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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 June 30, 2002
Commission file number 0-16341
SHELBOURNE PROPERTIES II, INC.
(Exact name of registrant as specified in its charter)
Delaware 04-3502382
(State or other jurisdiction of (I.R.S.Employer
incorporation or organization) Identification No.)
P.O. Box 9507, 7 Bulfinch Place, Suite 500, Boston, Massachusetts 02114
(Address of principal executive offices)
(617) 570-4600
(Registrant's telephone number, including area code)
Indicate by check 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___
As of August 13, 2002, there were 894,792 shares of common stock outstanding.
________________________________________________________________________________
SHELBOURNE PROPERTIES II, INC.
FORM 10-Q - JUNE 30, 2002
The financial information contained in this Form 10-Q for the periods prior to
April 17, 2001 are those of Shelbourne Properties II, Inc.'s predecessor in
interest, High Equity Partners L.P. - Series 86 (the "Predecessor Partnership").
On April 17, 2001, the Predecessor Partnership was merged with and into
Shelbourne Properties II, L.P., a limited partnership wholly owned, directly and
indirectly, by Shelbourne Properties II, Inc.
INDEX
Page
Part I. Financial Information
Item I. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets -
June 30, 2002 and December 31, 2001...............................3
Condensed Consolidated Statements of Operations -
Three and Six Months Ended June 30, 2002 and 2001..................4
Condensed Consolidated Statement of Equity -
Six Months Ended June 30, 2002................................5
Condensed Consolidated Statements of Cash Flows -
Six Months Ended June 30, 2002 and 2001.......................6
Notes to Condensed Consolidated Financial Statements..................7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................................14
Item 3. Quantitative and Qualitative Disclosures about Market Risk...........24
Part II. Other Information:
Item 1. Legal Proceedings....................................................25
Item 6. Exhibits and Reports on Form 8-K.....................................26
Signatures....................................................................28
2
SHELBOURNE PROPERTIES II, INC.
FORM 10-Q - JUNE 30, 2002
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, 2002 December 31, 2001
----------------- ---------------------
ASSETS
Real estate, net $ 24,720,985 $ 41,327,041
Cash and cash equivalents 13,396,784 26,011,761
Other assets 1,661,328 3,191,467
Receivables, net of allowances of
$77,568 and $92,074, respectively 61,664 151,706
Investment in joint ventures 20,754,671 -
------------------ ---------------------
TOTAL ASSETS $ 60,595,432 $ 70,681,975
=================== =====================
LIABILITIES AND EQUITY
Accounts payable and accrued expenses $ 2,446,161 $ 1,168,273
Note payable 29,779,343 -
------------------ ---------------------
Total Liabilities 32,225,504 1,168,273
------------------ ---------------------
COMMITMENTS AND CONTINGENCIES
CLASS A 5% PREFERRED PARTNERSHIP INTERESTS,
AT LIQUIDATION VALUE 1,015,148 -
------------------ ---------------------
EQUITY
Common stock:
$.01 par value share; authorized 2,500,000 shares;
issued 1,237,916 shares; outstanding 894,792 and
1,237,916, respectively 12,379 12,379
Additional capital 66,329,959 66,329,959
Treasury stock, at cost (17,866,603) -
Retained earnings (21,120,955) 3,171,364
------------------ ---------------------
Total Equity 27,354,780 69,513,702
------------------ ---------------------
TOTAL LIABILITIES AND EQUITY $ 60,595,432 $ 70,681,975
================== =====================
See notes to condensed consolidated financial statements.
3
SHELBOURNE PROPERTIES II, INC.
FORM 10-Q - JUNE 30, 2002
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
For the Three Months Ended For the Six Months Ended
June 30, June 30,
2002 2001 2002 2001
----------- ----------- ----------- -----------
Rental revenues $ 1,244,039 $ 3,042,154 $ 2,444,764 $ 6,096,413
----------- ----------- ----------- -----------
Costs and expenses
Operating expenses 445,204 976,043 887,196 1,909,824
Depreciation and amortization 361,040 547,963 658,704 1,107,374
Asset management fee - 334,378 157,582 666,026
Transition management fee 83,300 - 124,950 -
Purchase of advisory agreements - - 23,049,398 -
Administrative expenses 2,523,814 350,881 3,401,197 844,271
Property management fee 38,531 91,576 71,516 182,302
----------- ----------- ----------- -----------
3,451,889 2,300,841 28,350,543 4,709,797
----------- ----------- ----------- -----------
(Loss) income before equity income from joint
ventures, interest and other income (2,207,850) 741,313 (25,905,779) 1,386,616
Equity income from joint ventures 969,525 - 1,963,882 -
Interest expense (299,454) - (427,211) -
Interest income 44,388 182,429 95,416 416,002
Other income - 8,602 548 22,402
----------- ----------- ----------- -----------
Net (loss) income (1,493,391) 932,344 (24,273,144) 1,825,020
Preferred dividends (12,830) - (19,175) -
----------- ----------- ----------- -----------
Net (loss) income available for common shares $(1,506,221) $ 932,344 $(24,292,319) $ 1,825,020
=========== =========== =========== ===========
Earnings per share - basic and diluted
Net income (loss) per common share $ (1.68) $ 0.75 $ (24.79) $ 1.47
=========== =========== =========== ===========
Weighted average common shares 894,792 1,237,916 980,099 1,237,916
=========== =========== =========== ===========
See notes to condensed consolidated financial statements.
4
SHELBOURNE PROPERTIES II, INC.
FORM 10-Q - JUNE 30, 2002
CONDENSED CONSOLIDATED STATEMENT OF EQUITY
(Unaudited)
Common Additional Treasury Retained
Stock Capital Stock Earnings Totals
---------- ------------- --------------- --------------- ----------------
Balance, January 1, 2002 $ 12,379 $ 66,329,959 $ - $ 3,171,364 $ 69,513,702
Purchase of treasury stock - - (17,866,603) - (17,866,603)
Preferred dividends - - - (19,175) (19,175)
Net loss - - - (24,273,144) (24,273,144)
---------- ------------- --------------- --------------- ----------------
Balance, June 30, 2002 $ 12,379 $ 66,329,959 $ (17,866,603) $ (21,120,955) $ 27,354,780
========== ============= =============== =============== ================
See notes to condensed consolidated financial statements.
5
SHELBOURNE PROPERTIES II, INC.
FORM 10-Q - JUNE 30, 2002
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the Six Months Ended
June 30,
--------------------------------------------
2002 2001
-------------- ------------
CASH FLOW FROM OPERATING ACTIVITIES:
Net (Loss) income $ (24,273,144) $ 1,825,020
Adjustments to reconcile net (loss) income
to net cash provided by operating activities:
Depreciation and amortization 658,704 1,107,374
Straight-line adjustment for stepped
lease rentals 9,806 37,531
Purchase of advisory agreements 23,049,398 -
Equity income from joint venture (1,963,882) -
Change in assets and liabilities:
Accounts payable and accrued expenses 1,743,798 (20,758)
Receivables (2,318) (45,924)
Due to affiliates - (512,473)
Other assets 7,496,647 (499,292)
-------------- ------------
Net Cash Provided by Operating Activities: 6,719,009 1,891,478
-------------- ------------
CASH FLOW FROM INVESTING ACTIVITIES-
Improvements to real estate (274,176) (658,949)
-------------- ------------
CASH FLOW FROM FINANCING ACTIVITIES
Purchase of treasury stock (17,866,603) -
Proceeds from note payable 29,779,343 -
Payoff of note payable (22,034,250) -
-------------- ------------
Net Cash Used in Financing Activities (10,121,510) -
-------------- ------------
(Decrease) Increase in cash and cash equivalents (3,676,677) 1,232,529
Cash and cash equivalents, beginning of year 26,011,761 17,607,533
Cash and cash equivalents, related to investment
in joint ventures (8,938,300) -
-------------- ------------
Adjusted cash and cash equivalent, beginning of year 17,073,461 17,607,533
-------------- ------------
Cash and cash equivalents, end of quarter $ 13,396,784 18,840,062
============== ============
Supplemental Disclosure of Cash Flow Information
Cash paid for interest $ 427,211 $ -
============== ============
See notes to condensed consolidated financial statements.
6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. GENERAL
The accompanying condensed consolidated financial statements, notes and
discussions should be read in conjunction with the consolidated financial
statements, related notes and discussions contained in the Annual Report on
Form l0-K of Shelbourne Properties II, Inc., a Delaware corporation (the
"Company") for the year ended December 31, 2001.
The financial information contained herein is condensed and unaudited;
however, in the opinion of management, all adjustments (consisting only of
normal recurring adjustments) necessary for a fair presentation of such
financial information have been included. Results of operations for the
three and six months ended June 30, 2002 are not necessarily indicative of
the results to be expected for the entire year.
2. SIGNIFICANT ACCOUNTING POLICIES
Investment in Joint Ventures
Certain properties are owned in joint ventures with Shelbourne Properties
I, L.P. and/or Shelbourne Properties III, L.P. Prior to April 30, 2002, the
Company owned an undivided interest in the assets owned by these joint
ventures and was severally liable for indebtedness it incurred in
connection with its ownership interest in those properties. Therefore, for
periods prior to April 30, 2002, the Company's condensed consolidated
financial statements presented the assets, liabilities, revenues and
expenses of the joint ventures on a pro rata basis in accordance with the
Company's percentage of ownership.
After April 30, 2002, as a result of the Company's incurring debt in
connection with entering into the Note Payable discussed in Note 8, the
Company is no longer allowed to account for its investments in joint
ventures on a pro-rata consolidation basis in accordance with its
percentage of ownership but must instead utilize the equity method of
accounting. Accordingly, the Company's condensed consolidated balance sheet
at June 30, 2002 and the Company's condensed consolidated statements of
operations for the three and six month period ended June 30, 2002 reflect
the equity method of accounting.
The impact of the change to equity accounting on the December 31, 2001
condensed consolidated balance sheet reduced real estate by $16.3 million,
cash and cash equivalents by $8.9 million, receivables by $0.1 million,
accounts payable and accrued expenses by $0.5 million and increased other
assets by $6.1 million and investment in joint ventures by $18.8 million.
Real Estate
Real estate is carried at cost, net of adjustments for impairment. Repairs
and maintenance are charged to expense as incurred. Replacement and
betterments are capitalized. The Company will evaluate the recoverability
of the net carrying value of its real estate and related assets at least
annually, and more often if circumstances dictate. If this review indicates
that the carrying value of a property might not be recoverable, the Company
prepares estimates of the future undiscounted cash flows expected to result
from the use of the property and its eventual disposition, generally over a
five-year holding period. In performing this review, management takes into
account, among other things, the existing occupancy, the
7
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
expected leasing prospects of the property and the economic situation in
the region where the property is located.
If the sum of the expected future cash flows, undiscounted, is less than
the carrying amount of the property, the Company recognizes an impairment
loss and reduces the carrying amount of the property to its estimated fair
value. Fair value is the amount at which the property could be bought or
sold in a current transaction between willing parties, that is, other than
in a forced or liquidation sale. Management estimates fair value using
discounted cash flows or market comparables, as most appropriate for each
property. Independent certified appraisers are utilized to assist
management when warranted.
Impairment write-downs recorded by the Company prior to April 17, 2001 did
not affect the tax basis of the assets and were not included in the
determination of taxable income or loss. No write-downs have been recorded
since the effective date of the merger.
Because the expected cash flows used to evaluate the recoverability of the
property and their fair values are based upon projections of future
economic events, such as property occupancy rates, rental rates, operating
cost inflation and market capitalization rates, the amounts ultimately
realized at disposition may differ materially from the net carrying values
at the balance sheet dates. The cash flows and market comparables used in
this process were based on good faith estimates and assumptions developed
by management. Unanticipated events and circumstances may occur and some
assumptions may not materialize; therefore, actual results may vary
materially from the estimates. The Company may in the future provide
additional write-downs, which could be material, if real estate markets or
local economic conditions change.
Treasury Stock
Treasury stock is stated at cost.
Amounts Per Share
Net income (loss) per share is computed based on average shares
outstanding.
Recently Issued Accounting Pronouncements
In July 2001, the FASB issued SFAS No. 142 "Goodwill and Other Intangible
Assets." SFAS No. 142 addresses accounting and reporting for intangible
assets acquired, except for those acquired in a business combination. SFAS
No. 142 presumes that goodwill and certain intangible assets have
indefinite useful lives. Accordingly, goodwill and certain intangibles will
not be amortized but rather will be tested at least annually for
impairment. SFAS No. 142 also addresses accounting and reporting for
goodwill and other intangible assets subsequent to their acquisition. SFAS
No. 142 is effective for fiscal years beginning after December 15, 2001.
The Company has adopted this statement, which did not materially affect the
Company's financial statements.
In August 2001, the FASB issued SFAS No. 144 "Accounting for the Impairment
or Disposal of Long-Lived Assets," which addresses financial accounting and
reporting for the impairment or disposal of long-lived assets. This
statement supersedes SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of" and the
accounting and reporting provisions of APB Opinion No. 30, "Reporting the
Results of Operations - Reporting the Effects of a Disposal of a
8
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Business and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," for the disposal of a segment of a business. SFAS No. 144 is
effective for fiscal years beginning after December 15, 2001, and interim
periods within those fiscal years. The provisions of this Statement
generally are to be applied prospectively. The Company has adopted this
statement, which did not have a material effect on the Company's financial
statements.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical
Corrections," which updates, clarifies and simplifies existing accounting
pronouncements. In part, this statement rescinds SFAS 4, "Reporting Gains
and Losses from Exstinguishment of Debt." FASB No. 145 will be effective
for fiscal years beginning after May 15, 2002. Under adoption, enterprises
must reclassify prior period items that do not meet the extraordinary item
classification criteria in APB opinion No. 30. The Company does not expect
that this statement will have an effect on the Company's financial
statements.
3. RELATED PARTY TRANSACTIONS
On February 14, 2002, the Company, Shelbourne Properties I, Inc. and
Shelbourne Properties III, Inc. (the "Companies") consummated a transaction
(the "Transaction") whereby the Company purchased an advisory agreement
(the "Advisory Agreement") between the Company and Shelbourne Management
LLC ("Shelbourne Management"), an affiliate of Presidio Capital Investment
Company, LLC ("PCIC"), and the 343,124 shares of the Company's common stock
held by subsidiaries of PCIC. PCIC is controlled and principally owned by
affiliates of the former senior management and one current director of the
Company. The Company's operating partnership, Shelbourne Properties II,
L.P., issued preferred partnership interests with an aggregate liquidation
preference of $1,015,148 and a note in the amount of $22,034,250.
Shelbourne Management's obligations under the contract terminated as of the
effective date of the Transaction.
In conjunction with the Transaction, PCIC entered into an agreement with
the Companies and their respective operating partnerships to provide
transition services, namely, accounting, asset management, investor
services and treasury and cash management, for a period up to one year from
the date of the agreement (until February 14, 2003) for a fee of $83,300
per month. This fee is allocated equally among the Companies. For the
period from April 1 to June 30, 2002, the Company paid PCIC $83,300 for
transition services and for the period from February 15, 2002 to June 30,
2002, the Company paid PCIC $124,950 for transition services. As a result
of the settlement of all lawsuits (see note 9) this agreement was
terminated effective September 30, 2002 and all 3rd quarter transition fees
owed were required to be paid in full by the Company in July 2002. The
Company paid all transition fees owed on July 11, 2002.
Prior to the Transaction, under the terms of the Advisory Agreements,
Shelbourne Management provided the Company with all management, advisory
and property management services. For providing these services, Shelbourne
Management received (1) an annual asset management fee, payable quarterly,
equal to 1.25% of the gross asset value of the Company as of the last day
of each year, (2) property management fees of up to 6% of property
revenues, (3) $150,000 for non-accountable expenses and (4) reimbursement
of expenses incurred in connection with the performance of its services.
Upon its disposition of the Advisory Agreements, Shelbourne Management was
entitled to receive reimbursement for non-accountable expenses for the
period from January 1, 2002 through February 14, 2002. For that period
Shelbourne Management received $25,000. Shelbourne Management was also
entitled to receive an asset management fee for the period of January 1,
2002 through February 14, 2002
9
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
equal to 1.25% of the gross asset value of the Company. For that period,
Shelbourne Management received $157,582.
On April 17, 2001, High Equity Partners Series 86, (the "Predecessor
Partnership") was converted into a Real Estate Investment Trust. With the
conversion, the Managing General Partner of the predecessor partnership was
no longer entitled to receive fees for the administration of the
partnership. As of the conversion date, Shelbourne Management was entitled
to receive the fees formerly paid to the Managing General Partner. During
the quarter ended June 30, 2001, the Managing General Partner received
$9,444 for non-accountable expenses and $63,160 for the asset management
fee. Shelbourne Management received $40,556 for non-accountable expenses
and $271,218 for the asset management fee. For the six months ended June
30, 2001, the Managing General Partner received $59,444 and Shelbourne
Management received $40,556 for non-accountable expenses. For the six
months ended June 30, 2001 the Managing General Partner received $394,808
and Shelbourne Management received $271,218 for the asset management fee.
In October 2000, Kestrel Management L.P. ("Kestrel"), began performing all
property management services directly for the Predecessor Partnership and,
effective April 17, 2001, the Company. The Transaction did not have any
effect on the property management services contract between the Company and
Kestrel. For the quarters ended June 30, 2002 and 2001, Kestrel earned
$38,531 and $91,576, respectively. For the six months ended June 30, 2002
and 2001, Kestrel earned $71,516 and $182,302, respectively.
At June 30, 2002, $427,789 of receivables from joint venture's was
included in other assets.
4. REAL ESTATE
June 30, 2002 December 31, 2001
------------- -----------------
(Unaudited)
Land $ 6,499,704 $ 9,636,715
Buildings and improvements 33,460,920 57,034,945
---------- ------------
39,960,624 66,671,660
Less: Accumulated depreciation (15,239,639) (25,344,619)
------------ ------------
$24,720,985 $ 41,327,041
============ ============
See footnote 2 "Investment in Joint Ventures" for the impact on real estate
as a result of the change to equity accounting for joint ventures.
5. INVESTMENT IN JOINT VENTURES
The Company invests in four joint ventures, (568 Broadway, Century Park,
Seattle Landmark and Tri-Columbus). The joint ventures condensed
consolidated statement of operations for the three and six months ending
June 30, 2002 and 2001, are as follows:
10
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
FOR THREE MONTHS FOR SIX MONTHS ENDED
ENDED JUNE 30, JUNE 30,
2002 2002
---------------------------------------
Rental Revenues $4,806,319 $9,509,984
Costs and Expenses 2,329,927 4,554,254
---------------------------------------
Income before interest and other income 2,476,392 4,955,730
Interest Income 8,989 65,099
Other income
---------------------------------------
Net income for joint ventures $2,485,381 $5,020,829
=======================================
Equity Income from joint ventures for
Shelbourne Properties II, Inc. $ 969,525 $1,963,882
=======================================
6. FEDERAL INCOME TAX CONSIDERATIONS
As of April 17, 2001, the Predecessor Partnership was converted into a
corporation that elected to be taxed as a real estate investment trust
(REIT) under the provisions of the Internal Revenue Code. As a result, the
shareholders of the REIT are required to include their proportionate share
of any distribution of taxable income on their returns. REITs are required
to distribute at least 90% of their ordinary taxable income to shareholders
and meet certain income, asset and shareholder ownership requirements.
7. CONVERSION
As a first step in reorganizing the Predecessor Partnership as a
publicly-traded real estate investment trust, a registration statement was
filed with the Securities and Exchange Commission on February 11, 2000. On
or about February 15, 2001, a prospectus/consent solicitation statement was
mailed to the limited partners of the Predecessor Partnership seeking their
consent to the reorganization of the Predecessor Partnership into a real
estate investment trust. The consent solicitation period expired on April
16, 2001, and holders of a majority of the partnership units approved the
conversion.
On April 17, 2001 the conversion was accomplished by merging the
Predecessor Partnership into the current operating partnership. Pursuant to
the merger, each limited partner received two shares of stock of the
Company for each unit they owned, and the general partners received an
aggregate of 61,896 shares of stock of the Company in exchange for their
general partner interests. The common stock of the Company is listed on the
American Stock Exchange under the symbol HXE.
8. NOTE PAYABLE
On May 1, 2002, the operating partnerships of the Companies and certain of
the operating partnerships' subsidiaries entered into a $75,000,000
revolving credit facility with Bayerische Hypo-Und Vereinsbank
11
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
AG, New York Branch, as agent for itself and other lenders (referred to as
the "Credit Facility" or the "Note Payable"). The Credit Facility has a
term of three years and is prepayable in whole or in part at any time
without penalty or premium. The Companies initially borrowed $73,330,073
under the Credit Facility. The Company's share of the proceeds amounted to
$29,779,343 of which $22,034,250 was used to repay the note issued in the
Transaction, $215,768 to pay associated accrued interest and $840,624 to
pay costs associated with the Credit Facility. The excess proceeds of
approximately $6,688,701 were deposited into the Company's operating cash
account. The Companies have the right, from time to time, to elect an
annual interest rate equal to (i) LIBOR plus 2.5% or (ii) the greater of
(a) agent's prime rate or (b) the federal funds rate plus 1.5%. The
Companies are required to pay the lenders, from time to time, a commitment
fee equal to .25% of the unborrowed portion of the Credit Facility.
Interest is payable monthly in arrears. The interest rate at June 30, 2002
was approximately 4.19%.
The Credit Facility is secured by (i) a pledge by the operating
partnerships of their membership interest in their wholly-owned
subsidiaries that hold their interests in joint ventures with the other
Companies and (ii) mortgages on certain real properties owned directly or
indirectly by the operating partnerships. All of the properties of the
Company are security for the Credit Facility, except for its two real
properties located in Illinois.
Under the terms of the Credit Facility, the Companies may only sell the
pledged property if certain conditions are met. In addition, the Companies
must maintain certain debt yield maintenance ratios and comply with
restrictions relating to engaging in certain equity financings, business
combinations and other transactions that may result in a change of control
(as defined under the Credit Facility).
The Companies are jointly and severally liable under the Credit Facility
but have entered into a Contribution and Cross-Indemnification Agreement.
9. SUBSEQUENT EVENTS
On July 1, 2002, the Company, along with Shelbourne Properties I, Inc. and
Shelbourne Properties III, Inc., entered into settlement agreements with
respect to certain outstanding litigation involving the Companies. In
connection with the settlement, the Company entered into a stock purchase
agreement (the "HX Investors Stock Purchase Agreement") with HX Investors,
L.P. ("HX Investors") and Exeter Capital Corporation ("Exeter"), the
general partner of HX Investors, pursuant to which HX Investors, the owner
of approximately 12% of the outstanding common stock of the Company, agreed
to conduct a tender offer for up to an additional 30% of the Company's
outstanding stock at a price per share of $62.00 (the "HX Investors
Offer"). The tender offer commenced on July 5, 2002 following the filing of
the required tender offer documents with the Securities and Exchange
Commission by HX Investors.
Pursuant to the Stock Purchase Agreement, the board of directors of the
Company approved a plan of liquidation for the Company (the "Plan of
Liquidation") and agreed to submit the Plan of Liquidation to its
stockholders for approval at the 2002 annual meeting of stockholders to be
held on September 9, 2002 (the "Annual Meeting"). HX Investors agreed to
vote all of its shares in favor of the Plan of Liquidation at the Annual
Meeting. Under the Plan of Liquidation, HX Investors would have received an
incentive payment of 25% of gross proceeds after the payment of a priority
return of approximately $66.25 per share was made to the stockholders of
the Company.
12
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Subsequently, on July 29, 2002, Longacre Corp., an affiliate of Carl C.
Icahn, filed an action on July 29, 2002 in the United States District Court
for the Southern District of New York against the Companies seeking (i) a
declaration that HX Investors violated Sections 13(e) and 14(d) and (e) of
the Securities and Exchange Act of 1934, as amended, and the rules and
regulations promulgated thereunder, and that the 25% liquidation premium to
be paid to HX Investors and Exeter Capital Corporation upon liquidation of
the Companies is invalid and illegal; and (2) an injunction enjoining HX
Investors from proceeding with the HX Investors Offer until HX Investors
makes the appropriate filings and disclosures. A hearing on Longacre's
Motion for an Injunction was held on August 1, 2002, and the request for a
preliminary injunction was denied. .
On August 5, 2002, the Company entered into an amendment to the HX
Investors Stock Purchase Agreement. Pursuant to the terms of the amendment,
the purchase price per share offered under the HX Investors Offer was
increased from $62.00 to $73.85. The amendment also reduced the incentive
payment payable to HX Investors under the Plan of Liquidation from 25% to
15% of gross proceeds after payment of the approximately $66.25 per share
priority return to stockholders of the Company, and included certain
corporate governance provisions.
The HX Investors Offer is scheduled to expire at midnight on Friday, August
16, 2002.
13
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CAUTIONARY STATEMENTS UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995. Statements contained herein may constitute "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, as amended. Any statements
contained herein which are not statements of historical facts and that address
activities, events or developments that Shelbourne Properties II, Inc. expects,
believes or anticipates will or may occur in the future shall be deemed to be
forward-looking statements. Forward-looking statements are inherently subject to
risks and uncertainties, many of which cannot be predicted with accuracy and
some of which might not even be anticipated. Future events, actual results and
performance financial and otherwise, could differ materially from those set
forth in or contemplated by the forward-looking statements herein. Factors that
could cause actual results to differ materially from those in forward-looking
statements include the terms of future property sales, investments and
financings, general economic and business conditions and various other risk
factors listed in the registration statement of Shelbourne Properties II, Inc.
filed with the Securities and Exchange Commission.
This item should be read in conjunction with the financial statements and other
items contained elsewhere in the report.
On February 14, 2002, the Companies announced the consummation of the
Transaction whereby the Companies (i) purchased each of the Advisory Agreements
between the Companies and PCIC and (ii) repurchased all of the shares of common
stock in the Companies held by PCIC (the "Shares").
Pursuant to the Transaction, the Company paid PCIC $17,866,603 in cash and its
operating partnership, Shelbourne Properties II, L.P. issued preferred
partnership interests with an aggregate liquidation preference of $1,015,148 and
issued a note in the amount of $22,034,250.
The Transaction was unanimously approved by the Boards of Directors of each of
the Companies after recommendation by their respective Special Committees
comprised of the Companies' three independent directors.
Houlihan Lokey Howard & Zukin Capital served as financial advisor to the Special
Committees of the Companies and rendered a fairness opinion to the Special
Committees with respect to the Transaction.
On May 1, 2002, the operating partnerships of the Companies and certain of the
operating partnerships' subsidiaries entered into a $75,000,000 revolving credit
facility with Bayerische Hypo-Und Vereinsbank AG, New York Branch, as agent for
itself and other lenders (the "Credit Facility"). The Credit Facility has a term
of three years and is prepayable in whole or in part at any time without penalty
or premium. The Companies initially borrowed $73,330,073 under the Credit
Facility. The Company's share of the proceeds amounted to $29,779,343 of which
$22,034,250 was used to repay the note issued in the Transaction, $215,768 to
pay associated accrued interest and $840,624 to pay costs associated with the
Credit Facility. The excess proceeds of $6,688,701 were deposited into the
Company's operating cash account. The Companies have the right, from time to
time, to elect an annual interest rate equal to (i) LIBOR plus 2.5% or (ii) the
greater of (a) the agent's prime rate or (b) the federal funds rate plus 1.5%.
The Companies are required to pay the lenders, from time to time, a commitment
fee equal to .25% of the unborrowed portion of the Credit Facility.
14
The Credit Facility is secured by (i) a pledge by the operating partnerships of
their membership interest in their wholly-owned subsidiaries that hold their
interests in joint ventures with the other Companies and (ii) mortgages on
certain real properties owned directly or indirectly by the operating
partnerships. All of the properties of the Company are security for the Credit
Facility, except for its two real properties located in Illinois.
Under the terms of the Credit Facility, the Companies may only sell the pledged
property if certain conditions are met. In addition, the Companies must maintain
certain debt yield maintenance ratios and comply with restrictions relating to
engaging in certain equity financings, business combinations and other
transactions that may result in a change of control (as defined under the Credit
Facility).
The Companies are joint and severally liable under the Credit Facility but have
entered into a Contribution and Cross-Indemnification Agreement.
At the request of HX Investors, L.P. ("HX Investors") - the largest stockholder
of the Company and an entity controlled by Mr. Michael Ashner - on April 30,
2002 the board of directors of the Company waived a provision in the Company's
certificate of incorporation (as it applies to HX Investors) that otherwise
prohibits a stockholder from beneficially owning more than 8% of the common
stock of the Company to allow HX Investors to own up to 12% of the common stock
of the Company. Pursuant to a Stockholder Agreement among the Company,
Shelbourne Properties I, Inc., Shelbourne Properties III, Inc., HX Investors and
the general partner of HX Investors, HX Investors agreed that until January 1,
2003, with respect to all matters submitted for the approval of the Company's
stockholders (1) with the approval and recommendation of the Company's board of
directors or (2) by HX Investors or its affiliates, HX Investors and its
affiliates would vote all shares beneficially owned by them in excess of the 8%
threshold in proportion to the votes cast by the stockholders of the Company
(including the 8% of the shares beneficially owned by HX Investors). Mr. Ashner
is associated with Kestrel, the property manager for the Company's properties.
The foregoing descriptions of the Stockholder Agreement and the Credit Facility
are qualified in their entirety by reference to such agreements, copies of which
are attached as exhibits to our Current Report on Form 8-K filed on May 14,
2002, which is incorporated herein by reference.
Recent Developments
On July 1, 2002, the Company, along with Shelbourne Properties I, Inc. and
Shelbourne Properties III, Inc., entered into settlement agreements with respect
to certain outstanding litigation involving the Companies. In connection with
the settlement, the Company entered into a stock purchase agreement (the "HX
Investors Stock Purchase Agreement") with HX Investors and Exeter, the general
partner of HX Investors, pursuant to which HX Investors, the owner of
approximately 12% of the outstanding common stock of the Company, agreed to
conduct a tender offer for up to an additional 30% of the Company's outstanding
stock at a price per share of $62.00 (the "HX Investors Offer"). The tender
offer commenced on July 5, 2002 following the filing of the required tender
offer documents with the Securities and Exchange Commission by HX Investors.
Pursuant to the Stock Purchase Agreement, the board of directors of the Company
approved a plan of liquidation for the Company (the "Plan of Liquidation") and
agreed to submit the Plan of Liquidation to its stockholders for approval at the
2002 annual meeting of stockholders to be held on September 9, 2002 (the "Annual
Meeting"). HX Investors agreed to vote all of its shares in favor of the Plan of
Liquidation
15
at the Annual Meeting. Under the Plan of Liquidation, HX Investors would have
received an incentive payment of 25% of gross proceeds after the payment of a
priority return of approximately $66.25 per share was made to the stockholders
of the Company.
Subsequently, on July 29, 2002, Longacre Corp., an affiliate of Carl C. Icahn
("Icahn"), commenced a litigation against the Company, and Icahn publicly
announced that his related companies, together with outside investors, were
prepared to initiate a competing tender offer for the same number of shares of
common stock of the Company as were tendered for under the HX Investors Offer,
at a price per share of $68.20. Over the course of the next several days, Icahn
and HX Investors submitted competing proposals to the board of directors of the
Company and made those proposals public. On August 4, 2002, Icahn notified the
Company that he was no longer interested in proceeding with his proposed offer.
On August 5, 2002, the Company entered into an amendment to the HX Investors
Stock Purchase Agreement. Pursuant to the terms of the amendment, the purchase
price per share offered under the HX Investors Offer was increased from $62.00
to $73.85. The amendment also reduced the incentive payment payable to HX
Investors under the Plan of Liquidation from 25% to 15% of gross proceeds after
payment of the approximately $66.25 per share priority return to stockholders of
the Company, and included certain corporate governance provisions.
The HX Investors Offer is scheduled to expire at midnight on Friday, August 16,
2002.
Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions in certain circumstances that affect amounts reported in the
accompanying financial statements and related footnotes. In preparing these
financial statements, management has made its best estimates and judgments of
certain amounts included in the financial statements, giving due consideration
to materiality. The Company does not believe there is a great likelihood that
materially different amounts would be reported related to the accounting
policies described below. However, application of these accounting policies
involves the exercise of judgment and use of assumptions as to future
uncertainties and, as a result, actual results could differ from these
estimates.
Impairment of long-lived assets. At June 30, 2002 and December 31, 2001, the
Company had $29,720,985 and $29,984,138 of real estate (net), accounting for
approximately 41% and 36%, respectively, of the Company's total assets. Property
and equipment is carried at cost net of adjustments for impairment. The fair
value of the Operating Partnership's property and equipment is dependent on the
performance of the properties.
The Company evaluates recoverability of the net carrying value of its real
estate and related assets at least annually, and more often if circumstances
dictated. If there is an indication that the carrying value of a property might
not be recoverable, the Company prepares an estimate of the future undiscounted
cash flows expected to result from the use of the property and its eventual
disposition, generally over a five-year holding period. In performing this
review, management takes into account, among other things, the existing
occupancy, the expected leasing prospects of the property and the economic
situation in the region where the property was located.
16
If the sum of the expected future undiscounted cash flows is less than the
carrying amount of the property, the Company recognizes an impairment loss, and
reduces the carrying amount of the asset to its estimated fair value. Fair value
is the amount at which the asset could be bought or sold in a current
transaction between willing parties, that is, other than in a forced or
liquidation sale. Management estimates fair value using discounted cash flows or
market comparables, as most appropriate for each property. Independent certified
appraisers are utilized to assist management, when warranted.
For the years ended December 31, 2001, 2000, and 1999, no impairment losses have
been recorded. Cumulative impairment losses from previous years for all
properties included in real estate in the accompanying balance sheets would
amount to $20,100,000. Impairment write-downs recorded by the Corporation do not
affect the tax basis of the assets and are not included in the determination of
taxable income or loss.
Because the cash flows used to evaluate the recoverability of the assets and
their fair values are based upon projections of future economic events, such as
property occupancy rates, rental rates, operating cost inflation and market
capitalization rates which are inherently subjective, the amounts ultimately
realized at disposition may differ materially from the net carrying values at
the balance sheet dates. The cash flows and market comparables used in this
process are based on good faith estimates and assumptions developed by
management.
Unanticipated events and circumstances may occur and some assumptions may not
materialize; therefore, actual results may vary from the estimates and variances
may be material. The Company may provide additional write-downs, which could be
material in subsequent years if real estate markets or local economic conditions
change.
Useful lives of long-lived assets. Property and equipment, and certain other
long-lived assets are amortized over their useful lives. Depreciation and
amortization are computed using the straight-line method over the useful life of
the property and equipment. The cost of properties represents the initial cost
of the properties to the Company plus acquisition and closing costs less
impairment adjustments. Tenant improvements and leasing costs are amortized over
the applicable lease term. Useful lives are based upon management's estimate
over the period that the assets will generate revenue.
Revenue Recognition. Base rents are recognized on a straight-line basis over the
terms of the related leases. Percentage rents charged to retail tenants based on
sales volume are recognized when earned pursuant to Staff Accounting Bulletin No
101, "Revenue Recognition in Financial Statements," issued by the Securities and
Exchange Commission in December 1999, and the Emerging Issues Tax Force's
consensus on Issue 98-9, "Accounting for Contingent Rent in Interim Financial
Periods." The Company defers recognition of contingent rental income (i.e.,
percentage/excess rent) in interim periods until the specified target (i.e.,
breakpoint) that triggers the contingent rental income is achieved. Recoveries
from tenants or taxes, insurance and other operating expenses are recognized as
revenue in the period the applicable taxes are incurred.
New Accounting Policies
Certain properties are owned in joint ventures with Shelbourne Properties I,
L.P. and/or Shelbourne Properties III, L.P. Prior to April 30, 2002, the Company
owned an undivided interest in the assets owned by these joint ventures and was
severally liable for indebtedness it incurred in connection with its ownership
interest in those properties. Therefore, for periods prior to April 30, 2002,
the Company's condensed
17
consolidated financial statements presented the assets, liabilities, revenues
and expenses of the joint ventures on a pro rata basis in accordance with the
Company's percentage of ownership.
After April 30, 2002, as a result of the Company's incurring debt in connection
with entering into the Credit Facility discussed in Note 8 to the "Notes to
Condensed Consolidated Financial Statements", after April 30, 2002, the Company
is no longer allowed to account for its investments in joint ventures on a
pro-rata consolidation basis in accordance with its percentage of ownership but
must utilize the equity method of accounting. Accordingly, the Company's
condensed consolidated balance sheet at June 30, 2002 and the Company's
condensed consolidated statements of operations for the three and six month
period ended June 30, 2002 reflect the equity method of accounting.
Pro Forma Information
The following tables show (i) the pro-forma condensed consolidated balance sheet
as of December 31, 2001 and (ii) the pro-forma statement of operations for the
three and six months ended June 30, 2001, both reflecting the impact of the
change to equity accounting for the investment in joint ventures. The pro forma
information is provided for the purpose of comparing results of operations in
the review of management's discussion and analysis. The Company's total equity
did not change.
CONDENSED CONSOLIDATED PRO-FORMA BALANCE SHEET INFORMATION
Previously Reported Pro Forma Equity Method
December 31, 2001 Adjustments December 31, 2001
------------------- -------------- -----------------
ASSETS
Real estate, net $ 41,327,041 $(16,342,903) $ 24,984,138
Cash and cash equivalents 26,011,761 (8,938,300) 17,073,461
Other assets 3,191,467 6,097,689 9,289,156
Receivables, net of allowances
of $77,568 and $88,700, 151,706 (92,360) 59,346
respectively
Investment in joint ventures - 18,790,789 18,790,789
------------------- -------------- -----------------
Total Assets $ 70,681,975 $ (485,085) $ 70,196,890
=================== ============== =================
LIABILITIES
Accounts payable and accrued
expenses $ 1,168,273 $ (485,085) $ 683,188
------------------- -------------- -----------------
Total Liabilities $ 1,168,273 $ (485,085) $ 683,188
=================== ============== =================
18
CONDENSED CONSOLIDATED PRO-FORMA STATEMENTS OF OPERATIONS
For the Three Months Ended For the Six Months Ended
June 30, June 30,
Previously Pro forma Previously Pro forma
Reported Adjustments Reported Adjustments
2001 2001 Total 2001 2001 Total
----------- ------------ ---------- ---------- ------------ ----------
Rental revenues $ 3,042,154 $(1,719,619) $1,322,535 $6,096,413 (3,339,045) $2,757,368
----------- ------------ ---------- ---------- ------------ ----------
Costs and expenses 2,300,841 (814,230) 1,486,611 4,709,797 (1,629,196) 3,080,601
----------- ------------ ---------- ---------- ------------ ----------
Income (loss) before equity income from
joint ventures interest and other income 741,313 (905,389) (164,076) 1,386,616 (1,709,849) (323,233)
Equity income from joint ventures - 1,025,681 1,025,681 - 1,963,876 1,963,876
Interest Income 182,429 (111,690) 70,739 416,002 (245,425) 170,577
Other Income 8,602 (8,602) - 22,402 (8,602) 13,800
----------- ------------ ---------- ---------- ------------ ----------
Net income $ 932,344 $ - $ 932,344 $1,825,020 $ - $1,825,020
=========== ============ ========== ========== ============ ==========
Liquidity and Capital Resources
The Company uses its working capital reserves and any cash from operations as
its primary source of liquidity. Unlike the Predecessor Partnership, which could
not incur indebtedness or issue additional equity, the Company has as potential
sources of liquidity, in addition to cash, capital raised by either borrowing
money on a long-term or short-term basis, or issuing additional equity
securities. Due to the restrictions on the incurrence of debt on the Predecessor
Partnership and the resulting lack of mortgage debt on the properties, it is
anticipated that the Company will have significantly enhanced capital resources
as compared to the Predecessor Partnership. The Company's use of these sources
of capital may result in the encumbrance of its current and future assets with
substantial amounts of indebtedness. As a result, the Company may have an
increased risk of default on its obligations and thus a decrease in its
long-term liquidity.
The Company had $13,396,784 in cash and cash equivalents at June 30, 2002. Cash
and cash equivalents are temporarily invested in short-term instruments. The
Company's level of liquidity is based upon cash and cash equivalents, which
decreased by $3,676,677 from $17,073,461 for the year ended December 31, 2001.
The decrease in cash and cash equivalents is due to $17,866,603 paid to Presidio
in connection with the Transaction that was consummated on February 14, 2002
where the Company repurchased 343,124 shares held by Presidio. The Company also
incurred $274,176 in improvements to real estate. The Company received proceeds
from the initial borrowing under the Credit Facility of $29,779,393, of which
$22,034,250 was used to retire the note that was issued in relation to the
Transaction. These expenditures were offset by $6,719,009 of cash provided by
operating activities.
19
Currently, the Company's primary source of funds is cash flow from the operation
of its properties; principally rents billed to tenants, which amounted to
$1,244,039 and $2,444,764 for the three and six months ended June 30, 2002. In
the event the Company were to acquire additional assets, its cash flows from
operations would be derived from a larger, more diverse, and potentially riskier
group of assets than what is currently owned. Likewise, the Company's ability to
pay dividends may be affected by the leveraging of its assets and reinvestment
of sale and financing proceeds for the acquisition of additional assets.
For the six months ended June 30, 2002, the Company made $274,176 in capital
expenditures that were funded from cash flow and the Company's working capital
reserves. In addition to tenant improvements at the properties, the Company's
capital expenditures were for frontage repairs at the Matthews Festival property
due to a car accident.
The budgeted expenditures for 2002 capital improvements and capitalized tenant
procurement cost in 2002 are an aggregate of $412,690. These costs are to be
incurred in the normal course of business and funded from cash flows from the
operation of the properties and working capital reserves that are temporarily
invested in short-term money market instruments, as well as other sources of
capital , which could include financing proceeds and the issuance of additional
equity. However, the actual amount of such expenditures depends upon the level
of leasing activity and other factors that cannot be predicted with certainty.
In the event that the Company were to purchase additional real estate assets or
incur additional mortgage indebtedness, the Company's expenses would increase,
which would raise the risk that the Company would be unable to fund the
necessary capital and tenant procurement costs at its properties.
Except as discussed herein, management is not aware of any other trends, events,
commitments or uncertainties that will have a significant impact on the
Company's liquidity. If, however, real estate market conditions deteriorate in
any areas where the properties are located, there is substantial risk that
future cash flow may be insufficient to fund the capital improvements and lease
procurement costs of the properties. In that event, the Company would utilize
its remaining working capital reserves, reduce distributions, raise additional
capital through financing or the issuance of equity, or sell one or more
properties.
Results of Operations
Six months ended June 30, 2002 vs. June 30, 2001
Net income
The Company's net income decreased by $26,098,164 to $(24,273,144) for the six
months ended June 30, 2002 from $1,825,020 for the same period in 2001. This
increase is primarily due to the Transaction, as well as legal and professional
fees incurred in connection with the Transaction and subsequent lawsuits filed
against the Company, and the payment of consulting fees to Lazard Freres & Co
LLC ("Lazard.") The Company paid $23,049,348 in relation to the Transaction,
consisting of a note payable in the amount of $22,034,250 and a Class A 5%
cumulative preferred partnership interest with a liquidation preference of
$1,015,148. Legal costs associated with the Transaction and litigation was
$1,909,623 for the six months ended June 30, 2002. The Company incurred $878,827
in fees to Lazard for consulting services.
20
Rental Revenues
Rental revenues decreased by $312,604, or 11.3%, to $2,444,764 for the six
months ended June 30, 2002 from $2,757,368 for the same period in 2001. This is
primarily due to the loss of rental revenue of $493,440 following the sale of
Commonwealth Industrial Park on December 6, 2001. Increases in rental revenues
at Matthews Festival of $138,915 and Melrose Crossing of $27,723 due to
increased occupancy helped partially offset the decrease.
Income
Income (defined as rental revenues, equity income from joint ventures, interest
and other income) decreased $401,011, or 8.2% to $4,504,610 for the six months
ended June 30, 2002 from $4,905,621 in the same period in 2001 primarily due to
the decrease in rental income due to the sale of Commonwealth in December 2001
as well as decreases interest income and other income. Interest income decreased
by $75,161, or 44.1%, to $95,416 for the six months ended June 30, 2002 from
$170,577 for the same period in 2001 due to significantly lower cash balances
during that time as compared to the same period in 2001 as well as lower yields
on cash and cash equivalents. Other income decreased for the six months ended
June 30, 2002 as compared to the same period ended June 30, 2001 by $13,252, or
96%, to $548 from $13,800 due to the absence, as a result of the conversion of
the Predecessor Partnership into a REIT, of transfer fees that were previously
generated by the transfer of partnership interests.
Costs and expenses
Total costs and expenses, including interest expense, for the six months ended
June 30, 2002, amounted to $28,777,754, an increase of $25,697,153 as compared
to $3,080,601 in the same period in 2001. This increase consists of a one-time
expense of $23,049,398 in connection with the Transaction and interest expense
of $215,768 on the note issued in the Transaction and $211,443 in interest on
the proceeds received from the initial borrowing under the Credit Facility. The
remaining costs and expenses amounted to $5,301,145 for the six months ended
June 30, 2002, an increase of $2,220,544, or 72%, from $3,080,601 incurred for
the same period in 2001. The increase in the remaining costs and expenses is due
to an increase in general and administrative expenses primarily legal,
professional and consulting fees.
Operating expenses increased by $14,300, or 1.6% to $887,196 for the six months
ended June 30, 2002 from $872,896 for the same period in 2001 due to increased
insurance and real estate expenses. These increases were partially offset by a
saving as a result of the sale of Commonwealth Industrial Park. All other
operating expenses remained relatively the same.
Expenses related to asset management fees decreased by $383,494 to $282,532 for
the six months ended June 30, 2002 from $666,026 for the same period in 2001 as
the obligation to pay the partnership asset management fee terminated upon
consummation of the Transaction. Of the $666,026 in asset management fees for
the six months ended June 30, 2001, $394,808 was paid to the managing general
partner of the Predecessor Partnership and $271,218 was paid to Shelbourne
Management. For the six months ended June 30, 2002, of the $282,532 in asset
management fees, $157,582 was paid to Shelbourne Management prior to February
14, 2002 and $124,950 to PCIC thereafter in accordance with PCIC's agreement to
provide transition services to the Company upon the consummation of the
Transaction.
21
Inflation
Inflation is not expected to have a material impact on the operations or
financial position of the Company.
Three months ended June 30, 2002 vs. June 30, 2001
Net income
The Company incurred a net loss of $1,493,391, a decrease of $2,425,735, for the
three months ended June 30, 2002 from $932,344 of net income for the same period
in 2001. This decrease in net income was primarily due to the incurrence of
legal, professional and consulting fees $1,952,019. These fees were largely
incurred in legal fees relating to lawsuits filed subsequent to the Transaction
and the settlements of those lawsuits. The Company incurred $299,454 of interest
expense on the proceeds of the initial borrowing under the Credit Facility.
Rental Revenues
Rental revenues decreased by $78,496, or 6%, to $1,244,039 for the three months
ended June 30, 2002 from $1,322,535 for the same period in 2001. This is
primarily due to a loss of rental revenue of $255,411 following the sale of
Commonwealth Industrial Park on December 6, 2001. This loss was primarily offset
by increased revenues at Matthews Festival of $170,230 due to the lease of space
that was vacant during the same three months in 2001.
Income
Income (defined as rental revenues, equity income from joint ventures, interest
and other income) decreased $161,003, or 6.7%, to $2,257,952 for the three
months ended June 30, 2002 from $2,418,955 for the same period in 2001 primarily
due to the decrease in rental revenue as a result of the sale of the
Commonwealth Industrial Park property, which was partially offset by the
increased income at Melrose Crossing and Matthews Festival from the lease of
previously vacant space. Equity income from joint ventures decreased due to
increased vacancy at the Seattle Tower property. Interest income decreased by
$26,351, or 37.3% to $44,388 for the three months ended June 30, 2002 from
$70,739 for the same period in 2001 due to significantly lower cash balances and
lower yields on cash and cash equivalent investments.
Costs and Expenses
Total costs and expenses, including interest expense, for the three months ended
June 30, 2002, amounted to $3,751,343, an increase of $2,264,732 as compared to
$1,486,611 for the same period in 2001, primarily due to payments of
approximately $2,254,000 for legal, professional and consulting fees in
connection with the lawsuits and settlement of those lawsuits.
The sale of the Commonwealth Industrial Property is primarily responsible for
the slight decrease in property operating expense and management fees.
Funds From Operations
Management believes that Funds From Operations ("FFO") is helpful to investors
as a measure of the performance of an equity REIT because, along with cash flows
from operating activities, financing
22
activities and investing activities, it provides investors with an understanding
of the ability of the Company to incur and service debt, to make capital
expenditures and to fund other cash needs.
FFO, which is a commonly used measurement of the performance of an equity REIT,
as defined by the National Association of Real Estate Investment Trusts, Inc.
("NAREIT"), is net income (computed in accordance with generally accepted
accounting principles), excluding gains (or losses) from debt restructurings,
asset valuation provisions and sales of property, plus depreciation and
amortization, and after adjustments for unconsolidated partnerships and joint
ventures.
The Company's FFO may not be comparable to FFO reported by other REITs that do
not define the term in accordance with the current NAREIT definition or that
interpret the NAREIT definition differently. FFO does not represent cash
generated from operating activities determined in accordance with accounting
principles generally accepted in the United States and should not be considered
as an alternative to net income (determined in accordance with accounting
principles generally accepted in the United States) as a measure of the
Company's liquidity, nor is it indicative of funds available to fund the
Company's cash needs, including its ability to make cash distributions.
FFO for the three-month periods ended June 30, 2002 and 2001 are summarized in
the following table:
Three Months Six months
Ended Ended
June 30, 2002 June 30, 2001 June 30, 2002 June 30, 2001
------------- ------------- ------------- -------------
Net (Loss) Income (A) $(1,493,391) $ 932,344 $(24,273,144) $1,825,020
Plus: Depreciation
related to real estate and
tenant improvements 278,796 291,739 537,329 578,955
Plus: Amortization of
leasing commissions 33,358 38,849 63,886 71,736
Plus: Adjustments for
unconsolidated
joint ventures (B) 323,429 217,375 565,621 456,683
------------- ------------- ------------- -------------
Funds From Operations (A) $ (857,808) $1,480,307 $(23,106,308) $2,932,394
============= ============= ============= =============
(A) Net Income and Funds From Operations for the six months ended June 30, 2002
include $23,049,398 related to the purchase of the Advisory Agreements.
(B) Adjustments for unconsolidated joint ventures includes all adjustments to
convert the Company's share of net income from unconsolidated joint
ventures to FFO
23
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The primary market risk we face is interest rate sensitivity. Our long-term debt
bears interest at a floating rate, and therefore we are exposed to the risk of
interest rate changes. At August 13, 2002, borrowings under our secured
revolving credit facility totaled $29,779,343 and initially bore an interest
rate of LIBOR plus 2.5%. Based on the balance outstanding on our credit facility
at August 13, 2002 and the interest rate at that date, a 10% increase in LIBOR
would increase our interest expense in 2002 by approximately $51,600.
Conversely, a 10% decrease in LIBOR would decrease our interest expense in 2002
by the same amount. The gain or loss we ultimately realize with respect to
interest rate fluctuations will depend on the actual interest rates during that
period. We do not believe that we have any risk related to derivative financial
instruments.
24
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
HX Investors, L.P. litigation
HX Investors, L.P. ("HX Investors") and other plaintiffs filed an action on May
22, 2002 against the Company, Shelbourne Properties I and Shelbourne Properties
III (collectively, the "Companies") seeking an order directing that each of the
Companies hold a stockholder election for the purpose of electing directors to
nine seats on the boards of each of the Companies. The action (i) sought to
compel the holding of an annual meeting of stockholders and (ii) challenged an
action taken by the boards of directors of the Companies reclassifying the
boards of each company from nine to four directors and reappointing three
directors in connection with such reclassification.
A stipulation of dismissal, with prejudice, was entered on July 3, 2002. In
connection with the settlement, HX Investors agreed to conduct tender offers for
up to 30% of the outstanding common stock (the "HX Investors Offer"), and the
board of directors approved plans of liquidation for each of the Companies,
subject to stockholder approval. Also pursuant to the settlement, the parties
agreed that the board of directors of each of the Companies would be increased
to six members, with two directors designated by HX Investors, and four
directors would be independent.
Delaware Plaintiffs litigation
As previously disclosed in the Company's report on Form 10-Q filed May 15, 2002,
a group of plaintiffs (the "Delaware Plaintiffs") brought suit derivatively on
behalf of the Companies against NorthStar, PCIC, Shelbourne Management and eight
former and present directors of the boards of directors of the Companies (the
"Individual Defendants"). The Delaware Plaintiffs filed a consolidated class and
derivative complaint on April 10, 2002 alleging that the boards of directors of
the Companies mismanaged the Companies making it less likely that they could pay
dividends. Plaintiffs seek disgorgement of profits, accounting for profits and
rescission of an agreement to repurchase shares of stock held by PCIC and
purchase the Advisory Agreements.
The Delaware Plaintiffs also filed an action under Section 211 of the General
Corporation Law of Delaware on May 7, 2002 (i) seeking to compel the holding of
an annual meeting of stockholders and (ii) challenging an action taken by the
Companies' boards of directors in which the boards of directors of each company
were reclassified from nine to four directors. This matter was consolidated with
the HX Investors action described above, for the limited purpose of discovery on
the statutory issues.
A letter of agreement of settlement was signed by the parties on July 1, 2002. A
stipulation of settlement was entered on July 3, 2002. The principal terms of
the settlement were that the Companies and their boards of directors would
facilitate the completion of the HX Investors Offer; conduct annual meetings on
September 9, 2002 and expand the board of directors of each of the Companies
from four members to six, four of whom would be independent directors as well as
implementing corporate governance protections. The settlement also provided for
a contribution by Shelbourne Management of 42% of the Preferred Operating Units
of the Companies to HX Investors with the purpose of providing funds to HX
Investors in connection with the HX Investors Offer, as well as allowing for a
contribution of up to one million dollars, as approved by the court, for
plaintiffs' attorneys fees.
Icahn Litigation
25
As previously disclosed in the Company's report on Form 10-Q filed May 15, 2002,
in February 2002, Carl C. Icahn ("Icahn") brought suit derivatively in the New
York State Supreme Court on behalf of the Companies against NorthStar, PCIC,
Shelbourne Management and the Individual Defendants. On or about March 8 and
March 12, 2002, Icahn filed a motion seeking leave to intervene in the
unconsolidated actions in Delaware. On May 16, 2002, Icahn filed a Derivative
Complaint in Intervention. The matter has been settled with respect to NorthStar
and the actions in Delaware have been dismissed without prejudice.
Longacre Corp. litigation
Longacre Corp. ("Longacre") filed an action on July 29, 2002 in the United
States District Court for the Southern District of New York against the
Companies seeking (i) a declaration that HX Investors violated Sections 13(e)
and 14(d) and (e) of the Securities and Exchange Act of 1934, as amended, and
the rules and regulations promulgated thereunder, and that the 25% liquidation
premium to be paid to HX Investors and Exeter Capital Corporation upon
liquidation of the Companies is invalid and illegal; and (2) an injunction
enjoining HX Investors from proceeding with the HX Investors Offer until HX
Investors makes the appropriate filings and disclosures. A hearing on Longacre's
Motion for an Injunction was held on August 1, 2002, and the request for a
preliminary injunction was denied.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibits furnished pursuant to the requirements of Form 10-Q:
Number Description
- ------ -----------
(3.1) Amended and Restated Certificate of Incorporation of the Company*
(3.2) Amended and Restated Bylaws of the Corporation*
(4.1) Amended and Restated Agreement of Limited Partnership of the operating
partnership*
(4.2) Shareholder Rights Agreement*
(4.3) Amendment to Shareholder Rights Agreement**
(4.4) Certificate of Designations, Preferences and Rights of Series A
Preferred Stock*
(4.5) Stockholder Agreement, among the Companies and HX Investors, LP and
Exeter Capital Corporation, dated as of April 30, 2002***
(10.1) Revolving Credit Agreement, dated as of April 30, 2002, among the
operating partnerships of the Companies, such operating partnerships'
wholly-owned subsidiaries, the lenders from time to time party thereto
and Bayerische Hypo-Und Vereinsbank AG, New York branch, as agent for
itself and the other lenders. ***
(10.2) Promissory note, dated April 30, 2002, issued by the operating
partnerships of the Companies and such operating partnerships'
wholly-owned subsidiaries in favor of each lender in the aggregate
principal amount of $75,000,000. ***
(10.3) Cash Management Agreement, dated as of April 30, 2002, among the
operating partnerships of the Companies, such operating partnerships'
wholly-owned subsidiaries,
26
the agent and Deposit Bank (as defined therein), as the same may be
amended, restated, replaced, supplemented or otherwise modified from
time to time. ***
(10.4) Contribution and Cross-Indemnification Agreement, dated as of April
30, 2002, among the operating partnerships of the Companies and such
operating partnerships' wholly-owned subsidiaries. ***
(10.5) Pledge and Security Agreement, dated as of April 30, 2002, by the
operating partnerships of the Companies and such operating
partnerships' wholly-owned subsidiaries in favor of the lenders. ***
(10.6) Form of Mortgage, dated as of April 30, 2002, issued by Shelbourne
Properties II, Inc.to Bayerische Hypo- Und Vereinsbank AG, New York
Branch, as agent for itself and other lenders, with respect to its
real property located in Richmond, Virginia, Matthews, North Carolina
and Raleigh, North Carolina. ***
(99.1) Partnership Unit Designation of the Class A Preferred Partnership
Units of the Operating Partnership. **
(99.2) Certification pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
18 U.S.C. Section 1350.
* incorporated by reference to the Registration Statement of the Company on Form
S-4 filed on February 11, 2000, as amended
** incorporated by reference to the Current Report of the Company on Form 8-K
filed on February 14, 2002
*** incorporated by reference to the Current Report of the Company on Form 8-K
filed on May 14, 2002.
(b) Reports on Form 8-K
The following reports on Form 8-K were filed on behalf of the Registrant during
the quarter ended June 30, 2002:
(i) Press release announcing that the Companies had entered into a Revolving
Credit Facility with Hypo-Und Vereinsbank, AG.
Item reported: 5
Dated filed: April 14, 2002
(ii) Press release announcing that the Companies had retained Lazard Freres &
Co. as a strategic advisor.
Item reported: 5
Date filed: April 23, 2002
(iii) Press release announcing the date of the Annual Meeting of Stockholders of
the Company.
Item reported: 5
Date filed: May 9, 2002
(iv) Press release announcing a change in the date of the Annual Meeting of
Stockholders of the Company.
Item reported: 5
27
Date filed: June 5, 2002
28
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Shelbourne Properties II, Inc.
(Registrant)
Dated: August 19, 2002 By: /s/ Michael L. Ashner
___________________________
Michael L. Ashner
Chief Executive Officer
29
EXHIBIT INDEX
Number Description
- ------ -----------
(3.1) Amended and Restated Certificate of Incorporation of the Company*
(3.2) Amended and Restated Bylaws of the Corporation*
(4.1) Amended and Restated Agreement of Limited Partnership of the operating
partnership*
(4.2) Shareholder Rights Agreement*
(4.3) Amendment to Shareholder Rights Agreement**
(4.4) Certificate of Designations, Preferences and Rights of Series A
Preferred Stock*
(4.5) Stockholder Agreement, among the Companies and HX Investors, LP and
Exeter Capital Corporation, dated as of April 30, 2002***
(10.1) Revolving Credit Agreement, dated as of April 30, 2002, among the
operating partnerships of the Companies, such operating partnerships'
wholly-owned subsidiaries, the lenders from time to time party thereto
and Bayerische Hypo-Und Vereinsbank AG, New York branch, as agent for
itself and the other lenders. ***
(10.2) Promissory note, dated April 30, 2002, issued by the operating
partnerships of the Companies and such operating partnerships'
wholly-owned subsidiaries in favor of each lender in the aggregate
principal amount of $75,000,000. ***
(10.3) Cash Management Agreement, dated as of April 30, 2002, among the
operating partnerships of the Companies, such operating partnerships'
wholly-owned subsidiaries, the agent and Deposit Bank (as defined
therein), as the same may be amended, restated, replaced, supplemented
or otherwise modified from time to time. ***
(10.4) Contribution and Cross-Indemnification Agreement, dated as of April
30, 2002, among the operating partnerships of the Companies and such
operating partnerships' wholly-owned subsidiaries. ***
(10.6) Pledge and Security Agreement, dated as of April 30, 2002, by the
operating partnerships of the Companies and such operating
partnerships' wholly-owned subsidiaries in favor of the lenders. ***
(10.6) Form of Mortgage, dated as of April 30, 2002, issued by Shelbourne
Properties II, Inc.to Bayerische Hypo- Und Vereinsbank AG, New York
Branch, as agent for itself and other lenders, with respect to its
real property located in Richmond, Virginia, Matthews, North Carolina
and Raleigh, North Carolina. ***
(99.1) Partnership Unit Designation of the Class A Preferred Partnership
Units of the Operating Partnership. **
(99.2) Certification pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
18 U.S.C. Section 1350.
* incorporated by reference to the Registration Statement of the Company on Form
S-4 filed on February 11, 2000, as amended
** incorporated by reference to the Current Report of the Company on Form 8-K
filed on February 14, 2002
*** incorporated by reference to the Current Report of the Company on Form 8-K
filed on May 14, 2002.
30