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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
-------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ___________ TO ____________.
COMMISSION FILE NUMBER: 033-68728
-------------------------
CORPORATE PROPERTY ASSOCIATES 12 INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MARYLAND 13-3726306
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
50 ROCKEFELLER PLAZA 10020
NEW YORK, NEW YORK 10020 (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
REGISTRANT'S TELEPHONE NUMBERS:
INVESTOR RELATIONS (212) 492-8920
(212) 492-1100
-------------------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) of THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12 (g) OF THE ACT:
-------------------------
CPA(R):12 has SHARES OF COMMON STOCK registered pursuant to Section 12(g)
of the Act.
CPA(R):12 HAS NO SECURITIES registered on any exchanges.
CPA(R):12 does not have any Securities registered pursuant to Section 12(b)
of the Act.
CPA(R):12 (1) has filed all reports required by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for 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.
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [ ].
CPA(R):12 has no active market for common stock at November 10, 2003.
CPA(R):12 has 30,307,700 shares of common stock, $.001 par value
outstanding at November 10, 2003.
CORPORATE PROPERTY ASSOCIATES 12 INCORPORATED
INDEX
Page No.
--------
PART I
Item 1. - Financial Information*
Condensed Consolidated Balance Sheets as of September 30, 2003
and December 31, 2002 2
Condensed Consolidated Statements of Income for the three and nine
months ended September 30, 2003 and 2002 3
Condensed Consolidated Statements of Comprehensive Income for the three and
nine months ended September 30, 2003 and 2002 4
Condensed Consolidated Statements of Cash Flows for the nine months
ended September 30, 2003 and 2002 5
Notes to Condensed Consolidated Financial Statements 6-11
Item 2. - Management's Discussion and Analysis of Financial
Condition and Results of Operations 12-19
Item 3. - Quantitative and Qualitative Disclosure About Market Risk 20
Item 4. - Controls and Procedures 20
PART II - Other Information
Item 4. - Submission of Matters to a Vote of Security Holders 21
Item 6. - Exhibits and Reports on Form 8-K 21
Signatures 22
* The summarized condensed financial statements contained herein are unaudited;
however, in the opinion of management, all adjustments necessary for a fair
presentation of such financial statements have been included.
1
CORPORATE PROPERTY ASSOCIATES 12 INCORPORATED
PART I
Item 1. - FINANCIAL INFORMATION
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, 2003 December 31, 2002
------------------ -----------------
(Unaudited) (Note)
------------- -------------
ASSETS:
Land and buildings, net of accumulated depreciation of $40,016,614 at
September 30, 2003 and $34,815,471 at December 31, 2002 $ 310,342,201 $ 315,608,791
Net investment in direct financing leases 19,127,500 24,987,051
Equity investments 91,718,102 70,551,264
Assets held for sale 4,361,035 -
Cash and cash equivalents 11,047,767 40,084,470
Marketable securities 9,031,269 7,510,030
Other assets 17,246,099 13,386,909
------------- -------------
Total assets $ 462,873,973 $ 472,128,515
============= =============
LIABILITIES, MINORITY INTEREST AND SHAREHOLDERS' EQUITY:
Liabilities:
Limited recourse mortgage notes payable $ 182,370,979 $ 194,933,811
Limited recourse mortgage note payable on asset held for sale 3,236,510 -
Accrued interest 1,034,661 1,098,917
Accounts payable and accrued expenses 2,548,884 2,170,744
Due to affiliates 2,959,742 2,843,060
Deferred acquisition fees payable to affiliate 6,546,125 6,255,973
Dividends payable 6,252,988 6,223,080
Prepaid rental income and security deposits 4,369,584 5,059,112
------------- -------------
Total liabilities 209,319,473 218,584,697
------------- -------------
Minority interest 7,995,434 7,937,305
------------- -------------
Commitments and contingencies
Shareholders' equity:
Common stock, $.001 par value; authorized, 40,000,000 shares; issued
and outstanding, 31,163,771 shares at September 30, 2003 and
30,878,338 shares at December 31, 2002 31,164 30,878
Additional paid-in capital 281,701,748 278,735,372
Dividends in excess of accumulated earnings (29,099,273) (26,441,642)
Accumulated other comprehensive income 1,939,792 307,999
------------- -------------
254,573,431 252,632,607
Less, treasury stock at cost, 946,778 shares at September 30, 2003 and
747,252 shares at December 31, 2002 (9,014,365) (7,026,094)
------------- -------------
Total shareholders' equity 245,559,066 245,606,513
------------- -------------
Total liabilities, minority interest and shareholders'
equity $ 462,873,973 $ 472,128,515
============= =============
The accompanying notes are an integral part of the condensed
consolidated financial statements.
Note: The balance sheet at December 31, 2002 has been derived from the audited
consolidated financial statements at that date.
2
CORPORATE PROPERTY ASSOCIATES 12 INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
2003 2002 2003 2002
---- ---- ---- ----
Revenues:
Rental income $10,375,371 $ 9,963,219 $31,240,255 $29,792,878
Interest income from direct financing leases 646,458 1,052,641 1,939,374 3,722,231
Interest and other income 506,088 598,157 4,333,110 815,661
----------- ----------- ----------- -----------
11,527,917 11,614,017 37,512,739 34,330,770
----------- ----------- ----------- -----------
Expenses:
Interest 3,712,378 3,520,319 11,193,398 10,188,839
Depreciation 1,902,608 1,837,877 5,702,830 5,503,689
General and administrative 1,263,508 1,025,400 3,084,340 3,007,290
Property expenses 2,064,126 1,956,844 6,802,379 5,294,367
Impairment charge on real estate 1,000,000 - 1,000,000 -
Charge on early extinguishment of debt (net of
$960,602 of equity investees) - 1,284,509 - 1,284,509
----------- ----------- ----------- -----------
9,942,620 9,624,949 27,782,947 25,278,694
----------- ----------- ----------- -----------
Income before minority interest and equity
income, gain (loss) and discontinued
operations 1,585,297 1,989,068 9,729,792 9,052,076
Minority interest in income (383,151) (371,151) (1,139,869) (1,100,264)
Income from equity investments, including
charges on early extinguishment of debt of
$960,602 in 2002 2,534,573 1,614,736 7,600,384 4,123,733
----------- ----------- ----------- -----------
Income from continuing operations before
gain (loss) 3,736,719 3,232,653 16,190,307 12,075,545
Unrealized gain (loss) on warrants 111,396 100,140 25,424 (394,006)
Reversal of unrealized gain on warrants on
conversion to shares - - (237,340) -
Gain on settlement of derivatives contract - - 237,340 -
----------- ----------- ----------- -----------
Income from continuing operations 3,848,115 3,332,793 16,215,731 11,681,539
Discontinued operations:
Income (loss) from operations of
discontinued properties 3,477 93,421 (136,256) 324,256
----------- ----------- ----------- -----------
Net income $ 3,851,592 $ 3,426,214 $16,079,475 $12,005,795
=========== =========== =========== ===========
Basic and diluted income per common share:
Earnings from continuing operations $ .13 $ .11 $ .53 $ .39
Earnings from discontinued operations - - - .01
----------- ----------- ----------- -----------
Net income $ .13 $ .11 $ .53 $ .40
=========== =========== =========== ===========
Weighted average shares outstanding - basic and
diluted 30,242,024 30,074,431 30,206,867 30,003,632
=========== =========== =========== ===========
The accompanying notes are an integral part of the condensed
consolidated financial statements.
3
CORPORATE PROPERTY ASSOCIATES 12 INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS of COMPREHENSIVE INCOME (UNAUDITED)
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
2003 2002 2003 2002
---- ---- ---- ----
Net income $ 3,851,592 $ 3,426,214 $ 16,079,475 $12,005,795
Other comprehensive income:
Change in unrealized appreciation on
marketable securities 284,820 (3,148) 1,013,261 (3,148)
Change in foreign currency translation
adjustment 152,209 - 618,532 -
----------- ----------- ------------ -----------
437,029 (3,148) 1,631,793 (3,148)
----------- ----------- ------------ -----------
Comprehensive income $ 4,288,621 $ 3,423,066 $ 17,711,268 $12,002,647
=========== =========== ============ ===========
The accompanying notes are an integral part of the condensed
consolidated financial statements.
4
CORPORATE PROPERTY ASSOCIATES 12 INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine Months Ended September 30,
-------------------------------
2003 2002
---- ----
Cash flows from operating activities:
Net income $16,079,475 $12,005,795
Adjustments to reconcile net income to net cash provided by operating activities:
Income (loss) from discontinued operations 136,255 (324,256)
Depreciation and amortization 6,121,880 5,725,232
Straight-line rent adjustments (1,140,745) (686,239)
Income from equity investments before charge on extinguishment of debt in
excess of distributions received (1,726,146) (486,574)
Charge on extinguishment of debt - 2,245,111
Impairment charge on real estate 1,000,000 -
Fees paid by issuance of stock 2,332,140 2,136,830
Minority interest in income 1,139,869 1,100,264
Unrealized loss on warrants 25,424 394,006
Reversal of unrealized gain on warrants on conversion to shares 237,340 -
Gain on settlement of derivatives contract (237,340) -
Lease termination proceeds assigned to lender (2,540,000) -
Noncash settlement income (368,000) (371,294)
Prepayment premium on extinguishment of debt - (1,225,092)
Change in operating assets and liabilities, net (889,383) (339,195)
----------- -----------
Net cash provided by continuing operations 20,170,769 20,174,588
Net cash (used in) provided by discontinued operations (73,978) 386,533
----------- -----------
Net cash provided by operating activities 20,096,791 20,561,121
----------- -----------
Cash flows from investing activities:
Distributions from equity investments in excess of equity income 1,165,682 952,645
Distribution of mortgage financing proceeds received from equity investment 3,738,075 -
Capital distribution received from equity investment - 1,766,449
Purchases of real estate and equity investments and additional capitalized costs (22,160,839) (1,062,268)
Purchase of securities - (10,075,022)
Proceeds from sale of securities - 1,493,400
Payment of deferred acquisition fees (1,274,925) (1,375,711)
----------- -----------
Net cash used in investing activities (18,532,007) (8,300,507)
----------- -----------
Cash flows from financing activities:
Proceeds from mortgages - 44,704,110
Prepayments of mortgage principal (5,199,402) (8,908,195)
Payments on mortgage principal (4,126,920) (3,621,108)
Amounts advanced on credit facility - 10,000,000
Repayments of advances on credit facility - (10,000,000)
Distributions to minority interest partner (1,081,740) (1,081,741)
Payment of financing costs and mortgage deposits (132,478) (1,316,365)
Proceeds from issuance of shares, net of costs 634,522 958,990
Dividends paid (18,707,198) (18,503,165)
Purchase of treasury stock (1,988,271) (1,185,163)
----------- -----------
Net cash (used in) provided by financing activities (30,601,487) 11,047,363
----------- -----------
Net (decrease) increase in cash and cash equivalents (29,036,703) 23,307,977
Cash and cash equivalents, beginning of period 40,084,470 27,147,331
----------- -----------
Cash and cash equivalents, end of period $11,047,767 $50,455,308
=========== ===========
The accompanying notes are an integral part of the condensed
consolidated financial statements.
5
CORPORATE PROPERTY ASSOCIATES 12 INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 1. Basis of Presentation:
The accompanying unaudited condensed consolidated financial statements of
Corporate Property Associates 12 Incorporated (the "Company") have been prepared
in accordance with accounting principles generally accepted in the United States
of America for interim financial information and with the instructions to
Article 10 of Regulation S-X of the Securities and Exchange Commission.
Accordingly, they do not include all of the information and footnotes required
by accounting principles generally accepted in the United States of America for
complete financial statements. All significant intercompany balances and
transactions have been eliminated. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation of the results of the interim periods presented have been included.
The results of operations for the interim periods are not necessarily indicative
of results for the full year. These condensed consolidated financial statements
should be read in conjunction with the audited consolidated financial statements
and footnotes thereto included in the Company's Annual Report on Form 10-K for
the year ended December 31, 2002.
Certain prior year amounts have been reclassified to conform to current year
financial statement presentation.
Note 2. Transactions with Related Parties:
In connection with performing services on behalf of the Company, the Advisory
Agreement between the Company and Carey Asset Management Corp (the "Advisor"), a
wholly-owned subsidiary of W. P. Carey & Co. LLC, provides that the Advisor
receive asset management and performance fees, each of which are 1/2 of 1% of
Average Invested Assets as defined in the Advisory Agreement. The Advisor has
elected at its option to receive the performance fee in restricted shares of
common stock rather than cash. The Advisor is also reimbursed for the actual
cost of personnel needed to provide administrative work necessary to the
operation of the Company. The Company incurred asset management fees of $862,423
and $712,379 for the three months ended September 30, 2003 and 2002,
respectively, and $2,517,709 and $2,135,304 for the nine months ended September
30, 2003 and 2002, respectively, with performance fees in like amounts. For the
three months ended September 30, 2003 and 2002, the Company incurred personnel
cost reimbursements of $338,433 and $321,207, respectively, and $1,043,243 and
$975,835 for the nine months ended September 30, 2003 and 2002, respectively.
Fees are payable to the Advisor in connection with services performed relating
to the identification, evaluation, financing and purchase of properties. Current
and deferred fees for the nine months ended September 30, 2003 were $667,539 and
$534,031, respectively.
On March 12, 2003, the Company purchased from Corporate Property Associates 15
Incorporated ("CPA(R):15"), an affiliate, a 35% equity interest in a company
that leases thirteen properties to two lessees. In connection with the purchase,
the Company assumed an obligation for 35% of the deferred acquisition fee
payable to the Advisor which was $1,031,046. The Company's cash portion of the
purchase price included reimbursement to CPA(R):15 for 35% of the initial
current acquisition fee which was $1,288,807.
Note 3. Interest in Mortgage Loan Securitization:
The Company is accounting for its subordinated interest in the Carey Commercial
Mortgage Trust mortgage securitization as an available-for-sale marketable
security and it is measured at fair value with all gains and losses from changes
in fair value reported as a component of other comprehensive income as part of
shareholders' equity. As of September 30, 2003, the fair value of the Company's
interests was $8,166,772, reflecting an aggregate unrealized gain of $1,062,104
and cumulative net amortization of $133,954 ($97,362 for the nine months ended
September 30, 2003). The fair value of the Company's interests in the trust is
determined using a discounted cash flow model with assumptions of market rates
and the credit quality of the underlying lessees.
One of the key variables in determining fair value of the subordinated interest
is current interest rates. As required by SFAS No. 140, "Accounting for Transfer
and Servicing of Financial Assets and Extinguishments of Liabilities," a
sensitivity analysis of the current value of the interest based on adverse
changes in market interest rates of 1% and 2% is as follows:
Fair Value as of
September 30, 2003 1% Adverse Change 2% Adverse Change
------------------ ----------------- -----------------
Fair value of the interests $8,166,772 $7,764,562 $7,389,710
The above sensitivity is hypothetical and changes in fair value, based on a 1%
or 2% variation, should not be extrapolated because the relationship of the
change in assumption to the change in fair value may not always be linear.
6
CORPORATE PROPERTY ASSOCIATES 12 INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -
(CONTINUED)
Note 4. Lease Revenues:
The Company's operations consist of the investment in and the leasing of
industrial and commercial real estate. The financial reporting sources of
the leasing revenues for the nine-month periods ended September 30, 2003
and 2002 are as follows:
2003 2002
---- ----
Per Statements of Income:
Rental income from operating leases $31,240,255 $29,792,878
Interest from direct financing leases 1,939,374 3,722,231
Adjustment:
Share of leasing revenue applicable to minority interest (2,322,804) (2,324,636)
Share of leasing revenue from equity investments 19,090,603 12,074,119
----------- -----------
$49,947,428 $43,264,592
=========== ===========
For the nine-month periods ended September 30, 2003 and 2002, the Company
earned its net leasing revenues from its investments from the following
lease obligors:
2003 % 2002 %
---- - ---- -
Applied Materials, Inc. (a) $ 4,714,356 9% $ 4,718,086 11%
Advanced Micro Devices, Inc. (b) 2,444,203 5 2,444,203 6
Carrefour France, SA (b) 2,203,937 4 - -
Galyan's Trading Company 2,049,865 4 2,049,865 5
Starmark Camhood, L.L.C. (b) 1,770,830 4 - -
Scott Companies Inc. 1,653,559 3 1,546,711 4
Perry Graphic Communications, Inc. and Judd's Incorporated 1,643,675 3 1,643,675 4
TruServ Corporation (b) 1,625,014 3 - -
Spectrian Corporation 1,613,250 3 1,522,633 3
Westell Technologies, Inc. 1,487,780 3 1,437,289 3
Special Devices, Inc. (b) 1,485,527 3 1,471,500 3
Best Buy Co., Inc. (b) 1,304,428 3 1,314,006 3
Career Education Corporation 1,302,606 3 1,302,606 3
Telos Corporation 1,249,154 2 1,218,584 3
Q Clubs, Inc. 1,165,047 2 1,154,523 3
PPD Development, Inc. 1,128,142 2 1,128,142 3
Del Monte Corporation (b) 1,108,285 2 1,012,553 2
Sicor, Inc. (b) 1,104,552 2 1,104,552 3
The Upper Deck Company (b) 1,089,165 2 1,089,165 2
Silgan Containers Corporation 1,066,015 2 992,838 2
Compucom Systems, Inc. (b) 1,056,033 2 1,030,188 2
McLane Company, Inc. (b) 1,055,934 2 1,044,231 2
The Bon-Ton Stores, Inc. 1,050,833 2 1,011,091 2
Childtime Childcare, Inc. 952,733 2 892,555 2
Textron, Inc. (b) 929,804 2 912,743 2
Jen-Coat, Inc. 907,500 2 907,500 2
Medica-France, SA (b) 841,908 2 - -
ShopRite Supermarkets, Inc. (b) 818,521 2 811,588 2
Pacific Logistics, L.P. 764,502 2 752,443 2
Orbseal LLC 758,813 2 758,813 2
Garden Ridge Corporation 746,823 2 746,823 2
Other (b) 6,854,634 14 7,245,686 17
----------- --- ----------- ---
$49,947,428 100% $43,264,592 100%
=========== === =========== ===
(a) Net of minority interest of an affiliate.
(b) Represents the Company's proportionate share of lease revenues from
its equity investments.
7
CORPORATE PROPERTY ASSOCIATES 12 INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -
(CONTINUED)
For the nine-month period ended September 30, 2003, lessees were responsible for
the direct payment of approximately $3,725,000 of real estate taxes on behalf of
the Company.
Note 5. Equity Investments:
The Company owns interests in properties leased to corporations through equity
interests in (i) various partnerships and limited liability companies in which
its ownership interests are 50% or less and the Company exercises significant
influence, and (ii) tenancies-in-common subject to common control. The ownership
interests range from 15% to 50%. All of the underlying investments are owned
with affiliates that have similar investment objectives as the Company. The
lessees are Best Buy, Sicor, Inc., The Upper Deck Company, Advanced Micro
Devices, Inc., Compucom Systems, Inc., Textron, Inc., McLane Company, Inc., The
Fleming Companies, Inc., Del Monte Corporation, Special Devices, Inc., ShopRite
Supermarkets, Inc., TruServ Corporation, Starmark Camhood LLC ("Starmark"),
Medica-France, S.A. ("Medica") and affiliates of Carrefour, S.A. ("Carrefour").
The equity investments in Starmark, Medica and Carrefour were acquired during
the quarter ended March 31, 2003.
Summarized combined financial information of the Company's equity investees is
as follows:
(In thousands) September 30, 2003 December 31, 2002
------------------ -----------------
Assets (primarily real estate) $ 886,223 $ 505,304
Liabilities (primarily mortgage notes payable) 574,065 284,254
Partners' and members' equity 312,158 221,050
Nine Months Ended September 30,
-------------------------------
2003 2002
---- ----
Revenues (primarily rental revenue) $ 65,803 $ 29,452
Expenses (primarily interest on mortgages and
depreciation) (40,577) (17,022)
Charge on early extinguishment of debt - (2,506)
---------- ---------
Net income $ 25,226 $ 9,924
========== =========
Note 6. Acquisitions of Real Estate:
Investments acquired during the nine months ended September 30, 2003, all of
which were described in the Company's Quarterly Report on Form 10-Q for the
period ended March 31, 2003, are summarized as follows:
Original
Ownership Initial Mortgage Annual
Lease Obligor: Cost Interest Location Annual Rent Financing Debt Service Date Acquired
- -------------- ---- -------- -------- ----------- ----------- ------------ -------------
Carrefour (a) $37,438,205 35% 7 locations $ 3,908,631 $32,313,050 $ 2,423,547 March 12, 2003
in France
Medica (a) 14,114,745 35% 6 locations 1,479,263 13,041,210 991,502 March 12, 2003
in France
Starmark (a) 26,701,571 15% 15 health 2,740,860 16,245,000 1,514,047 February 7, 2003
club facilities
(a) Accounted for as an equity investment; amounts are shown pro rata
to reflect the Company's ownership interest.
Note 7. Gain on Settlement:
In October 2002, the Company and Rheometric Scientific, Inc. ("Rheometric")
entered into an agreement that would allow Rheometric to terminate its lease for
its facility in Piscataway, New Jersey upon completion of an asset sale of one
of its lines of business. On January 16, 2003, the Rheometric sale was
completed, at which time the lease termination agreement became effective and
Rheometric changed its name to Proterion Corporation ("Proterion"). In
connection with the settlement, the Company recognized $3,042,227 of other
income in 2003. The settlement included a grant of 650,000 shares of common
stock.
8
CORPORATE PROPERTY ASSOCIATES 12 INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -
(CONTINUED)
In connection with structuring the initial purchase transaction with Rheometric,
the Company was granted warrants for 466,140 shares of Rheometric common stock
at an exercise price of $2.00. Under the lease termination agreement, the
exercise price of the warrants was reduced to $0.01. On January 16, 2003, the
warrants were converted on a cashless basis to 456,424 shares of common stock of
Proterion. Because the Company had the ability to convert the warrants to shares
on a cashless basis, the warrants had been classified as a derivative
instrument. Upon conversion to shares, a cumulative unrealized gain in the fair
value of the warrants of $237,340 was reversed and a realized gain of $237,340,
representing the gain on the settlement of a derivatives contract was
recognized. The Company's 1,106,424 shares of Proterion are classified as an
available-for-sale marketable security and are measured at fair value with all
gains and losses in fair value reported as a component of other comprehensive
income as part of shareholders' equity. As of September 30, 2003, the fair value
of the Proterion shares held by the Company was $774,497 based on a quoted value
per share of $0.70.
Note 8. Impairment Charge on Real Estate:
The Company owns a property in Newark Delaware which, for the past several years
has been operated as a multi-tenant facility. During 2003, the occupancy rate of
the property declined substantially. In connection with this change in
circumstances, the property has been written down to its estimated fair value
and an impairment charge of $1,000,000 was recognized.
Note 9. Discontinued Operations:
In July 2003, the Company and Sentry Technology Corporation ("Sentry") entered
into a termination agreement. Sentry agreed not to contest an eviction from the
Company's property in Hauppauge, New York, in consideration for forgiveness of
rent arrearages of $486,000. Under the agreement, Sentry vacated the property in
September 2003, and assigned the Company the right to collect rent directly from
Sentry's sub-tenants. In addition, Sentry issued 1,000,000 shares of its common
stock to the Company which had a quoted per share value of $0.03 as of the date
of issuance and a $250,000 promissory note which Sentry is scheduled to repay
over a three-year period. As of September 30, 2003, the fair value of Sentry
shares held by the Company was $90,000. In connection with the settlement, the
Company recognized other income of $30,000, an amount equal to the value of the
shares received. Because of Sentry's inability to meet lease obligations, the
promissory note has been fully reserved for and settlement income from the note
will be recognized as received.
In September 2003, the Company entered into an agreement to sell the Hauppauge
property for $6,300,000, less selling costs, subject to the buyer's due
diligence review which is currently being performed. Accordingly, the property
is classified as held for sale with a carrying value of $4,361,035 as of
September 30, 2003.
The results of operations for the Hauppauge property are included in
discontinued operations and reflect income of $3,477 and a loss of $136,256 for
the three-month and nine-month periods ended September 30, 2003, respectively
and income of $93,421 and $324,256 for the three-month and nine-month periods
ended September 30, 2002, respectively. As a result of classifying the property
as held for sale, no depreciation has been incurred from the date of
reclassification. The effect of suspending depreciation expense was to reduce
depreciation expense by $3,460 for the three-month and nine-month periods ended
September 30, 2003.
Note 10. Accounting Pronouncements:
In June 2001, FASB issued SFAS No. 143 "Accounting for Asset Retirement
Obligations." SFAS No. 143 was issued to establish standards for the recognition
and measurement of an asset retirement obligation. SFAS No. 143 requires
retirement obligations associated with tangible long-lived assets to be
recognized at fair value as the liability is incurred with a corresponding
increase in the carrying amount of the related long-lived asset. SFAS No. 143 is
effective for financial statements issued for fiscal years beginning after June
15, 2002. SFAS No. 143 was adopted on January 1, 2003 and did not have a
material effect on the financial statements.
In May 2002, FASB issued SFAS No. 145 "Rescission of SFAS Nos. 4, 44 and 64,
Amendment of SFAS No. 13 and Technical Corrections" which eliminates the
requirement that gains and losses from the extinguishment of debt
9
CORPORATE PROPERTY ASSOCIATES 12 INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -
(CONTINUED)
be classified as extraordinary items unless it can be considered unusual in
nature and infrequent in occurrence. The Company adopted this Statement
effective January 1, 2003 and the adoption did not have a material effect on the
Company's financial statements. The Company no longer classifies gains and
losses for the extinguishment of debt as extraordinary items.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or Disposal
Activities". SFAS No. 146 addresses significant issues regarding the
recognition, measurement, and reporting of costs that are associated with exit
and disposal activities, including restructuring activities that are currently
accounted for pursuant to the guidance that the Emerging Issues Task Force
("EITF") has set forth in EITF Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)". The provisions of this
Statement are effective for exit or disposal activities that are initiated after
December 31, 2002, with early application encouraged. SFAS No. 146 was adopted
on January 1, 2003 and did not have a material effect on the Company's financial
statements.
In October 2002, the FASB issued SFAS No. 147, "Acquisition of Certain Financial
Institutions" which amends SFAS No. 72, SFAS No. 144 and FASB Interpretation No.
9. SFAS No. 147 provides guidance on the accounting for the acquisitions of
certain financial institutions and includes long-term customer relationships as
intangible assets within the scope of SFAS No. 144. SFAS No. 147 was adopted on
January 1, 2003 and did not have a material effect on the financial statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others," ("FIN 45") which changes the accounting for, and
disclosure of certain guarantees. Beginning with transactions entered into after
December 31, 2002, certain guarantees are required to be recorded at fair value,
which is different from prior practice, under which a liability was recorded
only when a loss was probable and reasonably estimable. In general, the change
applies to contracts or indemnification agreements that contingently require the
Company to make payments to a guaranteed third-party based on changes in an
underlying asset, liability, or an equity security of the guaranteed party. The
adoption of the accounting provisions of FIN 45 on January 1, 2003 did not have
a material effect on the Company's financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," which amends SFAS No. 123, Accounting
for Stock Based Compensation. SFAS No. 148 provides alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock based compensation (i.e., recognition of a charge for issuance of
stock options in the determination of income.). However, SFAS No. 148 does not
permit the use of the original SFAS No. 123 prospective method of transition for
changes to the fair value based method made in fiscal years beginning after
December 15, 2003. In addition, this Statement amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for stock based
employee compensation, description of transition method utilized and the effect
of the method used on reported results. The transition and annual disclosure
provisions for valuing stock-based compensation of SFAS No. 148 are to be
applied for fiscal years ending after December 15, 2002. The Company does not
have any employees nor any stock-based compensation plans.
On January 17, 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), the primary objective of which is to
provide guidance on the identification of entities for which control is achieved
through means other than voting rights ("variable interest entities" or "VIEs")
and to determine when and which business enterprise should consolidate the VIE
(the "primary beneficiary"). This new model applies when either (1) the equity
investors (if any) do not have a controlling financial interest or (2) the
equity investment at risk is insufficient to finance that entity's activities
without additional financial support. In addition, FIN 46 requires both the
primary beneficiary and all other enterprises with a significant variable
interest in a VIE make additional disclosures. On October 8, 2003, the FASB
staff issued a FASB staff position which deferred the effective date of FIN 46
until December 31, 2003 for VIEs created prior to February 1, 2003. The
Company's maximum loss exposure is the carrying value of its equity investments.
The Company has evaluated the potential impact and believes this interpretation
will not have a material impact on its accounting for its investments in
unconsolidated joint ventures as none of these investments are VIEs.
On April 30, 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain
10
CORPORATE PROPERTY ASSOCIATES 12 INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -
(CONTINUED)
derivative instruments embedded in other contracts, and for hedging under SFAS
No. 133. The changes in the statement improve financial reporting by requiring
that contracts with comparable characteristics be accounted for similarly. In
particular, the statement (1) clarifies under what circumstances a contract with
an initial net investment meets the characteristics of a derivative instrument
discussed in paragraph 6(b) of SFAS No. 133, (2) clarifies when a derivative
contains a financing component, (3) amends the definition of an underlying to
conform it to language used in FIN 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others", and (4) amends certain other existing pronouncements. SFAS No. 149 is
generally effective for contracts entered into or modified after June 30, 2003
and for hedging relationships designated after June 30, 2003. The adoption of
SFAS No. 149 did not have a material effect on the financial statements.
On May 30, 2003, the FASB issued SFAS No. 150 "Accounting for Certain Financial
Instruments with Characteristics of both Liability and Equity." SFAS No. 150
establishes standards to classify as liabilities certain financial instruments
that are mandatorily redeemable or include an obligation to repurchase. Such
financial instruments will be measured at fair value with changes in fair value
included in the determination of net income. SFAS No. 150 is effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. SFAS No. 150 was adopted on July 1, 2003 and did not have a material
effect on the financial statements.
11
CORPORATE PROPERTY ASSOCIATES 12 INCORPORATED
Item 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following information should be read in conjunction with Corporate Property
Associates 12, Incorporated's ("CPA(R):12") condensed consolidated financial
statements and notes thereto as of September 30, 2003 included in this quarterly
report and CPA(R):12's Annual Report on Form 10-K for the year ended December
31, 2002. This quarterly report contains forward-looking statements.
Forward-looking statements involve known and unknown risks, uncertainties and
other factors that may cause the actual results, performance or achievement of
CPA(R):12 to be materially different from the results of operations or plans
expressed or implied by such forward looking statements. Accordingly, such
information should not be regarded as representations by CPA(R):12 that the
results or conditions described in such statements or the objectives and plans
of CPA(R):12 will be achieved. Item 1 of the Annual Report on Form 10-K for the
year ended December 31, 2002 provides a description of CPA(R):12's business
objectives, acquisition and financing strategies and risk factors which could
affect future operating results.
CRITICAL ACCOUNTING POLICIES:
Certain accounting policies are critical to the understanding of CPA(R):12's
financial condition and results of operations. Management believes that an
understanding of financial condition and results of operations requires an
understanding of these accounting policies.
The preparation of financial statements requires that CPA(R):12 make estimates
and assumptions that affect the reported amount of assets, liabilities, revenues
and expenses. For instance, CPA(R):12 must assess its ability to collect rent
and other tenant-based receivables and determine an appropriate charge for
uncollected amounts. Because CPA(R):12's real estate operations have a limited
number of lessees, Management believes that it is necessary to evaluate specific
situations rather than solely use statistical methods. CPA(R):12 recognizes a
provision for uncollected rents which typically ranges between 0.25% and 1% of
lease revenues (rental income and interest income from direct financing leases)
and measures its allowance against actual rent arrearages and adjusts the
percentage applied.
Operating real estate is stated at cost less accumulated depreciation. Costs
directly related to build-to-suit projects, primarily interest, if applicable
are capitalized. CPA(R):12 considers a build-to-suit project as substantially
completed upon the completion of improvements, but no later than a date that is
negotiated and stated in the lease. If portions of a project are in service and
occupied and other portions have not yet reached that stage, the substantially
completed portions are accounted for separately. CPA(R):12 allocates costs
incurred between the portions under construction and the portions substantially
completed and only capitalizes those costs associated with the portion under
construction.
In connection with CPA(R):12's acquisition of properties, purchase costs will be
allocated to the tangible and intangible assets and liabilities acquired based
on their estimated fair values in accordance with SFAS No. 141, "Business
Combinations." The value of the tangible assets, consisting of land, buildings
and tenant improvements, will be determined as if vacant. Intangible assets
including the above-market or below-market value of leases, the value of
in-place leases and the value of tenant relationships will be recorded at their
relative fair values.
CPA(R):12 records above-market and below-market in-place lease values for owned
properties based on the present value (using an interest rate reflecting the
risks associated with the leases acquired) of the difference between (i) the
contractual amounts to be paid pursuant to the leases negotiated and in-place at
the time of acquisition of the properties and (ii) an estimate of fair market
lease rates for the property or equivalent property, measured over a period
equal to the remaining non-cancelable term of the lease. The capitalized
above-market lease value is amortized as a reduction of rental income over the
remaining non-cancelable term of each lease. The capitalized below-market lease
value is amortized as an increase to rental income over the initial term and any
fixed rate renewal periods in the respective leases.
The total amount of other intangible assets is allocated to in-place lease
values and tenant relationship intangible values based on CPA(R):12's evaluation
of the specific characteristics of each tenant's lease and its overall
relationship with each tenant. Characteristics considered in allocating these
values include the nature and extent of the existing relationship with the
tenant, prospects for developing new business with the tenant, the tenant's
credit quality and the expectation of lease renewals among other factors. The
aggregate value of other intangible assets acquired is measured based on the
difference between (i) the property valued with an in-place lease adjusted to
12
CORPORATE PROPERTY ASSOCIATES 12 INCORPORATED
Item 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
market rental rates and (ii) the property valued as if vacant. Independent
appraisals or our estimates are considered in determining these values.
Factors considered in the analysis include the estimated carrying costs of the
property during a hypothetical expected lease-up period, current market
conditions and costs to execute similar leases. CPA(R):12 also considers
information obtained about a property in connection with its pre-acquisition due
diligence. Estimated carrying costs will include real estate taxes, insurance,
other property operating costs and estimates of lost rentals at market rates
during the hypothetical expected lease-up periods, based on an assessment of
specific market conditions. CPA(R):12 estimates costs to execute leases
including commissions and legal costs to the extent that such costs are not
already incurred with a new lease that has been negotiated in connection with
the purchase of the property.
The value of in-place leases are amortized to expense over the remaining initial
term of each lease. The value of tenant relationship intangibles are amortized
to expense over the initial and renewal terms of the leases but no amortization
period for intangible assets will exceed the remaining depreciable life of the
building.
CPA(R):12 also uses estimates and judgments when evaluating whether long-lived
assets are impaired. When events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable, Management performs
projections of undiscounted cash flows, and if such cash flows are insufficient,
the assets are adjusted (i.e., written down) to their estimated fair value. An
analysis of whether a real estate asset has been impaired requires Management to
make its best estimate of market rent, residual value and holding period. As
CPA(R):12's investment objective is to hold properties on a long-term basis,
holding periods will range from five to ten years. In its evaluations, CPA(R):12
obtains market information from outside sources; however, such information
requires Management to determine whether the information received is appropriate
to the circumstances. Depending on the assumptions made and estimates used, the
estimated cash flow projected in the evaluation of long-lived assets can vary
within a range of outcomes. CPA(R):12 considers the likelihood of possible
outcomes in determining the best estimate of future cash flows. Because
substantially all of CPA(R):12's properties are leased to single tenants,
CPA(R):12 is more likely to incur significant writedowns when circumstances
deteriorate because of the possibility that a property will be vacated in its
entirety. This makes the risks faced by CPA(R):12 different than the risks faced
by companies that own multi-tenant properties. Events or changes in
circumstances can result in further writedowns and impact the gain or loss
ultimately realized upon sale of the asset. For its direct financing leases,
CPA(R):12 performs a review of its estimated residual value of properties at
least annually to determine whether there has been an other than temporary
decline in CPA(R):12's current estimate of residual value. If the review
indicates a decline in residual value that is other than temporary, a loss is
recognized and the accounting for the direct financing lease will be revised
using the changed estimate, that is, a portion of the future cash flow from the
lessee will be recognized as a return of principal rather than as revenue.
When assets are identified by Management as held for sale, CPA(R):12
discontinues depreciating the assets and estimates the sales price, net of
selling costs, of such assets. If, in Management's opinion, the net sales price
of the assets which have been identified for sale is less than the net book
value of the assets, an impairment charge is recognized and a valuation
allowance is established. If circumstances that previously were considered
unlikely occur and, as a result, CPA(R):12 decides not to sell a property
previously classified as held for sale, the property is reclassified as held and
used. A property that is reclassified is measured and recorded individually at
the lower of (a) the carrying value before it was classified as held for sale,
adjusted for any depreciation expense that would have been recognized had the
property been continuously classified as held and used, or (b) the fair value at
the time of the subsequent decision not to sell.
In 2002, CPA(R):12 acquired a subordinated interest in a mortgage trust that
consists of limited recourse loans on 62 properties that are owned by CPA(R):12
or three of its affiliates. The fair value of the interests in the trust is
determined using a discounted cash flow model with assumptions of market rates
and the credit quality of the underlying lessees. If there are adverse changes
in either market rates or the credit quality of the lessees, the model, and
therefore, the income recognized from the subordinated interests and the fair
value, will be adjusted. CPA(R):12 also holds warrants for common stock in
various lessees that are defined as derivative instruments because such warrants
are either readily convertible to cash or provide for net settlement upon
exercise. The changes in the fair value of these warrants are recognized
currently in earnings as gains or losses. The fair value is determined using
option pricing models that employ assumptions which include, but are not limited
to, volatility, risk-free rates of
13
CORPORATE PROPERTY ASSOCIATES 12 INCORPORATED
Item 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
return and expected life. For warrants in closely-held companies, certain
factors may be derived from public companies that are in the same industry and
have a similar capital structure.
CPA(R):12 and affiliates are investors in certain real estate assets. Certain of
the investments are held through incorporated or unincorporated jointly held
entities and certain investments are held directly as tenants in common.
Substantially all of these investments represent jointly purchased properties
which were net leased to a single tenant and were structured to provide
diversification and reduce concentration of a risk from a single lessee for
CPA(R):12 and the affiliates. The placement of an investment in a jointly held
entity or tenancy in common requires the approval of the Independent Directors.
All of the jointly held investments are structured so that CPA(R):12 and the
affiliates contribute equity, receive distributions and are allocated profit or
loss in amounts that are proportional to their ownership interests. No fees are
payable to affiliates under any of the limited partnership and joint venture
agreements. All of the jointly held investments are subject to contractual
agreements. The presentation of these jointly held investments is determined
based on factors such as controlling interest, significant influence and whether
each party has the ability to make independent decisions. Equity method
investments are reviewed for impairment in the event of a change in
circumstances that is other than temporary. An equity investment's value is only
impaired if Management's estimate of net realizable value of the investment is
less than the carrying value of the investment. To the extent an impairment has
occurred, the loss shall be measured as the excess of the carrying amount of the
investment over the fair value of the investment.
Stated rental revenue and interest income from direct financing leases are
recognized on a straight-line basis and a constant rate of interest,
respectively, over the terms of the respective leases. Unbilled rents receivable
represents the amount by which straight-line rental revenue exceeds rents
currently billed in accordance with the lease agreements. The majority of
CPA(R):12's leases provide for periodic rent increases based on formulas indexed
to increases in the CPI. CPI-based and other contingent-type rents are
recognized currently. CPA(R):12 recognizes rental income from sales overrides
after the level of sales requiring a rental payment to CPA(R):12 is reached.
CPA(R):12 classifies its directly-owned leased assets for financial reporting
purposes as either real estate leased under the operating method or net
investments in direct financing leases based on several criteria, including, but
not limited to, estimates of the remaining economic life of the leased assets
and the calculation of the present value of future minimum rents. In determining
the classification of a lease, CPA(R):12 uses estimates of remaining economic
life provided by independent appraisals of the leased assets. The calculation of
the present value of future minimum rents includes determining a lease's
implicit interest rate which requires an estimate of the residual value of
leased assets as of the end of the non-cancelable lease term. Different
estimates of residual value result in different implicit interest rates and
could possibly affect the financial reporting classification of leased assets.
The general terms of CPA(R):12 leases are not necessarily different for
operating and direct financing leases; however the classification is based on
accounting pronouncements which are intended to indicate whether the risks and
rewards of ownership are retained by the lessor or transferred to the lessee.
Management believes that it retains certain risks of ownership regardless of
accounting classification.
CPA(R):12 measures derivative instruments, including derivative instruments
embedded in other contracts, if any, at fair value and records them as an asset
or liability, depending on CPA(R):12's rights or obligations under the
applicable derivative contract. For derivatives designated as fair value hedges,
the changes in the fair value of both the derivative instrument and the hedged
item are recorded in earnings. For derivatives designated as cash flow hedges,
the effective portions of the derivative would be reported in other
comprehensive income, a component of shareholders' equity, and are subsequently
reclassified into earnings when the hedged item affects earnings (i.e., the
forecasted event occurs). Changes in fair value of derivative instruments not
designated as hedging and ineffective portions of hedges are recognized in the
determination of earnings.
Costs incurred in connection with obtaining mortgages and debt financing are
capitalized and amortized over the term of the related debt and included in
interest expense. Unamortized financing costs are written off and included in
charges for early extinguishment of debt if a loan is retired. Costs incurred in
connection with leases are capitalized and amortized on a straight-line basis
over the terms of the related leases and included in property expense.
Unamortized leasing costs are also charged to property expense upon early
termination of the lease.
14
CORPORATE PROPERTY ASSOCIATES 12 INCORPORATED
Item 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Public business enterprises are required to report financial and descriptive
information about their reportable operating segments. Operating segments are
components of an enterprise about which financial information is available that
is evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and in assessing performance. Management evaluates the
performance of its portfolio of properties as a whole, rather than by
identifying discrete operating segments. This evaluation includes assessing
CPA(R):12's ability to meet distribution objectives, increase the dividend and
increase value by evaluating potential investments in single tenant net lease
real estate and by seeking opportunities such as refinancing mortgage debt at
lower rates of interest, restructuring leases or paying off lenders at a
discount to the face value of the outstanding mortgage balance.
RESULTS OF OPERATIONS:
Net income for the three-month and nine-month periods ended September 30, 2003
increased by $425,000 and $4,074,000, respectively, as compared with the
three-month and nine-month periods ended September 30, 2002. The increases for
the comparable nine-month periods include $3,042,000 earned from lease
termination settlement agreements in 2003, offset by a noncash impairment charge
of $1,000,000. The results for 2002 include charges on early extinguishment of
debt of $2,245,000. CPA(R):12 also benefited from changes in unrealized gains
and losses on warrants it holds for common stock of several lessees which were
included in the determination of net income because they are classified as
derivative instruments. The results of operations for the periods ended
September 30, 2003 benefited from increases in income from its equity
investments and interest income from its investment in the CPA(R) mortgage loan
securitization.
The increase in income from equity investments of $920,000 and $3,477,000 for
the three-month and nine-month periods, respectively, was primarily due to the
acquisition of jointly-held investments with affiliates. Equity income in 2002
included a $961,000 charge on early extinguishment of debt incurred in
connection with refinancing property-level mortgage debt. The increase also
reflected the reclassification of a jointly-held interest in two properties
leased to ShopRite Supermarkets, Inc. to an equity investment in August 2002
when CPA(R):12's tenancy-in-common interest was contributed to a newly-formed
entity. The acquisition with affiliates of jointly-held investments in
properties leased to TruServ Corporation, Starmark Camhood LLC, Medica-France,
S.A. and affiliates of Carrefour, S.A. between December 2002 and March 2003
provided equity income of $874,000 and $2,179,000 for the current three-month
and nine-month periods, respectively. The reclassification of the ShopRite
investment provided $274,000 and $619,000 of equity income for the three-month
and nine-month periods; however, it had no effect on net income. In March 2003,
Fleming Companies, Inc. filed a voluntary petition for bankruptcy and
subsequently, terminated its lease at a property in Grand Rapids, Michigan, in
which CPA(R):12 owns a 40% interest. CPA(R):12's share of annual rent from the
Fleming lease was $617,000. CPA(R):12's share of annual property carrying costs
is estimated to be $180,000. The property is currently being remarketed for
lease. If the CPA(R):12 and Corporate Property Associates 14 Incorporated, the
majority owner of the Grand Rapids property, are successful in remarketing the
property, cash from equity investments will benefit even if rents do not reach
their previous level. There are several prospective lessees for the property who
are currently evaluating offers to occupy the property.
Lease revenue (rental income and interest income from direct financing leases)
increased by $6,000 and decreased by $335,000 for the three-month and nine-month
periods ended September 30, 2003, respectively. The three-month and nine-month
periods include decreases of $90,000 and $631,000, respectively, solely as a
result of the reclassification of ShopRite to an equity investment. Lease
revenues decreased by $77,000 and $360,000 for the comparable periods as a
result of a lease modification with Randall International, Inc. and a reduction
in lease revenue from two multi-tenant properties in Newark, Delaware and
Piscataway, New Jersey which are not fully occupied. The Newark property which
had several short-term tenants has experienced a significant decrease in
occupancy during 2003. As a result, CPA(R):12 recognized an impairment charge of
$1,000,000 in connection with writing down the Newark property to its estimated
fair value. The Piscataway property was net leased until January 2003 at which
time a settlement agreement with the lessee was entered into and it currently
has several short-term tenants. These decreases were offset by rent increases at
thirteen properties during 2002 and 2003. The majority of these rent increases
are based on formulas indexed to increases in the Consumer Price Index and
provide an aggregate increase in annual rents of $987,000.
Interest and other income increased by $3,517,000 in the nine months ended
September 30, 2003, primarily as a result of the lease termination settlements
and interest income from CPA(R):12's interest in the mortgage
15
CORPORATE PROPERTY ASSOCIATES 12 INCORPORATED
Item 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
securitization. In January 2003, CPA(R):12 and Rheometric Scientific, Inc.
completed an agreement that allowed Rheometric to terminate its lease in
Piscataway upon completion of an asset sale of one of its lines of business. To
date, CPA(R):12 has recognized $3,042,000 under the agreement. CPA(R):12
acquired its subordinated interest in the mortgage securitization in August 2002
and earned interest income of $265,000 and $816,000 from the investment for the
current three-month and nine-month periods, respectively.
Interest expense increased by $192,000 and $1,005,000 for the three-month and
nine-month periods ended September 30, 2003, respectively. The increase was
primarily due to $46,335,000 of limited recourse mortgage financing obtained in
August 2002 in connection with a mortgage securitization. The increase is
partially offset by a decrease in interest expense due to increasing mortgage
amortization on existing fixed rate mortgage loans and the payoff of a mortgage
loan on the Telos Corporation property in January 2003. Solely as a result of
the Telos payoff, annual debt service decreased by $433,000.
Property expense increased by $107,000 and $1,508,000 for the three-month and
nine-month periods ended September 30, 2003. Carrying costs on the Piscataway
and Newark properties during the nine-month period ended September 30, 2003 were
$517,000. Asset management fees increased as a result of the acquisition of
interests in properties leased to TruServ, Starmark Camhood, Medica-France and
Carrefour. An increase in the provision for uncollected rents was due to
arrearages from International Management Consulting Incorporated ("IMCI") and
Scott Companies Inc., both of which are experiencing financial difficulties, and
CPA(R):12 continues to closely monitor their financial condition and unpaid
balances. CPA(R):12 previously entered into a modification with IMCI and is
currently negotiating to lease a portion of the property and amend the lease
with IMCI. There is no assurance that the proposed lease changes will be
completed. Discontinued operations include the results of the Sentry property
which is held for sale as of September 30, 2003. The results for the nine-month
period include a payment of real estate taxes of $342,000 which Sentry was
unable to reimburse to CPA(R):12.
FINANCIAL CONDITION:
There has been no material change in CPA(R):12's financial condition since
December 31, 2002. CPA(R):12's cash and cash equivalents at September 30, 2003
have decreased $29,037,000 since December 31, 2002, primarily as a result of the
purchasing of equity ownership interests with affiliates which lease properties
to Carrefour and Medica-France in France and Starmark Camhood in the United
States as well as the payment of a balloon payment obligation on a mortgage
loan.
Cash flows from operations and equity investments of $21,262,000 were used to
pay dividends of $18,707,000, and distributions to minority partners of
$1,082,000, and $1,473,000 of CPA(R):12's mortgage principal payment
installments. Cash reserves were used to pay a portion of mortgage principal
payment obligations, and this was due, in part, to reduced operating cash flow
as a result of a deferral of rent from Randall under a lease modification
agreement and absorbing property expenses for the Grand Rapids, Newark and
Piscataway properties. With the acquisition of interests in Starmark, Carrefour
and Medica properties, annual cash flow is projected to increase by
approximately $3,300,000, which Management projects will allow CPA(R):12 to meet
cash flow objectives. As of September 30, 2003, CPA(R):12 has not yet received
cash distributions from the Carrefour and Medica equity investments. Annual
distributions from Carrefour and Medica are expected to be $2,070,000.
CPA(R):12's investing activities included using $22,161,000 to acquire its
equity investments in the Starmark, Carrefour and Medica properties and
$1,275,000 to pay the Advisor its annual installment of deferred acquisition
fees. CPA(R):12 received $3,738,000 from its share of mortgage proceeds obtained
by equity investees. CPA(R):12 is funding approximately $700,000 improvements to
its existing property leased to Wal-Mart Stores, Inc. in exchange for an
increase in annual rent of $110,000 and Wal-Mart's commitment to a five-year
extension term. The funding was completed in October 2003.
In addition to using cash to pay dividends to shareholders, distributions to
minority partners and mortgage principal installments, CPA(R):12's financing
activities included using $5,199,000 to pay off a mortgage loan collateralized
by a property leased to Telos Corporation in January 2003 and $1,988,000 to
purchase treasury stock. Solely as a result of paying off the Telos loan, annual
cash flow from the Telos property will increase by $433,000. CPA(R):12 has no
balloon payments scheduled on its mortgages until 2005. CPA(R):12 has a
$20,000,000 credit facility available to it for investment opportunities and
potential
16
CORPORATE PROPERTY ASSOCIATES 12 INCORPORATED
Item 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
liquidity needs. As of September 30, 2003, there were no amounts outstanding
under the credit facility. The credit agreement requires CPA(R):12 to meet
certain financial covenants, including restrictions on indebtedness and meeting
or exceeding certain operating and coverage ratios. The credit facility is a
general obligation of CPA(R):12 and matures in December 2003. CPA(R):12 is
evaluating whether it will renew the credit facility.
OFF-BALANCE SHEET ARRANGEMENTS, GUARANTEES AND AGGREGATE CONTRACTUAL AGREEMENTS:
A summary of CPA(R):12's contractual obligations and commitments as of September
30, 2003 is as follows:
(in thousands) Total 2003 2004 2005 2006 2007 Thereafter
----- ---- ---- ---- ---- ---- ----------
Obligations:
Limited recourse mortgage notes
payable (1) $185,607 $1,431 $5,969 $10,462 $11,556 $24,563 $131,626
Deferred acquisition fees 6,546 - 1,338 1,406 1,209 814 1,779
Subordinated disposition fees 1,376 1,376
Commitments:
Share of minimum rents payable
under office cost-sharing
agreement 513 26 177 177 133 - -
-------- ------ ------ ------- ------- ------- --------
$194,042 $1,457 $7,484 $12,045 $12,898 $25,377 $134,781
======== ====== ====== ======= ======= ======= ========
(1) The limited recourse mortgage notes payable were obtained in connection with
the acquisition of properties in the ordinary course of business.
ACCOUNTING PRONOUNCEMENTS:
In June 2001, FASB issued SFAS No. 143 "Accounting for Asset Retirement
Obligations." SFAS No. 143 was issued to establish standards for the recognition
and measurement of an asset retirement obligation. SFAS No. 143 requires
retirement obligations associated with tangible long-lived assets to be
recognized at fair value as the liability is incurred with a corresponding
increase in the carrying amount of the related long-lived asset. SFAS No. 143 is
effective for financial statements issued for fiscal years beginning after June
15, 2002. SFAS No. 143 was adopted on January 1, 2003 and did not have a
material effect on the financial statements.
In May 2002, FASB issued SFAS No. 145 "Rescission of SFAS Nos. 4, 44 and 64,
Amendment of SFAS No. 13 and Technical Corrections" which eliminates the
requirement that gains and losses from the extinguishment of debt be classified
as extraordinary items unless it can be considered unusual in nature and
infrequent in occurrence. CPA(R):12 adopted this statement effective January 1,
2003 and the adoption did not have a material affect on CPA(R):12's financial
statements. CPA(R):12 no longer classifies gains and losses for the
extinguishment of debt as extraordinary items.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or Disposal
Activities". SFAS No. 146 addresses significant issues regarding the
recognition, measurement, and reporting of costs that are associated with exit
and disposal activities, including restructuring activities that are currently
accounted for pursuant to the guidance that the Emerging Issues Task Force
("EITF") has set forth in EITF Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)". The provisions of this
Statement are effective for exit or disposal activities that are initiated after
December 31, 2002, with early application encouraged. SFAS No. 146 was adopted
on January 1, 2003 and did not have a material effect on CPA(R):12's financial
statements.
In October 2002, the FASB issued SFAS No. 147, "Acquisition of Certain Financial
Institutions" which amends SFAS No. 72, SFAS No. 144 and FASB Interpretation No.
9. SFAS No. 147 provides guidance on the accounting for the acquisitions of
certain financial institutions and includes long-term customer relationships as
intangible assets within the scope of SFAS No. 144. SFAS No. 147 was adopted on
January 1, 2003 and did not have a material effect on the financial statements.
17
CORPORATE PROPERTY ASSOCIATES 12 INCORPORATED
Item 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others," ("FIN 45") which changes the accounting for, and
disclosure of certain guarantees. Beginning with transactions entered into after
December 31, 2002, certain guarantees are required to be recorded at fair value,
which is different from prior practice, under which a liability was recorded
only when a loss was probable and reasonably estimable. In general, the change
applies to contracts or indemnification agreements that contingently require
CPA(R):12 to make payments to a guaranteed third-party based on changes in an
underlying asset, liability, or an equity security of the guaranteed party. The
adoption of the accounting provisions of FIN 45 on January 1, 2003 did not have
a material effect on CPA(R):12's financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," which amends SFAS No. 123, Accounting
for Stock Based Compensation. SFAS No. 148 provides alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock based compensation (i.e., recognition of a charge for issuance of
stock options in the determination of income.). However, SFAS No. 148 does not
permit the use of the original SFAS No. 123 prospective method of transition for
changes to the fair value based method made in fiscal years beginning after
December 15, 2003. In addition, this Statement amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for stock based
employee compensation, description of transition method utilized and the effect
of the method used on reported results. The transition and annual disclosure
provisions for valuing stock-based compensation of SFAS No. 148 are to be
applied for fiscal years ending after December 15, 2002. CPA(R):12 does not have
any employees nor any stock-based compensation plans.
On January 17, 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), the primary objective of which is to
provide guidance on the identification of entities for which control is achieved
through means other than voting rights ("variable interest entities" or "VIEs")
and to determine when and which business enterprise should consolidate the VIE
(the "primary beneficiary"). This new model applies when either (1) the equity
investors (if any) do not have a controlling financial interest or (2) the
equity investment at risk is insufficient to finance that entity's activities
without additional financial support. In addition, FIN 46 requires both the
primary beneficiary and all other enterprises with a significant variable
interest in a VIE make additional disclosures. On October 8, 2003, the FASB
staff issued a FASB Staff Position which deferred the effective date of FIN 46
until December 31, 2003 for VIEs created prior to February 1, 2003. CPA(R):12's
maximum loss exposure is the carrying value of its equity investments. CPA(R):12
has evaluated the potential impact and believes this interpretation will not
have a material impact on its accounting for its investments in unconsolidated
joint ventures as none of these investments are VIEs.
On April 30, 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging under SFAS No. 133. The
changes in the statement improve financial reporting by requiring that contracts
with comparable characteristics be accounted for similarly. In particular, the
statement (1) clarifies under what circumstances a contract with an initial net
investment meets the characteristics of a derivative instrument discussed in
paragraph 6(b) of SFAS No. 133, (2) clarifies when a derivative contains a
financing component, (3) amends the definition of an underlying to conform it to
language used in FIN 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others", and (4)
amends certain other existing pronouncements. SFAS No. 149 is generally
effective for contracts entered into or modified after June 30, 2003 and for
hedging relationships designated after June 30, 2003. The adoption of SFAS No.
149 did not have a material effect on the financial statements.
On May 30, 2003, the FASB issued SFAS No. 150 "Accounting for Certain Financial
Instruments with Characteristics of both Liability and Equity." SFAS No. 150
establishes standards to classify as liabilities certain financial instruments
that are mandatorily redeemable or include an obligation to repurchase. Such
financial instruments will be measured at fair value with changes in fair value
included in the determination of net income. SFAS No. 150 is effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is
18
CORPORATE PROPERTY ASSOCIATES 12 INCORPORATED
Item 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
effective at the beginning of the first interim period beginning after June
15, 2003. SFAS No. 150 was adopted on July 1, 2003 and did not have a material
effect on the financial statements.
19
CORPORATE PROPERTY ASSOCIATES 12 INCORPORATED
Item 3. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the exposure to loss resulting from changes in interest rates,
foreign currency exchange rates and equity prices. In pursuing its business
plan, the primary market risk to which CPA(R):12 is exposed is interest rate
risk and foreign currency exchange risk.
The value of CPA(R):12's real estate is subject to fluctuations based on changes
in interest and foreign currency exchange rates, local and regional economic
conditions and changes in the creditworthiness of lessees, and which may affect
CPA(R):12's ability to refinance its debt when balloon payments are scheduled.
CPA(R):12 owns marketable securities through its ownership interests in Carey
Commercial Mortgage Trust ("CCMT"). The value of the marketable securities is
subject to fluctuation based on changes in interest rates, economic conditions
and the creditworthiness of lessees at the mortgaged properties. As of September
30, 2003 the interests in CCMT had a fair value approximately of $8,167,000.
CPA(R):12 also owns marketable equity securities of Proterion Corporation and
Sentry Technology Corporation which based on the quoted per share prices of
$0.70 and $0.09, respectively, as of September 30, 2003 had a fair value of
approximately $774,000 and $90,000, respectively.
All of CPA(R):12's $185,607,000 long-term debt bears interest at fixed rates,
and the fair value of these instruments is affected by changes in market
interest rates. The following table presents principal cash flows based upon
expected maturity dates of the debt obligations and the related weighted-average
interest rates by expected maturity dates for the fixed rate debt. The interest
rate on the fixed rate debt as of September 30, 2003 ranged from 6.50% to 8.75%.
There has been no material change since December 31, 2002.
(in thousands) 2003 2004 2005 2006 2007 Thereafter Total Fair Value
---- ---- ---- ---- ---- ---------- ----- ----------
Fixed rate debt $1,431 $5,969 $10,462 $11,556 $24,563 $131,626 $185,607 $189,588
Average interest
rate 7.40% 7.40% 7.72% 7.74% 7.58% 7.47%
On March 12, 2003, through an equity investment, CPA(R):12 acquired an interest
in foreign operations. Accordingly, CPA(R):12 is subject to foreign currency
exchange risk from the effects of exchange rate movements of foreign currencies
and this may affect future costs and cash flows; however, exchange rate
movements to date have not had a significant effect on CPA(R):12's financial
position or results of operations. In addition, the underlying properties are
financed with fixed-rate mortgage debt so that changes in exchange rates that
would increase or decrease rental revenues from the properties would be
partially offset by exchange rate changes on debt service. CPA(R):12 has not
entered into any foreign currency forward exchange contracts to hedge the
effects of adverse fluctuations in foreign currency exchange.
Item 4. - CONTROLS AND PROCEDURES
The Co-Chief Executive Officers and Chief Financial Officer of the Company have
conducted a review of the Company's disclosure controls and procedures as of
September 30, 2003.
The Company's disclosure controls and procedures include the Company's controls
and other procedures designed to ensure that information required to be
disclosed in this and other reports filed under the Securities Exchange Act of
1934, as amended (the "Exchange Act") is accumulated and communicated to the
Company's management, including its Co-Chief Executive Officers and Chief
Financial Officer, to allow timely decisions regarding required disclosure and
to ensure that such information is recorded, processed, summarized and reported,
within the required time periods.
Based upon this review, the Company's Co-Chief Executive Officers and Chief
Financial Officer have concluded that the Company's disclosure controls (as
defined in Rule 13a-14(c) promulgated under the Exchange Act) are sufficiently
effective to ensure that the information required to be disclosed by the Company
in the reports it files under the Exchange Act is recorded, processed,
summarized and reported with adequate timeliness.
20
CORPORATE PROPERTY ASSOCIATES 12 INCORPORATED
PART II
Item 4. - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the quarter ended September 30, 2003, no matters were submitted to a vote
of Security Holders.
Item 6. - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
31.1 Certification of Co-Chief Executive Officers
31.2 Certification of Chief Financial Officer
32.1 Certification of Co-Chief Executive Officers Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K:
During the quarter ended September 30, 2003, CPA(R):12 was not
required to file any reports on Form 8-K.
- 21 -
CORPORATE PROPERTY ASSOCIATES 12 INCORPORATED
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CORPORATE PROPERTY ASSOCIATES 12 INCORPORATED
11/10/2003 By: /s/ John J. Park
------------- ----------------------------------
Date John J. Park
Managing Director and
Chief Financial Officer
(Principal Financial Officer)
11/10/2003 By: /s/ Claude Fernandez
------------- ----------------------------------
Date Claude Fernandez
Managing Director and
Chief Accounting Officer
(Principal Accounting Officer)
22