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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended December 31, 1998 OR
|_| Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from to ----------------
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Commission File Number 001-14183
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RECKSON SERVICE INDUSTRIES, INC.
(Exact name of registrant as specified in its charter)
Maryland 11-3233650
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
225 Broadhollow Road, 11747
Melville, NY (Zip Code)
(Address of principal
executive offices)
Registrant's telephone number, including area code: (516) 719-7400
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Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of Each Exchange on
Which Registered
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Common Stock, $.01 par value OTC Bulletin Board
Securities registered pursuant to Section 12(g) of the Act: None
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained to
the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K, or any
amendment to this Form 10-K. [ ]
The aggregate market value of the shares of common stock held by
non-affiliates was approximately $77,752,142 based on the average of the closing
bid and ask prices on the OTC Bulletin Board for such shares on March 24 ,1999.
The number of the Registrant's shares of common stock outstanding was
24,686,834 as of March 24,1999.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the Annual Shareholder's
Meeting to be held June 24,1999 are incorporated by reference into Part III.
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TABLE OF CONTENTS
Form 10-K
Item No. Report Page
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PART I
1. Business.......................................................... I-1
2. Properties........................................................ I-6
3. Legal Proceedings................................................. I-6
4. Submission of Matters to a Vote of Security
Holders........................................................... I-6
PART II
5. Market for Registrant's Common Equity and Related
Stockholder Matters............................................... II-1
6. Selected Financial Data........................................... II-2
7. Management's Discussion and Analysis of Financial Condition and
Results of Ooperations......................................... II-3
7a. Quantitative and Qualitative Disclosures about Market
Risk........................................................... II-9
8. Financial Statements and Supplementary Data....................... II-9
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure............................ II-9
PART III
10. Directors and Executive Officers of the Registrant................III-1
11. Executive Compensation............................................III-1
12. Security Ownership of Certain Beneficial Owners
and Management................................................ III-1
13. Certain Relationships and Related Transactions................... III-1
PART IV
14. Financial Statements and Schedules, Exhibits and
Reports on Form 8-K............................................ IV-1
ITEM 1. BUSINESS
General
Reckson Service Industries ("RSI" or the "Company"), a business service
provider, was formed on July 15, 1997 by Reckson Associates Realty Corp.
("Reckson"), to create, operate and manage a system of inter-related business
services offered for sale to its customer pool which currently includes business
customers of Reckson Operating Partnership, L.P. ("ROP") a commercial real
estate owner, Advantis, the Company's executive suite business, On-Site
Ventures, LLC, ("On-Site") the Company's telecommunications business, Reckson
Strategic Venture Partners, LLC ("RSVP") (collectively, the "RSI Customer Pool")
and third parties in the general marketplace through a centralized
infrastructure. The Company's growth strategy is to acquire or form strategic
alliances with established businesses with strong entrepreneurial management and
a reputation for high quality services within each of its targeted business
service sectors ("Business Service Platforms"). Specifically, the Company seeks
opportunities to provide business services for which there is broad demand in
the RSI Customer Pool. Such Business Service Platform investment or alliance
serves as a basis for sale and delivery of business services to the RSI Customer
Pool. The Company believes the RSI Customer Pool will attract exceptional
investment opportunities and strategic alliances which can capitalize on
enhanced revenue opportunities through a cross selling effort. The Company will
establish Business Service Platforms that present significant opportunities to
provide business services to the RSI Customer Pool and third parties. Currently,
the RSI Customer Pool retains third parties to provide many business to business
services for their day-to-day operations. Of these services, the Company may
seek to provide the RSI Customer Pool with telecommunications, outsourced
business services, E-commerce and content, executive suites and concierge
services, as well as other business services that the Company determines may be
utilized by the RSI Customer Pool. The RSI Customer Pool consists of small to
medium size businesses as well as the mobile workforce of large corporations.
RSI seeks to provide the RSI Customer Pool with high quality value-added
business services meeting all of their outsourcing needs and providing them with
resources to successfully compete in the marketplace. The Company will seek
growth in each Business Service Platform by (i) accessing the RSI Customer Pool
as an anchor for growth opportunities, (ii) integrating each Business Service
Platform into RSI's centralized infrastructure and (iii) acquiring similar
businesses, forming strategic alliances or making additional investments within
such Business Service Platform.
In connection with the initial capitalization of RSI, ROP contributed $4,256,324
for a 95% non-voting equity interest and certain members of Reckson management
contributed notes of $224,017 to the Company in exchange for a 5% voting
ownership interest. On October 29, 1997 the notes were repaid.
On June 11, 1998, ROP distributed its 95% of the common stock of RSI to its unit
holders of record on May 26, 1998 (the "Distribution"). Immediately prior to the
Distribution, the shares of non-voting common stock held by ROP were exchanged
by RSI for RSI common shares. Each share of the Company's common stock issued in
the Distribution was accompanied by one preferred share purchase right.
Simultaneously, Reckson distributed 100% of the RSI common shares received from
the Distribution to its common shareholders of the same record date. In
addition, simultaneously with the Distribution, the Company issued rights to its
stockholders to subscribe for the purchase of additional shares of common stock
of the Company.
Immediately after the distribution of RSI common stock, RSI granted to its
stockholders (each a "Holder") one subscription right for each share of RSI
common stock. Each subscription right entitled the Holders to purchase one share
of RSI common stock at a purchase price of $1.03 per share (the "Exercise
Price") and, at the election of such Holder, four additional shares (but not
less than four additional shares) at a purchase price of $1.03 per share. A
Holder of subscription rights had the opportunity to acquire up to an aggregate
of approximately 20,557,130 shares of RSI common stock. RSI and Reckson Standby,
LLC (the "Standby Purchaser") (an entity owned by several members of
management), entered into a standby agreement pursuant to which the Standby
Purchaser agreed to purchase, and RSI agreed to sell, any and all shares of RSI
common stock that were the subject of subscription rights in the rights offering
but were not subscribed for by a Holder on the expiration date at the Exercise
Price. The proceeds from the StandBy Purchaser were approximately $7,325,000.
RSI received net proceeds from the rights offering of approximately $19,852,000.
In connection with the Company's initial capitalization the Company obtained,
from ROP a five year $100 million unsecured credit facility (the "RSI
Facility"). The RSI Facility bears interest at a rate equal to the greater of
the prime rate plus 2% and (i) 12% per annum with the rate in this clause (ii)
increasing annually on outstanding borrowings at the rate of 4% per year over
the prior year's rate.
ROP and RSI have entered into an intercompany agreement (the "ROP Intercompany
Agreement") to formalize their relationship and to limit conflicts of interest.
Under the ROP Intercompany Agreement, RSI granted ROP a right of first
opportunity to make any Real Estate Investment Trust ("REIT")-qualified
investment that becomes available to RSI. In addition, if a REIT-qualified
investment opportunity becomes available to an affiliate of RSI, including RSVP,
the ROP Intercompany Agreement requires such affiliate to allow ROP to
participate in such opportunity to the extent of RSI's interest.
Under the ROP Intercompany Agreement, ROP granted RSI a right of first
opportunity to provide business services to ROP and its tenants. RSI is required
to provide services to ROP at rates and on terms as attractive as either the
best available for comparable services in the market or those offered by RSI to
third parties. In addition, ROP is required to give RSI access to its tenants
with respect to business services that may be provided to such tenants and,
under the ROP Intercompany Agreement, subject to certain conditions, ROP granted
RSI a right of first refusal to become the lessee of any real property acquired
by ROP if ROP determines that, consistent with Reckson's status as a REIT, it is
required to enter into a "master" lease agreement.
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RSI Fund Management, LLC a wholly owned subsidiary of RSI, is a managing member
of RSVP Holdings, LLC ("Holdings"), the managing member of RSVP, a real estate
venture capital fund formed to invest in real estate and real estate-related
operating companies outside of Reckson's core interests. RSVP will invest in
established entrepreneurial enterprises with experienced management teams in
market sectors which are in the early stages of their growth cycle or offer
unique circumstances for attractive investments as well as platforms for future
growth ("RSVP Investments"). ROP has committed $100 million to be invested in
RSVP Investments (the "RSVP Facility"). Paine Webber Real Estate Securities,
Inc. ("PWRES") is a non-managing member and holds a preferred interest in RSVP.
PWRES has committed $200 million in capital (the "PWRES Equity Facility") and
shares 66 2/3% in profits and losses of RSVP, subject to a maximum internal rate
of return ("IRR") of 16% of invested capital. On April 24, 1998, PWRES assigned
25% of its preferred equity interest in RSVP, representing an unfunded capital
committment of $50 million to Stratum Realty Fund, LLC ("Stratum"). The
assignment provides Stratum with similar rights and privileges. Excess returns
over 16% on the PWRES Equity Facility is to be distributed to Holdings. On March
17, 1999, PWRES transferred all of its rights, title and interest on its
invested capital to date in RSVP to Stratum.
Holdings has retained two managing directors (the "RSVP Managing Directors") to
manage the day-to-day operations of RSVP, subject to the strategic direction of
RSI. New World Realty, LLC ("New World"), an entity owned by the RSVP Managing
Directors acts as a managing member of Holdings. The Holdings operating
agreement (the "Managing Member Operating Agreement") provides for the payment
to New World of distributions out of the cash flow of Holdings, after RSI
and affiliated persons have received a return of their capital contributions to
RSVP investments plus a 12% IRR thereon, of $15 million and, thereafter, a share
of cash flows ranging from 15% to 27.75% based upon the IRR received by RSI and
affiliated persons above 12% in respect of RSVP investments. The Managing Member
Operating Agreement obligates RSI to contribute 100% of the capital
contributions to be made by Holdings to RSVP in an amount up to $100 million. In
the event that RSI defaults in making its capital contributions, distributions
of cash to RSI will be subordinated to certain distributions to New World and
RSI's management rights will be reduced and RSI will be obligated to purchase,
at the election of New World, a portion of New World's interest in Holdings for
a minimum of $15 million. At the termination of RSVP, New World has a right of
first refusal to purchase any RSVP investment proposed for sale. New World will
also be entitled to one-half of any asset management fee earned by Holdings from
ROP. Additionally, it is anticipated that New World will receive transaction
fees of up to $1 million a year for identifying investment opportunities for
RSVP.
The Company's executive offices are located at 225 Broadhollow Road, Melville,
New York 11747 and its telephone number at that location is (516) 719-7400. At
December 31, 1998, the Company had approximately 13 employees.
Recent Developments
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Investment Activities
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Set forth below is a brief description of the Company's major investment
activities during 1998:
Executive Office Suites
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On April 1, 1998, the Company acquired a 9.9% membership interest in Reckson
Executive Centers, LLC ("REC, LLC") for $200,000 from ROP and assumed debt of
approximately $322,000. On October 5, 1998, the Company contributed its interest
in REC, LLC to Reckson Executive Centers, Inc. ("REC") in exchange for 75% of
the common stock of REC.
On November 9, 1998, the Company acquired a majority interest in Interoffice
SuperHoldings Corporation ("Interoffice"), a nationally operated executive
office suite business. The aggregate purchase price paid by the Company was
approximately $20.5 million, and was financed through borrowings under the RSI
Facility. The Company also acquired receivables related to certain advances made
to certain other stockholders of Interoffice for approximately $10.3 million.
Such receivables are secured by the shares held by these stockholders.
On January 8, 1999, Interoffice (36 executive office suite centers) and REC (8
executive office suite centers) merged with Alliance National Incorporated, a
holding company which owns and operates approximately 90 nationally located
executive office suite centers.The merged company changed its name to Advantis.
The stockholders of Interoffice and REC received shares of the Series C
Preferred Stock of Advantis which represent approximately
40% of the equity interest in Advantis. The Company thereafter owned
approximately 23% of Advantis. The holders of the Series C Preferred Stock have
the right to appoint four of the ten members of the Board of Directors of
Advantis, including Chairman of the Board and received specified preemptive
rights and other specified rights. RSI and the other stockholders of Interoffice
hold the Series C Preferred Stock received in respect of the merger of
Interoffice through Interoffice Superholdings, LLC ("IS LLC"), a newly formed
Delaware limited liability company of which RSI is the sole managing member. RSI
also holds the Series C Preferred Stock received in respect of the merger of REC
through Reckson Office Centers, LLC, a newly formed Delaware limited liability
company of which a subsidiary of RSI is the managing member.
Advantis and RSI have also entered into an intercompany agreement pursuant to
which RSI has the opportunity to be the exclusive provider of certain business
services to Advantis, provided certain third party and "most-favored nation"
conditions are satisfied.
RSI acquired certain ownership rights related to the Series C Preferred Stock of
Advantis from a stockholder of Interoffice which provided the Company with
enhanced governance rights for $6.5 million. In addition, the Company paid $3.5
million to another stockholder of Interoffice for an option to purchase that
stockholders effective interest in the Series C Preferred Stock for a purchase
price of $6.75 million. If the option is not exercised, the stockholder has the
right to sell such interests to the Company at fair value, as determined in
accordance with the applicable agreement. A significant number of items
presented to the Advantis Board will require the separate approval of a majority
of the representatives of the Series
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C Preferred Stock on the Board, including significant acquisitions, sale or
leasing of assets, approval of Advantis's annual operating budget, certain
borrowings and capital expenditures by Advantis, the hiring or termination of
senior executives and other matters. The holders of Series C Preferred Stock
also have the right to appoint half of the members of the executive and audit
committees of the Board. The preferred stockholders of Advantis (including the
holders of Advantis' Class A Preferred Stock, Class B Preferred Stock and Class
C Preferred Stock) were granted super-majority voting rights with respect to
certain corporate actions, including the issuance of equity securities, changes
to the charter documents of Advantis and other matters.
Telecommunications
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The Company currently has a 1% interest and holds a subordinated note
convertible into a 58.69% equity interest in On-Site, a company that provides
advanced telecommunications systems and services within commercial and
residential buildings and/or building complexes. The Company has advanced
On-Site $6.5 million through December 31, 1998 to fund certain operating costs
under the terms of the subordinated note. The loan bears interest at a rate of
12% per annum. In May 1998, the Company made an initial capital contribution of
$300,000 for a 58.69% interest in On-Site Commerce and Content, LC ("OCC"), a
Company established to acquire and develop software products. As of December 31,
1998 OCC had no operations.
Real Estate Venture Capital Fund
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On August 11, 1998, RSVP, through a wholly owned subsidiary, formed a joint
venture, Gateway Development Group, LLC ("Gateway"), with Gateway Management
Group. Gateway is a start up entity that pursues opportunities in privatized
military housing. During 1998, RSVP contributed $549,238 to Gateway. The Company
is uncertain whether it will recover its invested dollars from Gateway's future
cash flows. At December 31, 1998, RSVP has recognized a loss of $650,531 which
includes a reserve for their total contributed dollars and investment costs of
$101,293.
On August 12, 1998, RSVP acquired, through a wholly owned subsidiary a 45%
interest in Assisted Living Investments, LLC ("ALI") for approximately $3.25
million. ALI is a joint venture that develops, leases, operates and finances
assisted living facilities. In addition, RSVP has agreed to contribute 80% of
the equity of ALI, up to a maximum $16.0 million for a total maximum commitment
of $19.25 million. RSVP funded $7.5 million of its $19.25 million commitment
upon the closing of the transaction. RSVP has funded 50% of its capital
contributions through draws under the PWRES Equity Facility.
On August 27, 1998, RSVP formed a joint venture with Dominion, an
Oklahoma-based, privately-owned group of companies that focuses on the
development, acquisition and ownership of government occupied office buildings
and correctional facilities. The joint venture, Dominion Venture Group LLC, (the
"Dominion Venture"), is owned by RSVP-Dominion, LLC, a subsidiary of RSVP, and
by Burgess Services, LLC, an entity owned and controlled by Calvin Burgess,
President and Chief Executive Officer of Dominion. The Dominion Venture will
engage primarily in acquiring, developing and/or owning government-occupied
office buildings and privately operated correctional facilities and related
activities. RSVP is to invest up to $100 million in the Dominion Venture subject
to its affirmative voting rights relating to investment activities. RSVP funded
its total capital contribution of $8,597,455 through draws under the PWRES
Equity Facility and the RSVP facility. ROP has contributed $10,065,338 to the
Dominion Venture.
Financing Activities
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During 1998, RSI established the RSI Facility with ROP in the amount of $100
million for RSI's business service sector operations and other general corporate
purposes. Borrowings under the RSI Facility bear interest at the rate equal to
the greater of (i) the prime rate plus 2% and (ii) 12% per annum, with the rate
referred to in clause (ii) increasing annually on outstanding borrowings at a
rate of 4% per year of the prior year's rate. The RSI Facility is expected to be
payable on an interest only basis from net cash flow and have a five year term.
Advances under the RSI Facility will be a recourse obligation of RSI. Under the
terms of the RSI facility, as long as there are outstanding advances under such
facility the Company is prohibited from paying dividends on any shares of its
capital stock. At December 31, 1998, RSI had availability under the RSI Facility
to borrow an additional $66.3 million.
During 1998, ROP approved the funding of $100 million of investments with or in
RSVP. It is anticipated that a portion of these investments will be funded
through advances to RSI under the RSVP Facility. The RSVP Facility has a term
and interest rate similar to that of the RSI Facility. At December 31, 1998, RSI
had availability under the RSVP facility to borrow an additional $82,652,881.
Corporate Strategies, Growth Opportunities and Business Segments
The Company's primary business objective is to maximize the long term return to
shareholders through the appreciation in the value of its common stock. The
Company plans to achieve these objectives by executing the corporate strategies
and growth opportunities described below.
Corporate Strategies. Management believes that there exists a significant
opportunity to create, operate and manage a system to deliver business to
business services to the RSI Customer Pool. Management also believes that it is
in a unique position to invest in companies that will expand the RSI Customer
Pool and thereby increase its business services business. Management intends to
execute an
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operating strategy that will provide the RSI Customer Pool with high quality
value-added services to meet the customer's outsourcing needs while providing
them with a competitive advantage in the marketplace. These operating strategies
include the implementation of (i) a marketing program that will survey our
customers to comprehend their outsourcing service needs and design creative
approaches to sell RSI's business services, (ii) programs to form strategic
alliances with business service companies to enable RSI to quickly and
efficiently bundle and deliver a variety of service products to the RSI Customer
Pool, (iii) an acquisition strategy to expand the RSI Customer Pool through our
executive suites business or by making strategic investments in key business
service providers, and (iv) cost control management and systems that take
advantage of economies of scale that arise from the Company's large customer
base and market position.
Internal Growth. Currently the RSI Customer Pool consists of customers of the
following investees and business partners: (i) Advantis Executive Suites which
total approximately 15,000 customers (ii) ROP which has approximately 1,500
business tenants, employing additional thousands of personnel and (iii) On-Site
that has 170 business customers. The Company will initially target this large
customer base to provide business services. The Company believes that it can
build a substantial service business by penetrating this Customer Pool.
External Growth. The Company intends to seek external growth opportunities
through investment in business service companies or strategic alliances with
such companies. These investments and alliances will serve to increase the RSI
Customer Pool and expand the distribution and variety of service products
available for sale to the RSI Customer Pool. For example, the Company will seek
to increase its investment in the executive suite business through the
acquisition and development of executive suite centers by Advantis. The Company
will utilize the RSI Facility to fund its additional investment. The Company
will also seek other forms of equity capital through strategic venture partners.
Business Segments
Executive Office Suites
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The executive office suites business ("EOS") began approximately 35 years ago.
There has been a significant expansion in the business during the last decade.
This growth resulted largely from corporate downsizing and the development of
technology which decreased the need for employees to be present in large
corporate offices. Instead, more work has been outsourced to consultants, or
smaller groups, who often work closer to their homes. A wide range of services
are now offered by EOS businesses and are only paid for on an "as-used" basis.
The EOS business meets the needs of a broad range of businesses from individual
entrepreneurs to branch offices of Fortune 500 firms offering basic telephone
and clerical services as well as more advanced services such as
teleconferencing, internet access and virtual office concepts.
The industry combines many aspects of the real estate business - supply, demand
and location - with those of a service intensive business, including technology.
The industry is currently fragmented with only two large participants operating
on a national basis with many operating under an affiliation or networking
basis.
The merger of the Company's executive suite businesses, REC and Interoffice
with Advantis, on January 8, 1999 created the nation's largest executive suite
company.
Telecommunications
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Building centric communications is a newer sector of the telecommunications
industry, having evolved largely as a result of the Telecommunications Act of
1996. This sector includes those companies involved in providing local and
long-distance telecommunications and high-speed Internet access. The industry
and this sector are regulated on both the federal and state level. Competing in
this sector requires significant capital expenditures for wiring and equipment.
Companies with access to lower-cost capital have a competitive advantage due to
the significant capital expenditures incurred by participants in this sector.
This sector is undergoing rapid change, development and innovation. On-Site is
one of several companies seeking to establish a significant presence in this
market.
Student Housing
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The student housing industry is a specialized market sector that is highly
fragmented and has relatively few large participants. Management believes that
student housing represents a market sector that will maintain growth trends as
the student population increases. According to the 1994 Statistical Abstract of
the United States, 8.6 million students were enrolled in higher education
institutions nationwide in 1970. This population increased to over 12.1 million
in 1980. By 1995, it was estimated that the student population was over 16.5
million with over 18 million students projected by 2005. While the student
population has continued to increase, the rate of growth slowed somewhat during
the last several years. The U.S. Department of Education estimates that the
student housing industry is currently a $10 billion dollar industry and could
grow to a $20 billion industry in less than ten years.
While the student population and the demand for student housing has increased,
housing stock and in particular on-campus housing stock, has not kept up with
demand. Student housing is comprised of two different sub-sectors, on-campus and
off-campus housing. However, some university-run student housing projects are
experiencing declining occupancy rates, as a direct result of age, general
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mismanagement, and physical and functional obsolescence rather than due to a
lack of demand. The failure of the housing supply to keep pace with the
increased demand provides the opportunity to develop new private on and off
campus student housing and to improve the management and physical condition of
existing university owned housing through privatization.
Privatization
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In the United States the Privatization Industry is in the initial stages of an
anticipated significant period of growth. Traditionally, government
organizations have financed new facilities through a combination of budget
appropriations and bonds. As governments of all types face increasing pressure
to control costs and improve the quality of services, they are increasingly
turning to the private sector.
Privatization holds a great deal of promise due to expected growth, which will
arise mainly from increasing demand from municipalities that will outstrip the
available supply of real estate dedicated to governmental use, and governments'
embracing the economic benefits and other efficiencies of private sector
financing, ownership and management, which will cause governments to depart from
their historic primary reliance upon budget appropriations for financing,
self-development and self-management.
Opportunities in privatization of correctional facilities will arise from an
extremely favorable demand/supply environment. Many prison jurisdictions are
currently operating their prisons at levels exceeding their legal capacities and
are therefore under federal court order to alleviate prison overcrowding.
According to the Bureau of Justice Statistics, as of year end 1996, state
prisons were operating at between 16% to 24% overcapacity, while the federal
correction systems was 25% overcrowded. Sentencing jurisdictions cannot
appropriate funds or obtain financing to construct new facilities because of
other pressing fiscal demands and requirements for public approval. Many
governments have been, and more will be, forced to consider private ownership of
correctional facilities.
As high occupancy rate and prison overcrowding have resulted in an increased
demand for new correctional facilities, the new construction can be absorbed in
the market. These factors create a strong opportunity for growth in investments
with companies that have demonstrated capabilities in developing and leasing
correctional facilities.
Privatization of government office, industrial, residential and other real
estate will create new opportunities for investment by the private sector as
governments acknowledge the benefits of a shift from public ownership and
development of such assets towards the increasing involvement of, and ultimately
dependence on, the private sector. As with correctional facilities, development
and construction capabilities enhance investment opportunities in these types of
privatized real estate.
Assisted Living
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Assisted living is currently the fastest growing segment of the seniors-housing
industry with over 6.5 million senior adults (adults over the age of 65) in need
of some form of assistance with the activities of daily living. Activities of
daily living are defined to mean those activities necessary to health, grooming,
personal sanitation, and well-being which reasonably competent and healthy
individuals can ordinarily perform for themselves. Such activities include, but
are not limited to, walking, bathing, shaving, dental care, grooming, dressing
oneself, shopping food preparation, self-administration of medication,
recreation, and leisure activities.
The number of senior adults will approximately double over the next 20 years,
and over the next five years, it is estimated that seniors will account for
one-third of all population growth in the United States. Because of these
demographic trends, new capital is flowing rapidly into assisted living. The
capital sources are attracted to the fact that, although there are currently
facilities which cater to those suffering from Alzheimer's disease or other
illnesses, assisted living facilities fill the gap for housing requirements for
the remainder of the frail elderly that require some form of assistance with the
activities of daily living, but do not need the nursing services provided by
more specialized facilities.
The goal of assisted living residences is to provide a home-like environment
with hospitality services and to provide assistance with daily living activities
to those who need it where such need has not risen to the level of skilled
nursing in a long term facility environment. Assisted living facilities are
defined to be a building or group of buildings in which room, board, meals,
laundry, and assistance with personal care and other services are provided by
trained professionals to elderly adults.
Financial information about the Company's industry segments may be found in Note
6 to the Company's consolidated financial statements presented in Item 8 of this
Annual Report on From 10-K and incorporated herein by reference.
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ITEM 2. PROPERTIES
The Company leases its principal office at 225 Broadhollow Road, Melville, New
York, 11747, in a building owned in part by certain members of management. In
addition, the Company also leases an office at 10 East 50th Street, New York,
New York, 10017.
Reckson Executive Centers, Inc. leases its offices at 225 Broadhollow Road,
Melville, New York, 11747. Interoffice Holdings Corporation maintains its
principal office at 11350 Random Hills Road, Fairfax, Virginia, 22030.
On-Site Ventures, LLC leases its principal office at 680 Third Avenue, New York
New York.
Reckson Strategic Venture Partners, LLC leases its principal office at 50
Charles Lindbergh Boulevard, Suite 400, Uniondale, New York, 11553 as a lessee
in a building owned by Reckson Operating Partnership, L.P.
Management believes that such properties are sufficient to meet their present
needs and does not anticipate any difficulty in securing additional space, as
needed, on terms acceptable to the Company.
ITEM 3. LEGAL PROCEEDINGS
The Company is not presently subject to any material litigation nor, to the
Company's knowledge, is any litigation threatened against the Company, other
than routine actions for negligence or other claims and administrative
proceedings arising in the ordinary course of business, some of which are
expected to be covered by liability insurance and all of which collectively are
not expected to have a material adverse effect on the liquidity, results of
operations or business or financial condition of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of stockholders during the fourth quarter of
the year ended December 31, 1998.
I-6
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock began trading over-the-counter ("OTC") on June 29,
1998 under the symbol "RSII". The following table sets forth the quarterly high
and low closing bid prices per share of the common stock reported for each
respective quarter. These OTC market quotations reflect inter-dealer prices,
without retail mark-up, mark-down or commission and may not necessarily
represent actual transactions. Since inception, the Company has not paid any
dividends to its stockholders. Under the terms of the credit facilities that the
Company has obtained from Reckson Operating Partnership, L. P. ("ROP") as long
as there are outstanding advances under such facilities, the Company is
prohibited from paying dividends on any shares of its capital stock.
High Low
---- ---
June 29, 1998..................... $4.063 $3.625
June 30, 1998..................... $3.750 $3.125
September 30, 1998................ $4.500 $2.000
December 31, 1998................. $4.625 $1.688
The Company's Registration Statement on Form S-1 (File No. 333-44419) with
respect to the spin-off distribution of its shares and the registration of
20,557,130 shares of the Company's common stock in connection with the rights
offering, was declared effective by the Securities and Exchange Commission on
May 13, 1998. In connection with the rights offering, which expired on June 29,
1998, the Company sold 20,557,130 shares of common stock for aggregate proceeds
of approximately $21.1 million before deducting approximately $1.2 million of
offering costs. As of December 31, 1998, the Company had used approximately
$17.7 million of the net proceeds of the rights offering to repay indebtedness
(and related interest) to ROP, approximately $1 million to fund advances to
On-Site and approximately $1.2 million to pay operating and other expenses.
II-1
ITEM 6. SELECTED FINANCIAL DATA
For the For the period
year ended July 15, 1997 to
December 31, 1998 December 31, 1997
------------------------ ------------------------
OPERATIONS SUMMARY:
Total revenues..................................... $ 1,342,504 $ 30,383
Equity in earnings (loss) of investments........... (3,966,399) 223,437
Total expenses..................................... 5,455,963 511,707
Cumulative effect of change in accounting principle (67,945) -----
Net loss........................................... $ (8,147,803) $ (257,887)
PER SHARE DATA: (1)
Basic and diluted net loss......................... $ (.56) $ ----
BALANCE SHEET DATA (PERIOD END):
Equity Investments ................................ $ 45,837,711 $ 5,845,258
Affiliate receivables.............................. 9,396,070 832,854
Equipment.......................................... 99,928 -----
Other assets....................................... 1,483,427 30,185
Total assets....................................... 58,842,663 7,519,695
Credit facilities.................................. 40,981,500 -----
Loans payable to affiliates........................ ----- 3,177,857
Total liabilities.................................. 42,875,157 3,297,241
Total shareholders' equity......................... $ 15,967,506 $ 4,222,454
- -----------
(1) Based on 14,522,513 weighted average shares of common stock outstanding for
the year ended December 31, 1998.
II-2
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the accompanying
Financial Statements of Reckson Service Industries, Inc. (the "Company" or
"RSI") and related notes thereto.
The Company considers certain statements set forth to be forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, with respect to
the Company's expectations for future periods. Certain forward-looking
statements, including, without limitation, statements relating to the ability to
identify and acquire interests in commercial services companies, the financing
of the Company's operations, the timing and success of such acquisitions and the
ability to integrate and manage effectively its various acquisitions, involve
certain risks and uncertainties. Although the Company believes that the
expectation reflected in such forward-looking statements are based on reasonable
assumptions, the actual results may differ materially from those set forth in
the forward-looking statements and the Company can give no assurance that its
expectations will be achieved. Certain factors that might cause the results of
the Company to differ materially from those indicated by such forward-looking
statements include, among other factors, general economic conditions, a lack of
attractive business opportunities or suitable acquisitions, the Company's
dependence upon financing from Reckson Operating Partnership, L.P., ("ROP")
conflicts of interest of management, competition for targeted acquisitions and
the ability to otherwise finance business opportunities. Consequently, such
forward-looking statements should be regarded solely as reflections of the
Company's current operating and development plans and estimates. These plans and
estimates are subject to revision from time to time as additional information
becomes available, and actual results may differ from those indicated in the
referenced statements.
OVERVIEW AND BACKGROUND
The Company's primary business is to create and operate a system of interrelated
business services offered for sale to its customer pool which includes customers
of ROP, a commercial real estate owner, Advantis, the Company's executive suite
business, On-Site Ventures, LLC ("On-Site"), the Company's telecommunications
business, and Reckson Strategic Venture Partners, LLC ("RSVP"), (collectively,
the "RSI Customer Pool") and third parties in the general marketplace through a
centralized infrastructure. The Company's growth strategy is to acquire or form
strategic alliances with established businesses with strong entrepreneurial
management and a reputation for high quality services within each of its
targeted business service sectors ("Business Service Platforms"). Specifically,
the Company seeks opportunities for which there is broad demand in the RSI
Customer Pool. Such Business Service Platform investment or alliance serves as a
basis for sale and delivery of business services to the RSI Customer Pool. The
Company will establish Business Service Platforms that present significant
opportunities to provide business services to the RSI Customer Pool and other
third parties. Currently, the RSI Customer Pool retains third parties to provide
many business to business services for their day-to-day operations. Of these
services, the Company may seek to provide the RSI Customer Pool with
telecommunications, outsourced business services, E-commerce and content,
executive suites and concierge services, as well as with other business services
that the Company determines may be utilized by the RSI Customer Pool. The
Company will seek growth in each Business Service Platform by (i) accessing the
RSI Customer Pool as an anchor for growth opportunities (ii) integrating each
Business Service Platform into RSI's centralized infrastructure and (iii)
acquiring similar businesses, forming strategic alliances, or making additional
investments within such Business Service Platform.
In connection with the initial capitalization of RSI, ROP contributed $4,256,324
for a 95% non-voting equity interest and certain members of Reckson management
contributed notes of $224,017 to the Company in exchange for a 5% voting
ownership interest. On October 29, 1997 the notes were repaid.
On June 11, 1998, ROP distributed its 95% of the common stock of RSI to its unit
holders of record on May 26, 1998 (the "Distribution"). Immediately prior to the
Distribution, the shares of non-voting common stock held by ROP were exchanged
by RSI for RSI common shares. Each share of the Company's common stock issued in
the Distribution was accompanied by one preferred share purchase right.
Simultaneously, Reckson Associates Realty Corp. ("Reckson") distributed 100% of
the RSI common shares received from the Distribution to its common shareholders
of the same record date. In addition, simultaneously with the Distribution, the
Company issued rights to its stockholders to subscribe for the purchase of
additional shares of common stock of the Company.
Immediately after the Distribution of RSI common stock, RSI granted to its
stockholders (each a "Holder") one subscription right for each share of RSI
common stock. Each subscription right entitled the Holder to purchase one share
of RSI common stock at a purchase price of $1.03 per share (the "Exercise
Price") and, at the election of such Holder, four additional shares (but not
less than four additional shares) at a purchase price of $1.03 per share. A
Holder of subscription rights had the opportunity to acquire up to an aggregate
of approximately 20,557,130 shares of RSI common stock. RSI and Reckson Standby,
LLC (the "Standby Purchaser") (an entity owned by several members of
management), entered into a standby agreement pursuant to which the Standby
Purchaser agreed to purchase, and RSI agreed to sell, any and all shares of RSI
common stock that were the subject of subscription rights in the rights offering
but were not subscribed for by a Holder on the expiration date at the Exercise
Price. The proceeds from the Standby Purchaser were
II-3
approximately $7,325,000. RSI received net proceeds from the rights offering of
approximately $19,852,000. In connection with the Company's initial
capitalization the Company obtained, from ROP a five year $100 million unsecured
credit facility (the "RSI Facility"). The RSI Facility bears interest at a rate
equal to the greater of the prime rate plus 2% and (i) 12% per annum with the
rate in clause (ii) increasing annually on outstanding borrowings at the rate of
4% per year over the prior year's rate.
ROP and RSI have entered into an intercompany agreement (the "ROP Intercompany
Agreement") to formalize their relationship and to limit conflicts of interest.
Under the ROP Intercompany Agreement, RSI granted ROP a right of first
opportunity to make any Real Estate Investment Trust ("REIT") -qualified
investment that becomes available to RSI. In addition, if a REIT-qualified
investment opportunity becomes available to an affiliate of RSI, including RSVP,
the ROP Intercompany Agreement requires such affiliate to allow ROP to
participate in such opportunity to the extent of RSI's interest.
Under the ROP Intercompany Agreement, ROP granted RSI a right of first
opportunity to provide commercial services to ROP and its tenants. RSI will
provide services to ROP at rates and on terms as attractive as either the best
available for comparable services in the market or those offered by RSI to third
parties. In addition, ROP is required to give RSI access to its tenants with
respect to business services that may be provided to such tenants and, under the
ROP Intercompany Agreement, subject to certain conditions, ROP granted RSI a
right of first refusal to become the lessee of any real property acquired by ROP
if ROP determines that, consistent with the REIT status of Reckson, it is
required to enter into a "master" lease agreement.
RSI Fund Management, LLC a wholly owned subsidiary of RSI, is a managing member
of RSVP Holdings, LLC ("Holdings"), the managing member of RSVP, a real estate
venture capital fund formed to invest in real estate and real estate-related
operating companies outside of Reckson's core interests. RSVP will invest in
established entrepreneurial enterprises with experienced management teams in
market sectors which are in the early stages of their growth cycle or offer
unique circumstances for attractive investments as well as platforms for future
growth ("RSVP Investments"). ROP has committed $100 million to be invested in
RSVP Investments (the "RSVP Facility"). Paine Webber Real Estate Securities,
Inc. ("PWRES") is a non-managing member and holds a preferred interest in RSVP.
PWRES has committed $200 million in capital (the "PWRES Equity Facility") and
shares 66 2/3% in profits and losses of RSVP, subject to a maximum internal rate
of return ("IRR") of 16% of invested capital. On April 24, 1998, PWRES assigned
25% of its preferred equity interest in RSVP, representing an unfunded capital
committment of $50 million to Stratum Realty Fund, LLC ("Stratum"). Excess
returns over 16% on the PWRES Equity Facility is to be distributed to Holdings.
On March 17, 1999, PWRES transferred all of its rights, title and interest on
its invested capital to date in RSVP to Stratum.
Holdings has retained two managing directors (the "RSVP Managing Directors") to
manage the day-to-day operations of RSVP, subject to the strategic direction of
RSI. New World Realty, LLC ("New World"), an entity owned by the RSVP Managing
Directors acts as a managing member of Holdings. The Holdings operating
agreement (the "managing member operating agreement") provides for the payment
to New World of distributions out of the cash flow of Holdings, after RSI and
affiliated persons have received a return of their capital contributions to RSVP
investments plus a 12% IRR thereon, of $15 million and, thereafter, a share of
cash flows ranging from 15% to 27.75% based upon the IRR received by RSI and
affiliated persons above 12% in respect of RSVP investments. The managing member
operating agreement obligates RSI to contribute 100% of the capital
contributions to be made by Holdings to RSVP in an amount up to $100 million. In
the event RSI defaults in making its capital contributions, distributions of
cash to RSI will be subordinated to certain distributions to New World and RSI's
management rights will be reduced and RSI will be obligated to purchase, at the
election of New World, a portion of New World's interest in Holdings for a
minimum of $15 million. At the termination of RSVP, New World has a right of
first refusal to purchase any RSVP investment proposed for sale.
New World will also be entitled to one-half of
any asset management fee earned by Holdings from ROP. Additionally, it is
anticipated that New World will receive transaction fees of up to $1 million a
year for identifying investment opportunities for RSVP.
On April 1, 1998, the Company acquired a 9.9% membership interest in Reckson
Executive Centers, LLC ("REC, LLC") for $200,000 from ROP and assumed debt of
approximately $322,000. On October 5, 1998, the Company contributed its interest
in REC, LLC to Reckson Executive Centers, Inc. ("REC") in exchange for 75% of
the common stock of REC.
On November 9, 1998, the Company acquired a majority interest in Interoffice
SuperHoldings Corporation ("Interoffice"), a nationally operated executive
office suite business. The aggregate purchase price paid by the Company was
approximately $20.5 million and was financed through borrowings under the RSI
Facility. The Company also acquired receivables related to certain advances made
to certain other stockholders of Interoffice for approximately $10.3 million.
Such receivables are secured by the share held by these stockholders.
On January 8, 1999, Interoffice (36 executive office suite centers) and REC (8
executive office suite centers) merged with Alliance National Incorporated, a
holding company which owns and operates approximately 90 nationally located
executive office suite centers. The merged company changed its name to Advantis.
The stockholders of Interoffice and REC received shares of the Series C
Preferred Stock of Advantis which represent approximately 40% of the equity
interest in Advantis. The Company thereafter owned approximately 23% of
Advantis. The holders of the Series C Preferred Stock have the right to appoint
four of the ten members of the board of directors of Advantis, including
Chairman of the Board and received specified preemptive rights and other
specified rights. RSI and the other stockholders of Interoffice hold the Series
C Preferred Stock received in respect of the merger of Interoffice through
Interoffice Superholdings, LLC ("IS LLC"), a newly formed Delaware limited
liability company of which RSI is the sole managing member. RSI also holds the
Series C Preferred Stock received in respect of the merger of REC through
Reckson Office Centers, LLC, a newly formed Delaware limited liability company
of which a subsidiary of RSI is the managing member.
II-4
Advantis and RSI have also entered into an intercompany agreement pursuant to
which RSI has the opportunity to be the exclusive provider of certain business
services to Advantis, provided certain third party and "most-favored nation"
conditions are satisfied.
RSI acquired certain ownership rights related to the Series C Preferred Stock of
Advantis from a stockholder of Interoffice which provided the Company with
enhanced governance rights for $6.5 million. In addition, the Company paid $3.5
million to another stockholder of Interoffice for an option to purchase that
stockholders effective interest in the Series C Preferred Stock for a purchase
price of $6.75 million. If the option is not exercised, the stockholder has the
right to sell such interests to the Company at fair value, as determined in
accordance with the applicable agreement. A significant number of items
presented to the Advantis Board will require the separate approval of a majority
of the representatives of the Series C Preferred Stock on the Board, including
significant acquisitions, sale or leasing of assets, approval of Advantis's
annual operating budget, certain borrowings and capital expenditures by
Advantis, the hiring or termination of senior executives and other matters. The
holders of Series C Preferred Stock also have the right to appoint half of the
members of the executive and audit committees of the Board. The preferred
stockholders of Advantis (including the holders of Advantis' Class A Preferred
Stock, Class B Preferred Stock and Class C Preferred Stock) were granted
super-majority voting rights with respect to certain corporate actions,
including the issuance of equity securities, changes to the charter documents of
Advantis and other matters.
The Company currently has a 1% interest and holds a subordinated note
convertible into a 58.69% equity interest in On-Site, a company that provides
advanced telecommunications systems and services within commercial and
residential buildings and/or building complexes. The Company has advanced
On-Site $6.5 million through December 31, 1998 to fund certain operating costs
under the terms of the subordinated note. The loan bears interest at a rate of
12% per annum. In May 1998, the Company made an initial capital contribution of
$300,000 for a 58.69% interest in On-Site Commerce and Content, LLC ("OCC"), a
Company established to acquire and develop software products. As of December 31,
1998 OCC had no operations.
RESULTS OF OPERATIONS
For the period from July 15, 1997 (commencement of operations) to December 31,
1997 the Company reported total revenues of $253,820. Total revenues include (i)
equity in earnings of $245,593 which represents RSI's 33 1/3% interest in a
joint venture that owns a 70% interest in Dobie Center Properties, Ltd.
.("Dobie"), (ii) equity in loss of American Campus Communities, LLC ("ACC") of
$22,156 and (iii) interest income of $30,383 relating to loans made to certain
affiliates. The Company also reported total expenses of $511,707 which
substantially represents payroll and office costs.
II-5
Summary of Operations by Business Segment
Executive Suites
- ----------------
For the period November 9, 1998 to December 31, 1998, Interoffice reported loss
of $73,509. RSI's share after adjustments, was income of $54,161. For the period
April 1, 1998 to December 31, 1998, REC reported losses of $275,818. RSI's share
of these losses was $149,079. REC's losses were generally attributable to costs
of opening new centers.
Telecommunications
- ------------------
For the period May 18, 1998 to December 31, 1998, On-Site reported losses of
$3,055,505. On-Site's losses were generally attributable to start-up costs. The
Company's share of losses attributable to its 1% equity interest was $30,555. In
connection with the Company's convertible notes with On-Site, RSI recognized
$345,428 in interest income.
RSVP Holdings, LLC
- ------------------
For the year ended December 31, 1998, Holdings, reported total revenues of
$646,678, equity in losses on investments of $3,993,755 and expenses of
$7,261,529. RSI's share of Holdings' loss for the year ended December 31, 1998
was $3,959,989. Included in Holdings' operating results are the following RSVP
activities:
Student Housing
- ---------------
For the year ended December 31, 1998, Dobie reported income of $869,412. RSI's
share of income for its period of ownership, January 1, 1998 to March 31, 1998
was $170,567. For the period April 1, 1998 to December 31, 1998 RSVP's share of
income was $32,296. Student rental revenues are generally recognized over the
school year. In addition, in August of 1998, the mortgage indebtedness in Dobie
Center was refinanced with a larger mortgage loan resulting in increased
interest expense.
For the period April 1, 1998 to December 31, 1998, ACC, reported losses of
$2,226,330. RSI's share of those losses for its period of ownership, January 1,
1998 to March 31, 1998 was $51,504. For the period April 1, 1998 to December 31,
1998 RSVP's share of losses was $518,895. ACC losses generally related to
operating expenses on new projects prior to student occupancy,
in addition to interest expense and amortization of leaseholds.
Privatization
- -------------
On August 11, 1998, RSVP, through a wholly owned subsidiary, formed a joint
venture, Gateway Development Group,LLC ("Gateway") with Gateway Management
Group. During 1998, RSVP contributed $549,238 to Gateway. RSVP is currently
uncertain whether it will recover its invested dollars from Gateway's future
cash flows.
At December 31, 1998, RSVP has recognized a loss of $650,531 which includes a
reserve for their total contributed dollars and investment costs of $101,293.
For the period August 27, 1998 to December 31, 1998 Dominion Venture Group, LLC
reported income of $970,608. RSVP's share of income was $296,970.
Assisted Living
- ---------------
For the period August 21, 1998 to December 31,1998 Assisted Living Investments,
LLC ("ALI") reported losses of $5,102,096. RSVP's share of losses amounted to
$2,907,607. ALI's losses were generally attributable to the opening of new
assisted living facilities and the costs of operating and maintaining those
facilities prior to their lease up.
LIQUIDITY AND CAPITAL RESOURCES
Summary of Cash Flows
- ---------------------
Net cash used by operating activities totaled approximately $15 million in 1998
and $1.9 million for the period July 15, 1997 to December 31, 1997. Cash used in
operations for 1998 and 1997 were primarily attributable to the start-up losses
incurred by the Company, advances to affiliates and general and administrative
operating costs.
Net cash used in investing activities totaled approximately $44 million in 1998
and $2 million for the period July 15, 1997 to December 31, 1997. Cash used in
investing activities related primarily to investments in and advances to
Holdings, Interoffice and On-Site.
II-6
Net cash provided by financing activities totaled approximately $61 million in
1998, and $4 million for the period July 15, 1997 to December 31, 1997. Cash
provided by financing activities during 1998 is attributable to proceeds from
the rights offering and draws on the RSI facility and the RSVP facility.
Financing Activities
On June 15, 1998, RSI established the RSI Facility with ROP in the amount of
$100 million for RSI's service sector operations and other general corporate
purposes. On the same date, RSI established the RSVP Facility with ROP for
funding of investments of up to $100 million with or in RSVP through (i)
RSVP-controlled joint venture REIT-qualified investments, or (ii) advances made
to RSI subsequent to the Distribution. Advances under the RSVP Facility in
excess of $25 million in respect of any single platform are subject to approval
by Reckson's board of directors, while advances under the RSI Facility in excess
of $10 million in respect of any single investment in a Business Service
Platform, as well as advances for investments in opportunities in non-commercial
services, are subject to approval by Reckson's board of directors, or a
committee thereof. The RSI and RSVP Facilities (the "Credit Facilities") each
have a term of five years and advances thereunder are recourse obligations of
RSI. Interest accrues on advances made under the Credit Facilities at a rate
equal to the greater of (i) the prime rate plus 2% and (ii) 12% per annum, with
the rate on balances outstanding for more than one year increasing annually at a
rate of 4% of the prior year's rate. Prior to maturity, interest is payable
quarterly but only to the extent of net cash flow and on an interest-only basis
and is prepayable without penalty at the option of RSI. As long as there are
outstanding advances under the Credit Facilities, RSI is prohibited from paying
dividends on any shares of its capital stock. The Credit Facilities are subject
to certain other covenants and will prohibit advances thereunder to the extent
such advances could, in the determination of Reckson, endanger Reckson's status
as a REIT. Additional indebtedness may be incurred by subsidiaries of RSI. As of
December 31, 1998, approximately $33.7 million was outstanding under RSI
Facility and approximately $17.3 million was advanced under the RSVP Facility of
which approximately $10.1 million represents an investment by ROP in RSVP joint
ventures and approximately $7.2 million represents outstanding borrowings.
Additionally, RSVP has obtained the PWRES Equity Facility which provides for the
investment by PWRES of up to $200 million in RSVP in the form of preferred
equity, subject to certain conditions. Amounts available under the PWRES Equity
Facility have been used by RSVP to make investments consistent with its business
objectives and to fund working capital. Under the terms of the PWRES Equity
Facility, RSVP is subject to various covenants and events of default and related
remedies. Such remedies include increased control rights of PWRES over the
operation of RSVP under certain circumstances. Advances under the PWRES Equity
Facility are partially funded by an investment fund that is jointly sponsored by
financier George Soros and PWRES. In addition, PWRES and such investment fund
will receive a priority or preferred distribution from RSVP prior to the
distribution of cash to RSI. As of December 31, 1998, PWRES and Stratum have
contributed $37,465,384. On March 17, 1999, PWRES transferred all of its rights,
title and interest on its invested capital to date in RSVP to Stratum. This
transfer will include the rights to distributions based upon the amount of
funded capital contributions.
The Company utilizes the advances under the RSI Facility primarily to make
investments in operating companies that provide business services. The Company
may make additional investments in these operating companies to accommodate
their respective growth plans. The Company's investments in operating companies
are anticipated to produce net cash flow as a result of their operating
activities over the long term, although the level and timing of net cash flow
for each investment in the short-and long-term may vary based upon the stage of
the respective operating company's growth cycle and the level of the Company's
ownership interest. The Company targets investments in operating companies that
will produce net cash flow in the long-term. It is expected that certain of the
Company's investments will be made in Companies which it does not own a
majority interest or fully control. Thereby cash flow of these companies will be
used for growth opportunities at such companies and not for distribution to its
owners. It is also expected that the Company will seek to invest in companies
where it controls operations and consolidates such companies cash flows with
those of the Company. Under such circumstances net cash flow produced by the
Company's investments will be used for debt service under the RSI Facility and
for the Company's operating costs. The Company expects to meet its short term
liquidity requirements generally through its net cash flow produced by its
operations along with advances under the RSI Facility. The Company expects that
it will refinance indebtedness under the RSI Facility at maturity or retire such
debt through the issuance of debt securities or equity securities, although
there can be no assurance that the Company will be able to refinance or retire
such indebtedness. The Company anticipates that cash on hand, net cash flows
from operating activities, together with cash available from borrowings under
the RSI Facility, will be adequate to meet the capital and liquidity
requirements of the Company in both the short-and long-term.
IMPACT OF YEAR 2000
With respect to the year 2000 disclosure, the following Company information
pertains to RSI, its direct investments (On-Site, Interoffice and Holdings), as
well as the RSVP platform investments.
Some of the Company's older computer programs were written using two digits
rather than four to define the applicable year. As a result, those computer
programs have time-sensitive software that recognizes a date using "00" as the
year 1900 rather than the year 2000. This could cause a system failure or
miscalculation causing disruptions of operations, including, among other things,
a temporary inability to
II-7
process transactions, or engage in similar normal business activities.
The Company has completed an assessment to modify or replace portions of its
software so that its computer systems will function properly with respect to
dates in the year 2000 and thereafter. Currently, the entire property management
system is year 2000 compliant and has been thoroughly tested. Since the
Company's accounting software is maintained and supported by a third party, the
total year 2000 project cost is estimated to be minimal.
The year 2000 project is estimated to be completed not later than July 31, 1999,
which is prior to any anticipated impact on its operating systems. Additionally,
the Company has received assurances from its contractors that all of the
Company's building management and mechanical systems are currently year 2000
compliant or will be made compliant prior to any impact on those systems.
However, the Company cannot guarantee that all contractors will comply with
their assurances and therefore, the Company may not be able to determine year
2000 compliance of those contractors. At that time, the Company will determine
the extent to which the Company will be able to replace non-compliant
contractors. The Company believes that with modifications to existing software
and conversions to new software, the year 2000 issue will not pose significant
operational problems for its computer systems. However, if such modifications
and conversions are not made, or are not complete timely costs associated with
the year 2000 issue could be significant and have a material impact on the
operations on the Company.
To date, the Company has expended approximately $21,000 and expects to expend an
additional $60,000 in connection with upgrading building management, mechanical
and computer systems. The costs of the project and the date on which the Company
believes it will complete the year 2000 modifications are based on management's
best estimates, which were derived utilizing numerous assumptions of future
events, including the continued availability of certain resources and other
factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from those anticipated.
Specific factors that might cause such material differences include, but are not
limited to, the availability and costs of personnel trained in this area, the
ability to locate and correct all relevant computer codes, and similar
uncertainties.
In a "worst case scenario" of the failure of the third party to deliver to, on a
timely basis, the necessary upgrades to the accounting software, the Company
would be required to process transactions, such as the issuance of
disbursements, manually until an alternative system was implemented.
If the Company is not successful in implementing its year 2000 compliance plan,
the Company may suffer a material adverse impact on their results of operations
and financial condition. Because of the importance of addressing the year 2000
issue, the Company expects to develop contingency plans if they determine that
the compliance plans will not be implemented by July 31, 1999.
INFLATION
The Credit Facilities bear interest at the greater of the prime rate plus 2% or
12% (on balances outstanding more than one year increasing 4% per year, as
described above). The rate of interest on the Credit Facilities will be
influenced by changes in short-term rates and is sensitive to inflation and
other economic factors. A significant increase in interest rates may have a
negative impact on the earnings of the Company due to the variable interest rate
under the Credit Facilities.
The privatization, assisted living and student housing sectors are subject to
incremental rent increases each year. The Company believes that inflationary
increases will be offset by these rent increases.
RECENT PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement No. 133,
"Accounting for Derivative Instruments and Hedging Activities", which is
required to be adopted in years beginning after June 15, 1999. The Statement
permits early adoption as of the beginning of any fiscal quarter after its
issuance. The Company expects to adopt the new Statement effective January 1,
2000. The Company does not anticipate that the adoption of this Statement will
have any effect on its results of operations or financial position.
II-8
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The primary market risk facing the Company is interest rate risk on its Credit
Facilities. The Company does not hedge interest rate risk using financial
instruments. The Credit Facilities bear interest at the greater of the prime
rate plus 2% or 12% (with balances outstanding more than one year increasing 4%
per year, as described above). The rate of interest on the Credit Facilities
will be influenced by changes in short term rates and is sensitive to inflation
and other economic factors. A significant increase in interest rates may have a
negative impact on the earnings of the Company due to the variable interest rate
under the Credit Facilities.
The following table sets forth the Company's Credit Facilities obligations,
principal cash flows by scheduled maturity, weighted average interest rates and
estimated fair market value ("FMV") at December 31, 1998.
1999 2000 2001 2002 2003 Thereafter Total FMV
---- ---- ---- ---- ---- ---------- ----- ---
Variable rate $ ------ $ ----- $ ------ $ ----- $ 40,981,500 $ ----- $40,981,500 $40,981,500
Average interest ------ ----- ------ ----- 12% ----- 12% ------
rate
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is included in a separate section of this Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
II-9
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information contained in the section captioned "Proposal I: Election of
Directors" of the Company's definitive proxy statement for the 1999 annual
meeting of stockholders is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information contained in the section captioned "Executive Compensation" of
the Company's definitive proxy statement for the 1999 annual meeting of
stockholders is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information contained in the section captioned "Principal and Management
Stockholders" of the Company's definitive proxy statement for the 1999 annual
meeting of stockholders is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information contained in the section captioned "Certain Relationships and
Related Transactions" of the Company's definitive proxy statement for the 1999
annual meeting of the stockholders is incorporated herein by reference.
III-1
PART IV
ITEM 14. FINANCIAL STATEMENTS AND SCHEDULES, EXHIBITS AND REPORTS ON FORM 8-K
(a) (1 and 2) Financial Statements and Schedules
The following consolidated financial information is included as a
separate section of this annual report on Form 10-K:
PAGE
-----------
RECKSON SERVICE INDUSTRIES, INC.
Report of Independent Auditors.................................................................... IV-6
Consolidated Balance Sheets as of December 31, 1998 and December 31, 1997......................... IV-7
Consolidated Statements of Operations for the year ended December 31, 1998 and for
the period from July 15, 1997 (commencement of operations) to December 31, 1997................ IV-8
Consolidated Statements of Shareholders' Equity for the year ended December 31, 1998
and for the period from July 15, 1997 (commencement of operations) to December 31, 1997........ IV-9
Consolidated Statements of Cash Flows for the year ended December 31, 1998 and for
the period from July 15, 1997 (commencement of operations) to December 31, 1997................ IV-10
Notes to Consolidated Financial Statements........................................................ IV-11
IV-1
FINANCIAL STATEMENTS INCLUDED PURSUANT TO RULE 3-09 OF REGULATION S-X
INTEROFFICE SUPERHOLDINGS CORPORATION AND SUBSIDIARIES
Report of Independent Auditors ............................................. IV-26
Consolidated Balance Sheet as of December 31, 1998 ......................... IV-27
Consolidated Statement of Operations for the period from November 9, 1998
to December 31, 1998 ..................................................... IV-28
Consolidated Statement of Stockholders' Equity for the period from November
9, 1998 to December 31, 1998............................................. IV-29
Consolidated Statement of Cash Flows for the period from November 9, 1998 to
December 31, 1998 ........................................................ IV-30
Notes to Consolidated Financial Statements ................................. IV-31
RSVP HOLDINGS, LLC
Report of Independent Auditors ............................................. IV-41
Consolidated Balance Sheet as of December 31, 1998 ......................... IV-42
Consolidated Statement of Operations for the period from February 26, 1998
(commencement of operations) to December 31, 1998 ........................ IV-43
Consolidated Statement of Members' Equity for the period from February 26,
1998 (commencement of operations) to December 31, 1998 ................... IV-44
Consolidated Statement of Cash Flows for the period from February 26, 1998
(commencement of operations) to December 31, 1998 ........................ IV-45
Notes to Consolidated Financial Statements ................................. IV-46
Other schedules are omitted since the required information is not present in
amounts sufficient to require submission of the the schedule or because the
information required is included in the financial statements and notes thereto.
IV-2
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
3.1* Certificate of Incorporation
3.2* By-Laws of Registrant
3.3 Amended and Restated Certificate of Incorporation
4.1* Specimen Share Certificate of Common Stock
10.1 Intercompany Agreement between Reckson Operating Partnership, L..P. and
Reckson Service Industries, Inc. dated May 13, 1998
10.2A Credit Agreement between Reckson Operating Partnership, L.P. and
Reckson Service Industries, Inc. relating to the operations of Reckson
Strategic Venture Partners,LLC dated June 15, 1998
10.2B Credit Agreement between Reckson Operating Partnership, L.P. and
Reckson Service Industries, Inc. relating to the operations of Reckson
Service Industries, Inc. dated June 15, 1998
10.3* Limited Liability Company Agreement of OnSite Ventures, LLC
10.4* StandBy Purchase Agreement
10.5* Limited Liability Company Agreement of RSVP Holdings, LLC
10.6A* Operating Agreement of Reckson Strategic Venture Partners, LLC
10.6B* Supplemental Agreement to Operating Agreement of Reckson Strategic
Venture Partners, LLC
10.7* Registration Rights Agreement between Reckson Service Industries, Inc.
and certain affiliates thereof dated May 13, 1998
10.8* Option to acquire Interoffice Superholdings Corporation
10.9 Loan Agreement regarding On-Site Convertible Loans
10.10A* Stock Option Plan
10.10B 1998 employee stock option plan
10.11* Employment Agreement of Steven H. Shepsman
10.12* Employment Agreement of Seth B. Lipsay
10.13* Limited Liability Company Agreement of Interoffice Superholdings, LLC
by and among Interoffice Superholdings, LLC, RSI I/O Holdings, Inc.,
JAH I/O, LLC and Rieger I/O LLC
10.14* Fourth Amended and Restated Stockholder's Agreement dated January 8,
1999 by and among Alliance National Incorporated and the security
holders identified therein.
10.15** Letter Agreement dated November 9, 1998 by and between JAH I/O LLC and
Reckson Management Group, Inc., Reckson Service Industries, Inc., RSI
I/O Holdings, Inc., and Reckson Office Centers, LLC
10.16** Letter Agreement by and between Reckson Service Industries, Inc., and
RFIA, LLC
10.17*** Amended and Restated Operating Agreement of Assisted Living Investments
LLC
10.18# Operating Agreement of Dominion Venture Group LLC
10.19## Agreement and Plan of Merger by and among Alliance National
Incorporated, Alliance Holding Inc., Interoffice Superholdings
Corporation and Interoffice Superholdings, LLC
10.20## Agreement and Plan of Merger by and among Alliance National
Incorporated, ANI Holdings, Inc., Reckson Executive Centers, Inc., and
Reckson Office Centers, LLC
10.21 $4 million Senior Secured Promissory Note of On-Site Ventures, LLC
12.1 Statement of Ratios of Earnings to Fixed Charges
21.1 Statement of Subsidiaries of Reckson Service Industries, Inc.
24.1 Powers of Attorney (included in Part IV of this Form 10-K)
27.0 Financial Data Schedule
99.1* Form of Letter to Stockholders regarding Rights Offering
99.2* Subscription Agent Agreement between Reckson Service Industries, Inc.,
and American Stock Transfer & Trust Company
- -------------
* Previously filed as an exhibit to Registration Statement on Form S-1 (No.
333-44419) and incorporated herein by reference.
** Previously filed as an exhibit to the Company's Form 8-K filed with the SEC
on January 25, 1999 and incorporated herein by reference.
*** Previously filed as an exhibit to the Company's form 8-K report filed with
the SEC on September 8, 1998 and incorporated herein by reference.
# Previously filed as an exhibit to the Company's form 8-K report field with
the SEC on September 11, 1998 and incorporated herein by reference.
## Previously filed as an exhibit to the Company's Form 8-K filed with the SEC
on December 1, 1998 and incorporated herein by reference.
IV-3
(3) Exhibits
(b) Reports on Form 8-K
On November 9, 1998 the Company filed a report on Form 8-K/A in order to file
financial statements relating to RSVP's purchase of an interest in Assisted
Living Investments, LLC.
On November 10, 1998 the Company filed a report on Form 8-K/A in order to file
financial statements relating to the formation of joint venture (Dominion
Venture Group, LLC) between RSVP and Dominion.
On November 20, 1998 the Company filed a report on Form 8-K announcing the
exercise of its option to acquire a majority interest in Interoffice
SuperHoldings Corporation from Reckson Management Group, Inc.
On December 1, 1998, the Company filed a report on Form 8-K announcing its
execution of merger agreements with Alliance National Incorporated and Reckson
Executive Centers, Inc., and Interoffice SuperHoldings Corporation.
IV-4
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 on March ___________, 1999.
RECKSON SERVICE INDUSTRIES, INC.
By: /s/ SCOTT RECHLER
---------------------------------
(Scott Rechler)
President, Chief Executive Officer
and Director
KNOW ALL MEN BY THESE PRESENTS, that we, the undersigned officers and
directors of Reckson Service Industries, Inc., hereby severally constitute Scott
H. Rechler, Mitchell D. Rechler and Michael Maturo, and each of them singly, our
true and lawful attorneys with full power to them, and each of them singly, to
sign for us and in our names in the capacities indicated below, the Form 10-K
filed herewith and any and all amendments to said Form 10-K, and generally to do
all such things in our names and in our capacities as officers and directors to
enable Reckson Service Industries, Inc. to comply with the provisions of the
Securities Exchange Act of 1934, and all requirements of the Securities and
Exchange Commission, hereby ratifying and confirming our signatures as they may
be signed by our said attorneys, or any of them, to said Form 10-K and any and
all amendments thereto.
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Name Title Date
---- ----- ----
/s/ SCOTT H. RECHLER
- ---------------------------------------
(Scott H. Rechler) President,-Chief-Executive-Officer-and-Director March 30, 1999
/s/ MICHAEL MATURO
- ---------------------------------------
(Michael Maturo) Executive Vice President, Chief Financial Officer and Director March 30, l999
Financial-Officer-and-Accounting-Officer)
/s/ DONALD J. RECHLER
- ---------------------------------------
(Donald J. Rechler) Chairman of the Board and Director March 30, 1999
/s/ ROGER M. RECHLER
- ---------------------------------------
(Roger M. Rechler) Member of Management Advisory Committee and Director March 30, 1999
/s/ MITCHELL D.. RECHLER
- ---------------------------------------
(Mitchell D. Rechler) Secretary,-Member-of-Management-Advisory-Committee-and-Director March 30, 1999
/s/ GREGG M.. RECHLER
- --------------------------------------
(Gregg M. Rechler) Member of Management Advisory Committee and Director March 30, 1999
- --------------------------------------
(Paul Amoruso) Director March 30, 1999
/s/ RONALD COOPER
- --------------------------------------
(Ronald Cooper) Director March 30, 1999
IV-5
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
Reckson Service Industries, Inc.
We have audited the accompanying consolidated balance sheets of Reckson Service
Industries, Inc. as of December 31, 1998 and 1997, and the related consolidated
statements of operations, shareholders' equity, and cash flows for the year
ended December 31, 1998 and for the period from July 15, 1997 (commencement of
operations) to December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Reckson Service
Industries, Inc. as of December 31, 1998 and 1997, and the consolidated results
of its operations and its cash flows for the year ended December 31, 1998 and
for the period July 15, 1997 (commencement of operations) to December 31, 1997
in conformity with generally accepted accounting principles.
/S/ERNST & YOUNG LLP
New York, New York
March 12, 1999
IV-6
RECKSON SERVICE INDUSTRIES, INC.
CONSOLIDATED BALANCE SHEETS
December 31, 1998 December 31, 1997
----------------- -----------------
Assets:
Cash and cash equivalents $ 2,025,527 $ 129,704
Equity investments (Note 3) 45,837,711 5,845,258
Affiliate receivables (Notes 3 and 5) 9,396,070 832,854
Organization and pre-acquisition costs net of amortization of $8,214, (1997) ----- 681,694
Equipment (net of depreciation of $15,337) 99,928 -----
Other assets 1,483,427 30,185
----------------------- -----------------------
Total Assets $ 58,842,663 $ 7,519,695
======================= =======================
Liabilities and Shareholders' Equity:
Accounts payable and accrued expenses $ 1,893,657 $ 119,384
Loans payable to affiliates ---- 3,177,857
Credit facilities with related parties (Note 5) 40,981,500 ---
----------------------- -----------------------
Total Liabilities 42,875,157 3,297,241
----------------------- -----------------------
Commitments and Contingencies (Note 8)
Shareholders' Equity: (Notes 1 and 4)
Preferred stock, $.01 par value 25,000,000 shares authorized, none issued ----- -----
and outstanding
Common stock, $.01 par value, 100,000,000 shares authorized, 24,685,514
and 1,000 shares issued and outstanding, respectively 246,855 10
Additional paid in capital 24,126,341 4,480,331
Accumulated deficit ( 8,405,690) (257,887)
----------------------- -----------------------
Total Shareholders' Equity 15,967,506 4,222,454
----------------------- -----------------------
Total Liabilities and Shareholders' Equity $ 58,842,663 $ 7,519,695
======================= =======================
(See accompanying notes to consolidated financial statements)
IV-7
RECKSON SERVICE INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the year For the period from
ended July 15, 1997 to
December 31, 1998 December 31, 1997
-------------------------------------------------------
Revenues:
Interest income $ 1,006,551 $ 30,383
Management fee income (Note 5) 277,778 ---
Other income 58,175 ---
----------------------- ------------------------
Total Revenues 1,342,504 30,383
----------------------- ------------------------
Equity in earnings (loss) of investments (Note 3) (3,966,399) 223,437
----------------------- ------------------------
Expenses:
Professional fees 457,901 12,575
General and administrative expenses 2,086,989 466,538
Amortization and depreciation 39,179 8,214
Terminated transaction and related costs 1,220,694 ---
Interest expense (Note 5) 1,651,200 24,380
----------------------- ------------------------
Total Expenses 5,455,963 511,707
----------------------- ------------------------
Loss before cumulative effect of change in accounting principle (8,079,858) (257,887)
Cumulative effect of change in accounting principle (Note 2) (67,945) ---
----------------------- ------------------------
NET LOSS $ (8,147,803) $ (257,887)
======================= ========================
Basic and diluted net loss per weighted average common share $ (.56) $ ---
======================= ========================
Basic and diluted weighted average common shares outstanding 14,522,513 ---
======================= ========================
(See accompanying notes to consolidated financial statements)
IV-8
RECKSON SERVICE INDUSTRIES, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
Total
Common Additional Paid Accumulated Shareholders'
Stock in Capital Deficit Equity
----------------------------------------------------------------------------
Initial capitalization, July 15, 1997.......... $ 10 $ 4,480,331 $ -- $ 4,480,341
Net Loss....................................... -- -- (257,887) (257,887)
-------------- ---------------- ------------- ----------------
Shareholders' equity, December 31,1997......... 10 4,480,331 (257,887) 4,222,454
Distribution of shares......................... 41,142 -- -- 41,142
Proceeds from rights offering,
Net of costs of $1,296,537................... 205,703 19,646,010 -- 19,851,713
Net loss....................................... -- -- (8,147,803) (8,147,803)
------------- ------------- -------------- --------------
Shareholders' equity, December 31, 1998........ $ 246,855 $24,126,341 $ (8,405,690) $ 15,967,506
-----------------------------------------------------------------------------
(see accompanying notes to consolidated financial statements)
IV-9
RECKSON SERVICE INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Twelve months Period from
ended July 15, 1997 to
December 31, 1998 December 31, 1997
----------------------- -----------------------
CASH FLOWS FROM OPERATING:
Net Loss $ (8,147,803) $ (257,887)
Adjustments to reconcile net loss to net cash used in operating activities:
Amortization and depreciation 39,179 8,214
Cumulative effect of change in accounting principle 67,945 ----
Equity in (earnings) loss of investments 3,966,399 (223,437)
Changes in operating assets and liabilities:
Other assets (1,453,242) (30,185)
Purchase of equipment (115,265) ----
(Increase) decrease in organization and pre-acquisition costs 589,907 (689,908)
Accounts payable and accrued expenses 1,774,273 119,384
Advances to affiliates (11,741,073) (832,854)
--------------- --------------
Net cash used in operating activities (15,019,680) (1,906,673)
--------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in American Campus Communities, LLC (278,985) (1,674,321)
Investment in and advances to Reckson Executive Centers, LLC (1,041,973) ----
Investment in and convertible loans to On-Site Ventures, LLC (6,806,885) (325,000)
Investment in and advances to RSVP Holdings, LLC (13,602,579) ----
Investment in Interoffice SuperHoldings Corporation (22,228,430) ----
--------------- -------------
Net cash used in investing activities (43,958,852) (1,999,321)
--------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Capital contributions ---- 857,841
Net proceeds from credit facilities 40,981,500 ----
Proceeds from affiliate loans ---- 3,177,857
Net proceeds from rights offering 19,892,855 ----
--------------- --------------
Net cash provided by financing activities 60,874,355 4,035,698
--------------- --------------
Net increase in cash and cash equivalents 1,895,823 129,704
Cash and cash equivalents at beginning of period 129,704 ----
--------------- --------------
Cash and cash equivalents at end of period $ 2,025,527 $ 129,704
=============== ==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest $ 815,604 $ ----
=============== =============
NON-CASH TRANSACTIONS:
Contributions of assets from ROP $ ---- $ 3,622,500
=============== =============
Contribution of non cash assets to Reckson Strategic
Venture Partners, LLC - $ (1,879,646) $ ----
Investment in American Campus Communities, LLC
=============== =============
(see accompanying notes to consolidated financial statements)
IV-10
RECKSON SERVICE INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. Organization and Formation of the Company
Reckson Service Industries ("RSI" or the "Company"), a business service
provider, was formed on July 15, 1997 by Reckson Associates Realty Corp.
("Reckson"), to create, operate and manage a system of inter-related business
services offered for sale to its customer pool which includes business customers
of Reckson Operating Partnership, L.P. ("ROP") a commercial real estate owner,
Advantis, the Company's executive suite business, On-Site Ventures, LLC,
("On-Site") the Company's telecommunications business, and Reckson Strategic
Venture Partners, LLC ("RSVP") (collectively, the "RSI Customer Pool") and third
parties in the general marketplace through a centralized infrastructure. The
Company's growth strategy is to acquire or form strategic alliances with
established businesses with strong entrepreneurial management a reputation for
high quality services within each of its targeted business service sectors
("Business Service Platforms"). Specifically, the Company seeks opportunities
for which there is broad demand in the RSI Customer Pool. Such Business Service
Platform investment or alliance serves as a basis for sale and delivery of
business services to the RSI Customer Pool. The Company believes the RSI
Customer Pool will attract exceptional investment opportunities and strategic
alliances which can capitalize on enhanced revenue opportunities through a cross
selling effort. The Company will establish Business Service Platforms that
present significant opportunities to provide business services to the RSI
Customer Pool and other third parties. Currently, the RSI Customer Pool retains
third parties to provide many business to business services for their day-to-day
operations. Of these services, the Company may seek to provide the RSI Customer
Pool with telecommunications, document storage, document reproduction and
logistics services (i.e., inventory services, messenger services and delivery
services), as well as the other business services that the Company determines
may be utilized by the RSI Customer Pool. The RSI Customer Pool consists of
small to medium size businesses as well as the mobile workforce of large
corporations. RSI seeks to provide the RSI Customer Pool high quality
value-added business services meeting all of their outsourcing needs providing
them with resources to successfully compete in the marketplace. The Company will
seek growth in each Business Service Platform by (i) accessing the RSI Customer
Pool as an anchor for growth opportunities, (ii) integrating each Business
Service Platform into RSI's centralized infrastructure and (iii) acquiring
similar businesses, forming strategic alliances or making additional investments
within such Business Service Platform.
In connection with the initial capitalization of RSI, ROP contributed $4,256,324
for a 95% nonvoting equity interest and certain members of Reckson management
contributed notes of $224,017 to the Company in exchange for a 5% voting
ownership interest. On October 29, 1997 the notes were repaid.
On June 11, 1998, ROP distributed its 95% of the common stock of RSI to its unit
holders of record on May 26, 1998 (the "Distribution"). Immediately prior to the
Distribution, the shares of non-voting common stock held by ROP were exchanged
by RSI for RSI common shares. Each share of the Company's common stock issued in
the Distribution was accompanied by one preferred share purchase right.
Simultaneously, Reckson distributed 100% of the RSI common shares received from
the Distribution to its common shareholders of the same record date. In
addition, simultaneously with the Distribution, the Company issued rights to its
stockholders to subscribe for the purchase of additional shares of common stock
of the Company.
Immediately after the Distribution, RSI granted to its stockholders (a "Holder")
one subscription right for each share of RSI common stock. Each subscription
right entitled the Holder to purchase one share of RSI common stock at a
purchase price of $1.03 per share (the "Exercise Price") and, at the election of
such Holder, four additional shares (but not less than four additional shares)
at a purchase price of $1.03 per share. A Holder of subscription rights had the
opportunity to acquire up to an aggregate of approximately 20,557,130 shares of
RSI common stock. RSI and Reckson Standby, LLC (the "Standby Purchaser") (an
entity owned by several members of management), entered into a Standby agreement
pursuant to which the Standby Purchaser agreed to purchase, and RSI agreed to
sell, any and all shares of RSI common stock that were the subject of
subscription rights in the rights offering but were not subscribed for by a
Holder on the expiration date at the Exercise Price. The proceeds from the
stand-by purchaser were approximately $7,325,000. RSI received net proceeds from
the rights offering of approximately $19,852,000. In connection with the
Company's initial capitalization the Company obtained, from ROP, a five year
$100 million unsecured credit facility (the "RSI Facility"). The RSI Facility
bears interest at a rate equal to the greater of the prime rate plus 2% and (i)
12% per annum with the rate in this clause (ii) increasing annually on
outstanding borrowings at the rate of 4% per year over the prior years rate.
RSVP was formed on March 5, 1998 to invest in real estate and real
estate-related operating companies with experienced management teams in market
sectors which are in the early stages of their growth cycle or offer unique
circumstances for attractive investments as well as platforms for future growth.
Through RSVP Holdings, LLC ("Holdings") the Company is a managing member and
100% owner of the common equity of RSVP. New World Realty, LLC ("New World"), an
entity owned by two individuals retained by Holdings,(the "Managing Directors"),
acts as a managing member of Holdings, and has a carried interest which provides
for the Managing Directors to receive a share in the profits of RSVP after the
Company and Paine Webber Real Estate Securities, Inc. ("PWRES") have received
certain minimum returns and a return of capital. PWRES is a non-managing member
and preferred equity owner who has committed $200 million in capital (the "PWRES
Equity Facility") and shares 66 2/3% in profits and losses of RSVP with the
Company, subject to a maximum internal rate of return of 16% of invested
capital. On April 24, 1998, PWRES assigned 25% of its preferred equity interest
in RSVP, representing an unfunded capital commitment of $50 million to Stratum
Realty Fund, LLC ("Stratum").The assignment provides Stratum with similar rights
and priorities.
IV-11
Holdings, has retained two managing directors (the "RSVP Managing Directors") to
manage the day-to-day operations of RSVP, subject to the strategic direction of
RSI. New World Realty, LLC ("New World"), an entity owned by the RSVP Managing
Directors acts as a managing member of RSVP Holdings, LLC. The RSVP Holdings,
LLC operating agreement (the "Managing Member Operating Agreement") provides for
the payment to New World of distributions out of the cash flow of Holdings after
RSI and affiliated persons have received a return of their capital contributions
to RSVP investments plus a 12% internal rate of return ("IRR") thereon, of $15
million and, thereafter, a share of cash flows ranging from 15% to 27.75% based
upon the IRR received by RSI and affiliated persons above 12% in respect of RSVP
investments. The Managing Member Operating Agreement obligates RSI to contribute
100% of the capital contributions to be made by RSVP Holdings, LLC to RSVP in an
amount up to $100 million. In the event that RSI defaults in making its capital
contributions, distributions to New World and RSI's management rights will be
reduced and RSI will be obligated to purchase, at the election of New World, a
portion of New World's interest in RSVP Holdings, LLC for a minimum of $15
million. At the termination of RSVP, New World has a right of first refusal to
purchase any RSVP investment proposed for sale. New World will also be entitled
to one-half of any asset management fee earned by Holdings from ROP.
Additionally, it is anticipated that New World will receive transaction fees of
up to $1 million a year for identifying investment opportunities for RSVP.
ROP and RSI have entered into an intercompany agreement (the "ROP Intercompany
Agreement") to formalize their relationship and to limit conflicts of interest.
Under the ROP Intercompany Agreement, RSI granted ROP a right of first
opportunity to make any Real Estate Investment Trust ("REIT")-qualified
investment that becomes available to RSI. In addition, if a REIT-qualified
investment opportunity becomes available to an affiliate of RSI, including RSVP,
the ROP Intercompany Agreement requires such affiliate to allow ROP to
participate in such opportunity to the extent of RSI's interest.
Under the ROP Intercompany Agreement, ROP granted RSI a right of first
opportunity to provide business services to ROP and its tenants. RSI is required
to provide services to ROP at rates and on terms as attractive as either the
best available for comparable services in the market or those offered by RSI to
third parties. In addition, ROP is required to give RSI access to its tenants
with respect to business services that may be provided to such tenants and,
under the ROP Intercompany Agreement, subject to certain conditions, ROP granted
RSI a right of first refusal to become the lessee of any real property acquired
by ROP if ROP determines that, consistent with Reckson's status as a REIT, it is
required to enter into a "master" lease agreement.
IV-12
RECKSON SERVICE INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements present the financial
position of the Company at December 31, 1998 and 1997 and the results of its
operations and its cash flows for the year ended December 31, 1998 and for the
period July 15, 1997 (commencement of operations) to December 31, 1997. The
Company accounts for its investments of less than controlling interests under
the equity method of accounting. All significant intercompany balances and
transactions have been eliminated in the consolidated financial statements.
The investments in Dobie Center Properties, Ltd ("Dobie") and American Campus
Communities, LLC ("ACC") through March 31, 1998, and Holdings, Reckson Executive
Centers, Inc. ("REC"), InterOffice Superholdings Corporation ("Interoffice") and
On-Site are reflected in the accompanying financial statements under the equity
method of accounting.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
Cash and Cash Equivalents
The Company considers highly liquid investments with a maturity of three months
or less when purchased to be cash equivalents.
Long-Lived Assets
The Company assesses the need to record impairment losses on long-lived assets
used in operations when indicators of impairment are present. On an on-going
basis, management reviews the value and period of amortization or depreciation
of long-lived assets, including excess investments of equity investments. During
this review, the Company re-evaluates the significant assumptions used in
determining the original cost of long-lived assets. Although the assumptions may
vary from transaction to transaction, they generally include revenue growth,
operating results, cash flows and other indicators of value. Management then
determines whether there has been a permanent impairment of the value of
long-lived assets based upon events or circumstances which have occurred since
acquisition.
Stock Options
The Company has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for its employee stock options because the
alternative fair value accounting provided for under FASB Statement No. 123,
"Accounting for Stock-Based Compensation," ("FAS No. 123") requires the use of
option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, no compensation expense was recognized because the
exercise price of the Company's employee stock options equals the market price
of the underlying stock on the date of grant.
(See Note 4).
IV-13
RECKSON SERVICE INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
2. Summary of Significant Accounting Policies (continued)
Income Taxes
At inception, the Company adopted Statement of Financial Accounting Standards
("SFAS") No. 109, "Accounting for Income Taxes" ("SFAS No. 109"), which
prescribes an asset and liability method of accounting for income taxes. Under
SFAS No. 109, deferred tax assets are recognized for temporary differences that
will result in deductible amounts in future years and for carry forward. A
valuation allowance is recognized if it is more likely than not that some
portion of the deferred asset will not be recognized. At December 31, 1998 any
deferred tax assets have been reserved for 100% due to the uncertainty as to
whether these assets will have benefit in future periods.
Earnings Per Share
In 1997, the FASB issued Statement No. 128, "Earnings per Share" ("FAS 128").
FAS 128 replaced the calculation of primary and fully diluted earnings per share
with basic and diluted earnings per share. Unlike primary earnings per share,
basic earnings per share excludes any dilutive effects of options, warrants and
convertible securities. Diluted earnings per share is very similar to the
previously reported fully diluted earnings per share. All earnings per share
amounts for all periods have been presented to conform to the FAS 128
requirements.
Comprehensive Income
In 1997, the FASB issued Statement No. 130, ("SFAS 130") Reporting Comprehensive
Income SFAS No. 130 which is effective for fiscal years beginning after December
15, 1997. SFAS 130 established standards for reporting comprehensive income and
its components in a full set of general-purpose financial statements. SFAS 130
requires that all components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements. The adoption of this standard had no impact on the Company's
financial position or results of operations.
Fair Value of Financial Instruments
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments" requires
RSI to disclose the estimated fair values of its financial instrument assets and
liabilities. The carrying amounts approximate fair value for cash and cash
equivalents because of the short maturity of those instruments. For the loans
payable to affiliates the estimated fair value approximates the recorded
balance.
Disclosures about Segments of an Enterprise and Related Information
In 1997, the FASB issued Statement No. 131 "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131") which is effective for fiscal
years beginning after December 15, 1997. SFAS 131 establishes standards for
reporting information about operating segments in annual financial statements
and in interim financial reports. It also establishes standards for related
disclosures about products and services, geographic areas and major customers.
The adoption of this standard had no impact on the Company's financial position
or results of operations, but did effect the disclosure of segment information,
see Note 6.
Derivative Instruments and Hedging Activities
In June 1998, the FASB issued Statement No. 133,
"Accounting for Derivative Instruments and Hedging Activities", which is
required to be adopted in years beginning after June 15, 1999. The Statement
permits early adoption as of the beginnning of any fiscal quarter after its
issuance. The Company expects to adopt the new Statement effective January 1,
2000. The Company does not anticipate that the adoption of this Statement will
have any effect on its results of operations or financial position.
Change in Accounting Principle
In April 1998, the American Institute of Certified Public Accountants'
Accounting Standards Executive Committee issued SOP No. 98-5, "Reporting on the
Costs of Start-Up Activities". This standard provides guidance on the financial
reporting for start-up costs and requires that such costs be expensed as
incurred. The standard is effective for fiscal years beginning after December
15, 1998. In accordance with this standard the Company changed its method of
accounting for start-up costs and organizational costs in 1998. Previously,
start-up activities and organization costs were capitalized and amortized over 5
years. The cumulative effect of this change in accounting principle for 1998
was $67,945, has been included in 1998 operations.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current year
presentation.
IV-14
RECKSON SERVICE INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
3. INVESTMENTS
The Company's equity investments are summarized as follows:
December 31, 1998 December 31, 1997
---------------------- -----------------------
Investment in Dobie $ -- 3,868,093
Investment in ACC --- 1,652,165
Investment in and advances to Holdings 15,560,896 ---
Investment in and advances to REC 892,894 ---
Investment in and convertible loans to On-Site 7,101,330 325,000
Investment in and advances to Interoffice 22,282,591 ---
------------- ----------
TOTAL EQUITY INVESTMENTS 45,837,711 $ 5,845,258
============= ==========
The following are the Company's summarized equity in earnings (loss) of
investments:
For the year For the period from
ended July 15, 1997 to
December 31, 1998 December 31, 1997
---------------------- ----------------------
Equity in earnings of Dobie $ 170,567 $ 245,593
Equity in loss of ACC (51,504) (22,156)
Equity in loss of Holdings (3,959,989) -----
Equity in loss of REC (149,079) -----
Equity in loss of On-Site (30,555) -----
Equity in earnings of Interoffice 54,161 -----
-------------- ----------
TOTAL EQUITY IN EARNINGS (LOSS) OF INVESTMENTS $ (3,966,399) $ 223,437
============== ==========
IV-15
RECKSON SERVICE INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
3. Investments (Continued)
The Company's significant investments are summarized as follows:
RSVP Holdings, LLC
Summarized financial information and a summary of the Company's investment in,
advances to Holdings and RSI's share of loss is as follows:
BALANCE SHEET December 31, 1998
- ------------- -----------------
Assets
Investment in Dobie..................................................... $ 32,296
Investment in ACC....................................................... 1,262,415
Investment in Assisted Living Investments, LLC.......................... 4,676,272
Investment in Dominion Venture Group, LLC ............................. 29,288,973
Deferred compensation................................................... 4,938,539
Other assets............................................................ 4,552,917
---------
Total Assets........................................................ $ 44,751,412
===============
Liabilities and Members' Equity
Due to affiliates...................................................... $ 1,591,459
Other liabilities...................................................... 1,397,412
---------
Total Liabilities.................................................. 2,988,871
---------
Minority interest...................................................... 31,201,645
Preferred capital offering costs....................................... (5,000,000)
RSI investment in and advances to Holdings ............................ 15,560,896
----------
Total Liabilities and Members' Equity............................ $ 44,751,412
================
In connection with the PWRES Equity Facility, RSVP paid a commitment fee of 2.5%
of the total preferred equity commitment of $5,000,000.
IV-16
RECKSON SERVICE INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
3. INVESTMENTS - (CONTINUED)
Statement of Operations
For the period from
February 26, 1998 to
December 31, 1998
-----------------
Revenues:
Interest income......................................... $ 193,034
Other income............................................ 453,644
-------
Total Revenues..................................... 646,678
-------
Equity in earnings (loss) of investments
Equity in earnings of Dobie............................. 32,296
Equity in loss of ACC................................... (518,895)
Equity in loss of Gateway Development Group, LLC........ (650,531)
Equity in loss of Assisted Living Investments, LLC...... (2,907,607)
Equity in earnings of Dominion Venture Group, LLC....... 296,970
------
Total Equity in loss of investments..................... (3,747,767)
----------
Expenses:
Operating expenses...................................... 2,212,440
General and administrative expenses..................... 3,769,716
Organization costs ..................................... 757,644
Interest expense........................................ 491,172
Depreciation and amortization........................... 30,557
---------
Total Expenses.................................... 7,261,529
---------
Minority Interest....................................... (6,263,739)
----------
Net loss................................................ (4,098,879)
Less: Elimination of intercompany management fee........ 138,890
-------
RSI's share of net loss................................. $(3,959,989)
==========
On April 1, 1998, the Company acquired a 9.9% membership interest in Reckson
Executive Centers, LLC ("REC, LLC") for $200,000 from ROP and assumed debt of
approximately $322,000. REC, LLC owns and operates eight executive office suite
centers in the New York TriState Area. The Company also loaned REC, LLC
approximately $623,000 to fund purchases of certain business assets in
connection with the operation of the executive centers. These loans accrue
interest at 12%. On October 5, 1998, the Company contributed its interest in
REC, LLC to Reckson Executive Centers, Inc. ("REC") in exchange for 75% of the
Common Stock of REC. For the period April 1, 1998 to December 31, 1998, the
Company recognized a loss of $149,079.
On November 9, 1998, the Company announced the exercise of its option to acquire
a majority interest in Interoffice, the executive office suite business held by
Reckson Management Group, Inc. ("RMG"). The aggregate purchase price paid by the
Company to RMG was approximately $20.5 million and was financed through
borrowings under the RSI Facility. The Company also acquired rights to certain
advances made by RMG to the other stockholders' of Interoffice for approximately
$10.3 million. Such receivables are secured by the shares held by these
stockholders.
On January 8, 1999 Interoffice and REC merged with Alliance National
Incorporated ("Alliance") (See Note 8).
IV-17
RECKSON SERVICE INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
3. INVESTMENTS - (CONTINUED)
Summarized financial information and a summary of the Company's investment in,
advances to and share of income from Interoffice is as follows:
Balance Sheet
- -------------
December 31, 1998
-----------------
Assets
Current assets $ 6,045,328
Property & Equipment, net 8,598,216
Goodwill 31,811,421
Other Assets 3,250,511
-----------------
TOTAL ASSETS $ 49,705,476
=================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities $ 6,312,533
Long-term liabilities 9,544,196
----------------
Total liabilities 15,856,729
----------------
Stockholders' Equity
Non-RSI Stockholders 13,038,002
Net RSI investment and advances to Interoffice 22,282,591
Less: Non-Interoffice equity in RSI investment (1,471,846
----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 49,705,476
================
Statement of Operations
For the period
November 9, 1998 to
December 31, 1998
-----------------
Revenues
Rental income $ 4,089,740
Services income 4,024,810
Other income 141,701
------------------
Total Revenues 8,256,251
------------------
Expenses
Rent 2,889,699
Services 1,604,313
General and administrative 3,123,747
Depreciation and amortization 663,127
Interest expense 48,874
-----------------
Total expenses 8,329,760
-----------------
Net loss as reported by Interoffice (73,509)
Add: Adjustment for non-RSI costs incurred 164,727
-------------------
Net income as adjusted 91,218
Less: non-RSI share (37,057)
-------------------
RSI share of net income $ 54,161
====================
IV-18
RECKSON SERVICE INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
3. INVESTMENTS - (CONTINUED)
Student Housing
The Company acquired a 33 1/3% interest in a wholly owned subsidiary of RFG
Capital Group, LLC for $1.51 million whose sole net investment is a 76.09%
interest in ACC, a student housing enterprise which owns, develops, constructs,
manages and acquires, on-and off campus student housing projects. On April 1,
1998, RSI transferred its interest in ACC to RSVP. RSI's loss for its period of
ownership, January 1, 1998 to March 31, 1998 was $51,504. For the period April
1, 1998 to December 31, 1998, RSVP's share of losses was $518,895.
In 1997, the Company invested through other affiliated entities $3.62 million in
Reckson Opportunity Partners, LP ("RO").RO invested approximately $10.8
million to acquire a 70% interest in Dobie,
which owns 100% in Dobie Center, a mixed-use student
housing and retail property located in Austin, Texas. On April 1, 1998, the
Company transferred its interest in RO to RSVP, net of certain proceeds related
to the refinancing of Dobie Center. RSI's income for its period of ownership,
January 1, 1998 to March 31, 1998 was $170,567. For the period April 1, 1998 to
December 31, 1998 RSVP's share of income was $32,296.
Privatization
On August 11, 1998, RSVP acquired through a wholly owned subsidiary an interest
in Gateway Development Group, LLC ("Gateway") with Gateway Management for
approximately $377,000. Gateway is a start up entity that pursues opportunities
in privatized military housing. The Company is uncertain whether it will recover
its invested dollars from Gateway's future cash flows. At December 31, 1998,
RSVP has recognized a loss of $650,531 which includes a reserve for their
invested dollars plus acquisition costs of $101,293.
On August 27, 1998, the Company announced the formation of a joint venture
between RSVP and Dominion, an Oklahoma-based, privately-owned group of
companies that focuses on the development, acquisition and ownership of
government occupied office buildings and correctional facilities. The new
venture, Dominion Venture Group LLC (the "Dominion Venture"), is owned by
RSVP-Dominion LLC, a subsidiary of RSVP, and by Burgess Services, LLC, an entity
owned and controlled by Calvin Burgess, President and Chief Executive Officer of
Dominion. The Dominion Venture will engage primarily in acquiring, developing
and/or owning government-occupied office buildings and privately operated
correctional facilities and related activities. Under the Operating Agreement,
RSVP is to invest up to $100 million, some of which may be invested by ROP
(together, the "RSVP Capital"), for capital requirements approved by RSVP. RSVP
funded its total capital contribution of $8,597,455 through draws under its
PWRES Equity Facility and the RSVP Facility with ROP. ROP contributed
$10,065,338 in connection with the Dominion Venture. For the period August 27,
1998 to December 31, 1998, RSVP recognized $296,970 of income.
IV-19
RECKSON SERVICE INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
3. INVESTMENTS (CONTINUED)
Assisted Living
On August 12, 1998, RSVP acquired through a wholly owned subsidiary a 45%
interest in Assisted Living Investments, LLC ("ALI") for approximately $3.25
million. ALI is a joint venture that develops, leases, operates and finances
assisted living facilities. In addition, RSVP has agreed to contribute 80% of
the equity of ALI, up to a maximum $16.0 million for a total maximum commitment
of $19.25 million. RSVP funded $7.5 million of its $19.25 million commitment
upon the closing of the transaction. RSVP funded 50% of its capital contribution
through draws under the PWRES Equity Facility. The remaining 50% capital
contribution was funded through a draw under the RSVP facility (see Note 5).
As of December 31, 1998, the excess of the RSVP's investment over its share of
the equity in the underlying net assets of ALI ("Excess ALI Investment") was
$2,887,585. The Excess ALI Investment is being amortized over the life of the
investment estimated at 25 years.
Summarized financial information and a summary of RSVP's investment in and share
of loss is as follows:
Balance Sheet
December 31, 1998
---------------------
Assets
Property and equipment, net...................... $ 79,101,531
Other assets..................................... 6,483,316
------------------------
$ 85,584,847
Total Assets................................ ========================
Liabilities and Members' Deficit
Note payable..................................... $ 82,883,473
Other liabilities................................ 8,087,520
-----------------------
Total Liabilities............................ 90,970,993
-----------------------
Minority interest................................ (7,174,833)
RSVP investment in ALI........................... 4,676,272
Less: Excess ALI investment..................... (2,887,585)
------------------------
Total Members' Deficit (5,386,146)
-----------------------
Total Liabilities and Members' Deficit........... $ 85,584,847
========================
Statement of Operations
For the period from
August 12, 1998 to
December 31, 1998
Total Revenues............................................... $ 2,847,404
------------
Operating expenses........................................... 3,509,287
Pre-opening expenses......................................... 1,090,673
Depreciation and amortization................................ 1,180,190
Interest expense............................................. 1,759,929
Other expenses............................................... 409,421
----------
Total expenses........................................ 7,949,500
----------
Net loss as reported by ALI.................................. (5,102,096)
Adjustment for equity accounting basis....................... 545,337
----------
Net loss as adjusted......................................... (4,556,759)
Less: Non-RSVP share........................................ (1,708,785)
----------
RSVP share of net loss....................................... (2,847,974)
Amortization of excess investment and pre-opening costs...... (59,633)
----------
Total RSVP share of net loss................................. $(2,907,607)
===========
IV-20
RECKSON SERVICE INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
3. INVESTMENTS (CONTINUED)
With respect to RSVP's investment in ALI, on February 1, 1999, a member of Sun
Healthcare Group, Inc., ("SUN") the parent of an ALI member, reported a
significant loss from operations during the quarter ended December 31, 1998.
Additionally, SUN continues to implement a comprehensive restructuring of its
operations. The restructuring of SUN's operations had led the partners of ALI to
enter into negotiations regarding ALI's ongoing business plan and potentially
modify allocations and priorities of cash flow, profits and losses. These
negotiations are in progress. As of December 31, 1998, RSVP determined that
there was no impairment on its investment in ALI.
Telecommunications
RSI holds a subordinated note convertible into a 58.69% equity interest in
On-Site, a company that provides advanced telecommunications systems and
services within commercial buildings and/or building complexes. The Company has
advanced OnSite $6.5 million through December 31, 1998 to fund operating costs
under the terms of the note. The loan bears interest at a rate of 12% per annum.
On May 18, 1998, the Company purchased a membership interest in On-Site equal to
1% of the aggregate membership interests. At December 31, 1998, the Company
recognized a loss of $30,555 relating to its 1% interest.
In May 1998, the Company made an initial capital contribution of $300,000 for a
58.69% interest in On-Site Commerce and Content, LLC ("OCC"), a Company
established to acquire and develop software products. As of December 31, 1998
OCC had no operations.
4. SHAREHOLDERS' EQUITY
The Company has established the 1998 stock option plan (the "Plan") for the
purpose of attracting and retaining executive officers, directors and other key
employees. Pursuant to the Plan 3,700,376 of the Company's authorized shares
have been reserved for issuance under the Plan. On January 10, 1998 and March
30, 1998, the Company granted options to purchase 542,892 and 2,732,085,
respectively of the Company's common shares at an exercise price of $1.10 and
$1.04 respectively per share based on the fair value on each date of grant,
which the board of directors of the Company has concluded to be the book value
on each date of grant. These options fully vest on January 1, 1999.
On August 4, 1998, the Board of Directors of the Company adopted a "broad based"
stock option plan for the purpose of awarding options to non-executive officers
and new hires. Pursuant to such adoption, 100,000 of the Company's authorized
shares have been reserved for this purpose.
Additionally, on August 4, 1998, the Company granted options to purchase 456,564
shares at an exercise price of $2 per share, which approximated market value at
the time of the grant. These options have a five year vesting period.
IV-21
RECKSON SERVICE INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
4. SHAREHOLDERS' EQUITY (CONTINUED)
Stock Option Plan
Options granted under the 1998 qualified stock option plan are exercisable at
the market price on the date of the grant and, subject to termination of
employment, expire ten years from date of the grant, are not transferable other
than on death.
Pro forma information regarding net income and earnings per share is required by
FAS No. 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of that Statement. The fair
value for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumption for 1998,
risk-free interest rate of 5%, no expected dividend yield, a volatility factor
of the expected market price of the Company's common stock of 1.723 and a
weighted-average expected life of the option of 7 years.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. For the year ended
December 31, 1998 the Company's pro forma information follows:
Pro forma net loss (in thousands) $ (11,495,683)
-------------
Basic and diluted net loss per share $ (.79)
-------------
A summary of the Company's stock option activity, and related information
for the year ended December 31, 1998 is as follows:
Weighted- Weighted-
Average Average
Options Exercise Price Fair Value
Outstanding - December 31, 1997 ----- $ ----- $ ----
Granted 3,731,541 1.16 1.15
Exercised ---- ----- -----
Forfeited ---- ----- -----
--------------- ----------------- -------------------
Outstanding - December 31, 1998 3,731,541 $1.16 $ 1.15
=============== ================= ===================
IV-22
RECKSON SERVICE INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31,1998
5. TRANSACTIONS WITH RELATED PARTIES
On June 15,1998 RSI established the RSI Facility with ROP in the amount of
$100 million for RSI's service sector operations and other general corporate
purposes. ROP has advanced the Company $33,699,719 at December 31,1998. These
advances bear interest at 12% per annum. Additionally, RSI established the RSVP
Facility with ROP for funding the RSVP investments. The amount available under
RSVP Facility is reduced by any amount invested by ROP in joint ventures with
RSVP. As of December 31,1998, ROP has advanced RSI $7,281,781 under the RSVP
Facility and has invested $10,065,338 in joint ventures with RSVP. The total
outstanding at December 31,1998 owed by RSI under both credit facilities was
$40,981,500.
In February 1998, Holdings entered into employment agreements with the two
Managing Directors of RSVP. The agreements provide for a minimum annual salary
of $500,000 and have a seven-year term. In addition to the base salary each
Managing Director has received from the Company a $3.0 million grant of common
stock of Reckson (the "Reckson Stock") which will vest equally over five years.
The Reckson Stock was purchased by the Company and contributed to Holdings. In
addition, in April 1998, the Company advanced each managing director a tax loan
of approximately $1.4 million in connection with the grant of Reckson Stock.
These loans bear interest at 8% per annum and are due in April, 2003 and are
secured by the Reckson Stock. Additionally, New World will receive transaction
fees of up to $1 million per year related to identifying RSVP investment
opportunities. In August of 1998, $1 million of such fees were paid to New World
by third parties.
RSI and Reckson Standby, LLC (the "Standby Purchaser") (an entity owned by
several members of management), entered into an agreement pursuant to which the
Standby Purchaser agreed to Purchase, and RSI agreed to sell, any and all shares
of RSI common stock that were subject of subscription rights in the rights
offering but were not subscribed for by Holders on the expiration date at
the Expiration Price. Pursuant to the standby agreement, in July 1998, the
Standby Purchaser acquired 7,111,650 shares of RSI common stock for an
aggregate purchase price of approximately $7,325,000.
The Company is entitled to a cumulative management fee of $2 million with
respect to RSVP, of which $1.5 million is subordinate to PWRES receiving an
annual minimum rate of return of 16% and a return of its capital. The
unsubordinated amount for the period March 5, 1998 to December 31, 1998 was
$416,667.
The Comapny reimburses ROP with respect to general and administrative expenses
(including payroll expenses) incurred by ROP for the benefit of the Company.
During 1998, the Company reimbursed ROP $399,387 for such activities.
IV-23
RECKSON SERVICE INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
6. SEGMENT DISCLOSURE
Each of the segments has a managing director who reports directly to the Board
of Directors/Executive Committees who have been identified as the Chief
Operating Decision Makers ("CODM") because of their final authority over
resource allocation decisions and performance assessment.
The CODM evaluate the operating performance of these segments based on sectors.
RSI's governance and control rights are generally exercised through Board of
Directors seats and through representation on the executive committees of the
various segment entities.
The following table sets for the Company's segments and their revenues and
expenses and other related disclosures as required by SFAS 131 for the year
ended December 31, 1998.
TELE
EXEC. OFFICE COMMU ASSISTED STUDENT OTHER
SUITES NICATIONS LIVING PRIVATIZATION HOUSING HOLDINGS TOTAL
------------ --------------- ----------------- ------------ ---------------- -------------- -------------
INVESTMENT $ 23,175,485 $7,101,330 $ 2,338,136 $2,970,770 $ 1,294,711 $8,957,279 $45,837,711
------------ --------------- ----------------- ------------ ---------------- -------------- -------------
REVENUES 13,012,817 950,015 2,847,404 19,442,953 17,036,554
------------ --------------- ----------------- ------------ ---------------- -------------- -------------
EXPENSES 13,226,017 5,863,052 7,949,500 18,892,316 18,393,472 1,819,736
------------ --------------- ----------------- ------------ ---------------- -------------- -------------
NET INCOME (213,200) (4,913,037) (5,102,096) 550,637 (1,356,918)
(LOSS)
------------ --------------- ----------------- ------------ ---------------- -------------- -------------
RSI/EQUITY $ (94,918) $ (30,555) $(1,453,804) $(199,850) $ (367,536) $ (1,819,736) $(3,966,399)
IN LOSS
------------ --------------- ----------------- ------------ ---------------- -------------- -------------
7. OFFICE LEASES
The Company leases office space, pursuant to a non-cancelable operating lease
from a ROP affiliated entity. Future minimum lease commitments relating to the
lease as of December 31, 1998 is as follows:
1999................................... $ 48,798
2000................................... 50,568
2001................................... 52,404
2002................................... 54,318
2003................................... 56,310
Thereafter............................. 274,418
-------
$ 536,816
=======
8. SUBSEQUENT EVENTS
On January 8, 1999, each of Interoffice (36 executive office suite centers) and
REC (8 executive office suite centers) an executive center business acquired by
the Company from ROP and an officer of REC, merged with Alliance a holding
company which owns and operates approximately 90 nationally located executive
office suites centers. The merged entity changed its name to Advantis. The
stockholders of Interoffice and REC received shares of the Series C Preferred
Stock of Advantis which represent approximately 40% of the equity interest in
Advantis. The Company thereafter owned approximately 23% of Advantis.
The holders of the Series C Preferred Stock have the right to appoint
four of the ten members of the board of directors of Advantis, including
Chairman of the Board and specified preemptive rights and other specified
rights. RSI and the other stockholders of Interoffice hold the Series C
Preferred Stock received in respect of the Merger of Interoffice through
Interoffice Superholdings LLC ("IS LLC"), a newly formed Delaware limited
liability company of which RSI is the sole manager. Likewise, RSI holds the
Series C Preferred Stock received in respect of the merger of REC through REC
LLC, a newly formed Delaware limited liability company of which a subsidiary of
RSI is the managing member.
IV-24
Advantis and RSI have also entered into an intercompany agreement pursuant to
which RSI has the opportunity to be the exclusive provider of certain business
services to Advantis, provided certain third party and "most-favored nation"
conditions are satisfied.
RSI acquired certain ownership rights related to the Series C Preferred Stock of
Advantis from a stockholder of Interoffice which provided the Company with
enhanced governance rights for $6.5 million. In addition, the Company paid $3.5
million to another stockholder of Interoffice for an option to purchase that
stockholders effective interest in the Series C Preferred Stock for a purchase
price of $6.75 million. If the option is not exercised, the stockholder has the
right to sell such interests to the Company at fair value, as determined in
accordance with the applicable agreement. A significant number of items
presented to the Board will require the separate approval of a majority of the
representatives of the Series C Preferred Stock on the Board, including
significant acquisitions, sale or leasing of assets, approval of Advantis'
annual operating budget, certain borrowings and capital expenditures by
Advantis, the hiring or termination of senior executives and other matters. The
holders of Series C Preferred Stock also have the right to appoint half of the
members of the executive and audit committees of the Board. The preferred
stockholders of Advantis (including the holders of Advantis Class A Preferred
Stock, Class B Preferred Stock and Class C Preferred Stock) were granted
super-majority voting rights with respect to certain corporate actions,
including the issuance of equity securities, changes to the charter documents of
Advantis and other matters.
On February 10, 1999, the Company along with another member of On-Site (the
"Members"), executed a senior secured promissory note with On-Site for
$4,000,000. The Members initially funded $2,000,000, in which RSI funded
approximately $1.35 million. The note matures in February 2000. Interest in
compounded monthly at a variable rate subject to the terms in the loan
agreement.
On March 17, 1999, PWRES transferred all of its rights, title and interest in
its invested capital to date in RSVP to Stratum. This transfer will include the
rights to distributions based upon the amount of funded capital contributions.
(Unaudited)
10. QUARTERLY FINANCIAL DATA (UNAUDITED)
The following summary represents the Company's results of operations for each
quarter during 1998:
First Quarter Second Quarter Third Quarter Fourth Quarter
------------- ------------ ------------- ------------
Total revenues........................ $ 46,661 $ 205,382 $ 495,135 $ 595,326
------------ ----------- ----------- ------------
Equity in loss of investments....... (424,353) (26,751) (735,458) ( 2,779,837)
-------------- ------------ ------------- --------------
Total expenses...................... $ 331,517 $ 595,107 $ 1,003,678 $ 3,525,661
------------ ----------- ----------- ------------
Cumulative effect of change in
accounting principle.............. (67,945) ------ ------ -----
============ ============ ============= =============
Net loss............................. (777,154) (416,476) (1,244,001) (5,710,172)
============ ============ ============= =============
Basic and diluted net loss per
weighted average common share $ (.20) $ (.09) $ (.05) $ (.23)
============ ============= ============== =============
Basic and diluted weighted average
common shares outstanding..... 3,864,573 4,513,975 24,685,514 24,685,514
============ ========== ============= ============
The above quarterly information has been restated to reflect the Company's
early adoption of SOP 98-5.
IV-25
Report of Independent Auditors
To the Board of Directors of
Interoffice Superholdings Corporation
We have audited the accompanying consolidated balance sheet of Interoffice
Superholdings Corporation and Subsidiaries ("Interoffice") as of December 31,
1998 and the related consolidated statements of operations, stockholders' equity
and cash flows for the period November 9, 1998 to December 31, 1998. These
financial statements are the responsibility of Interoffice's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Interoffice
Superholdings Corporation and Subsidiaries at December 31, 1998 and the
consolidated results of their operations and their cash flows for the period
November 9, 1998 to December 31, 1998, in conformity with generally accepted
accounting principles.
s/Ernst & Young LLP
New York, New York
March 12, 1999
IV-25
Interoffice Superholdings Corporation and Subsidiaries
Consolidated Balance Sheet
December 31, 1998
Assets
Current assets:
Cash and cash equivalents $ 3,420,947
Accounts receivable, net of allowance for doubtful accounts of $48,400 2,053,508
Prepaid expenses, prepaid taxes and other assets 459,218
Due from related party 111,655
-------------------
Total current assets 6,045,328
Goodwill, net 31,811,421
Property and equipment, net 8,598,216
Deferred acquisition costs 1,346,536
Restricted cash 688,246
Certificate of deposits 565,125
Deposits 544,309
Other assets 106,295
-------------------
Total assets $ 49,705,476
===================
Liabilities and Stockholders'Equity
Current liabilities:
Accounts payable and accrued expenses $ 4,624,897
Capital lease obligations 1,644,345
Notes payable 43,291
-------------------
Total current liabilities 6,312,533
Notes payable 365,440
Deferred rent payable 1,332,822
Due to stockholder 1,750,000
Capital lease obligations 460,484
Security deposits 4,767,348
Deferred income taxes 2,618,102
------------------
Total liabilities 17,606,729
------------------
Stockholders' equity:
Common stock, $1 par value; 50,000 Class A shares authorized, 50,000 Class B
shares; 11,468 Class A shares issued and outstanding 11,468
Additional paid-in-capital 32,918,835
Accumulated deficit (831,556)
-------------------
Total stockholders' equity 32,098,747
-------------------
Total liabilities and stockholders' equity $ 49,705,476
===================
See accompanying notes.
IV-26
Interoffice Superholdings Corporation and Subsidiaries
Consolidated Statement of Operations
For the period November 9, 1998 to December 31, 1998
Business center operations:
Revenues:
Office rentals $ 4,089,740
Support services 4,024,810
-----------------
8,114,550
-----------------
Expenses:
Rent 2,889,699
Support services 1,604,313
Center general and administrative 1,626,694
-----------------
6,120,706
-----------------
Contribution from operation of business centers 1,993,844
-----------------
Other (expense) income:
Corporate general and administrative (1,497,053)
Depreciation and amortization (663,127)
Interest expense (48,874)
Other income 138,623
-----------------
(2,070,431)
-----------------
Loss before income taxes (76,587)
Benefit from income taxes 3,078
-----------------
Net loss $ (73,509)
=================
Share information
Net loss per common share-basic and diluted $ (6)
=================
Cash distributions per common share $ 77
=================
See accompanying notes.
IV-27
Interoffice Superholdings Corporation and Subsidiaries
Consolidated Statement of Stockholders' Equity
For the period November 9, 1998 to December 31, 1998
Class A and Class B Retained
Common Shares $1 par Earnings
value Additional (Accumulated
Paid-In Capital Deficit) Total
----------------------------------------------------------------------------------
Balance at November 9, 1998 $ 11,468 $ 32,918,835 $ 123,762 $ 33,054,065
Net loss for the period - (73,509) (73,509)
Stockholders' distributions - - (881,809) (881,809)
==================================================================================
Balance at December 31, 1998 $ 11,468 $ 32,918,835 $ (831,556) $ 32,098,747
==================================================================================
See accompanying notes.
IV-28
Interoffice Superholdings Corporation and Subsidiaries
Consolidated Statement of Cash Flows
For the period November 9, 1998 to December 31, 1998
Operating activities
Net loss $ (73,509)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization 663,127
Deferred income taxes (46,848)
Bad debt expense 46,573
Changes in operating assets and liabilities:
Accounts receivable (515,605)
Prepaid expenses 59,324
Certificates of deposit (4,586)
Restricted cash (267,953)
Deposits (67,032)
Accounts payable and accrued expenses 2,049,537
Deferred rent payable 236,270
Security deposits 100,540
Due from stockholder 1,750,000
-------------------
Net cash provided by operating activities 3,929,838
-------------------
Investing activities
Purchases of property and equipment (769,606)
Deferred acquisition costs (1,453,205)
-------------------
Net cash used in investing activities (2,222,811)
Financing activities
Payments of notes payable (16,824)
Payments of capital lease obligations (429,844)
Distributions to stockholders (881,809)
-------------------
Net cash used in financing activities (1,328,477)
-------------------
Change in cash and cash equivalents 378,550
Cash and cash equivalents, beginning of period 3,042,397
-------------------
Cash and cash equivalents, end of period $ 3,420,947
===================
Supplemental disclosure
Interest paid $ 48,874
===================
Income taxes paid $ 118,364
===================
See accompanying notes.
IV-29
Interoffice Superholdings Corporation and Subsidiaries
Notes to Consolidated Financial Statements
For the period November 9, 1998 to December 31, 1998
1. Organization
Interoffice Superholdings Corporation (the "Company"), was formed on November
20, 1997 in connection with its acquisition of Interoffice (Holdings)
Corporation ("Interoffice" - see Acquisition Transaction below).
The Company operates 36 office centers throughout the United States. The Company
leases executive office suites and provides secretarial and administrative
services and amenities to their tenants for lease terms generally ranging from
one month to one year.
2. Acquisition Transactions
On January 29, 1998, the Company purchased from the sole stockholder of
Interoffice (the "Seller") all of the outstanding shares of common stock for
approximately $24.5 million pursuant to the terms and conditions of a stock
purchase agreement assigned to the Company by RFG Capital Management Partners,
L.P. ("RFG"). The purchase price was paid by RFG directly to the Seller and
resulted in an increase to goodwill and additional paid in capital for that
amount. Concurrently with the purchase of Interoffice, the Company caused
Interoffice to issue 10,000 shares of common stock to the Company at par value.
The Company wholly owns Interoffice.
On July 14, 1998, Interoffice reclassified its common stock into Class A common
stock and Class B common stock. Each share of common stock is identical except
that the Class B shares do not entitle the holder to vote for, or consent to any
matter, transaction or event. Each share of issued and outstanding common stock
of Interoffice was converted to a share of Class A common stock.
Based on the above transactions, Interoffice has 50,000 authorized Class A
common shares and 50,000 authorized Class B common shares. In July 1998,
Interoffice issued approximately 1,468 shares to the Company, the proceeds of
which were used to fund the purchase of Xebec Management Services Incorporated
and XMS Greenhaven Incorporated (collectively referred to as "Xebec") discussed
below.
IV-30
9
2. Acquisition Transactions (continued)
In connection with the sale, Interoffice transferred its investment in
residential real estate to the Seller and forgave all loans to the Seller.
Reckson Management Group, Inc. ("RMG") originally owned 58.9% of the Company and
granted Reckson Services Industries, Inc. ("RSI") an option to purchase RMG's
entire interest in the Company. This option was exercised on November 9, 1998.
On July 20, 1998, the Company purchased substantially all of the assets of
Xebec. Xebec is engaged in the business of developing and operating executive
office suites at six locations in the Sacramento, California area. The purchase
price for the purchased assets was $8,875,000. The transaction was accounted for
under the purchase method of accounting with the goodwill resulting from the
purchase after adjustments amounting to approximately $7,944,000. In addition,
the Company paid the principal shareholders of Xebec for a covenant to not
compete for a period of three years. The agreement provides for additional
amounts not to exceed $1,000,000 to be paid by the Company to Xebec through
December 31, 1999 if Earnings Before Interest Taxes Depreciation and
Amortization (EBITDA) exceeds certain agreed upon benchmarks.
3. Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements have been prepared for the purpose of
complying with Rule 3.09 of Regulation S-X of the Securities and Exchange
Commission.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from these estimates.
IV-31
3. Summary of Significant Accounting Policies (continued)
Income Recognition
Office rental revenue and support services revenue are recognized as the related
services are provided.
Cash and Cash Equivalents
Investments with maturities at purchase of three months or less are considered
to be cash equivalents.
Accounts Receivable
Accounts receivable primarily consists of fixed and variable charges due from
tenants, net of prepayments.
Property and Equipment
Furniture, equipment and leasehold improvements are stated at cost. Depreciation
is computed using straight-line methods over terms ranging from 3 1/2 to 15
years. Expenditures for major renewals and betterments that extend the useful
lives of property and equipment are capitalized. Expenditures for maintenance
and repairs are charged to expense when paid.
Restricted Cash
Restricted cash represents monies pledged as collateral for letters of credit
required under certain lease agreements and monies in escrow for transactions
not closed at December 31, 1998.
Goodwill
Goodwill represents the excess of the Company's purchase price over the amounts
allocated to the underlying assets and liabilities of both the purchase of
InterOffice (Holdings) Corporation in January 1998 and the Xebec acquisition in
July 1998 (see Note 2). Goodwill is amortized over a period of 30 years based on
the Company's assessment of the significant barriers to entry due to the rapid
consolidation in the executive suites business and the increase over the last
several years of the large national corporations
IV-32
3. Summary of Significant Accounting Policies (continued)
Goodwill (continued)
which utilize executive suites companies that have an expanded national
presence. Goodwill is evaluated when indicators of impairment are present and
provisions for possible losses are recorded when undiscounted cash flows
estimated to be generated by those assets are less than the carrying amounts.
Accumulated amortization of goodwill, through December 31, 1998 is $1,050,584.
Income Taxes
The Company accounts for income taxes under the provisions of Financial
Accounting Standards Board Statement No. 109, "Accounting for Income Taxes".
Statement 109 utilizes the asset and liability method for computing tax
expenses. Under the asset and liability method, deferred income taxes are
recognized for the tax consequences of "temporary differences" by applying
statutory tax rates to differences between the financial statement carrying
amounts and the tax bases of existing assets and liabilities. Deferred tax
assets are recognized for temporary differences that will result in deductible
amounts in future years and for carryforwards. A valuation allowance is
recognized if it is more likely than not that some portion of the deferred asset
will not be recognized. When evaluating whether a valuation allowance is
appropriate, Statement 109 requires a company to consider such factors as
previous operating results, future earnings potential, tax planning strategies
and future reversals of existing temporary differences. The valuation allowance
is increased or decreased in future years based on changes in these criteria.
Rent Expense
Generally accepted accounting principles require that rent expense be recognized
on a straight-line basis over the term of the related lease. The difference
between the rent expense recognized for financial reporting purposes and the
actual payments made in accordance with the lease agreement is recognized as
deferred rent payable.
Earnings Per Common Share
Basic earnings per common share is computed using the weighted average number of
shares outstanding. Diluted earnings per common share is equal to basic earnings
per
IV-33
3. Summary of Significant Accounting Policies (continued)
Earnings Per Common Share (continued)
common share as the strike price of the options outstanding approximates current
estimated market value.
4. Certificates of Deposit - Restricted
The Company has certificates of deposit totaling $565,125 as of December 31,
1998, which are pledged as collateral for letters of credit, required under
certain lease agreements totaling approximately $1,631,000 as of December 31,
1998.
5. Property and Equipment
Property and equipment as of December 31, 1998 consists of:
Furniture and fixtures $ 5,021,344
Equipment 4,496,707
Leasehold improvements 1,398,171
-------------------
Less: Accumulated depreciation (2,318,006)
===================
$ 8,598,216
===================
6. Capital Lease Obligations
The Company leases substantially all of the furniture and equipment under
capital leases. At December 31, 1998, approximately $10,460,000 of property and
equipment were under capital leases. The present value of future minimum lease
payments under these leases and the corresponding liabilities have been recorded
in the financial statements as property and equipment and capital lease
obligations, respectively.
IV-34
6. Capital Lease Obligations (continued)
The future minimum lease payments under capital leases together with the present
value of minimum lease payments as of December 31, 1998 are as follows:
Year ending December 31,
1999 $ 1,600,941
2000 527,271
2001 113,561
2002 35,251
-------------------
2,277,024
Less - amount representing interest 172,195
-------------------
Present value of minimum lease payments $ 2,104,829
===================
7. Notes Payable
The Company has three notes payable to a related party totaling $124,876 as of
December 31, 1998, as discussed below and in note 9. The remaining notes payable
are due to unrelated third parties.
Two notes provide for interest only payments at 8.56% until June 2004, when
balloon payments will be due totaling $94,750. The third note provides for
interest only payments at 8.56% until August 2005, when a balloon payment will
be due totaling $31,126.
A subsidiary rented office space under a lease that expired in July 1997. The
original lease, including amendments, provided for a note payable in the amount
of $252,172 to be due at lease end. At lease end, the subsidiary signed a new 10
year lease expiring July 2007. The lease requires the original note payable due
in July 1997, to become due in July 2007. This note will be reduced each year by
5% of the total amount of the note, provided the monthly lease payments are made
on a timely basis.
Another subsidiary signed a note payable in the amount of $192,348 plus interest
of prime plus 1.5% due to the landlord as an amendment to its original lease.
The note is to be paid in 24 equal installments that were to begin June 1997.
During 1997, note payments were not made as management was in negotiations with
the landlord to reduce the note amount and extend the current lease that expires
in May 1999. The full amount due is included in notes payable on the
accompanying consolidated balance sheets. In
IV-35
7. Notes Payable (continued)
February 1998, the Company made a lump sum payment covering the June 1997
through February 1998 period.
At December 31, 1998 the aggregate maturities of notes payable are as follows:
December 31, 1999 $ 43,291
2000 -
2001 -
2002 -
2003 -
Thereafter 365,440
===================
$ 408,731
===================
8. Income Taxes
The Company accounts for income taxes in accordance with Financial Accounting
Standards Board Statement No. 109, "Accounting for Income Taxes." Deferred
income tax assets and liabilities are determined based upon differences between
financial reporting and tax bases of assets and liabilities and are measured
using the enacted tax rates and laws that will be in effect when the differences
are expected to reverse.
The components of the income tax benefit are as follows:
For the period
November 9, 1998
to December 31,
1998
------------------
Current federal tax $ 43,770
Current state tax -
Deferred federal tax (51,438)
Deferred state tax 4,590
==================
$ (3,078)
==================
IV-36
8. ncome Taxes (continued)
The reconciliation of income tax computed at the U.S. federal statutory rate to
income tax benefit is as follows:
For the period from November 9 to
December 31, 1998
Amount Percent
------------------------------------
Tax at U.S. statutory rate $ (26,806) 35.0%
State taxes, net of federal benefit (3,829) 5.0%
Change in valuation allowance 67,353 51.9%
Effect of permanent differences (39,796) (87.9)%
====================================
$ (3,078) 4.0%
====================================
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's net deferred income taxes are as follows:
December 31,
1998
-------------------
Deferred tax assets:
Net operating loss carryforwards $ 720,937
AMT credit carryforward 251,879
Book/tax basis difference 286,501
Less: valuation allowance (360,470)
-------------------
898,847
-------------------
Deferred tax liabilities:
Rent accrual 2,442,016
Depreciation 265,794
Book/tax basis difference 776,660
Goodwill 32,479
-------------------
-------------------
3,516,949
-------------------
Net deferred tax liability after valuation allowance $ (2,618,102)
===================
IV-37
8. Income Taxes (continued)
Statement 109 requires a valuation allowance to reduce the deferred tax assets
reported if, based on the weight of the evidence, it is more likely than not
that some portion or all of the deferred tax assets will not be realized. After
consideration of all the evidence, both positive and negative, management has
determined that approximately $284,000 of a valuation allowance at December 31,
1998 is necessary to reduce the deferred tax assets to the amount that will more
likely than not be realized.
At December 31, 1998, Interoffice has available unused net operating loss
carryforwards of approximately $1,246,000.
9. Related Parties
An executive of Interoffice owns a real estate brokerage company which has
received commissions from landlords of the centers for leasing certain
facilities at the sites the subsidiaries are located. The brokerage company
received commissions from the landlords and shared an allocated portion with
Interoffice. Total commissions earned for the period November 9, 1998 to
December 31, 1998 were approximately $75,000, and have been included in service
income on the accompanying consolidated statements of income.
The Company has notes payable to the above mentioned related party as discussed
in note 7.
In connection with the Company's acquisition of three executive office suite
centers in France (see note 13), a stockholder loaned the Company $1,750,000.
This amount was repaid in January 1999.
10. 401(k) Profit Sharing Plan
The Company has an established profit sharing plan under Section 401(k) of the
Internal Revenue Code. The plan, which is open to substantially all employees,
provides for employer matching contributions of 50%, up to a maximum of $2,400
per employee per year. Employer contributions totaled $19,042 for the period
November 9, 1998 to December 31, 1998.
IV-38
11. Management Incentive Bonus Structure
Certain members of the senior management team of the Company, consisting of five
employees, by contract are paid an incentive bonus based on Interoffice's cash
flow, as defined, monthly. Senior management bonus percentages during 1998
averaged 11%. Also, most other Company employees receive incentive bonuses
through a discretionary bonus structure monitored by senior management.
12. Commitments and Contingencies
The Company leases the premises from which operations are conducted from third
parties. These noncancellable arrangements expire from January 1998 to May 2009
and contain rent escalations up to 5% per year. Rent paid during the period
November 9, 1998 to December 31, 1998 was approximately $2,578,000.
As of December 31, 1998, the approximate minimum lease payments under the terms
of these agreements are as follows:
December 31, 1999 $ 15,724,000
2000 16,121,000
2001 16,203,000
2002 15,046,000
2003 13,821,000
Thereafter 32,844,000
===================
$ 109,759,000
===================
Included in rent expense is escalation expenses of approximately $127,000 in the
period November 9, 1998 to December 31, 1998.
The Company has guaranteed approximately $2.5 million of lease payments for
certain of its subsidiaries.
During 1998, the Company entered into four separate employment agreements. The
employees have been awarded options to purchase 225 shares of Class B common
stock of the aggregate issued and outstanding shares of Class A and Class B
common stock of the Company at an aggregate purchase price per share, as
defined. Such options vest in equal installments over a two to three year
period.
IV-39
13. Subsequent Events (Unaudited)
On January 5, 1999, the Company closed on a contract to acquire three executive
office suite centers in France for approximately $1.5 million. In connection
with this acquisition, the Company has guaranteed certain leases and bank loans
of approximately $500,000 which were previously personally guaranteed by the
Seller.
On January 8, 1999, the Company merged with a wholly-owned subsidiary of
Alliance National Incorporated ("Alliance"), a Nevada corporation. In connection
with the merger, Alliance issued 11,567,247 shares of Series C preferred stock
to shareholders of the Company. In addition, the Company issued 1,357 common
stock in connection with the merger.
On May 8, 1998, the Company entered into a stock purchase agreement whereby
Interoffice will purchase all of the issued and outstanding shares of the
capital stock of Pacific Office Centers, Inc. for approximately $7.1 million.
Pacific Office Center, Inc. consists of nine office centers located in southern
California. Alliance, as successor to the Company, closed this agreement
effective February 1, 1999.
14. Impact of Year 2000 (Unaudited)
The Company's management has assessed the Year 2000 issue, and has developed an
action plan to address the issue. Management believes that its action plan will
be implemented and completed in a timely fashion, and that it will not
materially affect the Company's future operating results or future financial
condition.
IV-40
REPORT OF INDEPENDENT AUDITORS
MEMBERS OF RSVP HOLDINGS, LLC
We have audited the accompanying consolidated balance sheet of RSVP Holdings,
LLC as of December 31, 1998 and the related consolidated statements of
operations, members' equity, and cash flows for the period from February 26,
1998 (commencement of operations) to December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of RSVP Holdings, LLC
as of December 31, 1998 and the consolidated results of its operations and its
cash flows for the period February 26, 1998 (commencement of operations) to
December 31, 1998 in conformity with generally accepted accounting principles.
/S/ERNST & YOUNG, LLP
New York, New York
March 5, 1999
IV-41
RSVP HOLDINGS, LLC
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1998
ASSETS
Cash $ 123,020
Equity Investments (Note 3) 35,259,956
Affiliate receivables (Note 4) 3,637,471
Deferred Compensation (Notes 1 and 4) 4,938,539
Equipment (net of accumulated depreciation of $30,557) 105,699
Other assets (Note 5) 686,727
-------------
TOTAL ASSETS $44,751,412
===========
LIABILITIES AND MEMBERS' EQUITY
Accounts payable and accrued expenses $ 1,397,412
Affiliate payables (Note 4 and 5) 5,232,929
------------
TOTAL LIABILITIES 6,630,341
---------
Minority Interest 31,201,645
COMMITMENTS AND CONTINGENCIES (Notes 1, 4 and 6) -
Members' equity 6,919,426
---------
TOTAL LIABILITIES AND MEMBERS' EQUITY $44,751,412
===========
(See accompanying notes to consolidated financial statements)
IV-42
RSVP HOLDINGS, LLC
CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE PERIO
FEBRUARY 26, 1998 TO
REVENUES DECEMBER 31, 1998
- -------- -----------------
Fee income (Note 4) $ 92,791
Interest income 193,034
Other income 360,853
--------------
TOTAL REVENUES 646,678
--------------
EQUITY IN LOSS ON INVESTMENTS (Note 3) (3,747,767)
--------------
EXPENSES
Payroll & related costs (Note 4) 2,893,914
Office expenses 493,781
Professional fees 382,021
Management fees (Note 4) 416,667
Travel 109,384
Terminated transaction costs (Note 2) 1,686,389
Amortization and depreciation 30,557
Organization costs (Note 2) 757,644
Interest expense 491,172
--------------
TOTAL EXPENSES 7,261,529
--------------
LOSS BEFORE MINORITY INTEREST (10,362,618)
Minority Interest 6,263,739
--------------
NET LOSS $(4,098,879)
===========
(See accompanying notes to consolidated financial statements)
IV-43
RSVP HOLDINGS, LLC
CONSOLIDATED STATEMENT OF MEMBERS' EQUITY
For the period February 26, 1998 to December 31, 1998
RSI FUND
MANAGEMENT, LLC
---------------
Contribution of Reckson Stock (Note 1) $ 5,887,000
Cost of Capital - March 13, 1998 (Note 1) (5,000,000)
Contribution of Investment in American Campus Communities, LLC 1,879,646
Contribution of Investment in Dobie Center Properties, Ltd. --------
Contributions for Investments in Gateway Development Group, LLC 182,908
Contributions for Investments in Assisted Living Investments, LLC 3,769,125
Contributions for Investments in Dominion Venture Group, LLC 2,865,818
Contributions for working capital 1,433,808
Net Loss - February 26, 1998 to December 31, 1998 (4,098,879)
-----------
MEMBERS' EQUITY AT DECEMBER 31, 1998 $ 6,919,426
=============
(See accompanying notes to consolidated financial statements)
IV-44
RSVP HOLDINGS, LLC
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE PERIOD FEBRUARY 26, 1998 TO DECEMBER 31, 1998
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (4,098,879)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 30,557
Minority interest (6,263,739)
Equity in loss of investments 3,747,767
Write-off of organization costs 757,644
Changes in operating assets and liabilities:
Affiliate receivables (3,637,471)
Deposit (466,666)
Other assets (220,061)
Accounts payable and accrued expenses 1,397,412
-------------
Net cash used in operating activities (8,753,436)
-------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of equipment (136,256)
Distribution from American Campus Communities, LLC 98,335
Investment in Gateway Development Group, LLC (650,531)
Investment in Assisted Living Investments, LLC (7,583,879)
Investment in Dominion Venture Group, LLC (28,992,002)
Organization and pre-acquisition costs (757,644)
-------------
Net cash used in investing activities (38,021,977)
------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from affiliate loans 5,232,929
Offering costs (5,000,000)
Deferred compensation (4,938,539)
Contributions of minority members 37,465,384
Contributions of members 14,138,659
------------
Net cash provided by financing activities 46,898,433
-----------
Net increase in cash which is cash at end of period $ 123,020
-------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for interest $ 130,296
===========
SUPPLEMENTAL DISCLOSURES OF NON-CASH TRANSACTIONS
Contribution of non-cash assets to Reckson Strategic Venture Partners,
LLC-Investment in American Campus Communities, LLC $1,879,646
==========
(See accompanying notes to consolidated financial statements)
IV-45
RSVP HOLDINGS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. ORGANIZATION AND FORMATION OF THE COMPANY
RSVP Holdings, LLC ("Holdings" or the "Company") was formed on February 26, 1998
to be the managing member of Reckson Strategic Venture Partners, LLC and related
entities ("RSVP") a real estate venture capital fund, of which the Company owns
100% of the common equity interests. The Company is composed of two members, RSI
Fund Management LLC, a wholly owned subsidiary of Reckson Service Industries,
Inc., ("RSI") and New World Realty, LLC ("New World"), an entity formed by the
two RSVP managing directors to manage the day-to-day operations of RSVP, subject
to the strategic direction of RSI. RSI Fund Management, LLC, owns 100% of the
common equity interests and New World has a carried interest in profits. The
Holdings operating agreement (the "Managing Member Operating Agreement")
provides for the payment to New World after RSI and affiliated persons (the
"Reckson Investors") have received a return of their capital contributions to
RSVP investments plus a 12% internal rate of return ("IRR ") thereon, of $15
million and, thereafter, a share of cash flows ranging from 15% to 27.75% based
upon the IRR received by the Reckson Investors in respect of RSVP investments.
RSVP was formed on March 5, 1998 to invest in real estate and real
estate-related operating companies with experienced management teams in market
sectors which are in the early stages of their growth cycle or offer unique
circumstances for attractive investments as well as platforms for future growth.
RSVP has retained highly experienced professionals that who source, structure
and execute transactions within each platform as well as manage the day-to-day
operations of RSVP, subject to the overall management of RSI's executive
officers.
On March 5, 1998, Paine Webber Real Estate Securities, Inc., ("PWRES") became a
non-managing member and sole preferred equity owner of RSVP, with a capital
commitment of $200 million (the "Preferred Equity Facility"). PWRES will share
in profits and losses of RSVP, as defined in the RSVP'S operating agreement
subject to a maximum IRR of 16% on invested capital. Allocations of income and
losses are made in accordance with provisions defined in the operating
agreement. In connection with the PWRES preferred equity financing, RSVP paid a
commitment fee of $5,000,000. On April 24, 1998, PWRES assigned 25% of its
preferred equity interest in RSVP, representing an unfunded capital commitment
of $50 million to Stratum Realty Fund, LLC ("Stratum"). The assignment provides
Stratum with similar rights and priorities.
Each of the RSVP Managing Directors has entered into an employment agreement
with the Company which provides for a minimum annual base salary of $500,000 and
has a term of the earlier of seven years or the term of RSVP, but not less than
five years. Each of the RSVP Managing Directors has received from RSI a $3
million grant of common stock of Reckson Associates Realty Corp. ("Reckson")
which vests equally throughout the first five years of employment (see Note 4).
New World is also entitled to one-half of any asset management fee earned by
Holdings from the Reckson Investors. Additionally, it is anticipated that New
World will receive transaction fees of up to $1 million a year for identifying
investment opportunities for RSVP.
The Managing Member Operating Agreement provides New World with certain rights
regarding major capital decisions of RSVP, including the disposition of RSVP's
investments except for dispositions at an independently determined fair value.
The Managing Member Operating Agreement obligates RSI to contribute 100% of the
capital contributions to be made by Holdings to RSVP in an amount up to $100
million. At the termination of RSVP, New World has a right of first refusal to
purchase any RSVP investment proposed for sale.
IV-46
RSVP HOLDINGS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared for the purpose of
complying with Rule 3-09 of regulation S-X of the Securities and Exchange
Commission.
Basis of Presentation
The accompanying consolidated financial statements include the financial
position of the Company and RSVP, at December 31, 1998 and the results of its
operations and its cash flows for the period February 26, 1998 to December 31,
1998. All significant intercompany balances and transactions have been
eliminated in the consolidated financial statements. The preferred interest of
PWRES and Stratum in RSVP are reflected in minority interests in the
accompanying consolidated financial statements.
The investments accounted for under the equity method are Dobie Center
Properties, Ltd., American Campus Communities, LLC, Assisted Living Investments,
LLC, Dominion Venture Group, LLC and Gateway Development Group, LLC
(collectively, the "RSVP Investments").
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
Cash Equivalents
The Company considers highly liquid investments with a maturity of three months
or less when purchased to be cash equivalents.
Long-Lived Assets
The Company assesses the need to record impairment losses on long-lived assets
used in operations when indicators of impairment are present. On an on-going
basis, management reviews the value and period of amortization or depreciation
of long-lived assets, including excess investments of equity investments. During
this review, the Company reevaluates the significant assumptions used in
determining the original cost of long-lived assets. Although the assumptions may
vary from transaction to transaction, they generally include revenue growth,
operating results, cash flows and other indicators of value. Management then
determines whether these have been a permanent impairment of the value of
long-lived assets based upon events or circumstances which have occurred since
acquisition.
Transaction Costs
Costs incurred in connection with potential acquisitions are deferred until the
transaction is consummated, or if terminated, such costs are expensed.
Change in Accounting Principle
In April 1998, the Accounting Standards' Executive Committee of the American
Institute of Certified Public Accountants issued SOP No. 98-5, "Reporting on the
Costs of Start-Up Activities". This standard provides guidance on the financial
reporting for start-up costs and requires that such costs be expenses as
incurred. The standard is effective for fiscal years beginning after December
15, 1998. In accordance with this standard the Company adopted this policy in
1998. The Company expensed organization costs of $757,644 in 1998.
Income Taxes
The Company is not subject to federal or state income taxes. As such, no
provisions for these taxes has been made, since the aforementioned taxes are the
responsibility of the individual members of the Company. The Company is subject
to New York State Limited Liability Company fees.
IV-47
RSVP HOLDINGS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
3. INVESTMENTS
As of December 31, 1998, the Company's equity investments are as follows:
Investment in American Campus Communities,LLC $ 1,262,415
Investment in Dobie Center Properties, Ltd. 32,296
Investment in Assisted Living Investments, LLC 4,676,272
Investment in Dominion Venture Group, LLC 29,288,973
------------
TOTAL EQUITY INVESTMENTS $ 35,259,956
===========
The following are the Company's equity in earnings (loss) of investments for the
period February 26, 1998 to December 31, 1998:
Equity in loss of American Campus Communities, LLC $ (518,895)
Equity in earnings of Dobie Center Properties, Ltd. 32,296
Equity in loss of Gateway Development Group, LLC (650,531)
Equity in loss of Assisted Living Investments, LLC (2,907,607)
Equity in earnings of Dominion Venture Group, LLC 296,970
-----------
TOTAL EQUITY IN LOSS OF INVESTMENTS $(3,747,767)
============
Student Housing
- ---------------
In 1997, RSI acquired a 33 1/3% interest in a wholly owned subsidiary of RFG
Capital Group, LLC ("RFG") for $1.51 million. RFG's sole net investment is a
76.09% interest in American Campus Communities, LLC ("ACC"), a student housing
enterprise which owns, develops, constructs, manages and acquires, on-and off
campus student housing projects. On April 1, 1998, RSI transferred its equity
interest to RSVP. For the period April 1, 1998 to December 31, 1998, RSVP
recognized a loss of $518,895 attributable to ACC.
In 1997, RSI invested through affiliated entities $3.62 million for a 33 1/3%
interest in Reckson Opportunity Partners, LP ("RO"). RO used such proceeds along
with equal proceeds from RO's two other owners to acquire a 70% interest in
Dobie Center Properties, Ltd. ("Dobie"), which owns 100% of Dobie Center, a
mixed-use student housing and retail property located in Austin, Texas. On April
1, 1998, RSI transferred its interest in RO, net of certain proceeds related to
the refinancing of Dobie, to RSVP. For the period April 1, 1998 to December 31,
1998, RSVP recognized income of $32,296 attributable to Dobie.
Privatization
- -------------
On August 27, 1998, a joint venture was formed between RSVP and Dominion, an
Oklahoma-based, privately-owned group of companies that focuses on the
development, acquisition and ownership of government occupied office buildings
and correctional facilities. The new venture, Dominion Venture Group, LLC (the
"Dominion Venture") is owned by RSVP-Dominion LLC, a subsidiary of RSVP, and by
Burgess Services, LLC, an entity owned and controlled by Calvin Burgess,
President and Chief Executive Officer of Dominion.
The Dominion Venture consists of two operating divisions. Dominion Properties,
LLC, will directly or indirectly own real estate and other Real Estate
Investment Trust ("REIT") qualified investments (the "Properties Division"). A
subsidiary of ROP owns a membership interest in the Properties Division.
Dominion Asset Services, LLC, owns companies that engage in businesses that
create non-REIT qualifying income (the "Services Division"). The businesses of
the Services Division will include (i) leasing correctional facilities from the
Properties Division and contracting with a third party for the management of
such facilities, (ii) acting as a general contractor or a construction manger
for the construction of real estate both for the Properties Division and for
third parties, and (iii) the management of existing and newly developed and
constructed government leased office buildings.
In 1998, total RSVP contributions to the Dominion Venture were $28,728,130 of
which $25,862,312 was contributed by PWRES and $2,865,818 by RSI.
Allocations of income and cash flow distributions are made in accordance with
provisions defined in the Operating Agreement.
IV-48
RSVP HOLDINGS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
3. INVESTMENTS (CONTINUED)
As of December 31, 1998, the excess of the RSVP's investment over its share of
the equity in the underlying net assets of the Dominion Venture ("Excess
Investment") was $263,873. This Excess Investment is being amortized over the
life of the investment estimated at 25 years.
Summarized financial information and a summary of RSVP's investment in and share
of income of the Dominion Venture is as follows:
Balance Sheet December 31, 1998
----------------
Property and equipment, net..................... $ 132,872,232
Intangibles..................................... 15,777,941
Other assets.................................... 9,505,124
-------------
Total Assets.................................... $ 158,155,297
=============
Current liabilities............................. $ 25,222,798
Mortgage payable................................ 48,847,698
-------------
Total Liabilities............................... 74,070,496
=============
Minority Interest............................... 10,188,332
Preferred equity................................ 44,871,369
RSVP investment in Dominion Venture............. 29,288,973
Less: Excess Investment........................ (263,873)
-------------
Total Members' Equity........................... 73,896,469
--------------
Total Liabilities & Members' Equity............. $ 158,155,297
===============
Statement of Operations For the period from
August 27, 1998 to
December 31, 1998
-----------------
Construction revenue............................ $ 10,313,898
Other revenue................................... 8,744,453
Total Revenue................................... ---------
19,058,351
----------
Cost of sales................................... 14,483,812
General and administrative expenses............. 1,359,293
Depreciation and amortization expense........... 1,418,351
Interest expense, net........................... 703,293
---------
Total Expenses.................................. 17,964,749
---------
Minority Interest............................... 122,994
---------
Net income...................................... 970,608
Less: Preferred Members' share................. (673,638)
---------
RSVP's share.................................... $ 296,970
==========
On August 11, 1998, RSVP, through a wholly owned subsidiary, formed a joint
venture Gateway Development Group, LLC ("Gateway"), with Gateway Management
Group. Gateway is a start up entity that pursues opportunities in privatized
military housing. In 1998, RSVP has funded $549,238. The Company is uncertain
whether it will to recover its invested dollars from Gateway's future cash
flows. At December 31, 1998, RSVP has recognized a loss of $650,531 which
includes a reserve for their total contributed dollars plus investment costs of
$101,293.
IV-49
RSVP HOLDINGS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
3. INVESTMENTS (CONTINUED)
Assisted Living
- ---------------
On August 12, 1998, RSVP, acquired through a wholly owned subsidiary, a 45%
interest in Assisted Living Investments, LLC ("ALI") for approximately $3.25
million. ALI is a joint venture that develops, leases, operates and finances
assisted living facilities. In addition, RSVP has agreed to contribute 80% of
the equity of ALI, up to a maximum $16.0 million for a total maximum commitment
of $19.25 million. RSVP funded $7.5 million of its $19.25 million commitment
upon the closing of the transaction. RSVP has funded 50% of its capital
contributions through draws under the Preferred Equity Facility.
As of December 31, 1998, the excess of the Company's investment over its share
of the equity in the underlying net assets of ALI ("Excess Investment") was
$2,887,585. The Excess Investment is being amortized over the life of the
investment estimated at 25 years.
Summarized financial information and a summary of RSVP's investment in and share
of loss is as follows:
Balance Sheet December 31, 1998
-----------------
Property and equipment, net $ 79,101,531
Other assets................................. 6,483,316
---------
Total Assets............................ $ 85,584,847
===========
Note payable................................. $ 82,883,473
Other liabilities............................ 8,087,520
---------
Total Liabilities....................... 90,970,993
----------
Minority interest............................ (7,174,833)
Net RSVP investment in ALI................... 4,676,272
Less: Excess investment..................... (2,887,585)
---------
Total Members' Deficit.................. (5,386,146)
---------
Total Liabilities and Members' Deficit.. $ 85,584,847
============
Statement of Operations For the period from
August 12, 1998 to
December 31, 1998
----------------
Total Revenues.......................... $ 2,847,404
------------
Operating expenses....................... 3,509,287
Pre-opening expenses..................... 1,090,673
Depreciation and amortization............ 1,180,190
Interest expense......................... 1,759,929
Other expenses........................... 409,421
---------
Total Expenses...................... 7,949,500
---------
Net loss as reported by ALI.............. (5,102,096)
Adjustment for equity accounting basis... 545,337
---------
Net loss as adjusted..................... (4,556,759)
Less: Non-RSVP share.................... (1,708,785)
---------
RSVP share of net loss................... (2,847,974)
Amortization of excess investment and
pre-opening costs...................... (59,633)
---------
Total RSVP share of net loss.............. $ (2,907,607)
==============
IV-50
RSVP HOLDINGS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
4. TRANSACTIONS WITH RELATED PARTIES
On June 15, 1998, RSI established a credit facility of $100 million ("RSVP
Facility") with ROP for funding the common equity component of RSVP investments.
The amount available under the RSVP Facility is reduced by any amount invested
by ROP directly in joint ventures with RSVP. The RSVP Facility has a term of
five years and bears interest at a rate equal to the greater of (i) the prime
rate plus 2% and (ii) 12% per annum, with the rate referred to in clause (iii)
increasing annually on outstanding borrowings at a rate of 4% of the prior
year's rate. As of December 31, 1998, ROP has advanced RSI $7,281,781 under the
RSVP Facility and has invested $10,065,338 in the Dominion Venture (See Note 3).
Included in affiliate payables are interim advances of approximately $1.2
million made to the Company by RSI for working capital. These advances accrue
interest at a rate equal to the rate on the RSVP facility.
Each RSVP Managing Director received a $3.0 million grant of common stock of
Reckson Associates Realty Corp. (the "Reckson Stock") which will vest equally
over five years. The Reckson Stock was purchased by RSI and contributed to
Holdings. The amortization of the Reckson stock for the period March 5, 1998 to
December 31, 1998 was $948,461. It was charged to RSVP and is included in
payroll and related costs in the accompanying consolidated statement of
operations. In addition, in April 1998, RSI advanced each managing director a
tax loan of approximately $1.4 million in connection with the grant of Reckson
Stock. These loans bear interest at 8% per annum, are due in April, 2003, and
are secured by the Reckson stock. These amounts are included in affiliate
receivables.
New World is entitled to receive transaction fees of up to $1 million per year
related to identifying RSVP investment opportunities. In August of 1998, $1
million of such fees were paid to New World by a third party.
RSI is entitled to a cumulative annual management fee of $2 million with respect
to RSVP, of which $1.5 million is subordinate to PWRES receiving an annual
minimum rate of return of 16% and a return of its capital. The unsubordinated
amount earned by RSI for the period March 5, 1998 to December 31, 1998 was
$416,667.
In 1998, RSVP received an asset management fee of $92,791 for services provided
to Dobie Center Properties, Ltd.
5. OTHER ASSETS
Included in other assets is a deposit of $466,666 which represents funds
reserved for future capital improvements for Dobie Center. Upon release, these
funds would be payable to RSI. These funds are held in a trustee's account and
are not controlled by RSVP.
6. SUBSEQUENT EVENTS (UNAUDITED)
With respect to RSVP's investment in Assisted Living Investments, LLC, on
February 1, 1999, a member of Sun Healthcare Group, Inc., ("SUN") the parent of
an ALI member, reported a significant loss from operations during the quarter
ended December 31, 1998. Additionally, SUN continues to implement a
comprehensive restructuring of its operations. The restructuring of SUN's
operations has led the partners of ALI to enter into negotiations regarding
ALI's ongoing business plan and potentially modify allocations and priorities of
cash flow, profits and losses. These negotiations are in progress. As of
December 31, 1998, the Company determined that there was no impairment on its
investment in ALI.
On March 17, 1999, PWRES transferred rights, title and interest on its invested
capital to date in RSVP to Stratum. This transfer will include the rights to
distributions based upon the amount of funded capital contributions.
IV-51
RSVP HOLDINGS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
7. YEAR 2000 COMPLIANCE (UNAUDITED)
The Company and the RSVP Investments have completed an assessment to modify or
replace portions of their software so that their computer systems will function
properly with respect to dates in the year 2000 and thereafter. Since their
accounting software is maintained and supported by a third party, the total year
2000 project cost is estimated to be minimal. The year 2000 project is estimated
to be completed no later than July 31, 1999, which is prior to any anticipated
impact on their operating systems. Additionally, their mechanical systems are
currently year 2000 compliant. However, the Company and the RSVP Investments
cannot guarantee that all contractors will comply with their assurances and
therefore, they will not be able to replace non-compliant contractors. They
believe that with modifications to existing software and conversions to new
software, the year 2000 issue will not pose significant operational problems for
its computer systems. However, if such modifications and conversions are not
made, or are not complete timely costs associated with the year 2000 issue could
be significant and have a material impact on the operations of the Company and
the RSVP Investments.
To date, the Company and the RSVP Investments have expended approximately
$21,000 and expect to expend an additional $60,000 in connection with upgrading
of their computer system. The costs of the project and the date on which they
believe it will complete the year 2000 modifications are based on management's
best estimates, which were derived utilizing numerous assumptions of future
events, including the continued availability of certain resources and other
factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from those anticipated.
Specific factors that might cause such material differences include, but are not
limited to, the availability and costs of personnel trained in this area, the
ability to locate and correct all relevant computer codes, and similar
uncertainties.
IV-52
Exhibit Index
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
3.1* Certificate of Incorporation
3.2* By-Laws of Registrant
3.3 Amended and Restated Certificate of Incorporation
4.1* Specimen Share Certificate of Common Stock
10.1 Intercompany Agreement between Reckson Operating Partnership, L..P. and
Reckson Service Industries, Inc. dated May 13, 1998
10.2A Credit Agreement between Reckson Operating Partnership, L.P. and
Reckson Service Industries, Inc. relating to the operations of Reckson
Strageic Venture Partners, LLC dated June 15, 1998
10.2B Credit Agreement between Reckson Operating Partnership, L.P. and
Reckson Service Industries, Inc. relating to the operations of Reckson
Service Industries, Inc. dated June 15, 1998
10.3* Limited Liability Company Agreement of OnSite Ventures, LLC
10.4* StandBy Purchase Agreement
10.5* Limited Liability Company Agreement of RSVP Holdings, LLC
10.6A* Operating Agreement of Reckson Strategic Venture Partners, LLC
10.6B* Supplemental Agreement to Operating Agreement of Reckson Strategic
Venture Partners, LLC
10.7* Registration Rights Agreement between Reckson Service Industries, Inc.
and certain affiliates thereof dated May 13, 1998
10.8* Option to acquire Interoffice Superholdings Corporation
10.9 Loan Agreement regarding On-Site Convertible Loans
10.10A* Stock Option Plan
10.10B 1998 employee stock option plan
10.11* Employment Agreement of Steven H. Shepsman
10.12* Employment Agreement of Seth B. Lipsay
10.13* Limited Liability Company Agreement of Interoffice Superholdings, LLC
by and among Interoffice Superholdings, LLC, RSI I/O Holdings, Inc.,
JAH I/O, LLC and Rieger I/O LLC
10.14* Fourth Amended and Restated Stockholder's Agreement dated January 8,
1999 by and among Alliance National Incorporated and the security
holders identified therein.
10.15** Letter Agreement dated November 9, 1998 by and between JAH I/O LLC and
Reckson Management Group, Inc., Reckson Service Industries, Inc., RSI
I/O Holdings, Inc., and Reckson Office Centers, LLC
10.16** Letter Agreement by and between Reckson Service Industries, Inc., and
RFIA, LLC
10.17*** Amended and Restated Operating Agreement of Assisted Living Investments
LLC
10.18# Operating Agreement of Dominion Venture Group LLC
10.19## Agreement and Plan of Merger by and among Alliance National
Incorporated, Alliance Holding Inc., Interoffice Superholdings
Corporation and Interoffice Superholdings, LLC
10.20## Agreement and Plan of Merger by and among Alliance National
Incorporated, ANI Holdings, Inc., Reckson Executive Centers, Inc., and
Reckson Office Centers, LLC
10.21 $4 Million Senior Secured Promissory Note of On-Site Ventures, LLC
12.1 Statement of Ratios of Earnings to Fixed Charges
21.1 Statement of Subsidiaries of Reckson Service Industries, Inc.
24.1 Powers of Attorney (included in Part IV of this Form 10-K)
27.0 Financial Data Schedule
99.1* Form of Letter to Stockholders regarding Rights Offering
99.2* Subscription Agent Agreement between Reckson Service Industries, Inc.,
and American Stock Transfer & Trust Company
- -------------
* Previously filed as an exhibit to Registration Statement on Form S-1 (No.
333-44419) and incorporated herein by reference.
** Previously filed as an exhibit to the Company's Form 8-K filed with the SEC
on January 25, 1999 and incorporated herein by reference.
*** Previously filed as an exhibit to the Company's form 8-K report filed with
the SEC on September 8, 1998 and incorporated herein by reference.
# Previously filed as an exhibit to the Company's form 8-K report field with
the SEC on September 11, 1998 and incorporated herein by reference.
## Previously filed as an exhibit to the Company's Form 8-K filed with the SEC
on December 1, 1998 and incorporated herein by reference.