ITEM 1. BUSINESS.
EQUITY OFFICE
As used herein, the terms "we," "us," "our," or "Equity Office" refer to Equity Office Properties Trust, a Maryland real estate investment trust, individually or together with its subsidiaries, including EOP Operating Limited Partnership, a Delaware limited partnership (sometimes referred to as "EOP Partnership"), and our predecessors. With EOP Partnership, we were formed as a REIT to continue and expand the national office property business organized by Mr. Samuel Zell, our Chairman of the Board, and to complete the consolidation of our predecessors. We completed our initial public offering, or "IPO," on July 11, 1997. We are a fully integrated, self-managed real estate company engaged in acquiring, owning, managing, developing and leasing office properties. We have elected to be taxed as a real estate investment trust, or "REIT," for federal income tax purposes and generally will not be subject to federal income tax if we distribute 100% of our taxable income and comply with a number of organizational and operational requirements.
As of December 31, 2000, we owned or had an interest in 381 office properties containing approximately 99.0 million rentable square feet of office space (the "Office Properties") and owned nine stand-alone parking facilities containing approximately 14,244 parking spaces (the "Parking Facilities" and, together with the Office Properties, the "Properties"). The weighted average occupancy for the Office Properties at December 31, 2000 was approximately 94.6%. The Office Properties are located in 104 submarkets in 37 markets in 24 states and the District of Columbia. The Office Properties, by rentable square feet, are located approximately 51.3% in central business districts ("CBDs") and 48.7% in suburban markets. We own substantially all of our assets and conduct substantially all of our operations through EOP Partnership. We owned approximately 87.9% of EOP Partnership as of December 31, 2000 and are its sole general partner.
Our executive offices are located at Two North Riverside Plaza, Suite 2100, Chicago, Illinois 60606, and our telephone number is (312) 466-3300.
ACQUISITION ACTIVITY
Since the IPO, we have invested approximately $13.9 billion, calculated on a cost basis, in acquisitions of institutional quality office properties and parking facilities throughout the United States. During the year ended December 31, 2000, we completed several acquisitions, including Cornerstone Properties Inc. and its operating partnership subsidiary, in which we acquired 85 office properties containing an aggregate of approximately 21.0 million square feet of rentable space and several vacant land parcels. The aggregate consideration we paid for these acquisitions during 2000 was approximately $4.9 billion, comprised of $1.5 billion in cash, $1.6 billion in Equity Office common shares and units of limited partnership interest in EOP Partnership and $1.8 billion in assumed liabilities.
CORNERSTONE MERGER
On June 19, 2000, we completed the merger of Cornerstone Properties Limited Partnership ("Cornerstone Partnership") with and into EOP Partnership and the merger of Cornerstone Properties Inc. ("Cornerstone") with and into Equity Office (collectively, the "Cornerstone Merger") at a total cost of approximately $4.5 billion comprised of the issuance of Equity Office Common Shares and options, EOP Partnership Units, the assumption of debt and assumed liabilities and cash. The cash portion of the Cornerstone Merger of approximately $1.2 billion was funded from EOP Partnership's credit facilities. As a result of the Cornerstone Merger, Equity Office acquired an interest in 82 Office Properties containing approximately 18.9 million square feet of office space.
PENDING MERGER WITH SPIEKER PROPERTIES, INC.
In February 2001, Equity Office and Spieker Properties, Inc. ("Spieker") entered into a merger agreement in which Spieker will merge into Equity Office and EOP Partnership will acquire Spieker Properties, L.P., Spieker's operating partnership subsidiary (the "Spieker Merger"). The transaction values Spieker (including the outside interests in Spieker Properties, L.P.) at approximately $7.2 billion, which includes transaction costs and the assumption of approximately $2.1 billion in debt and $431 million in preferred stock and partnership units. Equity Office will pay approximately $1.085 billion in cash and issue approximately 118.6 million new Equity Office common shares and EOP Partnership units and 14.3 million new Equity Office preferred shares in the transaction. We intend to finance the $1.085 billion cash portion of the purchase price using a combination of available borrowing capacity under our existing Credit Facility, and a new bridge loan facility to be entered into before the closing of the merger and/or through the issuance by EOP Partnership of senior unsecured notes.
Following the merger, Equity Office will own and operate 616 office buildings consisting of 124 million square feet of office space nationwide, including 25 million square feet of office space attributable to Spieker. Equity Office will also acquire Spieker's industrial portfolio of approximately 13.5 million square feet and its development properties totaling 1.7 million square feet.
Upon completion of the merger, Equity Office will expand its Board of Trustees from 13 to 16 members. The new members will be Warren E. Spieker, Jr., chairman of Spieker, and Co-Chief Executive Officers Craig G. Vought and John A. Foster.
The merger is intended to qualify as a tax-free reorganization at the corporate level for federal income tax purposes, with Spieker stockholders recognizing taxable income only up to the amount of cash received in the merger. The closing of the transaction is conditioned upon each party receiving an acceptable tax opinion to that effect. The merger, which will be accounted for using purchase accounting, is subject to the approval of the shareholders of both companies and to other customary conditions.
BUSINESS AND GROWTH STRATEGIES
Our primary business objective is to achieve sustainable long-term growth in cash flow and portfolio value in order to maximize shareholder value. We intend to achieve this objective by owning and operating high-quality office buildings and providing a superior level of service to tenants across the United States. We plan on supplementing this strategy through Access, a strategic business service unit that provides customers access to various business products and services.
INTERNAL GROWTH. We believe that our future internal growth will come from:
(a) tenant roll-over at increased rents where market conditions permit;
(b) lease up of vacant space;
(c) completion and lease-up of development properties;
(d) recycling of capital through selective disposition of certain assets and reinvestment in properties or other assets consistent with our long term growth strategy;
(e) ancillary revenues generated from providing business products and services to tenants through Access;
(f) reduction of various expenses as a percentage of revenues; and
(g) increased capital market efficiencies.
As of December 31, 2000, 4.3 million rentable square feet of our office property space was vacant. During the period from December 31, 2000 through December 31, 2005, there are 6,088 leases for approximately 57.6 million rentable square feet of space that are scheduled to expire. As of December 31, 2000, the average rent for this space was $26.83 per square foot. The actual rental rates at which available space will be relet will depend on prevailing market factors at the time.
As of December 31, 2000, we have more than 2.7 million square feet of projects in our development pipeline. We have continued to prudently pursue projects with local development experts where customer need is evident and market conditions warrant.
In addition to our current development pipeline, we own various undeveloped land parcels on which approximately seven million square feet of office space could be developed, assuming our receipt of all-necessary permits, licenses and approvals. Our policy is to develop land only when market conditions warrant. Although we may develop some properties ourselves, a portion of this activity may be conducted with joint venture partners.
EXTERNAL GROWTH. Assuming that capital is available to us on reasonable terms, we expect to actively pursue, over the long term, acquisitions of additional office properties. Properties may be acquired separately or as part of a portfolio, and may be acquired for cash and/or in exchange for our equity or debt securities. These acquisitions may be customary real estate transactions, joint ventures, and/or mergers or other business combinations.
EMPLOYEES
As of December 31, 2000, we had approximately 2,061 employees providing in-house expertise in:
- property management; - Access and business development; - leasing; - finance; - tax; - acquisition; - development; - disposition; - marketing; - accounting; - information systems; and - law
Our seven executive officers have an average tenure of 11.5 years with us or our affiliates and an average of 22 years experience in the real estate industry.
EXECUTIVE AND SENIOR OFFICERS OF EQUITY OFFICE
As of March 16, 2001, the following executive and senior officers of Equity Office held the offices indicated.
Set forth below are biographical information for each of the executive officers:
Timothy H. Callahan has been a trustee, President and Chief Executive Officer of Equity Office since October 1996. Mr. Callahan also has held the following positions:
- Served on the Board of Managers and was the Chief Executive Officer of Equity Office Holdings, L.L.C ("EOH"), and Equity Office Properties, L.L.C. ("EOP LLC"), predecessors of Equity Office, from August 1996 until October 1997; - Executive Vice President and Chief Financial Officer of Equity Group Investments, Inc. ("EGI"), an owner, manager and financier of real estate and corporate investments, from January 1995 until August 1996; - Executive Vice President of EGI from November 1994 through January 1995; - Senior Vice President of EGI from July 1992 until November 1994;
- Vice President -- Finance of the Edward J. DeBartolo Corporation, a developer, owner and operator of shopping centers, in Youngstown, Ohio, from July 1988 until July 1992; and - Employed by Chemical Bank, a commercial bank located in New York, New York, from July 1973 until March 1987.
Richard D. Kincaid has been Executive Vice President and Chief Financial Officer of Equity Office since March 1997 and has also held the following positions:
- Senior Vice President and Chief Financial Officer of Equity Office from October 1996 until March 1997; - Senior Vice President and Chief Financial Officer of EOH from July 1995 until October 1997; - Senior Vice President of EGI from February 1995 until July 1995; - Senior Vice President of the Yarmouth Group, a real estate investment company in New York, New York, from August 1994 until February 1995; - Senior Vice President -- Finance for EGI from December 1993 until July 1994; - Vice President -- Finance for EGI from August 1990 until December 1993; and - Vice President for Barclays Bank PLC, a commercial bank located in Chicago, Illinois, from August 1987 until August 1990.
Michael A. Steele has been Executive Vice President -- Real Estate Operations and Chief Operating Officer of Equity Office since March 1998 and has also held the following positions:
- Executive Vice President -- Real Estate Operations of Equity Office from October 1996 until February 1998; - President and Chief Operating Officer of EOP LLC from July 1995 until October 1997; - Executive Vice President of EOH from July 1995 until October 1997; - President and Chief Operating Officer of Equity Office Properties, Inc., a subsidiary of EGI, which provided real estate property management services ("EOP, Inc."), from November 1993 through October 1995; - President and Chief Executive Officer of First Office Management, a former division of Equity Property Management, Inc., that provided real estate property management services ("FOM"), from June 1992 until October 1993; and - Senior Vice President and regional director for Rubloff, Inc., a full service real estate company in Chicago, Illinois, from April 1987 until June 1992.
Stanley M. Stevens has been Executive Vice President and Chief Legal Counsel and Secretary of Equity Office since October 1996 and has also held the following positions:
- Executive Vice President and General Counsel of EOH from September 1996 until October 1997; - Vice President of Rosenberg & Liebentritt, P.C., a law firm in Chicago, Illinois, that has since dissolved, from December 1993 until September 1996; and - Partner at Rudnick & Wolfe, a national law firm based in Chicago, Illinois, from October 1987 until December 1993.
David A. Helfand has been Executive Vice President -- Business Development of Equity Office since February 2000 and has also held the following positions:
- Senior Vice President -- New Business Development from July 1998 to February 2000; - Managing Director of Equity International Properties, Ltd. a real estate investment company from December 1997 until July 1998; - Chief Executive Officer of Manufactured Home Communities, Inc. from August 1996 until December 1997; - President of Manufactured Home Communities, Inc. from January 1995 until July 1996; - Chief Financial Officer of Manufactured Home Communities, Inc. from December 1992 until February 1995; - Vice President of Manufactured Home Communities, Inc. from March 1994 until January 1995; and - Member of the Board of Directors of Manufactured Home Communities, Inc. since May 1995.
Sybil J. Ellis has been Executive Vice President -- Real Estate Investments of Equity Office since November 2000 and has also held the following positions:
- Senior Vice President -- Real Estate Investments from December 1999 to November 2000; - Senior Vice President -- Acquisitions from March 1997 to December 1999 - Senior Vice President -- Acquisitions of EOH from July 1995 until October - Senior Vice President -- Acquisitions of EOP, Inc. from July 1994 through July 1995; - Vice President -- Acquisitions of EOP, Inc. from November 1993 until July 1994; and - Vice President -- Acquisitions of EAM from March 1990 until October 1993.
David H. Naus has been Executive Vice President -- Real Estate Investments of Equity Office since November 2000 and has also held the following positions:
- Senior Vice President -- Real Estate Investments from December 1999 to November 2000; - Senior Vice President -- Acquisitions from March 1997 to December 1999; - Senior Vice President -- Acquisitions for EOH from December 1995 until October 1997; - Vice President -- Acquisitions of EOH from July 1995 until December 1995; - Vice President -- Acquisitions of EOP, Inc. from November 1993 until July 1995; - Vice President -- Acquisitions of EAM from November 1992 until November 1993; and - Vice President of EAM from October 1988 until November 1992.
COMPETITION
The leasing of real estate is highly competitive. Equity Office's properties compete for tenants with similar properties located in its markets primarily on the basis of location, rent charged, services provided and the design and condition of improvements. Equity Office also experiences competition when attempting to acquire interests in desirable real estate, including competition from domestic and foreign financial institutions, other REITs, life insurance companies, pension trusts, trust funds, partnerships and individual investors. In addition, Equity Office competes for acquisition of building sites or redevelopment opportunities with domestic and foreign financial institutions, other REITs, life insurance companies, pension trusts, trust funds, partnerships and individual investors.
INDUSTRY SEGMENTS
Equity Office's primary business is the ownership and operation of Office Properties. Equity Office's long-term tenants are in a variety of businesses and no single tenant is significant to Equity Office's business. Information related to this segment for the years ended December 31, 2000, 1999 and 1998 is set forth in note 18 to the consolidated financial statements that are part of this report.
ITEM 2.
ITEM 2. PROPERTIES.
All capitalized terms used herein and not otherwise defined shall have the meaning given in the Financial Statements set forth in Item 8.
GENERAL
Equity Office's portfolio, based on revenue and square footage, is the largest portfolio of office properties of any publicly traded, full-service office company in the United States. As of December 31, 2000, Equity Office owned or had an interest in 381 Office Properties containing approximately 99.0 million rentable square feet of office space and owned nine stand-alone Parking Facilities containing approximately 14,244 parking spaces. The Office Properties are located in 104 submarkets in 37 markets in 24 states and the District of Columbia. The Office Properties, by rentable square feet, are located approximately 51.3% in CBDs and approximately 48.7% in suburban markets. As of December 31, 2000, the Office Properties were, on a weighted average basis, 94.6% occupied by a total of 7,153 tenants, with no single tenant accounting for more than 1.9% of Equity Office's aggregate annualized rent or 1.5% of the aggregate occupied square feet, except for the U.S. General Services Administration, which accounted for 2.2% of annualized rent and 2.5% of the occupied square feet.
All property data are as of December 31, 2000.
OFFICE PROPERTIES BY REGION
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(a) Annualized Rent is the monthly contractual rent under existing leases as of December 31, 2000, multiplied by 12. This amount reflects total base rent before any rent abatements, but includes expense reimbursements, which may be estimates.
OFFICE PROPERTY STATISTICS
Certain Properties are encumbered with mortgages. See Schedule III -- Real Estate and Accumulated Depreciation as of December 31, 2000 in Item 14(a)(2) for this information.
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(a) Annualized Rent per square foot is annualized rent divided by occupied square feet at December 31, 2000. This amount reflects total base rent before any rent abatements, but includes expense reimbursements, which may be estimates.
(b) All or a portion of this Office Property is held subject to a ground lease with the exception of Denver Post Tower which is subject to an air rights lease.
(c) This Office Property is held in a private real estate investment trust in which Equity Office owns 51.6% of the outstanding shares.
(d) This Office Property is held in a partnership with an unaffiliated third party and, in the case of San Felipe Plaza, an affiliated party.
(e) The following development properties were placed in service as indicated below:
(f) Equity Office's interest in the amenities component of this Office Property is primarily attributed to its ownership of mortgage indebtedness encumbering the theatre/plaza, retail, health club and parking facilities associated therewith.
(g) This Office Property is 100% leased to a single tenant on a triple net basis, whereby the tenant pays for certain operating expenses directly rather than reimbursing Equity Office. The amounts shown above for
annualized rent include the amounts of reimbursement of expenses paid by Equity Office but do not make any adjustments for expenses paid directly by the tenant.
(h) This Office Property is held subject to an interest in the improvements at the Property held by an unaffiliated third party. In addition, Equity Office has a mortgage interest in such improvements.
(i) This Office Property was purchased in conjunction with the purchase of One Phoenix Plaza for the sole purpose of providing additional parking for the tenants of One Phoenix Plaza.
(j) Equity Office's interest, or partial interest in certain cases, in these Office Properties is primarily attributed to its ownership of indebtedness.
PARKING FACILITIES
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(a) Each of these Parking Facilities is operated by the designated third-party service company (each a "Service Company") under a lease agreement whereby Equity Office and the Service Company share the gross receipts from the parking operation or Equity Office receives a fixed payment from the Service Company, and Equity Office bears none of the operational expenses.
(b) Equity Office owns an interest in this parking facility by assignment of a concession agreement. Under the terms of the agreement, Equity Office pays an annual fee based on a percentage of parking revenues.
(c) Equity Office has a 50% membership interest in a portfolio of four Parking Facilities serving the St. Louis, Missouri area.
LEASE EXPIRATION (AS OF 12/31/00)
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(1) Total net rentable square feet represented by expiring leases. (2) Percentage of total net rentable feet represented by expiring leases. (3) Annualized Rent is the monthly contractual rent under existing leases as of December 31, 2000 multiplied by 12. This amount reflects total base rent before any rent abatements, but includes expense reimbursements.
LEASE EXPIRATIONS -- TOTAL PORTFOLIO
The following table sets forth a summary schedule of the lease expirations for the Office Properties for the leases in place as of December 31, 2000, assuming that none of the tenants exercise renewal options or termination rights, if any, at or prior to the scheduled expirations.
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(1) Based on current payable rent.
(2) Represents lease expirations from January 1, 2001 to December 31, 2001 and month-to-month leases.
(3) Reconciliation for total net rentable square footage is as follows:
LEASE DISTRIBUTION
The following table sets forth information relating to the distribution of the Office Property leases, based on rentable square feet under lease, as of December 31, 2000.
OCCUPANCY
The table below sets forth weighted average occupancy rates, based on square footage occupied, of the Office Properties owned by Equity Office at the indicated date:
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
Neither Equity Office nor any of its Properties is presently subject to material litigation nor, to Equity Office's knowledge, is any litigation threatened against Equity Office or any of the Properties, other than routine actions for negligence and other claims and administrative proceedings arising in the ordinary course of business, some of which are expected to be covered by liability insurance and all of which collectively are not expected to have a material adverse effect on the liquidity, results of operations, or business or financial condition of Equity Office.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Equity Office's common shares are traded on the New York Stock Exchange ("NYSE") under the symbol "EOP." On March 16, 2001, the reported closing sale price per common share on the NYSE was $29.02 and there were approximately 942 holders of record. The high and low sales prices during 2000 and 1999 on the NYSE were as follows:
ISSUANCE OF UNREGISTERED SECURITIES. In December 2000, EOP Partnership issued 73,776 Units at a weighted average price of $28.75 per Unit (the Units were recorded at a weighted average cost of $32.11 per Unit for a total of $2.4 million for accounting purposes) for the remaining 11% interest in certain partnerships that collectively own 11 office buildings located in suburban Philadelphia, Pennsylvania. We acquired an 89% interest in the partnerships in 1997. In addition, in December 2000 EOP Partnership issued 42,397 Units valued at $29.825 per Unit in connection with the acquisition of rights to certain land located in San Francisco, California. The Units issued in these transactions were issued as a private placement of securities in reliance on an exemption from the registration requirements of the Securities Act pursuant to Section 4(2) and Rule 506 of Regulation D promulgated thereunder. Units issued by EOP Partnership generally are convertible into common shares of Equity Office on a one-for-one basis, or the cash equivalent thereof, subject to certain restrictions.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.(1)
The following sets forth selected consolidated and combined financial and operating information on a historical basis for Equity Office and Equity Office's predecessors ("Equity Office Predecessors"). The following information should be read in conjunction with the consolidated financial statements and notes thereto of Equity Office included elsewhere in this Form 10-K.
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(1) The selected financial data has been derived from the historical consolidated or combined financial statements of Equity Office and Equity Office Predecessors, audited by Ernst & Young LLP, independent auditors.
(2) On June 19, 2000, Equity Office completed its acquisition of Cornerstone. See Item 1. Business -- Cornerstone Merger and Note 3 to Equity Office's consolidated financial statements included elsewhere herein.
(3) On December 19, 1997, Equity Office completed its acquisition of Beacon Properties Corporation and Beacon Partnership L.P. (the "Beacon Merger") at a cost of approximately $4.3 billion. As a result of the Beacon Merger, Equity Office acquired an interest in 130 Properties containing approximately 20.9 million square feet.
(4) Property operating expenses include real estate taxes, insurance, repairs and maintenance and other property operating expenses.
(5) The White Paper on Funds from Operations approved by the Board of Governors of the National Association of Real Estate Investment Trusts ("NAREIT") in March 1995 defines Funds from Operations as net income (loss), computed in accordance with GAAP, excluding gains (or losses) from debt restructuring and sales of properties, plus real estate related depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures. In November 1999, NAREIT issued a National Policy Bulletin effective January 1, 2000 clarifying the definition of Funds from Operations to include all operating results, both recurring and non-recurring, except those defined as extraordinary under GAAP. In accordance with this NAREIT Bulletin, Equity Office no longer adjusts for the
amortization of discounts and premiums on mortgages when calculating Funds from Operations. Accordingly, Equity Office restated the prior period data for comparative purposes. Equity Office believes that Funds from Operations is helpful to investors as a measure of the performance of an equity REIT because, along with cash flow from operating activities, financing activities and investing activities, it provides investors with an indication of the ability of Equity Office to incur and service debt, to make capital expenditures and to fund other cash needs. Equity Office computes Funds from Operations in accordance with standards established by NAREIT, which may not be comparable to Funds from Operations reported by other REITs that do not define the term in accordance with the current NAREIT definition or that interpret the current NAREIT definition differently than Equity Office. Funds from Operations does not represent cash generated from operating activities in accordance with GAAP, nor does it represent cash available to pay distributions and should not be considered as an alternative to net income, determined in accordance with GAAP, as an indication of Equity Office's financial performance or to cash flow from operating activities, determined in accordance with GAAP, as a measure of Equity Office's liquidity, nor is it indicative of funds available to fund Equity Office's cash needs, including its ability to make cash distributions. For a reconciliation of net income to Funds from Operations, see "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Funds from Operations."
(6) Property net operating income is defined as rental income, including tenant reimbursements, parking and other income less property operating expenses, including real estate taxes, insurance, repairs and maintenance and other property operating expenses.
(7) Earnings before interest, taxes, depreciation and amortization is defined as net income excluding interest expense, taxes, depreciation and amortization, minority interest allocation with respect to EOP Partnership, net gain (loss) on sales of real estate, gains (losses) from extraordinary items and income from investment in unconsolidated joint ventures plus Equity Office's share of the earnings before interest, taxes, depreciation and amortization for the unconsolidated joint ventures. Earnings before interest, taxes, depreciation and amortization is presented because Equity Office believes this data is used by some investors to evaluate Equity Office's ability to meet debt service requirements. Equity Office considers earnings before interest, taxes, depreciation and amortization to be an indicative measure of its operating performance due to the significance of Equity Office's long-lived assets and because this data can be used to measure Equity Office's ability to service debt, fund capital expenditures and expand its business. However, this data should not be considered as an alternative to net income, operating profit, cash flows from operations or any other operating or liquidity performance measure prescribed by GAAP. In addition, earnings before interest, taxes, depreciation and amortization as calculated by Equity Office may not be comparable to similarly titled measures reported by other companies. Interest expense, taxes, depreciation and amortization, which are not reflected in the presentation of earnings before interest, taxes, depreciation and amortization, have been, and will be, incurred by Equity Office. Investors are cautioned that these excluded items are significant components in understanding and assessing Equity Office's financial performance.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
OVERVIEW
The following discussion and analysis of the consolidated financial condition and consolidated results of operations should be read together with the consolidated financial statements of Equity Office and notes thereto contained in this Form 10-K. Terms employed herein as defined terms, but without definition, shall have the meaning set forth in the financial statements. Statements contained in this "Management's Discussion and Analysis of Financial Condition and Results of Operations," including, without limitation, the "Market Risk" and "Developments" disclosures, which are not historical fact may be forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 (the "Exchange Act"). Equity Office intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in Section 21E of the Exchange Act. Such statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from those projected or anticipated. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of December 31, 2000. Among the factors that Equity Office has made assumptions are the following:
- Equity Office's ability to successively integrate Cornerstone's operations into those of Equity Office; - Future economic conditions which may have an impact upon the demand for office space and tenant ability to pay rent, either at current or at increased levels; - Prevailing interest rates; - The extent of any inflation on operating expenses; - Equity Office's ability to reduce various expenses as a percentage of revenues; - Equity Office's continuing ability to pay amounts due to its noteholders and preferred shareholders before any distribution to holders of Common Shares; - The cost to complete and lease-up pending developments; - Equity Office's continued access to adequate credit facilities or other debt financing on acceptable terms, including amounts required for the Spieker Merger; and - The demand from Equity Office's customers for office-related services.
During the year ended December 31, 2000, Equity Office completed the following key transactions:
- Acquired Cornerstone (see "Cornerstone Merger" below for additional information); - Acquired through a joint venture a 45% general partner equity interest and a debt interest in a limited partnership that owns 1301 Avenue of the Americas, a 1.77 million square foot office building located in Midtown Manhattan in New York. Equity Office's share of this investment at closing was approximately $163.2 million; - Sold 11 parking facilities for approximately $180.0 million; - Sold seven office properties and a development parcel for approximately $146.4 million; - Sold a 49.9% interest in Bank of America Tower in Seattle for approximately $209.6 million; - Issued approximately $2.2 billion of unsecured notes in four separate offerings; and - Invested approximately $75 million in convertible preferred stock of HQ Global Workplaces, Inc. ("HQ"), a provider of temporary office suites.
CORNERSTONE MERGER
On June 19, 2000, we completed the merger of Cornerstone Partnership with and into EOP Partnership and the merger of Cornerstone with and into Equity Office at a total cost of approximately $4.5 billion. The purchase price consisted of:
(a) Equity Office's issuance of approximately 51.2 million Common Shares valued at $24.68 per share and the assumption of approximately 3.7 million share options, for a total of approximately $1,268.6 million; (b) EOP Partnership's issuance of approximately 12.4 million Units to third parties valued at $24.68 per Unit for a total of approximately $306.0 million;
(c) the cash redemption of approximately 58.5 million shares of Cornerstone common stock valued at $18.00 per share for a total of approximately $1,052.2 million; (d) the cash redemption of approximately 3.0 million shares of Cornerstone preferred stock valued at $18.00 per share, plus accrued but unpaid dividends, for a total of approximately $57.6 million; (e) the assumption of approximately $1,304.9 million of secured debt and $415.5 million of unsecured debt; (f) the payment of merger costs of approximately $82.9 million; and (g) the assumption of net liabilities of approximately $19.8 million.
The cash portion of the Cornerstone Merger of approximately $1.2 billion was funded from the $1.0 Billion Credit Facility and the Line of Credit. See "Lines of Credit" for additional information.
SPIEKER MERGER
In February 2001, Equity Office and Spieker Properties, Inc. ("Spieker") entered into a merger agreement in which Spieker will merge into Equity Office and EOP Partnership will acquire Spieker Properties, L.P., Spieker's operating partnership subsidiary (the "Spieker Merger"). The transaction values Spieker (including the outside interests in Spieker Properties, L.P.) at approximately $7.2 billion, which includes transaction costs and the assumption of approximately $2.1 billion in debt and $431 million in preferred stock and partnership units. Equity Office will pay approximately $1.085 billion in cash and issue approximately 118.6 million new Equity Office Common Shares and EOP Partnership units and 14.3 million new Equity Office preferred shares in the transaction. We intend to finance the $1.085 billion cash portion of the purchase price using a combination of available borrowing capacity under our existing Line of Credit and a new bridge loan facility to be entered into before the closing of the merger and/or through the issuance of EOP Partnership of senior unsecured notes.
Following the merger, Equity Office is expected to own and operate 616 office buildings consisting of 124 million square feet of office space nationwide, which includes 25 million square feet of office space attributable to Spieker. Equity Office will also acquire Spieker's industrial portfolio of approximately 13.5 million square feet and its development properties totaling 1.7 million square feet.
Upon completion of the merger, Equity Office will expand its Board of Trustees from 13 to 16 members. The new members will be Warren E. Spieker, Jr., chairman of Spieker, and Co-Chief Executive Officers Craig G. Vought and John A. Foster.
The merger is intended to qualify as a tax-free reorganization at the corporate level for federal income tax purposes, with Spieker stockholders recognizing taxable income only up to the amount of cash received in the merger. The closing of the transaction is conditioned upon each party receiving an acceptable tax opinion to that effect. The merger, which will be accounted for using purchase accounting, is subject to the approval of the shareholders of both companies and to other customary conditions.
RESULTS OF OPERATIONS
GENERAL
The following discussion is based primarily on the consolidated financial statements of Equity Office as of December 31, 2000 and 1999, and for the years ended December 31, 2000, 1999 and 1998.
Equity Office receives income primarily from rental revenue from the Office Properties, including reimbursements from tenants for certain operating costs, and from parking revenue from Office Properties and Parking Facilities.
Below is a summary of Equity Office's acquisition and disposition activity since January 1, 1999. The buildings and total square feet shown include Properties Equity Office owns in joint ventures with other partners and reflects the total square footage of the Properties. Excluding the joint venture partners' share of
the square feet of these Properties, Equity Office effectively owned 92.7 million square feet of office space as of December 31, 2000.
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(1) The 601 Tchoupitoulas garage previously was considered a stand-alone garage and included in the number of Parking Facilities.
As a result of the acquisition and disposition of properties, the financial data presented shows changes in revenues and expenses from period to period. Therefore, Equity Office does not believe its period-to-period financial data are necessarily comparable. The following analysis shows changes resulting from Properties that were held during the entire period for the periods being compared (the "Core Portfolio") and the changes in the Total Portfolio.
As reflected in the tables below, property revenues include rental revenues, reimbursements from tenants for certain expenses, parking revenue, Access services revenue and other property operating revenues. Property operating expenses include real estate taxes, insurance, repairs and maintenance and other property operating expenses.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2000 TO DECEMBER 31, 1999
The table below represents selected operating information for the Total Portfolio and for the Core Portfolio consisting of 265 Office Properties and seven Parking Facilities acquired or placed in service on or prior to January 1, 1999.
Property Revenues
The increase in property revenues in the Core Portfolio resulted from an increase in rental rates partially offset by a decrease in occupancy. The weighted average occupancy of the Core Portfolio decreased from 95.3% at January 1, 1999 to 94.4% at December 31, 2000, mainly due to tenant rollover at various Properties. Included in Property Revenues are lease termination fees. These fees relate to specific tenants who have paid a fee to terminate their lease obligations before the end of the contractual term of their lease. Although Equity Office has historically experienced similar levels of such termination fees, there is no way of predicting the timing or amounts of future lease termination fees.
Interest/Dividend Income
Total Portfolio interest/dividend income increased primarily as a result of a $75 million investment in May 2000 in Series A Convertible Cumulative Preferred Stock (the "Series A Preferred Stock") of HQ Global Workplaces, Inc. ("HQ"). The Series A Preferred Stock has an initial dividend rate of 13.5% per annum, which increases by 50 basis points each year through maturity in 2007. Interest/dividend income also
increased as a result of a $73.9 million investment in September 1999 in a mezzanine-level debt position related to the SunAmerica Center office property. Equity Office's share of the face amount of the note is approximately $136.0 million and bears interest at 7.25% and matures August 31, 2014. Equity Office also earned interest from property disposition proceeds held in escrow accounts. The amounts in escrow will be utilized for property acquisitions or returned to Equity Office.
Interest Expense
Total Portfolio interest expense increased from the prior period as a result of having a higher average outstanding debt balance as compared to the prior period, mainly as a result of the Cornerstone Merger, and an increase in the weighted average interest rate. In addition, the following statistics for each period for the Total Portfolio are as follows:
- Total debt to total assets increased to 46.8% from 41.7%; - Interest coverage ratio decreased to 2.7 times from 2.9 times; and - Weighted average interest rate increased to 7.5% from 7.2%.
Core Portfolio interest expense decreased from the prior period due to the paydown of mortgage debt on certain Properties partially offset by the financing of Park Avenue Tower and 850 Third Avenue. Interest expense on unsecured notes and the lines of credit are not reflected in the Core Portfolio.
Depreciation and Amortization
Total Portfolio depreciation and amortization expense increased from the prior period as a result of Properties acquired and capital and tenant improvements made during the periods. Core Portfolio depreciation and amortization expense increased as a result of capital and tenant improvements made during the periods.
Property Operating Expenses
Core Portfolio property operating expenses increased mainly as a result of increases in real estate taxes and other operating expenses. Real estate taxes increased approximately $11.9 million due to higher property tax assessments. Other operating expenses increased approximately $21.7 million primarily due to higher repairs and maintenance costs, increased utility costs and an increase in expenses at certain properties that were under development.
General and Administrative Expenses
General and administrative expenses increased due to an increase in the number of employees at the corporate office as a result of the establishment of new revenue-producing business groups such as Access and the hiring of additional personnel in other corporate groups, primarily the information technology group. In addition, general and administrative expenses increased as a result of hiring additional personnel due to the Cornerstone Merger, which was anticipated. Although general and administrative expenses are expected to increase along with any increase in the size of the portfolio, it is also anticipated that economies of scale will be realized with future growth, should it occur.
Income from Investment in Unconsolidated Joint Ventures
Income from investment in unconsolidated joint ventures increased for the Total Portfolio due to the acquisition of an interest in 1301 Avenue of the Americas office property in August 2000 and the partial sale of 12 Office Properties in December 1999 and two Office Properties in June 2000. Equity Office retained an equity interest in these Office Properties that were partially sold and accounts for its remaining interests under the equity method of accounting. Prior to the sale, the results of operations of such Office Properties were consolidated.
Net Gain on Sales of Real Estate
Net gain on sales of real estate decreased due to the combined gross sales price in excess of book value at the time of disposition for the seven office properties, 11 parking facilities and the partial sale of two Office Properties in 2000 being less than the combined gross sales price in excess of book value at the time of disposition for four office properties and the partial sale of 11 Office Properties in 1999.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 1999 TO DECEMBER 31, 1998
The table below represents selected operating information for the Total Portfolio and for the Core Portfolio consisting of 236 Office Properties and 16 Parking Facilities acquired or placed in service prior to January 1, 1998.
Property Revenues
The increase in property revenues in the Core Portfolio resulted from a combination of occupancy and rental rate increases. The weighted average occupancy of the Core Portfolio increased from 93.8% at January 1, 1998 to 94.6% at December 31, 1999. This increase represents approximately .5 million square feet of additional occupancy in the Core Portfolio.
Property revenues for the Total Portfolio include lease termination fees of approximately $15.9 million and $15.5 million for the years ended December 31, 1999 and 1998, respectively, and property revenues for the Core Portfolio include lease termination fees of approximately $12.8 million and $14.0 million for the years ended December 31, 1999 and 1998, respectively (lease termination fees are included in the "other revenue" category on the consolidated statements of operations). These fees relate to specific tenants who have paid a
fee to terminate their lease obligations before the end of the contractual term of their lease. Although Equity Office has historically experienced similar levels of such termination fees, there is no way of predicting the timing or amounts of future lease termination fees.
Property revenues for the Total Portfolio also include straight-line rent adjustments of approximately $65.4 million and $68.1 million for the years ended December 31, 1999 and 1998, respectively. Property revenues for the Core Portfolio include straight-line rent adjustments of approximately $44.7 million and $58.0 million for the years ended December 31, 1999 and 1998, respectively.
Interest Expense
Total Portfolio interest expense increased from the prior period as a result of having more debt outstanding primarily attributable to property acquisitions. The following statistics for each period for the Total Portfolio are as follows:
- Total debt to total assets decreased to 41.7% from 42.3%; - Interest coverage ratio decreased to 2.9 times from 3.0 times; and - Weighted average interest rate increased to 7.2% from 7.1%.
Core Portfolio interest expense decreased from the prior period due to the paydown of mortgage debt with proceeds from various unsecured notes offerings and borrowing on the lines of credit. Interest expense on the unsecured notes and the lines of credit is not reflected in the Core Portfolio.
Depreciation and Amortization
Total Portfolio depreciation and amortization expense increased as a result of Properties acquired and capital and tenant improvements made during 1999 and 1998. Core Portfolio depreciation and amortization expense increased as a result of capital and tenant improvements made to the Properties.
Property Operating Expenses
Core Portfolio property operating expenses increased due to an increase in real estate tax expense of approximately $10.1 million due to higher property tax assessments in certain markets and an increase in insurance expense. These increases were partially offset by decreases in repairs and maintenance and other property operating expenses.
General and Administrative Expenses
General and administrative expenses increased due to increases in the size of Equity Office's portfolio and additional expenses associated with being a public company. During 1999, Equity Office made significant investments in its information systems, including the hiring of additional personnel and established a real estate services group. In addition, Equity Office incurred severance costs during 1999 that were not incurred in 1998. While general and administrative expenses are expected to continue to increase along with any increase in the size of Equity Office's portfolio, it is also anticipated that Equity Office will realize economies of scale with future growth, should it occur.
Income from Investment in Unconsolidated Joint Ventures
Income from investment in unconsolidated joint ventures increased for the Total Portfolio due to the partial sale of twelve Office Properties in December 1999. Equity Office retained an equity interest in the twelve Office Properties and accounts for its remaining interest under the equity method of accounting. Prior to the sale, Equity Office consolidated the results of operations of such Office Properties.
ACCESS INCOME
Equity Office generates income by providing its tenants with access to services and by investments in companies that provide tenant services. Below is a table summarizing this income:
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(1) Amounts reflected for Access services include income from the following: Telecom, Adcom, ATMs, Book Fairs and Vending.
(2) Equity Office received common stock and/or warrants to purchase common stock for allowing companies that provide telecommunication and other services access to Equity Office properties. The securities received from these companies were recorded as deferred revenue at fair value at the time such securities were earned and are included in other liabilities on the balance sheet. The deferred revenue is being amortized into other income over the terms of the respective license agreements.
(3) Equity Office indirectly owns a 47.5% membership interest in this joint venture. The joint venture provides fully furnished offices under short-term, flexible rental agreements to prospective tenants seeking this type of office space.
PARKING OPERATIONS
In May 2000 Equity Office disposed of 11 of its 20 Parking Facilities. The financial condition and the results of operations of the remaining nine Parking Facilities are not considered by management to be material to Equity Office's consolidated results. Therefore, summary financial information for the Parking Facilities for the year ended December 31, 2000 is not presented.
The Total Portfolio and Core Portfolio selected operating information for 1999 and 1998 presented above includes results of operations from the Parking Facilities. Summarized information for the Parking Facilities is presented below.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 1999 TO DECEMBER 31, 1998
The table below represents selected operating information for the Total Portfolio and the Core Portfolio consisting of 16 Parking Facilities acquired prior to January 1, 1998.
PROPERTY DISPOSITIONS
Equity Office has disposed or partially disposed of the following office properties and parking facilities since January 1, 1998:
(1) These Office Properties were partially sold. Equity Office accounts for its remaining interest in these Office Properties under the equity method of accounting.
(2) These 11 parking facilities were disposed of on May 17, 2000.
(3) Media Center was a development site.
(4) Consists of two parking facilities.
Below is a summary of the results of operations of these properties through their respective disposition dates:
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
Net cash from operations represents the primary source of liquidity to fund distributions, debt service, recurring capital costs and non-revenue enhancing tenant improvements. Equity Office expects that its Line of Credit will provide for temporary working capital, the funding of capital improvements and revenue enhancing tenant improvements, unanticipated cash needs and funding of acquisitions and development costs. In order to qualify as a REIT for federal income tax purposes, Equity Office must distribute annually at least 95% of its REIT taxable income (excluding capital gains). For taxable years beginning after December 31, 2000, this REIT distribution requirement will be 90%. Accordingly, Equity Office currently intends to continue to make, but has not contractually bound itself to make, regular quarterly distributions to holders of Common Shares and preferred shares. Subject to the foregoing, Equity Office has established annual distribution rates as follows:
- $1.80 per annum per Common Share; - 8.98% per annum ($2.245 per share) for each Series A Preferred Share; - 5.25% per annum ($2.625 per share) for each Series B Preferred Share; and - 8.625% per annum ($2.15625 per share) for each Series C Preferred Share.
Since Equity Office's anticipated distributions will not allow Equity Office, using only cash from operations, to retire all of its debt as it comes due, Equity Office will be required to repay maturing debt with funds from debt and/or equity financing. There can be no assurance that such financing will be available on acceptable terms or at all.
Debt Financing
The table below summarizes the mortgage debt, unsecured notes and lines of credit indebtedness at December 31, 2000 and 1999, including a net unamortized (discount)/premium on mortgage debt of $(17,825) and $10,574, respectively, and a net unamortized (discount)/premium on unsecured notes of
$(3,807) and $47, respectively, recorded in connection with property acquisitions, mergers and the issuance of unsecured notes.
The variable rate debt bears interest at an interest rate based on various spreads over LIBOR.
MORTGAGE DEBT
As of December 31, 2000, total mortgage debt (excluding Equity Office's share of unconsolidated debt of approximately $834.1 million) consisted of approximately $2.8 billion of fixed-rate debt with a weighted average interest rate of approximately 7.8% and $133.5 million of variable rate debt based on various spreads over LIBOR. Equity Office's mortgage debt at December 31, 2000 will mature as follows:
The instruments encumbering the Properties restrict transfer of the respective Properties subject to the terms of the mortgage, prohibit additional liens and require payment of real estate taxes on the Properties, maintenance of the Properties in good condition, maintenance of insurance on the Properties and obtaining lender consent to material tenant leases.
LINES OF CREDIT
During 1999, Equity Office had a $1.0 billion revolving credit facility (the "$1.0 Billion Credit Facility"). The interest rate was based on Equity Office's investment grade rating on its unsecured debt and was at LIBOR plus 60 basis points with a facility fee, based on the aggregate amount of the facility, equal to 20 basis points per annum.
When the Cornerstone Merger was completed, the cash portion of the merger consideration of approximately $1.2 billion was funded from the $1.0 Billion Credit Facility and a new $1.0 billion revolving
credit facility obtained in May 2000 (the "Line of Credit"). Concurrently with the Cornerstone Merger, Equity Office borrowed $1.0 billion under the $1.0 Billion Credit Facility and amended this facility into a term loan (the "Term Loan"). Interest on the Term Loan was based on LIBOR plus 80 basis points and was scheduled to mature on May 29, 2001. In November 2000, Equity Office repaid the Term Loan and terminated the loan agreement. As a result, Equity Office incurred an extraordinary loss of $.9 million representing unamortized deferred loan costs.
The remaining cash consideration in the Cornerstone Merger was funded under the Line of Credit, which bears interest at LIBOR plus 60 basis points and matures on June 19, 2003. There is also an annual facility fee of $2.0 million payable quarterly. In addition, a competitive bid option, whereby the lenders participating in the credit facility bid on the interest rate to be charged, is available for up to $350 million of the borrowings under the credit facility. In addition, as part of the Cornerstone Merger, Equity Office assumed interest rate protection agreements in the notional amount of $250 million ($185 million terminated in December 2000 and the remaining interest rate protection agreements terminated in January 2001). These interest rate protection agreements effectively converted a portion of the Line of Credit to a fixed-blended interest rate of 4.6% during the term of the protection agreements. As of March 16, 2001, there was $76.0 million outstanding on the Line of Credit.
In January 2000, Equity Office obtained an additional unsecured borrowing facility from the Chase Manhattan Bank for short-term borrowings not to exceed $300 million in the aggregate. Upon request of Equity Office, and at the lender's option, the lender may offer to lend funds at mutually agreed upon interest rates and terms, as determined by current market condition. In April 2000, this term loan was repaid in the amount of $100 million with proceeds from the $1.0 Billion Credit Facility and the agreement was terminated.
UNSECURED NOTES
The table below summarizes Equity Office's unsecured notes outstanding as of December 31, 2000:
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(1) Includes the cost of terminated interest rate protection agreements, offering and transaction costs and premiums and discounts on certain unsecured notes. (2) The notes are subject to mandatory redemption and a remarketing agreement in 2002 but do not mature until 2012. (3) These notes are exchangeable into Common Shares at an exchange price of $34.00 per share, which is equal to an exchange rate of 29.4118 Common Shares per $1,000 principal amount of notes. If the closing price of a Common Share on the NYSE at the time a holder exercises its exchange right is less than the exchange price of $34.00, the holder will receive, in lieu of Common Shares, cash in an amount equal to 97% of the product of: (a) the number of Common Shares into which the principal amount of notes subject to such exercise would otherwise be exchangeable; and (b) such closing price per Common Share. The notes were issued by EOP Partnership and are guaranteed by Equity Office.
EOP Partnership previously filed a shelf registration statement, which was declared effective on July 22, 1998, relating to the issuance from time to time of up to $2.0 billion of unsecured debt securities and warrants exercisable for debt securities in amounts, at initial prices and on terms to be determined at the time of the offering. In August 2000, EOP Partnership registered an additional $60 million of unsecured notes under this registration statement in connection with the issuance of $360 million of senior exchangeable notes guaranteed as to principal and interest by Equity Office. EOP Partnership has issued a total of $2.06 billion of unsecured notes under the registration statement, of which $860 million were issued in 2000. Net proceeds from the issuance and sale of notes in 2000 were used to pay down balances from time to time outstanding under the Term Loan.
EOP Partnership filed a shelf registration statement, which was declared effective by the SEC on August 31, 2000, relating to the issuance from time to time of up to an additional $2.0 billion of unsecured debt securities and warrants exercisable for debt securities in amounts, at initial prices and on terms to be determined at the time of the offering. In November 2000, EOP Partnership issued $1.0 billion of unsecured notes under this registration statement. The net proceeds from this offering were used to pay down the Term Loan and the Line of Credit.
RESTRICTIONS AND COVENANTS
Agreements or instruments relating to the unsecured notes and lines of credit contain certain restrictions and requirements regarding total debt-to-assets ratios, secured debt-to-total assets ratios, debt service coverage ratios, minimum ratio of unencumbered assets to unsecured debt and other limitations.
EQUITY SECURITIES
A summary of the activity of Equity Office's Common Shares and EOP Partnership's Units during 2000 is as follows:
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(a) As part of the share repurchase plan, 4,742,500 Common Shares were repurchased and retired in January and February 2000 at an average share price of $25.27 for approximately $119.8 million in the aggregate,
including commissions of approximately $.2 million. The share repurchase plan was suspended in February 2000.
MARKET RISK
QUALITATIVE INFORMATION ABOUT MARKET RISK
Equity Office's future earnings, cash flows and fair values relevant to financial instruments are dependent upon prevalent market rates. Market risk is the risk of loss from adverse changes in market prices and interest rates. Equity Office manages its market risk by matching projected cash inflows from operating, investing and financing activities with projected cash outflows to fund debt service, acquisitions, capital expenditures, distributions to shareholders and unitholders and other cash requirements. The majority of Equity Office's outstanding debt (maturing at various times through 2029) has a fixed interest rate, which minimizes the risk of fluctuating interest rates. Equity Office utilizes certain derivative financial instruments at times to limit interest rate risk. Interest rate protection agreements are used to convert variable rate debt to a fixed rate basis or to hedge anticipated financing transactions. Derivatives are used for hedging purposes rather than speculation. Equity Office does not enter into financial instruments for trading purposes.
QUANTITATIVE INFORMATION ABOUT MARKET RISK
Interest Rate Risk
As of December 31, 2000, total outstanding debt was approximately $8.8 billion, of which approximately $184.5 million, or 2.1%, is variable rate debt. If market rates of interest on the variable rate debt increase by 10% (or approximately 76 basis points), the increase in interest expense on the variable rate debt would decrease future earnings and cash flows by approximately $1.4 million annually. If market rates of interest increased by 10%, the fair value of the total outstanding debt would decrease by approximately $84.1 million. If market rates of interest on the variable rate debt decrease by 10% (or approximately 76 basis points), the decrease in interest expense on the variable rate debt would increase future earnings and cash flows by approximately $1.4 million annually. If market rates of interest decrease by 10%, the fair value of the total outstanding debt would increase by approximately $85.8 million.
As of December 31, 1999, total outstanding debt was approximately $5.9 billion, of which approximately $.6 billion, or 10%, was variable rate debt. If market rates of interest on the variable rate debt increased by 10% (or approximately 74 basis points), the increase in interest expense on the variable rate debt would have decreased future earnings and cash flows by approximately $4.3 million. If market rates of interest increased by 10%, the fair value of the total outstanding debt would have decreased by approximately $157.1 million. If market rates of interest on the variable rate debt decreased by 10% (or approximately 74 basis points), the decrease in interest expense on the variable rate debt would have increased future earnings and cash flows by approximately $4.3 million. If market rates of interest decreased by 10%, the fair value of the total outstanding debt would have increased by approximately $166.2 million.
Market Rate Risk
At December 31, 2000, Equity Office had put option agreements outstanding in connection with the acquisition of certain properties in 1997 from Wright Runstad & Company. On August 12, 1999, Equity Office and the holders of the Wright Runstad & Company options (the "WR Holders") amended their put option agreement to defer to August 13, 2000 (or to August 13, 2001 at the option of the WR Holders) the exercise date for 1,717,844 of the 3,435,688 Common Shares affected by the put option agreement (a maximum exposure to Equity Office of approximately $54.1 million when and if this put option is exercised). Equity Office and the WR Holders also agreed to cancel the put option on the remaining 1,717,844 Common Shares in exchange for Equity Office's payment to the WR Holders of approximately $11.3 million on September 13, 1999. The payment represented the excess of $31.50 over $24.90 (the average price of a Common Share calculated over the five trading days immediately prior to August 13, 1999), for each of the 1,717,844 Common Shares affected by the put option agreement. The portion of the amounts paid in excess of $29.10625 per Common Share totaling approximately $4.1 million was reflected as a preferred distribution. The remaining $7.2 million of the payment was recorded as a reduction to shareholders' equity.
The WR Holders exercised their option to extend the date to August 13, 2001, at which time the WR Holders can require Equity Office to purchase all or a portion of the remaining 1,717,844 Common Shares issued to them at a price equal to $31.50 per Common Share. Prior to such date, if the WR Holders sell all or a portion of their Common Shares to a third party for a price less than $29.10625, then Equity Office is obligated to pay to the WR Holders for each Common Share sold at such lower price an amount equal to the difference between $29.10625 and such lower price, not to exceed $3.00 per Common Share. Any amounts paid by Equity Office as a result of such sales will be recorded as a reduction in shareholders' equity. For put options exercised on August 13, 2001, any amounts paid up to $29.10625 per Common Share would be reflected as a reduction in shareholders' equity and the portion of any amounts paid in excess of $29.10625 per Common Shares (not to exceed $2.39375 per Common Share up to an aggregate of approximately $4.1 million) will be reflected as a put option settlement. The $4.1 million portion of the total potential payment has been reflected as a put option settlement on a straight-line basis over the period between August 13, 1999 and August 13, 2000.
Equity Office's cash flows could decrease by up to $5.2 million if, prior to August 13, 2001, the WR Holders sell all their Common Shares to third parties. Cash flows may decrease by up to approximately $54.1 million if the WR Holders exercise their rights under the put option agreement on August 13, 2001. There will be no impact on cash flows from this transaction if the put option is not exercised.
Equity Office has several investments in marketable securities. If the market price of these securities increases or decreases by 10%, Equity Office's investment in the securities would increase or decrease by approximately $.7 million. Changes in the market prices of these securities are required to be reflected as a corresponding adjustment to accumulated other comprehensive income. At December 31, 2000, Equity Office had an unrealized holding loss on these investments totaling approximately $28.3 million, which is reflected as accumulated other comprehensive (loss) income. This compares to an unrealized holding gain of $10.9 million at December 31, 1999. There will be no impact on earnings or cash flows of Equity Office from market price fluctuations unless Equity Office disposes of these investments or writes-down the investments upon the determination that these investments have suffered a permanent impairment.
Interest and market risk amounts were determined by considering the impact of hypothetical interest rates and equity prices on Equity Office's financial instruments. These analyses do not consider the effect of the reduced level of overall economic activity that could exist in such an environment. Further, in the event of a change of such magnitude, management would likely take actions to further mitigate its exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, these analyses assume no changes in Equity Office's financial structure.
CAPITAL EXPENDITURES AND TENANT IMPROVEMENTS
Capital expenditures are categorized as follows:
- Non-recurring capital improvements -- capital improvements completed in the year of acquisition and the following two years (which were planned at the time of acquisition) and major renovations that enhance the value of the property; - Recurring capital expenditures -- capital improvements incurred that enhance the value of the Property that are not classified as non-recurring capital improvements; - Development costs -- all hard and soft costs associated with the development or redevelopment of a Property, including tenant improvements, leasing commissions and capitalized interest and operating costs until the Property is substantially complete and ready for its intended use; - Revenue enhancing tenant improvements and leasing commissions -- tenant improvements and leasing commissions incurred on space which is vacant at the time of acquisition or has been vacant for nine months or more; and - Non-revenue enhancing tenant improvements and leasing commissions -- tenant improvements and leasing commissions incurred in connection with the renewal or retenanting of currently leased space to maintain the revenue being generated by such space.
The table below details the amounts incurred for each type of expenditure:
DEVELOPMENTS
Equity Office currently owns several Properties in various stages of development or pre-development. These developments are funded with proceeds from working capital and the credit facility. Specifically identifiable direct acquisition, development and construction costs are capitalized including, where applicable, salaries and related costs, real estate taxes, interest and certain pre-construction costs essential to the development of a property. The Properties under development as of December 31, 2000 are as follows:
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(1) The Estimated Placed in Service Date represents the date the certificate of occupancy has been or is currently anticipated to be obtained. Subsequent to obtaining the certificate of occupancy, the Property is expected to undergo a lease-up period. The Total Estimated Costs represent current estimates of total development costs, including amounts required to tenant the Property. These costs are estimates and are subject to change upon or prior to completion of the development.
(2) Equity Office and Wilson Investors ("WI") entered into a joint venture agreement to form Wilson/ Equity Office, LLC ("W/EO") for the purpose of developing, constructing, leasing and managing developments. W/EO is owned 49.9% by Equity Office and 50.1% by WI. William Wilson III, a trustee of Equity Office, through his ownership of WI, owns approximately 22% of W/EO (and approximately 30% of any promote to which WI is entitled under the joint venture agreement). Equity Office will loan up to $25 million to WI for their required contribution to W/EO at a 15% return per annum. The current outstanding balance of this loan as of December 31, 2000, is approximately $4.1 million.
Equity Office has created or anticipates creating joint ventures with W/EO, and, in certain cases, unaffiliated third parties, for the development properties included herein. The costs for these developments generally will be funded by Equity Office and W/EO in a 60%/40% ratio and in some cases by third parties as described within each development's respective operating agreement. The Board of Trustees has also authorized Equity Office to negotiate and enter into an agreement with W/EO providing for the extension of first mortgage financing to the ownership entities of each of these developments at LIBOR plus 2.4642%, generally maturing 36 months after initial funding, or earlier at the option of Equity Office in the event alternative financing sources are available on terms reasonably acceptable to WI and any unrelated third-party investors. The aggregate amount of any such financing would be generally capped at 70% of budgeted construction costs. In accordance with the W/EO
Operating Agreement, Equity Office is entitled to purchase the W/EO interest in each development subsequent to project stabilization.
(3) The Estimated Placed in Service Date represents the date the certificate of occupancy has been or is currently anticipated to be obtained. Effective Ownership Percentage represents Equity Office's direct interest in the development and its 49.9% interest in W/EO. Costs Incurred as of December 31, 2000, and Total Estimated Costs are based on Equity Office's Effective Ownership Percentage. The remaining ownership interest/costs are owned/funded by WI through its investment in W/EO and on certain developments unaffiliated third parties.
(4) Total Project Estimated Costs represents 100% of the estimated costs including Equity Office's, WI's and any unaffiliated third party's portions. These costs are subject to change upon or prior to the completion of the development and include amounts required to tenant the Property.
(5) Foundry Square is a project with four sites, each of which has a separate joint venture structure. Equity Office's Effective Ownership Percentages are approximately 68%, 64%, 40% and 40%.
(6) Under the terms of the lease for the property, the lessor is entitled to share, in addition to base rent, in 50% of proceeds from the operation and ownership of this development after a preferred 11% cumulative return to the lessee (8% prior to project stabilization). Other partners may share in excess cash flow, if any.
(7) Under the terms of the ground lease, the ground lessor is entitled to share, in addition to ground rent, in proceeds from the operation and ownership of this development after a 10% return to lessee, calculated at 25.7% of proceeds prior to a 14% cumulative return (18% after 2018) and 20.7% thereafter.
(8) Larkspur Landing is a potential development currently being evaluated by W/EO.
In addition to the developments described above, Equity Office owns various land parcels available for development. These sites represent possible future development of up to approximately seven million square feet of office space. The development of these sites will be impacted by the timing and likelihood of success of the entitlement process, which is uncertain. These various sites include, among others: Reston Town Center, Reston, VA; Prominence in Buckhead, Atlanta, GA; Perimeter Center, Atlanta, GA; Tabor Center, Denver, CO; Orange Center, Orange, CA; and City Center Bellevue, Bellevue, WA.
IMPACT OF NEW ACCOUNTING STANDARDS
In June 1998, the FASB issued Statement No. 133 "Accounting for Derivative Instruments and Hedging Activities." The statement requires recording all derivative instruments as assets or liabilities, measured at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. The standard's effective date was deferred by FASB Statement No. 137 to all fiscal years beginning after June 15, 2000. Equity Office adopted the standard on January 1, 2001 and recorded a cumulative effect of a change in accounting principle resulting in a loss of approximately $1.1 million. Management does not anticipate that the adoption will have a material impact on Equity Office's financial condition and results of operations.
INFLATION
Substantially all of the office leases require the tenant to pay, as additional rent, a portion of any increases in real estate taxes (except, in the case of certain California leases, which limit the ability of the landlord to pass through to the tenants the effect of increased real estate taxes attributable to a sale of real property interests) and operating expenses over a base amount. In addition, many of the office leases provide for fixed increases in base rent or indexed escalations (based on the Consumer Price Index or other measures). Equity
Office believes that the majority of inflationary increases in expenses will be offset, in part, by the expense reimbursements and contractual rent increases described above.
FUNDS FROM OPERATIONS
Management of Equity Office believes Funds from Operations, as defined by the Board of Governors of the National Association of Real Estate Investment Trusts ("NAREIT") to be an appropriate measure of performance for an equity REIT. While Funds from Operations is a relevant and widely used measure of operating performance of equity REITs, it does not represent cash flow from operations or net income as defined by GAAP, and it should not be considered as an alternative to these indicators in evaluating liquidity or operating performance of Equity Office.
The following table reflects the calculation of Funds from Operations for the years ended December 31, 2000, 1999 and 1998:
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(1) The White Paper on Funds from Operations approved by NAREIT in March 1995 defines Funds from Operations as net income (loss), computed in accordance with GAAP, excluding gains (or losses) from debt restructuring and sales of properties, plus real estate related depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures. In November 1999, NAREIT issued a National Policy Bulletin effective January 1, 2000 clarifying the definition of Funds from Operations to include all operating results, both recurring and non-recurring, except those defined as extraordinary under GAAP. In accordance with this NAREIT Bulletin, Equity Office no longer adjusts for the amortization of discounts and premiums on mortgages when calculating Funds from Operations. Accordingly, Equity Office restated the prior period data for comparative purposes. Equity Office believes that Funds from Operations is helpful to investors as a measure of the performance of an equity REIT because, along with cash flow from operating activities, financing activities and investing activities, it provides investors with an indication of the ability of Equity Office to incur and service debt, to make capital expenditures and to fund other cash needs. Equity Office computes Funds from Operations in
accordance with standards established by NAREIT, which may not be comparable to Funds from Operations reported by other REITs that do not define the term in accordance with the current NAREIT definition or that interpret the current NAREIT definition differently than Equity Office. Funds from Operations does not represent cash generated from operating activities in accordance with GAAP, nor does it represent cash available to pay distributions and should not be considered as an alternative to net income, determined in accordance with GAAP, as an indication of Equity Office's financial performance or to cash flow from operating activities, determined in accordance with GAAP, as a measure of Equity Office's liquidity, nor is it indicative of funds available to fund Equity Office's cash needs, including its ability to make cash distributions.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information about quantitative and qualitative disclosures about market risk is incorporated herein by reference from Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations in the Market Risk section.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS.
REPORT OF INDEPENDENT AUDITORS
The Board of Trustees and Shareholders of Equity Office Properties Trust
We have audited the accompanying consolidated balance sheets of Equity Office Properties Trust ("Equity Office") as of December 31, 2000 and 1999, and the related consolidated statements of operations, shareholders' equity and comprehensive income and cash flows for each of the three years in the period ended December 31, 2000. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and the schedule are the responsibility of Equity Office's management. Our responsibility is to express an opinion on these financial statements and the schedule 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Equity Office at December 31, 2000 and 1999, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
Ernst & Young LLP Chicago, Illinois February 5, 2001 except for Note 25, as to which the date is February 23, 2001
EQUITY OFFICE PROPERTIES TRUST CONSOLIDATED BALANCE SHEETS
See accompanying notes.
EQUITY OFFICE PROPERTIES TRUST CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying notes.
EQUITY OFFICE PROPERTIES TRUST CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
See accompanying notes.
EQUITY OFFICE PROPERTIES TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS
EQUITY OFFICE PROPERTIES TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS -- (CONTINUED)
See accompanying notes.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- BUSINESS AND FORMATION OF EQUITY OFFICE
As used herein, "Equity Office" means Equity Office Properties Trust, a Maryland real estate investment trust, together with its subsidiaries, including EOP Operating Limited Partnership, a Delaware limited partnership ("EOP Partnership") and the predecessors thereof ("Equity Office Predecessors"). Equity Office was formed on October 9, 1996 to continue and expand the national office property business organized by Mr. Samuel Zell, Chairman of the Board of Trustees of Equity Office, and to complete the consolidation of the Equity Office Predecessors (the "Consolidation"). Equity Office completed its initial public offering (the "IPO") on July 11, 1997 having sold its common shares of beneficial interest, $0.01 par value per share ("Common Shares"). The net proceeds from the IPO were contributed to EOP Partnership in exchange for units of partnership interest ("Units"). Equity Office is a fully integrated, self-administered and self-managed real estate company engaged in acquiring, owning, managing, developing, leasing and renovating office properties and parking facilities. Equity Office has elected to be taxed as a real estate investment trust ("REIT") for federal income tax purposes and generally will not be subject to federal income tax if it distributes 100% of its taxable income and complies with a number of organizational and operational requirements. As of December 31, 2000, Equity Office owned or had an interest in 381 office properties (the "Office Properties") containing approximately 99.0 million rentable square feet of office space and owned nine stand-alone parking facilities (the "Parking Facilities" and, together with the Office Properties, the "Properties") containing approximately 14,244 parking spaces. The weighted average occupancy for the Office Properties at December 31, 2000 was approximately 94.6%. The Office Properties are located in 104 submarkets in 37 markets in 24 states and the District of Columbia. The Office Properties, by rentable square feet, are located approximately 51.3% in central business districts ("CBDs") and 48.7% in suburban markets.
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
Equity Office's assets, which include investments in joint ventures, are primarily owned by, and its operations are substantially conducted through, EOP Partnership. Equity Office is the sole general partner of EOP Partnership. Due to Equity Office's ability as general partner to control EOP Partnership and various other property holding entities and various other subsidiaries, each such entity has been consolidated with Equity Office for financial reporting purposes. All intercompany transactions and balances have been eliminated in consolidation.
The Consolidation, the Beacon Merger and the Cornerstone Merger were accounted for as purchases in accordance with Accounting Principles Board Opinion No. 16. Accordingly, the fair value of the consideration given by Equity Office was used as the valuation basis for these transactions. The assets acquired and liabilities assumed by Equity Office were recorded at their fair values as of the closing dates of the Consolidation, the Beacon Merger and the Cornerstone Merger, as applicable, and the excess of the purchase price over the related historical basis of the net assets acquired was allocated primarily to investment in real estate.
Investment in Real Estate
Rental property and improvements, including interest and other costs capitalized during construction, are included in investment in real estate and are stated at cost. Expenditures for ordinary maintenance and repairs are expensed to operations as they are incurred. Significant renovations and improvements, which improve or extend the useful life of the assets are capitalized. Except for amounts attributed to land, rental property and
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
improvements are depreciated over their estimated useful lives using the straight-line method. The estimated useful lives by asset category are:
Deferred Leasing and Financing Costs
Deferred leasing and financing costs are recorded at cost. The deferred leasing costs are amortized over the terms of the respective leases and the deferred financing costs are amortized over the terms of the respective financings on a straight-line basis, which approximates the effective yield method.
Rental Income
Certain leases provide for tenant occupancy during periods for which no rent is due or where minimum rent payments increase during the term of the lease. Equity Office records rental income for the full term of each lease on a straight-line basis. Accordingly, a receivable is recorded from tenants for the amount that is expected to be collected over the remaining lease term rather than currently ("Deferred Rent Receivable"). When a property is acquired the term of existing leases is considered to commence as of the acquisition date for purposes of this calculation. The amounts included in rental income for the years ended December 31, 2000, 1999 and 1998, which were not currently collectible as of such dates, were approximately $69.8 million, $65.4 million and $68.1 million, respectively. Deferred Rent Receivable is not recognized for income tax purposes.
Cash Equivalents
Cash equivalents are considered to be all highly liquid investments purchased with a maturity of three months or less at the date of purchase.
Escrow Deposits and Restricted Cash
Escrow deposits primarily consist of amounts held by lenders to provide for future real estate tax expenditures and tenant improvements, earnest money deposits on acquisitions and net proceeds from tax-exempt dispositions. Restricted cash represents amounts committed for various utility deposits and security deposits. Certain of these amounts may be reduced upon the fulfillment of certain obligations.
Fair Value of Financial Instruments
Investments in marketable equity securities and investments in notes receivable are reported at fair value and included in other assets. All marketable equity securities held at December 31, 2000 were designated as available for sale, with unrealized holding gains and losses included in shareholders' equity as accumulated other comprehensive (loss) income.
Management believes that the carrying basis of the long-term debt consisting of secured and unsecured borrowings and interest rate protection agreements approximate their respective fair market values as of December 31, 2000 and 1999, respectively. The current value of debt was computed by discounting the projected debt service payments for each loan based on the spread between the market rate and the effective rate, including the amortization of loan origination costs, for each year. In addition, the carrying values of cash
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
equivalents, restricted cash, escrow deposits, tenant and other rents receivable, accounts payable and accrued expenses are reasonable estimates of their fair value.
Interest Rate Protection Agreements
Equity Office periodically enters into certain interest rate protection agreements to effectively convert or cap floating rate debt to a fixed rate basis, as well as to hedge anticipated future financing transactions. Net amounts paid or received under these agreements are recognized as an adjustment to interest expense when such amounts are incurred or earned. Settlement amounts paid or received in connection with terminated interest rate protection agreements are deferred and amortized as an adjustment to interest expense over the term of the related financing transaction on a straight-line basis, which approximates the effective yield method.
Derivatives and Hedging Activities
In June 1998, the FASB issued Statement No. 133 "Accounting for Derivative Instruments and Hedging Activities." The statement requires recording all derivative instruments as assets or liabilities, measured at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. The standard's effective date was deferred by FASB Statement No. 137 to all fiscal years beginning after June 15, 2000. Equity Office adopted the standard on January 1, 2001 and recorded a cumulative effect of a change in accounting principle resulting in a loss of approximately $1.1 million. Management does not anticipate that the adoption will have a material impact on Equity Office's financial condition and results of operations.
Deferred Revenue
During 2000 and 1999, Equity Office received common stock and/or warrants to purchase common stock for allowing companies that provide telecommunication and other services access to the Properties. The securities received from these companies were recorded as deferred revenue at fair value at the time such securities were earned and are included in other liabilities on the balance sheet. The deferred revenue will be amortized into other income over the terms of the respective license agreements. As of December 31, 2000 and 1999, approximately $37.2 million and $31.6 million is recorded as deferred revenue relating to these agreements and is being amortized over a five-year period. Approximately $5.7 million and $.7 million was recorded as other income during 2000 and 1999, respectively.
Income Taxes
The Office Properties and Parking Facilities primarily are owned by limited partnerships or limited liability companies, which are substantially pass-through entities. Some of the pass-through entities have corporate general partners or members, which are subject to federal and state income and franchise taxes. In addition, the management business is owned by a corporation and is subject to federal and state income taxes. Equity Office incurred federal and state income and franchise taxes of approximately $2.7 million, $0.7 million and $1.7 million for the years ended December 31, 2000, 1999 and 1998, respectively, which are included in general and administrative expenses.
Equity Office has elected to be taxed as a REIT, under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the "Code"). As a REIT, Equity Office generally will not be subject to federal income tax if it distributes 100% of its taxable income for each tax year to its shareholders. REITs are subject
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
to a number of organizational and operational requirements. If Equity Office fails to qualify as a REIT in any taxable year, it will be subject to federal income tax (including any applicable alternative minimum tax) on its taxable income at regular corporate tax rates. Even if Equity Office qualifies for taxation as a REIT, Equity Office may be subject to state and local income taxes and to federal income tax and excise tax on its undistributed income. The aggregate cost of land and depreciable property for federal income tax purposes as of December 31, 2000 and 1999 was approximately $12.2 billion and $10.3 billion, respectively.
Reconciliation of Net Income to Estimated Taxable Income (Unaudited)
Earnings and profits, which determine the taxability of distributions to stockholders, differ from net income reported for financial reporting purposes due to differences for U.S. Federal tax purposes in the estimated useful lives and methods used to compute depreciation and the carrying value (basis) of the investments in properties, among other things. The following table reconciles Equity Office's net income to estimated taxable income for the year ended December 31, 2000:
Minority Interests
EOP Partnership
Net income is allocated to minority interests based on their respective ownership percentage of EOP Partnership. The ownership percentage is calculated by dividing the number of Units held by the minority interests by the total Units held by both the minority interests and Equity Office. Issuance of additional Common Shares and Units changes the ownership interests of both the minority interests and Equity Office. Such transactions and the proceeds therefrom are treated as capital transactions.
Partially Owned Properties
Minority interests in partially owned properties is reflected on the balance sheet for the portion of properties consolidated that are not wholly owned. The earnings or losses from these properties attributable to the minority interests are reflected as minority interests in partially owned properties in the statements of operations.
Use of Estimates
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States 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 revenues and expenses during the reporting periods. Actual results could differ from those estimates.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
Reclassifications
Certain reclassifications have been made to the previously reported 1999 and 1998 statements in order to provide comparability with the 2000 statements reported herein. These reclassifications have not changed the 1999 or 1998 results or shareholders' equity.
NOTE 3 -- CORNERSTONE MERGER
On June 19, 2000, Equity Office, EOP Partnership, Cornerstone Properties Inc. ("Cornerstone") and Cornerstone Properties Limited Partnership ("Cornerstone Partnership") completed the merger of Cornerstone Partnership with and into EOP Partnership and the merger of Cornerstone with and into Equity Office (collectively, the "Cornerstone Merger") at a total cost of approximately $4.5 billion. The purchase price consisted of:
(1) the issuance by Equity Office of approximately 51.2 million Common Shares valued at $24.68 per share and the issuance of approximately 3.7 million share options for a total of approximately $1,268.6 million; (2) the issuance by EOP Partnership of approximately 12.4 million Units to third parties valued at $24.68 per Unit for a total of approximately $306.0 million; (3) the cash redemption of approximately 58.5 million shares of Cornerstone common stock valued at $18.00 per share for a total of approximately $1,052.2 million; (4) the cash redemption of approximately 3.0 million shares of Cornerstone preferred stock valued at $18.00 per share, plus accrued but unpaid dividends, for a total of approximately $57.6 million; (5) the assumption of approximately $1,304.9 million of secured debt and $415.5 million of unsecured debt; (6) the payment of merger costs of approximately $82.9 million; and (7) the assumption of net liabilities of approximately $19.8 million.
Certain of the amounts stated above related to the Cornerstone Merger are based on management's current best estimates, which are subject to adjustment within one year of the closing date of June 19, 2000.
The cash portion of the Cornerstone Merger of approximately $1.2 billion was funded from various credit facilities (see Note 10 -- Lines of Credit and Term Loans for more information). As a result of the Cornerstone Merger, Equity Office acquired an interest in 82 Office Properties containing approximately 18.9 million square feet of office space.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4 -- INVESTMENT IN REAL ESTATE
Investment in real estate, including Office Properties, Parking Facilities, properties under development and vacant land was as follows:
During the year ended December 31, 2000, in addition to the 82 Office Properties acquired in the Cornerstone Merger, Equity Office acquired the Properties, or remaining interests therein, listed below. Each Property was purchased from an unaffiliated party, except for Sunset North Corporate Campus and World Trade Center (see footnote (3) and (5) below), and was funded from working capital, credit facilities, assumption of mortgage debt, and/or issuance of Units. During 1999, Equity Office acquired ten Office Properties and one Parking Facility for a total cost of approximately $393.2 million.
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(1) Total acquisition cost includes the purchase price specified in the purchase contract, closing costs, acquisition costs and accounting adjustments recorded in accordance with GAAP.
(2) The total acquisition cost of Metropoint II represents the cost to acquire the remaining 30% limited partnership interest in the Property.
(3) The total acquisition cost of Sunset North Corporate Campus represents the cost to acquire the remaining interest in the Property from Wright Runstad Associates Limited Partnership ("WRALP"), a related party at the time of acquisition (See Note 21 -- Related Party Transactions, subfootnote (3)) and consisted of the assumption of debt and the remainder in cash.
(4) The total acquisition cost of 203 North LaSalle and the Theater District Garage represents the cost to acquire the remaining interests in the Property. The purchase price consisted of $12.5 million in cash and 91,406 Units valued at $28.81 per Unit.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4 -- INVESTMENT IN REAL ESTATE -- (CONTINUED)
(5) World Trade Center East was acquired from WRALP, a related party of Equity Office. The acquisition was funded primarily through the repayment of a $31.3 million mortgage note, the issuance of 227,011 Units recorded at $27.89 per Unit for a total of approximately $6.3 million and the remainder in cash.
(6) The total acquisition cost represents the cost to acquire the remaining 11% interest in these Properties and consisted of the issuance of 73,776 Units recorded at a weighted average cost of $32.11 per Unit and the remainder in cash.
NOTE 5 -- DISPOSITIONS
During 2000, Equity Office disposed of the following office properties and parking facilities:
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(1) A 49.9% interest in this 1,537,932 square foot Office Property was sold to an unaffiliated party. The remaining 50.1% interest is accounted for using the equity method of accounting.
During 1999, Equity Office disposed of four office properties totaling 668,796 square feet, a redevelopment property and partial interests in 12 Office Properties in various transactions for approximately $631.9 million and recognized a total net gain on sale of real estate of approximately $59.7 million.
During 1998, Equity Office disposed of four office properties located in Florida and one office property located in Washington, D.C. The combined square footage of these office properties was approximately 986,391 square feet. These office properties were sold for approximately $132.6 million generating a gain on sale of approximately $12.4 million.
NOTE 6 -- INVESTMENT IN NOTES RECEIVABLE
Equity Office has notes receivable that are included in Other Assets on the Consolidated Balance Sheets consisting primarily of the following:
In 1999, Equity Office acquired a 67% share of a $202.2 million mezzanine-level debt position for approximately $73.9 million as part of a debt restructuring related to the SunAmerica Center office property. The discount to the face amount of the note of approximately $64.2 million will be amortized to interest income based on the estimated yield of the investment. The note accrues interest at 7.25% per annum and matures on August 31, 2014. In addition, Equity Office previously had entered into two forward rate interest protection agreements effectively hedging the investment. These agreements were terminated prior to the investment in the mezzanine-level debt position for proceeds of approximately $1.1 million. The proceeds are
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6 -- INVESTMENT IN NOTES RECEIVABLE -- (CONTINUED)
being amortized to interest income over the term of the debt. In addition, Equity Office has the option to acquire 67% of the aggregate face amount of two other subordinate notes from the current holder, an affiliate of the property owner. The aggregate face amount of these notes is $15.0 million at December 31, 2000 and 1999.
In December 2000, Equity Office loaned approximately $21.5 million to Maguire Partners, a commercial real estate developer. The note matures on December 14, 2001 and accrues interest at 20% per annum. The note is collateralized by improvements to a 6.5-acre land parcel in Playa Vista, California, on which a 426,000 square foot office complex will be developed. In a separate agreement with the same party, Equity Office has the option to enter into a joint venture agreement with Maguire Partners to acquire an equity interest in the development. The option originally expired on March 15, 2001, but was extended to May 1, 2001.
NOTE 7 -- INVESTMENT IN SECURITIES
Equity Office owns equity interests in several companies that provide communication services or amenities to tenants. The equity interests are in the form of common or preferred stock, vested and unvested warrants to acquire common stock and an interest in a limited liability company. These investments are included in Other Assets on the Consolidated Balance Sheets. Below is a summary of these investments as of December 31, 2000:
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(1) The Square Feet (in millions) represents the portion of Equity Office's portfolio that is anticipated to be wired by each company in accordance with their respective agreements. These approximate square footage amounts are subject to change upon the signing of additional licensing agreements. As of December 31, 2000, approximately 70% of Equity Office's portfolio was wired and operational by at least one of Equity Office's strategic telecommunications providers. The majority of the portfolio is currently scheduled to be wired and operational by mid 2001.
(2) Common/preferred shares and warrants received may include amounts allocable to joint venture partners. Equity Office may earn additional common/preferred shares or warrants based upon achieving certain thresholds in accordance with the respective investment agreements or upon the signing of additional license agreements for properties.
(3) Equity Office's investments in publicly traded companies are adjusted to reflect their current market values. Equity Office's investments in privately held entities were recorded at estimated fair values when the investment was made and are valued at the lower of cost or market.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 7 -- INVESTMENT IN SECURITIES -- (CONTINUED)
(4) Equity Office invested approximately $75 million in Series A Convertible Cumulative Preferred Stock of HQ. The Series A Convertible Cumulative Preferred Stock has an initial dividend rate of 13.5% per annum and increases by 50 basis points each year. The accrued unpaid dividend, which is included in the above value, was approximately $5.9 million at December 31, 2000. This dividend may be paid in shares of additional preferred stock. The preferred stock is redeemable in 2004, matures in 2007, and may be converted to HQ's common stock upon a qualifying merger or initial public offering of HQ. In connection with the investment, Equity Office and HQ entered into a joint venture agreement to own and develop full service business centers in the Equity Office buildings. As of December 31, 2000, no amounts have been funded by Equity Office to this joint venture.
(5) Constellation Real Technologies, LLC ("Constellation") is a real estate technology company created by 11 of the nation's largest owners, managers and developers of real estate. Constellation was created to sponsor real estate-related Internet, e-commerce and telecommunications enterprises; acquire interests in existing "best of breed" companies on a synergistic basis; and act as an opportunistic consolidator across property sectors in the real estate technology area. The 11 members have committed to contribute a total of $135 million, with Equity Office committing up to $15 million. Equity Office has contributed $2.7 million as of December 31, 2000.
(6) Equity Office entered into an agreement with OnSite Access, Inc. ("OnSite"), a facilities-based provider of broadband data, video and voice communications services, delivered over fiber optic networks designed, constructed and owned by OnSite in large- and medium-sized office buildings. OnSite will provide its services to tenants in certain Office Properties. In return for access to the Office Properties, OnSite is obligated to grant Equity Office warrants to acquire common shares of OnSite for $2.36 per share.
In July 1998, Equity Office purchased 50,000 shares of Capital Trust 8.25% Preferred Securities, $1,000 liquidation preference per share, for $48.5 million. The discount of $1.5 million is being amortized as additional dividend revenue over the term of 20 years. The preferred shares are convertible at any time into common shares of Capital Trust at a conversion price of $11.70 and are non-callable for five years. The dividend is payable each quarter and commencing in year seven, the dividend will increase by 75 basis points per annum. Mr. Zell is Chairman of the Board of Capital Trust. During 2000, the terms were amended as follows:
(1) 60% of the investment, or approximately $30 million of the preferred securities were amended as follows:
- The coupon rate of 8.25% remains fixed for two more years. Thereafter, the rate will increase to the greater of: - 10%, increasing by 75 basis points per annum commencing October 1, 2004, or - a rate equal to Capital Trust's then dividend per common share divided by $7.00; - The conversion price decreased from $11.70 to $7.00 per share; - The common share equivalent was fixed at 4,285,714 shares; and - The call date was extended one year to September 30, 2004;
(2) 40% of the investment, or approximately $20 million of the preferred securities were amended as follows:
- The coupon rate of 8.25% increased to 13.0% and remained fixed until October 1, 2004 when it will increase by 75 basis points per annum; - The conversion feature is eliminated; and - The preferred securities may be called at any time; and
(3) The co-investment right was terminated.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 8 -- INVESTMENT IN UNCONSOLIDATED JOINT VENTURES
The following is a summary of Equity Office's economic ownership in unconsolidated joint ventures:
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(1) The amounts shown above approximate Equity Office's economic ownership interest for the periods presented. Cash flow from operations, capital transactions and net income are allocated to the joint venture partners in accordance with their respective partnership agreements. Equity Office's share of these items is subject to change based on, among other things, the operations of the Property and the timing and amount of capital transactions. Equity Office's legal ownership may differ.
(2) On August 2, 2000, a joint venture between Equity Office and an unaffiliated party acquired a 45% general partner equity interest and a debt interest in a limited partnership that owns 1301 Avenue of the Americas, a 1.77 million square foot office building located in Midtown Manhattan in New York. Equity Office's share of the investment at closing was approximately $163.2 million. In addition, Equity Office and its joint venture partner purchased options to acquire the remaining 55% equity interest over a period of three and one-half to eight years at a value described in the option agreements.
(3) The interest in One Post was acquired as part of the Cornerstone Merger.
(4) On June 2, 2000, Equity Office entered into a joint venture agreement with an unaffiliated party and sold a 49.9% interest in Bank of America Tower for approximately $209.6 million. See Note 5 -- Dispositions.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 8 -- INVESTMENT IN UNCONSOLIDATED JOINT VENTURES -- (CONTINUED)
(5) See Note 21 -- Related Party Transactions, subfootnote (6). Foundry Square is a project with four sites, each of which has a separate joint venture structure. Equity Office's economic ownership interests are approximately 68%, 64%, 40% and 40%.
These investments are accounted for using the equity method of accounting except for the investment in Four Oaks Place, which is accounted for utilizing the cost method of accounting. Under the equity method of accounting, the net equity investment of Equity Office is reflected on the consolidated balance sheets, and the consolidated statements of operations include Equity Office's share of net income or loss from the unconsolidated joint ventures. Any difference between the carrying amount of these investments on the balance sheets of Equity Office and the underlying equity in net assets is depreciated as an adjustment to income from unconsolidated joint ventures over 40 years.
Combined summarized financial information of the unconsolidated joint ventures is as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9 -- MORTGAGE DEBT
Equity Office had outstanding mortgage indebtedness of approximately $2.9 billion and $1.7 billion as of December 31, 2000 and 1999, respectively. The historical cost, net of accumulated depreciation of encumbered properties at December 31, 2000 and 1999 was approximately $6.3 billion and $3.8 billion, respectively. During the years ended December 31, 2000 and 1999, the following transactions occurred:
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(1) Excludes net (discount)/premium on mortgage debt of approximately $(17,825), $10,574 and $13,517 as of December 31, 2000, 1999 and 1998, respectively.
Fixed Rate Mortgage Debt
As of December 31, 2000 and 1999, Equity Office had outstanding fixed rate mortgage indebtedness of approximately $2.8 billion and $1.6 billion, respectively. Payments on fixed rate mortgage debt are generally due in monthly installments of principal and interest or interest only. As of December 31, 2000 and 1999, the effective interest rates ranged from 6.9% to 8.6% for both years, respectively. The weighted average fixed effective interest rate was approximately 7.8% and 7.5% as of December 2000 and 1999, respectively.
Variable Rate Mortgage Debt
As of December 31, 2000 and 1999, Equity Office had outstanding variable rate mortgage indebtedness of approximately $133.5 million and $126.3 million, respectively. Payments on variable rate mortgage debt are generally due in monthly installments of principal and interest or interest only. The variable interest rates are based on various spreads over LIBOR. As of December 31, 2000 and 1999, the weighted average variable effective interest rate was 7.7% and 7.2%, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9 -- MORTGAGE DEBT -- (CONTINUED)
Repayment Schedule
Scheduled payments of principal on mortgage debt for each of the next five years and thereafter as of December 31, 2000 are as follows:
NOTE 10 -- LINES OF CREDIT AND TERM LOANS
On August 14, 1998, Equity Office completed a term loan agreement with various financial institutions to provide Equity Office with a $328 million unsecured term loan facility (the "$328 Million Credit Facility"). The $328 Million Credit Facility was priced at 90-day LIBOR plus 80 basis points and was prepayable on any interest payment date. The term loan had a maturity date of August 15, 2000. On August 9, 1999, Equity Office prepaid the $328 Million Credit Facility with proceeds from a line of credit and approximately $.2 million of unamortized loan costs were written-off and accounted for as an extraordinary loss.
During 1999, Equity Office had a $1.0 billion credit facility (the "$1.0 Billion Credit Facility"). Equity Office incurred fees of approximately $2.5 million at the closing for the facility, which, along with approximately $1.0 million of unamortized deferred financing costs from a previous line of credit, were amortized over the term of the $1.0 Billion Credit Facility. The interest rate was based on Equity Office's investment grade rating on its unsecured debt and was at LIBOR plus 60 basis points with a facility fee, based on the aggregate amount of the facility, equal to 20 basis points per annum.
When the Cornerstone Merger was completed, the cash portion of the merger consideration of approximately $1.2 billion was funded from the $1.0 Billion Credit Facility and a new $1.0 billion credit facility (the "Line of Credit"), which was obtained in May 2000. Concurrently with the Cornerstone Merger, Equity Office borrowed $1.0 billion from the $1.0 Billion Credit Facility and amended the facility into a term loan (the "Term Loan"). Interest on the Term Loan was based on LIBOR plus 80 basis points and was scheduled to mature on May 29, 2001. The Term Loan was repaid in full using proceeds from several debt offerings completed during the latter part of 2000. As a result, Equity Office incurred an extraordinary loss of $.9 million representing unamortized deferred loan costs.
The remaining cash consideration in the Cornerstone Merger was funded from the Line of Credit, which bears interest at LIBOR plus 60 basis points and matures on June 19, 2003. There is also an annual facility fee of $2.0 million payable quarterly. In addition, a competitive bid option, whereby the lenders participating in the credit facility bid on the interest rate to be charged is available for up to $350 million of the borrowings under the Line of Credit. In addition, as part of the Cornerstone Merger, Equity Office assumed interest rate protection agreements in the notional amount of $250 million ($185 million terminated in December 2000 and the remaining interest rate protection agreements terminated in January 2001). These interest rate protection agreements effectively converted a portion of the Line of Credit to a fixed-blended interest rate of 4.6% during the term of the protection agreements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 10 -- LINES OF CREDIT AND TERM LOANS -- (CONTINUED)
In January 2000, Equity Office obtained an additional unsecured borrowing facility from Chase Manhattan bank for short-term borrowings not to exceed $300 million in the aggregate. Upon request of Equity Office, and at the lender's option, the lender could offer to lend funds at mutually agreed upon interest rates and terms, as determined by current market conditions. In April 2000, borrowings under this facility in the amount of $100 million were repaid with proceeds from the $1.0 Billion Credit Facility and the agreement was terminated.
NOTE 11 -- UNSECURED NOTES
The table below summarizes Equity Office's unsecured notes outstanding as of December 31, 2000:
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(1) Includes the cost of terminated interest rate protection agreements, offering and transaction costs and premiums and discounts on certain unsecured notes.
(2) These notes are subject to mandatory redemption and a remarketing agreement in 2002 but does not mature until 2012.
(3) These notes are exchangeable into Common Shares at an exchange price of $34.00 per share, which is equal to an exchange rate of 29.4118 Common Shares per $1,000 principal amount of notes. If the closing price of a Common Share on the NYSE at the time a holder exercises its exchange right is less than the exchange price of $34.00, the holder will receive, in lieu of Common Shares, cash in an amount equal to
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 11 -- UNSECURED NOTES -- (CONTINUED)
97% of the product of: (a) the number of Common Shares into which the principal amount of notes subject to such exercise would otherwise be exchangeable; and (b) such closing price per Common Share. The notes were issued by EOP Partnership and are guaranteed by Equity Office.
EOP Partnership previously filed a shelf registration statement, which was declared effective on July 22, 1998, relating to the issuance from time to time of up to $2.0 billion of unsecured debt securities and warrants exercisable for debt securities in amounts, at initial prices and on terms to be determined at the time of the offering. In August 2000, EOP Partnership registered an additional $60 million of unsecured notes under this registration statement in connection with the issuance of $360 million of senior exchangeable notes guaranteed as to principal and interest by Equity Office. EOP Partnership has issued a total of $2.06 billion of unsecured notes under the registration statement, of which $860 million were issued in 2000. Net proceeds from the issuance and sale of notes in 2000 were used to pay down balances from time to time outstanding under the Term Loan.
EOP Partnership filed a shelf registration statement, which was declared effective by the SEC on August 31, 2000, relating to the issuance from time to time of up to an additional $2.0 billion of unsecured debt securities and warrants exercisable for debt securities in amounts, at initial prices and on terms to be determined at the time of the offering. In November 2000, EOP Partnership issued $1.0 billion of unsecured notes under this registration statement. The net proceeds from this offering were used to pay down the Term Loan and the Line of Credit.
Restrictions and Covenants
Agreements or instruments relating to the unsecured notes and lines of credit contain certain restrictions and requirements regarding total debt-to-assets ratios, secured debt-to-total assets ratios, debt service coverage ratios, minimum ratio of unencumbered assets to unsecured debt and other limitations.
NOTE 12 -- MINORITY INTERESTS IN PARTIALLY OWNED PROPERTIES
The following Properties are controlled and partially owned by Equity Office but have partners with minority interests. Equity Office has included 100% of the financial condition and results of operations of these properties in the consolidated financial statements and made an allocation to the minority interests. The equity interests of the unaffiliated partners are reflected as minority interests.
The amounts shown below approximate Equity Office's economic ownership interest for the period presented. Cash flow from operations, capital transactions and net income are allocated to the joint venture partners in accordance with their respective partnership agreements. Equity Office's share of these items are
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 12 -- MINORITY INTERESTS IN PARTIALLY OWNED PROPERTIES -- (CONTINUED)
subject to change based on, among other things, the operations of the Property and the timing and amount of capital transactions. Equity Office's legal ownership may differ.
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(1) In 2000, Equity Office and an unaffiliated party formed a partnership, which owns Park Avenue Tower and 850 Third Avenue.
(2) Equity Office acquired the minority interest partners' interest in 2000. See Note (4) -- Investment in Real Estate for additional information.
(3) Equity Office sold this Property in 2000.
(4) These Office Properties were acquired in the Cornerstone Merger.
Equity Office has additional Properties that are partially owned by unaffiliated parties where Equity Office's approximate economic ownership is 100% and have not been presented above.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 13 -- SHAREHOLDERS' EQUITY
Common Shares
The following table presents the changes in the issued and outstanding Common Shares since January 1, 1999 (excluding Units of 42,060,891 and 34,203,912 outstanding at December 31, 2000 and 1999, respectively, which are convertible into Common Shares on a one-for-one basis, or the cash equivalent thereof, subject to certain restrictions):
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(1) Certain common shares were placed in escrow subject to release pursuant to the provisions of the Merger Agreement, Plan of Liquidation and Escrow Agreements entered into at the time of Consolidation. In 1999, 11,332,203 Common Shares were released from escrow and 8,220,969 of such Common Shares were cancelled and exchanged for Units, which represented a reallocation of Units owned by the Company to other minority interest partners. This reallocation did not change the total number of Units outstanding or the amount of fully diluted Common Shares and Units outstanding.
(2) In 1999, Equity Office announced a share repurchase plan. During 1999, 715,600 Common Shares were repurchased at an average share price of $23.14 for approximately $16.6 million in the aggregate and were retired. An additional 4,742,500 Common Shares were repurchased and retired between January and February 2000 at an average share price of $25.27 for approximately $119.8 million in the aggregate. In February 2000, Equity Office suspended its share repurchase plan in anticipation of the Cornerstone Merger. Prior to the implementation of Equity Office's share repurchase plan, Equity Office repurchased 324,434 Common Shares and approximately 1.2 million Units in a private transaction.
Ownership of EOP Partnership
Equity Office's ownership in EOP Partnership was approximately 87.9% and 88.0% as of December 31, 2000 and 1999, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 13 -- SHAREHOLDERS' EQUITY -- (CONTINUED) Preferred Shares
Listed below is a summary of Equity Office's Preferred Shares. The Preferred Share holders are entitled to receive, when and as authorized by Equity Office, cumulative preferential cash distributions. Equity Office may redeem the Preferred Shares at certain dates in whole or in part at a cash redemption price equal to the redemption preference plus all accrued unpaid dividends to the date fixed for redemption.
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(1) The Series B Preferred Shares are convertible at any time by the holder into Common Shares at a conversion price of $35.70 per share. These shares are non-callable for five years with a mandatory call on February 15, 2008.
In January 2000, Equity Office repurchased 6,000 Series A Cumulative Redeemable Preferred Shares and 37,100 Series C Cumulative Redeemable Preferred Shares at an average share price of $20.66 for approximately $.9 million in the aggregate and the shares were retired. The difference between the share repurchase amount and the carrying amount of the preferred shares was classified as a preferred distribution in the statement of operations for the year ended December 31, 2000.
Distributions
The following tables summarize the distributions paid to common shareholders, unitholders and preferred shareholders during the years ended December 31, 2000 and 1999:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 13 -- SHAREHOLDERS' EQUITY -- (CONTINUED)
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(1) For federal income tax purposes, 13.03% (unaudited) of the dividends paid in 2000 represented a capital gain distribution, 3.2% (unaudited) represented a return of capital and the remaining 83.77% (unaudited) represented ordinary income. In addition, 17.7% (unaudited) of the dividends paid in 1999 represented a capital gain distribution and the remaining 82.3% (unaudited) represented ordinary income.
(2) The distribution represents a prorated distribution from December 8, 1998 (the date the Series C Preferred Shares were issued) through March 14, 1999.
NOTE 14 -- FUTURE MINIMUM RENTS
Future minimum rental receipts due on noncancelable operating leases at the Office Properties and Parking Facilities as of December 31, 2000 were as follows:
Equity Office is subject to the usual business risks associated with the collection of the above scheduled rents. The future minimum rents from Equity Office's investment in unconsolidated joint ventures have not been included in the above schedule.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 15 -- FUTURE MINIMUM LEASE PAYMENTS
As of December 31, 2000, there are certain Office Properties and Parking Facilities that are subject to ground leases. Certain of these leases are subject to rental increases based upon the appraised value of the Property at specified dates or certain financial calculations based on the operations of the respective Property. As disclosed in Note 21, Equity Office leases its office space from an affiliate. Future minimum lease obligations under these noncancelable leases as of December 31, 2000 were as follows:
Rental expense for the years-ended December 31, 2000, 1999 and 1998 was approximately $12.8 million $10.6 million and $11.1 million, respectively.
NOTE 16 -- EXTRAORDINARY ITEMS
Equity Office incurred extraordinary losses of approximately $1.8 million, $10.5 million and $7.5 million during the years ended December 31, 2000, 1999 and 1998, respectively. These extraordinary losses related to the write-off of unamortized deferred loan costs and unamortized discounts and premiums and pre-payment penalties related to the early extinguishment of debt in those years. Approximately $7.0 million of the extraordinary loss in 1998 was related to fees charged upon the termination of $300 million of interest rate protection agreements in connection with the issuance of the Series B Preferred Shares.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 17 -- EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per Common Share:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 17 -- EARNINGS PER SHARE -- (CONTINUED)
The following securities were not included in the computation of diluted earnings per Common Share and common share equivalents since they would have an antidilutive effect:
For additional disclosures regarding the employee stock options and the restricted shares see Note 22 -- Share Option Plan and Share Award Plan.
NOTE 18 -- SEGMENT INFORMATION
As discussed in Note 1, Equity Office's primary business is the ownership and operation of Office Properties. Equity Office's long-term tenants are in a variety of businesses and no single tenant is significant to Equity Office's business. Information related to this segment for the years ended December 31, 2000, 1999 and 1998 is below:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 18 -- SEGMENT INFORMATION -- (CONTINUED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 18 -- SEGMENT INFORMATION -- (CONTINUED)
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(1) Interest expense for the Office Properties does not include allocation of interest expense on corporate unsecured debt.
NOTE 19 -- PRO FORMA STATEMENT OF OPERATIONS (UNAUDITED)
The pro forma data presented below is included to illustrate the effect on Equity Office's operations as a result of the Cornerstone Merger as if it occurred on January 1, 2000 and 1999, respectively. The pro forma condensed consolidated financial statements have been prepared by management and do not purport to be indicative of the results which would actually have been obtained had the Cornerstone Merger been completed on January 1, 2000 and 1999, respectively, or which may be obtained in the future.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 20 -- QUARTERLY DATA (UNAUDITED)
Quarterly data for the last two years are presented in the tables below:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 20 -- QUARTERLY DATA (UNAUDITED) -- (CONTINUED)
NOTE 21 -- RELATED PARTY TRANSACTIONS
Related parties provide various services to Equity Office. Fees and reimbursements paid by Equity Office to affiliates for the years ended December 31, 2000, 1999 and 1998 were as follows (there were no amounts payable to affiliates as of December 31, 2000 and 1999, respectively):
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(1) Represents amounts primarily paid to Rosenberg & Liebentritt, P.C., a law firm, for legal fees and expenses incurred in connection with acquisition, corporate and leasing activity. A trustee of Equity
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 21 -- RELATED PARTY TRANSACTIONS -- (CONTINUED)
Office was a principal of this law firm until September 1, 1997. In 1999, Rosenberg & Liebentritt, P.C. dissolved and, as a result, no longer provides legal services to Equity Office.
(2) Represents amounts paid to EGI Risk Services Inc. for reimbursement of property insurance premiums to an affiliated company and fees for risk management services including reviewing, obtaining and/or researching various insurance policies. EGI Risk Services, Inc. was a wholly owned subsidiary of the Equity Group, of which Mr. Samuel Zell is the Chairman of the Board. Effective October 1, 1999, Equity Office no longer utilizes the services provided by EGI Risk Services Inc., and its employees have become employees of Equity Office.
(3) H. Jon Runstad, a former trustee who resigned in July 2000, is a principal of Wright Runstad & Company, the general partner of Wright Runstad Associates Limited Partnership ("WRALP") which provides property management, leasing and development services. Equity Office and an affiliate together own a 30% limited partnership interest in WRALP. During 2000, 1999 and 1998, Equity Office received distributions of approximately $9.7 million, $2.7 million and $1.4 million, respectively from WRALP. Since December 1997, WRALP served as the co-property manager with Equity Office and leasing agent for certain Office Properties acquired in December 1997 from WRALP and for several other Office Properties. In addition to the amounts paid above to WRALP for development and management fees, leasing commissions and related expense reimbursements with respect to some of our Properties, an additional $5.0 million, $4.7 million and $3.8 million was paid during 2000, 1999 and 1998, respectively, to WRALP for the reimbursement of salaries of personnel in connection with such management services.
WRALP owned a 20% interest and Equity Office owned an 80% interest in Sunset North Corporate Campus, a three-building office complex located in Bellevue, Washington. WRALP served as the developer of the project. On June 30, 2000, Equity Office acquired the interest held by WRALP at a price based on a formula set forth in the joint venture agreement. See Note 4 for additional information.
WRALP owns a 20% interest and Equity Office owns an 80% interest in Key Center, an Office Property located in Bellevue, Washington. WRALP served as the developer of the project and currently serves as the co-property manager with Equity Office and the leasing agent.
On September 8, 2000, Equity Office obtained the World Trade Center East located in Seattle, Washington, from WRALP. WRALP served as the developer of the project. See Note 4 for additional information.
In accordance with the agreement governing the investment in WRALP, Equity Office agreed to make available to WRALP up to $20.0 million in additional financing or credit support for future development. As of December 31, 2000, no amounts have been funded pursuant to this agreement. However, Equity Office has guaranteed WRALP's line of credit, which has an outstanding balance of approximately $18.1 million as of December 31, 2000.
Wright Runstad & Company leases space in certain Office Properties. The terms of the leases are consistent with terms of unaffiliated tenant's leases. Total rents and other amounts paid by Wright Runstad & Company under its lease were approximately $.5 million, $.3 million and $.3 million for the years ended December 31, 2000, 1999 and 1998, respectively.
As mentioned above, Mr. Runstad resigned as a trustee of Equity Office in July 2000. Transactions with WRALP will no longer be considered related party transactions.
(4) Equity Office leases its corporate office space from an affiliate of the Equity Group.
(5) During 1999, fees were paid to the Equity Group for miscellaneous consulting services. In 1998 administrative services also included fees paid to Equity Group for centralized services, such as real estate tax consulting, payroll processing, employee benefits and telecommunications, all of which are now performed by Equity Office.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 21 -- RELATED PARTY TRANSACTIONS -- (CONTINUED)
(6) Equity Office and Wilson Investors ("WI") entered into a joint venture agreement to form Wilson/ Equity Office, LLC ("W/EO") for the purpose of developing, constructing, leasing and managing developments. W/EO is owned 49.9% by Equity Office and 50.1% by WI. William Wilson III, a trustee of Equity Office, through his ownership of WI, owns approximately 22% of W/EO (and approximately 30% of any promote to which WI is entitled under the joint venture agreement). Equity Office will loan up to $25 million to WI for their required contribution to W/EO at a 15% return per annum. The current outstanding balance of this loan as of December 31, 2000, is approximately $4.1 million. Equity Office's investment in W/EO as of December 31, 2000 is approximately $15.5 million, which is net of a net loss allocation of approximately $.7 million.
As of December 31, 2000, Equity Office has created or anticipates creating joint ventures with W/EO, certain of which have unaffiliated parties, for the purpose of developing office properties. The total square footage that may be developed is approximately 2.3 million and the total projected estimated cost, including Equity Office's, WI's and any unaffiliated party's share, to complete the developments is approximately $770.2 million. Equity Office's share of the cost incurred to date for the properties under development with W/EO is approximately $480.3 million. William Wilson III did not, in his capacity as trustee, approve the foregoing arrangements with Equity Office.
(7) In connection with the Cornerstone Merger, $250 million of mortgage debt was assumed on certain properties payable to Stichting Pensioenfonds voor de Gezondheid, Gaestelijke en Meatshappelljke Belangen ("PGGM"), of which Jan H.W.R. van der Vlist, a trustee of Equity Office, is a director of real estate. In October 2000, Equity Office repaid $65 million encumbering one of the Properties, TransPotomac Plaza, upon its maturity. At December 31, 2000, $185 million of principal and approximately $3.5 million of accrued interest was payable to PGGM.
In connection with the Cornerstone Merger, Equity Office paid $5.0 million to John S. Moody to enter into a non-compete agreement. Mr. Moody became a trustee of Equity Office at the time of the Cornerstone Merger and is the former president and chief executive officer of Cornerstone.
Equity Office acquired Palo Alto Square, an Office Property located in Palo Alto, California, on October 1, 1999, from a private investment partnership controlled by Mr. Samuel Zell. The acquisition was funded primarily through the issuance of 1,035,389 Units valued at $23.64 per Unit for a total of approximately $24.5 million and the assumption of $53.2 million in debt.
Equity Office has an investment in Allied Riser Corporation ("ARC") (See Note 7 -- Investment in Securities for additional information). A private investment entity controlled by Mr. Zell also has a substantial investment in ARC.
As disclosed in Note 7 -- Investment in Securities, Equity Office owns preferred shares of Capital Trust. Mr. Zell is Chairman of the Board of Capital Trust.
Amounts Received from Related Parties
Related parties of Equity Office, including WRALP, leased space in certain Office Properties. Total rents and other amounts paid by these related parties under the terms of their respective leases were approximately
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 21 -- RELATED PARTY TRANSACTIONS -- (CONTINUED)
$1.2 million, $1.2 million and $0.3 million for the years ended December 31, 2000, 1999 and 1998, respectively. In addition, in 2000 and 1999 Equity Office provided real estate tax consulting and risk management services to related parties for which it received approximately $1.4 million and $1.2 million, respectively.
NOTE 22 -- SHARE OPTION PLAN AND SHARE AWARD PLAN
Equity Office has established the 1997 Share Option and Share Award Plan, as amended (the "Employee Plan"). The purpose of the Employee Plan is to attract and retain highly qualified executive officers, trustees, employees and consultants. Through the Employee Plan, certain officers, trustees, employees and consultants of Equity Office are offered the opportunity to acquire Common Shares pursuant to grants of (i) options to purchase Common Shares ("Options") and (ii) Share Awards (defined below). The Employee Plan is administered by the Compensation and Option Committee (the "Compensation Committee"), which is appointed by the Board of Trustees. The Compensation Committee determines those officers, trustees, key employees and consultants to whom, and the time or times of which, grants of Options and Share Awards will be made. The Compensation Committee interprets the Employee Plan, adopts rules relating thereto and determines the terms and provisions of Options. In 2000, 1999 and 1998 the Common Shares subject to Options and Share Awards under the Employee Plan were limited to 20,873,729, 19,433,472 and 11,121,786, respectively. The maximum aggregate number of Common Shares that may be granted for all rights under the Plan may not exceed 6.8% of the outstanding shares, calculated on a fully diluted basis and determined annually on the first day of each calendar year. No more than one-half of the maximum aggregate number of Common Shares shall be granted as Share Awards. To the extent that Options expire unexercised or are terminated, surrendered or canceled, the Common Shares allocated to such Options shall become available for future grants under the Plan, unless the Plan has terminated. The Employee Plan will terminate at such times as it issues all of the unissued Common Shares reserved for the Plan. The Board of Trustees may at any time amend or terminate the Employee Plan, but termination will not affect Options and Share Awards previously granted. Any Options or Share Awards, which vest prior to any such termination, will continue to be exercisable by the holder thereof.
The Compensation Committee determines the vesting schedule of each Option and the term, which shall not exceed ten years from the date of the grant. As to the Options that have been granted through December 31, 2000, the vesting schedules range from the entire option grant being exercisable as of the grant date, to one-third of the Options being exercisable as of the first anniversary of the grant date, an additional one-third being exercisable as of the second anniversary of the grant date and the remaining one-third of the Options being exercisable as of the third anniversary of the grant date. The exercise price for all Options under the Employee Plan shall not be less than the fair market value of the underlying Common Shares at the time the Option is granted.
Each member of the board of trustees receives an annual grant of an Option to purchase 10,000 common shares on the date of each annual meeting of shareholders. If an individual becomes a member of the board other than at an annual meeting, he or she is entitled to a prorated Option grant based upon the number of days until the next annual meeting of shareholders. In addition, the Employee Plan permits the issuance of Share Awards to executive officers, trustees and key employees upon such terms and conditions as are determined by the Compensation Committee in its sole discretion. A share award is an award of Common Shares, which (i) may be fully vested upon issuance ("Share Awards") or (ii) may be subject to risk of forfeiture under Section 83 of the Internal Revenue Code ("Restricted Share Award"). Generally, members of the Board of Trustees have been granted Share Awards pursuant to the Employee Plan as payment of their board fees. In addition, certain senior officers were issued Share Awards as part of their bonus for fiscal year 2000 and 1999. In each case, the number of Share Awards granted to trustees and senior officers was equal to the dollar value of the fees or bonus earned divided by the fair market value of the shares on the date the fee or bonus would have been paid. In addition to these Share Awards, Restricted Share Awards were granted to
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 22 -- SHARE OPTION PLAN AND SHARE AWARD PLAN -- (CONTINUED)
certain officers and employees in 2000, 1999 and 1998. The Restricted Share Awards vest over a five year period as follows: (a) 50% on the third anniversary of the initial grant date; (b) 25% on the fourth anniversary of the initial grant date; and (c) the remaining 25% on the fifth anniversary of the initial grant date.
Equity Office has elected to apply the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25") in the computation of compensation expense. Under APB No. 25's intrinsic value method, compensation expense is determined by computing the excess of the market price of the shares over the exercise price on the measurement date. For Options, there is no intrinsic value on the measurement date (or grant date), and no compensation expense is recognized. Financial Accounting Standards Board No. 123 ("FASB No. 123") requires the disclosure of pro forma net income and net income per share as if a fair value based accounting method had been used in the computation of compensation expense. The fair value of the Options computer under FASB No. 123 would be recognized over the vesting period of the Options. The fair value for Options granted in 2000, 1999, and 1998 was estimated at the time the Options were granted using the Black-Scholes option-pricing model with the following weighted average assumptions for 2000, 1999, and 1998, respectively:
The Black-Scholes option valuation model was developed for use in estimating the fair value of trade options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because the Options have characteristics significantly different from those traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its Options and may not be representative of the effects on reported net income for future years. For purposes of pro forma disclosures, the estimated fair value of the Options is amortized to expense during the Options' vesting period. The following is the unaudited pro forma information for the years ended December 31, 2000, 1999 and 1998.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 22 -- SHARE OPTION PLAN AND SHARE AWARD PLAN -- (CONTINUED)
The table below summarizes the Option activity of the Employee Plan for the years ended December 31, 2000, 1999 and 1998:
As of December 31, 2000, there were 9,146,993 Options under the Employee Plan that were exercisable and 4,074,378 Options that were not exercisable. Exercise prices for the 13,221,371 Options outstanding as of December 31, 2000 ranged from $12.09 to $33.00, with a weighted average exercise price of $24.82. Expiration dates ranged from July 11, 2007 to August 2010. The remaining weighted average contractual life of Options was 7.8 years. The weighted average grant date fair value of Options granted during 2000, 1999 and 1998 was $5.63, $2.91 and $4.88, respectively.
In addition, there were 555,100 Restricted Shares issued during 2000 and 380,000 Restricted Shares issued during 1998. The Restricted Shares vest over three to five years. The Restricted Shares were valued at an average of $23.91 per share. The restricted shares vest 50% on the third anniversary of the grant date, 25% on the fourth anniversary of the grant date and 25% on the fifth anniversary of the grant date. The value of the Restricted Shares is amortized to compensation expense on a straight-line basis and included in general and administrative expenses.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 23 -- 401(K) PLAN
The Equity Office Properties Trust Section 401(k) Savings/Retirement Plan (the "401(k) Plan") was established to cover eligible employees of Equity Office and employees of any designated affiliate. The 401(k) Plan permits eligible persons to defer up to 16% of their annual compensation, subject to certain limitations imposed by the Internal Revenue Code. The employees' elective deferrals are immediately vested and nonforfeitable upon contribution to the 401(k) Plan. Equity Office matches dollar for dollar employee contributions to the 401(k) Plan up to 4% of the employees' annual salary. In addition, Equity Office may elect to make a discretionary profit sharing contribution. Equity Office incurred expense of approximately $3.6 million, $2.9 million and $2.4 million in each of the three years ended December 31, 2000, 1999 and 1998, respectively, related to the 401(k) Plan.
NOTE 24 -- COMMITMENTS AND CONTINGENCIES
Concentration of Credit Risk
Equity Office maintains its cash and cash equivalents at financial institutions. The combined account balances at each institution typically exceed FDIC insurance coverage and, as a result, there is a concentration of credit risk related to amounts on deposit in excess of FDIC insurance coverage. Management of Equity Office believes that the risk is not significant.
Environmental
Equity Office, as an owner of real estate, is subject to various environmental laws of federal and local governments. Compliance by Equity Office with existing laws has not had a material adverse effect on Equity Office's financial condition and results of operations, and management does not believe it will have such an impact in the future. However, Equity Office cannot predict the impact of new or changed laws or regulations on its current Properties or on properties that it may acquire in the future.
Litigation
Neither Equity Office nor any of its Properties is presently subject to material litigation nor, to Equity Office's knowledge, is any litigation threatened against Equity Office or any of the Properties, other than routine actions for negligence and other claims and administrative proceedings arising in the ordinary course of business, some of which are expected to be covered by liability insurance and all of which collectively are not expected to have a material adverse effect on the liquidity, results of operations, or business or financial condition of Equity Office.
Insurance
Equity Office is self-insured for certain amounts related to losses that may be incurred at the Properties and has third party insurance coverage for specified amounts above the deductible amounts. However, management does not believe that this exposure will have a material adverse effect on Equity Office.
Equity Office carries earthquake insurance on all of the Properties, including those located in California, subject to coverage limitations which Equity Office believes are commercially reasonable. In light of the California earthquake risk, California building codes since the early 1970s have established construction standards for all new buildings. The current and strictest construction standards were adopted in 1987. Of the 104 Properties located in California, 19 have been built since January 1, 1988, and Equity Office believes that all of the Properties were constructed in full compliance with the applicable standards existing at the time of construction. No assurance can be given that material losses in excess of insurance proceeds will not occur in the future.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 24 -- COMMITMENTS AND CONTINGENCIES -- (CONTINUED)
Commitments
In accordance with the agreement governing the investment in WRALP, Equity Office agreed to make available to WRALP up to $20.0 million in additional financing or credit support for future development. As of December 31, 2000, no amounts have been funded pursuant to this agreement. However, Equity Office has guaranteed WRALP's line of credit, which has an outstanding balance of approximately $18.1 million as of December 31, 2000.
Contingencies
Certain Properties owned in joint ventures with unaffiliated parties have buy/sell options that may be exercised to acquire the other venturer's interest by either Equity Office or its joint venture partner if certain conditions are met as defined in the respective joint venture agreement.
In connection with the acquisition of certain Properties, Equity Office has agreed not to sell such Properties in a taxable transaction for a period of time as defined in their respective agreements, or Equity Office may be obligated to make additional payments to the respective sellers.
The holders of the Wright Runstad & Company options (the "WR Holders") exercised their option to extend the date to August 13, 2001 at which time the WR Holders can require Equity Office to purchase all or a portion of the remaining 1,717,844 Common Shares issued to them at a price equal to $31.50 per Common Share. Prior to such date, if the WR Holders sell all or a portion of their Common Shares to a third party for a price less than $29.10625, then Equity Office is obligated to pay to the WR Holders for each Common Share sold at such lower price an amount equal to the difference between $29.10625 and such lower price, not to exceed $3.00 per Common Share. Any amounts paid by Equity Office as a result of such sales will be recorded as a reduction in shareholders' equity. For put options exercised on August 13, 2001, any amounts paid up to $29.10625 per Common Share would be reflected as a reduction in shareholders' equity and the portion of any amounts paid in excess of $29.10625 per Common Share (not to exceed $2.39375 per Common Share up to an aggregate of approximately $4.1 million) will be reflected as a put option settlement. The $4.1 million portion of the total potential payment has been reflected as a put option settlement on a straight-line basis over the period between August 13, 1999 and August 13, 2000.
In connection with the acquisition of Worldwide Plaza on October 1, 1998, Equity Office issued a transferable put option on the 6,861,166 Units issued in the transaction, which is exercisable only on the third anniversary of closing with an estimated fair value of approximately $27.4 million. This option entitles its holder to additional Common Shares, the number of which shall be determined using a formula based on the extent, if any, that the Common Shares are then trading at less than $29.05 per share.
NOTE 25 -- SUBSEQUENT EVENTS
1. On January 19, 2001, the mortgage note encumbering Palo Alto Square was prepaid. The total payoff was approximately $50.2 million which included accrued interest of approximately $.2 million.
2. On January 25, 2001, Warner Park Center in Woodland Hills, CA was disposed of for approximately $8.95 million to Adler Realty Advisors, Inc. and its investors. The building consisted of 57,366 square feet and was 66.3% occupied.
3. In February 2001, Equity Office and Booz Allen & Hamilton, a management and technology-consulting firm, entered into a 12-year lease for 122,000 square feet of office space in an office building to be developed by Equity Office. The office building, named EJ Randolph II, will be located in McLean, Virginia, and is expected to be completed in 2002 at a cost of approximately $35.7 million.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 25 -- SUBSEQUENT EVENTS -- (CONTINUED)
4. On February 15, 2001, the mortgage note encumbering Community Corporate Center was prepaid. The total payoff amount was approximately $16.5 million.
5. On February 22, 2001, Equity Office and Spieker Properties, Inc. ("Spieker") entered into a merger agreement in which Spieker will merge into Equity Office and EOP Partnership will acquire Spieker Properties, L.P., Spieker's operating partnership subsidiary (the "Spieker Merger"). The transaction values Spieker (including the outside interests in Spieker Properties, L.P.) at approximately $7.2 billion, which includes transaction costs and the assumption of approximately $2.1 billion in debt and $431 million in preferred stock and partnership units. Equity Office will pay approximately $1.085 billion in cash and issue approximately 118.6 million new Equity Office common shares and EOP Partnership Units and 14.3 million new Equity Office preferred shares in the transaction. We intend to finance the $1.085 billion cash portion of the purchase price using a combination of available borrowing capacity under our existing Line of Credit, and a new bridge loan facility to be entered into before the closing of the merger and/or through the issuance by EOP Partnership of senior unsecured notes.
Following the merger, Equity Office will own and operate 616 office buildings consisting of 124 million square feet of office space nationwide, which includes 25 million square feet of office space attributable to Spieker. Equity Office will also acquire Spieker's industrial portfolio of approximately 13.5 million square feet and its development properties totaling 1.7 million square feet.
Upon completion of the merger, Equity Office will expand its Board of Trustees from 13 to 16 members. The new members will be Warren Spieker, chairman of Spieker, and Co-Chief Executive Officers Craig Vought and John Foster.
The merger is intended to qualify as a tax-free reorganization at the corporate level for federal income tax purposes, with Spieker stockholders recognizing taxable income only up to the amount of cash received in the merger. The closing of the transaction is conditioned upon each party receiving an acceptable tax opinion to that effect. The merger, which will be accounted for using purchase accounting, is subject to the approval of the shareholders of both companies and to other customary conditions.
6. On February 23, 2001, the mortgage note encumbering Wachovia was prepaid. The total payoff was approximately $25.3 million.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Information about Trustees of Equity Office is incorporated by reference from the discussion under Proposal 1 in our Proxy Statement for the 2001 Annual Meeting of Shareholders. The balance of the response to this item is contained in the discussion entitled "Executive and Senior Officers of Equity Office" under Item 1 of Part I of this report.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
Information about executive compensation is incorporated by reference from the discussion under the heading "Executive Compensation" in our Proxy Statement for the 2001 Annual Meeting of Shareholders.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Information about security ownership of certain beneficial owners and management is incorporated by reference from the discussion under the heading "Common Share and Unit Ownership by Trustees and Executive Officers" in our Proxy Statement for the 2001 Annual Meeting of Shareholders.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information about certain relationships and transactions with related parties is incorporated herein by reference from the discussion under the heading "Certain Relationships and Related Transactions" in our Proxy Statement for the 2001 Annual Meeting of Shareholders.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a)(1) Financial Statements Report of Independent Auditors Consolidated Balance Sheets as of December 31, 2000 and 1999 Consolidated Statements of Operations for the years ended December 31, 2000, 1999 and 1998 Consolidated Statements of Shareholders' Equity and Comprehensive Income for the years ended December 31, 2000, 1999 and 1998 Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999 and 1998 Notes to Consolidated Financial Statements
(a)(2) Financial Statement Schedules
Schedule III -- Real Estate and Accumulated Depreciation
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.
(a)(3) Exhibits:
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* Incorporated herein by reference to the same-numbered exhibit to Equity Office's Annual Report on Form 10-K for the year ended December 31, 1997, as amended.
+ Represents a management contract or compensatory plan, contract or agreement.
(b) Reports on Form 8-K:
None.
(c) Exhibits:
See Item 14(a)(3) above.
(d) Financial Statement Schedules:
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in Chicago, Illinois, as of the 15th day of March, 2001.
EQUITY OFFICE PROPERTIES TRUST
By: /s/ TIMOTHY H. CALLAHAN ------------------------------------ Timothy H. Callahan President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities indicated as of the 15th day of March 2001.
INDEX TO EXHIBITS
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* Incorporated herein by reference to the same-numbered exhibit to Equity Office's Annual Report on Form 10-K for the year ended December 31, 1997, as amended.
+ Represents a management contract or compensatory plan, contract or agreement.
SCHEDULE III -- REAL ESTATE AND ACCUMULATED DEPRECIATION AS OF DECEMBER 31, 2000
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(1) The aggregate cost for Federal Income Tax purposes as of December 31, 2000 was approximately $12.2 billion.
(2) The life to compute depreciation on building is 40 years. The life to compute depreciation on building improvements is 4-40 years.
(3) The date acquired represents the date these Properties were acquired by Equity Office Predecessors. The acquisition of the Properties, or interest therein, by the Company from Equity Office Predecessors in connection with the Consolidation on July 11, 1997, was accounted for using the purchase method of accounting in accordance with Accounting Principles Board Opinion No. 16. Accordingly, the assets were recorded by the Company at their fair values.
(4) This Property contains 106 residential units in addition to 224,405 square feet of office space.
(5) This Property contains 161 residential units in addition to 187,573 square feet of office space.
(6) These properties were previously under development and have been placed into service during 2000.
(7) These loans are subject to cross default and collateralization provisions.
(8) The Prudential Portfolio consists of six Office Buildings located in Philadelphia, PA, Dallas, TX, and Houston, TX. These Office Buildings were constructed between 1969 and 1984.
(9) These loans are subject to cross default and collateralization provisions.
(10) These loans are subject to cross default and collateralization provisions.
(11) These loans are payable to Stichting Pensioenfonds voor de Gezondheid, Gaestelijke en Meatschappelljke Belangen and are subject to cross collateralization and cross default provisions.
(12) These properties are in various development stages. During the development period certain operating costs, including real estate taxes together with interest incurred during the development stages will be capitalized.
(13) The encumbrance on the 203 North LaSalle Garage is also secured by a first lien on the Theatre District Garage.
(14) The encumbrances at December 31, 2000 include a net discount (net of accumulated amortization of approximately $1.0 million) of approximately $17.8 million.
A SUMMARY OF ACTIVITY OF INVESTMENT IN REAL ESTATE AND ACCUMULATED DEPRECIATION IS AS FOLLOWS:
The changes in investment in real estate for the years ended December 31, 2000, 1999 and 1998, are as follows:
The changes in accumulated depreciation for the years ended December 31, 2000, 1999 and 1998, are as follows:
(1) The 2000 and 1999 Properties disposed of amounts include approximately $.4 billion and $1.1 billion, respectively, of disposed assets related to the partial sale of interests in various Properties. The related accumulated depreciation on the partially sold Properties was approximately $18.7 million and $58.5 million, respectively.