United States
Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Quarterly Period Ended June 30, 2003
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 001-13301
----------------------
PRIME RETAIL, INC.
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(Exact name of registrant as specified in its charter)
Maryland 38-2559212
- ---------------------------------- --------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
100 East Pratt Street
Nineteenth Floor
Baltimore, Maryland 21202
- ------------------------------------------ ------------------
(Address of principal executive offices) (Zip Code)
(410) 234-0782
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(Registrant's telephone number, including area code)
NOT APPLICABLE
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(Former name, former address, or 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 periods that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- ------
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.
As of August 12, 2003, the issuer had outstanding 43,577,916 shares of Common
Stock, $.01 par value per share.
Page - (2)
Prime Retail, Inc.
Form 10-Q
INDEX
PART I: FINANCIAL INFORMATION PAGE
----
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets as of June 30, 2003 and
December 31, 2002................................................ 1
Consolidated Statements of Operations for the three
and six months ended June 30, 2003 and 2002...................... 2
Consolidated Statements of Cash Flows for the three
and six months ended June 30, 2003 and 2002...................... 3
Notes to the Consolidated Financial Statements..................... 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.......................... 22
Item 3. Quantitative and Qualitative Disclosures of Market Risk........ 48
Item 4. Controls and Procedures........................................ 49
PART II: OTHER INFORMATION
Item 1. Legal Proceedings.............................................. 50
Item 3. Defaults Upon Senior Securities................................ 50
Item 4. Submission of Matters to a Vote of Security Holders............ 51
Item 6. Exhibits and Reports on Form 8-K............................... 51
Signatures.............................................................. 53
Page - (3)
Introduction
Unless the context otherwise requires, all references to "we," "us," "our"
or the "company" contained in this Quarterly Report on Form 10-Q mean Prime
Retail, Inc. and those entities owned or controlled by Prime Retail, Inc.,
including Prime Retail, L.P. (the "Operating Partnership").
Historical results and percentage relationships set forth in this Quarterly
Report on Form 10-Q are not necessarily indicative of future operations.
Forward-Looking Statements
Statements contained in this Quarterly Report on Form 10-Q, including the
section entitled "Management's Discussion and Analysis of Financial Condition
and Results of Operations" contain certain forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995, which reflect
management's current views with respect to future events and financial
performance. In addition, we may make forward-looking statements in future
filings with the Securities and Exchange Commission and in written material,
press releases and oral statements issued by us or on our behalf.
Forward-looking statements include statements regarding the intent, belief, or
current expectations of us or our officers, including statements preceded by,
followed by, or including forward-looking terminology such as "may," "will,"
"should," believe," "expect," "anticipate," "estimate," "continue," "predict,"
or similar expressions with respect to various matters.
These statements are subject to potential risks and uncertainties and,
therefore, actual results may differ materially. Such forward-looking statements
are subject to certain risks and uncertainties, including, but not limited to,
the risk associated with our high level of leverage and our ability to refinance
such indebtedness as it becomes due; the risk that we or one or more of our
subsidiaries are not able to satisfy scheduled debt service obligations or will
not remain in compliance with existing loan covenants; the risk of material
adverse affects of future events, including tenant bankruptcies, abandonments
and the non-payment by tenants of contractual rents and additional rents, on our
financial performance; the risk related to the retail industry in which our
outlet centers compete, including the potential adverse impact of external
factors, such as inflation, consumer confidence, unemployment rates and consumer
tastes and preferences; the risk associated with our potential asset sales; the
risk of potential increases in market interest rates from current levels; the
risk associated with real estate ownership, such as the potential adverse impact
of changes in local economic climate on the revenues and the value of our
properties; the risk associated with litigation; and the risk associated with
competition from web-based and catalogue retailers.
All forward-looking statements in this report are based on information
available to us on the date of this report. We do not undertake to update any
forward-looking statements that may be made by us or on our behalf in this
report or otherwise.
Page - (4)
PRIME RETAIL, INC.
Unaudited Consolidated Balance Sheets
(Amounts in thousands, except share information)
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June 30, December 31,
2003 2002
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Assets
Investment in rental property:
Land $ 100,246 $ 101,546
Buildings and improvements 735,505 740,024
Furniture and equipment 13,592 13,292
--------- ---------
849,343 854,862
Accumulated depreciation (227,456) (213,604)
--------- ---------
621,887 641,258
Cash and cash equivalents 6,008 6,908
Restricted cash 108,102 107,037
Accounts receivable, net 878 3,049
Deferred charges, net 2,857 3,766
Investment in unconsolidated joint ventures 50,947 49,889
Other assets 8,263 6,181
--------- ---------
Total assets $ 798,942 $ 818,088
========= =========
Liabilities and Shareholders' Equity
Bonds payable $ 22,406 $ 22,495
Notes payable, including $41,570 in default in 2003 507,263 511,443
Defeased notes payable 74,280 74,764
Accrued interest 4,816 3,984
Real estate taxes payable 5,158 3,484
Accounts payable and other liabilities 36,953 43,059
--------- ---------
Total liabilities 650,876 659,229
Minority interests 1,487 1,487
Shareholders' equity:
Shares of preferred stock, 24,315,000 shares authorized:
10.5% Series A Senior Cumulative Preferred Stock,
$0.01 par value (liquidation preference of $79,386),
2,300,000 shares issued and outstanding 23 23
8.5% Series B Cumulative Participating Convertible
Preferred Stock, $0.01 par value (liquidation preference
of $256,004), 7,828,125 shares issued and outstanding 78 78
Shares of common stock, 150,000,000 shares authorized:
Common stock, $0.01 par value, 43,577,916 shares
issued and outstanding 436 436
Additional paid-in capital 709,373 709,373
Distributions in excess of earnings (563,331) (552,538)
--------- ---------
Total shareholders' equity 146,579 157,372
--------- ---------
Total liabilities and shareholders' equity $ 798,942 $ 818,088
========= =========
====================================================================================================================================
See accompanying notes to consolidated financial statements.
Page - (5)
PRIME RETAIL, INC.
Unaudited Consolidated Statements of Operations
(Amounts in thousands, except per share information)
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Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------- -----------------------------
2003 2002 2003 2002
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Revenues
Base rents $ 18,535 $ 22,867 $ 37,528 $ 47,176
Percentage rents 473 436 1,450 1,756
Tenant reimbursements 11,816 12,723 22,774 25,557
Interest and other 3,705 2,273 7,717 5,133
-------- -------- -------- --------
Total revenues 34,529 38,299 69,469 79,622
Expenses
Property operating 9,751 10,957 19,706 21,168
Real estate taxes 3,086 3,627 6,070 7,293
Depreciation and amortization 7,281 9,214 14,561 19,422
Corporate general and administrative 3,528 2,877 7,994 6,296
Interest 11,944 16,996 23,800 34,725
Other charges 853 4,266 1,541 6,738
Provision for asset impairment 6,590 - 6,590 -
-------- -------- -------- --------
Total expenses 43,033 47,937 80,262 95,642
-------- -------- -------- --------
Loss before gain (loss) on sale of real estate (8,504) (9,638) (10,793) (16,020)
Gain (loss) on sale of real estate - (10,991) - 5,802
-------- -------- -------- --------
Loss from continuing operations (8,504) (20,629) (10,793) (10,218)
Discontinued operations, including gain (loss) of
$2,121 and $(7,502) on dispositions in 2002
periods, respectively - (9,557) - (18,287)
-------- -------- -------- --------
Net loss (8,504) (30,186) (10,793) (28,505)
Allocations to preferred shareholders (5,668) (5,668) (11,336) (11,336)
-------- -------- -------- --------
Net loss applicable to common shares $(14,172) $(35,854) $(22,129) $(39,841)
======== ======== ======== ========
Basic and diluted earnings per common share:
Loss from continuing operations $ (0.33) $ (0.60) $ (0.51) $ (0.49)
Discontinued operations - (0.22) - (0.42)
-------- -------- -------- --------
Net loss $ (0.33) $ (0.82) $ (0.51) $ (0.91)
======== ======== ======== ========
Weighted-average common shares
outstanding - basic and diluted 43,578 43,578 43,578 43,578
======== ======== ======== ========
====================================================================================================================================
See accompanying notes to consolidated financial statements.
Page - (6)
PRIME RETAIL, INC.
Unaudited Consolidated Statements of Cash Flows
(Amounts in thousands)
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Six Months Ended June 30, 2003 2002
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Operating Activities
Loss from continuing operations $ (10,793) $ (10,218)
Adjustments to reconcile loss from continuing
operations to net cash provided by operating activities:
Gain on sale of real estate - (5,802)
Provision for asset impairment 6,590 -
Equity in earnings of unconsolidated joint ventures (1,752) 114
Depreciation and amortization 14,561 19,422
Amortization of deferred financing costs 847 2,983
Amortization of debt premiums (1,045) (998)
Bad debt expense 997 3,013
Discontinued operations - 5,608
Changes in operating assets and liabilities:
Decrease in accounts receivable 1,174 957
Decrease (increase) in restricted cash (1,065) 57
Increase in other assets (1,916) (541)
Decrease in accounts payable and other liabilities (6,106) (5,316)
Increase in real estate taxes payable 1,674 1,101
Increase (decrease) in accrued interest 832 (444)
--------- ---------
Net cash provided by operating activities 3,998 9,936
--------- ---------
Investing Activities
Additions to investment in rental property (2,969) (2,649)
Distributions from unconsolidated joint ventures 694 -
Proceeds from sales of operating properties and land 1,085 22,320
--------- ---------
Net cash provided by (used in) investing activities (1,190) 19,671
--------- ---------
Financing Activities
Principal repayments on notes payable (3,708) (31,943)
--------- ---------
Cash used in financing activities (3,708) (31,943)
--------- ---------
Decrease in cash and cash equivalents (900) (2,336)
Cash and cash equivalents at beginning of period 6,908 7,537
--------- ---------
Cash and cash equivalents at end of period $ 6,008 $ 5,201
========= =========
====================================================================================================================================
See accompanying notes to consolidated financial statements.
Page - (7)
PRIME RETAIL, INC.
Unaudited Consolidated Statements of Cash Flows (continued)
(Amounts in thousands)
Supplemental Disclosure of Non-cash Investing and Financing Activities
The following assets and liabilities were disposed in connection with the
disposition of properties during the period indicated:
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Six Months Ended June 30, 2002
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Book value of net assets disposed $ 116,026
Notes payable paid (36,836)
Notes payable assumed by buyer (46,862)
Notes payable transferred to lender (15,621)
Investment in unconsolidated joint ventures (2,975)
Gain on sale of real estate, net 8,588
---------
Cash received, net $ 22,320
=========
================================================================================
See accompanying notes to consolidated financial statements.
Page - (8)
Prime Retail, Inc.
Notes to Unaudited Consolidated Financial Statements
(Amounts in thousands, except share and unit information)
Note 1 - Interim Financial Presentation
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States ("GAAP") for interim financial information and the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all
of the information and notes required by GAAP for complete financial statements.
In the opinion of management, all adjustments, consisting only of recurring
accruals, considered necessary for a fair presentation have been included.
Operating results for such interim periods are not necessarily indicative of the
results that may be expected for a full fiscal year. For further information,
refer to the consolidated financial statements and notes thereto included in
Prime Retail, Inc.'s (the "Company") Annual Report on Form 10-K for the year
ended December 31, 2002.
Unless the context otherwise requires, all references to "we," "us," "our"
or the Company herein mean Prime Retail, Inc. and those entities owned or
controlled by Prime Retail, Inc., including Prime Retail, L.P. (the "Operating
Partnership").
The consolidated financial statements include the accounts of the Company,
the Operating Partnership and the partnerships in which it has a controlling
financial interest. Profits and losses are allocated in accordance with the
terms of the agreement of limited partnership of the Operating Partnership. The
preparation of financial statements in conformity with GAAP requires us to make
estimates and assumptions that affect the (i) reported amounts of assets and
liabilities, (ii) disclosure of contingent liabilities at the date of the
financial statements and (iii) reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
Investments in unconsolidated joint ventures are accounted for under the
equity method of accounting. Income (loss) applicable to minority interests and
common shares as presented in the consolidated statements of operations is
allocated based on income (loss) before minority interests after income
allocated to preferred shareholders.
Significant inter-company accounts and transactions have been eliminated in
consolidation. Certain prior period financial information has been reclassified
to conform to the current period presentation, which did not have an impact on
our results of operations or financial position.
Note 2 - Recent Accounting Pronouncements
In December 2002, the FASB issued Interpretation ("FIN") No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN No. 45 elaborates on the
disclosures to be made by a guarantor in interim and annual financial statements
about the obligations under certain guarantees. FIN No. 45 also clarifies that a
guarantor is required to recognize, at the inception of the guarantee, an
initial liability for the fair value of the obligation undertaken in issuing the
guarantee. The disclosure requirements of FIN No. 45 are effective for financial
statements of interim or annual periods ending after December 15, 2002. We
adopted the disclosure provisions of FIN No. 45 effective December 31, 2002. The
initial recognition and initial measurement provisions of FIN No. 45 are
applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. We did not issue or modify any guarantees during the six
months ended June 30, 2003. See "Guarantees and Guarantees of Indebtedness of
Others" contained in Note 4 - "Debt" for additional information.
Page - (9)
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable
Interest Entities." FIN No. 46 clarifies the application of existing accounting
pronouncements to certain entities in which equity investors do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. The provisions of FIN No. 46
were immediately effective for all variable interests in variable interest
entities created after January 31, 2003, and we will need to apply the
provisions of FIN No. 46 to any existing variable interests in variable interest
entities by no later than July 1, 2003. We did not create any variable interest
entities during the six months ended June 30, 2003 and we do not believe that
FIN No. 46 will have a significant impact on our financial statements for our
existing investments in unconsolidated joint ventures.
In May 2003, the FASB issued FAS No 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." FAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). Many of these instruments
were previously classified as equity. FAS No. 150 is generally applicable to
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. It is to be implemented by reporting the cumulative effect of a change
in accounting principle for financial instruments created before the issuance of
FAS No. 150 and still existing at the beginning of the interim period of
adoption. We will adopt FAS No. 150 in the third quarter of 2003 and do not
believe the implementation of FAS No. 150 will have a significant impact on our
financial statements.
Note 3 - Property Dispositions
We disposed of 17 properties through various transactions (including sale,
joint venture arrangements, foreclosure and transfer of ownership to the
respective lender) during 2002. In accordance with FAS No. 144, the operating
results of these properties are reflected in either our results from continuing
operations or discontinued operations through the respective dates of
disposition as discussed below.
2002 Dispositions - Continuing Operations
The operating results for seven properties that were sold to joint venture
partnerships during 2002 and in which still have a significant continuing
involvement are not classified as discontinued operations in the Consolidated
Statements of Operations. Such properties and/or their operating results through
the dates of their respective disposition are collectively referred to as the
"2002 Joint Venture Properties". The 2002 Joint Venture Properties consist of
our sales of (i) Prime Outlets at Hagerstown (the "Hagerstown Center") and six
outlet centers (collectively, the "Bridge Properties"). Additionally, the
operating results of Phases II and III of the Bellport Outlet Center (the
"Bellport Outlet Center"), which was previously owned through a joint venture
partnership and was sold during 2002, are not classified as discontinued
operations. We accounted for our ownership interest in the Bellport Outlet
Center through the date of disposition in accordance with the equity method of
accounting.
Page - (10)
The following table summarizes these dispositions.
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Gain/(Loss) Provision
Date of Sales Reduction Net on Sale/ for Asset
Continuing Operations: Disposition Property Type GLA Price of Debt Proceeds Disposition Impairment
- ------------------------------------------------------------------------------------------------------------------------------------
Hagerstown Center January 2002 1 Outlet Center 487,000 $ 80,500 $ (57,914) $ 12,113 $ 16,793 $ -
Bellport Outlet Center -
Phases II/III April 2002 1 Outlet Center 197,000 6,500 - 522 (703) -
Bridge Properties July 2002 6 Outlet Centers 1,304,000 118,650 (111,009) - (10,288) -
--------- --------- ---------- -------- -------- -----
Total 1,988,000 $ 205,650 $ (168,923) $ 12,635 $ 5,802 $ -
========= ========= ========== ======== ======== =====
====================================================================================================================================
2002 Dispositions - Discontinued Operations
We have classified the operating results, including gains and losses
related to disposition, for certain properties either disposed of or classified
as assets held for sale during 2002 as discontinued operations in the
Consolidated Statements of Operations for the 2002 period.
The following table summarizes these dispositions.
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Gain/(Loss) Provision
Discontinued Date of Sales Reduction Net of Sale/ for Asset
Operations: Disposition Property Type GLA Price of Debt Proceeds Disposition Impairment
- ------------------------------------------------------------------------------------------------------------------------------------
Conroe Center January 2002 1 Outlet Center 282,000 $ - $ (15,621) $ (554.00) $ - $ -
Edinburgh Center April 2002 1 Outlet Center 305,000 27,000 (16,317) 9,551 (9,623) -
Western Plaza June 2002 1 Community Center 205,000 9,500 (9,467) 688 2,121 -
Jeffersonville II August 2002 1 Outlet Center 314,000 - (17,938) - 17,121 -
Vero Beach September 2002 1 Outlet Center 326,000 - (25,126) - - 12,200
Melrose Place October 2002 1 Community Center 27,000 2,500 (1,935) 555 990 -
Puerto Rico Center December 2002 1 Outlet Center 176,000 36,500 (19,202) 13,958 - 15,557
Colorado Properties December 2002 2 Outlet Centers 808,000 96,000 (74,849) 12,628 15,543 -
--------- --------- --------- --------- -------- --------
Total 2,443,000 $ 171,500 $(180,455) $ 36,826 $ 26,152 $ 27,757
========= ========= ========= ========= ======== ========
====================================================================================================================================
The following summary presents the operating results of those properties
disposed of during 2002 whose results are classified as discontinued operations
in the Consolidated Statements of Operations:
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Three Months Ended Six Months Ended
June 30, June 30,
2002 2002
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Revenues
Base rents $ 5,070 $ 11,167
Percentage rents 159 374
Tenant reimbursements 2,657 5,474
Interest and other 294 492
-------- ---------
Total revenues 8,180 17,507
Expenses
Property operating 1,903 4,097
Real estate taxes 1,001 1,974
Depreciation and amortization 1,733 3,748
Interest 2,878 5,810
Other charges 143 463
Provision for asset impairment 12,200 12,200
-------- ---------
Total expenses 19,858 28,292
-------- ---------
Loss before gain (loss) on (11,678) (10,785)
sale of real estate
Gain (loss) on sale of real estate 2,121 (7,502)
-------- ---------
Discontinued operations $ (9,557) $ (18,287)
======== =========
================================================================================
Page - (11)
2003 Dispositions
Latham Center
On March 31, 2003, PFP Venture LLC (the "PFP Venture"), a joint venture
partnership in which we indirectly have an ownership interest of approximately
25.2% as of June 30, 2003, completed the sale of Prime Outlets at Latham (the
"Latham Center"), an outlet center located in Latham, New York. The Latham
Center, which was one of the Bridge Properties, was sold to 400 Old Loudon Road
Realty, LLC for cash consideration of $2,200. The net cash proceeds from the
sale were $184, after (i) repayment of $1,870 of existing mortgage indebtedness
on the Bridge Properties and (ii) prorations, closing costs and fees. In
connection with the sale of the Latham Center, the PFP Venture recorded a gain
on the sale of real estate of $117 during the first quarter of 2003. We account
for our investment in the Bridge Properties in accordance with the equity method
of accounting.
Woodbury Center
During August of 2002, certain of our subsidiaries suspended regularly
scheduled monthly debt service payments on two non-recourse mortgage loans which
were cross-collateralized by Prime Outlets at Vero Beach (the "Vero Beach
Center"), located in Vero Beach, Florida, and Prime Outlets at Woodbury (the
"Woodbury Center"), located in Woodbury, Minnesota (collectively, the "John
Hancock Properties"). These non-recourse mortgage loans were held by John
Hancock Life Insurance Company ("John Hancock").
During the second quarter of 2002, we incurred a provision for asset
impairment of $12,200 to adjust our carrying value of the Vero Beach Center to
its estimated fair value in accordance with the provisions of FAS No. 144.
Effective September 9, 2002, John Hancock foreclosed on the Vero Beach Center
and its related assets and liabilities, including our carrying value of the
indebtedness of $25,126 (principal outstanding of $24,497 and unamortized debt
premium of $629), were transferred to John Hancock. Foreclosure on the Vero
Beach Center did not have a material impact on our results of operations or
financial condition.
Effective July 24, 2003, John Hancock foreclosed on the Woodbury Center and
its related assets and liabilities were transferred to John Hancock. Foreclosure
on the Woodbury Center is not expected to have a material impact on our results
of operations or financial condition.
The carrying value of the Woodbury Center was $15,488 as of June 30, 2003.
Such value was exceeded by our carrying value of the associated indebtedness of
$16,651 (principal outstanding of $16,331 and unamortized debt premium of $320)
as of June 30, 2003. As a result of the foreclosure of the Woodbury Center, we
expect to record a non-recurring gain for the difference between the carrying
value of the Woodbury Center and its related net assets, including the carrying
value of the indebtedness, during the third quarter of 2003.
Page - (12)
Note 4 - Debt
We have fixed rate tax-exempt revenue bonds collateralized by properties
located in Chattanooga, Tennessee (the "Chattanooga Bonds") which contain (i)
certain covenants, including a minimum debt-service coverage ratio financial
covenant (the "Financial Covenant") and (ii) cross-default provisions with
respect to certain of our other credit agreements. Based on the operations of
the collateral properties, we were not in compliance with the Financial Covenant
for the quarters ended June 30, September 30 and December 31, 2002. In the event
of non-compliance with the Financial Covenant or default, the holders of the
Chattanooga Bonds (the "Bondholders") had the ability to put such obligations to
us at a price equal to par plus accrued interest. On January 31, 2003, we
entered into an agreement (the "Forbearance Agreement") with the Bondholders.
The Forbearance Agreement provides amendments to the underlying loan and other
agreements that enable us to be in compliance with various financial covenants,
including the Financial Covenant. So long as we continue to comply with the
provisions of the Forbearance Agreement and are not otherwise in default of the
underlying loan and other documents through December 31, 2004, the revised
financial covenants will govern. Additionally, certain quarterly tested
financial covenants and other covenants become effective June 30, 2004. Pursuant
to the terms of the Forbearance Agreement, we were required to fund $1,000 into
an escrow account to be used for conversion of certain of the retail space in
the collateral properties to office space and agreed that an event of default
with respect to the other debt obligations related to the property would also
constitute a default under the Chattanooga Bonds. We funded this required escrow
in February 2003. The outstanding balance of the Chattanooga Bonds was $17,920
as of June 30, 2003.
Notes payable included unamortized debt premiums of $6,910 in the aggregate
at June 30, 2003. Our debt premiums are being amortized over the terms of the
related debt instruments in accordance with the effective interest method.
Amortization of debt premiums (included in interest expense in the Consolidated
Statements of Operations) was $526 and $1,045 for the three and six months ended
June 30, 2003, respectively, and $502 and $998 for the three and six months
ended June 30, 2002, respectively.
Defaults on Certain Non-recourse Mortgage Indebtedness
During August 2002, certain of our subsidiaries suspended regularly
scheduled monthly debt service payments on non-recourse mortgage loans which
were cross-collateralized by the Vero Beach Center and the Woodbury Center.
These non-recourse mortgage loans were held by John Hancock. Effective September
9, 2002, John Hancock foreclosed on the Vero Beach Center. Additionally,
effective July 24, 2003, John Hancock foreclosed on the Woodbury Center. See
Note 3 - "Property Dispositions" for additional information.
Page - (13)
In December 2002, we notified the servicer of certain non-recourse mortgage
loans (cross-collateralized by Prime Outlets at Bend, Prime Outlets at Post
Falls and Prime Outlets at Sedona) totaling $24,919 as of June 30, 2003 that the
net cash flow from the properties securing the loans was insufficient to fully
pay the required monthly debt service. At that time, certain of our subsidiaries
suspended the regularly scheduled monthly debt service payments. Subsequent to
our notification to the servicer, we have been remitting on a monthly basis all
available cash flow from the properties, after a reserve for monthly operating
expenses, as partial payment of the debt service. The failure to pay the full
amount due constitutes a default under the loan agreements which allows the
lender to accelerate the loan and to exercise various remedies contained in the
loan agreements, including application of escrow balances to delinquent payments
and, ultimately, foreclosure on the properties which collateralize the loans.
The lender has notified us that it has accelerated the loans and intends to
commence foreclosure action on the collateral properties. However, any
foreclosure action on these properties is not expected to have a material impact
on our results of operations or financial condition because we are currently
only remitting available cash flow. These non-recourse mortgage loans require
the monthly funding of escrow accounts for the payment of real estate taxes,
insurance and capital improvements. Such escrow accounts totaled $105 as of June
30, 2003, which is included in restricted cash in the Consolidated Balance
Sheet. The aggregate carrying value of these properties was $21,558 as of June
30, 2003. Such amount is exceeded by the aggregate outstanding balance of the
non-recourse mortgage loans of $24,919 as of June 30, 2003. Upon foreclosure of
the collateral properties, we will record a non-recurring gain for the
difference between the carrying value of the properties and their related net
asset, including the outstanding loan balances.
Defeased Notes Payable
On December 6, 2002, we completed the sale of two outlet centers (together,
the "Colorado Properties"), which were part of the 15 properties contained in
the collateral pool securing a first mortgage and expansion loan (the "Mega Deal
Loan"), which had a then outstanding balance of $338,940. In connection with the
release of the Colorado Properties from the collateral pool, we were required to
partially defease the Mega Deal Loan. Therefore, the Mega Deal Loan was
bifurcated into (i) a defeased portion in the amount of $74,849 (the "Defeased
Notes Payable") and (ii) an undefeased portion in the amount of $264,091, which
is still referred to as the Mega Deal Loan. Both the Defeased Notes Payable and
the Mega Deal Loan (i) bear interest at a fixed-rate of 7.782%, (ii) require
monthly payments of principal and interest pursuant to a 30-year amortization
schedule and (iii) have an anticipated maturity through an optional prepayment
date on November 11, 2003. The Mega Deal Loan is now secured by the remaining 13
properties contained in the collateral pool. We used $79,257 of the gross
proceeds from the sale of the Colorado Properties to purchase US Treasury
Securities, which were placed into a trustee escrow (the "Trustee Escrow"). The
Trustee Escrow is used to make the scheduled monthly debt service payments,
including the payment of the then outstanding principal amount, together with
all accrued and unpaid interest on November 11, 2003, under the Defeased Notes
Payable. As of June 30, 2003, the outstanding balance of the Defeased Notes
Payable was $74,280 and the balance of the Trustee Escrow was $76,671 (included
in restricted cash in the Consolidated Balance Sheet). Furthermore, in
connection with the partial defeasance of the Mega Deal Loan we amended the Mega
Deal Loan so that (i) we are required to fund 10 monthly payments of $500 into a
lender escrow to be used as additional cash collateral and (ii) release prices
for the remaining 13 properties in the collateral pool were amended to provide
for a more orderly refinancing of the Mega Deal Loan.
Page - (14)
Debt Service Obligations
The scheduled principal maturities of our debt, excluding (i) unamortized
debt premiums of $6,910 and (ii) $41,250 of aggregate non-recourse mortgage
indebtedness in default (see "Defaults on Certain Non-recourse Mortgage
Indebtedness" above), and related average contractual interest rates by year of
maturity as of June 30, 2003 are as follows:
- ------------------------------------------------------------------------------------------------------------------------------------
Bonds Payable
(including sinking Defeased
fund payments) Notes Payable Notes Payable Total Debt
---------------------------- ----------------------- ----------------------- -------------------------
Average Average Average Average
Interest Principal Interest Principal Interest Principal Interest Principal
Years Ended December 31, Rates Maturities Rates Maturities Rates Maturities Rates Maturities
- ------------------------------------------------------------------------------------------------------------------------------------
2003 6.61% $ 591 7.79% $ 263,524 7.78% $ 74,280 7.78% $ 338,395
2004 6.34% 726 7.97% 4,571 7.75% 5,297
2005 6.34% 773 8.58% 11,574 8.44% 12,347
2006 6.34% 820 8.83% 120,437 8.81% 121,257
2007 6.34% 878 7.60% 1,002 7.02% 1,880
Thereafter 6.52% 18,618 7.59% 57,995 7.33% 76,613
---- -------- ---- --------- ---- -------- ---- ---------
6.50% $ 22,406 8.06% $ 459,103 7.78% $ 74,280 7.96% $ 555,789
==== ======== ==== ========= ==== ======== ==== =========
====================================================================================================================================
Such indebtedness in the amount of $481,509 had a weighted-average maturity
of 2.3 years and bore contractual interest at a weighted-average rate of 7.98%
per annum. At June 30, 2003, all of such indebtedness bore interest at fixed
rates. Our remaining scheduled principal payments during 2003 for such
indebtedness aggregated $338,395. In addition to regularly scheduled principal
payments, the remaining 2003 scheduled principal payments also reflect
anticipated balloon payments of (i) $260,681 for the Mega Deal Loan and (ii)
$73,882 due for the Defeased Notes Payable. Both the Mega Deal Loan and the
Defeased Notes Payable have an anticipated maturity through an optional
prepayment date on November 11, 2003. All debt service due under the Defeased
Notes Payable, including the balloon payment due at anticipated maturity, will
be made from the Trustee Escrow. See "Going Concern" for additional information.
Additionally, we are obligated to refinance a first mortgage loan (the
"Hagerstown First Mortgage Loan") in the amount of $46,862 on Prime Outlets at
Hagerstown (the "Hagerstown Center") on or before June 1, 2004. The Hagerstown
First Mortgage Loan was assumed by an unconsolidated joint venture partnership
(the "Prime/Estein Venture"), in which we have an indirect 30% ownership
interest, in January 2002. See "Prime/Estein Venture Guarantees" contained in
"Guarantees and Guarantees of Indebtedness of Others" for additional information
Defaults on Certain Non-recourse Mortgage Indebtedness of Unconsolidated
Partnerships
Two mortgage loans related to projects in which we, through subsidiaries,
indirectly own joint venture interests have matured and are in default. The
mortgage loans, at the time of default, were (i) a $10,389 first mortgage loan
on Phase I of the Bellport Outlet Center, held by Union Labor Life Insurance
Company ("Union Labor"); and (ii) a $13,338 first mortgage loan on Oxnard
Factory Outlet, an outlet center located in Oxnard, California, held by Fru-Con.
An affiliate of ours has a 50% ownership interest in the partnership, which owns
Phase I of the Bellport Outlet Center. Fru-Con and us are each a 50% partner in
the partnership that owns the Oxnard Factory Outlet.
Union Labor filed for foreclosure on Phase I of the Bellport Outlet Center
and a receiver was appointed March 27, 2001 by the court involved in the
foreclosure action. Effective May 1, 2001, a manager hired by the receiver began
managing and leasing Phase I of the Bellport Outlet Center. A judgment for
foreclosure was entered on January 25, 2003 in the amount of $12,711. The
foreclosure occurred on March 17, 2003 with Union Labor acquiring the property
for $5,100. Approximately $1,100 of post-judgment interest and fees was
subsequently awarded to Union Labor. We continue to negotiate the terms of a
transfer of our ownership interest in Oxnard Factory Outlet to Fru-Con. We do
not manage or lease Oxnard Factory Outlet.
Page - (15)
We believe neither of these mortgage loans is recourse to us. It is
possible, however, that either or both of the respective lenders will, after
completing its foreclosure action, file a lawsuit seeking to collect from us the
difference between the value of the mortgaged property and the amount due under
the loan. If such an action is brought, the outcome, and our ultimate liability,
if any, cannot be predicted at this time.
In addition, we are currently not receiving, directly or indirectly, any
cash flow from Oxnard Factory Outlet and were not receiving any cash flow from
Phase I of the Bellport Outlet Center prior to the loss of control of such
project. We account for our interests in (i) Phases I of the Bellport Outlet
Center and (ii) the Oxnard Factory Outlet in accordance with the equity method
of accounting. As of June 30, 2003, we had no carrying value for our investment
in these properties.
Guarantees and Guarantees of Indebtedness of Others
HGP Guarantees
On July 15, 2002, Horizon Group Properties, Inc. and its affiliates ("HGP")
announced they had refinanced a secured credit facility (the "HGP Secured Credit
Facility") through a series of new loans aggregating $32,500. Prior to the
refinancing, we were a guarantor under the HGP Secured Credit Facility in the
amount of $10,000. In connection with the refinancing, our guarantee was reduced
to a maximum of $4,000 as security for a $3,000 mortgage loan and a $4,000
mortgage loan (collectively, the "HGP Monroe Mortgage Loan") secured by HGP's
outlet shopping center located in Monroe, Michigan. The HGP Monroe Mortgage Loan
has a 3-year term, bears interest at the prime lending rate plus 2.50% (with a
minimum of 9.90%) and requires monthly interest-only payments. The HGP Monroe
Mortgage Loan may be prepaid without penalty after two years. Our guarantee with
respect to the HGP Monroe Mortgage Loan will be extinguished if the principal
amount of such obligation is reduced to $5,000 or less through repayments.
Additionally, we are a guarantor with respect to certain mortgage
indebtedness (the "HGP Office Building Mortgage") in the amount of $2,129 on
HGP's corporate office building and related equipment located in Norton Shores,
Michigan. The HGP Office Building Mortgage matures in August 31, 2003, bears
interest at LIBOR plus 5.50%, and requires monthly debt service payments.
We have not recorded any liability related to these guarantees and no
claims have been made under our guarantees with respect to the HGP Monroe
Mortgage Loan or the HGP Office Building Mortgage. HGP is a publicly traded
company that was formed in connection with our merger with Horizon Group, Inc.
("Horizon") in June 1998.
Prime/Estein Venture Guarantees
We indirectly have a 30% ownership interest in the Prime/Estein Venture, an
unconsolidated joint venture partnership which owns three outlet centers
(collectively, the "Prime/Estein Properties"). The Prime/Estein Properties
consist of Prime Outlets at Birch Run (the "Birch Run Center"), Prime Outlets at
Hagerstown (the "Hagerstown Center") and Prime Outlets at Williamsburg (the
"Williamsburg Center"). Pursuant to Prime/Estein Venture-related documents to
which affiliates of ours are parties, we are obligated to provide to, or obtain
for, the Prime/Estein Venture fixed-rate financing at an annual rate of 7.75%
(the "Interest Rate Subsidy Agreement") for the Prime/Estein Venture Properties.
Page - (16)
In August 2001, we, through affiliates, completed a refinancing of $63,000
of first mortgage loans secured by the Birch Run Center. The refinanced loan
(the "Birch Run First Mortgage") (i) has a term of 10-years, (ii) bears interest
at an effective rate of 8.12% and (iii) requires monthly payments of principal
and interest pursuant to a 25-year amortization schedule. Pursuant to the
Interest Rate Subsidy Agreement, we are required to pay to the Prime/Estein
Venture the difference between the cost of the financing at an assumed rate of
7.75% and the actual cost of such financing at the annual rate of 8.12% (the
"Interest Rate Subsidy Obligation"). The net present value of the Interest Rate
Subsidy Obligation (included in accounts payable and other liabilities in the
Consolidated Balance Sheet) was $1,382 as of June 30, 2003.
In October 2001, we, through affiliates, completed the refinancing of a
$32,500 first mortgage loan secured by the Williamsburg Center. The new first
mortgage loan (the "Williamsburg First Mortgage") (i) has a term of 10-years,
(ii) bears interest at a fixed-rate of 7.69% and (iii) requires monthly payments
of principal and interest pursuant to a 25-year amortization schedule. Pursuant
to the Interest Rate Subsidy Agreement, the Prime/Estein Venture is required to
pay to us the difference between the cost of the financing at an assumed rate of
7.75% and the actual cost of such financing at the annual rate of 7.69%.
On January 11, 2002, we sold the Hagerstown Center to the Prime/Estein
Venture. In connection with the sale, the Prime/Estein Venture assumed the
Hagerstown First Mortgage in the amount of $46,862; however, our guarantee of
such indebtedness remains in place. Additionally, we are obligated to refinance
the Hagerstown First Mortgage on behalf of the Prime/Estein Venture on or before
June 1, 2004, the date on which such indebtedness matures. Additionally, the
Prime/Estein Venture's cost of the Hagerstown First Mortgage and any refinancing
of it are fixed at an annual rate of 7.75% for a period of 10 years. If the
actual cost of such indebtedness should exceed 7.75% at any time during the
10-year period, we will be obligated to pay the difference to the Prime/Estein
Venture. If the actual cost of such indebtedness is less than 7.75% at any time
during the 10-year period, however, the Prime/Estein Venture will be obligated
to pay the difference to us. The actual cost of the Hagerstown First Mortgage is
30-day LIBOR plus 1.50%, or 2.62% as of June 30, 2003. Because the Hagerstown
First Mortgage bears interest at a variable rate, we are exposed to the impact
of interest rate changes. We have not recorded any liability related to our
guarantee of the Hagerstown First Mortgage; however, in connection with the sale
of the Hagerstown Center, we established a reserve for estimated refinancing
costs in the amount of $937, which is included in accounts payable and other
liabilities in the Consolidated Balance Sheet as of June 30, 2003. See Note 3 -
"Property Dispositions" for additional information.
Second Horizon First Mortgage Loan
In April 1998, Horizon consummated an agreement with Castle & Cooke
Properties, Inc. ("CCP") which released Horizon from future obligations under a
long-term lease of the Dole Cannery outlet center in Honolulu, Hawaii. In
connection with an amendment of the Second Horizon Group Limited Partnership
("Second Horizon") agreement (the "Amended Partnership Agreement"), Horizon
transferred to an affiliate of CCP (the "CCP Affiliate") substantially all of
Horizon's economic interest, but not legal title, in an outlet center (the "Lake
Elsinore Center") in Lake Elsinore, California. The Lake Elsinore Center is one
of five properties owned by Second Horizon which jointly and severally secure a
non-recourse, first mortgage loan (the "Second Horizon Mortgage Loan"). As a
result of our merger with Horizon in June 1998, we own the economic interests of
the other four properties (the "Prime Properties") and legal title to all five
entities. The outstanding balance of the Second Horizon Mortgage Loan as of June
30, 2003 was $94,586, of which $66,486 was allocated to the Prime Properties and
is included in notes payable in our Consolidated Balance Sheet as of June 30,
2003. The remaining $28,100 outstanding as of June 30, 2003 was allocated to the
Lake Elsinore Center.
Page - (17)
We, through our affiliates, assumed certain obligations under the Amended
Partnership Agreement with respect to the Second Horizon Mortgage Loan in
connection with our merger with Horizon in June 1998. Specifically, we are
obligated to contribute sufficient capital to Second Horizon (i) for certain
operating expenses associated with the Prime Properties and (ii) to satisfy the
outstanding balances of the allocated loan amounts for the Prime Properties
under the Second Horizon Mortgage Loan (including any associated expenses) to
enable the Second Horizon Mortgage Loan to be repaid in full at its optional
prepayment date of October 11, 2006. CCP Affiliate and its parent company are
similarly obligated with respect to the Lake Elsinore Center. No claims have
been made with respect to these obligations and we have not recorded any
liability related to these obligations as of June 30, 2003.
Mandatory Redemption Obligation
On July 26, 2002, we sold the Bridge Properties to the PFP Venture. In
connection with the sale, we guaranteed FRIT PRT Bridge Acquisition LLC
("FRIT"), a third-party joint venture partner, (i) a 13% return on its initial
$17,236 of invested capital and (ii) the full return of its invested capital
(the "Mandatory Redemption Obligation") by December 31, 2003. As of June 30,
2003, our Mandatory Redemption Obligation with respect to the full return of
FRIT's invested capital was $14,888 (included in accounts payable and other
liabilities in the Consolidated Balance Sheet). See "Going Concern" for
additional information.
Going Concern
Our liquidity depends on cash provided by operations and potential capital
raising activities such as funds obtained through borrowings, particularly
refinancing of existing debt, and cash generated through asset sales. Although
we believe that estimated cash flows from operations and potential capital
raising activities will be sufficient to satisfy our scheduled debt service and
other obligations and sustain our operations for the next year, there can be no
assurance that we will be successful in obtaining the required amount of funds
for these items or that the terms of the potential capital raising activities,
if they should occur, will be as favorable as we have experienced in prior
periods.
During 2003, our Mega Deal Loan is anticipated to mature with an optional
prepayment date on November 11, 2003. The Mega Deal Loan, which is secured by a
13 property collateral pool, had an outstanding principal balance of $262,083 as
of June 30, 2003 and will require a balloon payment of $260,681 at the
anticipated maturity. If the Mega Deal Loan is not satisfied at the optional
prepayment date, its interest rate will increase by 5.0% to 12.782% and all
excess cash flow from the 13 property collateral pool will be retained by the
lender and applied to principal after payment of interest. As discussed below,
certain restrictions have been placed upon us with respect to refinancing the
Mega Deal Loan in the short term. If the Mega Deal Loan is not refinanced, the
loss of cash flow from the 13 property collateral pool would eventually have
severe consequences on our ability to fund our operations.
Based on our discussions with various prospective lenders, we believe a
potential shortfall will likely occur with respect to refinancing the Mega Deal
Loan as we do not currently intend to refinance all of the 13 assets.
Nevertheless, we believe this shortfall can be alleviated through potential
asset sales and/or other capital raising activities, including the placement of
mezzanine level debt and mortgage debt on at least one of the assets we do not
currently plan on refinancing. We caution that our assumptions are based on
current market conditions and, therefore, are subject to various risks and
uncertainties, including changes in economic conditions which may adversely
impact our ability to refinance the Mega Deal Loan at favorable rates or in a
timely and orderly fashion and which may adversely impact our ability to
consummate various asset sales or other capital raising activities.
Page - (18)
On July 8, 2003 an affiliate of The Lightstone Group, LLC ("Lightstone")
and us entered into a merger agreement (the "Merger Agreement"). (See Note 10 -
"Merger Agreement" for additional information.) In connection with the execution
of the Merger Agreement, certain restrictions were placed on us with respect to
the refinancing of the Mega Deal Loan. Specifically, we are restricted from
negotiating or discussing the refinancing of the properties securing the Mega
Deal Loan with any lenders until September 15, 2003, at which time we are only
able to enter into refinancing discussions with certain enumerated lenders.
After November 11, 2003, we may seek refinancing from other lenders. In
addition, we are precluded from closing any loans relating to the Mega Deal Loan
until November 11, 2003. This November 11, 2003 date may be extended until
January 11, 2004, at the election of Lightstone, if Lightstone elects prior to
September 15, 2003 to (i) pay (A) one-half of the additional interest incurred
by us between November 11, 2003 and December 31, 2003, and (B) all of the
additional interest incurred by us between January 1, 2004 and January 11, 2004,
if so extended, in respect of the Mega Deal Loan and (ii) loan us any shortfall
in cash flow that results from the excess cash flow restrictions (all excess
cash flow from the 13 property collateral pool will be retained by the lender
and applied to principal after payment of interest) under the Mega Deal Loan
that become effective on November 11, 2003 and thereafter until the Mega Deal
Loan is paid in full.
In addition to the restrictions with respect to the refinancing of the Mega
Deal Loan discussed above, pursuant to the terms of the Merger Agreement, we
have also agreed to certain conditions pending the closing of the proposed
transaction. These conditions provide for certain restrictions with respect to
our operating and refinancing activities (see Note 10 - "Merger Agreement" for
additional information). These restrictions could adversely affect our liquidity
in addition to our ability to refinance the Mega Deal Loan in a timely and
orderly fashion.
If the Merger Agreement is terminated under certain circumstances, we would
be required to make payments to Lightstone ranging from $3,500 to $6,000 which
could adversely affect our liquidity. See Note 10 - "Merger Agreement" for
additional information.
In connection with the completion of the sale of the Bridge Properties in
July 2002, we guaranteed to FRIT (i) a 13% return on its $17,236 of invested
capital, and (ii) the full return of the Mandatory Redemption Obligation by
December 31, 2003. As of June 30, 2003, the Mandatory Redemption Obligation
(included in accounts payable and other liabilities in the Consolidated Balance
Sheet) was $14,888.
We continue to seek to generate additional liquidity to repay the Mandatory
Redemption Obligation through (i) the sale of FRIT's ownership interest in the
Bridge Properties and/or (ii) the placement of additional indebtedness on the
Bridge Properties. There can be no assurance that we will be able to complete
such capital raising activities by December 31, 2003 or that such capital
raising activities, if they should occur, will generate sufficient proceeds to
repay the Mandatory Redemption Obligation in full. Failure to repay the
Mandatory Redemption Obligation by December 31, 2003 would constitute a default,
which would enable FRIT to exercise its rights with respect to the collateral
pledged as security to the guarantee, including some of our partnership
interests in the 13 property collateral pool under the aforementioned Mega Deal
Loan. Because the Mandatory Redemption Obligation is secured by some of our
partnership interests in the 13 property collateral pool under the Mega Deal
Loan, we may be required to repay the Mandatory Redemption Obligation before, or
in connection with, the refinancing of the Mega Deal Loan. Additionally, any
change in control with respect to us accelerates the Mandatory Redemption
Obligation.
Page - (19)
In connection with the execution of the Merger Agreement, Lightstone has
agreed to provide sufficient financing, if necessary, to repay the Mandatory
Redemption Obligation in full at its maturity. The new financing would be at
substantially similar economic terms and conditions as those currently in place
for the Mandatory Redemption Obligation and would have a one-year term. See Note
10 - "Merger Agreement" for additional information.
As previously discussed, we currently have a Forbearance Agreement in place
with respect to our Chattanooga Bonds in the amount of $17,920. However, based
on our current projections, we believe we will not be compliance with certain
quarterly tested financial covenants when they become effective on June 30, 2004
which would enable the Bondholders to elect to put the Chattanooga Bonds to us
at their par amount plus accrued interest. We continue to explore opportunities
to (i) obtain alternative financing from other financial institutions, (ii) sell
the properties securing the Chattanooga Bonds and (iii) explore other possible
capital transactions in order to generate cash to repay the Chattanooga Bonds.
There can be no assurance that we will be able to complete any such activity
sufficient to repay the amount outstanding under the Chattanooga Bonds in the
event the Bondholders are able and elect to exercise their put rights.
These conditions raise substantial doubt about our ability to continue as a
going concern. The financial statements contained herein do not include any
adjustment to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from the outcome of these uncertainties.
Note 5 - Shareholders' Equity
To qualify as a real estate investment trust ("REIT") for federal income
tax purposes, we are required to pay distributions to our common and preferred
shareholders of at least 90% of our REIT taxable income in addition to
satisfying other requirements. Although we intend to make distributions, if
necessary, to remain qualified as a REIT under the Code, we also intend to
retain such amounts as we consider necessary from time to time for our capital
and liquidity needs.
Our policy remains to pay distributions only to the extent necessary to
maintain our status as a REIT for federal income tax purposes. During 2002, we
were not required to pay any distributions in order to maintain our status as a
REIT and based on our current federal income tax projections, we do not expect
to pay any distributions during 2003. On August 15, 2003 we will be in arrears
on 15 quarters of preferred stock distributions due February 15, 2000 through
August 15, 2003, respectively.
We may not make distributions to our common shareholders or our holders of
common units of limited partnership interests in the Operating Partnership
unless we are current with respect to distributions to our preferred
shareholders. As of June 30, 2003, unpaid dividends for the period beginning on
November 16, 1999 through June 30, 2003 on our Series A Senior Cumulative
Preferred Stock ("Series A Senior Preferred Stock") and Series B Cumulative
Convertible Participating Preferred Stock ("Series B Convertible Preferred
Stock") aggregated $21,886 and $60,301, respectively. The annualized dividends
on our 2,300,000 shares of Series A Senior Preferred Stock and 7,828,125 shares
of Series B Convertible Preferred Stock outstanding as of June 30, 2003 are
$6,037 ($2.625 per share) and $16,635 ($2.125 per share), respectively.
Note 6 - Legal Proceedings
Except as described below, neither we nor any of our properties are
currently subject to any material litigation, nor to our knowledge, is any
material or other litigation threatened against us, other than routine
litigation arising in the ordinary course of business, some of which is expected
to be covered by liability insurance and all of which collectively is not
expected to have an adverse effect on our consolidated financial statements.
Page - (20)
Certain tenants in our and our affiliates' outlet centers have made or may
make allegations concerning overcharging for common area maintenance ("CAM") and
promotion fund charges because of varying clauses in their leases pursuant to
which they claim under various circumstances that they were not required to pay
some or all of the pass-through charges. Such claims if asserted and found
meritorious, could have a material affect on our financial condition.
Determination of whether liability would exist to us would depend on
interpretation of various lease clauses within a tenant's lease and all of the
other leases at each center collectively. To date such issues have been raised
and resolved with Dinnerware Plus Holdings, Inc. ("Mikasa"), Melru Corporation,
Designs, Inc. and Brown Group Retail, Inc., all of which at one time or another
were in litigation, or threatened litigation with us. Additionally, on April 9,
2003, Gap Inc. notified us that it believes it is entitled to a refund of
certain pass-through charges as a result of certain clauses in its leases.
In the second quarter of 2002, we recorded a non-recurring charge to
establish a reserve in the amount of $3,000 for resolution of these matters, in
addition to the Mikasa matter referred to above. This reserve was estimated in
accordance with our established policies and procedures concerning loss
contingencies for additional information). The balance of the unused reserve
(which is included in the accounts payable and other liabilities in the
Consolidated Balance Sheet) is $2,240 as of June 30, 2003. Based on presently
available information, we believe it is probable the remaining reserve will be
utilized over the next several years in resolving claims relating to the
pass-through and promotional fund provisions contained in our leases, inclusive
of amounts that may be owed, if any, to the Gap Inc. We caution, however, that
given the inherent uncertainties of litigation and the complexities associated
with a large number of leases and other factual questions at issue, actual costs
may vary from this estimate. No other such tenant, however, has filed a suit or
indicated to us that it intends to file a suit. Nevertheless, it is too early to
make any predictions as to whether we or our affiliates may be found liable with
respect to other tenants, or to predict damages should liability be found.
Our affiliates routinely file lawsuits to collect past rent due from, and
to evict, tenants which have defaulted under their leases. There are currently
dozens of such actions pending. In addition to defending against our affiliates'
claims and eviction actions, some tenants file counterclaims against our
affiliates. A tenant who files such a counterclaim typically claims that our
affiliate which owns the outlet center in question defaulted under the tenant's
lease, overcharged the tenant for CAM and promotion fund charges, made
misrepresentations during the leasing process, or failed to maintain or market
the outlet center in question as required by the lease. One such case involves a
collections and eviction action in Puerto Rico captioned Outlet Village of
Puerto Rico Limited Partnership, S.E. v. WEPA, Inc., and another, for instance,
involves a collection case in San Marcos, Texas, captioned, San Marcos Factory
Stores, Ltd. v. SM Collectibles, Inc. d/b/a Country Clutter. Usually such
counterclaims are without merit. In response to such counterclaims our
affiliates usually continue to pursue their collection or eviction actions and
defend against the counterclaims. Despite the fact that we and our affiliates
believe such counterclaims are without merit and defend against them vigorously,
the outcome of all such counterclaims, and, thus, the liability, if any, of us
and our affiliates, cannot be predicted at this time.
Page - (21)
Several entities (the "eOutlets Plaintiffs") filed or stated an intention
to file lawsuits (collectively, the "eOutlets Lawsuits") against us and our
affiliates arising out of our on-line venture, primeoutlets.com. inc., also
known as eOutlets, an affiliate of ours. primeoutelts.com, inc. filed for
protection under Chapter 7 of the United States Bankruptcy Code in November of
2000 under the name E-Outlets Resolution Corp. (the "Debtor"). The eOutlets
Plaintiffs sought to hold us and our affiliates responsible under various legal
theories for liabilities incurred by primeoutlets.com, inc., including the
theories that we guaranteed the obligations of eOutlets and that we were the
"alter-ego" of eOutlets. Other than the suit filed on November 5, 2002 and
discussed below, these eOutlets Lawsuits against us have been resolved or are
now barred by the applicable statute of limitations or otherwise. On November 5,
2002, the bankruptcy trustee for the Debtor brought suit against Prime Retail,
L.P., Prime Retail, Inc., and Prime Retail E-Commerce, Inc. (the "Entity
Defendants") and certain former directors of the Debtor (the "Individual
Defendants"). The Trustee has asserted claims of alter ego, promissory estoppel,
breach of contract, breach of fiduciary duty, tortious interference with
prospective business advantage, unjust enrichment and quantum meruit against the
Entity Defendants and breach of fiduciary duty and gross negligence against the
individual defendants. We have tendered the suit, both as to the Entity
Defendants and Individual Defendants, to the Directors' and Officers' insurance
carrier. Motions to dismiss the suit have been filed by all Defendants. All
Defendants believe the suit is without merit and plan on defending it
vigorously. Nevertheless, the outcome of this lawsuit, and the ultimate
liability of us, if any, cannot be predicted at this time.
In May 2001, we, through affiliates, filed suit against Fru-Con
Construction, Inc. ("FCC"), the lender on Prime Outlets at New River ("New
River") as a result of FCC's foreclosure of New River upon the maturation of the
loan. We and our affiliates allege that they have been damaged because of FCC's
failure to dispose of the collateral in a commercially reasonable manner and as
a result of a violation of federal trademark laws. We, through affiliates, have
also filed suit against The Fru-Con Projects, Inc. ("Fru-Con"), a partner in
Arizona Factory Shops Partnership and an affiliate of FCC. We and our affiliates
allege that Fru-Con failed to use reasonable efforts to assist in obtaining
refinancing. Fru-Con has claims pending against us and our affiliates, as part
of the same suit, alleging that we and our affiliates breached our contract with
Fru-Con by not allowing Fru-Con to participate in an outlet project in Sedona,
Arizona (the "Sedona Project") and breached a management and leasing agreement
by simultaneously managing and leasing the Sedona Project. We believe our
affiliates and us acted property and FCC did not act properly. We and our
affiliates will vigorously defend the claims filed against them and prosecute
the claims they filed. Nevertheless, the ultimate outcome of the suit, including
the liability, if any, of us and our affiliates, cannot be predicted at this
time.
Note 7 - Investment in Unconsolidated Partnerships
We account for our investment in unconsolidated joint ventures in
accordance with the equity method of accounting as we exercise significant
influence, but do not control these entities. In all of our joint venture
arrangements, the rights of the investors are both protective as well as
participating. Therefore, these participating rights preclude us from
consolidating our investments. Our investments are recorded initially at our
cost and subsequently adjusted for equity in earnings (losses) and cash
contributions and distributions.
As of June 30, 2003 our interests in joint venture partnerships included
(i) three outlet centers owned by the Prime/Estein Venture and (ii) five
properties owned by the PFP Venture. The Prime/Estein Venture owns the Birch Run
Center, the Williamsburg Center and the Hagerstown Center which contain an
aggregate 1,485,000 square feet of GLA. The PFP Venture owns the Bridge
Properties (Prime Outlets at Anderson, Prime Outlets at Calhoun, Prime Outlets
at Gaffney, Prime Outlets at Lee and Prime Outlets at Lodi) which contain an
aggregate 1,261,000 square feet of GLA.
Page - (22)
Our equity in earnings (loss) of unconsolidated joint venture partnerships
was $626 and $1,752 during the three and six months ended June 30, 2003,
respectively, and $(267) and $(114) during the three and six months ended June
30, 2002, respectively. Our equity in earnings (loss) of unconsolidated joint
venture partnerships is included in interest and other income in the
Consolidated Statements of Operations.
The following summarizes unaudited condensed financial information for our
investment in unconsolidated joint venture partnerships:
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- ----------------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenues $ 13,682 $ 9,059 $ 29,192 $ 17,808
Total expenses 11,693 8,640 25,618 17,404
-------- ------- -------- --------
Net income (loss) $ 1,989 $ 419 $ 3,574 $ 404
======== ======= ======== ========
====================================================================================================================================
Note 8 - Stock-Based Compensation
In December 2002, the FASB issued FAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure." FAS No. 148 provides transition
methods for entities that elect to adopt the fair value method of accounting for
stock-based employee compensation. In addition, SFAS No. 148 requires disclosure
of comparable information regarding our method of accounting for stock-based
employee compensation for all interim periods. We account for our stock-based
employee compensation, which is in the form of common share option grants, under
the intrinsic method of Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees." Under APB No. 25, no compensation
expense is to be recognized for the common share option grants when the exercise
price of the options equals or exceeds the market price of the underlying shares
at the date of grant. Under our stock incentive plans, the exercise price for
all stock options granted have been no less than the fair market value of our
common stock on the date of grant. Accordingly, we have not recorded any
compensation expense.
Pro-forma information regarding net income and earnings per share is
required by FAS No. 123, "Accounting for Stock-Based Compensation," and has been
determined as if we had accounted for our stock compensation under the fair
value method of that statement. Under the fair value method of FAS No. 123, we
would have recognized additional compensation expense of $2 and $4 for the three
and six months ended June 30, 2003, respectively, and $13 and $26 for the three
and six months ended June 30, 2002, respectively. However, the additional
compensation that would have been recognized under FAS No. 123 would not have
had an impact on our reported earnings per share amounts for the three and six
months ended June 30, 2003 and 2002.
Note 9 - Special Charges
Provision for Asset Impairment
During the second quarter of 2003, certain events and circumstances related
to two of our properties occurred, including further reduced occupancy and
limited leasing success, that indicated these properties were impaired on an
other than temporary basis. As a result, we recorded a provision for asset
impairment aggregating $6,590 representing the write-down of these properties to
their estimated fair values in accordance with the requirements of FAS No. 144,
"Accounting for Impairment of Disposal of Long-lived Assets."
Page - (23)
Non-recurring Other Charges
During the second quarter of 2002, we recorded a non-recurring charge in
the amount of $3,000 to establish a reserve for pending and potential tenant
claims with respect to lease provisions related to their pass-through charges
and promotional fund charges. We had previously recorded a non-recurring charge
in the amount of $2,000 to establish a reserve for similar matters during the
fourth quarter of 2001. To date, we have entered into settlement agreements
which provided for payments aggregating $2,760, of which $2,607 was paid in 2002
and $153 was paid in January 2003. The remaining reserve of $2,240 is included
in accounts payable and other liabilities in the Consolidated Balance Sheet as
of June 30, 2003. See Note 6 - "Legal Proceedings" for additional information.
These reserves were estimated in accordance with our established policies
and procedures with respect to loss contingencies and are based on our current
assessment of the likelihood of any adverse judgments or outcomes to these
matters. Based on presently available information, we believe it is probable the
remaining reserve will be utilized over the next several years in connection
with the resolution of further claims relating to the pass-through and
promotional fund provisions contained in our leases. We caution, however, that
given the inherent uncertainties of litigation and the complexities associated
with a large number of leases and other factual questions at issue, actual costs
may vary from our estimate.
Note 10 - Merger Agreement
In June 2002, we selected Houlihan Lokey Howard & Zukin Capital to assist
us in exploring recapitalization, restructuring, financing and other strategic
alternatives designed to strengthen our financial position and address our
long-term capital requirements. Costs incurred related to such activities are
reflected in corporate general and administrative expense in the accompanying
Consolidated Statements of Operations.
On July 8, 2003, Lightstone and us jointly announced that an affiliate of
Lightstone had agreed to acquire the Company (the "Transaction"). The
Transaction will be effected in accordance with the terms of the Merger
Agreement between Prime Outlets Acquisition Company, LLC (the "Buyer"), a
Delaware limited liability company which is an affiliate of Lightstone, and us,
which provides for us to be merged with and into the Buyer. Consummation of the
Transaction is subject to a number of conditions including the approval of the
Transaction and the Merger Agreement by the holders of at least 66 2/3% of both
our Series A Senior Preferred Stock and Series B Convertible Preferred Stock,
each voting separately as a class, and the approval of a majority of our common
shareholders voting to both amend our charter and approve the Transaction and
the Merger Agreement, as well as other customary approvals.
The Transaction, which will result in aggregate consideration of $115,000
payable to the our shareholders and unit holders, has a total value of
approximately $638,000, including approximately $523,000 of debt expected to be
assumed by the Buyer. Under the terms of the Merger Agreement, each holder of
our Series A Senior Preferred Stock will receive cash in the amount of $16.25
per share, each holder of our Series B Convertible Preferred Stock will receive
cash in the amount of $8.66 per share, and each holder of our common stock will
receive cash in the amount of $0.18 per share.
Pursuant to the terms of the Merger Agreement, the Buyer and us have agreed
to certain conditions pending the closing of the Transaction. These conditions
provide for certain restrictions with respect to our operating and refinancing
activities, including our refinancing of the Mega Deal Loan (see Note 4 - "Debt"
for additional information).
Page - (24)
Our board of directors, as well as a special committee comprised of
disinterested members of the board of directors (the "Special Committee"), have
approved the Transaction and the Merger Agreement and recommended that the
shareholders vote in favor of the resolutions to be proposed at a special
meeting of our shareholders. Because our charter does not address the allocation
of consideration among our various classes of capital stock in the Transaction,
such allocation was determined by the Special Committee and approved by the
board of directors. Houlihan Lokey Howard & Zukin Capital acted as financial
advisor to the special committee and Houlihan Lokey Howard & Zukin Financial
Advisors, Inc., an affiliate of Houlihan Lokey Howard & Zukin Capital, has
provided an opinion to the Special Committee and our board of directors that the
consideration to be received by each of the classes of our stock, considered
independently, is fair to such respective classes, from a financial point of
view.
The Transaction is expected to be completed during the fourth quarter of
2003. Formal documentation relating to the Transaction and the Merger Agreement
will be sent to our shareholders and limited partners. This documentation will
include notices of the special meeting and details of the Transaction and the
Merger Agreement and related matters.
Concurrent with the consummation of the Transaction, the agreement of
limited partnership of the Operating Partnership will be amended and restated
(the "Amended Partnership Agreement") pursuant to which holders of common units
in the Operating Partnership (other than common units held by us) will have the
opportunity to exchange all, but not less than all, of their units for a like
number of preferred units in the Operating Partnership ("Preferred Unit"). Each
holder of Preferred Units will be entitled to require the Operating Partnership
to redeem all of such holder's Preferred Units for an amount per unit equal to
$0.18 (the consideration paid for a share of common stock of the Company in the
Transaction) plus accrued and unpaid distributions at the rate of 6% per annum.
In addition, the Amended Partnership Agreement contains certain tax related
provisions that, subject to certain exceptions, will benefit holders of
Preferred Units for a period of seven years including restrictions on the sale
of properties and requirements to allocate debt in a certain manner.
We have agreed to pay the Buyer a termination fee of $4,500, plus expenses
of up to $1,500, if the Transaction is not completed under certain
circumstances, including our election to pursue an alternative transaction. In
certain other circumstances in which the Transaction has not been completed,
including the failure to obtain the shareholder approval of the Transaction, a
termination fee will not be payable but we have agreed to reimburse the Buyer
for its expenses up to $3,500. As collateral for these obligations, we also
entered into an agreement with Lightstone providing for the assignment of our
rights to, and interest in, an escrow of $2,800 which was established in
connection with our sale of Prime Outlets of Puerto Rico in December 2002 to an
affiliate of Lightstone.
On July 16, 2003, we announced that two shareholders (the "Series A
Parties") that collectively own approximately 32% of the outstanding shares of
Series A Senior Preferred Stock have objected to the allocation of the
consideration under the Merger Agreement in separate communications to us.
In connection with the Transaction and the events described above, we have
proposed to facilitate limited discussions among certain of our preferred
shareholders to obtain their views with respect to the Transaction and the
proposed allocation of the merger consideration. In order to facilitate such
discussions, we are providing certain of our preferred shareholders (including
the Series A Parties) with certain information regarding the Transaction. (We
filed a Current Report on Form 8-K containing this information under Regulation
FD Disclosure with the Securities and Exchange Commission on August 5, 2003.)
There can be no assurances as to the timing, nature or outcome of these
discussions, which may include other shareholders of ours. Although under the
terms of the Merger Agreement, we have the right to modify, at our discretion,
the allocation of consideration among the various classes of stock until the
mailing of definitive proxy materials, any such modification would be subject to
approval of the Special Committee established in connection with the Transaction
and our board of directors.
Page - (25)
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
(Amounts in thousands, except share, unit and square foot information)
Introduction
Unless the context otherwise requires, all references to "we," "us," "our"
or the "company" herein mean Prime Retail, Inc. and those entities owned or
controlled by Prime Retail, Inc., including Prime Retail, L.P. (the "Operating
Partnership").
The following discussion and analysis of our consolidated financial
condition and results of operations should be read in conjunction with the
Consolidated Financial Statements and Notes thereto appearing elsewhere in this
Quarterly Report on Form 10-Q. Our operations are substantially conducted
through the Operating Partnership. As of June 30, 2003, we had an 80% general
partnership interest in the Operating Partnership with full and complete control
over its management, not subject to removal by the limited partners. We are
dependent upon the distributions or other payments from the Operating
Partnership to meet our financial obligations. Historical results and percentage
relationships set forth herein are not necessarily indicative of future
operations.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of
operations are based upon our Consolidated Financial Statements and Notes
thereto appearing elsewhere in this Quarterly Report on Form 10-Q. These
Consolidated Financial Statements and Notes thereto have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of such statements requires us to make certain estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses, and the related disclosure of contingent liabilities. We evaluate our
estimates on an on-going basis; including those related to (i) revenue
recognition, (ii) provisions for bad debt on accounts receivable, (iii)
potential impairment of the carrying value of rental properties held for use,
(iv) capitalization and depreciation of significant renovations and improvements
and (v) contingencies for debt guarantees and litigation. We base our estimates
on historical trends and certain other assumptions that we believe are
reasonable under the particular circumstances. These estimates ultimately form
the basis for making judgments about the carrying values of our assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions.
To assist you in understanding our financial condition and results from
operations, we have identified our critical accounting policies and discussed
them below. These accounting policies are most important to the portrayal of our
financial condition and results from operations, either because of the
significance of the financial statement items to which they relate or because
they require our management's most difficult, subjective or complex judgments.
Revenue Recognition
Leases with tenants are accounted for as operating leases. Minimum rental
income is recognized on a straight-line basis over the term of the lease and
unpaid rents are included in accounts receivable, net in the accompanying
Consolidated Balance Sheets. Certain lease agreements contain provisions, which
provide for rents based on a percentage of sales or based on a percentage of
sales volume above a specified threshold. These contingent rents are not
recognized until the required thresholds are exceeded. In addition, the lease
agreements generally provide for the reimbursement of real estate taxes,
insurance, advertising and certain common area maintenance costs. These
additional rents and tenant reimbursements are accounted for on the accrual
basis.
Page - (26)
Bad Debt Expense
We regularly review our accounts receivable to determine an appropriate
amount for the allowance for doubtful accounts based upon the impact of economic
conditions on ours tenants' ability to pay, past collection experience and such
other factors which, in our judgment, deserve current recognition. In turn, a
provision for uncollectible accounts receivable ("bad debt expense") is charged
against the allowance to maintain the allowance level within this range. If the
financial condition of our tenants were to deteriorate, resulting in impairment
in their ability to make payments due under their leases, additional allowances
may be required.
Impairment of Rental Property
We monitor our Properties for indicators of impairment on an on-going
basis. We record a provision for impairment when we believe certain events and
circumstances have occurred which indicate that the carrying value of our
Properties might have experienced a decline in value that is other than
temporary and the undiscounted cash flows estimated to be generated by those
assets are less than the carrying amounts of those assets. Impairment losses are
measured as the difference between the carrying value and the estimated fair
value for assets held in the portfolio. For assets held for sale, impairment is
measured as the difference between the carrying value and fair value, less
estimated costs to dispose. Fair value is based on estimated cash flows
discounted at a risk-adjusted rate of return. Adverse changes in market
conditions or deterioration in the operating results of our outlet centers and
other rental properties could result in losses or an inability to recover the
current carrying value of such assets. Such potential losses or the inability to
recover the current carrying value may not be reflected in our Properties'
current carrying value, thereby possibly requiring an impairment charge in the
future.
Capitalization and Depreciation of Significant Renovations and Improvements
Depreciation is calculated on the straight-line basis over the estimated
useful lives of the assets, based upon management's estimates. Significant
renovations and improvements, which improve and/or extend the useful life of
assets are capitalized and depreciated over their estimated useful lives, based
upon management's estimates.
Contingencies
We are subject to proceedings, lawsuits, and other claims related to
various matters (see Note 6 - "Legal Proceedings" of the Notes to the
Consolidated Financial Statements for additional information). Additionally, we
have guaranteed certain indebtedness of others (see Note 4 - "Debt" of the Notes
to Consolidated Financial Statements for additional information). With respect
to these contingencies, we assess the likelihood of any adverse judgments or
outcomes to these matters and, if appropriate potential ranges of probable
losses. A determination of the amount of reserves required, if any, for these
contingencies are made after careful analysis of each individual issue. Future
reserves may be required because of (i) new developments or changes to the
approach in which we deal with each matter or (ii) if unasserted claims arise.
Page - (27)
Outlet Center Portfolio
Portfolio GLA and Occupancy
Our outlet center portfolio size reflects (i) our past development (both
new outlet centers and expansions to outlet centers) and acquisition activities
and (ii) our more recent disposition activities. Our outlet portfolio (including
properties owned through joint venture partnerships) consisted of 36 properties
totaling 10,226,000 square feet of gross leasable area ("GLA") at June 30, 2003
compared to 42 properties totaling 11,893,000 square feet of GLA at June 30,
2002. The change in our outlet center GLA is because of certain property
dispositions, which are discussed below. Our outlet center portfolio was 84.8%
and 86.8% occupied as of June 30, 2003 and 2002, respectively. The
weighted-average occupancy of our outlet center portfolio (excluding those
properties disposed of whose results are included in discontinued operations)
during the three months ended June 30, 2003 and 2002 was 83.6% and 86.4%,
respectively. The weighted-average occupancy of our outlet center portfolio
(excluding those properties disposed of whose results are included in
discontinued operations) during the six months ended June 30, 2003 and 2002 was
84.7% and 86.7%, respectively.
We disposed of certain properties through various transactions (including
sale, joint venture arrangements, foreclosure and transfer of ownership to the
applicable lender). These transactions have had a significant impact on the size
of our portfolio for the periods presented and are summarized below.
During 2002, we completed transactions involving 17 properties aggregating
4,431,000 square feet of GLA. These transactions included (i) the sale of seven
outlet centers aggregating 1,791,000 square feet of GLA into joint venture
arrangements, (ii) the sale of five (including one consisting of 197,000 square
feet of GLA that we owned 51% through an unconsolidated joint venture) outlet
centers aggregating 1,486,000 square feet of GLA to unrelated third parties,
(iii) the foreclosure sale and/or transfer of three outlet centers aggregating
922,000 square feet of GLA to the applicable lender and (iv) the sale of two
community centers aggregating 232,000 square feet of GLA to unrelated third
parties.
The seven centers sold into joint venture arrangements consisted of two
separate transactions involving (i) Prime Outlets at Hagerstown (the "Hagerstown
Center"), which was sold to an existing joint venture partnership (the
"Prime/Estein Venture"), and (ii) six outlet centers (collectively, the Bridge
Properties"), which were sold to PFP Venture LLC (the "PFP Venture"), a joint
venture partnership in which we indirectly had a initial ownership interest of
18.2%. Such properties are collectively referred to as the "2002 Joint Venture
Properties". Commencing on the date of disposition, we account for our ownership
interest in the 2002 Joint Venture Properties in accordance with the equity
method of accounting. The operating results of the 2002 Joint Venture Properties
are reflected in our results from continuing operations for all periods
presented through their respective dates of disposition. Their operating results
have not been classified to discontinued operations because we have a
significant continuing involvement in these properties. Additionally, we sold
Phases II and III of the Bellport Outlet Center (the "Bellport Outlet Center").
We accounted for our ownership interest in the Bellport Outlet Center in
accordance with the equity method of accounting through its date of disposition.
The operating results of the remaining disposed properties through their
respective dates of disposition have been classified as discontinued operations
in the accompanying Consolidated Statements of Operations.
On March 31, 2003, the PFP Venture completed the sale of Prime Outlets at
Latham (the "Latham Center") consisting of 43,000 square feet of GLA. The Latham
Center was one of the Bridge Properties. See Note 3 - "Property Dispositions" of
the Notes to Consolidated Financial Statements.
Page - (28)
Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards ("FAS") No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." In accordance with the requirements of FAS No. 144, we have
classified the operating results, including gains and losses related to
disposition, for certain properties either disposed of or classified as assets
held for sale during 2002 as discontinued operations in the accompanying
Consolidated Statements of Operations for all periods presented. The operating
results for properties that were sold into joint venture partnerships during
2002 have not been classified to discontinued operations in the accompanying
Consolidated Statements of Operations because we still retain a significant
continuing involvement in their operations. Such properties and/or their
operating results through the dates of their respective disposition are
collectively referred to as the "2002 Joint Venture Properties". The following
discussion and tables regarding operating results for the comparable periods are
reflective of the classification requirements under FAS No. 144 and relate to
operating results from continuing operations unless otherwise indicated.
The table set forth below summarizes certain information with respect to
our outlet centers as of June 30, 2003 (see Note 4 - "Debt" of the Notes to
Consolidated Financial Statements contained herein for additional information
with respect to indebtedness on our Properties):
- ------------------------------------------------------------------------------------------------------------------------------------
Grand GLA Occupancy
Outlet Centers Opening Date (Sq. Ft.) Percentage (1)
- ------------------------------------------------------------------------------------------------------------------------------------
Prime Outlets at Fremont-- Fremont, Indiana October 1985 229,000 88%
Prime Outlets at Birch Run (2)-- Birch Run, Michigan September 1986 724,000 91
Prime Outlets at Williamsburg (2)-- Williamsburg, Virginia April 1988 274,000 96
Prime Outlets at Pleasant Prairie-- Kenosha, Wisconsin September 1988 269,000 96
Prime Outlets at Burlington-- Burlington, Washington May 1989 174,000 87
Prime Outlets at Queenstown-- Queenstown, Maryland June 1989 221,000 100
Prime Outlets at Hillsboro-- Hillsboro, Texas October 1989 359,000 87
Prime Outlets at Oshkosh-- Oshkosh, Wisconsin November 1989 260,000 90
Prime Outlets at Warehouse Row (4)-- Chattanooga, Tennessee November 1989 95,000 76
Prime Outlets at Perryville-- Perryville, Maryland June 1990 148,000 95
Prime Outlets at Sedona-- (5) Sedona, Arizona August 1990 82,000 89
Prime Outlets at San Marcos-- San Marcos, Texas August 1990 549,000 58
Prime Outlets at Anderson-- (3) Anderson, California August 1990 165,000 91
Prime Outlets at Post Falls-- (5) Post Falls, Idaho July 1991 179,000 64
Prime Outlets at Ellenton-- Ellenton, Florida October 1991 481,000 97
Prime Outlets at Morrisville-- Raleigh - Durham, North Carolina October 1991 187,000 78
Prime Outlets at Naples-- Naples/Marco Island, Florida December 1991 146,000 86
Prime Outlets at Niagara Falls USA-- Niagara Falls, New York July 1992 534,000 86
Prime Outlets at Woodbury-- (6) Woodbury, Minnesota July 1992 250,000 50
Prime Outlets at Calhoun-- (3) Calhoun, Georgia October 1992 254,000 82
Prime Outlets at Bend-- (5) Bend, Oregon December 1992 132,000 95
Page - (29)
- ------------------------------------------------------------------------------------------------------------------------------------
Grand GLA Occupancy
Outlet Centers Opening Date (Sq. Ft.) Percentage (1)
- ------------------------------------------------------------------------------------------------------------------------------------
Prime Outlets at Jeffersonville I-- Jeffersonville, Ohio July 1993 407,000 92%
Prime Outlets at Gainesville-- Gainesville, Texas August 1993 316,000 67
Prime Outlets at Grove City-- Grove City, Pennsylvania August 1994 533,000 99
Prime Outlets at Huntley-- Huntley, Illinois August 1994 282,000 68
Prime Outlets at Florida City-- Florida City, Florida September 1994 208,000 68
Prime Outlets at Pismo Beach-- Pismo Beach, California November 1994 148,000 98
Prime Outlets at Tracy-- Tracy, California November 1994 153,000 87
Prime Outlets at Odessa-- Odessa, Missouri July 1995 296,000 69
Prime Outlets at Darien (7)-- Darien, Georgia July 1995 307,000 58
Prime Outlets at Gulfport (8)-- Gulfport, Mississippi November 1995 306,000 89
Prime Outlets at Lodi-- (3)Burbank, Ohio November 1996 313,000 87
Prime Outlets at Gaffney (3) (7)-- Gaffney, South Carolina November 1996 305,000 91
Prime Outlets at Lee-- (3) Lee, Massachusetts June 1997 224,000 94
Prime Outlets at Lebanon-- Lebanon, Tennessee April 1998 229,000 89
Prime Outlets at Hagerstown (2)-- Hagerstown, Maryland August 1998 487,000 81
---------- ---
Total Outlet Centers (9) 10,226,000 85%
========== ===
====================================================================================================================================
Notes:
(1) Percentage reflects occupied space as of June 30, 2003 as a percent of
available square feet of GLA.
(2) Through affiliates, we have a 30% ownership interest in the joint venture
partnership that owns this outlet center.
(3) Through affiliates, we have an ownership interest of approximately 25.2% in
the joint venture partnership that owns this outlet center as of June 30,
2003.
(4) We own a 2% partnership interest as the sole general partner in this
property, but are entitled to 99% of the property's operating cash flow and
net proceeds from a sale or refinancing. This mixed-use development also
includes approximately 154,000 square feet of office space, not included in
this table, which was 95% occupied as of June 30, 2003.
(5) Non-recourse mortgage loans cross-collateralized by Prime Outlets at Bend,
Prime Outlets at Post Falls and Prime Outlets at Sedona are currently in
default and we are in the process of negotiating a transfer of our
ownership interests in these outlet centers to the lender. See Note 4 -
"Debt" of the Notes to Consolidated Financial Statements for additional
information.
(6) Non-recourse mortgage loans on Prime Outlets at Vero Beach and Prime
Outlets at Woodbury were cross-collateralized. The lender foreclosed on
Prime Outlets at Vero Beach on September 9, 2002 and Prime Outlets at
Woodbury on July 24, 2003. See Note 4 - "Debt" of the Notes to Consolidated
Financial Statements for additional information.
(7) We operate this outlet center pursuant to a long-term ground lease under
which we receive the economic benefit of a 100% ownership interest.
(8) The real property on which this outlet center is located is subject to a
long-term ground lease.
(9) Excludes Oxnard Factory Outlet. Through an affiliate, we have a 50% legal
ownership interest in the joint venture partnership that owns this outlet
center. However, we are currently receiving no economic benefit from the
Oxnard Factory Outlet.
Page - (30)
Results of Operations
Table 1 - Consolidated Statements of Operations
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended 2003 vs. 2002 Six Months Ended 2003 vs. 2002
June 30, -------------------- June 30, ----------------
------------------------ % % --------------------- % %
2003 2002 Change Change 2003 2002 Change Change
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues
Base rents $ 18,535 $ 22,867 $(4,332) -18.9% $ 37,528 $ 47,176 $(9,648) -20.5%
Percentage rents 473 436 37 8.5% 1,450 1,756 (306) -17.4%
Tenant reimbursements 11,816 12,723 (907) -7.1% 22,774 25,557 (2,783) -10.9%
Interest and other 3,705 2,273 1,432 63.0% 7,717 5,133 2,584 50.3%
-------- -------- ------- ------ -------- -------- ------- ------
Total revenues 34,529 38,299 (3,770) -9.8% 69,469 79,622 (10,153) -12.8%
Expenses
Property operating 9,751 10,957 (1,206) -11.0% 19,706 21,168 (1,462) -6.9%
Real estate taxes 3,086 3,627 (541) -14.9% 6,070 7,293 (1,223) -16.8%
Depreciation and amortization 7,281 9,214 (1,933) -21.0% 14,561 19,422 (4,861) -25.0%
Corporate general and administrative 3,528 2,877 651 22.6% 7,994 6,296 1,698 27.0%
Interest 11,944 16,996 (5,052) -29.7% 23,800 34,725 (10,925) -31.5%
Other charges 853 4,266 (3,413) -80.0% 1,541 6,738 (5,197) -77.1%
Provision for asset impairment 6,590 - 6,590 n/m 6,590 - 6,590 n/m
-------- -------- ------- ------ -------- -------- ------- ------
Total expenses 43,033 47,937 (4,904) -10.2% 80,262 95,642 (15,380) -16.1%
-------- -------- ------- ------ -------- -------- ------- ------
Loss before gain (loss) on
sale of real estate (8,504) (9,638) 1,134 -11.8% (10,793) (16,020) 5,227 -32.6%
Gain (loss) on sale of real estate, net - (10,991) 10,991 n/m - 5,802 (5,802) n/m
-------- -------- ------- ------ -------- -------- ------- ------
Loss from continuing operations (8,504) (20,629) 12,125 -58.8% (10,793) (10,218) (575) 5.6%
Discontinued operations,
including gain (loss) of
$2,121 and $(7,502) on
dispositions in 2002,
periods, respectively - (9,557) 9,557 n/m - (18,287) 18,287 n/m
-------- -------- ------- ------ -------- -------- ------- ------
Net loss (8,504) (30,186) 21,682 -71.8% (10,793) (28,505) 17,712 -62.1%
Allocations to preferred shareholders (5,668) (5,668) - 0.0% (11,336) (11,336) - 0.0%
-------- -------- ------- ------ -------- -------- ------- ------
Net loss applicable to common shares $(14,172) $(35,854) $21,682 -60.5% $(22,129) $(39,841) $17,712 -44.5%
======== ======== ======= ====== ======== ======== ======= ======
Basic and diluted earnings per
common share:
Loss from continuing operations $ (0.33) $ (0.60) $ (0.51) $ (0.49)
Discontinued operations - (0.22) - (0.42)
-------- -------- -------- --------
Net loss $ (0.33) $ (0.82) $ (0.51) $ (0.91)
======== ======== ======== ========
Weighted-average common shares
outstanding - basic and diluted 43,578 43,578 43,578 43,578
======== ======== ======== ========
====================================================================================================================================
Page - (31)
Comparison of the three months ended June 30, 2003 to the three months ended
June 30, 2002
Summary
We reported losses from continuing operations of $8,504 and $20,629 for the
three months ended June 30, 2003 and 2002, respectively. For the three months
ended June 30, 2003, the net loss applicable to our common shareholders was
$14,172, or $0.33 per common share. For the three months ended June 30, 2002,
the net loss applicable to our common shareholders was $35,854, or $0.82 per
common share.
During the three months ended June 30, 2002, we reported a loss from
discontinued operations of $9,557, or $0.22 per common share. This loss from
discontinued operations included a (i) gain related to dispositions of $2,221
and (ii) a provision for asset impairment of $12,200.
The 2003 results from continuing operations include a second quarter
provision for asset impairment of $6,590, or $0.15 per common share. The 2002
results from continuing operations include (i) a net loss on the sale of real
estate of $10,991, or $0.25 per common share and (ii) a second quarter
non-recurring charge (included in other charges) of $3,000, or $0.07 per common
share, related to pending and potential tenant claims with respect to certain
lease provisions.
Revenues
Total revenues were $34,529 for the three months ended June 30, 2003
compared to $38,299 for the same period in 2002, a decrease of $3,770, or 9.8%.
Base rents decreased $4,332, or 18.9%, to $18,535 in 2003 compared to $22,867 in
2002. These decreases are primarily due to (i) transactions involving the 2002
Joint Venture Properties, (ii) changes in economic rental rates and (iiii) the
reduction in outlet center occupancy during the 2003 period. Straight-line rent
expense, included in base rent was $230 and $20 for the three months ended June
30, 2003 and 2002, respectively.
Percentage rents, which represent rents based on a percentage of sales
volume above a specified threshold, increased $37 or 8.5%, to $473 during the
three months ended June 30, 2003 compared to $436 for the same period in 2002.
This increase was primarily due to (i) changes in economic rental rates
partially offset by (ii) transactions involving the 2002 Joint Venture
Properties.
Tenant reimbursements, which represent the contractual recovery from
tenants of certain operating expenses, decreased by $907, or 7.1%, to $11,816
during the three months ended June 30, 2003 compared to $12,723 for the same
period in 2002. This decline is primarily due to (i) transactions involving the
2002 Joint Venture Properties, (ii) changes in economic rental rates and (iii)
the reduced aggregate outlet center weighted-average occupancy during the 2003
period.
As shown in TABLE 2, tenant reimbursements as a percentage of recoverable
property operating expenses and real estate taxes was 92.0% during the three
months ended June 30, 2003 compared to 87.2% for the same period in 2002. The
increase in tenant reimbursements as a percentage of recoverable property
operating expenses and real estate taxes reflects the aforementioned changes in
economic rental rates and weighted-average occupancy.
Page - (32)
Table 2 - Tenant Recoveries as a Percentage of Total Recoverable Expenses
- --------------------------------------------------------------------------------
Three Months Ended June 30, 2003 2002
- --------------------------------------------------------------------------------
Tenant reimbursements $ 11,816 $ 12,723
======== =========
Recoverable Expenses:
Property operating $ 9,751 $ 10,957
Real estate taxes 3,086 3,627
-------- --------
Total recoverable expenses $ 12,837 $ 14,584
======== ========
Tenant reimbursements as a percentage
of total recoverable expenses 92.0% 87.2%
======== ========
================================================================================
Interest and other income increased by $1,432, or 63.0%, to $3,705 during
the three months ended June 30, 2003 compared to $2,273 for the same period in
2002. The increase was primarily attributable to (i) higher equity in earnings
of unconsolidated joint ventures of $893, (ii) increased leasing commissions
income of $384 and (iii) an increase in all other income of $155. The increase
in equity in earnings of unconsolidated joint ventures is primarily associated
with the transactions involving the 2002 Joint Venture Properties.
Expenses
Property operating expenses decreased by $1,206, or 11.0%, to $9,751 during
the three months ended June 30, 2003 compared to $10,957 for the same period in
2002. Real estate taxes expense decreased by $541, or 14.9%, to $3,086 during
the three months ended June 30, 2003 compared to $3,627 for the same period in
2002. The decrease in property operating expenses is primarily because of the
transactions involving the 2002 Joint Venture Properties partially offset by
higher insurance and marketing costs during the 2003 period. The decrease in
real estate taxes expense is primarily because of the transactions involving the
2002 Joint Venture Properties.
As shown in TABLE 3, depreciation and amortization expense decreased by
$1,933 or 21.0%, to $7,281 during the three months ended June 30, 2003 compared
to $9,214 for the same period in 2002. This decrease was primarily attributable
to the depreciation and amortization of assets associated with the transactions
involving the 2002 Joint Venture Properties.
Table 3 - Components of Depreciation and Amortization Expense
The components of depreciation and amortization expense for the three
months ended June 30, 2003 and 2002 are summarized as follows:
- --------------------------------------------------------------------------------
Three Months Ended June 30, 2003 2002
- --------------------------------------------------------------------------------
Building and improvements $ 3,423 $ 4,106
Land improvements 938 1,094
Tenant improvements 2,057 3,359
Furniture and fixtures 807 619
Leasing commissions 56 36
------- -------
Total $ 7,281 $ 9,214
======= =======
================================================================================
Page - (33)
As shown in TABLE 4, interest expense decreased by $5,052, or 29.7%, to
$11,944 during the three months ended June 30, 2003 compared to $16,996 for the
same period in 2002. This decrease reflects (i) lower interest incurred of
$5,652, (ii) a decrease in amortization of deferred financing costs of $882 and
(iii) higher amortization of debt premiums of $24. Partially offsetting these
items was interest expense of $1,506 associated with certain mortgage debt that
was defeased in December 2002. See Note 4 - "Debt" of the Notes to Consolidated
Financial Statements for additional information.
The decrease in interest incurred is primarily attributable to (i) a
reduction of approximately $171,826 in our weighted-average debt outstanding,
excluding debt premiums, during the three months ended June 30, 2003 compared to
the same period in 2002 and (ii) a decrease in the weighted-average contractual
interest rate on our debt for the three months ended June 30, 2003 compared to
the same period in 2002. The decrease in weighted-average debt outstanding was
primarily attributable to asset dispositions. The weighted-average contractual
interest rates for the 2003 and 2002 periods were approximately 8.11% and 9.34%,
respectively.
Table 4 - Components of Interest Expense
The components of interest expense for the three months ended June 30, 2003
and 2002 are summarized as follows:
- --------------------------------------------------------------------------------
Three Months Ended June 30, 2003 2002
- --------------------------------------------------------------------------------
Interest incurred $ 10,546 $ 16,198
Amortization of deferred financing costs 418 1,300
Amortization of debt premiums (526) (502)
Interest expense - defeased debt 1,506 -
-------- --------
Total $ 11,944 $ 16,996
======== ========
================================================================================
Other charges were $853 and $4,266 for the three months ended June 30, 2003
and 2002, respectively, which includes a non-recurring charge of $3,000 in the
2002 period. Excluding the effect of this non-recurring charge, which is
discussed below, other charges decreased by $413, or 32.6%, to $853 for the
three months ended June 30, 2003 compared to $1,266 for the same period in 2002.
This decrease was attributable to (i) lower bad debt expense of $209 and (ii) a
decrease in all other expenses of $204.
During the second quarter of 2002, we recorded a non-recurring charge
(included in other charges) of $3,000 to establish a reserve for pending an
potential tenant claims with respect to lease provisions related to their
pass-through charges and promotional fund charges. See "Liquidity and Capital
Resources" for additional information.
During the second quarter of 2003, certain events and circumstances related
to two of our properties occurred, including (i) changes to the anticipated
holding periods and (ii) further reduced occupancy and limited leasing success,
that indicated these properties were impaired on an other than temporary basis.
As a result, we recorded a provision for asset impairment aggregating $6,590
representing the write-down of these properties to their estimated fair values
in accordance with the requirements of Statement of Financial Accounting
Standards ("FAS") No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets."
Page - (34)
Comparison of the six months ended June 30, 2003 to the six months ended
June 30, 2002
Summary
We reported losses from continuing operations of $10,793 and $10,218 for
the six months ended June 30, 2003 and 2002, respectively. For the six months
ended June 30, 2003, the net loss applicable to our common shareholders was
$22,129, or $0.51 per common share. For the six months ended June 30, 2002, the
net loss applicable to our common shareholders was $39,841, or $0.91 per common
share.
During the six months ended June 30, 2002, we reported a loss from
discontinued operations of $18,287, or $0.42 per common share. This loss from
discontinued operations included a (i) a net loss related to dispositions of
$7,502 and (ii) a provision for asset impairment of $12,200.
The 2003 results from continuing operations include a second quarter
provision for asset impairment of $6,590, or $0.15 per common share. The 2002
results from continuing operations include (i) a net gain on the sale of real
estate of $5,802, or $0.13 per common share and (ii) a second quarter
non-recurring charge (included in other charges) of $3,000, or $0.07 per common
share, related to pending and potential tenant claims with respect to certain
lease provisions.
Revenues
Total revenues were $69,469 for the six months ended June 30, 2003 compared
to $79,622 for the same period in 2002, a decrease of 10,153, or 12.8%. Base
rents decreased $9,648, or 20.5%, to $37,528 in 2003 compared to $47,176 in
2002. These decreases are primarily due to (i) transactions involving the 2002
Joint Venture Properties, (ii) changes in economic rental rates and (iiii) the
reduction in outlet center occupancy during the 2003 period. Straight-line rent
expense, included in base rent was $369 and $59 for the six months ended June
30, 2003 and 2002, respectively.
Percentage rents, which represent rents based on a percentage of sales
volume above a specified threshold, decreased $306, or 17.4%, to $1,450 during
the six months ended June 30, 2003 compared to $1,756 for the same period in
2002. This decrease was primarily due to (i) transactions involving the 2002
Joint Venture Properties and (ii) changes in economic rental rates.
Tenant reimbursements, which represent the contractual recovery from
tenants of certain operating expenses, decreased by $2,783, or 10.9%, to $22,774
during the six months ended June 30, 2003 compared to $25,557 for the same
period in 2002. This decline is primarily due to (i) transactions involving the
2002 Joint Venture Properties, (ii) changes in economic rental rates and (iii)
the reduced aggregate outlet center weighted-average occupancy during the 2003
period.
As shown in TABLE 5, tenant reimbursements as a percentage of recoverable
property operating expenses and real estate taxes was 88.4% during the six
months ended June 30, 2003 compared to 89.8% for the same period in 2002. The
decline in tenant reimbursements as a percentage of recoverable property
operating expenses and real estate taxes reflects to the aforementioned changes
in economic rental rates and weighted-average occupancy.
Page - (35)
Table 5 - Tenant Recoveries as a Percentage of Total Recoverable Expenses
- --------------------------------------------------------------------------------
Six Months Ended June 30, 2003 2002
- --------------------------------------------------------------------------------
Tenant reimbursements $ 22,774 $ 25,557
======== ========
Recoverable Expenses:
Property operating 19,706 $ 21,168
Real estate taxes 6,070 7,293
-------- --------
Total recoverable expenses $ 25,776 $ 28,461
======== ========
Tenant reimbursements as a percentage
of total recoverable expenses 88.4% 89.8%
======== ========
================================================================================
Interest and other income increased by $2,584, or 50.3%, to $7,717 during
the six months ended June 30, 2003 compared to $5,133 for the same period in
2002. The increase was primarily attributable to (i) higher equity in earnings
of unconsolidated joint ventures of $1,866, (ii) increased leasing commissions
income of $576 and (iii) an increase in all other income of $142. The increase
in equity in earnings of unconsolidated joint ventures is primarily associated
with the transactions involving the 2002 Joint Venture Properties.
Expenses
Property operating expenses decreased by $1,462, or 6.9%, to $19,706 during
the six months ended June 30, 2003 compared to $21,168 for the same period in
2002. Real estate taxes expense decreased by $1,223, or 16.8%, to $6,070 during
the six months ended June 30, 2003 compared to $7,293 for the same period in
2002. The decrease in property operating expenses is primarily because of the
transactions involving the 2002 Joint Venture Properties partially offset by
higher insurance and marketing costs during the 2003 period. The decrease in
real estate taxes expense is primarily because of the transactions involving the
2002 Joint Venture Properties.
As shown in TABLE 6, depreciation and amortization expense decreased by
$4,861, or 25.0%, to $14,561 during the six months ended June 30, 2003 compared
to $19,422 for the same period in 2002. This decrease was primarily attributable
to the depreciation and amortization of assets associated with the transactions
involving the 2002 Joint Venture Properties.
Table 6 - Components of Depreciation and Amortization Expense
The components of depreciation and amortization expense for the six months
ended June 30, 2003 and 2002 are summarized as follows:
- --------------------------------------------------------------------------------
Six Months Ended June 30, 2003 2002
- --------------------------------------------------------------------------------
Building and improvements $ 6,870 $ 9,469
Land improvements 1,876 2,196
Tenant improvements 4,299 6,387
Furniture and fixtures 1,405 1,261
Leasing commissions 111 109
-------- --------
Total $ 14,561 $ 19,422
======== ========
================================================================================
Page - (36)
As shown in TABLE 7, interest expense decreased by $10,925, or 31.5%, to
$23,800 during the six months ended June 30, 2003 compared to $34,725 for the
same period in 2002. This decrease reflects (i) lower interest incurred of
$11,737, (ii) a decrease in amortization of deferred financing costs of $2,136
and (iii) higher amortization of debt premiums of $47. Partially offsetting
these items was interest expense of $2,995 associated with certain mortgage debt
that was defeased in December 2002. See Note 4 - "Debt" of the Notes to
Consolidated Financial Statements for additional information.
The decrease in interest incurred is primarily attributable to (i) a
reduction of approximately $184,847 in our weighted-average debt outstanding,
excluding debt premiums, during the six months ended June 30, 2003 compared to
the same period in 2002 and (ii) a decrease in the weighted-average contractual
interest rate on our debt for the six months ended June 30, 2003 compared to the
same period in 2002. The decrease in weighted-average debt outstanding was
primarily attributable to asset dispositions. The weighted-average contractual
interest rates for the 2003 and 2002 periods were approximately 8.10% and 9.33%,
respectively.
Table 7 - Components of Interest Expense
The components of interest expense for the six months ended June 30, 2003
and 2002 are summarized as follows:
- --------------------------------------------------------------------------------
Six Months Ended June 30, 2003 2002
- --------------------------------------------------------------------------------
Interest incurred $ 21,003 $ 32,740
Amortization of deferred financing costs 847 2,983
Amortization of debt premiums (1,045) (998)
Interest expense - defeased debt 2,995 -
-------- --------
Total $ 23,800 $ 34,725
======== ========
================================================================================
Other charges were $1,541 and $6,738 for the six months ended June 30, 2003
and 2002, respectively, which includes the previously discussed non-recurring
charge of $3,000 in the 2002 period. Excluding the effect of this non-recurring
charge, other charges decreased by $2,197, or 58.8%, to $1,541 for the six
months ended June 30, 2003 compared to $3,738 for the same period in 2002. This
decrease was attributable to (i) lower bad debt expense of $2,016 and (ii) a
decrease in all other expenses of $181. The decrease in bad debt expense
resulted from (i) resolution of certain disputes with tenants and (ii) reduced
tenant bankruptcies, abandonments and store closings during the 2003 period.
During the second quarter of 2003, certain events and circumstances related
to two of our properties occurred, including further reduced occupancy and
limited leasing success, that indicated these properties were impaired on an
other than temporary basis. As a result, we recorded a provision for asset
impairment aggregating $6,590 representing the write-down of these properties to
their estimated fair values in accordance with the requirements of FAS No. 144.
Merchant Sales
For the three and six months ended June 30, 2003, same-store sales in our
outlet center portfolio increased by 1.2% and decreased by 2.8%, respectively,
compared to the same periods in 2002. "Same-store sales" is defined as the
weighted-average sales per square foot reported by merchants for stores open
since January 1, 2002. The weighted-average sales per square foot reported as
reported by our merchants were $245 for the year ended December 31, 2002.
Page - (37)
Liquidity and Capital Resources
Sources and Uses of Cash
For the six months ended June 30, 2003, net cash provided by operating
activities was $3,998, net cash used in investing activities was $1,190 and cash
used in financing activities was $3,708.
The net cash used in investing activities during the six months ended June
30, 2003 consisted of $2,969 of additions to rental property partially offset by
$1,085 of net proceeds from the disposition of excess land and $694 of
distributions from unconsolidated joint venture partnerships. The additions to
rental property included costs incurred in connection with re-leasing space to
new merchants and costs associated with renovations. During the six months ended
June 30, 2003, we did not engage in any significant development activities,
however, we continue to engage in certain consulting activities in Europe. Such
activities do not have a significant impact on our liquidity or financial
condition.
The gross uses of cash for financing activities of $3,708 during six months
ended June 30, 2003 consisted of scheduled principal amortization on debt.
Defaults on Certain Non-recourse Mortgage Indebtedness
During August 2002, certain of our subsidiaries suspended regularly
scheduled monthly debt service payments on non-recourse mortgage loans which
were cross-collateralized by the Vero Beach Center and the Woodbury Center.
These non-recourse mortgage loans were held by John Hancock. Effective September
9, 2002, John Hancock foreclosed on the Vero Beach Center. Additionally,
effective July 24, 2003, John Hancock foreclosed on the Woodbury Center. See
Note 3 - "Property Dispositions" of the Notes to Consolidated Financial
Statements for additional information.
In December 2002, we notified the servicer of certain non-recourse mortgage
loans (cross-collateralized by Prime Outlets at Bend, Prime Outlets at Post
Falls and Prime Outlets at Sedona) totaling $24,919 as of June 30, 2003 that the
net cash flow from the properties securing the loans was insufficient to fully
pay the required monthly debt service. At that time, certain of our subsidiaries
suspended the regularly scheduled monthly debt service payments. Subsequent to
our notification to the servicer, we have been remitting on a monthly basis all
available cash flow from the properties, after a reserve for monthly operating
expenses, as partial payment of the debt service. The failure to pay the full
amount due constitutes a default under the loan agreements which allows the
lender to accelerate the loan and to exercise various remedies contained in the
loan agreements, including application of escrow balances to delinquent payments
and, ultimately, foreclosure on the properties which collateralize the loans.
The lender has notified us that it has accelerated the loans and intends to
commence foreclosure action on the collateral properties. However, any
foreclosure action on these properties is not expected to have a material impact
on our results of operations or financial condition because we are currently
only remitting available cash flow. These non-recourse mortgage loans require
the monthly funding of escrow accounts for the payment of real estate taxes,
insurance and capital improvements. Such escrow accounts totaled $105 as of June
30, 2003, which is included in restricted cash in the Consolidated Balance
Sheet. The aggregate carrying value of these properties was $21,558 as of June
30, 2003. Such amount is exceeded by the aggregate outstanding balance of the
non-recourse mortgage loans of $24,919 as of June 30, 2003. Upon foreclosure of
the collateral properties, we will record a non-recurring gain for the
difference between the carrying value of the properties and their related net
asset, including the outstanding loan balances.
Page - (38)
Defeasance of Mega Deal Loan
On December 6, 2002, we completed the sale of two outlet centers (together,
the "Colorado Properties"), which were part of the 15 properties contained in
the collateral pool securing a first mortgage and expansion loan (the "Mega Deal
Loan"), which had a then outstanding balance of $338,940. In connection with the
release of the Colorado Properties from the collateral pool, we were required to
partially defease the Mega Deal Loan. Therefore, the Mega Deal Loan was
bifurcated into (i) a defeased portion in the amount of $74,849 (the "Defeased
Notes Payable") and (ii) an undefeased portion in the amount of $264,091, which
is still referred to as the Mega Deal Loan. Both the Defeased Notes Payable and
the Mega Deal Loan (i) bear interest at a fixed-rate of 7.782%, (ii) require
monthly payments of principal and interest pursuant to a 30-year amortization
schedule and (iii) have an anticipated maturity through an optional prepayment
date on November 11, 2003. The Mega Deal Loan is now secured by the remaining 13
properties contained in the collateral pool. We used $79,257 of the gross
proceeds from the sale of the Colorado Properties to purchase US Treasury
Securities, which were placed into a trustee escrow (the "Trustee Escrow"). The
Trustee Escrow is used to make the scheduled monthly debt service payments,
including the payment of the then outstanding principal amount, together with
all accrued and unpaid interest on November 11, 2003, under the Defeased Notes
Payable. As of June 30, 2003, the outstanding balance of the Defeased Notes
Payable was $74,280 and the balance of the Trustee Escrow was $76,671 (included
in restricted cash in the accompanying Consolidated Balance Sheet). Furthermore,
in connection with the partial defeasance of the Mega Deal Loan we amended the
Mega Deal Loan so that (i) we are required to fund 10 monthly payments of $500
into a lender escrow to be used as additional cash collateral and (ii) release
prices for the remaining 13 properties in the collateral pool were amended to
provide for a more orderly refinancing of the Mega Deal Loan.
Debt Service Obligations
The scheduled principal maturities of our debt, excluding (i) unamortized
debt premiums of $6,910 and (ii) $41,250 of aggregate non-recourse mortgage
indebtedness in default (see "Defaults on Certain Non-recourse Mortgage
Indebtedness" above), and related average contractual interest rates by year of
maturity as of June 30, 2003 are as follows:
- ------------------------------------------------------------------------------------------------------------------------------------
Bonds Payable
(including sinking Defeased
fund payments) Notes Payable Notes Payable Total Debt
---------------------------- ----------------------- ----------------------- -------------------------
Average Average Average Average
Interest Principal Interest Principal Interest Principal Interest Principal
Years Ended December 31, Rates Maturities Rates Maturities Rates Maturities Rates Maturities
- ------------------------------------------------------------------------------------------------------------------------------------
2003 6.61% $ 591 7.79% $ 263,524 7.78% $ 74,280 7.78% $ 338,395
2004 6.34% 726 7.97% 4,571 7.75% 5,297
2005 6.34% 773 8.58% 11,574 8.44% 12,347
2006 6.34% 820 8.83% 120,437 8.81% 121,257
2007 6.34% 878 7.60% 1,002 7.02% 1,880
Thereafter 6.52% 18,618 7.59% 57,995 7.33% 76,613
---- -------- ---- --------- ---- -------- ---- ---------
6.50% $ 22,406 8.06% $ 459,103 7.78% $ 74,280 7.96% $ 555,789
==== ======== ==== ========= ==== ======== ==== =========
====================================================================================================================================
Page - (39)
Such indebtedness in the amount of $481,509 had a weighted-average maturity
of 2.3 years and bore contractual interest at a weighted-average rate of 7.98%
per annum. At June 30, 2003, all of such indebtedness bore interest at fixed
rates. Our remaining scheduled principal payments during 2003 for such
indebtedness aggregated $338,395. In addition to regularly scheduled principal
payments, the remaining 2003 scheduled principal payments also reflect balloon
payments of (i) $260,681 for the Mega Deal Loan and (ii) $73,882 due for the
Defeased Notes Payable. Both the Mega Deal Loan and the Defeased Notes Payable
have an anticipated maturity through an optional prepayment date on November 11,
2003. All debt service due under the Defeased Notes Payable, including the
balloon payment due at anticipated maturity, will be made from the Trustee
Escrow. See "Going Concern" for additional information.
Additionally, we are obligated to refinance a first mortgage loan (the
"Hagerstown First Mortgage Loan") in the amount of $46,862 on Prime Outlets at
Hagerstown (the "Hagerstown Center") on or before June 1, 2004. The Hagerstown
First Mortgage Loan was assumed by an unconsolidated joint venture partnership
(the "Prime/Estein Venture"), in which we have an indirect 30% ownership
interest, in January 2002. See "Prime/Estein Venture Guarantees" contained in
"Guarantees and Guarantees of Indebtedness of Others" for additional
information.
Defaults on Certain Non-recourse Mortgage Indebtedness of Unconsolidated
Partnerships
Two mortgage loans related to projects in which we, through subsidiaries,
indirectly own joint venture interests have matured and are in default. The
mortgage loans, at the time of default, were (i) a $10,389 first mortgage loan
on Phase I of the Bellport Outlet Center, held by Union Labor Life Insurance
Company ("Union Labor"); and (ii) a $13,338 first mortgage loan on Oxnard
Factory Outlet, an outlet center located in Oxnard, California, held by Fru-Con.
An affiliate of ours has a 50% ownership interest in the partnership, which owns
Phase I of the Bellport Outlet Center. Fru-Con and us are each a 50% partner in
the partnership that owns the Oxnard Factory Outlet.
Union Labor filed for foreclosure on Phase I of the Bellport Outlet Center
and a receiver was appointed March 27, 2001 by the court involved in the
foreclosure action. Effective May 1, 2001, a manager hired by the receiver began
managing and leasing Phase I of the Bellport Outlet Center. A judgment for
foreclosure was entered on January 25, 2003 in the amount of $12,711. The
foreclosure occurred on March 17, 2003 with Union Labor acquiring the property
for $5,100. Approximately $1,100 of post-judgment interest and fees was
subsequently awarded to Union Labor. We continue to negotiate the terms of a
transfer of our ownership interest in Oxnard Factory Outlet to Fru-Con. We do
not manage or lease Oxnard Factory Outlet.
We believe neither of these mortgage loans is recourse to us. It is
possible, however, that either or both of the respective lenders will, after
completing its foreclosure action, file a lawsuit seeking to collect from us the
difference between the value of the mortgaged property and the amount due under
the loan. If such an action is brought, the outcome, and our ultimate liability,
if any, cannot be predicted at this time.
In addition, we are currently not receiving, directly or indirectly, any
cash flow from Oxnard Factory Outlet and were not receiving any cash flow from
Phase I of the Bellport Outlet Center prior to the loss of control of such
project. We account for our interests in (i) Phases I of the Bellport Outlet
Center and (ii) the Oxnard Factory Outlet in accordance with the equity method
of accounting. As of June 30, 2003, we had no carrying value for our investment
in these properties.
Page - (40)
Guarantees and Guarantees of Indebtedness of Others
HGP Guarantees
On July 15, 2002, Horizon Group Properties, Inc. and its affiliates ("HGP")
announced they had refinanced a secured credit facility (the "HGP Secured Credit
Facility") through a series of new loans aggregating $32,500. Prior to the
refinancing, we were a guarantor under the HGP Secured Credit Facility in the
amount of $10,000. In connection with the refinancing, our guarantee was reduced
to a maximum of $4,000 as security for a $3,000 mortgage loan and a $4,000
mortgage loan (collectively, the "HGP Monroe Mortgage Loan") secured by HGP's
outlet shopping center located in Monroe, Michigan. The HGP Monroe Mortgage Loan
has a 3-year term, bears interest at the prime lending rate plus 2.50% (with a
minimum of 9.90%) and requires monthly interest-only payments. The HGP Monroe
Mortgage Loan may be prepaid without penalty after two years. Our guarantee with
respect to the HGP Monroe Mortgage Loan will be extinguished if the principal
amount of such obligation is reduced to $5,000 or less through repayments.
Additionally, we are a guarantor with respect to certain mortgage
indebtedness (the "HGP Office Building Mortgage") in the amount of $2,129 on
HGP's corporate office building and related equipment located in Norton Shores,
Michigan. The HGP Office Building Mortgage matures in August 31, 2003, bears
interest at LIBOR plus 5.50%, and requires monthly debt service payments.
We have not recorded any liability related to these guarantees and no
claims have been made under our guarantees with respect to the HGP Monroe
Mortgage Loan or the HGP Office Building Mortgage. HGP is a publicly traded
company that was formed in connection with our merger with Horizon Group, Inc.
("Horizon") in June 1998.
Prime/Estein Venture Guarantees
We indirectly have a 30% ownership interest in the Prime/Estein Venture
which owns three outlet centers (collectively, the "Prime/Estein Properties").
The Prime/Estein Properties consist of Prime Outlets at Birch Run (the "Birch
Run Center"), Prime Outlets at Hagerstown (the "Hagerstown Center") and Prime
Outlets at Williamsburg (the "Williamsburg Center"). Pursuant to Prime/Estein
Venture-related documents to which affiliates of ours are parties, we are
obligated to provide to, or obtain for, the Prime/Estein Venture fixed-rate
financing at an annual rate of 7.75% (the "Interest Rate Subsidy Agreement") for
the Prime/Estein Venture Properties.
In August 2001, we, through affiliates, completed a refinancing of $63,000
of first mortgage loans secured by the Birch Run Center. The refinanced loan
(the "Birch Run First Mortgage") (i) has a term of 10-years, (ii) bears interest
at an effective rate of 8.12% and (iii) requires monthly payments of principal
and interest pursuant to a 25-year amortization schedule. Pursuant to the
Interest Rate Subsidy Agreement, we are required to pay to the Prime/Estein
Venture the difference between the cost of the financing at an assumed rate of
7.75% and the actual cost of such financing at the annual rate of 8.12% (the
"Interest Rate Subsidy Obligation"). The net present value of the Interest Rate
Subsidy Obligation (included in accounts payable and other liabilities in the
Consolidated Balance Sheet) was $1,382 as of June 30, 2003.
In October 2001, we, through affiliates, completed the refinancing of a
$32,500 first mortgage loan secured by the Williamsburg Center. The new first
mortgage loan (the "Williamsburg First Mortgage") (i) has a term of 10-years,
(ii) bears interest at a fixed-rate of 7.69% and (iii) requires monthly payments
of principal and interest pursuant to a 25-year amortization schedule. Pursuant
to the Interest Rate Subsidy Agreement, the Prime/Estein Venture is required to
pay to us the difference between the cost of the financing at an assumed rate of
7.75% and the actual cost of such financing at the annual rate of 7.69%.
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On January 11, 2002, we sold the Hagerstown Center to the Prime/Estein
Venture. In connection with the sale, the Prime/Estein Venture assumed the
Hagerstown First Mortgage in the amount of $46,862; however, our guarantee of
such indebtedness remains in place. Additionally, we are obligated to refinance
the Hagerstown First Mortgage on behalf of the Prime/Estein Venture on or before
June 1, 2004, the date on which such indebtedness matures. Additionally, the
Prime/Estein Venture's cost of the Hagerstown First Mortgage and any refinancing
of it are fixed at an annual rate of 7.75% for a period of 10 years. If the
actual cost of such indebtedness should exceed 7.75% at any time during the
10-year period, we will be obligated to pay the difference to the Prime/Estein
Venture. If the actual cost of such indebtedness is less than 7.75% at any time
during the 10-year period, however, the Prime/Estein Venture will be obligated
to pay the difference to us. The actual cost of the Hagerstown First Mortgage is
30-day LIBOR plus 1.50%, or 2.62% as of June 30, 2003. Because the Hagerstown
First Mortgage bears interest at a variable rate, we are exposed to the impact
of interest rate changes. We have not recorded any liability related to our
guarantee of the Hagerstown First Mortgage; however, in connection with the sale
of the Hagerstown Center, we established a reserve for estimated refinancing
costs in the amount of $937, which is included in accounts payable and other
liabilities in the Consolidated Balance Sheet as of June 30, 2003. See Note 3 -
"Property Dispositions" of the Notes to Consolidated Financial Statements for
additional information.
Second Horizon First Mortgage Loan
In April 1998, Horizon consummated an agreement with Castle & Cooke
Properties, Inc. ("CCP") which released Horizon from future obligations under a
long-term lease of the Dole Cannery outlet center in Honolulu, Hawaii. In
connection with an amendment of the Second Horizon Group Limited Partnership
("Second Horizon") agreement (the "Amended Partnership Agreement"), Horizon
transferred to an affiliate of CCP (the "CCP Affiliate") substantially all of
Horizon's economic interest, but not legal title, in an outlet center (the "Lake
Elsinore Center") in Lake Elsinore, California. The Lake Elsinore Center is one
of five properties owned by Second Horizon which jointly and severally secure a
non-recourse, first mortgage loan (the "Second Horizon Mortgage Loan"). As a
result of our merger with Horizon in June 1998, we own the economic interests of
the other four properties (the "Prime Properties") and legal title to all five
entities. The outstanding balance of the Second Horizon Mortgage Loan as of June
30, 2003 was $94,586, of which $66,486 was allocated to the Prime Properties and
is included in notes payable in our Consolidated Balance Sheet as of June 30,
2003. The remaining $28,100 outstanding as of June 30, 2003 was allocated to the
Lake Elsinore Center.
We, through our affiliates, assumed certain obligations under the Amended
Partnership Agreement with respect to the Second Horizon Mortgage Loan in
connection with our merger with Horizon in June 1998. Specifically, we are
obligated to contribute sufficient capital to Second Horizon (i) for certain
operating expenses associated with the Prime Properties and (ii) to satisfy
the outstanding balances of the allocated loan amounts for the Prime Properties
under the Second Horizon Mortgage Loan (including any associated expenses) to
enable the Second Horizon Mortgage Loan to be repaid in full at its optional
prepayment date of October 11, 2006. CCP Affiliate and its parent company are
similarly obligated with respect to the Lake Elsinore Center. No claims have
been made with respect to these obligations and we have not recorded any
liability related to these obligations as of June 30, 2003.
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Mandatory Redemption Obligation
On July 26, 2002, we sold the Bridge Properties to the PFP Venture. In
connection with the sale, we guaranteed FRIT PRT Bridge Acquisition LLC
("FRIT"), a third-party joint venture partner, (i) a 13% return on its initial
$17,236 of invested capital and (ii) the full return of its invested capital
(the "Mandatory Redemption Obligation") by December 31, 2003. As of June 30,
2003, our Mandatory Redemption Obligation with respect to the full return of
FRIT's invested capital was $14,888 (included in accounts payable and other
liabilities in the Consolidated Balance Sheet). See "Going Concern" for
additional information.
Going Concern
Our liquidity depends on cash provided by operations and potential capital
raising activities such as funds obtained through borrowings, particularly
refinancing of existing debt, and cash generated through asset sales. Although
we believe that estimated cash flows from operations and potential capital
raising activities will be sufficient to satisfy our scheduled debt service and
other obligations and sustain our operations for the next year, there can be no
assurance that we will be successful in obtaining the required amount of funds
for these items or that the terms of the potential capital raising activities,
if they should occur, will be as favorable as we have experienced in prior
periods.
During 2003, our Mega Deal Loan is anticipated to mature with an optional
prepayment date on November 11, 2003. The Mega Deal Loan, which is secured by a
13 property collateral pool, had an outstanding principal balance of $262,083 as
of June 30, 2003 and will require a balloon payment of $260,681 at the
anticipated maturity date. If the Mega Deal Loan is not satisfied at the
optional prepayment date, its interest rate will increase by 5.0% to 12.782% and
all excess cash flow from the 13 property collateral pool will be retained by
the lender and applied to principal after payment of interest. As discussed
below, certain restrictions have been placed upon us with respect to refinancing
the Mega Deal Loan in the short term. If the Mega Deal Loan is not refinanced,
the loss of cash flow from the 13 property collateral pool would eventually have
severe consequences on our ability to fund our operations.
Based on our discussions with various prospective lenders, we believe a
potential shortfall will likely occur with respect to refinancing the Mega Deal
Loan as we do not currently intend to refinance all of the 13 assets.
Nevertheless, we believe this shortfall can be alleviated through potential
asset sales and/or other capital raising activities, including the placement of
mezzanine level debt and mortgage debt on at least one of the asssets we do not
currently plan on refinancing. We caution that our assumptions are based on
current market conditions and, therefore, are subject to various risks and
uncertainties, including changes in economic conditions which may adversely
impact our ability to refinance the Mega Deal Loan at favorable rates or in a
timely and orderly fashion and which may adversely impact our ability to
consummate various asset sales or other capital raising activities.
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On July 8, 2003 an affiliate of The Lightstone Group, LLC ("Lightstone")
and us entered into a merger agreement (the "Merger Agreement"). (See Note 10 -
"Merger Agreement" for additional information.) In connection with the execution
of the Merger Agreement, certain restrictions were placed on us with respect to
the refinancing of the Mega Deal Loan. Specifically, we are restricted from
negotiating or discussing the refinancing of the properties securing the Mega
Deal Loan with any lenders until September 15, 2003, at which time we are only
able to enter into refinancing discussions with certain enumerated lenders.
After November 11, 2003, we may seek refinancing from other lenders. In
addition, we are precluded from closing any loans relating to the Mega Deal Loan
until November 11, 2003. This November 11, 2003 date may be extended until
January 11, 2004, at the election of Lightstone, if Lightstone elects prior to
September 15, 2003 to (i) pay (A) one-half of the additional interest incurred
by us between November 11, 2003 and December 31, 2003, and (B) all of the
additional interest incurred by us between January 1, 2004 and January 11, 2004,
if so extended, in respect of the Mega Deal Loan and (ii) loan us any shortfall
in cash flow that results from the excess cash flow restrictions (all excess
cash flow from the 13 property collateral pool will be retained by the lender
and applied to principal after payment of interest) under the Mega Deal Loan
that become effective on November 11, 2003 and thereafter until the Mega Deal
Loan is paid in full.
In addition to the restrictions with respect to the refinancing of the Mega
Deal Loan discussed above, pursuant to the terms of the Merger Agreement, we
have also agreed to certain conditions pending the closing of the proposed
transaction. These conditions provide for certain restrictions with respect to
our operating and refinancing activities (see Note 10 - "Merger Agreement" for
additional information). These restrictions could adversely affect our liquidity
in addition to our ability to refinance the Mega Deal Loan in a timely and
orderly fashion.
If the Merger Agreement is terminated under certain circumstances, we would
be required to make payments to Lightstone ranging from $3,500 to $6,000 which
could adversely affect our liquidity. See Note 10 - "Merger Agreement" of the
Notes to Consolidated Financial Statements for additional information.
In connection with the completion of the sale of the Bridge Properties in
July 2002, we guaranteed to FRIT (i) a 13% return on its $17,236 of invested
capital, and (ii) the full return of the Mandatory Redemption Obligation by
December 31, 2003. As of June 30, 2003, the Mandatory Redemption Obligation
(included in accounts payable and other liabilities in the Consolidated Balance
Sheet) was $14,888.
We continue to seek to generate additional liquidity to repay the Mandatory
Redemption Obligation through (i) the sale of FRIT's ownership interest in the
Bridge Properties and/or (ii) the placement of additional indebtedness on the
Bridge Properties. There can be no assurance that we will be able to complete
such capital raising activities by December 31, 2003 or that such capital
raising activities, if they should occur, will generate sufficient proceeds to
repay the Mandatory Redemption Obligation in full. Failure to repay the
Mandatory Redemption Obligation by December 31, 2003 would constitute a default,
which would enable FRIT to exercise its rights with respect to the collateral
pledged as security to the guarantee, including some of our partnership
interests in the 13 property collateral pool under the aforementioned Mega Deal
Loan. Because the Mandatory Redemption Obligation is secured by some of our
partnership interests in the 13 property collateral pool under the Mega Deal
Loan, we may be required to repay the Mandatory Redemption Obligation before, or
in connection with, the refinancing of the Mega Deal Loan. Additionally, any
change in control with respect to us accelerates the Mandatory Redemption
Obligation.
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In connection with the execution of the Merger Agreement, Lightstone has
agreed to provide sufficient financing, if necessary, to repay the Mandatory
Redemption Obligation in full at its maturity. The new financing would be at
substantially similar economic terms and conditions as those currently in place
for the Mandatory Redemption Obligation and would have a one-year term. See Note
10 - "Merger Agreement" for additional information.
We have fixed rate tax-exempt revenue bonds collateralized by properties
located in Chattanooga, Tennessee (the "Chattanooga Bonds") which contain (i)
certain covenants, including a minimum debt-service coverage ratio financial
covenant (the "Financial Covenant") and (ii) cross-default provisions with
respect to certain of our other credit agreements. Based on the operations of
the collateral properties, we were not in compliance with the Financial Covenant
for the quarters ended June 30, September 30 and December 31, 2002. In the event
of non-compliance with the Financial Covenant or default, the holders of the
Chattanooga Bonds (the "Bondholders") had the ability to put such obligations to
us at a price equal to par plus accrued interest. On January 31, 2003, we
entered into an agreement (the "Forbearance Agreement") with the Bondholders.
The Forbearance Agreement provides amendments to the underlying loan and other
agreements that enable us to be in compliance with various financial covenants,
including the Financial Covenant. So long as we continue to comply with the
provisions of the Forbearance Agreement and are not otherwise in default of the
underlying loan and other documents through December 31, 2004, the revised
financial covenants will govern. Additionally, certain quarterly tested
financial covenants and other covenants become effective June 30, 2004. Pursuant
to the terms of the Forbearance Agreement, we were required to fund $1,000 into
an escrow account to be used for conversion of certain of the retail space in
the collateral properties to office space and agreed that an event of default
with respect to the other debt obligations related to the property would also
constitute a default under the Chattanooga Bonds. We funded this required escrow
in February 2003. The outstanding balance of the Chattanooga Bonds was $17,920
as of June 30, 2003.
With respect to the Chattanooga Bonds, based on our current projections, we
believe we will not be compliance with certain quarterly tested financial
covenants when they become effective on June 30, 2004 which would enable the
Bondholders to elect to put the Chattanooga Bonds to us at their par amount plus
accrued interest. We continue to explore opportunities to (i) obtain alternative
financing from other financial institutions, (ii) sell the properties securing
the Chattanooga Bonds and (iii) explore other possible capital transactions in
order to generate cash to repay the Chattanooga Bonds. There can be no assurance
that we will be able to complete any such activity sufficient to repay the
amount outstanding under the Chattanooga Bonds in the event the Bondholders are
able and elect to exercise their put rights.
These conditions raise substantial doubt about our ability to continue as a
going concern. The financial statements contained herein do not include any
adjustment to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from the outcome of these uncertainties.
Dividends and Distributions
To qualify as a real estate investment trust ("REIT") for federal income
tax purposes, we are required to pay distributions to our common and preferred
shareholders of at least 90% of our REIT taxable income in addition to
satisfying other requirements. Although we intend to make distributions, if
necessary, to remain qualified as a REIT under the Code, we also intend to
retain such amounts as we consider necessary from time to time for our capital
and liquidity needs.
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Our policy remains to pay distributions only to the extent necessary to
maintain our status as a REIT for federal income tax purposes. During 2002, we
were not required to pay any distributions in order to maintain our status as a
REIT and based on our current federal income tax projections, we do not expect
to pay any distributions during 2003. On August 15, 2003 we will be in arrears
on 15 quarters of preferred stock distributions due February 15, 2000 through
August 15, 2003, respectively.
We may not make distributions to our common shareholders or our holders of
common units of limited partnership interests in the Operating Partnership
unless we are current with respect to distributions to our preferred
shareholders. As of June 30, 2003, unpaid dividends for the period beginning on
November 16, 1999 through June 30, 2003 on our Series A Senior Cumulative
Preferred Stock ("Series A Senior Preferred Stock") and Series B Cumulative
Convertible Participating Preferred Stock ("Series B Convertible Preferred
Stock") aggregated $21,886 and $60,301, respectively. The annualized dividends
on our 2,300,000 shares of Series A Senior Preferred Stock and 7,828,125 shares
of Series B Convertible Preferred Stock outstanding as of June 30, 2003 are
$6,037 ($2.625 per share) and $16,635 ($2.125 per share), respectively.
Merger Agreement
In June 2002, we selected Houlihan Lokey Howard & Zukin Capital to assist
us in exploring recapitalization, restructuring, financing and other strategic
alternatives designed to strengthen our financial position and address our
long-term capital requirements. Costs incurred related to such activities are
reflected in corporate general and administrative expense in the accompanying
Consolidated Statements of Operations.
On July 8, 2003, The Lightstone Group, LLC ("Lightstone"), a New
Jersey-based real estate company, and us jointly announced that an affiliate of
Lightstone had agreed to acquire the Company (the "Transaction"). The
Transaction will be effected in accordance with the terms of a merger agreement
(the "Merger Agreement") between Prime Outlets Acquisition Company, LLC (the
"Buyer"), a Delaware limited liability company which is an affiliate of
Lightstone, and us, which provides for us to be merged with and into the Buyer.
Consummation of the Transaction is subject to a number of conditions including
the approval of the Transaction and the Merger Agreement by the holders of at
least 66 2/3% of both our Series A Senior Preferred Stock and Series B
Convertible Preferred Stock, each voting separately as a class, and the approval
of a majority of our common shareholders voting to both amend our charter and
approve the Transaction and the Merger Agreement, as well as other customary
approvals.
The Transaction, which will result in aggregate consideration of $115,000
payable to the our shareholders and unit holders, has a total value of
approximately $638,000, including approximately $523,000 of debt expected to be
assumed by the Buyer. Under the terms of the Merger Agreement, each holder of
our Series A Senior Preferred Stock will receive cash in the amount of $16.25
per share, each holder of our Series B Convertible Preferred Stock will receive
cash in the amount of $8.66 per share, and each holder of our common stock will
receive cash in the amount of $0.18 per share.
Pursuant to the terms of the Merger Agreement, the Buyer and us have agreed
to certain conditions pending the closing of the Transaction. These conditions
provide for certain restrictions with respect to our operating and refinancing
activities, including our refinancing of the Mega Deal Loan (see Note 4 - "Debt"
of the Notes to Consolidated Financial Statements for additional information).
Page - (46)
Our board of directors, as well as a special committee comprised of
disinterested members of the board of directors (the "Special Committee"), have
approved the Transaction and the Merger Agreement and recommended that the
shareholders vote in favor of the resolutions to be proposed at a special
meeting of our shareholders. Because our charter does not address the allocation
of consideration among our various classes of capital stock in the Transaction,
such allocation was determined by the Special Committee and approved by the
board of directors. Houlihan Lokey Howard & Zukin Capital acted as financial
advisor to the Special Committee and Houlihan Lokey Howard & Zukin Financial
Advisors, Inc., an affiliate of Houlihan Lokey Howard & Zukin Capital, has
provided an opinion to the Special Committee and our board of directors that the
consideration to be received by each of the classes of our stock, considered
independently, is fair to such respective classes, from a financial point of
view.
The Transaction is expected to be completed during the fourth quarter of
2003. Formal documentation relating to the Transaction and the Merger Agreement
will be sent to our shareholders and limited partners. This documentation will
include notices of the special meeting and details of the Transaction and the
Merger Agreement and related matters.
Concurrent with the consummation of the Transaction, the agreement of
limited partnership of the Operating Partnership will be amended and restated
(the "Amended Partnership Agreement") pursuant to which holders of common units
in the Operating Partnership (other than common units held by us) will have the
opportunity to exchange all, but not less than all, of their units for a like
number of preferred units in the Operating Partnership ("Preferred Unit"). Each
holder of Preferred Units will be entitled to require the Operating Partnership
to redeem all of such holder's Preferred Units for an amount per unit equal to
$0.18 (the consideration paid for a share of common stock of the Company in the
Transaction) plus accrued and unpaid distributions at the rate of 6% per annum.
In addition, the Amended Partnership Agreement contains certain tax related
provisions that, subject to certain exceptions, will benefit holders of
Preferred Units for a period of seven years including restrictions on the sale
of properties and requirements to allocate debt in a certain manner.
We have agreed to pay the Buyer a termination fee of $4,500, plus expenses
of up to $1,500, if the Transaction is not completed under certain
circumstances, including our election to pursue an alternative transaction. In
certain other circumstances in which the Transaction has not been completed,
including the failure to obtain the shareholder approval of the Transaction, a
termination fee will not be payable but we have agreed to reimburse the Buyer
for its expenses up to $3,500. As collateral for these obligations, we also
entered into an agreement with Lightstone providing for the assignment of our
rights to, and interest in, an escrow of $2,800 which was established in
connection with our sale of Prime Outlets of Puerto Rico in December 2002 to an
affiliate of Lightstone.
On July 16, 2003, we announced that two shareholders (the "Series A
Parties") that collectively own approximately 32% of the outstanding shares of
Series A Senior Preferred Stock have objected to the allocation of the
consideration under the Merger Agreement in separate communications to us.
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In connection with the Transaction and the events described above, we have
proposed to facilitate limited discussions among certain of our preferred
shareholders to obtain their views with respect to the Transaction and the
proposed allocation of the merger consideration. In order to facilitate such
discussions, we are providing certain of our preferred shareholders (including
the Series A Parties) with certain information regarding the Transaction. (We
filed a Current Report on Form 8-K containing this information under Regulation
FD Disclosure with the Securities and Exchange Commission on August 5, 2003.)
There can be no assurances as to the timing, nature or outcome of these
discussions, which may include other shareholders of ours. Although under the
terms of the Merger Agreement, we have the right to modify, at our discretion,
the allocation of consideration among the various classes of stock until the
mailing of definitive proxy materials, any such modification would be subject to
approval of the Special Committee established in connection with the Transaction
and our board of directors.
Settlement of Tenant Matters
During 2002, we entered into settlement agreements with respect to certain
tenant matters providing for aggregate payments of $2,760. Through December 31,
2002, we made approximately $2,607 of such required payments. The 2002 payments
were principally made from certain funds escrowed under a mezzanine loan, which
was repaid in full in December 2002. The remaining payment of $153 was made in
January 2003 with cash from operations. These settlement agreements did not have
a material impact on our financial condition or our results from operations. We
had previously established reserves aggregating $5,000 for the settlement of
such matters.
Development Activities and Capital Expenditures
During 2003, we will continue to explore potential international
opportunities and will selectively consider expansion and/or redevelopment of
certain of our existing outlet centers. We do not currently expect such
activities to have a significant impact on our liquidity or financial condition.
Additionally, we expect to incur costs during the remainder of 2003 (i) in
connection with releasing space to new tenants and (ii) for repairs and
maintenance of our properties. However, we do not expect such expenditures to
have a significant impact on our liquidity or financial condition because
reserves for such costs are paid monthly into escrow accounts under many of our
loans.
Recent Accounting Pronouncements
In December 2002, the FASB issued Interpretation ("FIN") No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN No. 45 elaborates on the
disclosures to be made by a guarantor in interim and annual financial statements
about the obligations under certain guarantees. FIN No. 45 also clarifies that a
guarantor is required to recognize, at the inception of the guarantee, an
initial liability for the fair value of the obligation undertaken in issuing the
guarantee. The disclosure requirements of FIN No. 45 are effective for financial
statements of interim or annual periods ending after December 15, 2002. We
adopted the disclosure provisions of FIN No. 45 effective December 31, 2002. The
initial recognition and initial measurement provisions of FIN No. 45 are
applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. We did not issue or modify any guarantees during the six
months ended June 30, 2003. See "Guarantees and Guarantees of Indebtedness of
Others" contained in Note 4 - "Debt" of the Notes to Consolidated Financial
Statements for additional information.
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In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable
Interest Entities." FIN No. 46 clarifies the application of existing accounting
pronouncements to certain entities in which equity investors do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. The provisions of FIN No. 46
were immediately effective for all variable interests in variable interest
entities created after January 31, 2003, and we will need to apply the
provisions of FIN No. 46 to any existing variable interests in variable interest
entities by no later than July 1, 2003. We did not create any variable interest
entities during the six months ended June 30, 2003 and we do not believe that
FIN No. 46 will have a significant impact on our financial statements.
In May 2003, the FASB issued FAS No 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." FAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). Many of these instruments
were previously classified as equity. FAS No. 150 is generally applicable to
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. It is to be implemented by reporting the cumulative effect of a change
in accounting principle for financial instruments created before the issuance of
FAS No. 150 and still existing at the beginning of the interim period of
adoption. We will adopt FAS No. 150 in the third quarter of 2003 and do not
believe the implementation of FAS No. 150 will have a significant impact on our
financial statements.
Risk Management Activities
We are subject to various market risks and uncertainties, including, but
not limited to, the effects of current and future economic conditions, and the
resulting impact on our tenants' sales and our revenue; the effects of increases
in market interest rates from current levels (see below); the risks associated
with existing vacancy rates or potential increases in vacancy rates because of,
among other factors, tenant bankruptcies and store closures, and the resulting
impact on our revenue; and risks associated with refinancing our current debt
obligations or obtaining new financing under terms less favorable than we have
experienced in prior periods.
Interest Rate Risk
In the ordinary course of business, we are exposed to the impact of
interest rate changes. We employ established policies and procedures to manage
our exposure to interest rate changes. Historically, we have used a mix of fixed
and variable-rate debt to (i) limit the impact of interest rate changes on our
results from operations and cash flows and (ii) lower our overall borrowing
costs. In certain cases, we have used derivative financial instruments such as
interest rate protection agreements to manage interest rate risk associated with
variable-rate indebtedness. Nevertheless, as of June 30, 2003, all of our
outstanding indebtedness bore interest at fixed rates. See Item 3 -
"Quantitative and Qualitative Disclosures About Material Risk" for additional
information. Also see "Guarantees of Debt and Indebtedness of Others" for
additional information.
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Economic Conditions
In general, the leases relating to our outlet centers have terms of three
to five years and most contain provisions that somewhat mitigate the impact of
inflation. Such provisions include clauses providing for increases in base rent
and clauses enabling us to receive percentage rents for annual sales in excess
of certain thresholds based on merchants' gross sales. In addition, lease
agreements generally provide for (i) the recovery of a merchant's proportionate
share of actual costs of common area maintenance ("CAM"), refuse removal,
insurance, and real estate taxes, (ii) a contribution for advertising and
promotion and (iii) an administrative fee. CAM includes items such as utilities,
security, parking lot cleaning, maintenance and repair of common areas, capital
replacement reserves, landscaping, seasonal decorations, public restroom
maintenance and certain administrative expenses. We continually monitor our
lease provisions in light of current and expected economic conditions and other
factors. In this regard, we may consider alternative lease provisions (e.g.,
fixed CAM) where appropriate.
Funds from Operations
Industry analysts generally consider funds from operations ("FFO"), as
defined by the National Association of Real Estate Investment Trusts ("NAREIT"),
an alternative non-GAAP measure of performance of an equity REIT. In 1991,
NAREIT adopted its definition of FFO. This definition was clarified in 1995,
1999 and 2002. FFO is currently defined by NAREIT as net income or loss
(computed in accordance with GAAP), excluding gains or losses from provisions
for asset impairment and sales of depreciable operating property, plus
depreciation and amortization (other than amortization of deferred financing
costs and depreciation of non-real estate assets) and after adjustment for
unconsolidated partnerships and joint ventures and discontinued operations. FFO
includes non-recurring events, except for those that are defined as
"extraordinary items" in accordance with GAAP. FFO excludes the earnings impact
of "cumulative effects of accounting changes" as defined by GAAP. Effective
January 1, 2002, FFO related to assets held for sale, sold or otherwise
transferred and included in results of discontinued operations (in accordance
with the requirements of FAS No. 144) should continue to be included in FFO.
We believe that FFO is an important and widely used non-GAAP measure of the
operating performance of REITs, which provides a relevant basis for comparison
to other REITs. Therefore, FFO is presented to assist investors in analyzing our
performance. Our FFO is not comparable to FFO reported by other REITs that do
not define the term using the current NAREIT definition or that interpret the
current NAREIT definition differently than we do. Therefore, we caution that the
calculation of FFO may vary from entity to entity and, as such the presentation
of FFO by us may not be comparable to other similarly titled measures of other
reporting companies. We believe that to facilitate a clear understanding of our
operating results, FFO should be examined in conjunction with net income
determined in accordance with GAAP. FFO does not represent cash generated from
operating activities in accordance with GAAP and should not be considered as an
alternative to net income as an indication of our performance or to cash flows
as a measure of liquidity or ability to make distributions.
FFO was $5,988 for the three months ended June 30, 2003 compared to $2,256
for the same period in 2002. The second quarter of 2003 FFO results include $989
of net interest expense attributable to mortgage indebtedness that was defeased
in December 2002. This net interest expense had no impact on our operating cash
flow during 2003 because such payments were made from previously established
escrows. FFO adjusted ("Adjusted FFO") to exclude the impact of the net interest
expense attributable to the defeased indebtedness was $6,977.
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FFO was $11,142 for the six months ended June 30, 2003 compared to $9,219
for the same period in 2002. The 2003 FFO results include $1,953 of net interest
expense attributable to mortgage indebtedness that was defeased in December
2002. This net interest expense had no impact on our operating cash flow during
2003 because such payments were made from previously established escrows.
Adjusted FFO, which excludes the impact of the net interest expense attributable
to the defeased indebtedness, was $13,095.
The increases in our Adjusted FFO results during the 2003 periods compared
to our FFO results for the same periods in 2002 also reflects (i) interest
savings attributable to the repayment of indebtedness, (ii) the previously
discussed non-recurring charge of $3,000 in the second quarter of 2002 and (iii)
reduced bad debt expense. These items were partially offset by (i) the impact of
reduced weighted-average portfolio occupancy during the 2003 periods, (ii) the
impact of changes in economic rental rates and (iii) the loss of net operating
income resulting from the dispositions of properties during 2002, partially
offset by interest savings attributable to the repayment of indebtedness.
TABLE 5 provides a reconciliation of loss from continuing operations to FFO
and Adjusted FFO for the three and six months ended June 30, 2003 and 2002.
Table 5 - Funds from Operations
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------------- --------------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Loss from continuing operations $ (8,504) $ (20,629) $ (10,793) $ (10,218)
Adjustments:
Loss (gain) on sale of real estate - 10,991 - (5,802)
Provision for asset impairment 6,590 - 6,590 -
Depreciation and amortization 7,281 9,214 14,561 19,422
Non-real estate depreciation and amortization (745) (538) (1,277) (1,092)
Unconsolidated joint ventures' adjustments 1,366 963 2,061 1,746
Discontinued operations - 2,255 - 5,163
-------- --------- --------- ---------
FFO per NAREIT Definition 5,988 2,256 11,142 9,219
Defeased debt adjustment(1) 989 - 1,953 -
-------- --------- --------- ---------
Adjusted FFO $ 6,977 $ 2,256 $ 13,095 $ 9,219
======== ========= ========= =========
Other Data:
Net cash provided by operating activities $ 1,347 $ 5,268 $ 3,998 $ 9,936
Net cash provided by (used in) investing activities (1,817) 9,095 (1,190) 19,671
Cash used in financing activities (1,758) (15,252) (3,708) (31,943)
====================================================================================================================================
Note:
(1) In December 2002, we partially defeased our Mega Deal Loan in connection
with the sale of the Colorado Properties. In connection with the
defeasance, we purchased US Treasury Securities, which are maintained in a
Trustee Escrow. All debt service due under the Defeased Notes Payable
during the 2003 periods was made from the Trustee Escrow. During the three
and six months ended June 30, 2003, the interest income earned on the
Trustee Escrow was $517 and $1,042, respectively, and the interest expense
on the Defeased Notes Payable was $1,506 and $2,995, respectively, which
are included in our results from operations in the accompanying
Consolidated Statements of Operations. These items had no impact on our
operating cash flow during 2003 because the cash settlement with respect to
the Defeased Notes Payable occurred during 2002 and all payments made in
2003 were from restricted cash. Accordingly, we believe it is appropriate
to adjust for them in our Adjusted FFO calculation.
Page - (51)
Item 3. Quantitative and Qualitative Disclosures of Market Risk
Market Risk Sensitivity
We are subject to various market risks and uncertainties, including, but
not limited to, the effects of current and future economic conditions, and the
resulting impact on our revenue; the effects of increases in market interest
rates from current levels (see below); the risks associated with existing
vacancy rates or potential increases in vacancy rates because of, among other
factors, tenant bankruptcies and store closures, and the resulting impact on our
revenue; and risks associated with refinancing our current debt obligations or
obtaining new financing under terms less favorable than we have experienced in
prior periods.
Interest Rate Risk
In the ordinary course of business, we are exposed to the impact of
interest rate changes. We employ established policies and procedures to manage
our exposure to interest rate changes. Historically, we have used a mix of fixed
and variable-rate debt to (i) limit the impact of interest rate changes on our
results from operations and cash flows and (ii) lower our overall borrowing
costs. Nevertheless, as of June 30, 2003, all of our outstanding indebtedness
bore interest at fixed rates. The following table provides a summary of
principal cash flows, excluding (i) unamortized debt premiums of $6,910 and (ii)
non-recourse mortgage indebtedness aggregating $41,250 on certain properties
which is in default (see "Defaults on Certain Non-recourse Mortgage
Indebtedness" within "Liquidity and Capital Resources" of Item 2 - "Management's
Discussion and Analysis of Financial Condition and Results of Operations" for
additional information), and related contractual interest rates by fiscal year
of maturity. See Note 4 - "Debt" of the Notes to Consolidated Financial
Statements contained herein for additional information with respect to the terms
of our debt instruments.
- ------------------------------------------------------------------------------------------------------------------------------------
Year of Maturity
- ------------------------------------------------------------------------------------------------------------------------------------
2003 2004 2005 2006 2007 Thereafter Total
- ------------------------------------------------------------------------------------------------------------------------------------
Bonds Payable
Principal $ 591 $ 726 $ 773 $ 820 $ 878 $ 18,618 $ 22,406
Average interest rate 6.61% 6.34% 6.34% 6.34% 6.34% 6.52% 6.50%
Notes Payable
Principal $ 263,524 $ 4,571 $ 11,574 $ 120,437 $ 1,002 $ 57,995 $ 459,103
Average interest rate 7.79% 7.97% 8.58% 8.83% 7.60% 7.59% 8.06%
Defeased Notes Payable
Principal $ 74,280 $ 74,280
Average interest rate 7.78% 7.78%
====================================================================================================================================
Page - (52)
We sold Prime Outlets at Hagerstown (the "Hagerstown Center") on January
11, 2002 to an existing joint venture partnership (the "Prime/Estein Venture").
In connection with the sale, the Prime/Estein Venture assumed the first mortgage
loan on the Hagerstown Center (the "Hagerstown First Mortgage") in the amount of
$46,862; however, our guarantee of such indebtedness remains in place.
Additionally, we are obligated to refinance the Hagerstown First Mortgage on
behalf of the Prime/Estein Venture on or before June 1, 2004, the date on which
such indebtedness matures. The Prime/Estein Venture's cost of the Hagerstown
First Mortgage and any refinancing of it are fixed at an annual rate of 7.75%
for a period of 10 years. If the actual cost of such indebtedness should exceed
7.75% at any time during the 10-year period, we will be obligated to pay the
difference to the Prime/Estein Venture. If the actual cost of such indebtedness
is less than 7.75% at any time during the 10-year period, however, the
Prime/Estein Venture will be obligated to pay the difference to us. The actual
cost of the Hagerstown First Mortgage is 30-day LIBOR plus 1.50%, or 2.62% as of
June 30, 2003. Because the Hagerstown First Mortgage bears interest at a
variable rate, we are exposed to the impact of interest rate changes. At June
30, 2003, a hypothetical 100 basis point move in the LIBOR rate would impact our
guarantee by $469. See Note 4 - "Debt" of the Notes to Consolidated Financial
Statements for additional information.
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
We have conducted an evaluation of the effectiveness of our disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
promulgated under the Securities and Exchange Act of 1934, as amended) as
of the end of the period covered by this quarterly report on Form 10-Q,
which was conducted with the participation of our Chairman and Chief
Executive Officer along with our President, Chief Financial Officer and
Treasurer, Because of the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control
issues and instances of fraud, if any, within the Company have been
detected. However, based upon the evaluation, the Company's Chairman and
Chief Executive Officer along with the Company's President, Chief Financial
Officer and Treasurer concluded that, subject to the limitations described
above, the Company's disclosure controls and procedures are effective. In
addition, they concluded that there were no significant deficiencies in the
design or operations of internal controls, which could significantly affect
our ability to record, process, summarize and report financial data.
(b) Changes in Internal Controls
There was no significant change in our internal controls over financial
reporting that occurred during the fiscal quarter covered by this report
that has materially affected, or is reasonably likely to materially affect,
our internal controls over financial reporting.
Page - (53)
PART II: OTHER INFORMATION
Item 1. Legal Proceedings
For a description of legal proceedings involving us and our properties, please
see Part I, Item 3 - "Legal Proceedings" of our Annual Report on Form 10-K for
the year ended December 31, 2002 and Note 6 - "Legal Proceedings" of the Notes
to Consolidated Financial Statements contained herein. The following information
updates such disclosure.
Several entities (the "eOutlets Plaintiffs") filed or stated an intention to
file lawsuits (collectively, the "eOutlets Lawsuits") against us and our
affiliates arising out of our on-line venture, primeoutlets.com. inc., also
known as eOutlets, an affiliate of ours. primeoutelts.com, inc. filed for
protection under Chapter 7 of the United States Bankruptcy Code in November of
2000 under the name E-Outlets Resolution Corp. (the "Debtor"). The eOutlets
Plaintiffs sought to hold us and our affiliates responsible under various legal
theories for liabilities incurred by primeoutlets.com, inc., including the
theories that we guaranteed the obligations of eOutlets and that we were the
"alter-ego" of eOutlets. Other than the suit filed on November 5, 2002 and
discussed below, these eOutlets Lawsuits against us have been resolved or are
now barred by the applicable statute of limitations or otherwise. On November 5,
2002, the bankruptcy trustee for the Debtor brought suit against Prime Retail,
L.P., Prime Retail, Inc., and Prime Retail E-Commerce, Inc. (the "Entity
Defendants") and certain former directors of the Debtor (the "Individual
Defendants"). The Trustee has asserted claims of alter ego, promissory estoppel,
breach of contract, breach of fiduciary duty, tortious interference with
prospective business advantage, unjust enrichment and quantum meruit against the
Entity Defendants and breach of fiduciary duty and gross negligence against the
individual defendants. We have tendered the suit, both as to the Entity
Defendants and Individual Defendants, to the Directors' and Officers' insurance
carrier. Motions to dismiss the suit have been filed by all Defendants. All
Defendants believe the suit is without merit and plan on defending it
vigorously. Nevertheless, the outcome of this lawsuit, and the ultimate
liability of us, if any, cannot be predicted at this time.
Item 3. Defaults Upon Senior Securities
We are currently in arrears in the payment of distributions on our 10.5% Series
A Senior Cumulative Preferred Stock ("Series A Senior Preferred Stock") and 8.5%
Series B Cumulative Participating Convertible Preferred Stock ("Series B
Convertible Preferred Stock"). As of June 30, 2003, the aggregate arrearage on
the Series A Senior Preferred Stock and the Series B Convertible Preferred Stock
was approximately $21.9 million and approximately $60.3 million, respectively.
Page - (54)
Item 4. Submission of Matters to a Vote of Security Holders
(a) The Annual Meeting of Stockholders of Prime Retail, Inc. were held on June
10, 2003. At the meeting, the following matters were submitted to a vote:
(1) The common stockholders of Prime Retail, Inc. were asked to elect
two directors to hold office until the 2006 Annual Meeting of
Stockholders. The vote with respect to each nominee was as follows:
Nominee For Withheld
Glenn D. Reschke 40,671,184 1,530,361
Michael W. Reschke 40,648,180 1,553,167
(2) The holders of Series A Senior Preferred Stock and Series B
Convertible Preferred Stock, voting together as a class, were asked
to elect two directors to hold office until the 2006 Annual Meeting
of Stockholders or, if earlier, the date on which the full
dividends accumulated on all outstanding shares of preferred stock
have been paid in full or declared and a sum of money sufficient
the payment thereof set aside for payment. A quorum was not
present, in person or by proxy, at the meeting with respect to the
holders of Series A Senior Preferred Stock and Series B Convertible
Preferred Stock. The meeting was initially adjourned until June 24,
2003 and then again until June 30, 2003 for the limited purpose of
enabling the Company's preferred stockholders to elect two
directors. On June 27, 2003, the Company postponed the meeting for
a lack of a quorum.
Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are included in this Quarterly Report on Form 10-Q:
Exhibit 31.1 Certification of Glenn D. Reschke pursuant to Section
302 of the Sarbanes-Oxley Act of 2002, dated August
14, 2003.
Exhibit 31.2 Certification of Robert A. Brvenik pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, dated
August 14, 2003.
Exhibit 32.1 Certification of Glenn D. Reschke pursuant to Section
1350, Chapter 63 of Title 18, United States Code, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2003, dated as of August 14, 2003.
Exhibit 32.2 Certification of Robert A. Brvenik pursuant to
Section 1350, Chapter 63 of Title 18, United States
Code, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2003, dated as of August 14,
2003.
Reports on Form 8-K:
On June 30, 2003, we filed a Current Report on Form 8-K dated June 29,
2003, under Item 9, Regulation FD Disclosure. The filing included as an
exhibit, a press release we issued on June 29, 2003 regarding our
disclosure of limited discussions among certain of our restricted
preferred shareholders.*
Page - (55)
On July 9, 2003, we filed a Current Report on Form 8-K dated July 8,
2003, under Item 5, Other Events, relating to the joint announcement
between us and The Lightstone Group, LLC ("Lightstone"), a New
Jersey-based real estate company, providing for an affiliate of
Lightstone to acquire us (the "Transaction"). The Transaction will be
effected in accordance with the terms of an agreement and plan of
merger (the "Merger Agreement") dated as of July 8, 2003 between Prime
Outlets Acquisition Company, LLC (the "Buyer), a Delaware limited
liability company which is an affiliate of Lightstone, and us, which
provides for us to be merged with and into the Buyer. The filing
included as exhibits: (i) a copy of the Merger Agreement and (ii) a
copy of the joint press release issued by us and Lightstone regarding
the execution of the Merger Agreement.*
On July 17, 2003, we filed a Current Report on Form 8-K dated July 16,
2003, under Item 9, Regulation FD Disclosure. The filing included as an
exhibit, a press release we issued on July 16, 2003, announcing that
two shareholders that collectively own approximately 32% of the
outstanding shares of our Series A Senior Preferred Stock have objected
to the allocation of the consideration under the Merger Agreement in
separate communications to us.*
On August 5, 2003, we filed a Current Report on Form 8-K dated August
5, 2003, under Item 5, Other Events. The filing included as exhibits:
(i) certain background information regarding the proposed transaction
between us and Lightstone and (ii) a summary of the fairness opinion of
Houlihan Lokey Howard Zukin Financial Advisors, Inc. dated as of July
8, 2003 and a copy of such opinion. In addition, under Item 9,
Regulation FD Disclosure, the Company announced that it expects to
provide certain of its preferred stockholders with the information
contained in the filing.*
* Pursuant to General Instruction B of Form 8-K, the report submitted
to the Securities and Exchange Commission under Item 9, Regulation FD
Disclosure, is not deemed to be "filed" for purpose of Section 18 of
the Securities Exchange Act of 1934 (the "Exchange Act"), and we are
not subject to the liabilities of that section with respect to such
reports. We are not incorporating, and will not incorporate by
reference, such report into filings under the Securities Act of 1933 or
the Exchange Act.
Page - (56)
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.
PRIME RETAIL, INC.
Registrant
Date: August 14, 2003 /s/ Robert A. Brvenik
----------------------------------------
Robert A. Brvenik
President, Chief Financial Officer and
Treasurer