ITEM 1. BUSINESS
General
Your partnership is a Delaware limited partnership that owns commercial properties, most of which are net-leased to investment grade corporate tenants, as well as other real estate assets. Your partnership commenced operations on January 1, 2002 following the completion of a transaction that we refer to as the exchange, involving the merger into wholly-owned subsidiaries of your partnership of 90 limited partnerships, each of which owned commercial properties, and the acquisition by your partnership of various assets, including those related to the management or capital structure of those partnerships. See "Structure Chart" below. Each of the 90 partnerships, which we refer to as the "Newkirk partnerships", was organized and sponsored by Integrated Resources, Inc. between 1978 and 1984 and owned one or more commercial properties that we refer to as the "Newkirk properties". Integrated Resources filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code in February 1991 and is no longer in existence. Members of the Newkirk Group, which consists of affiliates of Apollo Real Estate Fund III, L.P., executive officers of Winthrop Financial Associates, and affiliates of Vornado Realty Trust, first acquired interests in the Newkirk partnerships in 1997.
Your partnership's initial capital structure consisted of units of limited partnership interest, which we refer to as units, that were issued in the exchange. These units were not registered under the Securities Act of 1933 (the "Securities Act") in reliance on an exemption from registration under that Act. There is no public market for the units, and there are substantial restrictions on the transfer of units.
As of March 29, 2004, there were 6,310,983 units outstanding, 6,121,990 of which were issued in the exchange and the balance of which were issued in a subsequent transaction. The outstanding units reflect the repurchase by your partnership of 128,820 units issued in the exchange.
Description of Assets
General. As of December 31, 2003, your partnership owned an interest in 225 of the Newkirk properties, subordinated interests in a securitized pool of notes evidencing first mortgage indebtedness secured by certain of your partnership's properties as well as other properties, limited partnership interests in various partnerships that own commercial net-leased properties, including 43 properties that are owned by partnerships whose operations are consolidated for financial reporting purposes with those of your partnership, substantially all of the interests in two entities that hold unsecured debt obligations of your partnership, an interest in a management company that provides services for your partnership as well as other real estate partnerships, ground leases, remainder interests or the right to acquire remainder interests in various properties and miscellaneous other assets. In addition, your partnership or an affiliate of your partnership's general partner controls the general partner of the real estate limited partnerships in which your partnership owns limited partnership interests, and your partnership has an option to acquire in the future second mortgage debt secured by a substantial number of your partnership's properties as well as the properties owned by 9 other partnerships. As of December 31, 2003, your partnership's commercial properties represented approximately 86% of the total value of your partnership's assets.
Properties. The table below summarizes as of December 31, 2003, information on the 225 Newkirk properties and 43 properties owned by 7 limited partnerships whose operations are consolidated for financial reporting purposes with those of your partnership. We refer to the partnerships that own the 43 properties as the consolidated partnerships and their properties as the consolidated properties.
Property Type Number Square Footage ------------- ------ --------------
Office 39 7,724,000 Retail 206 6,441,000 Other 23 5,277,000 ---------- ---------- TOTAL 268 19,442,000 ========== ==========
The primary lease terms on the properties generally range from 20 to 25 years from their original commencement dates (between 1977 and 1984) with primary term rents, typically above market, which, in most cases, fully amortize the first mortgage debt on the properties. In addition, tenants generally have multiple renewal options, with rents, on average, below market.
Below is a listing of tenants which accounted for 3% or more of the aggregate rental revenues in 2003 from the Newkirk properties and the consolidated properties:
- ---------- (1) Property leased to Raytheon represented approximately 12.4% of your partnership's total assets as of December 31, 2003. Raytheon is a public company subject to the reporting requirements under the Securities Exchange Act of 1934. As of December 31, 2003, no other lessee leased property representing more than 10% of your partnership's total assets.
The following chart sets forth certain information as of December 31, 2003 concerning lease expirations on the Newkirk properties and the consolidated properties (assuming no renewals) from 2004 to 2013:
- ---------- (1) Based on estimated base rent for the year ended December 31, 2004 and excludes rent on a property in Dallas, Texas with multiple tenants. See "ITEM 2.
ITEM 2. PROPERTIES
General
Substantially all of the Newkirk properties and the consolidated properties are net-leased to investment grade corporate tenants. At December 31, 2003 your partnership had six vacant properties that were not subject to leases. These properties contained an aggregate of 111,000 square feet or approximately ..6% of the total space of all properties. Your partnership also had one multi-tenanted property containing approximately 151,000 square feet or approximately .8% of the total space of all properties. This property was sold in January 2004. Your partnership's remaining properties are net leased to various tenants. The leases are similar in many respects and generally: (i) provide for fixed rent payments and obligate the tenant to pay all capital and operating expenses for a property; (ii) obligate the tenant to perform all responsibilities (other than the payment of debt service) relating to the property; (iii) require the tenant to maintain insurance against casualty and liability losses; (iv) permit the tenant to sublet the property; and (v) afford the tenant in many instances the right to terminate the lease at certain points during the primary term if it determines that continued use and occupancy of the property would be uneconomic or unsuitable. Many of the leases grant the tenant an option to purchase the property upon the expiration of the primary term of the lease and at the end of one or more renewal terms for a purchase price equal to the fair market value of such property. Your partnership maintains insurance on properties that are not leased and the general partner believes that your partnership's properties are adequately covered by insurance.
The following table sets forth certain information on the Newkirk properties and the consolidated properties as of December 31, 2003. Except as otherwise indicated in the table, the ownership interest is a fee interest in the underlying land.
- ---------- (1) Land held in land estate or pursuant to ground lease. (2) See "- Property Matters" below for information on these properties. (3) 55% interest owned by your partnership. (4) 53% interest owned by your partnership. (5) 99% interest owned by your partnership. (6) The property, an office building leased to multiple tenants, was sold in January 2004. See "- Property Matters" below for information on the sale. (7) In November 2002, your partnership received notice from the tenant exercising the economic discontinuance provisions of its lease. Under the terms of the notice, the tenant proposed to terminate the lease effective July 11, 2003 and to purchase the property for $630,797, an amount which would have been insufficient to satisfy existing mortgage indebtedness. Your partnership rejected the offer and satisfied the existing first mortgage of approximately $531,000. Your partnership has entered into a contract to sell the property for an amount in excess of the amount which would have been paid by the prior tenant. The contract is subject to completion of due diligence by the purchaser. (8) The lease on this property was terminated effective June 1, 2003. The tenant made a $276,576 early termination payment, $160,803 of which was applied to existing mortgage indebtedness. (9) These properties were sold in January 2004 (Morristown Township) and February and March 2004 (6 properties leased to CSK Auto). See "- Property Matters" below for information on the sale. (10) The lease on this property expired during the fourth quarter of 2003 and the property is now vacant.
(11) These properties were sold on March 31, 2004. See "- Property Matters" below for information on the sale. (12) The tenant defaulted on its lease and vacated this property during the fourth quarter of 2003. (13) Your partnership has received notice from Albertsons exercising a purchase option in accordance with their lease on fifteen of your partnership's properties. Your partnership has a right to reject this offer. If your partnership accepts the offer, the sale would be effective July 1, 2004 for 11 properties, October 1, 2004 for 3 properties and February 1, 2005 for 1 property. If your partnership rejects this offer, the tenant can elect to terminate the lease on July 1, 2004, October 1, 2004 and February 1, 2005, respectively, or extend its lease for eighteen months until December 31, 2005, March 31, 2006 or July 31, 2006. Rent during the eighteen month period would be at the renewal rates. If Albertsons elects to renew for the eighteen month period it will still have a series of five year renewal options. For all 15 of the properties Albertsons has elected to renew the lease for eighteen months assuming the purchase offer is rejected. Your partnership is currently reviewing all of the purchase offers in order to determine a course of action. (14) 47.52% interest owned by your partnership as of December 31, 2003. This percentage will be increased to 55.28% effective April 1, 2004. (15) 35.34% interest owned by your partnership. (16) 40.68% interest owned by your partnership as of December 31, 2003. This percentage will be increased to 68.68% effective April 1, 2004. (17) 57.75% interest owned by your partnership. (18) 60.5% interest owned by your partnership. (18) 60.5% interest owned by your partnership.
Property Matters. On January 22, 2002, Kmart Corporation, a tenant at 12 of your partnership's properties, filed for protection under Chapter 11 of the United States Bankruptcy Code. Kmart had the right to either accept or reject the leases. Kmart elected to reject the leases, which caused an immediate termination of such leases. Your partnership re-leased 9 of the properties to Furr's Restaurant Group for 10-year lease terms, one of the properties to Lithia Motors for a 10-year lease term and another property for use as a Chinese food restaurant for a 5-year lease term. The tenant of the Chinese restaurant subsequently defaulted on its lease. Your partnership is pursuing a claim against Kmart in the Bankruptcy Court. In January 2003, Furr's Restaurant Group filed for protection under Chapter 11 of the Bankruptcy Code and subsequently rejected the lease on 3 sites. The remaining sites continue to be leased to Furr's through 2012, and your partnership is pursuing a claim against Furr's in the Bankruptcy Court for the 3 rejected sites. Furr's also has the right to reject the lease that now covers the remaining sites. The aggregate annual rent for the 7 sites that are presently leased is approximately $1,269,600 compared to the approximately $1,885,000 that was scheduled to be received from Kmart on the 12 properties during its first renewal term, which would have begun in February 2003. Your partnership has purchased the land underlying all of the 12 original Kmart sites for $250,000, sold two of the vacant sites in the third quarter of 2003 and is seeking to sell or re-lease the three remaining vacant sites. The two sites were sold for $2,525,000. After satisfying existing mortgage indebtedness and closing costs, there were no net proceeds to your partnership.
On February 12, 2002, Kaiser Aluminum & Chemical Corp., the tenant at your partnership's property located in Oakland, California, filed for protection under Chapter 11. In an effort to protect your partnership's equity investment in the property, your partnership, from its cash reserve account, purchased the first mortgage debt that encumbered the property for $15,500,000. Your partnership subsequently secured approximately $14,530,000 of replacement financing from a third party lender. The note bore interest at LIBOR plus 4.5% per annum (6.42% at December 31, 2002), had a maturity date of September 1, 2003 and required monthly payments of principal and interest. Your partnership sold its interest in this property in March 2003 for approximately $122,918,000. After satisfying existing mortgage indebtedness, the net sales proceeds were approximately $28,000,000, half of which was applied to a principal payment required to be made on your partnership's loan with Fleet National Bank.
In November 2002 and January 2003, your partnership sold two properties owned by it in Oklahoma City, Oklahoma to the tenants of those properties. One property, leased to Safeway, Inc., was sold for $1,444,000 and the other property, leased to Fleming Companies, Inc., was sold for $945,611. Both properties were sold under the economic discontinuance provisions of their respective leases. As provided in the leases, the tenants had made rejectable offers to purchase the properties for specified amounts, and your partnership accepted the offers after it was unable to locate purchasers who would pay a higher price or secure new tenants for the properties. $1,023,689 of the price paid by Safeway, Inc. represented the rejectable offer price, and $420,323 represented deferred rent.
In January 2003, your partnership sold five properties owned by it in Allen, Ennis, Huntsville, Rockwell, and Waxahachie, Texas to Wal-Mart Stores, Inc., the tenant, for approximately $8,259,000. After satisfying existing mortgage indebtedness, the net sales proceeds were approximately $4,500,000, half of which was applied to a principal payment required to be made on your partnership's loan with Fleet National Bank. During 2002, Wal-Mart paid rent of $994,894 for the properties.
In February 2003, your partnership received the remaining balance due on a secured note of Cenland Associates Limited Partnership that it acquired in the exchange. The note had an outstanding balance of $1,342,000 at the time of the exchange that had been reduced to $158,000 as of December 31, 2002.
In May 2003 your partnership sold its distribution facility located in Flagstaff, Arizona to Walgreen Co., the tenant at the facility, after receiving notice from Walgreen that it was exercising its option to purchase the property. The purchase price was $9,500,000. After satisfying existing mortgage indebtedness and other costs and adjustments, the net sales proceeds were approximately $5,900,000, half of which was applied to a principal payment required to be made on your partnership's loan with Fleet National Bank.
In June 2003, one of the consolidated partnerships sold a property owned by it in Trumbull, Connecticut for $9,079,000, net of closing costs. $4,557,000 was used to pay mortgage indebtedness and your partnership received $2,149,000 of the remaining proceeds. Your partnership applied $1,075,000 to a prepaid payment on your partnership's loan to Fleet National Bank. Interests in this consolidated partnership had been acquired by your partnership from an affiliate of your partnership's general partner in January 2003. See "ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" for additional information.
In September 2003 your partnership sold a property owned by it in Sioux Falls, South Dakota for $2,700,000. After satisfying existing mortgage indebtedness and closing costs, the net sales proceeds of approximately $150,000 were applied to a principal payment required to be made on your partnership's loan with Fleet National Bank. The property had formerly been leased to Albertson's Inc. and your partnership had previously rejected an offer by Albertson's to purchase the property for $1,551,000 pursuant to the economic discontinuance provisions of its lease. Your partnership also received a $1,497,000 lease termination fee.
During the fourth quarter of 2003, your partnership sold the properties owned by it in Liberal, Kansas and New Bern, North Carolina for $775,000. After satisfying existing mortgage indebtedness and closing costs, the net sales proceeds were approximately $157,000, $117,700 of which was applied to a principal payment required to be made on your partnership's loan with Fleet National Bank.
In January 2004, your partnership sold the property owned by it in Morristown, New Jersey for $36,500,000. After satisfying existing mortgage indebtedness and closing costs, the net sales proceeds were approximately $7,532,000 which was applied to a principal payment on your partnership's loan with Fleet National Bank.
In January 2004, your partnership sold the multi-tenanted office building owned by it in Dallas, Texas for $13,000,000. After closing costs and adjustments, the net sales proceeds were approximately $11,939,000, $8,954,000 of which was applied to a principal payment on your partnership's loan with Fleet National Bank.
In February and March 2004, your partnership sold 6 retail properties owned by it and formerly leased to CSK Auto for $1,073,000. After closing costs and adjustments, the net sales proceeds were approximately $975,000, approximately $319,000 of which was used to pay off debt to T-Two Partners.
In March 2004, your partnership sold 3 retail properties formerly leased to Key Bancshares of Wyoming for $1,948,000. After closing costs and adjustments, the net sales proceeds were approximately $1,860,000, approximately $1,351,000 of which was used to pay off debt to T-Two Partners.
Land Estates and Ground Leases. As indicated above, your partnership holds either an estate for years with an option to lease the land upon expiration of the estate for years or leases a number of its properties pursuant to ground leases. Where your partnership holds an estate for years, the arrangement is for a stated period of time, which is typically one day longer than the primary term of the underlying lease. At the expiration of the estate for years, title to the land will automatically vest in a remainderman. Your partnership then has the option to lease the land from the remainderman for a stated period of time, which would in all cases exceed the aggregate number of years that a building lessee could extend its underlying lease by exercising all of its renewal terms. In general, the rentals due under the ground leases are nominal through the last renewal term of the improvements lease and then increase to fair market rent. The remainderman in almost all cases has subordinated its interest in the land to any first mortgage encumbering the property, but has not, in any case, subordinated its interest in the land to the second mortgage encumbering the property. Any second mortgage encumbers your partnership's option to lease the land at the expiration of your partnership's estate for years, and will encumber the leasehold interest in the land created upon any exercise of the option to lease by your partnership. Your partnership is continually seeking to acquire the "remainder" interests in its properties in an effort to acquire fee title to the properties.
With respect to those properties subject to a ground lease, your partnership has the right to extend the ground lease for at least as long as the aggregate number of years that a building lessee could extend its underlying lease by exercising all of its renewal terms. In general, the ground rent is passed through to the building lessee under the improvements lease.
On January 15, 2003, your partnership purchased the land underlying 12 sites formerly leased to Kmart Corporation for $250,000. Your partnership previously leased the land under ground leases.
In May and June 2003, your partnership purchased the remainder interest in the land underlying 25 properties for an aggregate of $1,193,000 and, as a result, now owns a fee interest in the underlying land. The improvements on 23 of the properties are owned by your partnership and the improvements on the two other properties are owned by partnerships in which your partnership owns limited partnership interests and controls the general partner.
Mortgage Indebtedness of Your Partnership
Mortgage Loans. Of your partnership's properties, all but 69 properties are secured by one or more mortgage loans. As of December 31, 2003, the first mortgage indebtedness, together with the second mortgage indebtedness described below on the El Segundo property, had an aggregate outstanding principal balance of $602,919,000 with interest at rates ranging from 4.2% per annum to 11.3% per annum and maturities at various dates from February 1, 2004 to January 1, 2024. Most of these mortgage loans are prepayable only with a yield maintenance payment or prepayment penalty. The weighted average interest rate on these loans is 8% per annum, and there were no variable rate loans at December 31, 2003.
The following is a summary of scheduled principal maturities, by year, under the mortgage debt described in the previous paragraph.
Year Amount ---- ------
2004............................... $ 116,964,000 2005............................... 103,848,000 2006............................... 134,805,000 2007............................... 94,653,000 2008............................... 70,390,000 Thereafter......................... 82,259,000 ------------- Total.............................. $ 602,919,000 =============
In December 2002, a substantial portion of the mortgage indebtedness encumbering properties in El Segundo, California in which your partnership owns a 53% interest was refinanced with (i) an $88,724,702 first mortgage, secured by the buildings and the land estate, bearing interest at 6% per annum and self-amortizing by January 1, 2009 and (ii) $25,352,919 of second mortgages, secured by the buildings and the land estate, bearing interest at 4.86% per annum, and maturing on January 1, 2024, at which time a $25,988,645 balloon payment will be due. In addition, a $3,235,880 prepayment penalty was paid as part of the refinancing. As part of the refinancing, your partnership purchased the land underlying the property for $1,700,000, which was provided by the proceeds of a new first mortgage secured by the land underlying the property. This mortgage, which is the responsibility of your partnership, bears interest at 6% per annum and is self-amortizing by January 1, 2009. Members of the Newkirk Group acquired approximately 55% of the second mortgage indebtedness in the refinancing for a purchase price of $1,012,486, exclusive of closing costs. See "ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" for additional information. Prior to the refinancing, the property was encumbered by approximately $56,800,000 of first mortgage indebtedness,
$50,500,000 of which bore interest at 13.25% and $6,300,000 of which bore interest at 13.6% per annum, as well as $51,611,251 of second mortgage indebtedness bearing interest at 15.5% per annum.
In August 2003, your partnership obtained a new $3,400,000 first mortgage loan on its property in Beaumont, Texas. The loan bears interest at 6.2% per annum and matures on November 30, 2007, at which time it is scheduled to be fully amortized.
In June 2003, your partnership obtained a new first mortgage on its property in Morris Township, New Jersey, that is leased to Crum & Forster. The $21,000,000 mortgage loan bore interest at LIBOR plus 2.875% per annum (4.1% at June 30, 2003), payable monthly, and had an initial term of three years. Principal payments of $25,000 were due monthly commencing February 1, 2005. $6,700,000 of the proceeds of the new loan were used to repay the existing first mortgage loan that had an interest rate of 12.5% per annum and $13,100,000 was used to satisfy the remaining balance payable by your partnership with respect to the second mortgage acquired by your partnership in January 2003. In October 2003 your partnership refinanced this loan. The new loan had a principal balance of $28,500,000, bore interest at 5.55% per annum and had a term of ten years. After payment of closing costs, $21,100,000 of proceeds were used to satisfy the existing first mortgage and $5,000,000 was applied to a principal payment on your partnership's loan with Fleet National Bank. This property was sold in January 2004. See "- Property Matters" above and "- Second Mortgage Loans" below.
Second Mortgage Loans. A number of your partnership's properties are encumbered by second mortgage loans. As of December 31, 2003, this second mortgage indebtedness, which is referred to in our financial statements as contract right mortgage notes, had an aggregate outstanding balance, including accrued interest, of $460,860,000, bore simple interest at contractual rates ranging from 5.31% per annum to 16.25% per annum and matured at various dates from January 1, 2008 to January 1, 2025. Each of the loans is prepayable at any time without premium or penalty subject to the prior or simultaneous satisfaction of the underlying first mortgage loans. The weighted average interest rate on these mortgage loans is 13.66% per annum. There are no variable interest rates on these loans.
The following is a summary of scheduled principal and accrued interest payable as of Dcember 31, 2003, by year, under the junior mortgage debt described in the previous paragraph.
Year Amount ---- ------
2004............................... $ 16,821,000 2005............................... 28,589,000 2006............................... 29,980,000 2007............................... 30,825,000 2008............................... 33,392,000 Thereafter......................... 321,253,000 ------------- Total.............................. $ 460,860,000 =============
The foregoing debt amounts represent amounts contractually due and owing, while your partnership's financial statements reflect the debt balance after making an adjustment to fair value in accordance with generally accepted accounting principles.
In January 2003, your partnership acquired a second mortgage loan that encumbered your partnership's property in Morris Township, New Jersey that is leased to Crum & Forster. Outstanding principal and accrued and unpaid interest on the mortgage was $28,100,000. The mortgage bore interest at 10.25% per annum. It was acquired for $22,100,000, $9,300,000 of which was initially paid and $12,800,000, together with interest at 6% per annum, of which was payable on the earlier of September 30, 2003 or the date on which your partnership obtained a new first mortgage loan on the property. In June 2003, your partnership obtained a new first mortgage loan on the property and satisfied the balance of the purchase price. See "- First Mortgage Loans" above. This property was sold in the first quarter of 2004. See "- Property Matters" above.
All rights of the mortgagee under each of the second mortgages are fully subject and subordinate to the rights granted the holders of the first mortgages. The second mortgages generally grant the mortgagee a security interest in and include a subordinate assignment of, among other things, your partnership's interest in its underlying lease. Each second mortgage contains an assignment of your partnership's interest in all rents, income, revenues, claims, issues and profits from and in respect of all of the property encumbered by that second mortgage.
Substantially all of the second mortgages contain restrictions affecting the ability of the applicable property-owning subsidiary of your partnership to refinance its existing first mortgage loan or incur additional financing during the primary term of the relevant lease. The principal restriction on such first mortgage financing is a debt service coverage test under which the scheduled rental payments from the properties at the time of such financing must be at least 103% of your partnership's aggregate debt service payments due under the second mortgage and such financing (except that if a lease is no longer in effect, the debt service coverage test may be satisfied based on the scheduled rent payments that otherwise would have been payable under the lease for the period that the financing is to be in place). There is also a general risk that a property encumbered by a second mortgage will not generate sufficient cash flow to satisfy the debt service payments on the second mortgage loan after satisfying payments on the first mortgage encumbering the property. However, the combination of the Newkirk properties pursuant to the exchange has lessened this risk to your partnership by substantially increasing the capital resources of your partnership and thereby enhancing your partnership's ability to respond to the capital needs of any particular property. In addition, as described under "ITEM 1. BUSINESS - Description of Assets - The Subordinate Mortgage Interests," your partnership has an option to acquire the interests in T-Two Partners and thereby effectively eliminate substantially all of its subordinate indebtedness.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In July 2002, an action was commenced in the Connecticut Superior Court by four limited partners of three Newkirk Partnerships against, among others, your partnership's general partner and various affiliates of your partnership's general partner. The action alleges, among other things, that the price paid to non-accredited investors in connection with the exchange was unfair and did not fairly compensate them for the value of their partnership interests. The complaint also alleges that the exchange values assigned in the exchange to certain assets contributed by affiliates of your partnership's general partner were too high in comparison to the exchange values assigned to the Newkirk partnerships, that the option arrangement relating to your partnership's potential acquisition in the future of T-Two Partners was unfair to limited partners and that the disclosure document used in connection with the exchange contained various misrepresentations and/or omissions of material facts. The complaint seeks to have the action classified as a class action as well as compensatory and punitive damages in an unspecified amount. The defendants have denied and continue to deny the allegations of the complaint. In order to avoid the expenses, distractions and uncertainties of litigation, the defendants entered into a settlement agreement dated December 31, 2003 to settle the litigation, which settlement agreement is subject to court approval. A court hearing on whether to approve the settlement is currently scheduled to take place on April 12, 2004. The settlement provides for the following material terms: (i) the Newkirk Group will convey to unitholders of the Newkirk partnerships who are unaffiliated with your general partner and who received limited partnership units in the exchange, units in your partnership equal to 1% of the outstanding units; (ii) your partnership will pay $1.5 million to an escrow agent for the benefit of unaffiliated unitholders; and (iii) your partnership will pay $2 million to an escrow agent for the benefit of unitholders of the Newkirk partnerships who were entitled to receive cash in the exchange. In addition, as described in "ITEM 1. BUSINESS" under the heading " - Description of Assets - The Subordinate Mortgage Interests," your partnership, in order to facilitate the settlement, entered into an agreement with T-Two Partners and its equityholders pursuant to which your partnership has the right to acquire substantially all of the assets of T-Two Partners or a 100% ownership interest in T-Two Partners at any time between November 24, 2006 and November 24, 2009. In addition, as part of the settlement agreement, defendants have also agreed not to object to the payment of reasonable attorneys fees expenses, and incentive awards to be paid from the consideration payable under the settlement agreement.
On December 31, 2002, a derivative action was commenced in the Dallas County Texas District Court by a limited partner of Eastgar Associates, L.P. against, among others, (i) the general partners of Eastgar and (ii) the Newkirk Group. Your partnership owns a 60.5% limited partnership interest in Eastgar and also controls the general partner of that partnership. The complaint alleges that the defendants have charged Eastgar excessive management fees and have unfairly prevented Eastgar from prepaying and refinancing its mortgage indebtedness. The complaint seeks compensatory and punitive damages in an unspecified amount, attorneys' fees and expenses, an accounting, and a declaration of the parties' future rights and obligations regarding management fees and the refinancing of mortgage indebtedness. The defendants have denied and continue to deny the allegations of the complaint. In order to avoid the expenses, distraction and uncertainties of litigation, the defendants entered into an agreement to settle the litigation for a $137,500 payment by the defendants other than Eastgar and to charge an asset management fee of $35,000 per year, adjusted for changes in the Consumer Price Index and as may be adjusted for extraordinary circumstances by Eastgar's general partner. After payment of
court-approved attorneys' fees and expenses, the remaining balance would be distributed to Eastgar's limited partners other than your partnership or its affiliates. The settlement also fixes the management fees to be charged to Eastgar, subject to any changes that Eastgar may approve in the future consistent with its fiduciary duty. The settlement has been, as required, approved by the trial court after notice to the limited partners of Eastgar.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report through the solicitation of proxies or otherwise.
PART II
ITEM 5.
ITEM 5. MARKET FOR LIMITED PARTNERSHIP UNITS, RELATED SECURITY HOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
General
There is no established public trading market for the units. As of December 31, 2003 , there were 1,372 holders of record of units. In addition, as of December 31, 2003, there were no units that could be sold pursuant to Rule 144 under the Securities Act, or that your partnership has agreed to register under the Securities Act for sale by unit holders, and there were no units that are being, or have been publicly proposed to be, publicly offered by your partnership.
Except as described under "ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Acquisition of Limited Partnership Interests", as of December 31, 2003, there were no options or warrants to purchase units in your partnership.
Distributions
Since January 1, 2002 your partnership has made the following distributions aggregating approximately $242,670,000
Date Per Unit Distribution ---- ---------------------
2/02 $30.31 (1) 4/02 $.50 7/02 $.65 10/02 $.70 2/03 $.75 4/03 $2.22 (2) 5/03 $.80 8/03 $.85 11/03 $.90 2/04 $1.75
- ---------- (1) This distribution represented proceeds received from the $225,000,000 loan obtained from Fleet National Bank. The consent solicitation statement sent to limited partners in the Newkirk partnerships in respect of the exchange had disclosed that your partnership was attempting to obtain the Fleet loan and that there would be a substantial distribution of the loan proceeds.
(2) This distribution represents proceeds from the sale of your partnership's property that was leased to Kaiser Aluminum.
Your partnership currently anticipates making regular quarterly distributions in respect of your partnership's operations as well as special distributions in respect of future property sales. However, future distributions are dependent upon many factors, including your partnership's earnings, capital requirements, property sales, financial condition and available cash flow. In this regard, your partnership's Fleet loan requires your partnership to maintain liquid assets of at
least $5,000,000 and a minimum consolidated net worth equal to $500,000,000 during the initial loan term and up to $550,000,000 during the last extended term. In addition, under the terms of the loan, your partnership is prohibited from making distributions if its unconsolidated debt service coverage ratio falls below 1.75 during the initial period of the loan or 2.0 during the extension periods. These and other restrictions relating to the Fleet loan that are discussed above under "ITEM 1. BUSINESS - Description of Indebtedness" could impact your partnership's ability to make distributions in the future.
Recent Sales of Unregistered Securities
In January 2003, your partnership issued 317,813 units to the Newkirk Group in exchange for a contribution of limited partnership interests in various partnerships that own net-leased properties. In January 2004, your partnership sent notice of its intention to exercise an option to purchase additional limited partnership interests in two of the above mentioned partnerships. It is anticipated that these additional limited partnership interests will be acquired on April 1, 2004 in exchange for 15,539 units. See "ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - THE EXCHANGE". These units were issued in reliance on an exemption from registration under the Securities Act provided by Section 4(2) thereof.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following financial data are derived from the audited consolidated financial statements of your partnership for the year ended December 31, 2002 and 2003 and from the combined consolidated financial statements of Newkirk RE Holdings, LLC and Newkirk NL Holdings, LLC ("Predecessor Entity") for the years ended December 31, 1999, 2000 and 2001. The financial data set forth below should be read in conjunction with "ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Liquidity and Capital Resources
At December 31, 2003 your partnership owned an interest in 225 Newkirk properties and limited partnership interests in seven partnerships which own 43 properties whose operations are consolidated for financial reporting purposes. Almost all of the properties are leased to one or more tenants pursuant to net leases with original lease terms, subject to extensions, ranging between approximately twenty and twenty-five years. Approximately 90% of the original lease terms expire between 2005 and 2009. There are six properties which are vacant and not leased which represent approximately 111,000 square feet of your partnership's Newkirk properties. The remaining 19,331,000 square feet or 99.4% are leased. Your partnership also holds subordinated interests in a securitized pool of notes evidencing first mortgage indebtedness secured by certain of your partnership's properties as well as other properties, limited partnership interests in various partnerships that own commercial net-leased properties, an interest in a management company that provides services for your partnership as well as other real estate partnerships, ground leases, remainder interests or the right to acquire remainder interests in various properties and miscellaneous other assets. In addition, your partnership, or an affiliate of your general partner, controls the general partner of the real estate limited partnerships in which your partnership owns limited partnership interests, and your partnership has an option to acquire in the future second mortgage debt secured by a substantial number of your partnership's properties as well as the properties owned by nine other partnerships.
Your partnership receives rental income from its properties which is its primary source of liquidity. Pursuant to the terms of the leases, the tenants are responsible for substantially all of the operating expenses with respect to the properties, including maintenance, capital improvements, insurance and taxes. If a tenant fails to exercise its renewal option or exercises its option to terminate its lease early, your partnership will be required to either sell the property or procure a new tenant. If your partnership attempts to procure a new tenant, it will be competing for new tenants in the then current rental markets, which may not be able to support terms as favorable as those contained in the original lease options.
The level of liquidity based on cash and cash equivalents experienced a $4,399,000 increase at December 31, 2003 as compared to December 31, 2002. The increase was due to net cash provided by operating activities of $162,017,000 and net cash provided by investing activities of $58,316,000, which were substantially offset by net cash used in financing activities of $215,934,000. Cash provided by operations consisted of $148,850,000 from continuing operations and $13,167,000 from discontinued operations. Cash provided by investing activities included $650,000 of cash related to previously unconsolidated limited partnerships and $61,491,000 of net proceeds from disposal of real estate, which were partially offset by land acquisitions of $2,518,000 and investments in limited partnership interests of $1,307,000. Cash used in financing activities consisted primarily of mortgage loan and contract right mortgage loan payoffs of $266,599,000, principal payments on mortgage, contract right and notes payable of $158,381,000, deferred costs expenditures of $8,550,000 and partner distributions of $34,731,000, which were partially offset by loan proceeds of $262,338,000. At December 31, 2003, your partnership had $37,851,000, of which $5,148,000 is restricted, in cash reserves which were invested primarily in money market mutual funds.
A summary of your partnership's contractual obligations is as follows:
- ---------- (1) The debt amounts represent amounts contractually due based upon December 31, 2003 principal and accrued interest payable. Your partnership's financial statements reflect the debt balance after making an adjustment to fair value in accordance with generally accepted accounting principles.
Off-Balance Sheet Arrangements
On November 24, 2003, at the same time as your partnership obtained its loan from Fleet National Bank, T-Two Partners obtained a $316,526,573 loan from Fleet National Bank. We refer to this loan as the T-Two Loan. The interest rate, maturity date and principal terms of the T-Two Loan are the same as your partnership's loan. The T-Two Loan is secured by all the assets of T-Two Partners, including the second mortgage loans receivable from your partnership. Your partnership guaranteed repayment of the T-Two Loan to Fleet National Bank. In consideration for your partnership's guarantee, the owners of T-Two Partners agreed to the elimination of their put option, and to provide a credit line to your partnership bearing interest at LIBOR plus 450 basis points. Any amounts advanced to your partnership under the credit line would have to be repaid in full before your partnership could purchase the interests in T-Two Partners if your partnership exercises the purchase option described below.
Your partnership's call option had previously provided for the acquisition of the interests in T-Two Partners in January 2008 in exchange for a number of units in your partnership to be determined at the time of exercise based on an agreed-upon formula. Your partnership and the owners of T-Two Partners modified your partnership's option in certain respects. First, the option can now be exercised by your partnership at any time between November 24, 2006 and November 24, 2009. Second, the purchase price is payable in cash rather than units in your partnership. Finally, the formula for determining the purchase price payable by your partnership if it exercises the option has been revised in a manner that your partnership's general partner believes to be significantly more favorable to your partnership than the formula previously in effect. Specifically, the purchase price is calculated as follows: the sum of $316,526,573 plus T-Two Partners' costs of obtaining the T-Two Loan
(approximately $7,346,000) and administering the trust that holds the second mortgage loans, together with interest on the foregoing sum at the effective rate of interest paid by T-Two Partners on the T-Two Loan, less all payments made from and after November 24, 2003 on the second mortgage loans.
Other Matters
On January 1, 2003, your partnership acquired from the Newkirk Group, an affiliate of your partnership's general partner, limited partnership interests in nine real estate limited partnerships that own net-leased commercial properties. The limited partnership interests acquired by your partnership ranged between 4.9% and 57.75% of each partnership and were acquired in exchange for 317,813 limited partnership units of your partnership. In January 2004, your partnership notified the Newkirk Group that it intends to exercise its option to purchase the additional limited partnership interests in two of the partnerships. It is anticipated that these additional limited partnership interests will be acquired as of April 1, 2004 in exchange for approximately 15,539 units. In determining the number of units issuable to the affiliate in exchange for such interests, your partnership's general partner estimated the value of nine real estate limited partnerships utilizing a discounted cash flow approach similar to that which was used to determine exchange values for Newkirk partnerships as part of the exchange to arrive at a value of $22,704,776 for the limited partnership interests. Your partnership's general partner then estimated the per unit value of your partnership in order to determine the number of units allocable to the affiliate for its interest in the limited partnerships. The $71.44 estimated per unit value of your partnership was derived from the aggregate value ascribed to your partnership in the exchange, as adjusted to reflect the proceeds from your partnership's indebtedness to Fleet National Bank that were distributed to limited partners following the exchange. During 2002, appraisals were obtained for each of the properties owned by the nine real estate limited partnerships. The aggregate appraised value of all of the properties was $288,675,000. Based solely on your partnership's ownership interests in the nine partnerships, $25,049,842 of the appraised value would be attributable to the interests owned by your partnership. In August 2003, your partnership acquired an additional 9.9% interest in one of those limited partnerships for a cash purchase price of $525,000.
In January 2003, your partnership acquired the land underlying the property owned by one of the net-leased partnerships referred to immediately above. The land was acquired from a company affiliated with your general partner for $1,000,000, $50,000 of which was paid in cash and the balance in the form of a $950,000 note due September 8, 2008. The note bore interest at the rate of 6% per annum, compounded annually, and was payable interest-only until maturity, at which time the full balance of the note was to be due. In October 2003, the note was satisfied by your partnership from cash reserves. The purchase price for the land sale was determined without arms-length negotiations. An independent appraisal was obtained on the value of the land that was acquired.
In February 2003, your partnership acquired from its limited partners 115,000 of its units of limited partnership interest at a purchase price of $35 per unit.
In January 2003, your partnership acquired a second mortgage loan that encumbered your partnership's property in Morris Township, New Jersey. The mortgage and accrued interest amounted to $28,100,000 at December 31, 2002. It was acquired for $22,100,000, $9,300,000 of which was initially paid and $12,800,000 of which was payable on or before September 30, 2003. The deferred portion of the purchase price bore interest at a rate of 6% per annum. Your partnership acquired this mortgage in connection with an extension of the lease on the property and obtained new first mortgage financing in June 2003 to satisfy the balance of the purchase price. The new first mortgage loan that was obtained in June 2003 had a principal balance of $21,000,000 and an initial term
of three years. The loan bore interest at LIBOR plus 2.875% per annum, payable monthly beginning August 1, 2003. Principal payments of $25,000 were due monthly commencing February 1, 2005. After payment of closing costs, $6,700,000 of proceeds were used to satisfy the existing first mortgage and the balance was used to satisfy the deferred portion of the second mortgage purchase price. This Loan was refinanced in October 2003.
In August 2003, your partnership obtained a new $3,400,000 first mortgage loan on its property in Beaumont, Texas. The loan bears interest at 6.2% per annum and matures on November 30, 2007, at which time it is scheduled to be fully amortized.
In October 2003, your partnership refinanced its first mortgage loan on its property in Morris Township, New Jersey. The new first mortgage loan had a principal balance of $28,500,000, bears interest at 5.55% per annum and had a term of ten years. After payment of closing costs, $21,100,000 of proceeds were used to satisfy the existing first mortgage and accrued interest. Additionally, $5,000,000 was applied to a principal payment on your partnership's loan with Fleet National Bank. This property was sold in the first quarter of 2004.
In February 2003, your partnership received a notice from Albertson's, Inc., the tenant at your partnership's Sioux Falls, South Dakota property, exercising the economic discontinuance provisions of the lease. Under the terms of the notice, Albertson's had proposed to terminate the lease effective November 5, 2003 and had made a rejectable offer to purchase the property for $1,551,000. Your partnership had until October 2003 to accept or reject this offer. Your partnership elected to reject the offer and sold the property in September 2003 for $2,700,000. Your partnership also received notice from Albertson's indicating that it intended to exercise its right to terminate the lease for the supermarket property located in Stuart, Florida. In accordance with the economic discontinuance provision of its lease, Albertson's made a rejectable offer to purchase the property for an amount stipulated in the lease of approximately $631,000. Your partnership elected to reject the offer. As a result of the rejection, your partnership was required to payoff the first mortgage encumbering the property, which had a balance of approximately $531,000. Your partnership satisfied the first mortgage using its cash reserves. Your partnership has entered into a contract to sell the property for a price in excess of the rejectable offer price. The sale, which is contingent upon the purchaser completing its due diligence, is expected to occur, if at all, in the second quarter of 2004.
Your partnership has also received notice from Albertsons exercising a purchase option in accordance with their lease on fifteen of your partnership's properties. Your partnership has a right to reject this offer. If your partnership accepts the offer, the sale would be effective July 1, 2004 for 11 properties, October 1, 2004 for 3 properties and February 1, 2005 for 1 property. If your partnership rejects this offer, the tenant can elect to terminate the lease on July 1, 2004, October 1, 2004 and February 1, 2005, respectively, or extend its lease for eighteen months until December 31, 2005, March 31, 2006 or July 31, 2006. Rent during the eighteen month period would be at the renewal rates. If Albertsons elects to renew for the eighteen month period it will still have a series of five year renewal options. For all 15 of the properties Albertsons has elected to renew the lease for eighteen months assuming the purchase offer is rejected. Your partnership is currently reviewing all of the purchase offers in order to determine a course of action.
During February 2003, your partnership received the remaining balance due on a secured note of Cenland Associates Limited Partnership that it acquired in the exchange. The note had an outstanding balance of $1,342,000 at the time of the exchange that had been reduced to $158,000 as of December 31, 2002.
In April and June 2003 your partnership acquired 30.6% and 46.1%, respectively, of the outstanding limited partnership interests in two partnerships that own commercial net-leased properties. The partnership interests were acquired for an aggregate cash purchase price of $711,250. Your partnership previously owned 1.5% and 3.8%, respectively, of the outstanding limited partnership interests in these two partnerships. Your partnership controls the general partners of each of these partnerships. Your partnership has consolidated these partnerships in accordance with the guidance provided by Statement of Position 78-9 "Accounting for Investments in Real Estate Ventures."
Results of Operations
Comparison of the year ended December 31, 2003 to the year ended December 31, 2002.
Income from Continuing Operations
Income from continuing operations decreased by $5,309,000 to $100,088,000 for the year ended December 31, 2003 from $105,397,000 for the year ended December 31, 2002. As more fully described below, this decrease is attributable to an increase in total expenses of $7,477,000 and an increase in minority interest expense of $7,392,000, which was partially offset by an increase in total revenue of $7,506,000 and an increase in equity in income from investments in limited partnerships of $2,054,000.
Rental Income
Rental income increased by $8,155,000 or approximately 3% to $274,971,000 for the year ended December 31, 2003 from $266,816,000 for the year ended December 31, 2002. The increase was primarily due to five newly acquired consolidated partnerships which contributed approximately $13,810,000 in rental income. This increase was partially offset by lower rental income received from properties previously leased by Kmart of $1,506,000 and lower rental income on lease renewals or renegotiations of $4,149,000.
Interest Income
Interest income decreased by $305,000 or approximately 9% to $2,983,000 for the year ended December 31, 2003 from $3,288,000 for the year ended December 31, 2002. The decrease was due to the payoff of a loan receivable and overall lower interest rates on the invested cash balances.
Management Fees
Management fees decreased by $344,000 or approximately 45% to $418,000 for the year ended December 31, 2003 from $762,000 for the year ended December 31, 2002. The decrease is attributable to fewer properties under management.
Interest Expense
Interest expense decreased by $5,868,000 or approximately 5% to $106,898,000 for the year ended December 31, 2003 compared to $112,766,000 for the year ended December 31, 2002. The decrease was primarily due to loan payoffs during the period and normal scheduled principal payments.
Depreciation
Depreciation expense increased by $10,096,000 or approximately 37% to $37,705,000 for the year ended December 31, 2003 compared to $27,609,000 for the year ended December 31, 2002. The increase is primarily attributable to changing the estimated useful lives of the real estate and additional depreciation expense from five newly acquired consolidated partnerships. A significant percentage of the increase in depreciation expense relating to the change in estimated useful lives is offset by a corresponding decrease in minority interest expense.
General and Administrative
General and administrative expenses increased by $2,368,000 or approximately 26% to $11,486,000 for the year ended December 31, 2003 compared to $9,118,000 for the year ended December 31, 2002. The increase is the result of $3,600,000 incurred related to legal settlements. This increase was substantially offset by one-time organizational expenses relating to the formation of your partnership in 2002.
Amortization Expense
Amortization expense increased by $917,000 or approximately 24% to $4,771,000 for the year ended December 31, 2003 as compared to $3,854,000 for the year ended December 31, 2002. The increase in amortization expense is the result of the refinancing of the Fleet debt which was partially offset by savings from loans which have been paid off.
Ground Rent
Ground rent expense increased by $37,000 to $3,202,000 for the year ended December 31, 2003 as compared to $3,165,000 for the year ended December 31, 2002. The increase in ground rent expense is the result of the addition of new properties in 2003 partially offset by land purchases made in 2003.
State Income Taxes
State income tax expense decreased by $73,000 or approximately 9% to $767,000 for the year ended December 31, 2003 compared to $840,000 for the year ended December 31, 2002. The decrease is the result of tax savings in the State of New Jersey.
Equity in Income from Investments in Limited Partnerships
Equity in income from investments in limited partnerships is the result of the January 2003 purchase of equity positions in five new partnerships.
Minority Interest Expense
Minority interest expense increased by $7,392,000 or approximately 91% to $15,509,000 for the year ended December 31, 2003 compared to $8,117,000 for the year ended December 31, 2002. The increase was the result of minority interests in the amount of $5,365,000 related to the five newly consolidated partnerships. The remaining increase of $2,027,000 related to increased profitability at the previous partially owned partnerships.
Discontinued Operations
During the year ended December 31, 2003, your partnership sold fourteen properties for a combined net sales price of $156,409,000. Your partnership recognized a net gain on disposal of these properties of $29,514,000. The sale and operation of these properties for all periods presented have been recorded as discontinued operations in compliance with the provisions of Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long Lived Assets."
Comparison of the year ended December 31, 2002 to the year ended December 31, 2001 (Pro-Forma).
Pro-Forma Information
Your partnership commenced operations on January 1, 2002 following completion of the Exchange. In the Exchange the 90 Newkirk partnerships, each of which owned commercial properties, were merged into wholly- owned subsidiaries of your partnership, and your partnership acquired various assets including those related to the management or capital structure of the Newkirk partnerships. The financial information contained in the audited financial statements for all periods, and as of all dates, prior to January 1, 2002 is comprised of the assets, liabilities, revenue and expenses of Newkirk RE Holdings, LLC and Newkirk NL Holdings, LLC, which are considered to be the Predecessor Entity. The equity method of accounting was used to reflect the Predecessor Entity's interest in Newkirk partnerships in which it did not own a controlling interest. Accordingly, the Predecessor Entity's share of assets and liabilities and revenue and expenses in those Newkirk partnerships was presented as a single item on the balance sheet and statement of operations. In addition, only a portion of the assets of the Predecessor Entity were contributed to your partnership in the Exchange.
In view of the foregoing facts, and in order to facilitate a comparison of the 2002 and 2001 results of operations in management's discussion and analysis of financial condition and results of operations, we have prepared pro-forma information. The pro-forma information has been prepared on the assumption that the Exchange had been consummated on January 1, 2001.
The pro-forma information is presented as a tool to facilitate the Management Discussion and Analysis of the Predecessor Entity and your partnership. The operations of your partnership are essentially the Newkirk properties (originally 230 properties), substantially all of which are net-leased to tenants that typically have high credit ratings and are stock exchange listed. Given the lease structure and the absence of tenant defaults, underlying operations do not vary significantly from year to year.
The components of the Predecessor Entity's operations do vary significantly from those of your partnership due to the acquisition by the Predecessor Entity of limited partnership interests in the Newkirk partnerships (certain assets, liabilities and operations of the Newkirk partnerships were accounted for on the equity method for various periods depending on the point at which control was achieved) and the inclusion of certain assets that were not ultimately contributed in the Exchange.
Rather than continually referring to a core set of reasons (assets not contributed to your partnership or liabilities not assumed by your partnership) for differences between the periods discussed it was considered more meaningful to highlight the changes in the underlying operations of what is now your partnership and reconcile those operations to the Predecessor Entity's reported financial position and results of operations.
The following table shows (i) the pro-forma consolidated statement of operations for the year ended December 31, 2001, reflecting the pro-forma impact had all the Newkirk partnerships' activities been consolidated effective January 1, 2001 and the assets not contributed by the Predecessor Entity were excluded.
CONSOLIDATED PRO-FORMA STATEMENT OF OPERATIONS (In Thousands)
Footnotes to Pro-Forma Statement of Operations:
(1) Reflects the consolidation of partnerships previously accounted for by the Predecessor Entity as an equity investment.
(2) Primarily the result of the Predecessor Entity not contributing its investments in contract right mortgages.
(3) Primarily the result of the Predecessor Entity not contributing Goodwill to the Partnership.
(4) Certain assets were not contributed and expenditures related thereto will not be incurred by the Partnership.
In order to provide a more meaningful comparison of the results of operations, the following analysis compares the years ended December 31, 2002 and 2001 as if the exchange had occurred on January 1, 2001.
Income from Continuing Operations before Minority Interest
Income from continuing operations before minority interest decreased by $11,453,000 to $113,514,000 for the year ended December 31, 2002 from $124,967,000 for the year ended December 31, 2001. As more fully described below, this decrease is attributable to a decrease in total revenue of $5,213,000 and an increase in total expenses of $6,240,000.
Rental Income
Rental income decreased by $3,830,000 or approximately 1% to $266,816,000 for the year ended December 31, 2002 from $270,646,000 for the year ended December 31, 2001. The decrease was primarily due to the January 2002 K-Mart Corporation Chapter 11 bankruptcy filing. K-Mart Corporation rejected the leases on 12 of your partnership's properties, which reduced 2002 revenues by $2,482,000. Eight of the properties have been re-leased. The aggregate rental rates under these leases is significantly less than the aggregate rent that was scheduled to be received during the renewal term under the K-Mart leases.
Additionally, rental income decreased as a result of lease renewals at lower rental rates.
Interest Income
Interest income decreased by $1,277,000 or approximately 28% to $3,288,000 for the year ended December 31, 2002 from $4,565,000 for the year ended December 31, 2001. The decrease was due to principal payments received by your partnership on loans receivable and overall lower interest rates on the invested cash balances.
Management Fees
Management fees decreased by $106,000 or approximately 12% to $762,000 for the year ended December 31, 2002 from $868,000 for the year ended December 31, 2001. The decrease is attributable to fewer properties under management.
Interest Expense
Interest expense increased by $3,600,000 or approximately 3% to $112,766,000 for the year ended December 31, 2002 compared to $109,166,000 for the year ended December 31, 2001. The increase was due to $20,314,000 in interest expense attributable to your partnership's mezzanine loan in the amount of $225,000,000 which was obtained in January 2002, which was substantially offset by decreases in the mortgage loan and contract right mortgage loan interest of $10,920,000 as a result of loan payoffs during the year, through scheduled principal payments and the net gain from the extinguishment of debt of $5,794,000 for the year ended December 31, 2002, compared to zero for the year ended December 31, 2001.
Depreciation
Depreciation expense decreased by $1,848,000 or approximately 6% to $27,609,000 for the year ended December 31, 2002 compared to $29,457,000 for the year ended December 31, 2001. The decrease is attributable to the completion of the useful lives of various partnership assets while no further additions to real estate were expended.
General and Administrative
General and administrative expenses increased by $3,869,000 or approximately 74% to $9,118,000 for the year ended December 31, 2002 compared to $5,249,000 for the year ended December 31, 2001. The increase was primarily the result of one-time organizational expenses relating to the formation of your partnership of $3,168,000. Additionally, legal expenses related to pending law suits were also incurred.
Amortization Expense
Amortization expense increased by $723,000 or approximately 23% to $3,854,000 for the year ended December 31, 2002 compared to $3,131,000 for the year ended December 31, 2001. The increase is primarily the result of mortgage cost amortization expense in the amount of $981,000 related to your partnership's mezzanine loan partially offset by savings in land lease amortization from 2001 land purchases.
Ground Rent
Ground rent expense decreased by $80,000 or approximately 2% to $3,165,000 for the year ended December 31, 2002 compared to $3,245,000 for the year ended December 31, 2001. The decrease is the result of a June 2001 acquisition of land previously leased resulting in no rent expense for the property in 2002.
State Income Taxes
State income taxes decreased by $24,000 or approximately 3% to $840,000 for the year ended December 31, 2002 compared to $864,000 for the year ended December 31, 2001.
Critical Accounting Policies
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying consolidated financial statements and related notes. In preparing these consolidated financial statements, management has made its best estimates and judgments of certain amounts included in the consolidated financial statements, giving due consideration to materiality. Your partnership does not believe there is a great likelihood that materially different amounts would be reported related to the accounting policies described below. However, application of these accounting policies involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates.
Impairment of long-lived assets. At December 31, 2003, your partnership had $1,129,237,000 of real estate (net) and $59,481,000 of real estate held for sale (net), which combined,,account for approximately 86% of your partnership's total assets. Buildings and improvements are carried at cost net of adjustments for depreciation and amortization. The fair values of your partnership's buildings and improvements are dependent on the performance of the properties.
Your partnership evaluates recoverability of the net carrying value of its real estate and related assets at least annually, and more often if circumstances dictate. If there is an indication that the carrying value of a property might not be recoverable, your partnership prepares an estimate of the future undiscounted cash flows expected to result from the use of the property and its eventual disposition, generally over a five-year holding period. In performing this review, management takes into account, among other things, the existing occupancy, the expected leasing prospects of the property and the economic situation in the region where the property is located.
If the sum of the expected future undiscounted cash flows is less than the carrying amount of the property, your partnership recognizes an impairment loss and reduces the carrying amount of the asset to its estimated fair value. Fair value is the amount at which the asset could be bought or sold in a current transaction between willing parties, that is, other than in a forced or liquidation sale. Management estimates fair value using discounted cash flows or market comparables, as most appropriate for each property. Independent certified appraisers are utilized to assist management when warranted. During the year ended December 31, 2003, your partnership recorded $1,560,000 in allowances for impairment.
Because the cash flows used to evaluate the recoverability of the assets and their fair values are based upon projections of future economic events, such as property occupancy rates, rental rates, operating cost inflation and market capitalization rates, which are inherently subjective, the amounts ultimately realized at disposition may differ materially from the net carrying values at the balance sheet dates. The cash flows and market comparables used in this process are based on good faith estimates and assumptions developed by management.
Unanticipated events and circumstances may occur, and some assumptions may not materialize; therefore, actual results may vary from the estimates, and variances may be material. The Partnership may provide additional write-downs, which could be material in subsequent years if real estate markets or local economic conditions change.
Useful lives of long-lived assets. Building and improvements and certain other long-lived assets are depreciated or amortized over their useful lives. Depreciation and amortization are computed using the straight-line method over the useful life of the building and improvements. The cost of properties represents the initial cost of the properties to your partnership plus acquisition and closing costs less impairment adjustments.
During 2003, the Partnership made a change to its accounting estimates with respect to the depreciable lives of its real estate assets. The change in accounting estimates resulted in a decrease in net income of approximately $6,823,000 and a decrease in net income per limited partnership unit of approximately $ 1.08 per unit for the year ended December 31, 2003.
Recently Issued Accounting Standards
None of the recently issued accounting standards had any effect on the partnership's consolidated financial statements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Your partnership has both fixed and variable rate debt, as well as one interest rate cap. All financial instruments were entered into for other than trading purposes. A change in interest rates on the fixed rate portion of the debt portfolio or the interest rate cap impacts the net financial instrument position, but has no impact on interest incurred or cash flows. A change in interest rates on the variable portion of the debt portfolio impacts the interest incurred and cash flows, but does not impact the net financial instrument position.
The fair value of your partnership's debt, based on discounted cash flows at the current market conditions and interest rates for the remaining term of such debt was less than the aggregate carrying amount by approximately $13,700,000 at December 31, 2003. The change in the fair value of your partnership's debt as of December 31, 2003 reflects the impact of the T-Two Partners refinancing affected by your partnership in November 2003.
At December 31, 2003, your partnership had one loan which had a variable interest rate. The loan which had an outstanding balance of $208.4 million at December 31, 2003, was obtained in November 2003 and has a three-year term. Interest on the outstanding balance accrues at a rate equal to, at your partnership's option, either, (i) LIBOR rate (as defined) plus 450 basis points or (ii) the bank's prime rate plus 250 basis points. Your partnership purchased an interest rate cap on the loan so that the interest rate would be capped at 9.5%.
Your partnership elected to pay the loan based on the LIBOR rate. The following table shows what the annual effect of a change in the LIBOR rate (1.21% at December 31, 2003) will have on interest expense based upon increases up to the cap of 9.5% all in interest rate.
Change in LIBOR (In thousands) ------------------------------------------ 1% 2% 3% 3.79% -- -- -- -----
Additional interest expense $2,084 $4,167 $6,251 $7,898
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See "Index to Financial Statements" under "ITEM 15. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K."
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Effective September 30, 2002, your partnership dismissed its prior Independent Auditors, Deloitte & Touche LLP (the "Prior Auditors"). The Prior Auditors auditors' report on the consolidated balance sheet of the Predecessor Entity as of December 31, 2001, and the related statements of operations, partner's equity and cash flows for each of the two years in the period ended December 31, 2001, did not contain an adverse opinion or a disclaimer of opinion, and were not qualified or modified as to uncertainty, audit scope, or accounting principles. The decision to change Independent Auditors was approved by your partnership's general partner. During calendar year ended 2001 and 2000 and through September 30, 2002, there were no disagreements between your partnership and the Prior Auditors on any matter or accounting principles or practices, financial statement disclosure, or auditing scope of procedure.
Effective October 10, 2002, your partnership engaged Imowitz, Koenig & Co., LLP as its Independent Auditors. Your partnership did not consult Imowitz Koenig & Co., LLP regarding any of the matters or events set forth in Item 304(a)(2) of Regulation S-K prior to October 10, 2002.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
In accordance with Exchange Act Rules 13a-15 and 15d-15, your partnership carried out an evaluation, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer of your general partner's manager, as well as other key members of your partnership's management, of the effectiveness of your partnership's disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, your partnership's Chief Executive Officer and Chief Financial Officer concluded that your partnership's disclosure controls and procedures were effective, as of the end of the period covered by this report, to provide reasonable assurance that information required to be disclosed in your partnership's reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms.
No change occurred in your partnership's internal controls concerning financial reporting during the fourth quarter of the fiscal year ended December 31, 2003 that has materially affected, or is reasonably likely to materially affect, your partnership's internal controls over financial reporting.
PART III
ITEM 10.
ITEM 10. MANAGERS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The general partner of your partnership is MLP GP LLC, a Delaware limited liability company, that is owned by affiliates of Vornado Realty Trust and executive officers of Winthrop Financial Associates. In addition, Winthrop Financial Associates performs asset management services for your partnership. MLP GP LLC has no assets, liabilities or equity and does not have an equity interest in your partnership.
The manager of your partnership's general partner is Newkirk MLP Corp., the principal officers of which are Michael L. Ashner, Chief Executive Officer; Peter Braverman, Executive Vice President; Thomas C. Staples, Chief Financial Officer; and Carolyn Tiffany, Chief Operating Officer. Such persons also serve in those capacities for Winthrop Financial Associates. These officers manage and control the day-to-day operations of your partnership on behalf of your partnership's general partner. However, significant transactions, whether by your partnership or any subsidiary partnership, such as sales, acquisitions, debt refinancings and mergers, require the consent of the members of the general partner under the limited liability company agreement of the general partner.
The principal occupations and relevant affiliations of the officers of your partnership's general partner are as follows:
Michael L. Ashner. Mr. Ashner, age 51, serves as the Chief Executive Officer of Winthrop Financial Associates and its affiliates, a position he has held since January 15, 1996, as well as the Chief Executive Officer of Newkirk MLP Corp., the manager of your partnership's general partner. Mr. Ashner has served as Chief Executive Officer of First Union Real Estate Equity and Mortgage Investments, a publicly traded real estate investment trust which we refer to as First Union, since December 31, 2003. Since August 2002, Mr. Ashner has also served as the Chief Executive Officer and a Director of Shelbourne Properties I, II and III, three separate publicly traded real estate investment trusts. Since 1981, Mr. Ashner has been Chairman of Exeter Capital Corporation, a firm that has organized and administered real estate limited partnerships. Since August 2001, Mr. Ashner has also served as Chief Executive Officer of AP-Fairfield GP, LLC, the general partner of Fairfield Inn by Marriott Limited Partnership, an entity that owns and operates 50 Fairfield Inns. Mr. Ashner also currently serves on the Boards of Directors of the following publicly traded companies: Greate Bay Hotel and Casino Inc., a hotel and casino operator, and NBTY Inc., a manufacturer, marketer and retailer of nutritional supplements.
Peter Braverman. Mr. Braverman, age 52, has served as the Executive Vice President of Winthrop Financial Associates and its affiliates since January 1996. Mr. Braverman also serves as the Executive Vice President of Newkirk MLP Corp., the manager of your partnership's general partner. Mr. Braverman has served as the Executive Vice President of First Union since January 2004. He has also been an Executive Vice President of AP-Fairfield GP, LLC since August 2001. Since August 2002, Mr. Braverman has also served as the Executive Vice President and a Director of Shelbourne Properties I, II and III.
Thomas C. Staples. Mr. Staples, age 48, has been with Winthrop Financial Associates since 1995. Since January 1999, Mr. Staples has served as the Chief Financial Officer of Winthrop Financial Associates. Mr. Staples has also served as the Treasurer and Chief Financial Officer of First Union since January 2004. Since August 2002, Mr. Staples has also served as Assistant Treasurer of
Shelbourne Properties I, II and III. In addition, Mr. Staples is the Chief Financial Officer of the Newkirk Group. He also serves as Chief Financial Officer and Treasurer of AP-Fairfield GP, LLC. Mr. Staples is a certified public accountant.
Carolyn Tiffany. Ms. Tiffany, age 37, has been with Winthrop Financial Associates since January 1993. Since December 1997, Ms. Tiffany has served as the Chief Operating Officer of Winthrop Financial Associates. Ms. Tiffany has served as the Chief Operating Officer and Secretary of First Union since January 2004. Ms. Tiffany also serves as Vice President, Treasurer, Secretary and Chief Financial Officer of Shelbourne Properties I, II and III. In addition, Ms. Tiffany is the Chief Operating Officer of The Newkirk Group. She has also been Chief Operating Officer of AP-Fairfield GP, LLC since August 2001.
One or more of the above persons are also directors or officers of a general partner (or general partners of a general partner) of a number of limited partnerships which either have a class of securities registered pursuant to Section 12(g) of the Securities and Exchange Act of 1934, or are subject to the reporting requirements of Section15(d) of such Act. In addition, each of the foregoing individuals hold similar positions with AP-PCC III, L.P., an entity that through one or more subsidiaries manage several limited partnerships that hold title to real property including, commercial properties and residential properties.
Except as indicated above, neither your partnership nor your general partner or its manager has any significant employees within the meaning of Item 401(c) of Regulation S-K. There are no family relationships among the officers and directors of the general partner.
Compliance with Section 16(a) of the Exchange Act.
Based solely upon a review of Forms 3 and 4 and amendments thereto furnished to your partnership under Rule 16a-34(e) during your partnership's most recent fiscal year and Forms 5 and amendments thereto furnished to your partnership with respect to its most recent fiscal year, your partnership is not aware of any manager, officer or beneficial owner of more than ten percent of the units of limited partnership interest in your partnership that failed to file on a timely basis, as disclosed in the above Forms, reports required by Section 16(a) of the Exchange Act during the most recent fiscal year or prior fiscal years.
Code of Ethics
Your partnership has adopted a Code of Ethics that applies to the chief executive officer and chief financial officer of the manager of your partnership's general partner, who perform functions similar to principal executive officer and principal financial officer, respectively, for the partnership. A copy of the Code of Ethics will be provided without charge to any person who requests it by writing to the attention of Thomas Staples at the address set forth on the cover page to this Form 10-K.
Your partnership has no directors and is not a "listed-issuer" under Item 401 to Regulation S-K. Accordingly, your partnership does not have an audit committee or an audit committee financial expert under Item 401 of Regulation S-K.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Your partnership has no employees. Winthrop Financial Associates, an affiliate of your general partner and of the Newkirk Group, provides the services of some of its employees, including the executive officers of the manager of your partnership's general partner, to perform asset management services. Winthrop Financial Associates receives an annual fee of $1,800,000 (subject to adjustment based on increases in the CPI) for its services to your partnership and 15 other affiliated partnerships. The CPI adjustment for 2003 was 2.4% bringing the fee to $1,843,200. See "ITEM 1. BUSINESS - Employees."
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTER
Security Ownership.
The following table sets forth the number of units held as of March 29, 2004 by (i) each person that, to our knowledge, beneficially owns more than 5% of the total number of units, (ii) each officer or director of Newkirk MLP Corp., the manager of your partnership's general partner, and (iii) the directors and executive officers of Newkirk MLP Corp. as a group.
Name and Address of Percent of Beneficial Owner Number of Units Total Units - ---------------- --------------- -----------
Michael L. Ashner 3,657,230 (2)(3) 57.95% Apollo Real Estate Investment Fund III, L.P. Apollo Real Estate Advisors III, L.P. Apollo Real Estate Management III, L.P. (1) Vornado Realty Trust 1,639,818 (3)(4) 25.98% 888 Seventh Avenue New York, NY 10019 Peter Braverman 0 -- Thomas Staples 0 -- Carolyn Tiffany 0 -- All executive officers and directors 3,657,230 (2)(3) 57.95% as a group (4 individuals)
- ---------- (1) The address for Apollo Real Estate Investment Fund III, L.P. ("Apollo Fund"), Apollo Real Estate Advisors III, L.P. ("Apollo Advisors"), and Apollo Real Estate Management III, L.P. ("Apollo Management") is 2 Manhattanville Road, Purchase, New York 10577. The address for Mr. Ashner is 100 Jericho Quadrangle, Jericho, New York 11753.
(2) Comprised of units that are held by Newkirk RE Holdings LLC, Newkirk NL Holdings LLC, Newkirk Tender Holdings LLC, Marbax Venture LLC, AP-WIN Associates, L.L.C., AP-III WEM WIN Tender LLC and AP-IV WEM WIN Tender LLC, each of which is directly or indirectly controlled by either WEM-Brynmawr Associates LLC, WEM Fund 1998 Limited Partnership or WEM-WIN Tender Associates (the "WEM Entities") and by Apollo Fund. For purposes of Section 13 of the Securities Exchange Act of 1934 (the "Exchange Act"), as the sole manager of each of the WEM Entities, Mr. Ashner may be deemed to be the beneficial owner of all units beneficially owned by the WEM Entities. In addition, for purposes of Section 13 of the Exchange Act, as the general partner of Apollo Fund, Apollo Advisors may be deemed to be the beneficial owner of all units beneficially owned by Apollo Fund, and all such units may be deemed to be beneficially owned by Apollo Management as the day-to-day manager of Apollo Fund. Also includes 217,418 units that Newkirk NL Holdings and Newkirk RE Holdings have a right to acquire from Vornado Newkirk L.L.C. and an aggregate of 15,539 units which will be issued to AP3-WEM WIN Tender LLC and AP-WIN Associates LLC on April 1, 2004. See "ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
OPTION MODIFICATION
As part of the exchange, your partnership and the Newkirk Group entered into an option arrangement that gave your partnership an option to acquire in January 2008 indirect interests in a pool of second mortgages of the Newkirk partnerships and various other partnerships. The Newkirk Group also had a put option to require your partnership to acquire these indirect interests in December 2007. In November 2003 your partnership's option was modified and the Newkirk Group's put option was eliminated. We refer you to "ITEM 1. BUSINESS - Description of Assets - The Subordinate Mortgage Interests" for additional information on the option arrangement and those interests.
ACQUISITION OF LIMITED PARTNERSHIP INTERESTS
In January 2003, your partnership acquired from the Newkirk Group limited partnership interests, ranging from a 4.9% interest to a 57.75% interest in nine partnerships that own net leased property in exchange for 317,813 units. We refer to these partnerships as the additional partnerships. Four of the additional partnerships are included in the consolidated partnerships and five of the additional partnerships are included in the unconsolidated partnerships. The 317,813 units were divided among the Newkirk Group as follows: 133,400 units to AP-WIN Associates L.L.C., 23,319 units to AP3-WEM WIN Tender LLC, 59,433 units to AP4-WEM WIN Tender LLC and 101,662 units to Vornado Realty L.P. In addition, in connection with this transaction, your partnership also acquired an option to purchase additional limited partnership interests in two of these partnerships. In January 2004, your partnership notified the Newkirk Group that it intends to exercise its option to purchase the additional limited partnership interests. It is anticipated that these additional limited partnership interests will be acquired as of April 1, 2004 in exchange for 15,539 units: 13,139 will be issued to AP-WIN Associates LLC and 2,400 will be issued to AP3-WEM Win Tender LLC. This acquisition will increase your partnership's ownership of interest in these partnerships to 68.68% and 55.28% from 40.68% and 47.52%, respectively.
In determining the number of units issuable to the Newkirk Group in exchange for such interests, your partnership's general partner estimated the value of the additional partnerships utilizing a discounted cash flow approach similar to that which was used to determine exchange values for Newkirk partnerships as part of the exchange to arrive at a value of $22,704,776 for the limited partnership interests acquired in January 2003. The limited partnership units to be acquired in April 2004 are being valued at $1,110,000. This value includes a $394,000 deduction from the original valuation in order to reflect a 2003 property sale. Your partnership's general partner estimated the per unit value of your partnership in order to determine the number of units allocable to the Newkirk Group for their interests in the additional partnerships. The estimated per unit value of your partnership ($71.44 per unit) was derived from the aggregate value ascribed to your partnership in the exchange, as adjusted to reflect the proceeds from your partnership's indebtedness to Fleet that were distributed to limited partners following the exchange. 47,743 of the units allocated to the Newkirk Group were in respect of limited partnership interests in the additional partnerships that the Newkirk Group had acquired in 2001 and 2002 for $1,305,204.
During 2002, appraisals were obtained for each of the properties owned by the additional partnerships. The aggregate appraised value of all of the properties was $288,675,000. Based solely on your partnership's ownership interests in the additional partnerships following its January 2003 acquisition, $25,049,842 of the appraised value would have been attributable to the interests owned by your partnership at that time.
LAND ACQUISITIONS
In January 2003, your partnership acquired the land underlying the property owned by one of its unconsolidated partnerships. The property is a 200,000 square foot office building that is net-leased to Associates First-Financial Corp. until September 2008 with renewal options extending until September 2038. This additional partnership has an estate for years in the land that runs until September 2013 followed by an option to ground lease the land for up to 45 years. The land was acquired from a company wholly-owned by Winthrop Financial Associates, an affiliate of your partnership's general
partner, for $1,000,000, $50,000 of which was paid in cash and the balance in the form of a $950,000 note due September 8, 2008. The note bears interest at the rate of LIBOR plus 6% per annum, compounded annually, and payable interest-only until maturity, at which time the full balance of the note is due. In determining the purchase price for this land sale described above, your partnership's general partner obtained a property appraisal.
MORTGAGE INDEBTEDNESS
Certain members of the Newkirk Group owned the three most junior tranches of the T-1 Certificate that is described in "ITEM 1. BUSINESS" under the heading "- Description of Assets - The Subordinate Mortgage Interests.". During the year ended December 31, 2003 and prior to November 24, 2003, approximately $1,800,000 of interest was paid on these three junior tranches. On November 24, 2003, $152,001,000 of the proceeds of the T-Two Loan referred to in Item 1 were used by T-Two Partners to acquire the T-1 Certificate, which payment included approximately $2,400,000 for accrued interest and approximately $4,400,000 of prepayment penalties. Approximately $17,806,000 of the payments made by T-Two Partners to acquire the T-1 Certificate were received by members of the Newkirk Group for their interests in the three junior tranches of the T-1 Certificate.
MORTGAGE REFINANCING
See "ITEM 2. PROPERTIES - Mortgage Indebtedness of Your Partnership" for information on the acquisition by members of the Newkirk Group of second mortgage indebtedness on properties owned by your partnership. During 2003, your partnership incurred approximately $685,000 of interest expense payable to members of the Newkirk Group on the mortgage indebtedness. At December 31, 2004, your partnership owed approximately $14,583,000 on the second mortgage to members of the Newkirk Group.
T-TWO PARTNERS
See "ITEM 1. BUSINESS - Description of Assets - The Subordinate Mortgage Interests" for a description of T-Two Partners, its ownership of second mortgage loans on your partnership's properties and the sale to your partnership of a mortgage loan encumbering a property in which your partnership has a 53% interest. During 2003, your partnership incurred approximately $14,295,000 of interest expense payable to T-Two Partners. T-Two Partners is owned by NK-CR Holdings and Holdings Subsidiary, both of which are owned by members of the Newkirk Group. After payment of the cost of acquiring the T-1 Certificate, approximately $164,526,000 of the proceeds of the T-Two Loan referred to in Item 1 were distributed to the owners of T-Two Partners. At the time of the closing of the T-Two Loan, T-Two Partners also distributed to its beneficial owners $29,475,000 that was being held by T-Two Partners. This additional amount represented payments that had previously been made on the second mortgage loans, including second mortgage loans on your partnership's properties, in which T-Two Partners owned subordinated beneficial interests, as well as proceeds from the sale to your partnership of the mortgage loan referred to above. A substantial portion of these amounts had previously been held in a reserve fund for the holders of the T-1 Certificate.
MORTGAGE ON PROPERTY OF AFFILIATE
See "ITEM 1. BUSINESS - Description of Assets - First Mortgage Interests" for information on a securitized pool of first mortgages held by your partnership that is partially secured by properties owned by partnerships that are controlled by affiliates of your partnership's general partner.
ASSET MANAGEMENT AGREEMENT
See "ITEM 1. BUSINESS - Description of Assets - The Management Company" for a description of fees paid to Winthrop Financial Associates by Newkirk Asset Management LLC for services rendered for your partnership and certain other partnerships.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The aggregate fees for professional services rendered by Imowitz, Koenig & Co. during 2003 and 2002 were as follows:
Audit Fees. Fees for the audit of your partnership's annual financial statements, the reviews of the financial statements in the Partnership's Forms 10-Q, the review of the financial statements in the Partnership's Form 10 and amendments thereto, and other services in connection with statutory and regulatory filings and engagements were $338,000 and $147,000, in 2003 and 2002, respectively.
Audit Related Fees. The aggregate audit-related fees billed during 2003 and 2002 for assurance and related services that were reasonably related to the performance of the audit or review of your partnership's financial statements and not reported under "Audit Fees" were in the amount of $15,000 and 0, respectively, billed by Imowitz, Koenig & Co. and covered agreed upon procedures related to a bank financing.
Tax Fees. Fees for tax services relating to tax compliance were $366,000 and $294,000 in 2003 and 2002, respectively.
All Other Fees. None.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements
See "Index to Financial Statements" below.
(b) Reports on Form 8-K
Date Items Reported Financial Statements ---- -------------- --------------------
11/26/03 5 None
(c) Exhibits
Exhibit No. Description - ----------- -----------
* 2.1 Agreement and Plan of Merger between the Newkirk Master Limited Partnership and each of the Merger Partnerships set forth on Schedule A, dated December 6, 2001.
* 2.2 Assignment and Assumption Agreement by and between Newkirk Stock LLC, The Newkirk Master Limited Partnership, Newkirk NL Holdings LLC and VNK Corp. dated as of December 26, 2001.
* 2.3 Assignment and Assumption Agreement by and between Newkirk Eastgar LLC, Newkirk Partner Interest LLC, The Newkirk Master Limited Partnership and Newkirk MLP Unit LLC dated as of December 26, 2001.
* 2.4 Assignment and Assumption Agreement by and between Vornado Realty L.P., Vornado Newkirk L.L.C., The Newkirk Master Limited Partnership, and Newkirk MLP Unit LLC, dated as of December 26, 2001.
* 2.5 Assignment and Assumption Agreement between Newkirk RE Associates LLC, The Newkirk Master Limited Partnership, Newkirk RE Holdings and Vornado Newkirk L.L.C. dated as of December 26, 2001.
* 2.6 Assignment and Assumption Agreement by and between Newkirk Associates LLC, The Newkirk Master Limited Partnership, Newkirk NL Holdings LLC and Vornado Newkirk L.L.C. dated as of December 26, 2001.
* 2.7 Agreement and Plan of Merger by and between The Newkirk Master Limited Partnership, Lanmar Associates Limited Partnership and Newkirk Lanmar L.P., dated as of December 6, 2001.
* 3 Certificate of Limited Partnership of the Newkirk Master Limited Partnership.
* 4.1 Agreement of Limited Partnership of The Newkirk Master Limited Partnership, by and among MLP GP LLC, Newkirk Manager Corp. and all other persons who shall, pursuant to the Exchange or otherwise become limited partners of the Partnership, dated as of October 23, 2001.
* 4.2 Additional provisions incorporated by reference into the Agreement of Limited Partnership of the Newkirk Master Limited Partnership.
* 4.3 Limited Liability Agreement of MLP GP LLC.
Exhibit No. Description - ----------- -----------
* 10.1 Amended and Restated Cash Participation Agreement, dated as of January 1, 2002, by and among Newkirk GP LLC, Newkirk Capital LLC, Newkirk RE Associates LLC, Newkirk Stock LLC, Newkirk Associates LLC, Vornado Realty L.P., Vornado Newkirk L.L.C., VNK Corp., on the one hand, and Administrator LLC, as agent for itself and as agent for the persons listed on Schedule A thereto.
* 10.2 Amended and Restated Pledge Agreement, dated as of January 1, 2002, by and between The Newkirk Master Limited Partnership and Administrator LLC, for itself and as agent for the parties listed on Schedule A thereto.
* 10.3 Put-Call Option Agreement, dated as of January 1, 2002, by and among The Newkirk Master Limited Partnership,, NK-CR Holdings LLC and Holdings Subsidiary LLC.
* 10.4 Asset Management Agreement dated as of January 1, 2002, by and between Newkirk Asset Management LLC and Winthrop Financial Associates.
* 10.5 Loan Agreement, dated January 30, 2002, among The Newkirk Master Limited Partnership and Fleet National Bank and the lenders party thereto.
* 10.6 Promissory Note, dated as of January 30, 2002, by The Newkirk Master Limited Partnership in favor of Fleet National Bank.
* 10.7 Security Agreement, dated as of January 30, 2002, between The Newkirk Master Limited Partnership and Fleet National Bank.
* 10.8 Ownership Interest Pledge and Security Agreement, dated as of January 30, 2002, from The Newkirk Master Limited Partnership, Newkirk GP Holding LLC and General Partners of Participating Limited Partnerships to Fleet National Bank.
* 10.9 Ownership Interest Pledge and Security Agreement, dated as of January 30, 2002, from The Newkirk Master Limited Partnership to Fleet National Bank.
* 10.10 Ownership Interest Pledge and Security Agreement, dated as of January 30, 2002, from The Newkirk Master Limited Partnership to Fleet National Bank.
* 10.11 Ownership Interest Pledge and Security Agreement, dated as of January 30, 2002, from The Newkirk Master Limited Partnership to Fleet National Bank.
** 10.12 Indemnity Agreement, dated as of January 30, 2002, among Newkirk NL Holdings, LLC, Newkirk MLP Corp., Vornado Realty, L.P., Vornado Newkirk, LLC, VNK Corp., Apollo Real Estate Fund III, L.P., The Newkirk Master Limited Partnership and Fleet National Bank.
*** 10.13 Master Loan Agreement, dated November 24,2003, among The Newkirk Master Limited Partnership, T-Two Partners, L.P., and Fleet National Bank and the lender's party thereto.
*** 10.14 Master Promissory Note, dated as of November 24, 2003, by The Newkirk Master Limited Partnership in favor of Fleet National Bank.
*** 10.15 Security Agreement, dated as of November 24, 2003, between The Newkirk Master Limited Partnership and Fleet National Bank.
*** 10.16 Ownership Interest Pledge and Security Agreement, dated as of November 24, 2003, from The Newkirk Master Limited Partnership, Newkirk GP Holding LLC and General Partners of certain Limited Partnerships to Fleet National Bank.
Exhibit No. Description - ----------- -----------
*** 10.17 Ownership Interest Pledge and Security Agreement (GMAC Partnerships), dated as of November 24, 2003, from The Newkirk Master Limited Partnership to Fleet National Bank.
*** 10.18 Ownership Interest Pledge and Security Agreement (Subsidiaries), dated as of November 24, 2003, from The Newkirk Master Limited Partnership to Fleet National Bank.
*** 10.19 Ownership Interest Pledge and Security Agreement (Finco and Capital), dated as of November 24, 2003, from The Newkirk Master Limited Partnership to Fleet National Bank.
*** 10.20 Amended and Restated Indemnity Agreement, dated as of November 24, 2003, among Newkirk NL Holdings, LLC, Newkirk MLP Corp., Vornado Realty, L.P., Vornado Newkirk, LLC, VNK Corp., Apollo Real Estate Fund III, L.P., The Newkirk Master Limited Partnership and Fleet National Bank.
*** 10.21 Guaranty from The Newkirk Master Limited Partnership to Fleet National Bank.
**** 10.22 Amended Stipulation of Settlement of Albert McCall, et. al., v. Newkirk Capital LLC, et al.
**** 16 Letter from Deloitte & Touche LLP.
* 21 List of subsidiaries of the Registrant.
31.1 Certificates of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certificates of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Chief Executive Officer's Certificate, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Chief Financial Officer's Certificate, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
- ---------- * Previously filed as an Exhibit to Form 10 filed on April 30, 2003.
** Previously filed as an Exhibit to Amendment No. 1 to Form 10 filed on September 10, 2003.
*** Incorporated by reference to Exhibits filed with Form 8-K dated November 24, 2003.
**** Previously filed as an Exhibit to Amendment No. 2 to Form 10 filed on February 12, 2004.
(d)(3) Financial Statement Schedule
Independent Auditor's Report on Financial Statement Schedule
Schedule of Real Estate and Accumulated Depreciation
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: April 2, 2004
THE NEWKIRK MASTER LIMITED PARTNERSHIP
By: MLP GP LLC, its General Partner
By: Newkirk MLP Corp., its Manager
By: /s/ Michael L. Ashner ------------------------------------ Name: Michael L. Ashner Title: 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 and in the capacities and on the date indicated:
Exhibit Index
Exhibit No. Description - ----------- -----------
14 Code of Ethics.
31.1 Certificates of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certificates of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Chief Executive Officer's Certificate, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Chief Financial Officer's Certificate, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
THE NEWKIRK MASTER LIMITED PARTNERSHIP
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Independent Auditors' Report
To the Partners of The Newkirk Master Limited Partnership
We have audited the accompanying consolidated balance sheets of The Newkirk Master Limited Partnership (a Delaware limited partnership) (the "Partnership") as of December 31, 2003 and 2002 and the related consolidated statements of operations, partners' equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Partnership as of December 31, 2003 and 2002, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
/s/ Imowitz Koenig & Co., LLP
New York, New York January 30, 2004
F - 1
INDEPENDENT AUDITORS' REPORT
To the Members of Newkirk RE Holdings, LLC and Newkirk NL Holdings, LLC:
We have audited the accompanying combined consolidated statements of operations, changes in members' capital, and cash flows of Newkirk RE Holdings, LLC and Newkirk NL Holdings, LLC and subsidiaries (the "Predecessor Company") for the year ended December 31, 2001. These financial statements are the responsibility of the Predecessor Company's management. Our responsibility is to express an opinion on the financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the combined consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the combined consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such combined consolidated financial statements present fairly, in all material respects, the results of operations and cash flows of the Predecessor Company for the year ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America.
DELOITTE & TOUCHE LLP
Boston, Massachusetts April 11, 2002
F - 2
THE NEWKIRK MASTER LIMITED PARTNERSHIP CONSOLIDATED BALANCE SHEETS (In thousands, except unit data)
See notes to consolidated financial statements.
F - 3
THE NEWKIRK MASTER LIMITED PARTNERSHIP STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (In thousands, except unit and per unit data)
See notes to consolidated financial statements.
F - 4
THE NEWKIRK MASTER LIMITED PARTNERSHIP
CONSOLIDATED STATEMENTS OF PARTNERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2003 and 2002 (In thousands, except unit data)
Limited Partnership Partners' Units Equity ----------- ----------
Equity Contributions 6,121,990 $ 98,893
Distributions -- (196,880)
Limited partner buyouts (5,412) (182)
Net income -- 122,862 ---------- ----------
Balance at December 31, 2002 6,116,578 24,693
Equity Contributions 317,813 11,050
Distributions -- (34,731)
Limited partner buyouts (115,000) (3,937)
Net income -- 149,936 ---------- ----------
Balance at December 31, 2003 6,319,391 $ 147,011 ========== ==========
PREDECESSOR COMBINED CONSOLIDATED STATEMENT OF MEMBERS' CAPITAL FOR THE YEAR ENDED DECEMBER 31, 2001 (In thousands)
Members' Capital ---------
Balance at January 1, 2001 $ 209,962
Contributions 5,329
Distributions (7,384)
Net income 49,611 ---------
Balance at December 31, 2001 $ 257,518 =========
See notes to consolidated financial statements.
F - 5
THE NEWKIRK MASTER LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (In thousands)
(Continued)
See notes to consolidated financial statements.
F - 6
THE NEWKIRK MASTER LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (In thousands) (continued)
(Continued)
See notes to consolidated financial statements.
F - 7
THE NEWKIRK MASTER LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (In thousands) (continued)
See notes to consolidated financial statements.
F - 8
THE NEWKIRK MASTER LIMITED PARTNERSHIP STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (Continued)
Supplemental Information
In January 2003, balances related to the issuance of 317,813 Units in the Partnership for the various assets contributed to the Partnership were as follows:
-------------- (In thousands)
Real estate investments, net $ 36,836 Cash and cash equivalents 382 Receivables 3,557 Deferred costs, net 1,512 Equity investments in limited partnerships 6,335 Mortgage notes payable (61,057) Accrued interest payable (1,134) Accounts payable and accrued expenses (68) Minority interests 24,687 --------
Partners' equity $ 11,050 ========
In connection with the disposal of real estate, the purchaser of a property assumed $94,918,000 of the Partnership's debt.
See notes to consolidated financial statements.
F - 9
THE NEWKIRK MASTER LIMITED PARTNERSHIP STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (Continued)
Supplemental Information (Continued)
The combined financial statements of Newkirk RE Holdings, LLC and Newkirk NL Holdings, LLC are considered the acquirer and predecessor of the business transferred to the Partnership in connection with the transaction because the members of the combined entity acquired majority control of the businesses transferred to the Partnership.
As of January 1, 2002, balances related to the exchange of Units in the Partnership for the various assets of the combined entity and other contributing unit holders were as follows:
-------------- (In thousands)
Real estate, net $ 1,233,756 Real estate held for sale 113,982 Cash and cash equivalents 10,776 Receivables 78,376 Deferred costs, net 19,957 Other assets 34,377 Other assets of discontinued operations 880 Mortgage notes payable (776,633) Contract right mortgage notes payable (325,264) Accrued interest (188,567) Accounts payable and accrued expenses (15,189) Liabilities of discontinued operations (123,078) Minority interest 35,520 Investment in limited partnerships -- ----------- Partners' equity $ 98,893 ===========
See notes to consolidated financial statements.
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THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - ORGANIZATION AND BUSINESS
The Newkirk Master Limited Partnership (the "Partnership") was organized in October 2001 as a limited partnership under the Delaware Revised Uniform Limited Partnership Act. The Partnership's term is perpetual unless it is otherwise dissolved in accordance with the terms of the Partnership's partnership agreement. The Partnership commenced operations on January 1, 2002 following the completion of a transaction (the "Exchange") involving the merger into wholly-owned subsidiaries of the Partnership of 90 limited partnerships, each of which owned commercial properties (the "Newkirk Partnerships"), and the acquisition by the Partnership of various assets, including those related to the management or capital structure of the Newkirk Partnerships. The Partnership was formed to facilitate and consummate the Exchange and for the purpose of directly or indirectly (whether through a subsidiary or otherwise), investing in, acquiring, owning, holding, managing, operating, selling, exchanging and otherwise disposing of interests in real estate and assets related to real estate and to engage in activities and transactions as the general partner deems necessary or advisable to promote the business of the Partnership.
As part of the Exchange, each Newkirk Partnership was merged with and into a separate newly-formed limited partnership that is wholly-owned by the Partnership; the Newkirk Partnerships ceased to exist following completion of the merger. Each Newkirk Partnership owned one or more commercial properties that are generally net leased to a single tenant. As a result of the Exchange, the Partnership owns the properties and other assets formerly owned by the Newkirk Partnerships, subject to the liabilities of such partnerships. In addition, as part of the Exchange, the "Newkirk Group" contributed certain assets to the Partnership. The Newkirk Group, which managed the Newkirk Partnerships, is comprised of certain affiliates of Apollo Real Estate Fund III, L.P., ("Apollo"), Vornado Realty Trust and senior executives of Winthrop Financial Associates, A Limited Partnership ("WFA"). At December 31, 2003, the Newkirk Group owned approximately 80% of the Partnership.
The limited partners of the Partnership consist of former limited partners of the Newkirk Partnerships, former limited partners that elected to participate in the Exchange of an additional limited partnership that was affiliated with the Newkirk Partnerships and affiliates of the Newkirk Group. The general partner of the Partnership is MLP GP LLC, a Delaware limited liability company owned by affiliates of the Newkirk Group. MLP GP LLC does not receive any compensation for managing the Partnership. MLP GP LLC has no assets, liabilities or equity and has no economic interest in the Partnership. WFA, which performed asset
F - 11
THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - ORGANIZATION AND BUSINESS (Continued)
management services for the Newkirk Partnerships, performs asset management services for the Partnership.
At December 31, 2003, the Partnership owned the following:
(i) Net-Leased Properties:
Ownership of 268 commercial properties located throughout the United States of America, each of which is generally net-leased to a single tenant.
(ii) Other Assets:
(a) General partnership interests in (i) seven consolidated partnerships, (ii) eight unconsolidated partnerships and (iii) six other partnerships that own commercial net leased properties.
(b) Limited partnership interests in (i) seven consolidated partnerships which represent between 32.1% and 60.5% and (ii) eight unconsolidated partnerships which represent between .5% and 36.88%.
(c) A 50.01% interest in Newkirk Capital LLC whose wholly-owned subsidiary, Newkirk Asset Management LLC, provides asset management and other services to the Partnership and the Other Partnerships. Prior to the Exchange, Newkirk Asset Management LLC provided these services to the Newkirk Partnerships and the Other Partnerships. Newkirk Capital LLC and Newkirk Asset Management LLC have retained WFA to perform certain of the services provided to the Partnership and the Other Partnerships. The fees payable to Newkirk Asset Management LLC and Newkirk Capital LLC are retained by the Partnership.
(d) Newkirk Finco LLC, which holds a note receivable from Administrator LLC, a 49.99% owner of Newkirk Capital LLC, valued at $13.2 million at December 31, 2003.
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THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - ORGANIZATION AND BUSINESS (Continued)
(e) The right to acquire T-Two Partners, L.P., ("T-Two Partners") from its current owners, affiliates of the Newkirk Group.
(f) Land interests comprised of ground leases, remainder interests or the right to acquire remainder interests in the land underlying certain properties owned by the Partnership and other real estate limited partnerships.
(g) An interest in NK Leasehold II LLC, which has a leasehold and second mortgage interest in a property owned by the Partnership.
(h) An interest in NK-Leyden Loan, L.P. and NK-Dautec Loan, L.P., each of which hold an unsecured note of the Partnership.
(i) Interests in entities which hold a securitized pool of 31 first mortgage loans encumbering 67 Partnership properties and 1 property owned by another limited partnership.
In February 2003, the Partnership acquired from its limited partners 115,000 of its units of limited partnership interest at a purchase price of $35 per unit.
F - 13
THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements present the consolidated financial position, results of operations and cash flows of the Partnership and its majority-owned subsidiaries. All significant intercompany transactions, receivables and payables have been eliminated in consolidation. Minority interests relate to the interest in certain partnerships not owned by the Partnership. The Partnership accounts for its investments in partnerships and joint ventures, in which it does not have a controlling interest, using the equity method of accounting. Equity investments are recorded initially at cost and subsequently adjusted for the Partnership's share of the net income or loss and cash contributions to and distributions from these partnerships and joint ventures.
The Partnership has accounted for the Exchange as an exchange of equity interests between entities under common control and initially recognized the assets and liabilities contributed at the carrying amounts of the contributing entities.
The combined financial statements of Newkirk RE Holdings, LLC and Newkirk NL Holdings, LLC are considered the Predecessor Entity (the "Predecessor Entity"). These entities are under the control of Apollo, which controlled the General Partnership interests in the Newkirk Partnerships and held more than a 50% voting ownership interest before and after the Exchange. As a result, the Predecessor Entity is considered the accounting acquirer and, accordingly, the combined consolidated operating results for the year ended December 31, 2001 reflect the historical results of operations of the Predecessor Entity. The combined consolidated operating results for the year ended December 31, 2001 is not comparable to the consolidated operating results for the years ended December 31, 2003 and 2002. The Predecessor Entity amounts include assets that were not transferred to the Partnership, and the Partnership's amounts included assets that were contributed to the Partnership by partners other than the Predecessor Entity.
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
F - 14
THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Real Estate
Investments in real estate are stated at historical cost basis less accumulated depreciation and amortization. Depreciation of buildings and improvements is computed on a straight-line basis over their estimated useful lives, which range from fourteen to forty years. Amortization of the land estates is computed on a straight-line basis over their estimated useful lives, which range from twenty-two to thirty years.
During 2003, the Partnership made a change to its accounting estimates with respect to the depreciable lives of its real estate assets. The change in accounting estimates resulted in a decrease in net income of approximately $6.8 million and a decrease in net income of approximately $1.08 per limited partnership unit for the year ended December 31, 2003.
The Predecessor Entity recorded its acquisition of the Newkirk Partnerships interests as purchase transactions in accordance with Accounting Principles Board Opinion No. 16, "Business Combinations" ("APB No. 16") as all such acquisitions were completed prior to July 1, 2001. The purchase price for such acquisitions was principally allocated to the real estate and debt acquired as of the date of each of the transactions. Statement of Financial Accounting Standards No. 141 "Business Combinations" ("SFAS No. 141") applied for the last six months of the year ended December 31, 2001. No acquisitions occurred in that period.
The Partnership's real estate investments are reviewed for impairment if events or changes in circumstances indicate that the carrying amount of the real estate may not be recoverable. In such an event, a comparison is made of the current and projected operating cash flows of such real estate on an undiscounted basis to the carrying amount of such real estate. Such carrying amount would be adjusted, if necessary, to estimated fair value to reflect impairment in the value of the real estate. Real estate assets for which the Partnership has committed to a plan to dispose of the assets, whether by sale or abandonment, are reported at the lower of carrying amount or fair value less cost to sell. Preparation of projected cash flows is inherently subjective and is based on the Partnership's best estimate of assumptions concerning expected future conditions.
F - 15
THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Real Estate (continued)
Upon acquisitions of real estate, the Partnership assesses the fair value of acquired assets (including land, buildings, tenant improvements, and identified intangibles such as above and below market leases and acquired in-place leases) and acquired liabilities, and allocates purchase price based on these assessments.
The Partnership accounts for properties as held for sale under the provisions of SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"), when all criteria of SFAS No. 144 have been met.
Cash and Cash Equivalents
The Partnership considers all highly liquid investments with original purchase maturity dates of three months or less to be cash equivalents.
Restricted Cash
Restricted cash includes reserves for tenant improvements, leasing commissions and related costs established pursuant to the Partnership's note payable agreement.
Concentration of Credit Risk
Substantially all of the Partnership's cash and cash equivalents consist of money market mutual funds which invest in U.S. Treasury Bills and repurchase agreements with original maturity dates of three months or less.
The Partnership maintains cash with one banking institution, which amounts at times exceed federally insured limits.
Interest Rate Protection Agreements
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," requires the recording of all derivative instruments as either assets or liabilities depending on the rights and obligations under the contracts. In addition, all derivative instruments shall be measured at fair value, with the resulting gain or loss being recognized either in earnings or equity in the period of change, depending on whether the contract is designated as a hedge or not. The Partnership invests in interest rate caps in order to cap the maximum interest rate payable on its variable rate debt. The interest rate caps are not designated as hedging instruments, and are measured at fair value, with the resulting gain or loss being recognized in interest expense in the period of change.
F - 16
THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Receivables
Receivables consist of rent from tenants and other receivables which are deemed collectable by the Partnership. No provision for doubtful accounts was considered necessary based upon the Partnership's evaluation of the collectability of these amounts.
Loans Receivable
The Partnership evaluates the collectability of both interest and principal of each of its loans, if circumstances warrant, to determine whether it is impaired. A loan is considered to be impaired, when based on current information and events, it is probable that the Partnership will be unable to collect all amounts due according to the existing contractual terms. When a loan is considered to be impaired, the amount of the loss accrual is calculated by comparing the recorded investment to the value determined by discounting the expected future cash flows at the loan's effective interest rate. Interest on impaired loans is recognized on a cash basis. Loans receivable are included with "other assets" in the accompanying consolidated balance sheets.
Investments in Debt Securities and Mortgage Loans
Investments in debt securities are classified as held-to-maturity and reported at amortized cost. Investment in mortgage loans is included with "other assets" in the accompanying consolidated balance sheets.
Deferred Costs
Fees paid in connection with the financing of the Partnership's and Predecessor Entity's properties are deferred and amortized over the terms of the related agreements as a component of interest expense.
F - 17
THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Investments in Limited Partnerships
The Predecessor Entity accounted for its investments in limited partnerships under the equity method when significant influence, but not control was exercised over the limited partnership. Where control was exercised, the limited partnerships were consolidated for financial statement purposes. The investments were recorded by the Predecessor Entity using the fair-value principles of APB No. 16, as all such acquisitions were completed prior to the effective date of SFAS No. 141 of July 1, 2001, whereby the Predecessor Entity's share of the assets acquired and liabilities assumed was adjusted to fair value. During 2001, a significant number of additional limited partnerships came under the control of the Predecessor Entity resulting in a change from the equity method to consolidation.
Revenue Recognition
The Partnership's lease agreements are operating leases and generally provide for varying rents over the lease terms. The Partnership records rental income for the full term of each lease on a straight-line basis. Accordingly, deferred rental income is recorded from tenants for the amount that is expected to be collected over the remaining lease term rather than currently. When a property is acquired, the term of existing leases is considered to commence as of the acquisition date for purposes of this calculation. Deferred rental income recorded amounted to $31.6 million and $27.1 million for the Partnership at December 31, 2003 and 2002, respectively.
F - 18
THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Income Taxes
Taxable income or loss of the Partnership is reported in the income tax returns of its partners. Accordingly, no provision for income taxes is made in the consolidated financial statements of the Partnership. However, the Partnership is required to pay certain state and local entity level taxes which are expensed as incurred.
The Predecessor Entity provided for income taxes with respect to the portion of the net income attributable to its taxable corporate subsidiaries. Income tax expense for 2001 represented current income taxes payable; no deferred income tax expense was recorded. The corporate subsidiaries were not contributed to the Partnership.
Net Income per Unit
Net income per Unit is computed by dividing net income by the 6,329,204 and 6,119,942 weighted average Units outstanding during the years ended December 31, 2003 and 2002, respectively.
The Predecessor Entity has only two members and does not have any limited partnership units outstanding.
Distributions; Allocations of Income and Loss
As provided in the partnership agreement, distributions are allocated to the limited partners based on their ownership of Units. No distributions, or net income or loss allocation, are made to the general partner. Income and loss for financial reporting purposes is allocated to limited partners based on their ownership of Units. Special allocation rules affect the allocation of taxable income and loss. The Partnership paid distributions of $34,731,000 ($5.52 per Unit) and $196,880,000 ($32.16 per Unit) to its limited partners during the years ended December 31, 2003 and 2002, respectively.
The members of the Predecessor Entity are Apollo Real Estate Investment Fund III L.P. holding 98.57% and WEM Brynmar Associates LLC holding 1.43%.
Segment Reporting
The Partnership has one reportable segment, net-leased commercial real estate. The Partnership evaluates performance based on net operating income, which is income before depreciation, amortization, interest and non-operating items.
F - 19
THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Fair Value of Financial Instruments
Financial instruments held by the Partnership include cash and cash equivalents, receivables, accounts payable and long-term debt. The fair value of cash and cash equivalents, receivables and accounts payable approximates their current carrying amounts due to their short-term nature. The fair value of long-term debt, which has fixed interest rates, was determined based upon current market conditions and interest rates. The fair value of the mortgage notes payable approximates fair value for debt with similar terms and conditions due to yield maintenance requirements and prepayment penalties. The fair value of the Partnership's contract right mortgage notes payable is approximately $393.0 million, which is $13.7 million less than the aggregate carrying amount at December 31, 2003. The fair value of the Partnership's interest rate cap is approximately $2.6 million at December 31, 2003. Such fair value estimates are not necessarily indicative of the amounts that would be realized upon disposition of the Partnerships' financial instruments.
Reclassifications
Certain prior year amounts have been reclassified to conform to the 2003 presentation, including the reporting of discontinued operations for those assets that have been disposed of or classified as held for sale in accordance with SFAS No. 144.
Recently Issued Accounting Standards
In January 2003, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 46, "Consolidation of Variable Interest Entities." This interpretation clarifies the application of existing accounting pronouncements to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. In December 2003, the FASB issued a revision to Interpretation No. 46 ("46R") to clarify some of the provisions of Interpretation No. 46, and to exempt certain entities from its requirements. The provisions of the interpretation need to be applied in the first fiscal period beginning after March 15, 2004, except for entities that are considered to be special-purpose entities which need to be applied as of December 31, 2003. This interpretation had no effect on the Partnership's consolidated financial statements.
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THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Recently Issued Accounting Standards (Continued)
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." The statement improves the accounting for certain financial instruments that under previous guidance, issuers could account for as equity. The new statement requires that those instruments be classified as liabilities in statements of financial position. SFAS No. 150 affects the issuer's accounting for three types of freestanding financial instruments. One type is mandatorily redeemable shares, which the issuing company is obligated to buy back in exchange for cash or other assets. A second type, which includes put options and forward purchase contracts, involves instruments that do or may require the issuer to buy back some of its shares in exchange for cash or other assets. The third type of instruments that are liabilities under this statement is obligations that can be settled with shares, the monetary value of which is fixed, tied solely or predominantly to a variable such as a market index, or varies inversely with the value of the issuers' shares. SFAS No. 150 does not apply to features embedded in a financial instrument that is not a derivative in its entirety. In addition to its requirements for the classification and measurement of financial instruments in its scope, SFAS No. 150 also requires disclosures about alternative ways of settling the instruments and the capital structure of entities, all of whose shares are mandatorily redeemable. Most of the guidance in SFAS No. 150 is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. In October 2003, the FASB deferred, indefinitely, the application of paragraphs 9 and 10 of SFAS No. 150 as it relates to recording mandatorily redeemable non-controlling interests in consolidated subsidiaries at fair value. The remainder of this statement had no effect on the Partnership's consolidated financial statements.
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THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 3 - REAL ESTATE INVESTMENTS
Most of the Partnership's properties are each net-leased to a single commercial tenant. The properties are located throughout the United States. The lease terms vary, but most leases have a primary term of 25 years followed by multiple 5-year optional renewal terms. The leases are similar in many respects and generally provide for fixed rent payments and obligate the tenant to pay all capital and operating expenses for a property; obligate the tenant to perform all responsibilities (other than the payment of debt service) relating to the property; require the tenant to maintain insurance against casualty and liability losses; permit the tenant to sublet the property; and afford the tenant in many instances the right to terminate the lease at certain points during the primary term if it determines that its continued use and occupancy of the property would be uneconomic or unsuitable.
The Partnership's ability to maintain and operate its properties and satisfy its contractual obligations is dependent upon the performance by the tenants of their obligations under their lease agreements with the Partnership. Under certain conditions (including the destruction of the property), many of the tenants have an option to purchase the property upon the expiration of the primary term of the lease and at the end of one or more renewal terms for a price stated in the lease agreement.
The Partnership's properties are encumbered by mortgage notes payable and subordinated contract rights payable.
The future minimum lease payments that are scheduled to be received under non-cancellable operating leases are as follows (in thousands):
2004 $ 265,547 2005 258,032 2006 243,429 2007 209,384 2008 153,892 Thereafter 95,828 ---------- $1,226,112 ==========
Two tenants accounted for approximately 24% and 25% of the aggregate rental revenues of the Partnership in 2003 and 2002, respectively.
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THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 3 - REAL ESTATE INVESTMENTS (Continued)
The Partnership owns the fee interest in the land on which certain of its properties are located, leases the land pursuant to ground leases or holds an estate for years with an option to lease the land upon expiration of the estate for years. Certain land interests held by the Newkirk Group comprised of ground leases, remainder interests or the right to acquire remainder interests in the land underlying certain properties were contributed to the Partnership in connection with the Exchange.
The rent payable under the ground leases is as follows (in thousands):
2004 $ 3,191 2005 3,143 2006 2,413 2007 1,769 2008 1,184 Thereafter 830 ------- $12,530 =======
Note 4 - NOTES AND CONTRACT RIGHTS PAYABLE
The Partnership, excluding discontinued operations, had outstanding mortgage notes payable and contract right mortgage notes payable of $895.9 million and $1.0 billion at December 31, 2003 and 2002, respectively. The mortgage notes are at fixed interest rates with payments of principal and interest generally due either monthly, quarterly or semi-annually. All the mortgage notes are collateralized by the Partnership's real estate; some of the mortgage notes are cross-collateralized.
An aggregate of $602.9 million in indebtedness under the mortgage notes mature at various dates from 2004 to 2024. Prepayment of most of the mortgage notes is permitted only with a yield maintenance payment or prepayment penalty as defined in the mortgage note agreements. Interest rates on the mortgages ranged from 4.2% to 11.3%, with a weighted average interest rate of 8.0% at December 31, 2003. Interest rates on the fixed rate mortgages ranged from 4.2% to 11.3% with a weighted average interest rate of 8.9% at December 31, 2002.
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THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 4 - NOTES AND CONTRACT RIGHTS PAYABLE (Continued)
The contract right mortgage notes aggregating $293.0 million mature at various dates from 2008 to 2024. The Partnership has the option to prepay some of these mortgage notes at a discount. All of the contract right mortgages are prepayable at any time without premium or penalty subject to the prior or simultaneous satisfaction of the underlying first mortgage loans. Interest rates ranged from 8.11% to 16.25%, with a weighted average interest rate of 10.3% at December 31, 2003. Interest rates ranged from 8.13% to 16.25%, with a weighted average interest rate of 10.99% at December 31, 2002.
Mortgage notes payable and contract right mortgage notes payable aggregating approximately $1.1 billion and accrued interest thereon were assumed as part of the Exchange. The Predecessor Entity recorded these notes at their fair value as of the various dates of acquisition. This accounting method resulted in recorded interest expense that was $3.8 million, $4.0 million and ($1.7) million greater (or less) than the contractual interest expense for the years ended December 31, 2003, 2002 and 2001, respectively. The effect of utilizing this accounting method was to increase the principal balance of mortgage and contract rights notes payable and reduce interest accrued on these obligations. The cumulative reduction in liabilities related to utilizing this accounting method was $56.1 million and $50.5 million at December 31, 2003 and 2002, respectively.
During January 2003, the Partnership acquired a second mortgage loan that encumbered the Partnership's property in Morris Township, New Jersey. The outstanding mortgage principal and accrued interest was $28.1 million at December 31, 2002. It was acquired for $22.1 million, $9.3 million of which was paid in January 2003 and $12.8 million of which was to be payable on or before September 30, 2003. The deferred portion of the purchase price bore interest at a rate of 6.0% per annum. The Partnership acquired this mortgage in connection with an extension of the lease on the property and obtained new first mortgage financing in June 2003 to satisfy the balance of the purchase price. The new first mortgage that was obtained in June 2003, had a principal balance of $21.0 million and bore interest at LIBOR plus 2.875% per annum. After payment of closing costs, $6.7 million of the proceeds were used to satisfy the existing first mortgage and the balance of the net proceeds was used to satisfy the deferred portion of the second mortgage purchase price. This loan was refinanced in October 2003.
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THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 4 - NOTES AND CONTRACT RIGHTS PAYABLE (Continued)
During October 2003, the Partnership refinanced its first mortgage loan on its property in Morris Township, New Jersey. The new first mortgage loan has a principal balance of $28.5 million, bears interest at 5.55%, and has a term of ten years. After payment of closing costs, $21.1 million of proceeds were used to satisfy the existing first mortgage and accrued interest.
During August 2003, the Partnership obtained a first mortgage loan encumbering the Partnership's property in Beaumont, Texas in the amount of $3.4 million. The new loan bears interest at 6.2% per annum and matures on November 30, 2007, at which time it is scheduled to be fully amortized.
During November 2003, the Partnership obtained a $208.5 million loan, which had an outstanding balance of $208.4 million at December 31, 2003. The note payable bears interest at a rate elected by the Partnership equal to either (1) LIBOR plus 450 basis points or (2) the prime rate charged by the bank plus 250 basis points. The note payable was obtained to replace the Partnership's existing note payable and effectively reduced the interest rate on such borrowing from a minimum of 8.5% to a floating rate which was 5.71% (LIBOR plus 450 basis points) at December 31, 2003 and that will in no event exceed 9.5%, after giving effect to the three-year interest rate protection agreement entered into by the Partnership. The note payable is scheduled to mature on November 24, 2006, subject to two one-year extensions. The note payable requires monthly payments of interest only. In addition, mandatory prepayments of principal are required from the proceeds of property sales and refinancings and other asset sales, as well as up to approximately $1.3 million per quarter to the extent that T-Two Partners does not make the required principal payments on the T-Two Loan that is described below. The Partnership can prepay the note payable in whole or in part at any time together with a premium of 1% if such prepayment occurs on or before November 24, 2004, 1/2% if such prepayment occurs between November 25, 2004 and November 24, 2005 and thereafter with no premium. In addition, the Partnership and T-Two Partners may prepay up to $50.0 million annually of this Loan and the T-Two Loan without a premium. The note payable is secured by substantially all of the assets of the Partnership, and contains customary financial and other covenants.
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THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 4 - NOTES AND CONTRACT RIGHTS PAYABLE (Continued)
At the same time as the Partnership obtained the loan, T-Two Partners obtained a $316.5 million loan. This loan is referred to as the T-Two Loan. The interest rate, maturity date and principal terms of the T-Two Loan are the same as the Partnership's note payable. T-Two Partners used part of the proceeds of the T-Two Loan to purchase the senior beneficial interests in the contract rights encumbering the Partnership's and certain other partnership's properties so that T-Two Partners is now the 100% beneficial owner of the contract rights. These senior beneficial interests in the contract rights are referred to as the T-1 Certificate. The T-Two Loan is secured by all the assets of T-Two Partners, including the contract rights receivable from the Partnership. The Partnership guaranteed repayment of the T-Two Loan. In consideration for the Partnership's guarantee, the owners of T-Two Partners agreed to the elimination of their put option, which could require the Partnership to purchase T-Two Partners in December 2007, provided a credit line to the Partnership bearing interest at LIBOR plus 450 basis points and modified the Partnership's option to acquire T-Two Partners in January 2008. The credit line is in an amount sufficient to satisfy any shortfall between amounts T-2 Partners collects from the Partnership and pays to the lender. The option can now be exercised anytime between November 24, 2006 and November 24, 2009 and the purchase price is payable in cash rather than Units. Any amounts advanced to the Partnership under the credit line would have to be repaid in full before the Partnership could purchase the interests in T-Two Partners if the Partnership exercises its purchase option for T-Two Partners.
T-Two Partners will reimburse the Partnership for approximately $7.3 million of closing costs incurred in connection with the note payable and the T-Two Loan, together with interest thereon at a rate equal to LIBOR plus 450 basis points.
In connection with the Partnership's refinancings, real estate sales and repayments of mortgage debt during 2003, the Partnership has recognized a net gain from early extinguishment of debt of $8.7 million, which is included in discontinued operations. The net gain from early extinguishment of debt consisted of gains from debt extinguishment of $9.1 million, net of mortgage prepayment penalties of $0.4 million. During 2002, the Partnership recognized a net gain from early extinguishment of debt of $6.3 million, $5.8 million of which is included in interest expense and $0.5 million of which is included in discontinued operations. The net gain from early extinguishment of debt consisted of gains from debt extinguishment of $11.0 million, net of mortgage prepayment penalties of $4.7 million.
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THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 4 - NOTES AND CONTRACT RIGHTS PAYABLE (Continued)
Scheduled payments of principal at December 31, 2003, for the next five years and thereafter through maturity, are as follows (in thousands):
Note 5 - MINORITY INTERESTS
Minority interests consist of external ownership interests in limited partnerships consolidated by the Partnership. Certain limited partnerships have negative partnership capital balances, as liabilities exceed assets, principally depreciated real estate. The limited partnerships have profitable operations and due to their nature, triple net-leased properties with declining debt service obligations are expected to maintain profitable operations and eliminate any negative capital balance.
Note 6 - RELATED PARTY TRANSACTIONS
WFA, an affiliate of the Newkirk Group, performs asset management services for the Partnership and received a fee of $1.8 million for the years ended December 31, 2003 and 2002. WFA performed asset management services for the Predecessor Entity and received a fee of $3.0 million for the year ended December 31, 2001.
The Partnership provides certain asset management, investor and administrative services to the Other Partnerships that were controlled by the Newkirk Group and were not merged into the Partnership. Control of the general partners of these partnerships was acquired by the Partnership. The Partnership earned $0.4 million and $0.8 million of management fees for these services for the years ended
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THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 6 - RELATED PARTY TRANSACTIONS (Continued)
December 31, 2003 and 2002, respectively. The Partnership had receivables for management fees of $1.1 million and $1.0 million due from these partnerships at December 31, 2003 and 2002, respectively. In addition, the Partnership had a receivable of $0.6 million at December 31, 2002 for a non-interest bearing advance made to one of these partnerships. This receivable was collected during 2003.
The Partnership had a loan receivable and accrued interest of $0.2 million at December 31, 2002 and earned interest income of $0.2 million for the year ended December 31, 2002 from Cenland Associates Limited Partnership, one of the Other Partnerships. In February 2003, the Partnership received the remaining amount due on this loan.
The Partnership has an ownership interest in the three most junior tranches of a securitized pool of first mortgages with respect to 31 first mortgage loans encumbering 67 Partnership properties and 1 other property controlled by affiliates of the general partner. The Partnership had a loan receivable, net of discount, of $9.8 million and $9.5 million at December 31, 2003 and 2002, respectively, and earned interest income of $1.2 million for the years ended December 31, 2003 and 2002, related to this ownership interest.
Affiliates and executives of the Newkirk Group owned $17.3 million of a $145.2 million Real Estate Mortgage Investment Conduit ("REMIC") which was secured by the contract rights payable. The affiliates and executives of the Newkirk Group earned $2.2 million, $2.5 million and $2.5 million of interest income during 2003, 2002 and 2001. The affiliates and executives were repaid when T-Two Partners purchased the T-1 Certificate as discussed in the following paragraph.
T-Two Partners, an affiliate of the Newkirk Group, is the 100% beneficial owner of the contract rights. T-Two Partners owned the portion of the contract rights referred to as the T-2 Certificate and during 2003, purchased the portion of the contract rights referred to as the T-1 Certificate. The Partnership incurred $14.3 million, $12.5 million and $6.3 million of interest expense on these contract rights during 2003, 2002 and 2001, respectively. The Partnership had the right to acquire T-Two Partners' interest in the contract rights in January 2008 by acquiring T-Two Partners in exchange for Units. The Newkirk Group had the right to require the Partnership to purchase this interest in December 2007 in exchange for Units. During 2003, the Partnership and the owners of T-Two Partners modified these rights. The Partnership can now exercise their option anytime between November 24, 2006 and November 24, 2009.
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THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 6 - RELATED PARTY TRANSACTIONS (Continued)
In addition, the purchase price is payable in cash rather than Units. The owners of T-Two Partners agreed to eliminate their put option which could require the Partnership to purchase T-Two Partners in December 2007 and the Partnership agreed to guarantee repayment of the T-Two Loan. T-Two Partners also agreed to provide a credit line to the Partnership bearing interest at LIBOR plus 450 basis points. If the Partnership exercises the option, the purchase price is to be calculated as follows: the sum of $316.5 million plus T-Two Partners' costs of obtaining the T-Two Loan (approximately $7.3 million) and administering the trust that holds the contract rights, together with interest on the foregoing sum at the effective rate of interest paid by T-Two Partners on the T-Two Loan, less all payments made from and after November 24, 2003 on the contract rights.
T-Two Partners will reimburse the Partnership for approximately $7.3 million of closing costs incurred in connection with the note payable and the T-Two Loan, together with interest thereon at a rate equal to LIBOR plus 450 basis points. The Partnership earned interest income of $37,000 during 2003.
Also see Note 8 for related party acquisitions.
Note 7 - CONTINGENCIES
Legal
In July 2002, an action was commenced in the Connecticut Superior Court against, among others, the Partnership's general partner and various affiliates of the Partnership's general partner. Plaintiffs are four limited partners of three of the Newkirk Partnerships. The action alleges, among other things, that the price paid to non-accredited investors in connection with the Exchange was unfair and did not fairly compensate them for the value of their partnership interests. The complaint also alleges that the exchange values assigned in the Exchange to certain assets contributed by affiliates of the Partnership's general partner were too high in comparison to the exchange values assigned to the Newkirk Partnerships, that the option arrangement relating to the Partnership's potential acquisition in the future of the T-2 Certificate, which represents an interest in a grantor trust, the mortgage assets of which consist of contract rights secured by the Partnership's real properties as well as other properties owned by other partnerships that are controlled by affiliates of the Partnership's general partner, was unfair to limited partners and that the disclosure document used in connection with the Exchange contained various misrepresentations and/or omissions of material facts. The complaint seeks to have
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THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 7 - CONTINGENCIES (Continued)
Legal (Continued)
the action classified as a class action as well as compensatory and punitive damages in an unspecified amount. The defendants have denied and continue to deny the allegations of the complaint. In order to avoid the expenses, distraction, and uncertainties of litigation, the defendants entered into a settlement agreement dated December 31, 2003 to settle the litigation, which settlement agreement is subject to court approval. A court hearing on whether to approve the settlement is currently scheduled to take place on April 12, 2004. The settlement provides for the following material terms: (i) the Newkirk Group will convey to unitholders of the Newkirk Partnerships who are unaffiliated with the general partner and who received limited partnership units in the Exchange, units in the Partnership equal to 1% of the outstanding units; (ii) the Partnership will pay $1.5 million to an escrow agent for the benefit of unaffiliated unitholders; and (iii) the Partnership will pay $2.0 million to an escrow agent for the benefit of unitholders of the Newkirk Partnerships who were entitled to receive cash in the Exchange. In addition, the Partnership, in order to facilitate the settlement, entered into an agreement with T-Two Partners and its equityholders pursuant to which the Partnership has the right to acquire substantially all of the assets of T-Two Partners or a 100% ownership interest in T-Two Partners at any time between November 24, 2006 and November 24, 2009. As part of the agreement, defendants have also agreed not to object to the payment of reasonable attorneys fees, expenses, and incentive awards to be paid from the consideration payable under the settlement agreement. The Partnership accrued $3.5 million with respect to this matter, which is included in general and administrative expense in the consolidated statement of operations for the year ended December 31, 2003.
On December 31, 2002, a derivative action was commenced in the Dallas County Texas District Court by a limited partner of Eastgar Associates, L.P. ("Eastgar") against, among others, the general partners of Eastgar and affiliates of the Newkirk Partnerships. The Partnership owns a 60.5% limited partnership interest in Eastgar and also controls the general partner of that partnership. The complaint alleges that the defendants have charged Eastgar excessive management fees and have unfairly prevented Eastgar from prepaying and refinancing its mortgage indebtedness. The complaint seeks compensatory and punitive damages in an unspecified amount, attorneys' fees and expenses, an accounting, and a declaration of the parties' future rights and obligations regarding management fees and the refinancing of mortgage indebtedness. The defendants have denied and continue to deny the allegations of the complaint. In order to avoid the expenses, distraction and uncertainties of litigation, the defendants entered into an agreement to settle the litigation for a
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THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 7 - CONTINGENCIES (Continued)
Legal (Continued)
$137,500 payment by the defendants other than Eastgar and to charge an asset management fee of $35,000 per year, adjusted for changes in the Consumer Price Index and as may be adjusted for extraordinary circumstances by Eastgar's general partner. After payment of court-approved attorneys' fees and expenses, the remaining balance would be distributed to Eastgar's limited partners other than the Partnership or its affiliates. The settlement also sets the management fees to be charged to Eastgar, subject to any changes that Eastgar may approve in the future consistent with its fiduciary duty. The settlement has been, as required, approved by the trial court after notice to the limited partners of Eastgar, and remains subject only to a potential appeal of court approval prior to the close of the appeals period. The Partnership accrued $137,500 with respect to this matter, which is included in general and administrative expense in the consolidated statement of operations for the year ended December 31, 2003.
Property Matters
In January 2002, Kmart Corporation ("Kmart"), a tenant at twelve of the Partnership's properties, filed for protection under Chapter 11 of the United States Bankruptcy Code. Kmart had the right to either accept or reject the leases. Kmart elected to reject the leases, which caused an immediate termination of such leases. The Partnership re-leased nine of the properties to Furr's Restaurant Group ("Furr's") for 10-year lease terms, one of the properties to Lithia Motors for a 10-year lease term and another property for use as a Chinese food restaurant for a five-year lease term. The remaining property was vacant. The Partnership is pursuing a claim against Kmart in Bankruptcy Court. In January 2003, Furr's filed for protection under Chapter 11 of the Bankruptcy Code and subsequently rejected the lease on three sites. The remaining sites continue to be leased to Furr's through 2012 and the Partnership is pursuing a claim against Furr's in Bankruptcy Court for the three rejected sites. Furr's also has the right to reject the lease that now covers the remaining sites. In addition, the Chinese food restaurant defaulted on its lease and that property has been vacated. The aggregate rent for the seven sites that are presently leased is approximately $0.6 million less than the amount that was scheduled to be received from Kmart on the twelve properties during its renewal term which would have begun in February 2003. The Partnership is responsible for the payment of insurance, real estate taxes and mortgage debt on the vacant properties. The Partnership has purchased the land underlying all twelve properties for $0.25 million. In September 2003, two of the vacant properties were sold. The
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THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 7 - CONTINGENCIES (Continued)
Property Matters (Continued)
Partnership is attempting to sell the three remaining vacant properties. The Partnership has classified the vacant properties as part of real estate held for sale in the accompanying consolidated balance sheet at December 31, 2003 and has classified the operations of the properties as part of discontinued operations in the accompanying consolidated statement of operations for the years ended December 31, 2003 and 2002.
Note 8 - ACQUISITIONS
On January 1, 2003, the Partnership acquired from an affiliate of the general partner, limited partnership interests in nine limited partnerships that own net-leased commercial properties. The limited partnership interests acquired by the Partnership ranged between 4.9% and 57.75% of each partnership and were acquired in exchange for 317,813 limited partnership units of the Partnership valued at $22.7 million. In August 2003, the Partnership acquired approximately an additional 9.9% interest in one of these limited partnerships for a cash purchase price of $525,000, increasing the partnership interest to 23.4% from 13.5%. These interests were aquired from unaffiliated limited partners. In January 2004, the Partnership sent notice of its intent to exercise an option to purchase additional limited partnership interests in two of the partnerships. It is anticipated that these additional limited partnership interests will be acquired on April 1, 2004. The values of the net-leased real estate partnerships and the Partnership units were determined without arms-length negotiations. Independent appraisals were obtained on the value of the properties owned by the limited partnerships. The Partnership has accounted for the acquisition on a historical cost basis. Four of the limited partnerships have been consolidated into the Partnership's financial statements and five of the limited partnerships are being accounted for under the equity method of accounting.
In January 2003, the Partnership acquired the land underlying the property owned by one of the net-leased partnerships referred to immediately above. The land was acquired from a company affiliated with the general partner for $1.0 million, $50,000 of which was paid in cash and the balance in the form of a $950,000 note due September 8, 2008. The note bore interest at the rate of 6.0% per annum, compounded annually, and was payable interest-only until maturity, at which time the full balance of the note was to be due. In October 2003, the note was satisfied by the Partnership from cash reserves. The purchase price for the land sale was
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THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 8 - ACQUISITIONS (Continued)
determined without arms-length negotiations. An independent appraisal was obtained on the value of the land that was acquired.
In April and June 2003, the Partnership acquired 30.6% and 46.1%, respectively, of the outstanding limited partnership interests in two Other Partnerships. The partnership interests were acquired for an aggregate cash purchase price of $711,250. The Partnership previously owned 1.5% and 3.8%, respectively, of the outstanding limited partnership interests in these two partnerships. The Partnership controls the general partners of each of these partnerships. The Partnership has consolidated these partnerships in accordance with the guidance provided by Statement of Position 78-9 "Accounting for Investments in Real Estate Ventures."
In May and June 2003, the Partnership purchased the remainder interest in the land underlying 25 properties for an aggregate purchase price of $1.2 million and, as a result, now owns a fee interest in the underlying land. The improvements on 23 of the properties are owned by the Partnership and the improvements on the two other properties are owned by one of the Other Partnerships in which the Partnership owns limited partnership interests and controls the general partner.
Note 9 - DISCONTINUED OPERATIONS AND SALES OF REAL ESTATE
During the year ended December 31, 2003, the Partnership sold fourteen properties for a combined net sales price of $156.4 million. The Partnership recognized a net gain on sale of these properties of $29.5 million. During the year ended December 31, 2002, the Partnership sold two properties for a combined net sales price of $3.2 million. The Partnership recognized a net loss on sale of these properties of $1.0 million. During the year ended December 31, 2001, the Predecessor Entity sold 3 properties for a combined net sales price of $.8 million. The Predecessor Entity recognized a net loss on sale of these properties of $2.9 million. The sale and operations of these properties for all periods presented have been recorded as discontinued operations in accordance with the provisions of SFAS No. 144. In addition, the Partnership has classified various properties which have met all of the criteria of SFAS No. 144 as real estate held for sale in the accompanying consolidated balance sheets and has classified the operations of the properties and the sold properties as discontinued operations in the accompanying consolidated statements of operations.
Discontinued operations for the years ended December 31, 2003, 2002 and 2001 are summarized as follows (in thousands):
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THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 9 - DISCONTINUED OPERATIONS AND SALES OF REAL ESTATE (Continued)
Expenses include interest expense to related parties of $459,000, $623,000 and $767,000 for the years ended December 31, 2003, 2002 and 2001, respectively.
Other assets of discontinued operations at December 31, 2003 and 2002 are summarized as follows (in thousands):
2003 2002 ------ ------
Receivables $ 734 $2,164 Other assets 221 126 ------ ------
$ 955 $2,290 ====== ======
Liabilities of discontinued operations at December 31, 2003 and 2002 are summarized as follows:
2003 2002 -------- --------
Mortgage notes and accrued interest payable $ 30,371 $ 44,999
Contract right mortgage notes and accrued interest payable (including $5,626 and $2,371 to related parties) 5,626 59,707
Accounts payable and accrued expenses -- 794 -------- --------
$ 35,997 $105,500 ======== ========
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THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 10 - INCOME TAXES
The Partnership's taxable income for 2003 and 2002 differs from net income for financial reporting purposes as follows (in thousands, except per unit data):
The net basis of the Partnership's assets and liabilities for tax reporting purposes is approximately $896.0 million and $1.0 billion lower than the amount reported for financial statement purposes at December 31, 2003 and 2002, respectively.
Note 11 - SUBSEQUENT EVENTS
During January 2004, the Partnership sold two properties to unaffiliated third parties for a combined net sales price of $48.4 million. For financial reporting purposes, the Partnership expects to recognize a net gain on sale of these properties of approximately $7.1 million during 2004.
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THE NEWKIRK MASTER LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 12 - SUMMARY OF QUARTERLY RESULTS (UNAUDITED)
The following summary represents the results of operations for each quarter in 2003 and 2002:
(In thousands, except units amounts)
(1) Includes gain from disposal of real estate of $26.1 million. (2) Includes gain from disposal of real estate of $6.2 million. (3) Includes loss from disposal of real estate of $2.0 million. (4) Includes loss from disposal of real estate of $0.8 million. (5) Includes loss from disposal of real estate of $1.0 million.
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Independent Auditor's Report
To the Partners of The Newkirk Master Limited Partnership
Under date of January 30, 2004, we reported on the consolidated balance sheets of The Newkirk Master Limited Partnership as of December 31, 2003 and 2002, and the related consolidated statements of operations, partners' equity, and cash flows for the years then ended, which is included in the Annual Report on Form 10-K. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedule listed under Item 15(d)(3) on page 60. This financial statement schedule is the responsibility of the Partnership's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, represents fairly, in all material respects, the information set forth therein.
/s/ Imowitz Koenig & Co., LLP
New York, New York January 30, 2004
THE NEWKIRK MASTER LIMITED PARTNERSHIP SCHEDULE III REAL ESTATE AND ACCUMULATED DEPRECIATION At December 31, 2003
THE NEWKIRK MASTER LIMITED PARTNERSHIP SCHEDULE III REAL ESTATE AND ACCUMULATED DEPRECIATION At December 31, 2003
THE NEWKIRK MASTER LIMITED PARTNERSHIP SCHEDULE III REAL ESTATE AND ACCUMULATED DEPRECIATION At December 31, 2003
THE NEWKIRK MASTER LIMITED PARTNERSHIP SCHEDULE III REAL ESTATE AND ACCUMULATED DEPRECIATION At December 31, 2003
* The above table:
A) excludes properties classified as discountinued operations B) includes land only parcels owned by the partnership
The aggregate cost for Federal income tax purposes was approximately $1.5 billion
NEWKIRK MASTER LIMITED PARTNERSHIP
SCHEDULE III REAL ESTATE AND ACCUMULATED DEPRECIATION (amounts in thousands)
The following is a reconciliation of real estate assets and accumulated depreciation: