Item 1. Business
General
Brandywine Realty Trust (collectively with its subsidiaries, the “Company”) is a self-administered and self-managed real estate investment trust (“REIT”) active in acquiring, developing, redeveloping, leasing and managing office and industrial properties. As of December 31, 2002, the Company owned 210 office properties, 27 industrial facilities and one mixed-use property (collectively, the “Properties”) containing an aggregate of approximately 16.1 million net rentable square feet. The Company was also performing management and leasing services for 43 properties containing an aggregate of 3.1 million net rentable square feet. In addition, as of December 31, 2002, the Company held economic interests in ten unconsolidated real estate ventures (the “Real Estate Ventures”) 	 that were formed with third parties to develop commercial properties. The Real Estate Ventures own eight office buildings that contain 	 approximately 800,000 net rentable square feet. As of December 31, 2002, the Company had an aggregate investment in the Real Estate 	 Ventures of approximately $14.8 million (net of returns of investment received by Company). As of December 31, 2002, the Company 	 also owned approximately 444 acres of undeveloped land and held options to purchase approximately 63 additional acres. The Company 		also holds an option to enter into a long-term ground lease of property adjacent to Amtrak’s 30th Street Station in Philadelphia 		 and develop a high-rise office property on the leasehold interest. The Properties are located in the office and industrial markets 		 in and surrounding Philadelphia, Pennsylvania, New Jersey and Richmond, Virginia.
Business Objectives
The Company’s business objectives are to:
• maximize cash flow through leasing strategies designed to capture potential rental growth as rental rates increase and as below-market leases are renewed;
• attain a high tenant retention rate through aggressive tenant service programs responsive to the varying needs of the Company’s diverse tenant base;
• increase economic diversification while maximizing economies of scale;
• develop high-quality office and industrial properties on the Company’s existing inventory of land, as warranted by market conditions;
• capitalize on management’s redevelopment expertise to selectively acquire, redevelop and reposition underperforming properties in desirable locations;
• acquire high-quality office and industrial properties and portfolios of such properties at attractive yields in selected submarkets within the Mid-Atlantic region that management expects will experience economic growth and that provide barriers to entry; and
• enhance the Company’s investment strategy through the pursuit of joint venture opportunities with high-quality partners having attractive real estate holdings or significant financial resources.
The Company expects to continue to concentrate its real estate activities in submarkets within the Mid-Atlantic region where it believes that: (i) barriers to entry (such as zoning restrictions, utility availability, infrastructure limitations, development moratoriums and limited developable land) will create supply constraints on office and industrial space; (ii) current market rents and absorption statistics justify limited new construction activity; (iii) it can maximize market penetration by accumulating a critical mass of properties and thereby enhance operating efficiencies; and (iv) there is potential for economic growth.
Organization
The Company was organized and commenced its operations in 1986 as a Maryland real estate investment trust. The Company owns its assets and conducts its operations through Brandywine Operating Partnership, L.P., a Delaware limited partnership (the “Operating Partnership”), and subsidiaries of the Operating Partnership. As of December 31, 2002, the Company’s ownership interest in the Operating Partnership entitled it to approximately 94.9% of the Operating Partnership’s distributions after distributions by the Operating Partnership to holders of its preferred units. The structure of the Company as an “UPREIT” is designed, in part, to permit persons contributing properties (or interests in properties) to the Company to defer some or all of the tax liability they might otherwise incur in a sale of properties. The Company conducts its real estate management services 	 through Brandywine Realty Services Corporation (the “Management Company”), a subsidiary of which 95% is owned by the 	 Operating Partnership. The remaining five percent is owed by a partnership comprised of two executives of the Company. 	 See “Management Activities.”
The Company’s executive offices are located at 401 Plymouth Road, Suite 500, Plymouth Meeting, Pennsylvania 19462 and its telephone number is (610) 325-5600. The Company has an internet website at www.brandywinerealty.com.
Credit Facility
The Company and the Operating Partnership maintain an unsecured credit facility (the “Credit Facility”) with a bank group (comprising 21 banks) led by Bank of America, N.A. A majority of the Company’s direct and indirect subsidiaries are parties to the Credit Facility as guarantors. The Credit Facility provides up to $500 million in credit availability for working capital advances and letters of credit. As of December 31, 2002, there was unused availability of $179.4 million under the Credit Facility. The Credit Facility is scheduled to mature in June 2004, but may be extended at the Company’s election for a period of one year upon payment of a fee equal to .25% of the amount of the Credit Facility at the time of extension.
Advances under the Credit Facility currently bear interest at the London Inter-Bank Offered Rate (“LIBOR”) (1.38% at December 31, 2002) plus 1.50%. The spread over LIBOR varies, based on the Company’s leverage, from a low of 1.25% to a high of 1.75%. The Company has the option to elect an interest rate equal to the higher of the Federal Funds rate plus .75% or Bank of America’s prime rate plus .25%. The Company generally elects the interest rate based on LIBOR for all or most of the borrowings on the Credit Facility. An alternative rate and pricing structure is set forth in the Credit Facility if the Company or the Operating Partnership obtains at least two investment grade debt ratings.
The Company has entered into interest rate swap and rate cap agreements designed to reduce the impact of interest rate changes on certain variable rate debt. At December 31, 2002, the Company had interest rate swap agreements for notional principal amounts aggregating $175 million. The swap agreements effectively fix the LIBOR portion of the Company’s interest rate on $100 million of Credit Facility borrowings at 4.230% and $75 million of Credit Facility borrowings at 4.215%, in each case until June 2004. The interest rate cap agreement effectively limits the interest rate on a mortgage with a notional value of $28 million at 8.7% until July 2004.
The Credit Facility contains provisions limiting: the incurrence of additional debt; the granting of liens; the consummation of mergers and consolidations; the disposition of certain assets and interests in subsidiaries; the making of certain loans, advances and investments; and the payment of dividends. The restriction on dividends permits the Company to pay dividends in the amount required for it to retain its qualification as a REIT under the Internal Revenue Code of 1986, and otherwise limits dividends to 90% of the Company’s funds from operations, as defined in the Credit Facility.
The Credit Facility also contains financial covenants that require the Company to maintain a debt service coverage ratio, an interest coverage ratio, a fixed charge coverage ratio, an unsecured debt ratio and an unencumbered cash flow ratio above certain specified minimum levels; to maintain net worth above an amount determined on a specified formula; and to maintain a leverage ratio and a secured debt ratio below certain maximum levels. One additional financial covenant limits the percentage of the Company’s total assets (on a consolidated basis) that can be held by subsidiaries not party to the Credit Facility.
Term Loan
On July 15, 2002, the Company and the Operating Partnership entered into an unsecured term loan agreement with a group of lenders under which those lenders funded a term loan of $100 million (the “Term Loan”) to the Company and the Operating Partnership. The proceeds of the Term Loan were used to repay existing indebtedness, consisting primarily of indebtedness that had been outstanding under the Credit Facility. The Term Loan, like the Credit Facility, is recourse to the Company, the Operating Partnership and those subsidiaries that are parties, as guarantors, to the Term Loan agreement (which are the same subsidiaries that are guarantors of the Credit Facility). Bank of America, N.A. serves as administrative agent for a group of lenders under the Term Loan, as it does for the lenders under the Credit Facility, although the groups of lenders are not identical under the Term Loan and Credit Facility.
There is no required principal amortization of the Term Loan prior to maturity. The Term Loan matures on July 15, 2005, subject to two extensions of one year each upon payment by the Company of an extension fee and the absence of any defaults at the time of each extension.
The Term Loan bears interest at a per annum floating rate equal to the one, two, three or six month LIBOR, plus between 1.05% and 1.90% (1.65% at December 31, 2002), depending on the leverage and debt rating of the Company and the Operating Partnership. At the Company’s option, the Term Loan may bear interest at the prime rate plus .25%. Interest is due at the end of the LIBOR term, unless a six month LIBOR term is selected, in which case interest is also paid at the end of the third month of the LIBOR term. If the Company elects interest based on the prime rate, then interest payments will be due monthly.
The agreement providing for the Term Loan contains financial and operating covenants identical to those in the agreement establishing the Credit Facility. In addition, the Term Loan agreement, like the Credit Facility agreement, requires payment of prepayment premiums in certain instances.
Additional Debt
Mortgage Indebtedness. The following table sets forth information regarding the Company’s mortgage indebtedness outstanding at December 31, 2002:
(a) For loans that bear interest at a variable rate, the rates in effect at December 31, 2002 have been assumed to remain constant.
(b) “Annual Debt Service” is calculated by annualizing the regularly scheduled principal and interest amortization.
(c) “Annual Debt Service” for construction loans that require payment of interest only is calculated by annualizing the interest payment based on the outstanding debt balances and rates in effect at December 31, 2002.
Guaranties. As of December 31, 2002, the Company had guaranteed repayment of approximately $2.0 million of loans on behalf of the Real Estate Ventures. See Item 2.
Item 2. Properties
Operating Property Acquisitions
The Company acquired the following operating properties during the year ended December 31, 2002:
During 2002, the Company acquired one parcel of land, containing 9.0 acres, for $1.5 million. In addition, the Company purchased the remaining partnership interests held by third parties in three of the Company’s Real Estate Ventures which owned two office properties containing 222,000 net rentable square feet and one parcel of land containing 1.0 acres for $2.3 million.
Development Properties Placed in Service
The Company placed in service the following properties during the year ended December 31, 2002:
The Company places properties under development in service once a property reaches 95% occupancy or one year after the completion of shell construction, whichever is earlier.
Property Sales and Dispositions
The Company sold or disposed of the following properties during the year ended December 31, 2002:
During 2002, the Company sold two parcels of land, containing 12.8 acres, for $.7 million.
Properties
As of December 31, 2002, the Company owned 210 office properties, 27 industrial facilities and one mixed-use property that contained an aggregate of approximately 16.1 million net rentable square feet. The properties are located in the markets in and surrounding Philadelphia, Pennsylvania; New Jersey; and Richmond, Virginia. As of December 31, 2002, the Properties were approximately 91.0% leased to 1,143 tenants and had an average age of approximately 17.4 years. The office Properties are primarily one to three story suburban office buildings containing an average of approximately 67,450 net rentable square feet. The industrial Properties accommodate a 	 variety of tenant uses, including light manufacturing, assembly, distribution and warehousing. The Company carries 	 comprehensive liability, fire, extended coverage and rental loss insurance covering all of the Properties, with policy 	 specifications and insured limits which the Company believes are adequate.
The Company currently has in development or redevelopment three sites aggregating 428,000 square feet. The total cost of these projects is estimated to be $83.7 million, of which $73.9 million was incurred as of December 31, 2002. As of December 31, 2002, the Company owned approximately 444 acres of undeveloped land and held options to purchase approximately 63 additional acres. The Company also holds an option to enter into a long-term ground lease of property adjacent to Amtrak’s 30th Street Station in Philadelphia and develop a high-rise office property 	 on the leasehold interest.
The following table sets forth certain information with respect to the Properties at December 31, 2002:
(a) Calculated by dividing net rentable square feet included in leases signed on or before December 31, 2002 at the property by the aggregate net rentable square feet of the Property.
(b) “Total Base Rent” for the twelve months ended December 31, 2002 represents base rents received during such period, excluding tenant reimbursements, calculated in accordance with generally accepted accounting principles (GAAP) determined on a straight-line basis. Tenant reimbursements generally include payment of real estate taxes, operating expenses and common area maintenance and utility charges.
(c) “Average Annualized Rental Rate” is calculated as follows: (i) for office leases written on a triple net basis, the sum of the annualized contracted base rental rates payable for all space leased as of December 31, 2002 (without giving effect to free rent or scheduled rent increases that would be taken into account under GAAP) plus the 2002 budgeted operating expenses excluding tenant electricity; and (ii) for office leases written on a full service basis, the annualized contracted base rent payable for all space leased as of December 31, 2002. In both cases, the annualized rental rate is divided by the total square footage leased as of December 31, 2002 without giving effect to free rent or scheduled rent increases that would be taken into account under GAAP.
(d) This Property is subject to a ground lease.
The following table shows certain information regarding rental rates and lease expirations for the Properties at December 31, 2002, assuming none of the tenants exercises renewal options or termination rights, if any, at or prior to scheduled expirations:
(a) “Final Annualized Base Rent” for each lease scheduled to expire represents the cash rental rate of base rents, excluding tenant reimbursements, in the final month prior to expiration multiplied by 12. Tenant reimbursements generally include payment of real estate taxes, operating expenses and common area maintenance and utility charges.
At December 31, 2002, the Properties were leased to 1,143 tenants that are engaged in a variety of businesses. The following table sets forth information regarding leases at the Properties with the 20 tenants with the largest amounts leased based upon Annualized Escalated Rent from the Properties as of December 31, 2002:
(a) The identified tenant includes affiliates in certain circumstances.
(b) Annualized Escalated Rent represents the monthly Escalated Rent for each lease in effect at December 31, 2002 multiplied by 12. Escalated Rent represents fixed base rental amounts plus tenant reimbursements which include payment of real estate taxes, operating expenses and common area maintenance and utility charges. The Company estimates operating expense reimbursements based on historical amounts and comparable market data.
The following table sets forth the year-end occupancy percentages of the Company’s Properties for the last five years:
Real Estate Ventures
As of December 31, 2002, the Company had invested approximately $14.8 million in ten unconsolidated Real Estate Ventures (net of returns of investment received by the Company). The Company, through subsidiaries, formed these ventures with unaffiliated third parties to develop office properties or to acquire land in anticipation of possible development of office properties. Eight of the Real Estate Ventures own eight office buildings that contain an aggregate of approximately 1.1 million net rentable square feet; one Real Estate Venture developed a hotel property that contains 137 rooms; and one Real Estate Venture holds approximately three acres of land for future development. At December 31, 2002, the operating properties owned by the Real Estate Ventures were approximately 57% leased to 56 tenants.
The Company’s investment in Real Estate Ventures is as follows (in thousands):
(1) Ownership percentage represents the Company’s entitlement to residual distributions after payment by the applicable venture of priority returns.
(2) During 2002, the Company purchased the remaining partnership interests in these Real Estate Ventures. The results of operations of these Real Estate Ventures are consolidated from the date of purchase of the remaining interests.
Item 3.
Item 3. Legal Proceedings
The Company is involved from time to time in litigation on various matters, which include disputes with tenants and disputes arising out of agreements to purchase or sell properties. Given the nature of the Company’s business activities, these lawsuits are considered routine to the conduct of its business. The result of any particular lawsuit cannot be predicted, because of the very nature of litigation, the litigation process and its adversarial nature, and the jury system.
The Company is a defendant in a case in which the plaintiffs allege that the Company breached its obligation to purchase a portfolio of properties for approximately $83.0 million. On July 9, 1999, the Superior Court of New Jersey, Camden County, dismissed the complaint against the Company with prejudice. The plaintiffs subsequently filed a motion for reconsideration, which motion the Superior Court denied. Plaintiffs then appealed to the Appellate Division, which is the intermediate appellate level court in New Jersey. In December 2000, the Appellate Division affirmed in part and reversed in part the Chancery Division’s earlier dismissal of the entire action. The Appellate Division affirmed the dismissal of the fraud and other non-contractual counts in the Complaint, but reversed the contract and reformation counts and remanded these to the lower court for further proceedings. The Company sought review of this decision by the Supreme Court of New Jersey, but in March 2001 that Court declined to consider the appeal. The case thereafter returned to the Chancery Division, where written and oral discovery was conducted in 2002 and in the first quarter of 2003. Discovery terminated on February 14, 2003. The Company filed a motion for summary judgment on all counts, seeking dismissal of all counts against it, and judgment for the Company on its counterclaim. The Chancery Division granted the Company’s summary judgment motion on March 25, 2003. At this time, the Company does not know whether plaintiffs will appeal, or if they appeal, whether plaintiffs will be successful in the appeal.
There have been recent reports of lawsuits against owners and managers of multifamily and office properties asserting claims of personal injury and property damage caused by the presence of mold in residential units or office space. The Company has been named as a defendant in two lawsuits that allege personal injury as a result of the presence of mold. Unspecified damages are sought. The Company has referred these lawsuits to its environmental insurance carrier and, as of the date of this Form 10-K, the insurance carrier is evaluating coverage.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
The Company did not submit any matters to a vote of security holders in the fourth quarter of the fiscal year ended December 31, 2002.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity and Related Shareholder Matters
The Common Shares are traded on the New York Stock Exchange (“NYSE”) under the symbol “BDN.” On March 24, 2003, there were approximately 377 holders of record of the Common Shares. On March 24, 2003, the last reported sales price of the Common Shares on the NYSE was $21.50. The following table sets forth the quarterly high and low closing sales price per share reported on the NYSE for the indicated periods and the distributions paid by the Company with respect to each such period.
Future distributions by the Company will be declared at the discretion of the Board of Trustees and will depend on the actual cash flow of the Company, its financial condition, capital requirements, the annual distribution requirements under the REIT provisions of the Internal Revenue Code of 1986 and such other factors as the Board of Trustees deems relevant.
During 2002 and through the date of this Annual Report on Form 10-K, the Company did not issue any securities that were not registered under the Securities Act of 1933.
The following table provides information as of December 31, 2002 with respect to compensation plans under which equity securities of the Company are authorized for issuance:
Equity Compensation Plan Information as of December 31, 2002
(1) Relates to the Company’s 1997 Long-Term Incentive Plan.
(2) Weighted-average exercise price of outstanding options, excludes restricted Common Shares.
Item 6.
Item 6. Selected Financial Data
(in thousands, except per Common Share data and number of properties)
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the financial statements appearing elsewhere herein. The results of operations, liquidity and capital resources and cash flows of the Company include the historical results of operations of the Properties held by the Company during the years ended December 31, 2002, 2001 and 2000. This Annual Report on Form 10-K contains forward-looking statements for purposes of the Securities Act of 1933 and the Securities Exchange Act of 1934 and as such may involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Although the Company believes that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, there can be no assurance that these expectations will be realized. See Item 1. Business - Risk Factors.
OVERVIEW
The Company currently manages its portfolio within three geographic segments: (1) Pennsylvania, (2) New Jersey and (3) Virginia. The Company believes it has established an effective platform in these office and industrial markets that provides a foundation for achieving its goals of maximizing market penetration and optimizing operating economies of scale.
During 2002, the Company sold 23 office and 20 industrial properties, containing 2.3 million net rentable square feet, and two parcels of land, containing 12.8 acres, for $190.8 million. The Company also acquired
seven office properties, containing 617,000 net rentable square feet, and one parcel of land, containing 9.0 acres, for $99.1 million.
The Company receives income primarily from rental revenue (including tenant reimbursements) from the Properties and, to a lesser extent, from the management of properties owned by third parties and from investments in the Real Estate Ventures.
The Company’s financial performance is dependent upon the demand for office and other commercial space in its markets. Current economic conditions, including recessionary pressures and capital market volatility, have enhanced the challenges facing the Company.
In the current economic climate, the Company continues to seek revenue growth through an increase in occupancy of its portfolio (91.0% at December 31, 2002). However, with a downturn in general leasing activity, owners of commercial real estate, including the Company, are experiencing longer periods in which to lease unoccupied space, and may face higher capital costs and leasing commissions to achieve targeted tenancies.
As the Company seeks to increase revenue, management also focuses on strategies to minimize operating risks, including (i) tenant rollover risk, (ii) tenant credit risk and (iii) development risk.
Tenant Rollover Risk:
The Company is subject to the risk that, upon expiration, leases may not be renewed, the space may not be relet, or the terms of renewal or reletting (including the cost of renovations) may be less favorable than the current lease terms. Leases accounting for approximately 11.7% of the aggregate annualized base rents from the Properties as of December 31, 2002 (representing approximately 11.4% of the net rentable square feet of the Properties) expire without penalty through the end of 2003. The Company maintains an active dialogue with its tenants in an effort to achieve a high level of lease renewals. 	 The Company’s retention rate for leases that were scheduled to expire in the year ended December 31, 2002 was 78.0%. 	 If the Company is unable to renew leases for a substantial portion of the space under expiring leases, or to promptly 	 relet this space, at anticipated rental rates, the Company’s cash flow could be adversely impacted.
Tenant Credit Risk:
In the event of a tenant default, the Company may experience delays in enforcing its rights as a landlord and may incur substantial costs in protecting its investment. Management regularly evaluates its accounts receivable reserve policy in light of its tenant base and general and local economic conditions. The accounts receivable allowances were $4.6 million or 12.5% of total receivables (including accrued rent receivable) as of December 31, 2002 compared to $4.5 million or 12.5% of total receivables (including accrued rent receivable) as of December 31, 2001.
Development Risk:
The Company currently has in development or redevelopment three sites aggregating 428,000 square feet. The total cost of these projects is estimated to be $83.7 million, of which $73.9 million was incurred as of December 31, 2002. As of December 31, 2002, these projects were approximately 43% leased. While the Company is actively marketing space at these projects to prospective tenants, management cannot provide assurance as to the timing or terms of any leases of such space. As of December 31, 2002, the Company owned approximately 444 acres of undeveloped land and held options to purchase approximately 63 additional acres. Risks associated with development of this land include construction cost overruns and construction delays, insufficient occupancy rates and inability to obtain necessary zoning, land-use, building, occupancy and other required governmental approvals.
CRITICAL ACCOUNTING POLICIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses the Company’s consolidated financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.
The Company’s significant accounting policies are described in Note 1 to the consolidated financial statements included this Annual Report on Form 10-K. While the estimates and judgments associated with the application of these accounting policies may be affected by different assumptions or conditions, the Company believes the estimates and judgments associated with the reported amounts are appropriate in the circumstances. The following explains several of the Company’s critical accounting policies that are used in preparing the Company’s consolidated financial statements which require the Company’s management to use significant judgment and estimates:
Revenue Recognition
Rental revenue is recognized on a straight-line basis over the lease term regardless of when payments are due. Certain lease agreements contain provisions that require tenants to reimburse a pro rata share of real estate taxes and certain common area maintenance costs.
Real Estate Investments
Real estate investments are carried at cost. The Company records acquisition of real estate investments under the purchase method of accounting and allocates the purchase price to land, buildings and intangible assets on a relative fair value basis. Depreciation is computed using the straight-line method over the useful lives of buildings and capital improvements (25 to 40 years) and over the shorter of the lease term or the life of the asset for tenant improvements. Direct construction costs related to the development of certain Properties and land holdings are capitalized as incurred. The Company expenses routine repair and maintenance expenditures.
Impairment of Long-Lived Assets
Management reviews investments in real estate and real estate ventures for impairment if facts and circumstances indicate that the carrying value of such assets may not be recoverable. Measurement of any impairment loss will be based on the fair value of the asset determined using customary valuation techniques, such as the present value of expected future cash flows.
In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, long-lived assets, such as real estate investments and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount 	 by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately 	 presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are 	 no longer depreciated. The assets and liabilities of a disposed group classified as held-for-sale would be presented 	 separately in the appropriate asset and liability sections of the balance sheet.
Allowance for Doubtful Accounts
The Company maintains an allowance for doubtful accounts that represents an estimate of losses that may be incurred from the inability of tenants to make required payments. The allowance is an estimate based on two calculations that are combined to determine the total amount reserved. First, the Company evaluates specific accounts where it has been determined that a tenant may have an inability to meet its financial obligations. In these situations, the Company uses its judgment, based on the facts and circumstances, and records a specific reserve for that tenant against amounts due to reduce the receivable to the amount that the Company expects to collect. These reserves are reevaluated and adjusted as additional information becomes available. Second, a reserve is established for all tenants based on a range of
percentages applied to aging categories. These percentages are based on historical collection and write-off experience. If the financial condition of the Company’s tenants were to deteriorate, additional allowances may be required.
Deferred Costs
The Company incurs direct costs related to the financing and leasing of the Properties. Management is required to use professional judgment in determining whether such costs meet the criteria for capitalization or must be expensed. Capitalized financing fees are amortized over the related loan term and capitalized leasing costs are amortized over the related lease term. Management re-evaluates the remaining useful lives of leasing costs as the creditworthiness of the Company’s tenants and economic and market conditions change.
RESULTS OF OPERATIONS
Comparison of the Year Ended December 31, 2002 to the Year Ended December 31, 2001
The results of operations for the years ended December 31, 2002 and 2001 include the respective operations of the Properties. Of the 238 Properties owned by the Company as of December 31, 2002, a total of 194 Properties containing an aggregate of 13.2 million net rentable square feet (“Same Store Properties”) were owned for the entire twelve-month periods ended December 31, 2002 and 2001. The following table set forth revenue and expense information as to these Same Store Properties for the twelve-month periods ended December 31, 2002 and 2001:
Revenue increased to $296.7 million for 2002 as compared to $276.5 million for 2001, primarily due to increased rental rates and additional properties in 2002, offset by decreased occupancy. The straight-line rent adjustment increased revenues by $ 5.9 million in 2002 and $6.2 million in 2001. Revenue for Same Store Properties decreased to $233.3 million in 2002 from $236.6 million in 2001. This decrease was the result of decrease occupancy in 2002 as compared to 2001. Average occupancy for the Same Store Properties decreased to 90.4% in 2002 from 94.5% in 2001. Other revenue represents lease termination fees, leasing commissions, third-party management fees and interest income. Other revenue decreased to $9.8 million in 2002 from $10.5 million in 2001 primarily due to reduced interest income earned in 2002 as compared to 2001.
Property operating expenses increased to $76.7 million in 2002 as compared to $72.5 million in 2001, primarily due to increased insurance and security costs and additional properties in 2002. Property operating expenses included a provision for doubtful accounts of $.9 million in 2002 and $2.9 million in 2001 to provide for increased tenant credit risk. Property operating expenses for the Same Store Properties increased to $71.2 million in 2002 as compared to $69.9 million in 2002 as a result of higher insurance and security costs.
Real estate taxes increased to $25.9 million in 2002 as compared to $23.1 million in 2001, primarily due to increased real estate tax assessments in 2002 and additional properties in 2002. Real estate taxes for the Same Store Properties increased to $21.9 million in 2002 as compared to $20.8 million in 2001 as a result of higher tax rates and property assessments.
Interest expense decreased to $63.5 million in 2002 as compared to $66.4 million in 2001, primarily due to decreased interest rates offset by increased average borrowings during 2002. Average outstanding debt balances for 2002 were $1.0 billion as compared to $949.5 million for 2001. The Company’s weighted- average interest rate from its unsecured credit facilities after giving effect to hedging activities on the unsecured credit facilities decreased to 5.41% in 2002 from 6.48% in 2001 and on mortgage notes payable decreased to 7.27% in 2002 from 7.39% in 2001.
Depreciation decreased to $51.9 million in 2002 as compared to $64.5 million in 2001 primarily due to a change made by the Company in the estimated useful lives of buildings from 25 to 40 years. The impact of this change in useful lives was $19.0 million or $.53 per share for the year ended December 31, 2002. Management determined that the longer period better reflected the useful lives of the buildings. Amortization, related to deferred leasing costs, increased to $5.7 million in 2002 as compared to $4.5 million in 2001, primarily due to increased leasing activity and additional properties in 2002.
Administrative expenses decreased to $14.8 million in 2002 as compared to $15.2 million in 2001, primarily due to decreased amortization of restricted stock.
Equity in income of Real Estate Ventures decreased to $1.0 million in 2002 as compared to $2.8 million in 2001. The 2001 results include a $785,000 gain on the sale of the Company’s interests in a Real Estate Venture. In addition, the Company acquired the remaining partnership interests in three Real Estate Ventures, and, accordingly, the results attributable to these properties are now consolidated from the date of acquisition.
During 2002, the Company sold 23 office properties containing an aggregate of 1.4 million net rentable square feet, 20 industrial properties containing an aggregate of .9 million net rentable square feet and two land parcels containing of 12.8 acres for $190.8 million, realizing a net gain of $8.6 million. During 2001, the Company sold three office properties, eight industrial properties and four land parcels for $31.3 million, realizing a net gain of $4.5 million.
Minority interest from continuing operations represents the equity in income attributable to the portion of the Operating Partnership not owned by the Company. Minority interest from continuing operations increased to $9.3 million in 2002 as compared to $7.9 million in 2001, primarily due to increased results of continuing operations in 2002 as compared to 2001.
Discontinued operations increased from $13.2 million in 2002 as compared to $11.7 million in 2001 primarily due to net gain on sales of real estate investments of $8.6 million in 2002. During 2002, the Company recorded an impairment loss of $665,000 related to one property held-for-sale for which the anticipated net sales price is less than the book value of the asset.
Comparison of the Year Ended December 31, 2001 to the Year Ended December 31, 2000
(a) In 2000, the Operating Partnership held a 95% economic interest in Brandywine Realty Services Corporation (the “Management Company”) through its ownership of 100% of the Management Company’s non-voting preferred stock
and 5% of its voting common stock. Effective January 1, 2001, the Company converted its non-voting equity interest in the Management Company to a voting interest. Accordingly, the Company owns 95% of the equity of and has voting control over the Management Company. Therefore, the 2002 and 2001 financial results of the Management Company have been consolidated. For purposes of the Management’s Discussion and Analysis of Financial Condition and Results of Operations, the 2000 results of operations presented below have been restated to reflect this presentation.
The results of operations for the year ended December 31, 2001 and 2000 include the respective operations of the Properties. Of the 270 Properties owned by the Company as of December 31, 2001, a total of 224 Properties containing an aggregate of 14.8 million net rentable square feet (“Same Store Properties”) were owned for the entire twelve-month periods ended December 31, 2001 and 2000. The following table set forth revenue and expense information as to these Same Store Properties for the twelve-month periods ended December 31, 2001 and 2000:
Revenue increased to $276.5 million for 2001 as compared to $259.8 million for 2000, primarily due to increased rental rates and additional properties in 2001, offset by decreased occupancy. The straight-line rent adjustment increased revenues by $6.2 million in 2001 and $6.4 million in 2000. Average occupancy decreased to 94.5% in 2001 as compared to 95.0% for 2000. Revenue for the Same Store Properties increased to $254.6 million in 2001 from $247.3 million in 2000. This increase was the result of increased rental rates offset by a slight decrease in occupancy in 2001 as compared to 2000. Average occupancy for the Same Store Properties decreased 	 to 95.1% in 2001 from 95.3% in 2000. Other revenue represents lease termination fees, leasing commissions, third-party management fees and 	 interest income. Other revenue decreased to $10.5 million in 2001 from $11.4 million in 2000 primarily due to additional interest income 	 earned in 2000 on deposits made to acquire properties.
Property operating expenses increased to $72.5 million in 2001 as compared to $64.0 million in 2000, primarily due to increased utilities expense, increased provision for doubtful accounts and additional properties in 2001. Property operating expenses included a provision for doubtful accounts of $2.9 million in 2001 and $332,000 in 2000 to provide for credit risk related to certain tenants. Property operating expenses for the Same Store Properties increased to $73.5 million in 2001 as compared to $69.4 million in 2000 as a result of higher utility expenses, increased repairs and maintenance costs and increased property management charges.
Real estate taxes increased to $23.1 million in 2001 as compared to $21.7 million in 2000, primarily due to increased real estate tax assessments in 2001 and additional properties in 2001. Real estate taxes for the Same Store Properties increased to $23.9 million in 2001 as compared to $23.2 million in 2000 as a result of higher tax rates and property assessments.
Interest expense increased to $66.4 million in 2001 as compared to $64.8 million in 2000, primarily due to increased average borrowings resulting from the Prentiss Properties transaction in 2001, partially offset by decreased interest rates. Average outstanding debt balances for 2001 were $949.5 million as compared to $871.3 million for 2000. The Company’s weighted-average interest rate after giving effect to hedging
activities on unsecured credit facilities decreased to 6.48% in 2001 from 7.84% in 2000 and on mortgage notes payable decreased to 7.39% in 2001 from 7.92% in 2000.
Depreciation increased to $64.5 million in 2001 as compared to $56.5 million in 2000 primarily due to additional properties in 2001. Amortization, related to deferred leasing costs, increased to $4.5 million in 2001 as compared to $3.5 million in 2000, primarily due to increased leasing activity and additional properties in 2001.
Administrative expenses increased to $15.2 million in 2001 as compared to $14.2 million in 2000, primarily due to amortization of deferred compensation costs related to additional restricted Common Shares awarded in 2001.
During the fourth quarter of 2001, the Company recorded a $6.6 million non-recurring charge related to the change in employment status of the Company’s Chairman to a non-executive, non-managerial status and the write-down of the Company’s $2.5 million investment in a telecommunications company that was deemed to be other than temporary. The $4.1 million charge related to the Company’s Chairman reflects an accrual on account of payment obligations of the Company under its employment agreement with the Chairman, accelerated vesting of his restricted shares and restructuring of his executive stock loan.
Equity in income of Real Estate Ventures was $2.8 million in 2001 and 2000. The income attributable to two ventures sold in 2001 was offset by four ventures commencing operations in 2001.
During 2001, the Company sold three office properties, eight industrial properties and four land parcels for $31.3 million, realizing a net gain of $4.5 million. During 2000, the Company sold seven office properties and two land parcels for $101.1 million, realizing a net gain of $11.6 million.
Minority interest decreased to $7.9 million in 2001 as compared to $8.9 million in 2000, primarily due to the $6.6 million non-recurring charge in 2001and decreased gains on sales of interests in real estate.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
During 2002, the Company generated $118.7 million in cash flow from operating activities. Other sources of cash in-flows consisted of: (i) $115.0 million of proceeds from the Term Loan and draws on the Credit Facility , (ii) $78.0 million of net proceeds from property sales, (iii) proceeds from $20.2 million of additional mortgage notes payable, (iv) $2.5 million of escrowed cash, (v) $2.0 million of cash distributions from Real Estate Ventures and (vi) $1.7 million from payments on employee loans. During 2002, cash out-flows consisted of: (i) $102.3 million of Credit Facility repayments, (ii) $75.0 million of distributions to shareholders, (iii) $48.6 million of mortgage note repayments, (iv) $38.8 million 	 to fund capital expenditures, (v) $25.1 million for property acquisitions, (vi) $20.2 million to repurchase Common Shares and minority 	 interest units in the Operating Partnership, (vii) $13.1 million of leasing costs, (viii) $.7 million of debt costs, (ix) $.4 million 	 of additional investment in Real Estate Ventures and (x) $.4 million of distributions to minority interest holders in excess of income 	 allocated.
During 2001, the Company generated $143.4 million in cash flow from operating activities. Other sources of cash in-flows consisted of: (i) proceeds from $135.2 million of additional mortgage notes payable, (ii) $91.0 million of proceeds from draws on the Credit Facility, (iii) $31.3 million of net proceeds from property sales, (iv) $5.5 million of cash distributions from Real Estate Ventures and (v) $1.0 million from payments on employee loans. During 2001, cash out-flows consisted of: (i) $127.9 million of mortgage note repayments, (ii) $107.4 million to fund capital expenditures, (iii) 	 $72.5 million of distributions to shareholders, (iv) $40.4 million for property acquisitions, (v) $35.0 million to repay borrowings 	 under the Credit Facility, (vi) $9.2 million of leasing costs, (vii) $6.5 million to repurchase Common Shares and minority interest 	 units in the Operating Partnership, (viii) $5.6 million of debt costs, (ix) $2.5 million of
additional investment in Real Estate Ventures, (x) $2.0 million of distributions to minority interest holders in excess of income allocated and (xi) $1.0 million of escrowed cash.
During 2000, the Company generated $103.1 million in cash flow from operating activities. Other sources of cash in-flows consisted of: (i) $107.4 million of additional mortgage notes payable, (ii) $101.1 million of net proceeds from property sales and (iii) $71.0 million of proceeds from draws on the Credit Facility. During 2000, cash out-flows consisted of: (i) $113.1 million to fund capital expenditures, (ii) $109.5 million to repay borrowings under the Credit Facility, (iii) $69.0 million of distributions to shareholders, (iv) $42.4 million of mortgage note repayments, (v) $15.3 million to repurchase Common Shares, (vi) $7.0 million for property acquisitions, (vii) $6.6 million of leasing costs, , (viii) $4.0 million of escrowed cash, (ix) $2.7 million of additional investment in Real Estate Ventures, (x) $1.7 million of debt costs and (xi) $.9 million of distributions to minority interest holders in excess of income allocated.
Capitalization
At December 31, 2002, the Company maintained a $500.0 million Credit Facility. (See Item 1. Business-Credit Facility)
As of December 31, 2002, the Company had approximately $1 billion of debt outstanding, consisting of $307.0 million of borrowings under the Credit Facility, $100.0 million of borrowings under the Term Loan and $597.7 million of mortgage notes payable. The mortgage notes payable consists of $537.1 million of fixed rate loans and $60.6 million of variable rate loans. Additionally, the Company has entered into interest rate swap and cap agreements to fix the interest rate on $203.0 million of the Credit Facility and variable rate loans. The mortgage loans mature between March 2003 and July 2027. As of December 31, 2002, the Company also had $13.6 	 million of letters of credit outstanding under the Credit Facility and $179.4 million of unused availability under the Credit 	 Facility. For the year ended December 31, 2002, the weighted-average interest rate under the Credit Facility and the related 	 swap agreements was 5.41%, the weighted- average interest rate for the Term Loan was 3.39% and the weighted-average interest 	 rate for borrowings under mortgage notes payable and the related cap agreements was 7.27%.
The following table outlines the timing of payment requirements related to the Company’s commitments as of December 31, 2002:
The Company intends to refinance its mortgage notes payable as they become due or repay those that are secured by properties being sold. The Company expects to renegotiate its Credit Facility and Term Loan prior to maturity or extend their terms.
As of December 31, 2002, the Company’s debt-to-market capitalization ratio was 49.8%. As a general policy, the Company intends, but is not obligated, to adhere to a policy of maintaining a long-term average debt-to-market capitalization ratio of no more than 50%.
The Company’s Board of Trustees approved a share repurchase program authorizing the Company to repurchase up to 4,000,000 of its outstanding Common Shares. Through December 31, 2002, the Company had repurchased 3.2 million of its Common Shares at an average price of $17.71 per share. Under the share repurchase program, the Company has the authority to repurchase an additional 834,000 shares. No time limit has been placed on the duration of the share repurchase program. The following table summarizes the share repurchases during the three years ended December 31, 2002:
The following table summarized the Class A Units tendered for redemption during the three years ended December 31, 2002:
Short- and Long-Term Liquidity
The Company believes that cash flow from operations and current financing alternatives are adequate to fund its short-term liquidity requirements for 2003. Cash flow from operations is generated primarily from rental revenues, operating expense reimbursements from tenants, and by providing of management services to third parties. The Company intends to use these funds to meet its principal short-term liquidity needs, which are to fund operating expenses, debt service requirements, recurring capital expenditures, tenant allowances, leasing commissions and the minimum distributions required to maintain the Company’s REIT qualifications under the Internal Revenue Code.
On December 20, 2002, the Board of Trustees declared a quarterly dividend distribution of $0.44 per share, paid on January 15, 2003 to shareholders of record as of December 31, 2002. Distributions declared in 2002 totaled $1.76 per share as compared to $1.70 per share in 2001, representing an increase of approximately 3.5%.
The Company expects to meet its long-term liquidity requirements, such as for property acquisitions, development, investments in real estate ventures, scheduled debt maturities, major renovations, expansions and other significant capital improvements, through borrowings under its Credit Facility, long-term secured and unsecured indebtedness, the issuance of equity securities and the disposition of certain properties.
Non-GAAP Supplemental Financial Measure: Funds from Operations
Industry analysts generally consider Funds From Operations an alternative measure of performance for an equity REIT. The Board of Governors of the National Association of Real Estate Investment Trusts (“NAREIT”) in its March 1995 White Paper (as clarified by the November 2000 NAREIT National Policy Bulletin which became effective on January 1, 2000) defines Funds From Operations to mean net income (loss) before minority interests of common unitholders (computed in accordance with GAAP), excluding extraordinary items, as defined by GAAP, and gains and losses from sales of depreciable operating property, plus real estate related depreciation and amortization (excluding amortization of deferred financing costs and depreciation of non-real estate assets), and after adjustment for unconsolidated partnerships and joint ventures.
The Company considers Funds From Operations an appropriate alternative measure of performance for an equity REIT because it is predicated on cash flow analyses. While Funds From Operations is a relevant and widely used measure of operating performance of equity REITs, other equity REITs may use different methodologies for calculating Funds From Operations and, accordingly, Funds From Operations as disclosed by such other REITs may not be comparable to Funds From Operations published by the Company in this report. Therefore, the Company believes that in order to facilitate a clear understanding of the historical operating results of the Company, Funds From Operations 	should be examined in conjunction with net income as presented in the financial statements included elsewhere in this report. 	 Funds From Operations should not be considered as a substitute to net income (loss) (computed in accordance with GAAP) as 	 an indicator of the Company’s financial performance or to cash flow from operating activities (computed in accordance 	 with GAAP) as an indicator of the Company’s liquidity, nor is it indicative of funds available to fund the Company’s cash 		 needs, including the Company’s ability to pay dividends or make distributions.
The following table summarizes FFO for the years ended December 31, 2002 and 2001 (in thousands, except share data):
Inflation
A majority of the Company’s leases provide for escalations of real estate taxes and operating expenses either on a triple net basis or over a base amount. In addition, many of the office leases provide for fixed base rent increases. The Company believes that inflationary increases in expenses will be significantly offset by expense reimbursement and contractual rent increases.
Interest Rate Risk and Sensitivity Analysis
The analysis below presents the sensitivity of the market value of the Company’s financial instruments to selected changes in market rates. The range of changes chosen reflects the Company’s view of changes which are reasonably possible over a one-year period. Market values are the present value of projected future cash flows based on the market rates chosen.
The Company’s financial instruments consist of both fixed and variable rate debt. As of December 31, 2002, the Company’s consolidated debt consisted of $537.1 million in fixed rate mortgages and $60.6 million in variable rate mortgage notes, $307.0 million borrowed under its Credit Facility and $100.0 million under its Term Loan. All financial instruments were entered into for other than trading purposes and the net market value of these financial instruments is referred to as the net financial position. Changes in interest rates have different impacts on the fixed and variable rate portions of the Company’s debt
portfolio. A change in interest rates on the fixed portion of the debt portfolio impacts the net financial instrument position, but has no impact on interest incurred or cash flows. A change in interest rates on the variable portion of the debt portfolio impacts the interest incurred and cash flows, but does not impact the net financial instrument position.
The Company has entered into interest rate swap and rate cap agreements designed to reduce the impact of interest rate changes on its variable rate debt. At December 31, 2002, the Company had interest rate swap agreements for notional principal amounts aggregating $175 million. The swap agreements effectively fix the LIBOR interest rate on $100 million of Credit Facility borrowings at 4.230% and on $75 million of Credit Facility borrowings at 4.215%, in each case until June 2004. The interest rate cap agreement effectively limits the interest rate on a mortgage with a notional value of $28 million at 8.7% until July 2004. The impact of the cap agreement is recorded as a component of interest expense.
The sensitivity analysis related to the fixed portion of the Company’s debt portfolio assumes an instantaneous 1% move in interest rates from their actual levels at December 31, 2002 with all other variables held constant. As of December 31, 2002, a 1% increase in actual interest rates would result in a decrease in beneficiaries’ equity of $27.6 million and a 1% decrease in actual interest rates would result in an increase in beneficiaries’ equity of $30.5 million.
Based on the Company’s variable rate debt as of December 31, 2002, a 1% increase in interest rates would result in an additional $2.6 million in interest expense per year and a 1% decrease would reduce interest expense by $2.6 million per year.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
See discussion in Management’s Discussion and Analysis included in Item 7 herein.
Item 8.
Item 8. Financial Statements and Supplementary Data
The financial statements and supplementary financial data are listed under Item 15(a) and filed as part of this Annual Report on Form 10-K. See Item 15.
KPMG LLP is the company’s independent public auditors and also provides the Company with tax compliance and advisory services. The Audit Committee of the Board of Trustees of the Company has approved the provision of services by KPMG to the Company.
Report of Management
The management of the Company is responsible for the preparation of the financial statements and related financial information included in this annual report. The statements were prepared in conformity with accounting principles generally accepted in the United States of America and, accordingly, include amounts that are based on informed estimates and judgments.
Management maintains a system of internal controls to provide reasonable assurance that assets are safeguarded and that transactions are properly authorized and accurately recorded. The concept of reasonable assurance is based on the recognition that there are inherent limitations in all systems of internal accounting control and that the costs of such systems should not exceed the benefits expected to be derived. The Company continually reviews and modifies these systems, where appropriate, to maintain such assurance. The system of internal controls includes careful selection, training and development of operating and financial personnel, well-defined organizational responsibilities and communication of Company policies and procedures throughout the organization.
The selection of the Company’s independent auditors, KPMG LLP, has been approved by the Board of Trustees. The Audit Committee of the Board of Trustees, comprised solely of outside Trustees, meets
periodically with the Company’s independent auditors and management to review the financial statements and related information and to confirm that they are properly discharging their responsibilities. In addition, the independent auditors meet with the Audit Committee, without the presence of management, to discuss their findings and their observations on other relevant matters. Recommendations made by KPMG LLP are considered and appropriate action is taken to respond to these recommendations.
Gerard H. Sweeney, President and Chief Executive Officer
Christopher P. Marr, Senior Vice President and Chief Financial Officer
Bradley W. Harris, Vice President and Chief Accounting Officer
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
On May 23, 2002, the Company dismissed Arthur Andersen LLP as its independent public accountants and appointed KPMG LLP as its new independent public auditors. The decision to dismiss Arthur Andersen and to retain KPMG was approved by the Audit Committee of the Company’s Board of Trustees. Arthur Andersen’s reports on the Company’s consolidated financial statements as of and for the fiscal years ended December 31, 2001 and 2000 did not contain any adverse opinion or disclaimer or opinion, nor were they qualified or modified as to uncertainty, audit scope, or accounting principles.
During the Company’s two most recent fiscal years ended December 31, 2001 and the subsequent interim period through May 30, 2002, there were no disagreements between the Company and Arthur Andersen on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to Arthur Andersen’s satisfaction, would have caused them to make reference to the subject matter of the disagreement in connection with their reports.
None of the reportable events described under Item 304(a)(1)(v) of Regulation S-K occurred within the Company’s two most recent fiscal years ended December 31, 2001, and the subsequent interim period through May 30, 2002.
The Company provided Arthur Andersen with a copy of the foregoing disclosures. A copy of Arthur Andersen’s letter, dated May 30, 2002, stating their agreement with these statements is attached as Exhibit 16 to the Company’s Form 8-K filed with the Securities and Exchange Commission on May 30, 2002. During the Company’s two most recent fiscal years ended December 31, 2001, and the subsequent interim period through May 30, 2002, neither the Company nor anyone acting on behalf of the Company consulted with KPMG regarding any of the matters or events set forth in Item 304(a)(2) of Regulation S-K.
PART III
Item 10.
Item 10. Trustees and Executive Officers of the Company
Incorporated herein by reference to the Company’s definitive proxy statement to be filed with respect to its Annual Meeting of Shareholders expected to be held on May 5, 2003.
Item 11.
Item 11. Executive Compensation
Incorporated herein by reference to the Company’s definitive proxy statement to be filed with respect to its Annual Meeting of Shareholders expected to be held on May 5, 2003.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
Incorporated herein by reference to the Company’s definitive proxy statement to be filed with respect to its Annual Meeting of Shareholders expected to be held on May 5, 2003.
Item 13.
Item 13. Certain Relationships and Related Transactions
Incorporated herein by reference to the Company’s definitive proxy statement to be filed with respect to its Annual Meeting of Shareholders expected to be held on May 5, 2003.
Item 14.
Item 14. Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commissions rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Within 90 days prior to the date of this report, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as defined in Exchange Act Rule 13(a)- 14(c). Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the date of that evaluation. There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect the internal controls subsequent to the date the Chief Executive Officer and Chief Financial Officer completed their evaluation.
PART IV
Item 15.
Item 15. Exhibits, Financial Statements, Schedules and Reports on Form 8-K
(a) 1. and 2. Financial Statements and Schedules
The financial statements and schedules listed below are filed as part of this annual report on the pages indicated.
Index to Financial Statements and Schedules
3. Exhibits
(13) 10.26
Form of Board of Trustees Designation Letter (Lazard)
(14) 10.27
Amended and Restated Employment Agreement dated as of December 8, 2000 of Anthony A. Nichols, Sr.**
(6) 10.28
Agreement dated as of December 31, 2001 with Anthony A. Nichols, Sr. replacing December 8, 2000 Employment Agreement**
(14) 10.29
Amended and Restated Employment Agreement dated as of May 7, 2002 of Gerard H. Sweeney**
(5) 10.30
Amended and Restated Non-Qualified Stock Option Award to Anthony A. Nichols, Sr. **
(5) 10.31
Amended and Restated Non-Qualified Stock Option Award to Gerard H. Sweeney **
(16) 10.32
Restricted Share Awards to Anthony A. Nichols, Sr. **
(16) 10.33
Restricted Share Awards to Gerard H. Sweeney **
(5) 10.34
Long-Term Performance Award for Anthony A. Nichols, Sr. **
(5) 10.35
Long-Term Performance Award for Gerard H. Sweeney**
(5) 10.36
Long-Term Performance Award for Anthony S. Rimikis **
(6) 10.37
Separation Agreement (Jeffrey F. Rogatz)
(5) 10.38
Severance Agreement (Anthony S. Rimikis) **
(5) 10.39
Third Amendment to Restricted Share Award to Anthony A. Nichols, Sr.**
(5) 10.40
Third Amendment to Restricted Share Award to Gerard H. Sweeney.**
(5) 10.41
Restricted Share Award to Anthony S. Rimikis.**
(5) 10.42
Loan Agreement with Gerard H. Sweeney.**
(5) 10.43
Loan Agreement with Anthony A. Nichols, Sr.**
(14) 10.44
Fourth Amendment to Restricted Share Award to Anthony A. Nichols, Sr.**
(14) 10.45
Fourth Amendment to Restricted Share Award to Gerard H. Sweeney**
(14) 10.46
Severance Agreement (Barbara L. Yamarick)**
(14) 10.47
Severance Agreement (Anthony A. Nichols, Jr.)**
(14) 10.48
Severance Agreement (H. Jeffrey De Vuono)**
(14) 10.49
Severance Agreement (George Sowa)**
(14) 10.50
Severance Agreement (Bradley W. Harris)**
(14) 10.51
Restricted Share Award to Anthony A. Nichols, Sr.**
(14) 10.52
Restricted Share Award to Gerard H. Sweeney**
(14) 10.53
Restricted Share Award to Anthony S. Rimikis**
(14) 10.54
Restricted Share Award to Barbara L. Yamarick
(14) 10.55
Restricted Share Award to Anthony A. Nichols, Jr.**
(14) 10.56
Restricted Share Award to H. Jeffrey De Vuono**
(14) 10.57
Restricted Share Award to George Sowa**
(14) 10.58
Restricted Share Award to Bradley W. Harris**
(17) 10.59
Exchange Agreement (Virginia properties) - Prentiss Transaction
(17) 10.60
Exchange Agreement (Pennsylvania/New Jersey properties) - Prentiss Transaction
(17) 10.61
Agreement of Purchase and Sale (Fee Transfer properties) - Prentiss Transaction
(17) 10.62
Agreement of Purchase and Sale (Entity Transfer properties) - Prentiss Transaction
(17) 10.63
Contribution Agreement (Joint Venture Interest) - Prentiss Transaction
(17) 10.64
Agreement of Purchase and Sale (935) First Avenue) - Prentiss Transaction
(18) 10.65
Fourteenth Amendment to Second Amended and Restated Agreement of Limited Partnership of Prentiss - Prentiss Transaction
(19) 10.66
Third Amended and Restated Credit Agreement
(15) 10.67
2002 Restricted Share Award for Gerard H. Sweeney**
(15) 10.68
2002 Form of Restricted Share Award for Executive Officers**
(20) 10.69
Term Credit Agreement
(20) 10.70
Consent and First Amendment to Third Amended and Restated Credit Agreement
(20) 10.71
Second Amendment to Third Amended and Restated Credit Agreement
(21) 10.72
2002 Restricted Share Award to Christopher P. Marr**
(21) 10.73
Severance Agreement to Christopher P. Marr
(22) 10.74
2002 Non-Qualified Option to Gerard H. Sweeney**
10.75
Letter to Cohen & Steers
10.76
Executive Deferred Compensation Plan
10.77
2003 Restricted Share Award to Gerard H. Sweeney**
10.78
2003 Restricted Share Award to Anthony S. Rimikis**
10.79
2003 Restricted Share Award to Barbara L. Yamarick**
10.80
2003 Restricted Share Award to Anthony A. Nichols, Jr.**
10.81
2003 Restricted Share Award to H. Jeffrey DeVuono**
10.82
2003 Restricted Share Award to George D. Sowa**
10.83
2003 Restricted Share Award to Bradley W. Harris**
10.84
2003 Restricted Share Award to Brad A. Molotsky**
10.85
2003 Restricted Share Award to Christopher P. Marr**
14.1
Code of Business Conduct and Ethics
21.1
List of Subsidiaries of the Company
23.1
Consent of KPMG LLP
99.1
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.2
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
1.
Previously filed as an exhibit to the Company’s Form 8-K dated June 9, 1997 and incorporated herein by reference.
2.
Previously filed as an exhibit to the Company’s Form 8-K dated September 10, 1997 and incorporated herein by reference.
3.
Previously filed as an exhibit to the Company’s Form 8-K dated June 3, 1998 and incorporated herein by reference.
4.
Previously filed as an exhibit to the Company’s Form 8-K dated October 13, 1998 and incorporated herein by reference.
5.
Previously filed as an exhibit to the Company’s Form 10-K for the fiscal year ended December 31, 1999 and incorporated herein by reference.
6.
Previously filed as an exhibit to the Company’s Form 10-K for the fiscal year ended December 31, 2002 and incorporated herein by reference.
7.
Previously filed as an exhibit to the Company’s Registration statement of Form S-11 (File No. 33-4175) and incorporated herein by reference.
8.
Previously filed as an exhibit to the Company’s Form 8-K dated August 22, 1996 and incorporated herein by reference.
9.
Previously filed as an exhibit to the Company’s Form 8-K dated December 17, 1997 and incorporated herein by reference.
10.
Previously filed as an exhibit to the Company’s Form 8-K dated April 13, 1998 and incorporated herein by reference.
11.
Previously filed as an exhibit to the Company’s Form 8-K dated May 14, 1998 and incorporated herein by reference.
12.
Previously filed as an exhibit to the Company’s Form 8-K dated July 30, 1998 and incorporated herein by reference.
13.
Previously filed as an exhibit to the Company’s Form 8-K dated August 13, 1998 and incorporated herein by reference.
14.
Previously filed as an exhibit to the Company’s Form 10-K for the fiscal year ended December 31, 2000 and incorporated herein by reference.
15.
Previously filed as an exhibit to the Company’s Form 10-Q for the quarter ended June 30, 2002 and incorporated herein by reference.
16.
Previously filed as an exhibit to the Company’s Form 10-K for the fiscal year ended December 31, 1997 and incorporated herein by reference.
17.
Previously filed as an exhibit to the Company’s Form 8-K dated March 23, 2001 and incorporated herein by reference.
18.
Previously filed as an exhibit to the Company’s Form 8-K dated April 23, 2001 and incorporated herein by reference.
19.
Previously filed as an exhibit to the Company’s Form 8-K dated July 12, 2001 and incorporated herein by reference.
20.
Previously filed as an exhibit to the Company’s Form 8-K dated July 16, 2002 and incorporated herein by reference.
21.
Previously filed as an exhibit to the Company’s Form 8-K dated August 27, 2002 and incorporated herein by reference.
Previously filed as an exhibit to the Company’s Form 10-Q for the quarter ended September 30, 2002 and incorporated herein by reference.
** Management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K
During the three months ended December 31, 2002 and through March 27, 2003, the Company filed the following:
(i) Current Report on Form 8-K filed February 28, 2003 (reporting under Item 7 and 12).
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
BRANDYWINE REALTY TRUST
By: /s/ Gerard H. Sweeney
Gerard H. Sweeney
President and Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.
CERTIFICATIONS PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Gerard H. Sweeney, certify that:
1. I have reviewed this annual report on Form 10-K of Brandywine Realty Trust.
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
6. The registrant’s other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
March 27, 2003
/s/ Gerard H. Sweeney
Date
Gerard H. Sweeney
President and Chief Executive Officer
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Christopher P. Marr, certify that:
1. I have reviewed this annual report on Form 10-K of Brandywine Realty Trust.
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
6. The registrant’s other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
March 27, 2003
/s/ Christopher P. Marr
Date
Christopher P. Marr
Senior Vice President and Chief Financial Officer
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REPORT OF INDEPENDENT AUDITORS
To the Shareholders and Board of Trustees of Brandywine Realty Trust:
We have audited the consolidated balance sheets of Brandywine Realty Trust and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of operations, beneficiaries’ equity and comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2002. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedules as listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Brandywine Realty Trust and subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States. Also in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
As discussed in Note 2 to the consolidated financial statements, effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.
/s/ KPMG LLP
Philadelphia, Pennsylvania
February 26, 2003
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BRANDYWINE REALTY TRUST
CONSOLIDATED BALANCE SHEETS
(in thousands, except number of shares)
The accompanying notes are an integral part of these consolidated financial statements.
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BRANDYWINE REALTY TRUST
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share information)
The accompanying notes are an integral part of these consolidated financial statements.
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BRANDYWINE REALTY TRUST
CONSOLIDATED STATEMENTS OF BENEFICIARIES’ EQUITY AND COMPREHENSIVE INCOME
For the years ended December 31, 2002, 2001 and 2000
(in thousands, except number of shares)
The accompanying notes are an intergral part of these consolidated financial statements.
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BRANDYWINE REALTY TRUST
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
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BRANDYWINE REALTY TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2001 AND 2000
1. ORGANIZATION AND NATURE OF OPERATIONS
Brandywine Realty Trust, a Maryland Real Estate Investment Trust (collectively with its subsidiaries, the “Company”), is a self-administered and self-managed real estate investment trust (a “REIT”) active in acquiring, developing, redeveloping, leasing and managing office and industrial properties. As of December 31, 2002, the Company’s portfolio included 210 office properties, 27 industrial facilities and one mixed-use property (collectively, the “Properties”) that contained an aggregate of 16.1 million net rentable square feet. The Properties are located in the office and industrial markets in and surrounding Philadelphia, Pennsylvania, New Jersey and Richmond, Virginia. As of December 31, 2002, the Company also held economic interests in ten unconsolidated real estate ventures (the “Real Estate Ventures”) formed with third parties to develop commercial properties.
The Company’s interest in its assets is held through Brandywine Operating Partnership, L.P., a Delaware limited partnership (the “Operating Partnership”). The Company is the sole general partner of the Operating Partnership and, as of December 31, 2002, was entitled to approximately 94.9% of the Operating Partnership’s distributions after distributions to holders of Series B Preferred Units (as defined in Note 3 below). The Operating Partnership owns a 95% interest in a taxable REIT subsidiary, Brandywine Realty Services Corporation, a Pennsylvania corporation (the “Management Company”), that, as of December 31, 2002, was performing management and leasing services for properties containing an aggregate of approximately 19.0 million net rentable square feet, of which 15.9 million net rentable square feet related to properties owned by the Company and approximately 3.1 million net rentable square feet related to properties owned by unaffiliated third parties. The remaining 5% of the Management Company is owned by a partnership comprised of two executives of the Company.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and the Operating Partnership. The portion of the Operating Partnership not owned by the Company is presented as minority interest. All intercompany accounts and transactions have been eliminated in consolidation. Certain amounts reported in prior years have been reclassified for comparative purposes.
Management Company
The Management Company, a taxable REIT subsidiary, provides management, leasing, construction, development, redevelopment and other real estate related services for the Company’s properties and for third parties. Prior to December 31, 2000, the Company owned 100% of the Management Company’s non- voting preferred stock and 5% of its voting common stock and accounted for its investment using the equity method. Effective January 1, 2001, the Company converted its non-voting interest in the Management Company to a voting interest. As a result, the Company owns 95% of the Management Company’s equity, has voting control and, therefore, has consolidated the Management Company since January 1, 2001.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
Operating Properties
Operating properties are carried at the lower of historical cost less accumulated depreciation and impairment losses. The cost of operating properties includes the purchase price or development costs of the properties. Costs incurred for
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the acquisition, renovation and betterment of the operating properties are capitalized to the Company’s investment in that property. Maintenance and repairs are charged to expense as incurred.
Depreciation and Amortization
The costs of buildings and improvements are depreciated using the straight-line method based on the following useful lives: buildings and improvements (5 to 40 years) and tenant improvements over the shorter of the lease term or the life of the asset.
Effective January 1, 2002, the Company changed the estimated useful lives of various buildings from 25 to 40 years. This change resulted in an increase of net income of $19.0 million or $.53 per share for the year ended December 31, 2002. Management determined the longer period to be a better estimate of the useful lives of the buildings.
Construction in Progress
Project costs clearly associated with the development and construction of a real estate project are capitalized as construction in progress. In addition, interest, real estate taxes and general and administrative expenses that are directly associated with and incremental to the Company’s development activities are capitalized during the period in which activities necessary to get the property ready for its intended use are in progress. Once the development and construction of the building shell of a real estate project is completed, the costs capitalized to construction in progress are transferred to land and buildings. Direct construction costs totaling $2.2 million in 2002, $2.7 million in 2001 and $1.8 million in 2000 and interest totaling $2.9 million in 2002, $5.2 million in 2001 and $8.2 million in 2000 were capitalized related to development of certain Properties and land holdings.
Impairment of Long-Lived Assets
Statement of Financial Accounting Standards No. 144 (“SFAS 144”), Accounting for the Impairment or Disposal of Long-Lived Assets, provides a single accounting model for long-lived assets as held-for-sale, broadens the scope of businesses to be disposed of that qualify for reporting as discontinued operations and changes the timing of recognizing losses on such operations. The Company adopted SFAS 144 on January 1, 2002.
In accordance with SFAS 144, long-lived assets, such as real estate investments and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of are separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The other assets and liabilities related to assets classified as held-for-sale are presented separately in the consolidated balance sheet.
Prior to adoption of SFAS 144, the Company accounted for the impairment of long-lived assets in accordance with SFAS 121, Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.
The Company recorded impairment losses of $665,000 for the year ended December 31, 2002 relating to assets held-for-sale. The Company recorded no impairment losses for the years ended December 31, 2001 and 2000.
Cash and Cash Equivalents
Cash equivalents are highly-liquid investments with original maturities of three months or less. The Company maintains cash equivalents in financial institutions in excess of insured limits.
Restricted Cash
Restricted cash consists of cash held as collateral to provide credit enhancement for the Company’s mortgage debt, cash for property taxes, capital expenditures and tenant improvements.
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Accounts Receivable
Leases with tenants are accounted for as operating leases. Minimum annual rentals under tenant leases are recognized on a straight-line basis over the term of the related lease. Accrued rent receivable represents the amount that straight-line rental income exceeds rents currently due under the lease agreements. Included in current tenant receivables are tenant reimbursements which are comprised of amounts recoverable from tenants for common area maintenance expenses and certain other recoverable expenses that are recognized as revenue in the period in which the related expenses are incurred. As of December 31, 2002 and 2001, no tenant represents more than 10% of accounts receivable.
Tenant receivables and accrued rent receivables are carried net of the allowances for doubtful accounts of $2.3 million and $2.3 million in 2002 and $2.5 million and $2.0 million in 2001. Management’s determination of the adequacy of these allowances is based primarily upon evaluations of historical loss experience, individual receivables and current economic conditions.
Deferred Costs
Costs incurred in connection with property leasing are capitalized as deferred leasing costs. Deferred leasing costs consist primarily of leasing commissions that are amortized on the straight-line method over the life of the respective lease which generally ranges from one to 15 years. Management re-evaluates the remaining useful lives of leasing costs as economic and market conditions change. Internal direct leasing costs deferred totaled $3.6 million in 2002, $3.1 million in 2001 and $2.5 million in 2000.
Costs incurred in connection with debt financing are capitalized as deferred financing costs. Deferred financing costs consist primarily of loan fees which are amortized over the related loan term. Total accumulated amortization related to these costs was $14.9 million in 2002 and $11.8 million in 2001.
Other Assets
As of December 31, 2002, other assets included a direct financing lease of $16.0 million, prepaid real estate taxes of $5.6 million, promissory notes of $4.0 million, furniture, fixtures and equipment of $2.1 million and $6.8 million of other assets. As of December 31, 2001, other assets included a direct financing lease of $16.0 million, prepaid real estate taxes of $5.5 million, deposits on properties to be purchased in 2002 totaling $4.0 million, furniture, fixtures and equipment of $2.7 million and $3.6 million of other assets.
Marketable Securities
The Company accounts for its investments in equity securities according to the provisions of SFAS 115, Accounting for Certain Investments in Debt and Equity Securities, which requires securities classified as “available-for-sale” to be stated at fair value. Adjustments to fair value of available-for-sale securities are recorded as a component of other comprehensive income (loss). A decline in the market value of equity securities below cost that is deemed to be other than temporary results in a reduction in the carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established.
Intangible Assets
On January 1, 2002, the Company adopted the provisions of SFAS 141, Business Combinations. This statement makes significant changes to the accounting for business combinations, goodwill, and intangible assets. Among other provisions, SFAS 141 requires that a portion of the purchase price of real estate acquisitions be assigned to the fair value of an intangible asset for above market operating leases or a liability for below market operating leases. Such intangible assets or liabilities are then required to be amortized into revenue over the remaining life of the related leases. Accordingly, during 2002, the Company recorded an intangible asset related to the origination value of acquired leases of $1.2 million (included in deferred costs), an acquired lease asset of $.7 million for above market leases (included in other assets) and an acquired lease liability of $2.1 million for below market leases (included in other liabilities). Amortization expense recorded during 2002 for the origination value of acquired leases totaled $256,000. The amortization of acquired leases resulted in a net increase in rental revenue of $459,000 during 2002. Management reviews the carrying value of intangible assets for impairment on an annual basis.
As of December 31, 2002, intangible assets and acquired lease liabilities consist of the following (in thousands):
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Intangible assets:
Acquired lease asset, net of accumulated amortization of $99
$
Origination value, net of accumulated amortization of $256
Net intangible assets
$ 1,566
Acquired lease liability, net of accumulated amortization of $558
$ 1,547
Fair Value of Financial Instruments
Carrying amounts reported in the balance sheet for cash, accounts receivable, other assets, accounts payable and accrued expenses, and borrowings under the Credit Facility approximate fair value due to the nature of these instruments. Accordingly, these items have been excluded from the fair value disclosures.
Revenue Recognition
Rental revenue is recognized on a straight-line basis over the lease term regardless of when payments are due. Deferred rental revenue represents rental revenue received from tenants prior to their due dates. The straight-line rent adjustment increased revenue by approximately $5.9 million in 2002, $6.2 million in 2001 and $6.4 million in 2000. Certain lease agreements contain provisions that require tenants to reimburse a pro rata share of real estate taxes and certain common area maintenance costs.
No tenant represented greater than 10% of the Company’s rental revenue in 2002, 2001 or 2000.
Income Taxes
The Company elects to be taxed as a real estate investment trust under Sections 856-860 of the Internal Revenue Code. In management’s opinion, the requirements to maintain this election are being met. Accordingly, no provision for Federal income taxes has been reflected in the financial statements.
Earnings and profits, which determine the taxability of distributions to shareholders, differ from net income reported for financial reporting purposes due to differences in cost basis, the estimated useful lives used to compute depreciation, and the allocation of net income and loss for financial versus tax reporting purposes. The tax basis in the Company’s assets was $1.3 billion as of December 31, 2002.
The Company is subject to a 4% Federal excise tax, if sufficient taxable income is not distributed within prescribed time limits. The excise tax equals 4% of the annual amount, if any, by which the sum of (a) 85% of the Company’s ordinary income and (b) 95% of the Company’s net capital gain exceeds cash distributions and certain taxes paid by the Company. No excise tax was incurred in 2002, 2001, or 2000.
The Management Company is subject to Federal and state income taxes. The operating results of the Management Company include a provision for income taxes of $115,000 in 2000. There was no provision required for income taxes in 2002 and 2001.
Earnings Per Share
Basic earnings per share is calculated by dividing income applicable to Common Shares by the weighted-average number of shares outstanding during the period. Diluted earnings per share includes the effect of common share equivalents outstanding during the period.
Stock-Based Compensation Plans
In December 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS 148, Accounting for Stock-Based Compensation - Transition and Disclosure. SFAS 148 amends SFAS 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for an entity that voluntarily adopts the fair value recognition method of recording stock option expense. SFAS 148 also amends the disclosure provisions of SFAS 123 and APB Opinion No. 28, Interim Financial Reporting, to require disclosure in the summary of significant accounting policies of the effects of an entity’s accounting policy with respect to stock options on reported net income and earnings per share in annual and interim financial statements.
At December 31, 2002, the Company had one stock option and incentive plan, which is described more fully in Note 11. Effective January 1, 2002, the Company voluntarily adopted the fair value recognition provisions of SFAS 123
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prospectively for all employee stock option awards granted or modified after January 1, 2002. Under the fair value recognition provisions of SFAS 123, total compensation expense related to stock options is determined using the fair value of the stock options on the date of grant. Total compensation expense is then recognized on a straight-line basis over the option vesting period
Prior to 2002, the Company accounted for stock options issued under the recognition and measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees and related Interpretations. As a result, no stock option expense is reflected in 2001 or 2000 net income, as all stock options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the fair value based method had been applied to all outstanding and unvested awards in each period (in thousands, except per share amounts):
Comprehensive Income
Comprehensive income or loss is recorded in accordance with the provisions of SFAS 130, Reporting Comprehensive Income. SFAS 130 establishes standards for reporting comprehensive income and its components in financial statements. Comprehensive income includes unrealized gains and losses on available-for-sale securities and the effective portions of changes in the fair value of derivatives.
Accounting for Derivative Instruments and Hedging Activities
Effective January 1, 2001, the Company adopted SFAS 133, Accounting for Derivative Instruments and Hedging Activities, and its corresponding amendments under SFAS 138. SFAS 133 requires the Company to measure every derivative instrument (including certain derivative instruments embedded in other contracts) at fair value and record them in the balance sheet as either an asset or liability. For derivatives designated as fair value hedges, the changes in 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 changes in the fair value of the derivative are reported in other comprehensive income. These amounts are subsequently reclassified to interest expense as a yield adjustment of the hedged interest payments in the same period in which the related interest affects earnings. The ineffective portions of cash flow hedges are recognized in earnings in the current period. For the years ended December 31, 2002 and 2001, the Company was not party to any derivative contract designated as a fair value hedge.
Upon adoption of this new standard as of January 1, 2001, the Company recorded a charge of $1.3 million to comprehensive loss for the cumulative effect of an accounting change to recognize at fair value all derivatives that are designated as cash flow hedging instruments. Over time, the unrealized gains/losses and the transition adjustment held in accumulated other comprehensive income will be reclassified into earnings as the underlying hedged items affect earnings, such as when the forecasted interest payments occur. It is expected that $5.0 million of net losses will be reclassified into earnings over the next twelve months.
The Company formally assesses, both at inception of the hedge and on an on-going basis, whether each derivative is highly-effective in offsetting changes in fair values of cash flows of the hedged item. If it is determined that a derivative is not highly-effective as a hedge or if a derivative ceases to be a highly- effective hedge, the Company will discontinue hedge accounting prospectively.
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The Company manages its ratio of fixed-to-floating rate debt with the objective of achieving a mix that management believes is appropriate. To manage this mix in a cost-effective manner, the Company, from time-to-time, enters into interest rate swap agreements, in which it agrees to exchange various combinations of amounts based on fixed and/or variable interest rates applied to notional amounts. As of December 31, 2002, the maximum length of time which the Company is hedging its exposure to the variability in future cash flows for forecasted transactions is through June 2004. There was no gain or loss reclassified from accumulated other comprehensive loss into earnings during 2002 as a result of the discontinuance of a cash flow hedge due to the probability of the original forecasted transaction not occurring.
New Pronouncements
In April 2002, the FASB issued SFAS 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. The most significant provisions of this statement relate to the rescission of Statement No. 4, Reporting Gains and Losses from Extinguishment of Debt. SFAS 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. Under SFAS 145, any gain or loss on extinguishment of debt that was classified as an extraordinary item in prior periods presented that does not meet certain defined criteria must be reclassified. The provisions of SFAS 145 are effective for fiscal years beginning after May 15, 2002. Management expects that the adoption of this statement in 2003 will not have a material effect on the Company’s results of operations or financial condition.
In June 2002, FASB issued SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3 Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity. SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. The provisions of SFAS 146 are effective for exit or disposal activities that are initiated after December 31, 2002. Management expects that the adoption of this statement will not have a material effect on the Company’s results of operations or financial condition.
In November 2002, the FASB issued Interpretation No. 45 (“FIN 45”), Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN 45 significantly changes the current practice in the accounting for, and disclosure of, guarantees. Guarantees and indemnification agreements meeting the characteristics described in FIN 45 are required to be initially recorded as a liability at fair value. FIN 45 also requires a guarantor to make significant new disclosures for virtually all guarantees even if the likelihood of the guarantor having to make payment under the guarantee is remote. The disclosure requirements within FIN 45 are effective for financial statements for annual or interim periods ending after December 15, 2002. The initial recognition and initial measurement provisions are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The Company adopted the disclosure provisions of FIN 45 as of December 31, 2002. Management does not expect the adoption of the initial recognition and measurement provisions will have a material effect on the Company’s results of operations or financial condition.
In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), Consolidation of Variable Interest Entities. FIN 46 clarifies the application of Accounting Research Bulletin No. 51, Consolidated Financial Statements and provides guidance on the identification of entities for which control is achieved through means other than through voting rights (“variable interest entities” or “VIEs”) and how to determine when and which business enterprise should consolidate the VIE. This new model for consolidation applies to an entity which 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 receiving additional subordinated financial support from other parties. The provisions of this interpretation are immediately effective for VIEs formed after January 31, 2003. For VIEs formed prior to January 31, 2003, the provisions of this interpretation apply to the first fiscal year or interim period beginning after June 15, 2003. Management does not expect that the adoption of this standard will have a material effect on the Company’s results of operations or beneficiaries’ equity and comprehensive income.
3. MINORITY INTEREST
Minority interest is comprised of Class A Units of limited partnership interest (“Class A Units”) and Series B Preferred Units of limited partnership interest (“Series B Preferred Units”). The Operating Partnership issued these interests to
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persons that contributed assets to the Operating Partnership. The Operating Partnership is obligated to redeem, at the request of a holder, each Class A Unit for cash or one Common Share, at the option of the Company. Each Series B Preferred Unit has a stated value of $50.00 and is convertible, at the option of the holder, into Class A Units at a conversion price of $28.00. The conversion price declines to $26.50, if the average trading price of the Common Shares during the 60-day period ending December 31, 2003 is $23.00 or less. The Series B Preferred Units bear a preferred distribution of 7.25% per annum, subject to an increase in the event quarterly distributions paid to holders of Common Shares exceed $0.51 per share. Income allocated to minority interest includes the amount of the Series B Preferred Unit distribution and the prorata share of net income of the Operating Partnership allocated to the Class A Units. The Company declared distributions of $7.1 million in 2002, 2001 and 2000 to the holders of Series B Preferred Units and $3.3 million in 2002, $3.7 million in 2001 and $3.5 million in 2000 to holders of Class A Units. As of December 31, 2002 and 2001, respectively, there were 1,787,436 and 2,151,658 Class A Units and 1,950,000 Series B Preferred Units held by third party investors.
4. REAL ESTATE INVESTMENTS
As of December 31, 2002 and 2001, the carrying value of the Company’s Operating Properties is as follows:
5. ACQUISITIONS AND DISPOSITIONS OF REAL ESTATE INVESTMENTS
The Company’s acquisitions were accounted for by the purchase method. The results of each acquired property are included in the Company’s results of operations from their respective purchase dates.
During 2002, the Company sold 23 office properties containing an aggregate of 1.4 million net rentable square feet, 20 industrial properties containing an aggregate of .9 million net rentable square feet and two parcels of land containing an aggregate of 12.8 acres for an aggregate of $190.8 million, realizing a net gain of $8.6 million before minority interest. The Company also purchased seven office properties containing 617,000 net rentable square feet and one parcel of land containing 9.0 acres for an aggregate of $99.1 million.
During 2001, the Company sold three office and eight industrial properties, containing 440,000 net rentable square feet, and four parcels of land, containing 15.8 acres, for $31.3 million, realizing a net gain of $4.5 million. Seven of the properties were sold for $21.6 million realizing an aggregate gain of $4.3 million, four of the properties were sold for $7.1 million, realizing an aggregate loss of $.7 million and four land parcels were sold for $2.6 million realizing an aggregate gain of $.9 million. The Company also acquired two office properties, containing 146,000 net rentable square feet, and three parcels of land, containing 30.0 acres, for $31.5 million, of which $4.2 million was satisfied with an exchange of property.
In addition to the sales and acquisitions above, the Company consummated an exchange of properties with Prentiss Properties Acquisition Partners, L.P. (“Prentiss”) during 2001. The Company acquired from Prentiss 30 properties (29 office and 1 industrial) containing 1.6 million net rentable square feet and 6.9 acres of developable land for total consideration of $215.2 million. The Company conveyed to Prentiss four office properties located in Northern Virginia that contain an aggregate of 657,000 net rentable square feet, assumed $79.7 million of mortgage debt secured by certain of the Prentiss properties, issued a $7.8 million promissory note, paid $15.9 million at closing and agreed to make additional payments totaling $7.0 million (including $5.4 million of payments discounted at 7.5%) over a three-year period subsequent to closing. The Company also contributed to Prentiss its interest in a real estate venture that
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owns two additional office properties that contain an aggregate of 452,000 net rentable square feet and received a combination of preferred and common units of limited partnership interest in Prentiss having a value of $10.7 million, as of the closing. In addition as part of the Prentiss transaction in June 2001, the Company purchased a 103,000 square foot building then under construction for $4.2 million and six acres of related developable land for $5.7 million.
Proforma
The following unaudited pro forma financial information for the year ended December 31, 2001 and 2000 gives effect to the exchange of properties with Prentiss as if the transaction occurred on January 1, 2000. The proforma financial information presented below is not necessarily indicative of the results which actually would have occurred if the transaction had been consummated on January 1, 2000, nor does the pro forma information purport to represent the results of operations for future periods.
During 2000, the Company sold seven office properties, containing 630,000 net rentable square feet, and two parcels of land, containing 5.0 acres, for $101.1 million, realizing a net gain of $11.6 million. Four of the properties were sold for $72.1 million realizing an aggregate gain of $15.8 million, three of the properties were sold for $27.8 million realizing an aggregate loss of $5.1 million, and two land parcels were sold for $1.2 million realizing an aggregate gain of $.9 million. In addition, the Company purchased 36.0 acres of land for $7.0 million.
The results of operations on a pro forma basis on the above acquisitions and dispositions are not material.
6. MANAGEMENT COMPANY
Management fees paid by the Properties to the Management Company amounted to $11.9 million in 2000. The Management Company also receives reimbursement of certain costs attributable to the operations of the Properties. These costs, included in property operating expenses, amounted to $9.2 million in 2000. Summarized unaudited financial information for the Management Company as of and for the year ended December 31, 2000 is as follows:
7. INVESTMENT IN UNCONSOLIDATED REAL ESTATE VENTURES
As of December 31, 2002, the Company had invested approximately $14.8 million in ten Real Estate Ventures (net of returns of investment received by the Company). The Company, through subsidiaries, formed these ventures with unaffiliated third parties to develop office properties or to acquire land in anticipation of possible development of office properties. Eight of the Real Estate Ventures own eight office buildings that contain an aggregate of a .8 million net rentable square feet; one Real Estate Venture developed a hotel property that contains 137 rooms; and one Real Estate Venture holds 3.0 acres of land for future development.
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During 2002, the Company purchased the remaining partnership interests held by third parties in three Real Estate Ventures which owned two office properties containing 222,000 net rentable square feet and one parcel of land containing 1.0 acres for $2.3 million. The results of operations of these Real Estate Ventures are consolidated from the date the Company acquired the remaining partnership interests.
The Company accounts for its non-controlling interests in Real Estate Ventures using the equity method. Non-controlling ownership interests generally range from 6% to 65%, subject to specified priority allocations in certain Real Estate Ventures. These investments, initially recorded at cost, are subsequently adjusted for the Company’s net equity in the ventures’ income or loss and cash contributions and distributions.
The following is a summary of the financial position of the unconsolidated Real Estate Ventures in which the Company had investment interests as of December 31, 2002 and 2001 (in thousands):
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The following is a summary of the financial position as of December 31, 2002 and the results of operations for the year ended December 31, 2002 for each of the unconsolidated Real Estate Ventures in which the Company had interests as of December 31, 2002 (in thousands):
(a) In July 2002, the Company purchased the remaining interests in these Real Estate Ventures for an aggregate of $2.3 million.
As of December 31, 2002, the aggregate maturities of non-recourse debt payable to third-parties is as follows (in thoudands):
$ 6,113
1,485
37,406
8,452
2007 and thereafter
95,673
$ 149,129
As of December 31, 2002, the Company had guaranteed repayment of approximately $2.0 million of loans on behalf of the Real Estate Ventures. See Item 2. Properties - Real Estate Ventures. The Company also guaranteed a $16.2 million loan on behalf of a former Real Estate Venture. Payment under the guaranty, which expires in January 2004, would be required only in the event of a default on the loan and if and to the extent the collateral for the loan were insufficient to provide for payment in full of the loan. The Company also provides customary environmental indemnities in connection with construction and permanent financing both for its own account and on behalf of its Real Estate Ventures.
The Company has assessed the investments in Real Estate Ventures using the guidelines established in FIN 46 to determine whether using the equity method of accounting is still appropriate. These Real Estate Ventures have sufficient total investment equity at risk to permit these entities to finance their activities without additional subordinated financial support from other parties, including the Company. Further, the equity investment at risk is not greater than the expected losses of the entity, if any, as of December 31, 2002.
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In addition, these entities are not considered variable interest entities because, in each case, the equity investors as a group, have (i) the ability to make decisions through voting rights or the terms of the partnership or operating agreements; (ii) the obligation to absorb the expected losses of the entity, if any; and (iii) the right to receive the expected residual returns of the entity, if they occur.
8. INDEBTEDNESS
The Company utilizes credit facility borrowings for general business purposes, including the acquisition of properties and the repayment of debt. The Company maintains a $500 million unsecured credit facility (the “Credit Facility”) that matures in June 2004. Borrowings under the Credit Facility bear interest at LIBOR (LIBOR was 1.38% at December 31, 2002) plus 1.5%, with the spread over LIBOR subject to reductions from .10% to .25% or increases of .25% based on the Company’s leverage. As of December 31, 2002, the Company had $307 million of borrowings and $13.6 million of letters-of-credit outstanding under the Credit Facility, leaving $179.4 million of unused availability. The weighted-average interest rate on the Company’s unsecured credit facilities was 5.41% in 2002, 6.48% in 2001, and 7.84% in 2000.
During 2002, the Company obtained a $100 million term loan. The Company used proceeds of the term loan to repay indebtedness, including indebtedness under its Credit Facility. The term loan is unsecured and matures on July 15, 2005, subject to two extensions of one year each upon payment by the Company of an extension fee and the absence of any defaults at the time of each extension. There are no scheduled principal payments prior to maturity. The term loan bears interest at a spread over the one, two, three or six month LIBOR that varies between 1.05% and 1.90% (1.65% as of December 31, 2002), based on the Company’s leverage ratio.
As of December 31, 2002, the Company had $597.7 million of mortgage notes payable secured by 111 of the Properties and certain land holdings. Fixed rate mortgages, totaling $537.1 million, require payments of principal and/or interest (or imputed interest) at rates ranging from 6.80% to 9.25% and mature at various dates from July 2003 through July 2027. Variable rate mortgages, totaling $60.6 million, require payments of principal and/or interest at rates ranging from LIBOR plus .76% to 1.75% or 75% of prime (the prime rate was 4.25% at December 31, 2002) and mature at various dates from March 2003 through July 2027. The weighted-average interest rate on the Company’s mortgages was 7.27% in 2002, 7.39% in 2001, and 7.92% in 2000.
The Company has entered into interest rate swap and rate cap agreements designed to reduce the impact of interest rate changes on certain variable rate debt. At December 31, 2002, the Company had interest rate swap agreements for notional principal amounts aggregating $175 million. The swap agreements effectively fix the LIBOR portion of the Company’s interest rate on $100 million of Credit Facility borrowings at 4.230% and $75 million of Credit Facility borrowings at 4.215%, in each case until June 2004. The interest rate cap agreement effectively limits the interest rate on a mortgage of $28 million to 8.7% until July 2004. As of December 31, 2002, the fair value of the interest rate swap agreements was $7.2 million, which represents the estimated amount that the Company would pay if the contracts were terminated.
Aggregate principal payments on mortgage notes payable at December 31, 2002 are due as follows (in thousands):
$ 113,611
67,286
7,490
17,676
21,132
2008 and thereafter
370,534
$ 597,729
The Credit Facility and Term Loan require the maintenance of certain ratios related to minimum net worth, debt-to-total capitalization and fixed charge coverage and various non-financial covenants. As of December 31, 2002, the Company was in compliance with all debt covenants. The Company paid interest (net of capitalized interest) totaling $61.8 million in 2002, $74.2 million in 2001 and $67.7 million in 2000. As of December 31, 2002, the carrying value of the Company’s debt was below fair market value by approximately $99.9 million, as determined by using year-end interest rates and market conditions.
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9. DISCONTINUED OPERATIONS
For the years ended December 31, 2002, 2001 and 2000, income from discontinued operations relates to 43 properties containing 2.3 million net rentable square feet that the Company sold during the year ended December 31, 2002 and two properties containing 127,000 net rentable square feet that the Company has designated as “held-for-sale” as of December 31, 2002. The following table summarizes information for the two properties designated as held-for-sale as of December 31, 2002 (in thousands):
Real Estate Investments:
Operating Properties
$ 8,729
Accumulated depreciation
(1,235 )
7,494
Construction-in-progress
7,549
Accrued rent receivable
Deferred costs, net
Other assets
$ 7,666
Tennant security deposits and deferred rents
$
The following table summarizes revenue and expense information for the above properties sold or held-for-sale in 2002:
As of December 31, 2002, the Company recorded an impairment charge of $665,000 in its consolidated statements of operations related to one of the assets held-for-sale.
Discontinued operations have not been segregated in the consolidated statements of cash flows. Therefore, amounts for certain captions will not agree with respective data in the Consolidated Statements of Operations.
10. PREFERRED SHARES AND BENEFICIARIES’ EQUITY
In 1998, the Company issued $37.5 million of convertible preferred securities with a 7.25% coupon rate (the Series A Preferred Shares). The Series A Preferred Shares, with a stated value of $50.00, are convertible into Common Shares, at the option of the holder, at a conversion price of $28.00. The conversion price declines to $26.50, if the trading price of the Common Shares during the 60-day period ending December 31, 2003 is $23.00 or less. The Series A Preferred
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Shares distribution is subject to an increase, if quarterly distributions paid to Common Share holders exceeds $0.51 per share. The Series A Preferred Shares are perpetual and may be redeemed, at the Company’s option, at par beginning in January 2004 or earlier, if the market price of the Common Shares exceeds specified levels.
In 1999, the Company issued $105.0 million of convertible preferred securities (the Series B Preferred Shares) with an 8.75% coupon rate for net proceeds of $94.8 million. The Company is accreting the discount as a charge to cumulative earnings through the redemption date in 2007. The unamortized discount was $6.4 million as of December 31, 2002 and $7.9 million as of December 31, 2001. The Series B Preferred Shares, convertible into Common Shares at a conversion price of $24.00 per share, are entitled to quarterly dividends equal to the greater of $0.525 per share or the quarterly dividend on the number of Common Shares into which a Series B Preferred Share is convertible. The Series B Preferred Shares are perpetual and may be redeemed, at the Company’s option, at par, beginning in April 2007. In addition, the Company may require the conversion of the Series B Preferred Shares into Common Shares starting in April 2004, if certain conditions are met, including that the Common Shares are then trading in excess of 130% of the conversion price. Upon certain changes in control of the Company, the holder may require the Company to redeem its Series B Preferred Shares. However, the Company has the ability and intent to cause the Series B Preferred Shares to be converted into Common Shares rather than redeemed in such circumstances. In addition, as part of the transaction, the Company issued the holder seven-year warrants exercisable for 500,000 Common Shares at an exercise price of $24.00 per share.
The Company’s Board of Trustees approved a share repurchase program authorizing the Company to repurchase its outstanding Common Shares. During 2001, the Board of Trustees increased the number of shares authorized to be repurchased from three million shares to four million shares. Through December 31, 2002, the Company has repurchased 3.2 million of its Common Shares at an average price of $17.71 per share. The Company repurchased 491,074 Common Shares for $11.1 million (average price of $22.51 per share) in 2002; 302,437 Common Shares for $5.9 million (average price of $19.54 per share) in 2001 and 957,729 Common Shares for $15.3 million (average price of $15.95 per share) in 2000. Under the share repurchase program, the Company has authority to repurchase an additional 834,000 shares. No time limit has been placed on the duration of the share repurchase program.
At December 31, 2002, 355,813 unvested restricted Common Shares were held by employees of the Company. The restricted shares, valued at $18.4 million at issuance, are amortized over their respective vesting periods of three to eight years. The Company recorded compensation expense of $2.5 million in 2002, $2.8 million in 2001 and $2.0 million in 2000 related to these shares.
11. SHARE PURCHASE OPTIONS AND WARRANTS
The Company maintains a plan that authorizes the issuance of various equity-based awards including incentive stock options. The terms and conditions of option awards are determined by the Board of Trustees. Incentive stock options may not be granted at exercise prices less than fair value of the stock at the time of grant. Options granted by the Company generally vest over two to five years. All options awarded by the Company to date are non-qualified stock options. As of December 31, 2002, the Company is authorized to issue five million equity-based awards of which 1.4 million shares remain available for future issuance under the plan.
The following table summarizes option activity for the three years ended December 31, 2002:
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The following table summarizes stock options outstanding as of December 31, 2002:
Using the Black-Scholes option pricing model, the estimated weighted-average fair value of stock options granted was $2.51 in 2002. Assumptions made in determining estimates of fair value include: risk-free interest rate of 2.7% in 2002, a volatility factor of .280 in 2002, a dividend yield of 8.4% in 2002, and a weighted-average life expectancy of 3 years in 2002.
As of December 31, 2002, there are 500,000 warrants outstanding to purchase Common Shares of the Company at an exercise price of $24.00.
Effective January 1, 2002, the Company voluntarily adopted the fair value recognition provisions of SFAS 123, prospectively for all employee awards granted, modified, or settled after January 1, 2002 (see Note 2). Accordingly, the Company recorded approximately $43,000 of compensation expense for the year ended December 31, 2002. This compensation expense relates to the Company’s grant of 100,000 stock options during 2002.
12. SEGMENT INFORMATION
The Company currently manages its portfolio within three segments: (1) Pennsylvania, (2) New Jersey and (3) Virginia. Corporate is responsible for cash and investment management and certain other general support functions.
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Segment information for the three years ended December 31, 2002, 2001 and 2000 is as follows (in thousands):
Net operating income is defined as total revenue less property operating expenses and real estate taxes. Below is a reconciliation of consolidated net operating income to consolidated income from continuing operations:
13. NET INCOME PER COMMON SHARE
The following table details the number of shares and net income used to calculate basic and diluted earnings per share for the three years ended December 31, 2002 (in thousands, except per share amounts):
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Securities totaling 11,256,776 in 2002, 11,622,922 in 2001 and 11,625,490 in 2000 were excluded from the earnings per share computations above as their effect would have been antidilutive.
14. DISTRIBUTIONS (UNAUDITED):
15. RELATED-PARTY TRANSACTIONS
In 1998, the Board authorized the Company to make loans totaling up to $5.0 million to enable employees of the Company to purchase Common Shares at fair market value. The loans have five-year terms, are full recourse, and are secured by the Common Shares purchased. Interest, payable quarterly, accrues on the loans at the lower of the interest rate borne on borrowings under the Company’s Credit Facility or a rate based on the dividend payments on the Common Shares. As of December 31, 2002, the interest rate was 2.92% per annum. The loans are payable at the earlier of the stated maturity date or 90 days following the employee’s termination. As of December 31, 2002, the Company had funded loans of $4.0 million to employees secured by an aggregate of 194,748 Common Shares.
The Company owns 384,615 shares of US Realtel, Inc. (“USR”) Common Stock and holds warrants exercisable for 600,000 additional shares. The warrants have an exercise price of $8.00 per share and expire on December 31, 2004. As of December 31, 2002, the Company’s investment in USR was $.4 million. An officer of the Company holds a position on USR’s Board of Directors.
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In February 2000, the Company loaned an aggregate of $2.5 million to two executive officers to enable them to purchase Common Shares of the Company. One loan has a four-year term and bears interest at the lower of the Company’s cost of funds or a rate based on the dividend payable on the Common Shares, but not to exceed 10% annum. This loan is subject to forgiveness over a three-year period, with the amount of forgiveness tied to the Company’s total shareholder return compared to the total shareholder return of peer group companies. This loan is also subject to forgiveness in the event of a change of control of the Company. The executive may repay the loan at maturity by surrendering Common Shares valued at the executive’s initial per share purchase price of $15.625. The Company recorded compensation expense of $877,000 in 2002, $881,000 in 2001 and $683,000 in 2000 relating to these executive stock loans. This loan is reflected as a reduction in beneficiaries equity. Effective December 31, 2001, the Company recorded a $4.1 million charge to restructure the other loan in connection with the executive’s transition to a non-executive, non-managerial status, which will be forgiven in equal installments in April 2002 and April 2003. Principal and interest totaling $.9 million was forgiven related to these loans in 2002 and 2001.
16. OPERATING LEASES
The Company leases properties to tenants under operating leases with various expiration dates extending to 2020. As of December 31, 2002, leases covering approximately 1.8 million square feet or 11.4% of the net rentable square footage are scheduled to expire during 2003. Minimum future rentals on noncancelable leases at December 31, 2002 are as follows (in thousands):
Total minimum future rentals presented above do not include amounts to be received as tenant reimbursements for increases in certain operating costs.
17. EMPLOYEE BENEFIT PLAN
The Company sponsors a 401(k) defined contribution plan for its employees. Each employee may contribute up to 18% of annual compensation. At its discretion, the Company can make matching contributions equal to a percentage of the employee’s elective contribution and profit sharing contributions. Employees vest in employer contributions over a five year service period. The Company contributions were $816,000 in 2002, $669,000 in 2001 and $690,000 in 2000.
18. SUMMARY OF INTERIM RESULTS (UNAUDITED)
The following is a summary of interim financial information as of and for the years ended December 31, 2002 and 2001 (in thousands, except per share data):
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(a) The Company recorded gains on sales of properties of $8.4 million during the 1st quarter of 2002.
(b) During the fourth quarter of 2001, the Company recorded a $6.6 million non-recurring charge related to the conversion of the Company’s Chairman to a non-executive, non-managerial status and the write-down due to the impairment of the Company’s $2.5 million investment in a telecommunications company that was deemed to be other than temporary. The $4.1 million charge related to the Company’s Chairman reflects an accrual on account of payment obligations of the Company under its employment agreement with the Chairman, accelerated vesting of his restricted shares and restructuring of his executive stock loan.(c) (d)
The summation of quarterly earnings per share amounts do not necessarily equal year to date amounts.
19. COMMITMENTS AND CONTINGENCIES
Legal Proceedings
The Company is involved from time to time in litigation on various matters, including disputes with tenants and disputes arising out of agreements to purchase or sell properties. Given the nature of the Company’s business activities, these lawsuits are considered routine to the conduct of its business. The result of any particular lawsuit cannot be predicted, because of the very nature of litigation, the litigation process and its adversarial nature, and the jury system.
The Company is a defendant in a case in which the plaintiffs allege that the Company breached its obligation to purchase a portfolio of properties for approximately $83.0 million. On July 9, 1999, the Superior Court of New Jersey, Camden County, dismissed the complaint against the Company with prejudice. The plaintiffs subsequently filed a motion for reconsideration, which motion the Superior Court denied. Plaintiffs then appealed to the Appellate Division, which is the intermediate appellate level court in New Jersey. In December 2000, the Appellate Division affirmed in part and reversed in part the Chancery Division’s earlier dismissal of the entire action. The Appellate Division affirmed the dismissal of the fraud and other non-contractual counts in the Complaint, but reversed the contract and reformation counts and remanded these to the lower court for further proceedings. The Company sought review of this decision by the Supreme Court of New Jersey, but in March 2001 that Court declined to consider the appeal. The case thereafter returned to the Chancery Division, where written and oral discovery was
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conducted in 2002 and in the first quarter of 2003. Discovery terminated on February 14, 2003. The Company filed a motion for summary judgment on all counts, seeking dismissal of all counts against it, and judgment for the Company on its counterclaim. The Chancery Division granted the Company’s summary judgment motion on March 25, 2003. At this time, the Company does not know whether plaintiffs will appeal, or if they appeal, whether plaintiffs will be successful in the appeal.
There have been recent reports of lawsuits against owners and managers of multifamily and office properties asserting claims of personal injury and property damage caused by the presence of mold in residential units or office space. The Company has been named as a defendant in two lawsuits that allege personal injury as a result of the presence of mold. Unspecified damages are sought. The Company has referred these lawsuits to its insurance carrier and, as of the date of this Form 10-K, the insurance carrier is evaluating coverage.
Letters-of-Credit
In connection with certain mortgages, the Company is required to maintain leasing and capital reserve accounts with the mortgage lenders through letters-of-credit which totaled $13.6 million at December 31, 2002. The Company is also required to maintain escrow accounts for taxes, insurance and tenant security deposits that amounted to $16.3 million at December 31, 2002. The related tenant rents are deposited into the loan servicer’s depository accounts, which are used to fund debt service, operating expenses, capital expenditures and the escrow and reserve accounts, as necessary. Any excess cash is included in cash and cash equivalents.
Other Commitments
As of December 31, 2002, the Company owned 444 acres of land for future development and held options to purchase 63 additional acres. The Company also holds an option to enter into a long-term ground lease of property adjacent to Amtrak’s 30th Street Station in Philadelphia and develop a high-rise office property on the leasehold interest.
20. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The following table details the components of accumulated other comprehensive income (loss) as of and for the three years ended December 31, 2002 (in thousands):
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Brandywine Realty Trust
Schedule II
Valuation and Qualifying Accounts
(in thousands)
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