, 1998, compared to $48,557,000 in the prior year's nine months, an increase of $95,657,000. These increases included (i) $35,393,000 and $93,078,000 from properties acquired which are not reflected in operations for all or a portion of the prior year's periods presented and (ii) $1,315,000 and $2,579,000 primarily for building maintenance at the Company's other properties. Depreciation and amortization was $16,210,000 in the quarter ended September 30, 1998, as compared to $6,611,000 in the prior year's quarter, an increase of $9,599,000. Depreciation and amortization was $41,605,000 for the nine months ended September 30, 1998, compared to $15,040,000 in the prior year's nine months, an increase of $26,565,000. These increases were primarily a result of acquisitions. General and administrative expenses were $6,775,000 in the quarter ended September 30, 1998 compared to $3,460,000 in the prior year's quarter, an increase of $3,315,000. General and administrative expenses were $18,792,000 for the nine months ended September 30, 1998, compared to $8,208,000 in the prior year's nine months, an increase of $10,584,000. Of these increases: (i) $921,000 and $4,237,000 is attributable to acquisitions, (ii) $1,660,000 and $3,703,000 resulted from payroll, primarily for additional employees, and corporate office expenses and (iii) $734,000 and $2,644,000 resulted from professional fees. The Company recognized an expense of $6,249,000 and $18,747,000 in the prior year's quarter and nine months representing the amortization of the deferred payment due to the Company's President, which was fully amortized at December 31, 1997. Income (loss) applicable to Alexander's (loan interest income, equity in income (loss) and depreciation) was $(2,340,000) in the quarter ended September 30, 1998, compared to $1,344,000 in the prior year's quarter, a decrease of $3,684,000. Income applicable to Alexander's was $806,000 for the nine months ended September 30, 1998, compared to $4,186,000 in the prior year's nine months, a decrease of $3,380,000. These decreases resulted primarily from (i) the Company's equity in Alexander's loss of $4,423,000 from the write-off of the carrying value of Alexander's Lexington Avenue building and predevelopment costs, partially offset by (ii) income from the commencement of leases at Alexander's Rego Park and Kings Plaza store properties and (iii) income from Alexander's acquisition of the remaining 50% interest in the Kings Plaza Mall. Income from partially-owned entities was $11,195,000 in the quarter ended September 30, 1998, compared to $669,000 in the prior year's quarter, an increase of $10,526,000. Income from partially-owned entities was $20,871,000 for the nine months ended September 30, 1998, compared to $1,471,000 in the prior year's nine months, an increase of $19,400,000. These increases resulted from: <TABLE> <CAPTION> Three Months Nine Months Date of Ended Ended Acquisitions: Acquisition September 30, 1998 September 30, 1998 ------------- ----------- ------------------ ------------------ <S> <C> <C> <C> Cold Storage Companies October 1997 $ 5,008,000 $ 8,172,000 Charles E. Smith Commercial Realty L.P. October 1997 1,054,000 3,405,000 Hotel Pennsylvania September 1997 1,361,000 2,750,000 Newkirk Joint Ventures July 1998 1,006,000 1,006,000 Mendik partially-owned office buildings April 1997 688,000 1,728,000 Merchandise Mart Management Company April 1998 324,000 1,272,000 ----------- ----------- 9,441,000 18,333,000 Other 1,085,000 1,067,000 ----------- ----------- $10,526,000 $19,400,000 =========== =========== </TABLE> Page 15
16 VORNADO REALTY TRUST MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Interest and other investment income (interest income on mortgage loans receivable, other interest income, dividend income and net gains on marketable securities) was $5,230,000 for the quarter ended September 30, 1998, compared to $6,086,000 in the prior year's quarter, a decrease of $856,000. This decrease resulted primarily from lower average investments this year. Interest and other investment income was $18,067,000 for the nine months ended September 30, 1998, compared to $17,744,000 in the prior year's nine months, an increase of $323,000. Interest and debt expense was $34,034,000 for the quarter ended September 30, 1998, compared to $13,622,000 in the prior year's quarter, an increase of $20,412,000. Interest and debt expense was $80,536,000 for the nine months ended September 30, 1998, compared to $30,972,000 in the prior year's nine months, an increase of $49,564,000. These increases resulted primarily from debt in connection with acquisitions. In the third quarter of 1998, the Company recorded a net gain of $9,649,000, in connection with an insurance settlement and condemnation proceeding (see Note 6 to the Consolidated Financial Statements). The minority interest is comprised of: <TABLE> <CAPTION> For The Three Months Ended For the Nine Months Ended -------------------------------------------- ---------------------------------------- September 30, 1998 September 30, 1997 September 30, 1998 September 30, 1997 ------------------ ------------------ ------------------- ------------------- <S> <C> <C> <C> <C> Preferential distributions to unit holders in the Operating Partnership $ 3,423,000 $ 2,500,000 $10,492,000 $ 4,600,000* 40% interest in 20 Broad Street 275,000 -- 275,000 -- ----------- ----------- ----------- ----------- $ 3,698,000 $ 2,500,000 $10,767,000 $ 4,600,000 =========== =========== =========== =========== </TABLE> * For the period from April 15, 1997 to September 30, 1997 The preferred stock dividends of $5,423,000 and $16,268,000 for the three and nine months ended September 30, 1998 and $5,241,000 for the three months ended September 30, 1997 and $10,096,000 for the period from April 15, 1997 to September 30, 1997 apply to the Company's $3.25 Series A Convertible Preferred Shares issued in April and December 1997 and include accretion of expenses of issuing them. Page 16
17 VORNADO REALTY TRUST MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS LIQUIDITY AND CAPITAL RESOURCES Nine Months Ended September 30, 1998 Cash flows provided by operating activities of $99,885,000 was primarily comprised of (i) income of $103,236,000 (net income of $112,885,000 less net gain from insurance settlement and condemnation proceeding of $9,649,000) and (ii) adjustments for non-cash items of $21,996,000, offset by (iii) the net change in operating assets and liabilities of $23,817,000. The adjustments for non-cash items are primarily comprised of (i) depreciation and amortization of $41,605,000 and (ii) minority interest of $10,767,000, partially offset by (iii) the effect of straight-lining of rental income of $14,977,000 and (iv) equity in net income of partially-owned entities of $14,593,000. The net change in operating assets and liabilities reflects an increase in prepaid real estate taxes of $15,792,000. Net cash used in investing activities of $1,184,759,000 was primarily comprised of (i) acquisitions of real estate of $855,800,000 (see detail below), (ii) investments in partially-owned entities of $308,000,000 (see detail below), (iii) capital expenditures of $67,392,000 and investments in securities of $73,773,000 (including $48,500,000 purchase of Capital Trust Preferred Stock), partially offset by (v) proceeds from the repayment of mortgage loans receivable of $67,663,000. Acquisitions of real estate and investments in partially-owned entities are comprised of (amounts in thousands): <TABLE> <CAPTION> Debt Value of Total Cash Assumed Units Issued Consideration ---- ------- ------------ ------------- <S> <C> <C> <C> <C> Real Estate: Merchandise Mart Properties $ 187,000 $ 327,000 $ 116,000 $ 630,000 One Penn Plaza Office Building 317,000 93,000 -- 410,000 770 Broadway Office Building 131,000 -- 18,000 149,000 150 East 58th Street Office Building 118,000 -- -- 118,000 40 Fulton Street Office Building 54,000 -- -- 54,000 689 Fifth Avenue Office Building 33,000 -- -- 33,000 Other 15,800 -- -- 15,800 ---------- ---------- ---------- ---------- $ 855,800 $ 420,000 $ 134,000 $1,409,800 ========== ========== ========== ========== Investments in Partially Owned Entities: Hotel Pennsylvania (acquisition of additional 40% interest increasing ownership to 80%) $ 22,000 $ 48,000 $ -- $ 70,000 570 Lexington Avenue Office Building (increased interest from 5.6% to approximately 50%) 32,300 4,900 -- 37,200 Acquisition of Freezer Services, Inc. (60% interest) 58,000 16,000 6,000 80,000 Reduction in Cold Storage Companies debt (60% interest) 44,000 -- -- 44,000 Acquisition of Carmar Group (60% interest) 86,400 8,400 -- 94,800 Investment in Newkirk Joint Ventures 56,000 -- -- 56,000 Other 9,300 -- -- 9,300 ---------- ---------- ---------- ---------- $ 308,000 $ 77,300 $ 6,000 $ 391,300 ========== ========== ========== ========== </TABLE> Net cash provided by financing activities of $869,773,000 was primarily comprised of (i) proceeds from borrowings of $1,423,953,000, and (ii) proceeds from the issuance of common shares of $445,282,000, partially offset by (iii) repayment of borrowings of $883,043,000, (iv) dividends paid on common shares of $94,430,000 and (v) dividend paid on preferred shares of $16,268,000. Page 17
18 VORNADO REALTY TRUST MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Nine Months Ended September 30, 1997 Cash flows provided by operating activities of $64,017,000 was comprised of (i) net income of $39,104,000 and (ii) adjustments for non-cash items of $33,445,000, partially offset by (iii) the net change in operating assets and liabilities of $8,532,000. The adjustments for non-cash items are primarily comprised of (i) amortization of deferred officer's compensation expense of $18,747,000, (ii) depreciation and amortization of $16,012,000, (iii) equity in loss of Alexander's of $497,000, and (iv) minority interest of $4,600,000, partially offset by (v) the effect of straight-lining of rental income of $4,947,000 and (vi) equity in net income of investees of $553,000. Net cash used in investing activities of $670,755,000 was primarily comprised of (i) expenditures of $263,790,000 in connection with the Mendik Transaction, (ii) investments in mortgage loans receivable of $67,663,000, (iii) capital expenditures and investments in partnerships and joint ventures of $308,295,000 and (iv) restricted cash for tenant improvements of $27,571,000. Investments in mortgage loans receivable are comprised of (a) a loan of $41,000,000 to affiliates of the Riese Organization cross collateralized by ten Manhattan properties and (b) a mortgage on a 460,000 square foot office building at 20 Broad Street in Manhattan, New York, purchased at a discount from a bank for $27,000,000. Net cash provided by financing activities of $575,409,000 was primarily comprised of proceeds from (i) borrowings of $523,000,000, and (ii) issuance of preferred shares of $276,000,000, partially offset by (iii) repayment of borrowings of $151,177,000, (iv) dividends paid of $60,187,000 and (v) the repayment of borrowings on U.S. Treasury obligations of $9,636,000. Funds from Operations for the Three and Nine Months Ended September 30, 1998 and 1997 Funds from operations were $58,608,000 in the quarter ended September 30, 1998, compared to $17,056,000 in the prior year's quarter, an increase of $41,552,000. Funds from operations were $157,789,000 in the nine months ended September 30, 1998, compared to $43,789,000 in the prior year's nine months, an increase of $114,000,000. Funds from operations for the prior year's quarter and nine months reflect amortization of the deferred payment due to the Company's President of $6,249,000 and $18,747,000. The following table reconciles funds from operations and net income: <TABLE> <CAPTION> For the Three Months Ended For the Nine Months Ended ----------------------------------------- ---------------------------------------- September 30, 1998 September 30, 1997 September 30, 1998 September 30, 1997 ------------------ ------------------ ------------------ ------------------ <S> <C> <C> <C> <C> Net income applicable to common shares $ 39,659,000 $ 10,385,000 $ 96,617,000 $ 29,008,000 Depreciation and amortization of real property 15,969,000 6,466,000 41,002,000 14,623,000 Straight-lining of property rentals for rent escalations (3,804,000) (830,000) (10,218,000) (2,317,000) Leasing fees received in excess of income recognized 310,000 480,000 1,047,000 1,333,000 Proportionate share of adjustments to equity in net income of partially owned entities to arrive at funds from operations 17,315,000 555,000 41,691,000 1,142,000 Net gain from insurance settlement and condemnation proceeding (9,649,000) -- (9,649,000) -- Minority interest in excess of preferential distributions (1,192,000) -- (2,701,000) -- ------------- ------------- ------------- ------------- $ 58,608,000 $ 17,056,000 $ 157,789,000 $ 43,789,000 ============= ============= ============= ============= </TABLE> The number of shares that should be used for determining funds from operations per share is the number used for diluted earnings per share. Page 18
19 VORNADO REALTY TRUST MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Funds from operations does not represent cash generated from operating activities in accordance with generally accepted accounting principles and is not necessarily indicative of cash available to fund cash needs, which is disclosed in the Consolidated Statements of Cash Flows for the applicable periods. There are no material legal or functional restrictions on the use of funds from operations. Funds from operations should not be considered as an alternative to net income as an indicator of the Company's operating performance or as an alternative to cash flows as a measure of liquidity. Management considers funds from operations a relevant supplemental measure of operating performance because it provides a basis for comparison among REITs; however, funds from operations may not be comparable to similarly titled measures reported by other REITs since the Company's method of calculating funds from operations is different from that used by NAREIT. Funds from operations, as defined by NAREIT, represents net income applicable to common shares before depreciation and amortization, extraordinary items and gains or losses on sales of real estate. Funds from operations as disclosed above has been modified to adjust for the effect of straight-lining of property rentals for rent escalations and leasing fee income. Below are the cash flows provided by (used in) operating, investing and financing activities: <TABLE> <CAPTION> For the Three Month Ended For the Nine Months ended ---------------------------------------- ------------------------------------------- September 30, 1998 September 30, 1997 September 30, 1998 September 30, 1997 ------------------ ------------------ ------------------ ------------------ <S> <C> <C> <C> <C> Operating activities $ 17,674,000 $ 13,028,000 $ 99,885,000 $ 64,017,000 ============= ============= =================== ============= Investing activities $(205,078,000) $ (40,942,000) $ (1,184,759,000) $(670,755,000) ============= ============= =================== ============= Financing activities $ 70,673,000 $(113,545,000) $ 869,773,000 $ 575,409,000 ============= ============= =================== ============= </TABLE> Certain Cash Requirements Affecting the Company's Liquidity at September 30, 1998: Pending Acquisitions and Investments On June 2, 1998, the Company entered into an agreement to acquire the leasehold interest in 888 Seventh Avenue, a 46 story office building containing approximately 847,000 square feet located in midtown Manhattan, for approximately $100 million. The acquisition of 888 Seventh Avenue is expected to be completed not later than the third quarter of 1999 in conjunction with other unrelated transactions to be effected by the seller, and is subject to customary closing conditions. On June 2, 1998, the Company entered into an agreement to settle existing litigation - see Legal Proceedings. The Settlement provides, among other things: (i) for Vornado to purchase the remaining 60% interest in Two Park Avenue for approximately $34.6 million, which will be paid in cash, or at the Company's election, in any combination of cash or shares of Vornado stock, plus the assumption of $39 million in existing debt; and (ii) for Vornado to purchase the Partnership's interest in 550-600 Mamaroneck Avenue, Harrison, New York and 330 West 34th Street, New York, New York for an aggregate price of $30 million in cash. On October 14, 1998, the Supreme Court of the State of New York for New York County approved the proposed settlement. On November 6, 1998, the Court's judgment became final. It is expected that the transaction will close within the next 30 days. On October 29, 1998, Vornado completed its acquisition of K Mart's 50% interest in the Las Catalinas Mall located in Caguas, Puerto Rico (adjacent to San Juan). In addition, Vornado acquired 75% and Vornado's partner in the Mall acquired 25% of K Mart's anchor store. Vornado's purchase price of $38 million was fully financed with 15 year non-recourse debt. Page 19
20 VORNADO REALTY TRUST MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company entered into an agreement to acquire the 1,050,000 square foot Market Square Complex of showrooms in High Point, NC, for approximately $95 million consisting of $6 million of cash, $44 million of debt and $45 million of Operating Partnership Units and Convertible Preferred Operating Partnership Units. This transaction is currently expected to close in the fourth quarter; however there can be no assurance it will ultimately be consummated. Financings: On April 15, 1998, the Company completed the sale of 10,000,000 common shares pursuant to an effective registration statement with net proceeds to the Company of approximately $401,000,000. On April 29, 1998, the Company sold 1,132,420 common shares to a unit investment trust, which were valued for purposes of the trust at $41.06 per share, resulting in net proceeds of approximately $44,000,000. On September 30, 1998, the Company had $683,250,000 outstanding under its $1,000,000,000 revolving credit facility at a blended interest rate of 6.49%. Also, in February 1998, the Company completed a $160,000,000 refinancing of the Green Acres Mall and prepaid the then existing $118,000,000 debt on the property. The new 10-year debt matures in March 2008 and bears interest at 6.75%. On April 23, 1998, the Cold Storage Companies completed a $550,000,000 non-recourse ten-year loan secured by 58 of its warehouses. The loan bears interest at 6.89%. The net proceeds from the loan together with working capital were used to repay $607,000,000 of bridge financing, which replaced high yield debt assumed at the date of acquisition. On June 15, 1998, the Company completed a $275,000,000 refinancing of its One Penn Plaza office building and borrowed $170,000,000 pursuant thereto. In the third quarter, the Company borrowed the remaining $105,000,000. The debt matures in June 2002, is prepayable at anytime, and bears interest at LIBOR + 1.25%; (currently 6.91%). This debt replaced the $93,000,000 bridge-mortgage loan financing put in place when the property was acquired. On October 16, 1998, the Company completed its spin-off of Vornado Operating Company, which the Company capitalized with an equity contribution of $25 million of cash. In addition, Vornado has agreed to enter into a $75 million revolving credit agreement with Vornado Operating Company. The Company anticipates that cash from continuing operations will be adequate to fund business operations and the payment of dividends and distributions on an ongoing basis for more than the next twelve months; however, capital outlays for significant acquisitions may require funding from borrowings or equity offerings. Page 20
21 VORNADO REALTY TRUST MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Year 2000 Issues Year 2000 compliance programs and information systems modifications were initiated by Vornado in early 1998 in an attempt to ensure that these systems and key processes will remain functional. This objective is expected to be achieved either by modifying present systems using existing internal and external programming resources or by installing new systems, and by monitoring supplier and other third-party interfaces. In many cases, Vornado will be relying on statements from outside vendors as to the Year 2000 readiness of their systems, and will not, in many circumstances, attempt any independent verification. Review of the systems affecting Vornado and its properties is progressing. The costs of Vornado's Year 2000 program to date have not been material, and Vornado does not anticipate that the costs of any required modifications to its information technology or embedded technology systems will have a material adverse effect on its financial position, results of operations or liquidity. Vornado has contingency plans for its own day-to-day operational systems and management is in the process of updating these plans for possible Year 2000 specific operational requirements. Recently Issued Accounting Standards In June of 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities". This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Because the Company does not currently utilize derivatives or engage in significant hedging activities, management does not anticipate that implementation of this statement will have a material effect on the Company's financial statements. Quantitative and Qualitative Disclosures About Market Risks The Company has no material exposure to market risk sensitive investments. Page 21
22 VORNADO REALTY TRUST PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In January 1997, two individual investors in Mendik Real Estate Limited Partnership ("RELP"), the publicly held limited partnership that indirectly owns a 60% interest in the Two Park Avenue Property, filed a purported class action against NY Real Estate Services 1, Inc. ("NY Real Estate"), Mendik RELP Corp., B&B Park Avenue, L.P. (an indirect subsidiary of the Company which acquired the remaining 40% interest in Two Park Avenue) and Bernard H. Mendik in the Supreme Court of the State of New York, County of New York, on behalf of all persons holding limited partnership interests in RELP. The complaint alleges that, for reasons which include purported conflicts of interest, the defendants breached their fiduciary duty to the limited partners, that the then proposed transfer of the 40% interest in Two Park Avenue would result in a burden on the operation and management of Two Park Avenue and that the transfer of the 40% interest violates RELP's right of first refusal to purchase the interest being transferred and fails to provide limited partners in RELP with a comparable transfer opportunity. Shortly after the filing of the complaint, another limited partner represented by the same attorneys filed an essentially identical complaint in the same court. Both complaints seek unspecified damages, an accounting and a judgment requiring either the liquidation of RELP and the appointment of a receiver or an auction of Two Park Avenue. In August 1997, a fourth limited partner, represented by separate counsel, commenced another purported class action in the same court by serving a complaint essentially identical to the complaints in the two previously commenced actions. These lawsuits have since been consolidated. On June 2, 1998, the parties entered into a Stipulation and Agreement of Compromise, Settlement and Release (the "Settlement"). By Order dated July 9, 1998, the Court granted preliminary approval of the Settlement and certified a class pursuant to CPLR 902, for settlement purposes. The Settlement provides, among other things: (i) for Vornado to purchase the Partnership's interest in Two Park Avenue for approximately $34.6 million, which will be paid in cash, or at Vornado's election, in any combination of cash or shares of Vornado stock (which will be freely tradable pursuant to a Section 3(a)(10) exemption under the Securities Act of 1933), plus the assumption of $39 million in existing debt; and (ii) for Vornado Realty to purchase the Partnership's interest in 550-600 Mamaroneck Avenue, Harrison, New York and 330 West 34th Street, New York, NY for an aggregate price of $30 million in cash. On October 14, 1998, the Supreme Court of New York for New York County approved the proposed settlement. On November 6, 1998, the Court's judgment became final. It is expected that the transaction will close within the next 30 days. Page 22
23 VORNADO REALTY TRUST ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits: The following exhibits are filed with this Quarterly Report on Form 10-Q. 10.7 Employment Agreement between Vornado Realty Trust and Joseph Macnow, dated January 1, 1998. 10.8 Employment Agreement between Vornado Realty Trust and Richard Rowan, dated January 1, 1998. 27 Financial Data Schedule. (b) Reports on Form 8-K During the quarter ended September 30, 1998, Vornado Realty Trust filed the reports on Form 8-K described below: <TABLE> <CAPTION> Date of Report (Date of Earliest Event Reported) Item Reported Date Filed --------------- ------------- ---------- <S> <C> <C> April 26,1998 Financial Statements and pro forma July 15, 1998 in connection with the acquisition of additional interest in 570 Lexington Avenue, the acquisition of 40 Fulton Street and 770 Broadway and the pending acquisition of 888 Seventh Avenue June 2, 1998 Proposed settlement agreement to August 12, 1998 purchase the properties of the Mendik Real Estate Limited Partnership with the financial statements and pro forma in connection therewith January 29, 1998 Proposed spin-off of Vornado Operating September 28, 1998 Company </TABLE> Page 23
24 VORNADO REALTY TRUST SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. VORNADO REALTY TRUST -------------------- (Registrant) Date: November 6, 1998 /s/ Irwin Goldberg ------------------------------------- IRWIN GOLDBERG Vice President - Chief Financial Officer and Chief Accounting Officer Page 24
25 VORNADO REALTY TRUST EXHIBIT INDEX EXHIBIT NO. 10.7 Employment Agreement between Vornado Realty Trust and Joseph Macnow, dated January 1, 1998. 10.8 Employment Agreement between Vornado Realty Trust and Richard Rowan, dated January 1, 1998. 27 Financial Data Schedule.