UNITED STATESSECURITIES AND EXCHANGE COMMISSION Washington, DC 20549
FORM 10-Q
Commission File Number: 001-11954
VORNADO REALTY TRUST (Exact name of registrant as specified in its charter)
(212) 894-7000 (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. Yes ý No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ý No o
As of July 30, 2004 125,938,568 of the registrant's common shares of beneficial interest are outstanding.
INDEX
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
VORNADO REALTY TRUST CONSOLIDATED BALANCE SHEETS
See notes to consolidated financial statements.
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VORNADO REALTY TRUST CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
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VORNADO REALTY TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
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VORNADO REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. Organization
Vornado Realty Trust ("Vornado") is a fully-integrated real estate investment trust. Vornado conducts its business through Vornado Realty L.P., a Delaware limited partnership (the "Operating Partnership"). Vornado is the sole general partner of, and owned approximately 86.6% of the common limited partnership interest in, the Operating Partnership at June 30, 2004. All references to the "Company" and "Vornado" refer to Vornado Realty Trust and its consolidated subsidiaries, including the Operating Partnership.
2. Basis of Presentation
The accompanying consolidated financial statements 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 accounting principles generally accepted in the United States of America have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2003, as filed with the Securities and Exchange Commission. The results of operations for the three and six months ended June 30, 2004, are not necessarily indicative of the operating results for the full year.
The accompanying consolidated financial statements include the accounts of Vornado and its majority-owned subsidiary, Vornado Realty L.P., as well as certain partially-owned entities in which the Company owns (i) more than 50% unless a partner has shared board and management representation and authority and substantive participation rights on all significant business decisions or (ii) 50% or less when the Company is considered the primary beneficiary and the entity qualifies as a variable interest entity under Financial Accounting Standards Board ("FASB") Interpretation No. 46 (Revised)—Consolidation of Variable Interest Entities ("FIN 46R"), which became effective on March 31, 2004. All significant intercompany amounts have been eliminated. Equity interests in partially-owned corporate entities are accounted for under the equity method of accounting when the Company's ownership interest is more than 20% but less than 50%. When partially-owned investments are in partnership form, the 20% threshold for equity method accounting may be reduced. Investments accounted for under the equity method are recorded initially at cost and subsequently adjusted for the Company's share of the net income or loss and cash contributions and distributions to or from these entities. For all other investments, the Company uses the cost method.
Management has made estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Certain prior year balances have been reclassified in order to conform to current year presentation.
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3. Recently Issued Accounting Standards
FASB Interpretation No. 46 (Revised)—Consolidation of Variable Interest Entities ("FIN 46R")
In January 2003, the FASB issued FIN 46, as amended in December 2003 by FIN 46R, which deferred the effective date until the first interim or annual reporting period ending after March 15, 2004. FIN 46R requires the consolidation of an entity by an enterprise known as a "primary beneficiary," (i) if that enterprise has a variable interest that will absorb a majority of the entity's expected losses, if they occur, receive a majority of the entity's expected residual returns, if they occur, or both and (ii) if the entity is a variable interest entity ("VIE"), as defined. An entity qualifies as a VIE if (i) the total equity investment at risk in the entity is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties or (ii) the equity investors do not have the characteristics of a controlling financial interest in the entity. The initial determination of whether an entity is a VIE shall be made as of the date at which an enterprise becomes involved with the entity and re-evaluated as of the date of triggering events, as defined. The Company has evaluated each partially-owned entity to determine whether any qualify as a VIE, and if so, whether the Company is the primary beneficiary, as defined. The Company has determined that its investment in Newkirk Master Limited Partnership ("Newkirk MLP"), in which it owns a 22.3% equity interest (see Note 5—Investments and Advances to Partially-Owned Entities), qualifies as a VIE. However, the Company has also determined that it is not the primary beneficiary and accordingly, consolidation is not required. The Company's maximum exposure to loss as a result of its involvement in Newkirk MLP is limited to its equity investment of approximately $150,468,000, as of June 30, 2004. In addition, the Company has variable interests in certain other entities which are primarily financing arrangements. The Company has evaluated these entities in accordance with FIN 46R and has determined that they are not VIEs. Based on the Company's evaluations, the adoption of FIN 46R on March 31, 2004 did not have a material effect on its consolidated financial statements.
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4. Acquisitions, Dispositions and Financings
Acquisitions
On February 3, 2004, the Company acquired the Forest Plaza Shopping Center for approximately $32,500,000, of which $14,000,000 was paid in cash and $18,500,000 was debt assumed. The purchase was funded as part of a Section 1031 tax-free "like-kind" exchange with the remaining portion of the proceeds from the sale of the Company's Two Park Avenue property. Forest Plaza is a 165,000 square foot shopping center located in Staten Island, New York, anchored by a Waldbaum's supermarket. The operations of Forest Plaza are consolidated into the accounts of the Company from the date of acquisition.
On March 19, 2004, the Company acquired a 62,000 square foot freestanding retail building located at 25 W. 14th Street in Manhattan for $40,000,000 in cash. The operations of 25 W. 14th Street are consolidated into the accounts of the Company from the date of acquisition.
On July 1, 2004, the Company acquired the Marriott hotel located in its Crystal City office complex from a limited partnership in which Robert H. Smith and Robert P. Kogod, trustees of the Company, together with family members own approximately 67 percent. The purchase price was $21,500,000 paid in cash. The hotel contains 343 rooms and is leased to an affiliate of Marriott International, Inc. until July 31, 2015, with one 10-year extension option. The land under the hotel was acquired in 1999. The operations of the hotel will be consolidated into the accounts of the Company from the date of acquisition.
On July 29, 2004, the Company acquired a real estate portfolio containing 25 supermarkets for $65,000,000. These properties, all of which are all located in Southern California and contain an aggregate of approximately 766,000 square feet, were purchased from the Newkirk MLP, in which the Company currently owns a 22.3% interest. The supermarkets are net leased to Stater Brothers for an initial term expiring in 2008, with six 5-year extension options. Stater Brothers is a Southern California regional grocery chain that operates 158 supermarkets and has been in business since 1936. The operations of this portfolio will be consolidated into the accounts of the Company from the date of acquisition. The Company's share of any gain recognized by Newkirk MLP on this transaction will be reflected as an adjustment to the Company's basis in its investment in Newkirk MLP and will not be recorded as income.
On July 28, 2004, the Company agreed to make a $159,000,000 convertible preferred investment in GMH Communities L.P. ("GMH"), a partnership focused on the student and military housing sectors run by an experienced operating management team led by Gary M. Holloway. The Company has funded $72,000,000 of the investment and is expected to fund the balance by the end of the year. The Company can convert up to $100,000,000 of its investment into up to 34% of GMH's common equity.
The acquisitions of 25 West 14th Street, the Crystal City Marriott and the Stater Brothers real estate portfolio were or will be funded as part of a Section 1031 tax-free "like-kind" exchange with a portion of the proceeds from the sale of the Company's Palisades Residential Complex (see Dispositions below).
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Dispositions
On January 9, 2003, the Company sold its Baltimore, Maryland shopping center for $4,752,000, which resulted in a net gain on sale after closing costs of $2,644,000.
On June 29, 2004, the Company sold its Palisades Residential Complex for $222,500,000, which resulted in a gain on sale after closing costs of $65,905,000. All or a portion of the proceeds from the sale will be reinvested pursuant to Section 1031 tax-free "like kind" exchanges, including certain of the acquisitions described above. On February 27, 2004, the Company had acquired the remaining 25% interest in the Palisades venture it did not previously own for approximately $17,000,000.
The Company recognized gains of $776,000 in the three months ended March 31, 2004 and gains of $94,000 and $282,000 in the three and six months ended June 30, 2003 from the sale of certain partially-owned properties.
The three and six months ended June 30, 2003 includes the Company's $1,388,000 share of loss on settlement of guarantees with affiliates of Primestone Investment Partners.
Financings
On January 6, 2004, the Company redeemed all of its 8.375% Series D-2 Cumulative Redeemable Preferred Units at a redemption price equal to $50.00 per unit for an aggregate of $27,500,000 plus accrued distributions. The redemption amount exceeded the carrying amount by $700,000, representing the original issuance costs. Upon redemption, these issuance costs were recorded as a reduction to earnings in arriving at net income applicable to common shares, in accordance with the July 2003 EITF clarification of Topic D-42.
On March 17, 2004, the Company redeemed all of its Series B Preferred Shares at a redemption price equal to $25.00 per share for an aggregate of $85,000,000 plus accrued dividends. The redemption amount exceeded the carrying amount by $3,195,000, representing the original issuance costs. Upon redemption, these issuance costs were recorded as a reduction to earnings in arriving at net income applicable to common shares, in accordance with the July 2003 EITF clarification of Topic D-42.
On May 27, 2004, the Company sold $35,000,000 of 7.2% Series D-11 Cumulative Redeemable Preferred Units to an institutional investor in a private placement. These perpetual preferred units may be called without penalty at the Company's option commencing in May 2009.
For details of the Company's financing activities see Note 8—Notes and Mortgages Payable.
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5. Investments and Advances to Partially-Owned Entities
The Company's investments in partially-owned entities and income recognized from such investments are as follows:
Investments:
Equity in Income (loss):
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Below is a summary of the debt of partially-owned entities as of June 30, 2004 and December 31, 2003, none of which is guaranteed by the Company.
Based on the Company's ownership interest in the partially-owned entities above, the Company's share of the debt of these partially-owned entities was $1,097,913,000 and $930,567,000 as of June 30, 2004 and December 31, 2003, respectively.
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Temperature Controlled Logistics
Based on the joint venture's policy of recognizing rental income when earned and collection is assured or cash is received, the Company did not recognize $9,651,000 and $16,116,000 of rent it was due for the three and six months ended June 30, 2004 and $7,726,000 and $11,103,000 of rent it was due for the three and six months ended June 30, 2003, which together with previously deferred rent is $65,552,000.
On February 5, 2004, AmeriCold Realty Trust completed a $254,400,000 mortgage financing for 21 of its owned and 7 of its leased temperature-controlled warehouses. The loan bears interest at LIBOR plus 2.95% (with a LIBOR floor of 1.5% with respect to $54,400,000 of the loan) and requires principal payments of $5,000,000 annually. The loan matures in April 2009 and is pre-payable without penalty after April 9, 2006. The net proceeds were approximately $225,000,000 after providing for usual escrows, closing costs and the repayment of $12,900,000 of existing mortgages on two of the warehouses, of which $135,000,000 was distributed to the Company and the remainder was distributed to its partner.
On January 20, and March 29, 2004, a joint venture in which the Company has a 44% interest acquired an aggregate of $10,200,000 of trade receivables from AmeriCold Logistics for $10,000,000 in cash. These receivables have been subsequently collected in full. On July 2, 2004, the joint venture acquired an additional $6,120,000 of trade receivables for $6,000,000 in cash.
Alexander's
The Company owns 33% of the outstanding common stock of Alexander's at June 30, 2004. Alexander's is managed, and its properties are leased and developed, by the Company. In addition, Building Maintenance Services ("BMS"), a wholly-owned subsidiary of the Company, supervises the cleaning, engineering and security at 731 Lexington Avenue for a fee of 6% of Alexander's costs for such services. On May 27, 2004, the Company entered into a further agreement with Alexander's under which the Company provides property management services to Alexander's for an annual fee of $0.50 per square foot of tenant-occupied office and retail space at 731 Lexington Avenue. The agreements covering all of the above expire in March of each year and are automatically renewable, except for the 731 Lexington Avenue development agreement which provides for a term lasting until substantial completion of the development of the property.
As of June 30, 2004, the Company had a receivable from Alexander's of $45,345,000 under the agreements discussed above. In addition, in the three and six months ended June 30, 2004, Alexander's paid $62,000 and $555,000, respectively, to BMS for cleaning and engineering services at Alexander's Lexington Avenue project.
Effective April 1, 2004, based on Alexander's improved liquidity, the Company modified its term loan and line of credit to Alexander's to reduce the spread on the interest rate it charges from 9.48% to 6%. Accordingly, the current interest rate was reduced to 9% from 12.48%.
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On February 13, 2004, Alexander's completed a $400,000,000 mortgage financing on the office space of its Lexington Avenue development project which was placed by German American Capital Corporation, an affiliate of Deutsche Bank. The loan bears interest at 5.33%, matures in February 2014 and beginning in the third year, provides for principal payments based on a 25-year amortization schedule such that over the remaining eight years of the loan, ten years of amortization will be paid. $253,529,000 of the loan proceeds was used to repay the entire amount outstanding under the construction loan with Hypo Real Estate Capital Corporation ("the Construction Loan"). The Construction Loan was modified so that the remaining availability is $237,000,000, which was approximately the amount estimated to complete the Lexington Avenue development project. The interest rate on the Construction Loan is LIBOR plus 2.5% (3.82% at June 30, 2004) and matures in January 2006, with two one-year extensions. The collateral for the Construction Loan is the same except that the office space has been removed from the lien. Further, the Construction Loan permits the release of the retail space for $15,000,000 and requires all proceeds from the sale of the residential condominiums units to be applied to the Construction Loan balance until it is fully repaid. In connection with reducing the principal amount of the Construction Loan, Alexander's wrote-off $3,050,000 of unamortized deferred financing costs in the first quarter of 2004, of which the Company's share was $1,010,000.
Equity in income from Alexander's includes Alexander's stock appreciation rights compensation expense of which the Company's share was $2,171,000 and $12,084,000 for the three and six months ended June 30, 2004, based on a closing Alexander's stock price of $167.74 on June 30, 2004. The three and six months ended June 30, 2003 include the Company's $3,285,000 share of Alexander's stock appreciation rights compensation expense based on a closing Alexander's stock price of $83.49 on June 30, 2003.
6. Notes and Mortgage Loans Receivable
On March 1, 2004, the Company's note receivable of $38,500,000 from Commonwealth Atlantic Properties was repaid.
On May 12, 2004, the Company made an $83,000,000 mezzanine loan secured by ownership interests in a subsidiary of Extended Stay America, Inc., which was recently acquired for approximately $3.1 billion by an affiliate of the Blackstone Group. The loan is part of a $166,000,000 facility, the balance of which was funded by Soros Credit LP, and is subordinate to $2.3 billion of other debt. The loan bears interest at LIBOR plus 5.50% and matures in May 2007, with two one-year extensions. Extended Stay America owns and operates 485 hotels in 42 states.
On June 1, 2004, the Company acquired Verde Group LLC ("Verde") convertible subordinated debentures for $14,350,000 in cash, bringing its total investment in Verde at June 30, 2004 to $16,850,000 (of a $25,000,000 commitment). Verde invests, operates and develops residential communities on the Texas-Mexico border.
On June 1, 2004, the Company invested $5,000,000 in a senior mezzanine loan, and $3,050,000 in senior preferred equity of 3700 Associates, LLC which owns 3700 Las Vegas Boulevard, a development land parcel located in Las Vegas, Nevada. The loan bears interest at 12% and matures on March 31, 2007. The preferred equity yields a 10% per annum cumulative preferred return.
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7. Identified Intangible Assets and Goodwill
The following summarizes the Company's identified intangible assets, intangible liabilities (deferred credit) and goodwill as of June 30, 2004 and December 31, 2003.
Amortization of acquired below market leases net of acquired above market leases (components of rental income) was $3,112,000 and $6,762,000 for the three and six months ended June 30, 2004, and $2,307,000 and $3,752,000 for the three and six months ended June 30, 2003. The estimated annual amortization of acquired below market lease net of acquired above market leases for each of the five succeeding years is as follows:
The estimated amortization of all other identified intangible assets (a component of depreciation and amortization expense) including acquired in-place leases, customer relationships, and third party contracts for each of the five succeeding years is as follows:
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8. Notes and Mortgages Payable
Following is a summary of the Company's debt:
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8. Notes and Mortgages Payable—(Continued)
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9. Fee And Other Income
The following table sets forth the details of fee and other income:
Fee and other income above includes management fee income from Interstate Properties, a related party, of $183,000 and $172,000 in the three months ended June 30, 2004 and 2003 and $396,000 and $348,000 in the six months ended June 30, 2004 and 2003. The above table excludes fee and other income from partially-owned entities which is included in income from partially-owned entities (see Note 5).
10. Discontinued Operations
Assets related to discontinued operations at June 30, 2004, consist primarily of real estate, net of accumulated depreciation and represent the Company's retail properties located in Vineland, New Jersey, and Baltimore (Dundalk), Maryland. At December 31, 2003, the assets related to discontinued operations consist primarily of real estate, net of accumulated depreciation, related to the Palisades and liabilities related to discontinued operations represent the Palisades mortgage payable of $120,000,000.
The combined results of discontinued operations in the following table include the operating results from the assets held for sale above, as well as (i) Palisades Residential Complex, sold on June 29, 2004, (ii) Two Park Avenue office property, sold on October 10, 2003, and (iii) Baltimore and Hagerstown, Maryland retail properties, sold on January 9, 2003 and November 3, 2003.
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11. Income Per Share
The following table provides a reconciliation of both net income and the number of common shares used in the computation of basic income per common share, which utilizes the weighted average number of common shares outstanding without regard to dilutive potential common shares, and diluted income per common share, which includes the weighted average common shares and dilutive share equivalents. Potential dilutive share equivalents include the Company's Series A Convertible Preferred Shares as well as Vornado Realty L.P.'s convertible preferred units.
12. Comprehensive Income
The following table sets forth the Company's comprehensive income:
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13. Commitments and Contingencies
At June 30, 2004, the Company utilized $17,349,000 of availability under its revolving credit facility for letters of credit and guarantees.
Each of the Company's properties has been subjected to varying degrees of environmental assessment at various times. The environmental assessments did not reveal any material environmental contamination. However, there can be no assurance that the identification of new areas of contamination, changes in the extent or known scope of contamination, the discovery of additional sites, or changes in cleanup requirements would not result in significant costs to the Company.
The Company carries comprehensive liability and all risk property insurance ((i) fire, (ii) flood, (iii) extended coverage, (iv) "acts of terrorism" as defined in the Terrorism Risk Insurance Act of 2002 which expires in 2005 and (v) rental loss insurance) with respect to its assets. In April 2004, the Company renewed its all risk policies and increased its coverage for Acts of Terrorism for each of its New York Office, CESCR Office and Merchandise Mart divisions. Below is a summary of the current all risk property insurance and terrorism risk insurance for each of the Company's business segments:
In addition to the coverage above, the Company carries lesser amounts of coverage for terrorist acts not covered by the Terrorism Risk Insurance Act of 2002.
The Company's debt instruments, consisting of mortgage loans secured by its properties (which are generally non-recourse to the Company), its senior unsecured notes due 2007 and 2010 and its revolving credit agreement, contain customary covenants requiring the Company to maintain insurance. Although the Company believes that it has adequate insurance coverage under these agreements, the Company may not be able to obtain an equivalent amount of coverage at reasonable costs in the future. Further, if lenders insist on greater coverage than the Company is able to obtain, it could adversely affect the Company's ability to finance and/or refinance its properties and expand its portfolio.
From time to time, the Company has disposed of substantial amounts of real estate to third parties for which, as to certain properties, it remains contingently liable for rent payments or mortgage indebtedness that cannot be quantified by the Company.
There are various legal actions against the Company in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the outcome of such matters will not have a material effect on the Company's financial condition, results of operations or cash flow.
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14. Stock-Based Compensation
Prior to 2003, the Company accounted for stock-based compensation using the intrinsic value method (i.e. the difference between the price per share at the grant date and the option exercise price). Accordingly, no stock-based compensation was recognized in the Company's consolidated financial statements for plan awards granted prior to 2003. If compensation cost for plan awards granted prior to 2003 had been determined based on fair value at the grant dates, net income and income per share would have been reduced to the pro-forma amounts below:
15. Retirement Plans
The following table sets forth the components of net periodic benefit costs:
Employer Contributions
During the six months ended June 30, 2004, the Company made contributions of $510,000 to the plans. The Company anticipates additional contributions of $480,000 to the plans during the remainder of 2004.
16. Related Party Transactions
On March 11, 2004, the Company loaned $2,000,000 to Melvyn Blum, an executive officer of the Company, pursuant to the revolving credit facility contained in his January 2000 employment agreement. The loan bears interest at 1.57% per annum (the Federal rate) and is due on March 10, 2007.
On July 1, 2004, the Company acquired the Marriott hotel located in its Crystal City office complex from a limited partnership in which Robert H. Smith and Robert P. Kogod, trustees of the Company, together with family members own approximately 67 percent. The purchase price was $21,500,000. In addition, on July 1, 2004, the partnership paid the Company $2,943,000, in accordance with the ground lease under which it leased the land from the Company. The Company had previously recognized this amount as income over the initial term of the ground lease.
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17. Segment Information
Below is a summary of net income and a reconciliation of net income to EBITDA(1) by segment for the three months ended June 30, 2004 and 2003.
EBITDA includes a net gain on sale of real estate of $65,905, which relates to the Other segment.
See footnotes on page 25.
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17. Segment Information—continued
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Below is a summary of net income and a reconciliation of net income to EBITDA(1) by segment for the six months ended June 30, 2004 and 2003.
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EBITDA includes a net gain on sale of real estate of $2,644, which relates to the Retail segment.
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Notes to segment information:
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Shareholders and Board of TrusteesVornado Realty TrustNew York, New York
We have reviewed the accompanying condensed consolidated balance sheet of Vornado Realty Trust as of June 30, 2004, and the related condensed consolidated statements of income for the three-month and six-month periods ended June 30, 2004 and 2003, and cash flows for the six-month periods ended June 30, 2004 and 2003. These interim financial statements are the responsibility of the Company's management.
We conducted our reviews in accordance with standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.
We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Vornado Realty Trust as of December 31, 2003, and the related consolidated statements of income, stockholders' equity, and cash flows for the year then ended (not presented herein); and in our report dated March 2, 2004, we expressed an unqualified opinion on those consolidated financial statements and included an explanatory paragraph relating to the Company's adoption of the provisions of SFAS No. 142 "Goodwill and Other Intangible Assets" and application of the provisions of SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets." In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2003 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
DELOITTE & TOUCHE LLPParsippany, New JerseyAugust 5, 2004
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Item 2. 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, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Our future results, financial condition and business may differ materially from those expressed in these forward-looking statements. You can find many of these statements by looking for words such as "believes," "expects," "anticipates," "intends," "plans," "will," "would," "may" or similar expressions in this quarterly report on Form 10-Q. These forward-looking statements are subject to numerous assumptions, risks and uncertainties. Many of the factors that will determine these items are beyond our ability to control or predict. Factors that may cause actual results to differ materially from those contemplated by the forward-looking statements include, but are not limited to, those set forth in the Company's Annual Report on Form 10-K for the year ended December 31, 2003 under "Forward Looking Statements" and "Item 1. Business—Certain Factors That May Adversely Affect the Company's Business and Operations." For these statements, the Company claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. We expressly disclaim any responsibility to update forward-looking statements, whether as a result of new information, future events or otherwise. Accordingly, investors should use caution in relying on forward-looking statements, which are based on results and trends at the time they are made, to anticipate future results or trends.
Management's Discussion and Analysis of Financial Condition and Results of Operations includes a discussion of the Company's consolidated financial statements for the three and six months ended June 30, 2004. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
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Overview
The Company owns and operates office, retail and showroom properties with large concentrations of office and retail properties in the New York City metropolitan area and in the Washington, DC and Northern Virginia area. In addition, the Company has a 60% interest in a partnership that owns cold storage warehouses nationwide.
The Company's business objective is to maximize shareholder value. The Company measures its success in meeting this objective by the total return to its shareholders. Below is a table comparing the Company's performance to the Morgan Stanley REIT Index ("RMS") for the following periods ending June 30, 2004:
The Company intends to continue to achieve its business objective by pursuing its investment philosophy and executing its operating strategies through:
The Company competes with a large number of real estate property owners and developers. Principal factors of competition are rent charged, attractiveness of location and quality and breadth of services provided. The Company's success depends upon, among other factors, trends of the national and local economies, financial condition and operating results of current and prospective tenants and customers, availability and cost of capital, construction and renovation costs, taxes, governmental regulations, legislation and population trends. The current economic recovery is fostered, in part, by low interest rates, Federal tax cuts, and increases in government spending. To the extent this recovery stalls, the Company may experience lower occupancy rates which may lead to lower initial rental rates, higher leasing costs and a corresponding decrease in net income, funds from operations and cash flow. Alternatively, if the recovery continues, the Company may experience higher occupancy rates leading to higher initial rents and higher interest rates causing an increase in the Company's weighted average cost of capital and a corresponding effect on net income, funds from operations and cash flow.
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Overview (continued)—Leasing Activity
The following table sets forth certain information for the properties the Company owns directly or indirectly, including leasing activity. Tenant improvements and leasing commissions are presented below based on square feet leased during the period and on a per annum basis based on the weighted average term of the leases.
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Square feet leased in the three and six months ended June 30, 2004 does not include 17,000 square feet and 39,000 square feet of retail space included in the NYC office properties which was leased at an initial rent of $108.00 and $131.00 per square foot respectively.
Critical Accounting Policies
A summary of the Company's critical accounting policies is included in the Company's annual report on Form 10-K for the year ended December 31, 2003 in Management's Discussion and Analysis of Financial Condition and Results of Operations and in the footnotes to the consolidated financial statements, Note 2—Summary of Significant Accounting Policies also included in the Company's annual report on Form 10-K. There have been no significant changes to those policies during 2004.
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Reconciliation of Net Income and EBITDA
See footnotes on page 33.
31
See following page for footnotes.
32
Notes:
33
Results of Operations
Revenues
The Company's revenues, which consist of property rentals, expense reimbursements, hotel revenues, trade show revenues, amortization of acquired below market leases net of above market leases pursuant to SFAS No. 141, and fee and other income, were $400,054,000 for the quarter ended June 30, 2004, compared to $371,135,000 in the prior year's quarter, an increase of $28,919,000. Below are the details of the increase by segment:
See "Overview—Leasing Activity" on page 29 for further details of leasing activity and corresponding changes in occupancy.
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Expenses
The Company's expenses were $232,703,000 for the quarter ended June 30, 2004, compared to $220,064,000 in the prior year's quarter, an increase of $12,639,000. Below are the details of the increase by segment:
Income Applicable to Alexander's
Equity in net income applicable to Alexander's (loan interest income, management, leasing, development and commitment fees, and equity in income) was $5,778,000 in the quarter ended June 30, 2004, compared to income of $4,348,000 in the prior year's quarter, an increase of $1,430,000. This increase resulted primarily from income from the commencement of leases with Bloomberg on November 15, 2003, and other tenants during May and June 2004 at Alexander's 731 Lexington Avenue property.
35
Income from Partially-Owned Entities
Below is the detail of income from partially-owned entities by investment as well as the increase (decrease) in income from partially-owned entities for the quarters ended June 30, 2004 and 2003:
36
Interest and Other Investment Income
Interest and other investment income (interest income on mortgage loans receivable, other interest income and dividend income) was $9,609,000 for the quarter ended June 30, 2004, compared to $3,628,000 in the prior year's quarter, an increase of $5,981,000. This increase resulted primarily from interest income of $6,051,000 recognized on the $225,000,000 GM Building mezzanine loans made by the Company in the fourth quarter of 2003.
Interest and Debt Expense
Interest and debt expense was $57,121,000 for the three months ended June 30, 2004, compared to $57,637,000 in the prior year's quarter, a decrease of $516,000. This decrease resulted primarily from an increase in capitalized interest on development projects, partially offset by higher average outstanding debt balances.
Net Loss on Disposition of Wholly-owned and Partially-owned Assets other than Real Estate
Net loss on disposition of wholly-owned and partially-owned assets other than depreciable real estate of $1,294,000 for the three months ended June 30, 2003 includes a $1,388,000 loss on settlement of guarantees of the Primestone loans, partially offset by a $94,000 net gain on sale of condominiums.
Minority Interest
Minority interest expense was $42,081,000 for the three months ended June 30, 2004, compared to $37,113,000 for the prior year's quarter, an increase of $4,968,000. This increase resulted primarily from higher income, partially offset by lower distributions to preferred unit holders as a result of the Company's redemption of the Series D-2 preferred units in January 2004, the Series D-1 preferred units in November 2003, and the Series C-1 preferred units during the fourth quarter of 2003.
Discontinued Operations
37
Three Months Ended June 30, 2004 and June 30, 2003
Below are the details of the changes by segment in EBITDA.
38
See footnotes on page 41.
39
40
41
The Company's revenues, which consist of property rentals, expense reimbursements, hotel revenues, trade show revenues, amortization of acquired below market leases net of above market leases pursuant to SFAS No. 141, and fee and other income, were $793,104,000 for the six months ended June 30, 2004, compared to $736,112,000 in the prior year's six months, an increase of $56,992,000. Below are the details of the increase by segment:
42
The Company's expenses were $474,534,000 for the six months ended June 30, 2004, compared to $444,313,000 in the prior year's six months, an increase of $30,221,000. Below are the details of the increase by segment:
Equity in net income applicable to Alexander's (loan interest income, management, leasing, development and commitment fees, and equity in income) was $3,250,000 in the six months ended June 30, 2004, compared to income of $11,602,000 in the prior year's six months, a decrease of $8,352,000. This decrease resulted from an increase in the Company's share of Alexander's stock appreciation rights compensation expense of $8,799,000 and the Company's $1,010,000 share of Alexander's loss on early extinguishment of debt in the six months ended June 30, 2004, partially offset by income from the commencement of leases with Bloomberg on November 15, 2003 and other tenants in May and June 2004 at Alexander's 731 Lexington Avenue property.
43
Below is the detail of income from partially-owned entities by investment as well as the increase (decrease) in income from partially-owned entities for the six months ended June 30, 2004 and 2003:
44
Interest and other investment income (interest income on mortgage loans receivable, other interest income and dividend income) was $18,854,000 for the six months ended June 30, 2004, compared to $13,424,000 in the prior year's six months, an increase of $5,430,000. This increase resulted primarily from interest income of $12,102,000 recognized on the $225,000,000 GM Building mezzanine loans made by the Company in the fourth quarter of 2003, partially offset by $6,284,000 of interest received in the first quarter of 2003 in connection with the Dearborn Center loan receivable repayment (of which $5,655,000 was contingent interest income).
Interest and debt expense was $115,826,000 for the six months ended June 30, 2004, compared to $114,537,000 in the prior year's six months, an increase of $1,289,000. This increase resulted primarily from higher average outstanding debt during the six months ended June 30, 2004, partially offset by an increase in capitalized interest on development projects in 2004.
Net Gain (Loss) on Disposition of Wholly-owned and Partially-owned Assets other than Real Estate
Net gain (loss) on disposition of wholly-owned and partially-owned assets other than depreciable real estate for the six months ended June 30, 2004 reflects the Company's $776,000 share of gains on disposition of certain partially-owned development assets. Net Loss on disposition of wholly-owned and partially-owned assets other than depreciable real estate for the six months ended June 30, 2003 includes (i) a $1,388,000 loss on settlement of the guarantees of the Primestone Loans, partially offset by gains on the sale of condominiums of $282,000.
Minority interest expense was $73,589,000 for the six months ended June 30, 2004, compared to $75,770,000 for the prior year's six months, a decrease of $2,181,000. This decrease resulted primarily from lower distributions to preferred unit holders as a result of the Company's redemption of the Series D-2 preferred units in January 2004, the Series D-1 preferred units in November 2003, and the Series C-1 preferred units during the fourth quarter of 2003, partially offset by a higher allocation of income in 2004 to minority interest as a result of higher income.
45
Six Months Ended June 30, 2004 and June 30, 2003
46
Liquidity And Capital Resources
Six Months Ended June 30, 2004
Cash flows provided by operating activities of $286,895,000 was primarily comprised of (i) income of $244,440,000, (ii) adjustments for non-cash items of $72,653,000, partially offset by (iii) the net change in operating assets and liabilities of $30,198,000. The adjustments for non-cash items are primarily comprised of (i) depreciation and amortization of $118,527,000, (ii) minority interest of $73,589,000 and (iii) write-off of preferred share and unit issuance costs of $3,895,000, partially offset by, (iv) gain on sale of real estate of $65,905,000, (v) the effect of straight-lining of rental income of $22,849,000, (vi) equity in net income of partially-owned entities and Alexander's of $27,066,000 and (vii) amortization of acquired below market leases net of above market leases of $6,762,000.
Net cash provided by investing activities of $23,731,000 was primarily comprised of (i) proceeds from the sale of real estate, of $220,447,000, (ii) distributions from partially-owned entities of $163,755,000, (iii) repayments on notes and mortgages receivable of $38,500,000, partially offset by (iv) investments in notes and mortgage loans receivable of $105,552,000, (v) capital expenditures of $55,421,000, (vi) development and redevelopment expenditures of $54,542,000, (vii) investments in partially-owned entities of $5,396,000 and (viii) acquisitions of real estate of $69,957,000.
Net cash used in financing activities of $405,733,000 was primarily comprised of (i) dividends paid on common shares of $192,952,000, (ii) repayments of borrowings of $313,955,000, (iii) redemption of preferred shares and units of $112,467,000, (iv) dividends paid on preferred shares of $10,184,000, and (v) distributions to minority partners of $69,979,000, partially offset by (vi) proceeds from borrowings of $225,597,000, (vii) proceeds of $34,125,000 from the issuance of perpetual preferred shares and units and (viii) proceeds of $34,082,000 from the exercise by employees of share options.
Capital expenditures are categorized as follows:
47
Below are the details of capital expenditures, leasing commissions and development and redevelopment expenditures and a reconciliation of total expenditures on an accrual basis to the cash expended in the six months ended June 30, 2004. See page 29 for per square foot data.
See the following page for details of development and redevelopment projects.
48
Six Months Ended June 30, 2003
Cash flows provided by operating activities of $264,488,000 was primarily comprised of (i) net income of $179,499,000 and (ii) adjustments for non-cash items of $101,832,000, partially offset by (iii) the net change in operating assets and liabilities of $16,843,000. The adjustments for non-cash items are primarily comprised of (i) depreciation and amortization of $106,504,000 and (ii) minority interest of $75,770,000, partially offset by (iii) the effect of straight-lining of rental income of $20,517,000, (iv) equity in net income of partially-owned entities and Alexander's of $54,635,000 and (v) amortization of acquired below market leases net of above market leases of $3,752,000.
Net cash provided by investing activities of $2,473,000 was primarily comprised of (i) distributions from partially-owned entities of $33,439,000, (ii) proceeds from the sale of real estate of $4,752,000, (iii) repayments on notes and mortgages receivable of $26,092,000, (iv) a decrease in restricted cash of $123,665,000 (used primarily to repay the cross-collateralized mortgages on 770 Broadway and 595 Madison Avenue), partially offset by (v) capital expenditures of $42,990,000, (vi) development and redevelopment expenditures of $32,237,000 (see table below), (vii) investments in partially-owned entities of $36,011,000, (viii) the acquisition of Building Maintenance Service Company of $13,000,000, (ix) the acquisition of Kaempfer company of $31,237,000 and (x) the acquisition of 20 Broad Street of $30,000,000.
Net cash used in financing activities of $301,962,000 was primarily comprised of (i) dividends paid on common shares of $150,175,000, (ii) repayments of borrowings of $293,006,000, (iii) dividends paid on preferred shares of $10,851,000, and (iv) distributions to minority partners of $89,547,000, partially offset by (v) proceeds from borrowings of $217,000,000 and (vi) proceeds of $24,617,000 from the exercise by employees of stock options.
Below are the details of capital expenditures, leasing commissions and development and redevelopment expenditures and a reconciliation of total expenditures on an accrual basis to the cash expended in the six months ended June 30, 2003.
49
SUPPLEMENTAL INFORMATION
Three Months Ended June 30, 2004 vs. Three Months Ended March 31, 2004
Below are the details of the changes by segment in EBITDA for the three months ended June 30, 2004 from the three months ended March 31, 2004.
Below is a reconciliation of net income and EBITDA for the three months ended March 31,2004.
50
FUNDS FROM OPERATIONS ("FFO") FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2004 AND 2003
Three months ended June 30, 2004 and 2003.
FFO was $159,674,000, or $1.22 per diluted share for three months ended June 30, 2004, compared to $133,410,000, or $1.14 per diluted share for prior year's quarter, an increase of $26,264,000 or $.08 per share. Included in FFO are certain items that affect comparability as detailed below. Before these items, second quarter 2004 FFO is 5.1% higher than second quarter 2003 on a per share basis.
Six months ended June 30, 2004 and 2003.
FFO was $288,649,000, or $2.24 per diluted share for six months ended June 30, 2004, compared to $263,515,000, or $2.29 per diluted share for prior year's six months, an increase of $25,134,000, or $.05 per share lower on a per share basis. Included in FFO are certain items that affect comparability as detailed below. Before these items, six months ended June 30, 2004 FFO is 1.3% higher than six months ended June 30, 2003 on a per share basis.
51
The following table reconciles FFO and net income:
FFO does not represent cash generated from operating activities in accordance with accounting principles generally accepted in the United States of America 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. FFO should not be considered as an alternative to net income as an indicator of the Company's operating performance. Management considers FFO a relevant supplemental measure of operating performance because it provides a basis for comparison among REITs. FFO is computed in accordance with the National Association of Real Estate Investment Trust's ("NAREIT") definition, which may not be comparable to FFO reported by other REITs that do not compute FFO in accordance with NAREIT's definition.
52
On February 3, 2004, the Company acquired the Forest Plaza Shopping Center for approximately $32,500,000, of which $14,000,000 was paid in cash and $18,500,000 was debt assumed. The purchase was funded as part of a Section 1031 tax-free "like-kind" exchange with the remaining portion of the proceeds from the sale of the Company's Two Park Avenue property. Forest Plaza is a 165,000 square foot shopping center located in Staten Island, New York, anchored by a Waldbaum's supermarket.
On March 19, 2004, the Company acquired a 62,000 square foot free-standing retail building located at 25 W. 14th Street in Manhattan for $40,000,000 in cash.
On July 1, 2004, the Company acquired the Marriott hotel located in its Crystal City office complex from a limited partnership in which Robert H. Smith and Robert P. Kogod, trustees of the Company, together with family members own approximately 67 percent. The purchase price was $21,500,000 paid in cash. The hotel contains 343 rooms and is leased to an affiliate of Marriott International, Inc. until July 31, 2015, with one 10-year extension option. The land under the hotel was acquired in 1999.
On July 29, 2004, the Company acquired a real estate portfolio containing 25 supermarkets for $65,000,000. These properties, all of which are all located in Southern California and contain an aggregate of approximately 766,000 square feet, were purchased from the Newkirk MLP, in which the Company currently owns a 22.3% interest. The supermarkets are net leased to Stater Brothers for an initial term expiring in 2008, with six 5-year extension options. Stater Brothers is a southern California regional grocery chain that operates 158 supermarkets and has been in business since 1936. The Company's share of any gain recognized by Newkirk MLP on this transaction will be reflected as an adjustment to the Company's basis in its investment in Newkirk MLP and will not be recorded as income.
The Company recognized gains of $776,000 in the three months ended March 31, 2004 and gains of $94,000 and $282,000 in the three and six months ended June 30, 2003 from the sale of certain partially owned properties.
53
For details of the Company's financing activities see "Note 8—Notes and Mortgages Payable" in the notes to the Company's consolidated financial statements.
The Company anticipates that cash from continuing operations will be adequate to fund business operations and the payment of dividends and distributions on an on-going basis for more than the next twelve months; however, capital outlays for significant acquisitions would require funding from borrowings or equity offerings.
54
Item 3. Quantitative and Qualitative Disclosures About Market Risks
The Company has exposure to fluctuations in market interest rates. Market interest rates are highly sensitive to many factors that are beyond the control of the Company. Various financial instruments exist which would allow management to mitigate the impact of interest rate fluctuations on the Company's cash flows and earnings.
As of June 30, 2004, the Company has an interest rate swap as described in footnote 1 to the table below. In addition, during 2003 the Company purchased two interest rate caps with notional amounts aggregating $295,000,000, and simultaneously sold two interest rate caps with the same aggregate notional amount on substantially the same terms as the caps purchased. As the significant terms of these arrangements are the same, the effects of a revaluation of these instruments are expected to substantially offset one another. Management may engage in additional hedging strategies in the future, depending on management's analysis of the interest rate environment and the costs and risks of such strategies.
The Company's exposure to a change in interest rates on its wholly-owned and partially-owned debt (all of which arises out of non-trading activity) is as follows:
The fair value of the Company's debt, based on discounted cash flows at the current rate at which similar loans would be made to borrowers with similar credit ratings for the remaining term of such debt, exceeds the aggregate carrying amount by approximately $118,018,000 at June 30, 2004.
Item 4. Controls and Procedures
Disclosure Controls and Procedures: The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures (as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based on such evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company's disclosure controls and procedures are effective.
Internal Control Over Financial Reporting: There have not been any changes in the Company's internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities and Exchange Act of 1934, as amended) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
55
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is from time to time involved in legal actions arising in the ordinary course of its business. In the opinion of management, after consultation with legal counsel, the outcome of such matters, including the matters referred to below, is not expected to have a material adverse effect on the Company's financial position, results of operations or cash flows.
The following updates the discussion set forth under "Item 3. Legal Proceedings" in the Company's Annual Report on Form 10-K for the year ended December 31, 2003.
Stop & Shop
As previously disclosed, on January 8, 2003, Stop & Shop filed a complaint with the United States District Court for the District of New Jersey ("USDC-NJ") claiming the Company has no right to reallocate and therefore continue to collect the $5,000,000 of annual rent from Stop & Shop pursuant to the Master Agreement and Guaranty, because of the expiration of the East Brunswick, Jersey City, Middletown, Union and Woodbridge leases to which the $5,000,000 of additional rent was previously allocated. Stop & Shop asserted that a prior order of the Bankruptcy Court for the Southern District of New York dated February 6, 2001, as modified on appeal to the District Court for the Southern District of New York on February 13, 2001, terminated the Company's right to reallocate. On March 3, 2003, after the Company moved to dismiss for lack of jurisdiction, Stop & Shop voluntarily withdrew its complaint.
On March 26, 2003, Stop & Shop filed a new complaint in New York Supreme Court, asserting substantially the same claims as in its USDC-NJ complaint. On April 9, 2003, the Company moved the New York Supreme Court action to the United States District Court for the Southern District of New York. On June 30, 2003, the District Court ordered that the case be placed in suspension and ordered the parties to proceed in a related case that the Company commenced in the United States Bankruptcy Court for the Southern District of New York. On July 24, 2003, the Bankruptcy Court referred the related case to mediation. The mediation concluded in June 2004 without resolving the dispute. On June 9, 2004, after reconvening the hearing on the Company's motion to interpret, the Bankruptcy Court entered an order abstaining from hearing the Company's motion. On June 17, 2004, the Company filed a notice of appeal from the Bankruptcy Court's order. The appeal will be heard in the District Court. Briefing of the appeal is in progress.
The Company believes that the additional rent provision of the guaranty expires at the earliest in 2012 and will vigorously oppose Stop & Shop's complaint.
Item 2. Changes in Securities and Use of Proceeds and Issuer Purchases of Equity Securities
Not applicable.
56
Item 4. Submission of Matters to a Vote of Security Holders
On May 27, 2004, the Company held its annual meeting of shareholders. The shareholders voted, in person or by proxy, for (i) the election of three nominees to serve on the Board of Trustees for terms described below and until their respective successors are duly elected and qualified and (ii) the ratification of the selection of independent auditors with regard to the current fiscal year. The results of the voting are shown below:
Election of Trustees:
Item 6. Exhibits and Reports on Form 8-K
57
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.
58
EXHIBIT INDEX
59
60
61
62
63
64
65
66
67
68
69
70
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