ITEM 1. BUSINESS
Investors should review the Risk Factors commencing on page 4 of this Report for a discussion of risks that may impact our financial condition, business or share price.
GENERAL
Entertainment Properties Trust ("we," "us," "EPR" or the "Company") was formed on August 22, 1997 as a Maryland real estate investment trust ("REIT") to capitalize on the opportunities created by the development of destination entertainment and entertainment-related properties, including megaplex movie theatre complexes. We completed an initial public offering of our common shares of beneficial interest ("Common Shares") on November 18, 1997. We are the first publicly-traded REIT formed exclusively to invest in entertainment-related properties.
We are a self-administered REIT. As of December 31, 2003, our real estate portfolio was comprised primarily of 45 megaplex theatre properties located in eighteen states, two entertainment retail centers ("ERCs") located in Westminster, Colorado, and New Rochelle, New York, and land parcels leased to restaurant and retail operators adjacent to several of our theatre properties. Our theatre properties are leased to leading theatre operators, including American Multi-Cinema, Inc. ("AMC"), a subsidiary of AMC Entertainment, Inc. ("AMCE"), Muvico Entertainment, LLC ("Muvico"), Regal Cinemas, Inc. ("Regal"), Consolidated Theatres ("Consolidated"), Loews Cineplex Entertainment ("Loews"), Rave Motion Pictures ("Rave"), AmStar Cinemas, LLC ("AmStar") , Wallace Theatres ("Wallace") and Crown Theatres ("Crown"). Approximately 62% of the Company's megaplex theatre properties are leased to AMC.
For a discussion of material property acquisitions during the three months ended December 31, 2003, see Item 7 - "Management's Discussion and Analysis - Recent Developments" and our current report on Form 8-K filed with the Securities and Exchange Commission on November 12, 2003, as amended by Form 8-K/A filed January 12, 2004 incorporated by reference herein.
We aggregate the financial information of all our properties into one reportable segment because the properties all have similar economic characteristics and provide similar services to similar types and classes of customers.
We believe entertainment is an important sector of the retail real estate industry and that, as a result of our focus on properties in this sector and the industry relationships of our management, we have a competitive advantage in providing capital to operators of these types of properties. Our principal business strategy is to be the nation's leading entertainment real estate company by continuing to acquire high-quality properties leased to entertainment and entertainment-related business operators, generally under long-term triple-net leases that require the tenant to pay substantially all expenses associated with the operation and maintenance of the property.
Megaplex theatres typically have at least 14 screens with stadium-style seating (seating with elevation between rows to provide unobstructed viewing) and are equipped with amenities that significantly enhance the audio and visual experience of the patron. We believe the development of megaplex theatres has accelerated the obsolescence of many of the previous generation of existing multiplex movie theatres by setting new standards for moviegoers, who, in our experience, have demonstrated their preference for the more attractive surroundings, wider variety of films and superior customer service typical of megaplex theatres (see "Operating risks in the entertainment industry may affect the ability of our tenants to perform
under their leases" and "Market prices for our shares may be affected by perceptions about the financial health or share value of our tenants or the performance of REIT stocks generally" under "Risk Factors").
We expect the development of megaplex theatres to continue in the United States and abroad for the foreseeable future. With the development of the stadium style megaplex theatre as the preeminent store format for cinema exhibition, the older generation of smaller flat-floor theatres has generally experienced a significant downturn in attendance and performance. As a result of the significant capital commitment involved in building these new properties and the experience and industry relationships of our management, we believe we will continue to have opportunities to provide capital to businesses that seek to develop and operate these properties but would prefer to lease rather than own the properties. We believe our ability to finance these properties will enable us to continue to grow and diversify our asset base. See Item 7 - "Management's Discussion and Analysis" for a discussion of capital requirements necessary for the Company's continued growth.
BUSINESS OBJECTIVES AND STRATEGIES
Our primary business objective is to continue to enhance shareholder value by achieving predictable and increasing Funds From Operations ("FFO") per Share (See Item 7 - "Management's Discussion and Analysis - Funds From Operations" for a discussion of FFO), through the acquisition of high-quality properties leased to entertainment and entertainment-related business operators. We intend to achieve this objective by continuing to execute the Growth Strategies, Operating Strategies and Capitalization Strategies described below:
GROWTH STRATEGIES
FUTURE PROPERTIES
We intend to pursue acquisitions of high-quality entertainment related properties from operators with a strong market presence. As a part of our growth strategy, we will consider entering into additional joint ventures with other developers or investors in real estate, developing additional megaplex theatre properties and developing or acquiring entertainment retail centers ("ERCs") and single-tenant, out-of-home, location-based entertainment and entertainment-related properties.
OPERATING STRATEGIES
LEASE RISK MINIMIZATION
To avoid initial lease-up risks and produce a predictable income stream, we typically acquire single-tenant properties that are leased under long-term leases. We believe our willingness to make long-term investments in properties offers our tenants financial flexibility and allows tenants to allocate capital to their core businesses. Although we will continue to emphasize single-tenant properties, we have acquired and may continue to acquire multi-tenant properties we believe add value to our shareholders.
LEASE STRUCTURE
We typically structure leases on a triple-net basis under which the tenants bear the principal portion of the financial and operational responsibility for the properties. During each lease term and any renewal periods, the leases typically provide for periodic increases in rent and/or percentage rent based upon a percentage of the tenant's gross sales over a pre-determined level. In our multi-tenant property leases and some of our theatre leases, we require the tenant to pay a common area maintenance (CAM) charge to defray its pro rata share of insurance, taxes and maintenance costs.
TENANT RELATIONSHIPS
We intend to continue developing and maintaining long-term working relationships with theatre, restaurant, retail and other entertainment-related business operators and developers by providing capital for
multiple properties on a national or regional basis, thereby enhancing efficiency and value to those operators and to the Company.
PORTFOLIO DIVERSIFICATION
We will endeavor to further diversify our asset base by property type, geographic location and tenant. In pursuing this diversification strategy, the Company will target theatre, restaurant, retail and other entertainment-related business operators which management views as leaders in their market segments and which have the financial strength to compete effectively and perform under their leases with the Company.
CAPITALIZATION STRATEGIES
USE OF LEVERAGE; DEBT TO TOTAL CAPITALIZATION
We seek to enhance shareholder return through the use of leverage (see "Risk Factors - "There is risk in using debt to fund property acquisitions" and "We must obtain new financing in order to grow"). In addition, we have issued and may in the future seek to issue additional equity as circumstances warrant and opportunities to do so become available. We expect to maintain a debt to total capitalization ratio (i.e., total debt of the Company as a percentage of shareholder equity plus total debt) of approximately 50% to 55%.
JOINT VENTURES
We will examine and pursue potential additional joint venture opportunities with institutional investors or developers if they are considered to add value to our shareholders. We may employ higher leverage in joint ventures (See "Risk Factors - - Joint ventures may limit flexibility with jointly owned investments").
PAYMENT OF REGULAR DISTRIBUTIONS
We have paid and expect to continue paying quarterly dividend distributions to our Common and Preferred shareholders. Our Preferred Shares have a dividend rate of 9.5%. Among the factors the Board of Trustees considers in setting the Common Share distribution rate are the applicable REIT rules and regulations that apply to distributions, the Company's results of operations, including FFO per Share, and the Company's Cash Available for Distribution (defined as net cash flow available for distribution after payment of operating expenses, debt service, and other obligations). We expect to periodically increase distributions as FFO and Cash Available for Distribution increase and as other considerations and factors warrant. See "Risk Factors - We cannot assure you we will continue paying dividends at historical rates".
COMPETITION
We compete for real estate financing opportunities with other companies that invest in real estate, as well as traditional financial sources such as banks and insurance companies. While we were the first publicly traded REIT formed to specialize in entertainment-themed properties, other REITs have sought and may continue to seek to finance entertainment properties as new megaplex theatres, ERCs and related restaurant and retail properties are developed or become available for acquisition.
EMPLOYEES
As of December 31, 2003, the Company had nine full time employees.
WEBSITE ACCESS TO EXCHANGE ACT REPORTS AND OTHER DOCUMENTS
Our internet website address is www.eprkc.com. We make available free of charge through our website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to the SEC. You may also view our Code of Business Conduct and Ethics, Corporate Governance Guidelines and the charters of our audit, nominating and compensation committees on our website.
RISK FACTORS
There are many risks and uncertainties that can affect our future business, financial performance or share price. Some of these are beyond our control. Here is a brief description of some of the important factors which could cause our future business, operating results, financial condition or share price to be materially different than our expectations. This discussion includes a number of forward-looking statements. You should refer to the description of the qualifications and limitations on forward-looking statements on page 22 of this report.
RISKS THAT MAY IMPACT OUR FINANCIAL CONDITION OR PERFORMANCE
WE COULD BE ADVERSELY AFFECTED BY A TENANT'S BANKRUPTCY
If a tenant becomes bankrupt or insolvent, that could diminish the income we expect from that tenant's leases. We may not be able to evict a tenant solely because of its bankruptcy. On the other hand, a bankruptcy court might authorize the tenant to terminate its leases with us. If that happens, our claim against the bankrupt tenant for unpaid future rent would be subject to statutory limitations that might be substantially less than the remaining rent owed under the leases. In addition, any claim we have for unpaid past rent would likely not be paid in full.
The development of megaplex movie theatres has rendered many older multiplex theatres obsolete. To the extent our tenants own a substantial number of multiplexes, they have been, or may in the future be, required to take significant charges against earnings resulting from the impairment of these assets. Megaplex theatre operators have also been and could in the future be adversely affected by any overbuilding of megaplex theatres in their markets and the cost of financing, building and leasing megaplex theatres. Two of our tenants, Edwards Theatre Circuit, Inc., (now part of the Regal Entertainment Group), which operates two of our theatre properties, and Loews Cineplex Entertainment, which operates two of our theatres, have filed for, and emerged from, bankruptcy reorganization. The Company did not incur any significant expenses or loss of revenue as a result of those bankruptcy reorganizations.
OPERATING RISKS IN THE ENTERTAINMENT INDUSTRY MAY AFFECT THE ABILITY OF OUR TENANTS TO PERFORM UNDER THEIR LEASES
The ability of our tenants to operate successfully in the entertainment industry and remain current on their lease obligations depends on a number of factors, including the availability and popularity of motion pictures, the performance of those pictures in tenants' markets, the allocation of popular pictures to tenants and the terms on which the pictures are licensed. Neither we nor our tenants control the operations of motion picture distributors. Megaplex theatres represent a greater capital investment, and generate higher rents, than the previous generation of multiplex theatres. For this reason, the ability of our tenants to operate profitably and perform under their leases could be dependent on their ability to generate higher revenues per screen than multiplex theatres typically produce.
The success of "out-of-home" entertainment venues such as megaplex theatres and entertainment retail centers also depends on general economic conditions and the willingness of consumers to spend time and money on out-of-home entertainment.
A SINGLE TENANT REPRESENTS A SUBSTANTIAL PORTION OF OUR LEASE REVENUES
Approximately 62% of our megaplex theatre properties are leased to AMC, one of the nation's largest movie exhibition companies. AMCE has guaranteed AMC's performance under the leases. We have diversified and expect to continue to diversify our real estate portfolio by entering into lease transactions with a number of other leading theatre operators. Nevertheless, our revenues and our continuing ability to pay shareholder dividends are currently substantially dependent on AMC's performance under its leases and AMCE's performance under its guaranty.
We believe AMC occupies a strong position in the industry and we intend to continue acquiring and leasing back AMC theatres. However, if for any reason AMC failed to perform under its lease obligations and AMCE did not perform under its guaranty, we could be required to reduce or suspend our shareholder dividends and may not have sufficient funds to support operations until substitute tenants are obtained. If that happened, we cannot predict when or whether we could obtain substitute quality tenants on acceptable terms.
THERE IS RISK IN USING DEBT TO FUND PROPERTY ACQUISITIONS
We have used leverage to acquire properties and expect to continue to do so in the future. Although the use of leverage is common in the real estate industry, our use of debt to acquire properties does expose us to some risks. If a significant number of our tenants fail to make their lease payments and we don't have sufficient cash to pay principal and interest on the debt, we could default on our debt obligations. Our debt financing is secured by mortgages on our properties. If we fail to meet our mortgage payments, the lenders could declare a default and foreclose on those properties.
A PORTION OF OUR SECURED DEBT HAS "HYPER-AMORTIZATION" PROVISIONS WHICH MAY REQUIRE US TO REFINANCE THE DEBT OR SELL THE PROPERTIES SECURING THE DEBT PRIOR TO MATURITY
As of December 31, 2003, we had approximately $98.1 million outstanding under a single secured mortgage loan agreement that contains a "hyper-amortization" feature, in which the principal payment schedule is rapidly accelerated, and our principal payments are substantially increased, if we fail to pay the balance on the anticipated prepayment date of July 11, 2008. We undertook this debt on the assumption that we can refinance the debt prior to these hyper-amortization payments becoming due. If we cannot obtain acceptable refinancing at the appropriate time, the hyper-amortization payments will require substantially all of the revenues from those properties securing the debt to be applied to the debt repayment, which would substantially reduce our Common Share dividend rate and could adversely affect our financial condition and liquidity.
WE MUST OBTAIN NEW FINANCING IN ORDER TO GROW
As a REIT, we are required to distribute at least 90% of our taxable net income to shareholders in the form of dividends. This means we are limited in our ability to use internal capital to acquire properties and must continually raise new capital in order to continue to grow and diversify our real estate portfolio. Our ability to raise new capital depends in part on factors beyond our control, including conditions in equity and credit markets, conditions in the cinema exhibition industry and the performance of real estate investment trusts generally. We continually consider and evaluate a variety of potential transactions to raise additional capital, but we cannot assure that attractive alternatives will always be available to us, nor that our share price will increase or remain at a level that will permit us to continue to raise equity capital privately or publicly.
IF WE FAIL TO QUALIFY AS A REIT, WE WOULD BE TAXED AS A CORPORATION, WHICH WOULD SUBSTANTIALLY REDUCE FUNDS AVAILABLE FOR PAYMENT OF DIVIDENDS TO OUR SHAREHOLDERS
If we fail to qualify as a REIT for federal income tax purposes, we will be taxed as a corporation. We are organized and believe we qualify as a REIT, and intend to operate in a manner that will allow us to continue to qualify as a REIT. However, we cannot assure you that we will remain qualified in the future. This is because qualification as a REIT involves the application of highly technical and complex provisions of the Internal Revenue Code on which there are only limited judicial and administrative interpretations, and depends on facts and circumstances not entirely within our control. In addition, future legislation, new regulations, administrative interpretations or court decisions may significantly change the tax laws, the application of the tax laws to our qualification as a REIT or the federal income tax consequences of that qualification.
If we fail to qualify as a REIT we will face tax consequences that will substantially reduce the funds available for payment of dividends:
- We would not be allowed a deduction for dividends paid to shareholders in computing our taxable income and would be subject to federal income tax at regular corporate rates
- We could be subject to the federal alternative minimum tax and possibly increased state and local taxes
- Unless we are entitled to relief under statutory provisions, we could not elect to be treated as a REIT for four taxable years following the year in which we were disqualified
In addition, if we fail to qualify as a REIT, we will no longer be required to pay dividends. As a result of these factors, our failure to qualify as a REIT could adversely affect the market price for our shares.
OUR DEVELOPMENT FINANCING ARRANGEMENTS EXPOSE US TO FUNDING AND PURCHASE RISKS
Our ability to meet our construction financing obligations which we may enter into from time to time depends on our ability to obtain equity or debt financing in the required amounts. There is no assurance we can obtain this financing at rates which will lock-in a spread between our cost of capital and the rent payable under the leases to be entered into upon completion of construction. We will be obligated to purchase and lease-back the theatres that are subject to certain arrangements at predetermined rates. (See Item 7 - "Management's Discussion and Analysis - Liquidity and Capital Resources - Liquidity Requirements.")
RISKS THAT APPLY TO OUR REAL ESTATE BUSINESS
THERE ARE RISKS ASSOCIATED WITH OWNING AND LEASING REAL ESTATE
Although our lease terms obligate the tenants to bear substantially all of the costs of operating the properties, investing in real estate involves a number of risks, including:
- The risk that tenants will not perform under their leases, reducing our income from the leases or requiring us to assume the cost of performing obligations (such as taxes, insurance and maintenance) that are the tenant's responsibility under the lease
- The risk that changes in economic conditions or real estate markets may adversely affect the value of our properties
- The risk that local conditions (such as oversupply of megaplex theatres or other entertainment-related properties) could adversely affect the value of our properties
- We may not always be able to lease properties at favorable rates
- We may not always be able to sell a property when we desire to do so at a favorable price
- Changes in tax, zoning or other laws could make properties less attractive or less profitable
If a tenant fails to perform on its lease covenants, that would not excuse us from meeting any debt obligation secured by the property and could require us to fund reserves in favor of our lenders, thereby reducing funds available for payment of dividends. We cannot be assured that tenants will elect to renew their leases when the terms expire. If a tenant does not renew its lease or if a tenant defaults on its lease obligations, there is no assurance we could obtain a substitute tenant on acceptable terms. If we cannot obtain another quality movie exhibitor to lease a megaplex theatre property, we may be required to modify the property for a different use, which may involve a significant capital expenditure and a delay in re-leasing the property.
SOME POTENTIAL LOSSES ARE NOT COVERED BY INSURANCE
Our leases require the tenants to carry comprehensive liability, casualty, workers' compensation, extended coverage and rental loss insurance on our properties. We believe the required coverage is of the type, and amount, customarily obtained by an owner of similar properties. We believe all of our properties are adequately insured. However, there are some types of losses, such as catastrophic acts of nature, for which we or our tenants cannot obtain insurance at an acceptable cost. If there is an uninsured loss or a loss in excess of insurance limits, we could lose both the revenues generated by the affected property and the capital we have invested in the property. We would, however, remain obligated to repay any mortgage indebtedness or other obligations related to the property. Since September 11, 2001, the cost of insurance protection against terrorist acts has risen dramatically. There can be no assurance our tenants will be able to obtain terrorism insurance coverage, or that any coverage they do obtain will adequately protect our properties against loss from terrorist attack.
JOINT VENTURES MAY LIMIT FLEXIBILITY WITH JOINTLY OWNED INVESTMENTS
We may continue to acquire or develop properties in joint ventures with third parties when those transactions appear desirable. We would not own the entire interest in any property acquired by a joint venture. If we have a dispute with a joint venture partner, we may feel it necessary or become obligated to acquire the partner's interest in the venture. However, we cannot assure you that the price we would have to pay or the timing of the acquisition would be favorable to us. If we own less than a 50% interest in any joint venture, or if the venture is jointly controlled, the assets and financial results of the joint venture may not be reportable by us on a consolidated basis. To the extent we owe commitments to, or are dependant on, any such "off-balance sheet" arrangements, or if those arrangements or their properties or leases are subject to material contingencies, our liquidity, financial condition and operating results could be adversely affected by those commitments or off-balance sheet arrangements.
OUR MULTI-TENANT PROPERTIES EXPOSE US TO ADDITIONAL RISKS
Our entertainment retail centers in Westminster, Colorado and New Rochelle, New York and similar properties we may seek to acquire or develop in the future involve risks not typically encountered in the purchase and lease-back of megaplex theatres which are operated by a single tenant. The ownership or development of multi-tenant retail centers could expose us to the risk that a sufficient number of suitable tenants may not be found to enable the center to operate profitably and provide a return to us. Retail centers are also subject to tenant turnover and fluctuations in occupancy rates, which could affect our operating results. Multi-tenant retail centers also expose us to the risk of potential "CAM slippage," which may occur when CAM fees paid by tenants are exceeded by the actual cost of taxes, insurance and maintenance at the property.
FAILURE TO COMPLY WITH THE AMERICANS WITH DISABILITIES ACT AND OTHER LAWS COULD RESULT IN SUBSTANTIAL COSTS
Our theatres must comply with the Americans with Disabilities Act (ADA). The ADA requires that public accommodations reasonably accommodate individuals with disabilities and that new construction or alterations be made to commercial facilities to conform to accessibility guidelines. Failure to comply with the ADA can result in injunctions, fines, damage awards to private parties and additional capital
expenditures to remedy noncompliance. Our leases require the tenants to comply with the ADA.
Our properties are also subject to various other federal, state and local regulatory requirements. We believe our properties are in material compliance with all applicable regulatory requirements. However, we do not know whether existing requirements will change or whether compliance with future requirements will involve significant unanticipated expenditures. Although these expenditures would be the responsibility of our tenants, if tenants fail to perform these obligations, we may be required to do so.
POTENTIAL LIABILITY FOR ENVIRONMENTAL CONTAMINATION COULD RESULT IN SUBSTANTIAL COSTS
Under federal, state and local environmental laws, we may be required to investigate and clean up any release of hazardous or toxic substances or petroleum products at our properties, regardless of our knowledge or actual responsibility, simply because of our current or past ownership of the real estate. If unidentified environmental problems arise, we may have to make substantial payments, which could adversely affect our cash flow and our ability to make distributions to our shareholders. This is so because:
- As owner we may have to pay for property damage and for investigation and clean-up costs incurred in connection with the contamination
- The law may impose clean-up responsibility and liability regardless of whether the owner or operator knew of or caused the contamination
- Even if more than one person is responsible for the contamination, each person who shares legal liability under environmental laws may be held responsible for all of the clean-up costs
- Governmental entities and third parties may sue the owner or operator of a contaminated site for damages and costs
These costs could be substantial and in extreme cases could exceed the value of the contaminated property. The presence of hazardous substances or petroleum products or the failure to properly remediate contamination may adversely affect our ability to borrow against, sell or lease an affected property. In addition, some environmental laws create liens on contaminated sites in favor of the government for damages and costs it incurs in connection with a contamination. Most of our loan agreements require the Company or a subsidiary to indemnify the lender against environmental liabilities. Our leases require the tenants to operate the properties in compliance with environmental laws and to indemnify us against environmental liability arising from the operation of the properties. We believe all of our properties are in material compliance with environmental laws. However, we could be subject to strict liability under environmental laws because we own the properties. There is also a risk that tenants may not satisfy their environmental compliance and indemnification obligations under the leases. Any of these events could substantially increase our cost of operations, require us to fund environmental indemnities in favor of our lenders and reduce our ability to service our debt and pay dividends to shareholders.
REAL ESTATE INVESTMENTS ARE RELATIVELY NON-LIQUID
We may desire to sell a property in the future because of changes in market conditions or poor tenant performance or to avail ourselves of other opportunities. We may also be required to sell a property in the future to meet debt obligations or avoid a default. Specialty real estate projects such as megaplex theatres cannot always be sold quickly, and we cannot assure you that we could always obtain a favorable price. We may be required to invest in the restoration or modification of a property before we can sell it.
RISKS THAT MAY AFFECT THE MARKET PRICE OF OUR SHARES
WE CANNOT ASSURE YOU WE WILL CONTINUE PAYING DIVIDENDS AT HISTORICAL RATES
Our ability to continue paying dividends at historical rates or to increase our Common Share dividend rate will depend on a number of factors, including our financial condition and results of future operations, the performance of lease terms by tenants, our ability to acquire, finance and lease additional properties at
attractive rates, and provisions in our loan covenants. If we do not maintain or increase our dividend rate, that could have an adverse effect on the market price of our Common Shares.
MARKET INTEREST RATES MAY HAVE AN EFFECT ON THE VALUE OF OUR SHARES
One of the factors that investors may consider in deciding whether to buy or sell our Common Shares is our dividend rate as a percentage of our share price, relative to market interest rates. If market interest rates increase, prospective investors may desire a higher dividend on our Common Shares or seek securities paying higher dividends or interest.
MARKET PRICES FOR OUR SHARES MAY BE AFFECTED BY PERCEPTIONS ABOUT THE FINANCIAL HEALTH OR SHARE VALUE OF OUR TENANTS OR THE PERFORMANCE OF REIT STOCKS GENERALLY.
To the extent any of our tenants or other movie exhibitors report losses or slower earnings growth, take charges against earnings resulting from the obsolescence of multiplex theatres or enter bankruptcy proceedings, the market price for our shares could be adversely affected. The market price for our shares could also be affected by any weakness in movie exhibitor stocks generally. We believe these trends had an adverse impact on our Common Share price during 2001 and 2000.
LIMITS ON CHANGES IN CONTROL MAY DISCOURAGE TAKEOVER ATTEMPTS WHICH MAY BE BENEFICIAL TO OUR SHAREHOLDERS
There are a number of provisions in our Declaration of Trust, Maryland law and agreements we have with others which could make it more difficult for a party to make a tender offer for our shares or complete a takeover of the Company which is not approved by our Board of Trustees. These include:
- A staggered Board of Trustees that can be increased in number without shareholder approval
- A limit on beneficial ownership of our shares, which acts as a defense against a hostile takeover or acquisition of a significant or controlling interest, in addition to preserving our REIT status
- The ability of the Board of Trustees to issue preferred shares or reclassify preferred or common shares without shareholder approval
- Limits on the ability of shareholders to remove trustees without cause
- Requirements for advance notice of shareholder proposals at annual shareholder meetings
- Provisions of Maryland law restricting business combinations and control share acquisitions not approved by the Board of Trustees
- Provisions of Maryland law protecting corporations (and by extension REITs) against unsolicited takeovers by limiting the duties of the trustees in unsolicited takeover situations
- Provisions in Maryland law providing that the trustees are not subject to any higher duty or greater scrutiny than that applied to any other director under Maryland law in transactions relating to the acquisition or potential acquisition of control
- Provisions of Maryland law creating a statutory presumption that an act of the trustees satisfies the applicable standards of conduct for directors under Maryland law
- Provisions in loan or joint venture agreements putting the Company in default upon a change in control
- Provisions of employment agreements with our officers calling for share purchase loan forgiveness upon a hostile change in control
Any or all of these provisions could delay or prevent a change in control of the Company, even if the change was in our shareholders' interest or offered a greater return to our shareholders.
ITEM 2.
ITEM 2. PROPERTIES
As of December 31, 2003, the Company's real estate portfolio consisted of 45 megaplex theatre properties and various restaurant, retail and other properties located in 18 states. Except as otherwise noted, all of the real estate investments listed below are owned or ground leased directly by the Company. The following table lists the Company's properties, their locations, acquisition dates, number of theatre screens, number of seats, gross square footage, and the tenant.
(1) Third party ground leased property. Although the Company is the tenant under the ground leases and has assumed responsibility for performing the obligations thereunder, pursuant to the leases, the theatre tenants are responsible for performing the Company's obligations under the ground leases.
(2) In addition to the theatre property itself, the Company has acquired land parcels adjacent to the theatre property, which the Company has or intends to ground lease or sell to restaurant or other entertainment themed operators.
(3) Property is included as security for a $105 million mortgage note payable.
(4) Property is included as security for $20 million in mortgage notes payable.
(5) Property is included in the Atlantic-EPR I joint venture.
(6) Property is included as security for $125 million in mortgage notes payable.
(7) Property is included as security for a $17 million mortgage note payable.
(8) Property is included as security for a $75 million secured credit facility.
(9) Property is included as security for a $50 million revolving credit facility.
(10) Property is included as security for a $155.5 million mortgage.
(11) Property is included as security for a $14.7 million mortgage.
(12) Property is included as security for a $66 million and $4 million credit facility.
OFFICE LOCATION. The Company's executive office is located in Kansas City, Missouri and is leased from a third party landlord. The office occupies approximately 10,960 square feet with annual rentals of $192,000. The lease expires in December, 2009.
TENANTS AND LEASES
The Company's existing leases on rental property (on a consolidated basis - excluding joint venture property) provide for aggregate annual rentals of approximately $100.4 million (not including periodic rent escalations or percentage rent). The megaplex theatre leases have an average remaining base term lease life of 13.2 years and may be extended for predetermined extension terms at the option of the tenant. The theatre leases are typically triple-net leases that require the tenant to pay substantially all expenses associated with the operation of the properties, including taxes, other governmental charges, insurance, utilities, service, maintenance and any ground lease payments.
PROPERTY ACQUISITIONS IN 2003
The following table lists the rental properties acquired or developed during 2003:
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Other than routine litigation and administrative proceedings arising in the ordinary course of business, the Company is not presently involved in any litigation nor, to its knowledge, is any litigation threatened against the Company or its properties, which is reasonably likely to have a material adverse effect on the liquidity or results of operations of the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The following table sets forth, for the quarterly periods indicated, the high and low sales prices per Share for the Company's Common Shares on the New York Stock Exchange under the trading symbol "EPR" and the distributions declared.
The Company declared quarterly distributions to shareholders aggregating $2.00 per Common Share in 2003 and $1.90 per Common Share in 2002.
While we intend to continue paying regular quarterly dividends, future dividend declarations will be at the discretion of the Board of Trustees and will depend on the actual cash flow of the Company, its financial condition, capital requirements, the annual distribution requirements under the REIT provisions of the Code, debt covenants and other factors the Board of Trustees deems relevant. The actual cash flow available to pay dividends may be affected by a number of factors, including the revenues received from rental properties, the operating expenses of the Company, interest expense on Company borrowings, the ability of lessees to meet their obligations to the Company and any unanticipated capital expenditures (See "Risk Factors - We cannot assure you we will continue paying dividends at historical rates," in Item 1, and "Liquidity and Capital Resources" in Item 7 - "Management's Discussion and Analysis"). The Company's Preferred Shares have a fixed dividend rate of 9.5%.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto of the Company included in this Annual Report on Form 10-K. The forward-looking statements included in this discussion and elsewhere in this Form 10-K involve risks and uncertainties, including anticipated financial performance, business prospects, industry trends, shareholder returns and other matters, which reflect management's best judgment based on factors currently known. Actual results and experience could differ materially from the anticipated results and other expectations expressed in the Company's forward-looking statements as a result of a number of factors, including but not limited to those discussed in this Item and in Item 1 "Business - Risk Factors".
OVERVIEW
Our primary business strategy is to purchase real estate (land, buildings and other improvements) leased to operators of destination-based entertainment and entertainment-related properties under long-term, triple-net leases. As of December 31, 2003, we had invested approximately $936 million (before accumulated depreciation) in 45 megaplex theatre properties and various restaurant, retail and other properties located in 18 states. As of December 31, 2003, we had invested approximately $29.2 million in development land, for which we actively develop or pursue development projects that we feel would add value to the overall entertainment experience of theatre patrons.
Substantially all of our single-tenant properties are leased pursuant to long-term, triple-net leases, under which the tenants typically pay all operating expenses of a property, including, but not limited to, all real estate taxes, assessments and other governmental charges, insurance, utilities, repairs and maintenance. Tenants at our multi-tenant properties pay CAM charges to defray their pro rata portion of these costs.
Substantially all of our revenues are derived from rents received or accrued under long-term leases and interest earned from the temporary investment of funds in short-term investments.
The Company incurs general and administrative expenses including compensation expense for our executive officers and other employees, professional fees and various expenses incurred in the process of identifying and acquiring additional properties. We are self-administered and managed by our trustees, executive officers and other employees. Our primary non-cash expense is the depreciation of our properties. We depreciate buildings and improvements on our properties over a seven-year to 40-year period for tax purposes and primarily a 40-year period for financial reporting purposes. We do not own or lease any significant personal property or equipment at any property we currently own.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying Consolidated Financial Statements and related notes. In preparing these financial statements, management has made its best estimates and assumptions that affect the reported assets and liabilities. The most significant assumptions and estimates relate to revenue recognition, depreciable lives of the real estate and the valuation of real estate. Application of these assumptions requires the exercise of judgment as to future uncertainties and, as a result, actual results could differ from these estimates.
Revenue Recognition
Base rents are recognized on a straight-line basis over the term of the lease, and the base rent escalation is recognized when measurable. Base rent escalation in most of our leases is dependant upon increases in the Consumer Price Index (CPI) and accordingly, management does not include any future base rent escalation
amounts in current revenue. Most of our leases provide for percentage rents based upon the level of sales achieved by the tenant. These percentage rents are recognized once the required sales level is achieved.
Real Estate Useful Lives
We are required to make subjective assessments as to the useful lives of our properties for the purpose of determining the amount of depreciation to reflect on an annual basis with respect to those properties. These assessments have a direct impact on the Company's net income. Depreciation and amortization are provided on the straight-line method over the useful lives of the assets, as follows:
Impairment of Real Estate Values
We are required to make subjective assessments as to whether there are impairments in the value of our rental properties. These estimates of impairment may have a direct impact on the Company's consolidated financial statements.
We apply the provisions of Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. We assess the carrying value of our rental properties whenever events or changes in circumstances indicate that the carrying amount of a property may not be recoverable. Certain factors that may occur and indicate that impairments may exist include, but are not limited to: underperformance relative to projected future operating results, tenant difficulties and significant adverse industry or market economic trends. No such indicators existed during 2003. If an indicator of possible impairment exists, a property is evaluated for impairment by a comparison of the carrying amount of the property to the estimated undiscounted future cash flows expected to be generated by the property. If the carrying amount of a property exceeds its estimated future cash flows on an undiscounted basis, an impairment charge is recognized by the amount by which the carrying amount of the property exceeds the fair value of the property. Management estimates fair value of its rental properties based on projected discounted cash flows using a discount rate determined by management to be commensurate with the risk inherent in the Company. Management did not record any impairment charges for 2003.
RECENT DEVELOPMENTS
During the three months ended December 31, 2003, we completed approximately $133 million of rental property acquisitions. Our purchase of 71.4% in New Roc Associates, LP closed on October 27, 2003. The partnership property is an entertainment retail center in New Rochelle, New York, called New Roc City. The remaining acquisitions during the last three months of 2003 were theatre properties in Suffolk, VA, Columbia, SC, and Hialeah, FL. Also, during the three months ended December 31, 2003, we completed approximately $8.6 million of development land acquisitions. This land is currently being used to develop megaplex theatres. We paid cash and assumed certain indebtedness to acquire the properties described above. The cash portions were primarily obtained from our common stock offering completed in September of 2003.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002
Rental revenue was $90 million for the year ended December 31, 2003, as compared to $71.6 million for the year ended December 31, 2002. The $18.4 million increase resulted primarily from property acquisitions completed in 2002 and 2003, base rent increases and percentage rents on existing properties. In addition, other revenue increased by $1.2 million in 2003 due to a payment received related to the cancellation of the Van's Skate Park lease at the entertainment retail center in Westminster, Colorado, which was closed during the third quarter, and income received from claims we filed in the Loews Cineplex bankruptcy proceedings. Percentage rents of $1.9 million and $600 thousand were recognized in 2003 and 2002, respectively.
Our property operating expenses totaled $698 thousand for the year ended December 31, 2003, as compared to $201 thousand for the year ended December 31, 2002. These expenses arise from our non-triple net retail property operations in Southfield, Michigan; Greenville, South Carolina; Westminster, Colorado; Tampa, Florida; New Rochelle, New York; and Suffolk, Virginia.
Our general and administrative expenses were $3.9 million for the year ended December 31, 2003, as compared to $2.3 million for the year ended December 31, 2002. The increase is primarily due to the following:
- Increases in insurance expense, including premiums for both Director and Officer insurance and property and casualty insurance compared to 2002 due to an overall increase in premiums in the insurance market.
- An increase in fees paid for professional services, primarily for legal fees related to compliance with the Sarbanes Oxley Act.
- An increase in payroll and related expenses attributable to increases in base compensation, bonus awards, payroll taxes related to the vesting of stock grants and stock bonuses, and the addition of two employees.
- Increased costs associated with our Board of Trustees meetings and increases in trustee compensation.
- Increases in franchise and other miscellaneous taxes paid.
Our net interest expense increased by $6 million to $30.6 million for the year ended December 31, 2003 from $24.5 million for the year ended December 31, 2002. The increase in net interest expense primarily resulted from increases in long-term debt used to finance real estate acquisitions.
Depreciation and amortization expenses, totaled $16.4 million for the year ended December 31, 2003 compared to $12.9 million for the same period in 2002. The $3.5 million increase resulted from the property acquisitions completed in 2002 and 2003. Amortization of non-vested shares was $926 million and $1,048 million in 2003 and 2002, respectively.
Income from joint venture totaled $401 thousand for the year ended December 31, 2003 compared to $1.4 million for the same period in 2002. The decrease was due to the Company's lower ownership interest in
the Atlantic-EPR I joint venture (20% ownership throughout 2003 compared to 76.9% weighted average interest in 2002).
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Total revenue was $71.6 million for the year ended December 31, 2002, as compared to $54.7 million for the year ended December 31, 2001. The $16.9 million increase resulted from property acquisitions completed in 2002, property acquisitions completed during 2001, the acquisition and consolidation in December 2001 of the remaining third party interest in the Westcol joint venture, and from base rent increases and percentage rent payments on existing properties.
Our property operating expenses totaled $200 thousand for the year ended December 31, 2002. These expenses arise from the operations of Westcol Center, an entertainment and retail center in Westminster Colorado, in which the Company acquired sole ownership in December 2001 by buying the remaining interest in the Westcol joint venture. For the same period in 2001, we accounted for our partial interest in the Westcol joint venture under the equity method of accounting. Therefore, the Company did not recognize expenses related to the venture in 2001.
Our interest expense increased to $24.5 million for the year ended December 31, 2002 from $20.3 million for the year ended December 31, 2001. The $4.1 million increase in interest expense resulted from an increase in long-term debt related to financings of property acquisitions made during fiscal 2002 and 2001, and the recognition of interest expense from the Westcol theatre first mortgage loan, acquired with the acquisition/consolidation of the remaining third party interest in the Westcol joint venture in December 2001.
Our depreciation and amortization expenses, including amortization of share based compensation, totaled $13.9 million for the year ended December 31, 2002 compared to $10.4 million for the same period in 2001. The $3.5 million increase resulted from the property acquisitions completed in 2001 and 2002 and from increases in amortization of stock based compensation.
Income from joint venture totaled $1.4 million for the year ended December 31, 2002 compared to $2.2 million for the same period in 2001. The decrease was primarily attributed to the acquisition of the remaining third party interest in the Westcol joint venture in December 2001 which was consolidated for entire year in 2002. During 2001, through the date of acquisition, we accounted for our interest in the Westcol joint venture using the equity method of accounting, which represented $735,000 of the 2001 income from joint ventures. In December 2002, our partner in our remaining joint venture substantially increased its interest in that joint venture.
For the year ended December 31, 2002 minority interest in net income was $1.2 million, arising from the issuance of $15 million of common and preferred interests by EPT Gulf States, LLC, our consolidated subsidiary, as a result of the Gulf States theatres acquisition completed on March 15, 2002. In 2001, the Company had no minority interest outstanding.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents were $30.5 million at December 31, 2003. In addition, the Company had restricted cash of $6.5 million available for debt service in connection with the $116.5 million mortgage debt due in February 2006.
Mortgage Debt and Credit Facilities
As of December 31, 2003, we had total debt outstanding of $506.6 million. All of our debt was mortgage debt secured by substantially all of our rental properties. Of this debt, $86 million was variable rate debt and $420.6 million was fixed rate debt. All of our debt is described in footnote 5 in the "Notes to Consolidated Financial Statements" in this Form 10-K.
At December 31, 2003, we had no debt outstanding under our $50 million Fleet Bank credit facility. The Fleet Bank credit facility is a secured facility and at December 31, 2003, there were four theatre properties and two theatre and retail mix properties pledged to that facility. We expect to use proceeds from the facility for additional acquisitions of rental property and general corporate purposes. The credit facility matures in April 2005 and carries interest at LIBOR plus 300 basis points.
As of December 31, 2003, we had $20 million of debt outstanding under our iSTAR $75 million credit facility. The credit facility has three years remaining and carries interest at LIBOR plus 400 basis points. On September 23, 2003, the Company issued 2.4 million common shares in a registered public offering for net proceeds of $72.2 million. The proceeds were used to fund the acquisition of three megaplex theatres (including one with retail shops), one entertainment retail center, and three land parcels for theatre development in fourth quarter 2003.
Our principal investing activity is the purchase of rental property, which is generally financed with mortgage debt and the proceeds from equity offerings. Continued growth of our rental property portfolio will depend in part on our continued ability to access funds through additional borrowings and equity security offerings.
Liquidity Requirements
Short-term liquidity requirements consist primarily of normal recurring corporate operating expenses, debt service requirements and distributions to shareholders. Cash provided by operating activities was $51 million in 2003, $45.9 million in 2002 and $34.9 million in 2001. We anticipate that our cash on hand and cash provided by operating activities will provide adequate liquidity to conduct operations, fund administrative and operating costs and interest and principal payments on our debt, and allow distributions to the Company's shareholders so as to avoid corporate level federal income or excise tax in accordance with Internal Revenue Code requirements for qualification as a REIT.
Long-term liquidity requirements at December 31, 2003 consisted primarily of maturities of long-term debt. Contractual obligations as of December 31, 2003 are as follows (in thousands):
In February of 2004, the Company entered into an agreement to refinance the $66 million in variable rate debt which matures in 2003.
We believe that we will be able to obtain financing in order to repay our debt obligations by refinancing the properties as the debt comes due. However, there can be no assurance that additional financing or capital will be available, or that terms will be acceptable or advantageous to us. We anticipate that long-term liquidity requirements will also include amounts for acquisition of properties. We have identified approximately $260 million in properties for acquisition in 2004. We expect to meet long-term liquidity requirements through long-term borrowings and other debt and equity financing alternatives. The availability and terms of any such financing will depend upon market and other conditions.
There can be no assurance that we will be able to obtain such financing in the future, which would not affect our liquidity, but would affect our ability to grow (See "We must obtain new financing in order to grow", and "Risks that may affect the market price of our shares" under "Risk Factors").
In addition to the contractual obligations listed in the table above, the Company had five theatre projects under construction at December 31, 2003. These theatres will have a total of 86 screens and their development costs will be approximately $66 million. The Company has already purchased the development land for $16.3 million as of December 31, 2003, and plans to fund the remaining estimated development costs of these properties through new debt facilities and additional equity. The cost of development is paid by the Company either in periodic draws or upon successful completion of construction. If management of the Company determines the construction is not being completed per the executed development agreement, the Company can discontinue funding of periodic draws or refuse to purchase the completed theatre. Upon successful completion of construction, the Company will lease these theatres to already established theatre operators for approximately $7.6 million in annual rentals.
Off Balance Sheet Arrangements
At December 31, 2003, the Company had a 20% investment interest in one non-consolidated real estate joint venture, Atlantic-EPR I, which is accounted for under the equity method of accounting. We do not anticipate any material impact on our liquidity as a result of any commitments that may arise involving that joint venture. The following is a brief description of the joint venture:
On May 11, 2000, the Company completed the formation of a joint venture partnership, Atlantic-EPR I, a Delaware general partnership (Atlantic-EPR I), with Atlantic of Hamburg, Germany (Atlantic), whereby the Company contributed the AMC Cantera 30 theatre with a carrying value of $33.5 million in exchange for cash proceeds from mortgage financing of $17.8 million and a 100% interest in Atlantic-EPR I. During 2000 through 2002, the Company sold to Atlantic a total of an 80% interest in Atlantic-EPR I in exchange for $14.3 million in cash. The final contribution by Atlantic of $8.4 million was paid to the partnership in December 2002 but was not paid to the Company until January 2003. Accordingly, such contribution is included as a receivable from joint venture in the consolidated balance sheet at December 31, 2002.
The joint venture agreement allows Atlantic to exchange up to a maximum of 10% of its ownership interest in Atlantic-EPR I per year, beginning in 2005, for Common Shares of the Company or, at the discretion of the Company, cash.
The Company accounts for its investment in Atlantic-EPR I under the equity method of accounting. The Company recognized income of $401, $1,421, and $1,468 (in thousands) from its investment in this joint venture during 2003, 2002 and 2001, respectively.
FUNDS FROM OPERATIONS (FFO)
The National Association of Real Estate Investment Trusts (NAREIT) developed FFO as a non-GAAP financial measure of performance and liquidity of an equity REIT in order to recognize that income-producing real estate historically has not depreciated on the basis determined under GAAP. FFO is a widely used measure to help management and investors evaluate the operating performance of real estate companies and is provided here as a supplemental measure to Generally Accepted Accounting Principles (GAAP) net income available to common shareholders and earnings per share. FFO, as defined under the revised NAREIT definition and presented by us, is net income, computed in accordance with GAAP, excluding gains and losses from sales of depreciable operating properties, plus real estate related depreciation and amortization, and after adjustments for unconsolidated partnerships, joint ventures and other affiliates. Adjustments for unconsolidated partnerships, joint ventures and other affiliates are calculated to reflect FFO on the same basis. FFO is a non-GAAP financial measure. FFO does not represent cash flows from operations as defined by GAAP and is not indicative that cash flows are adequate to fund all cash needs and is not to be considered an alternative to net income or any other GAAP measure as a measurement of the results of the Company's operations or the Company's cash flows or liquidity as defined by GAAP.
The following tables summarize the Company's FFO for the years ended December 31, 2003 and December 31, 2002 (in thousands):
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46, Consolidation of Variable Interest Entities, which was issued in January 2003. The Company must apply FIN 46R to variable interest in VIEs created after December 31, 2003. For variable interests in VIEs created before January 1, 2004, the Interpretation will be applied beginning on January 1, 2005. For any VIEs that must be consolidated under FIN 46R that were created before January 1, 2004, the assets, liabilities and non-controlling interests of the VIE initially would be measured at their carrying amounts with any difference between the net amount added to the balance sheet and any previously recognized interest being recognized as the cumulative effect of an accounting change. If determining the carrying amounts is not practicable, fair value at the date FIN 46R first applies may be used to measure the assets, liabilities and non-controlling interest of the
VIE. As of December 31, 2003, the Company's financial statements have not been impacted by the issuance of FIN 46R. Further, the Company does not expect any impact on the financial statements in the future.
FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, was issued in May 2003. This Statement establishes standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. The Statement also includes required disclosures for financial instruments within its scope. For the Company, the Statement was effective for instruments entered into or modified after May 31, 2003 and otherwise will be effective as of January 1, 2004, except for mandatory redeemable financial instruments. For certain mandatory redeemable financial instruments, the Statement will be effective for the Company on January 1, 2005. The effective date has been deferred indefinitely for certain other types of mandatory redeemable financial instruments. As of December 31, 2003, the Company's financial statements have not been impacted by the issuance of FASB Statement No. 150. Further, the Company does not expect any impact on the financial statements in the future.
INFLATION
Investments by the Company are financed with a combination of equity and secured mortgage indebtedness. During inflationary periods, which are generally accompanied by rising interest rates, the Company's ability to grow may be adversely affected because the yield on new investments may increase at a slower rate than new borrowing costs.
All of the Company's megaplex theatre leases provide for base and participating rent features. To the extent inflation causes tenant revenues at the Company's properties to increase over baseline amounts, the Company would participate in those revenue increases through its right to receive annual percentage rent. The Company's leases also generally provide for escalation in base rents in the event of increases in the Consumer Price Index, with a limit of 2% per annum, or fixed periodic increases.
All of the Company's theatre leases are triple-net leases requiring the tenants to pay substantially all expenses associated with the operation of the properties, thereby minimizing the Company's exposure to increases in costs and operating expenses resulting from inflation.
FORWARD LOOKING INFORMATION
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
WITH THE EXCEPTION OF HISTORICAL INFORMATION, THIS REPORT ON FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS AS DEFINED IN THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 AND IDENTIFIED BY SUCH WORDS AS "WILL BE," "INTEND," "CONTINUE," "BELIEVE," "MAY," "EXPECT," "HOPE," "ANTICIPATE," "GOAL," "FORECAST," OR OTHER COMPARABLE TERMS. THE COMPANY'S ACTUAL FINANCIAL CONDITION, RESULTS OF OPERATIONS OR BUSINESS MAY VARY MATERIALLY FROM THOSE CONTEMPLATED BY SUCH FORWARD LOOKING STATEMENTS AND INVOLVE VARIOUS RISKS AND UNCERTAINTIES, INCLUDING BUT NOT LIMITED TO THOSE DISCUSSED UNDER "BUSINESS - RISK FACTORS." INVESTORS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON ANY FORWARD-LOOKING STATEMENTS.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risks, primarily relating to potential losses due to changes in interest rates. We seek to mitigate the effects of fluctuations in interest rates by matching the term of new investments with new long-term fixed rate borrowings whenever possible.
We are subject to risks associated with debt financing, including the risk that existing indebtedness may not be refinanced or that the terms of such refinancing may not be as favorable as the terms of current indebtedness. Our borrowings are subject to mortgages or contractual agreements which limit the amount of indebtedness we may incur. Accordingly, if we are unable to raise additional equity or borrow money due to these limitations, our ability to acquire additional properties may be limited.
The following table presents the principal amounts, weighted average interest rates, and other terms required by year of expected maturity to evaluate the expected cash flows and sensitivity to interest rate changes as of December 31:
Expected Maturities (in millions)
We have not engaged extensively in the use of derivatives to manage our interest rate and market risk due to the Company's limited use of variable rate debt. For a discussion of derivative financial instruments and interest rate hedging activity, see note 9 to the consolidated financial statements.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Entertainment Properties Trust
CONTENTS
Independent Auditors' Report
The Board of Trustees Entertainment Properties Trust:
We have audited the accompanying consolidated balance sheets of Entertainment Properties Trust (the Company) as of December 31, 2003 and 2002, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for the years then ended. In connection with our audit of the consolidated financial statements, we have also audited the accompanying financial statement schedules listed in the Index at Item 15(d). These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules 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 Entertainment Properties Trust as of December 31, 2003 and 2002, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
KPMG LLP
Kansas City, Missouri February 3, 2004
Report of Independent Auditors
The Board of Trustees Entertainment Properties Trust
We have audited the accompanying consolidated statements of income, changes in shareholders' equity and cash flows of Entertainment Properties Trust (the Company) for the year ended December 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated results of operations and cash flow of Entertainment Properties Trust for the year ended December 31, 2001, in conformity with accounting principles generally accepted in the United States.
Ernst & Young LLP
Kansas City, Missouri March 28, 2002
ENTERTAINMENT PROPERTIES TRUST
Consolidated Balance Sheets
(In thousands except share and per share data)
See accompanying notes to consolidated financial statements.
ENTERTAINMENT PROPERTIES TRUST
Consolidated Statements of Income
(In thousands except per share data)
See accompanying notes to consolidated financial statements.
ENTERTAINMENT PROPERTIES TRUST
Consolidated Statements of Changes in Shareholders' Equity
(In thousands)
See accompanying notes to consolidated financial statements.
ENTERTAINMENT PROPERTIES TRUST
Consolidated Statements of Cash Flows (In thousands)
ENTERTAINMENT PROPERTIES TRUST
Consolidated Statements of Cash Flows (In thousands)
See accompanying notes to consolidated financial statements
Entertainment Properties Trust Notes to Consolidated Financial Statements December 31, 2003, 2002, and 2001
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Entertainment Properties Trust (the Company) is a Maryland real estate investment trust (REIT) organized on August 29, 1997. The Company was formed to acquire and develop entertainment properties including megaplex theatres and entertainment retail centers. At December 31, 2003, the Company owned 45 megaplex theatre properties, including two joint venture properties, located in eighteen states, two entertainment retail centers ("ERC") located in Westminster, Colorado, and New Rochelle, New York, and land parcels leased to restaurant and retail operators and related properties adjacent to several of its theatre properties.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Entertainment Properties Trust and its subsidiaries all of which are substantially wholly-owned except for New Roc Associates, LP (New Roc). New Roc was acquired in October 2003 and is 71.4% owned. All significant inter-company transactions have been eliminated in consolidation.
USE OF ESTIMATES
Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ from those estimates.
RENTAL PROPERTIES
Rental properties are carried at cost less accumulated depreciation. Costs incurred for the acquisition of the properties are capitalized. Accumulated depreciation is computed over the estimated useful lives of the assets, which generally are estimated to be 40 years for buildings, 5 to 7 years for furniture, fixtures and equipment, and the base term of the lease for tenant improvements. Expenditures for ordinary maintenance and repairs are charged to operations in the period incurred. Significant renovations and improvements which improve or extend the useful life of the asset are capitalized and depreciated over their estimated useful life.
The Company applies Statement of Financial Accounting Standards (SFAS) No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", for the recognition and measurement of impairment of long-lived assets to be held and used. Management reviews a property for impairment whenever events or changes in circumstances indicate that the carrying value of a property may not be recoverable. The review of recoverability is based on an estimate of undiscounted future cash flows expected to result from its use and eventual disposition. If impairment exists due to the inability to recover the carrying value of the property, an impairment loss is recorded to the extent that the carrying value of the property exceeds its estimated fair value.
DEFERRED FINANCING COSTS
Included in other assets are deferred financing costs which are amortized over the terms of the related long-term debt obligations.
Entertainment Properties Trust Notes to Consolidated Financial Statements December 31, 2003, 2002, and 2001
CAPITALIZED DEVELOPMENT COSTS
The Company capitalizes certain costs that relate to real estate under development including interest and development personnel costs.
OPERATING SEGMENT
The Company aggregates the financial information of all its properties into one reportable segment because the properties all have similar economic characteristics and provide similar services to similar types and classes of customers.
REVENUE RECOGNITION
A majority of the Company's leases contain provisions for periodic escalation in base rent (base rent escalation), which are primarily based on an inflation index. Base rents are recognized on a straight-line basis over the term of the lease, and the base rent escalation is recognized when measurable. In addition, tenants are subject to additional rents if gross revenues of the properties exceed certain thresholds defined in the lease agreements (percentage rents). Percentage rents are recognized at the time when specific triggering events occur as provided by the lease agreements. Percentage rents of $1.9 million and $600 thousand were recognized in 2003 and 2002, respectively. No percentage rents were recognized in 2001.
INCOME TAXES
The Company operates in a manner intended to enable it to qualify as a REIT under the Internal Revenue Code (the Code). A REIT which distributes at least 90% of its taxable income to its shareholders each year and which meets certain other conditions is not taxed on that portion of its taxable income which is distributed to its shareholders. The Company intends to continue to qualify as a REIT and distribute substantially all of its taxable income to its shareholders. Accordingly, no provision has been made for income taxes.
Earnings and profits, which determine the taxability of distributions to shareholders, may differ from that reported for financial reporting purposes due primarily to differences in the basis of the assets and the estimated useful lives used to compute depreciation.
CONCENTRATION OF RISK
American Multi-Cinema, Inc. (AMC) is the lessee of 62% of the megaplex theatre rental properties owned by the Company (including joint venture properties) at December 31, 2003. A substantial portion of the Company's revenues (approximately $66.1 million or 73%, and $51.6 million or 72% for the years ended December 31 2003 and 2002, respectively, including joint ventures) result from the rental payments by AMC under the leases, or its parent, AMC Entertainment, Inc. (AMCE), as the guarantor of AMC's obligations under the leases. AMC Entertainment, Inc. is a publicly held company (AMEX:AEN) and accordingly, their financial information is publicly available.
CASH EQUIVALENTS
Cash equivalents include bank demand deposits and shares of highly liquid institutional money market mutual funds for which cost approximates market value.
Entertainment Properties Trust Notes to Consolidated Financial Statements December 31, 2003, 2002, and 2001
RESTRICTED CASH
Restricted cash represents demand deposits required in connection with the $125 million secured non-recourse mortgage notes payable due in 2006. These deposits are restricted for debt service under the terms of the loans.
SHARE BASED COMPENSATION
Prior to 2003, the Company accounted for stock options issued under its share incentive plan under the recognition and measurement provisions of APB Opinion No. 25 "Accounting for Stock Issued to Employees," and related interpretations. No stock-based compensation cost related to such options is reflected in 2002 and 2001 net income, as all options had an exercise price equal to the market value of the underlying common stock on the date of grant.
Effective January 1, 2003, the Company adopted the fair value recognition provisions of FASB Statement No. 123, "Accounting for Stock-Based Compensation," prospectively for all employee awards granted, modified, or settled after January 1, 2003. Awards under the Company's plan vest either immediately or up to a period of 5 years. Therefore the cost related to stock based employee compensation related to stock options included in the determination of net income for 2003 is less than that which would have been recognized if the fair value based method had been applied to all awards since the original effective date of Statement 123. The following table illustrates the effect on net income and earnings per share if the fair value based method had been applied to all outstanding and unvested awards for each period (in thousands):
Entertainment Properties Trust Notes to Consolidated Financial Statements December 31, 2003, 2002, and 2001
The fair value for these options was estimated at the date of grant using the Black-Scholes option pricing model with the following assumptions: risk-free interest rate of 4.0% in 2003, 4% in 2002, and 5.0% in 2001, dividend yield of 8%, volatility factors of the expected market price of the Company's common shares of 14.6% in 2003, 22.3% to 25.1% in 2002, and 35% in 2001; and an expected life of the options of eight years.
Restricted share awards, which vest over time, are recorded as unearned compensation when granted using the fair value of the stock at the grant date, and amortized to expense over the vesting period.
2. RENTAL PROPERTIES
The following table summarizes the carrying amounts of rental properties as of December 31, 2003 and 2002 (in thousands):
Entertainment Properties Trust Notes to Consolidated Financial Statements December 31, 2003, 2002, and 2001
Depreciation expense on rental properties was $16.2 million, $12.7 million and $10.1 million for the years ended December 31, 2003, 2002 and 2001, respectively.
3. REAL ESTATE JOINT VENTURES
ATLANTIC JOINT VENTURE
On May 11, 2000, the Company completed the formation of a joint venture partnership, Atlantic-EPR I, a Delaware general partnership (Atlantic-EPR I), with Atlantic of Hamburg, Germany (Atlantic), whereby the Company contributed the AMC Cantera 30 theatre with a carrying value of $33.5 million in exchange for cash proceeds from mortgage financing of $17.8 million and a 100% interest in Atlantic-EPR I. During 2000 through 2002, the Company sold to Atlantic a total of an 80% interest in Atlantic-EPR I in exchange for $14.3 million in cash. The final contribution by Atlantic of $8.4 million was paid to Atlantic-EPR I in December 2002 but was not paid to the Company until January 2003. Accordingly, such contribution is included as a receivable from joint venture in the consolidated balance sheet at December 31, 2002.
The joint venture agreement allows Atlantic to exchange up to a maximum of 10% of its ownership interest in Atlantic-EPR I per year, beginning in 2005, for Common Shares of the Company or, at the discretion of the Company, cash.
The Company accounts for its investment in Atlantic-EPR I under the equity method of accounting. The Company recognized income of $401, $1,421, and $1,468 (in thousands) from its investment in this joint venture during 2003, 2002 and 2001, respectively.
Condensed financial information for Atlantic-EPR I is as follows as of and for the years ended December 31, 2003, 2002, and 2001 (in thousands):
WESTCOL JOINT VENTURE
On June 30, 1999, the Company completed the formation of a joint venture, whereby the Company contributed certain undeveloped land parcels with a carrying value of $8.7 million in exchange for a 50% interest in the real estate joint venture, comprised of undeveloped land parcels and the Westminster AMC 24 screen theatre in Westminster, Colorado. In December 2001, the Company purchased the remaining third party interest in the Westcol joint venture for $13.5 million, which approximated the book value of the proportionate share of the underlying net assets of Westcol. As a result of the acquisition of the
Entertainment Properties Trust Notes to Consolidated Financial Statements December 31, 2003, 2002, and 2001
remaining interest, the Company consolidated the assets and liabilities of the joint venture at the time of acquisition. The Company recognized income of $735 in thousands from its investment in this joint venture during 2001.
4. OPERATING LEASES
The Company's rental properties are leased under operating leases with expiration dates ranging from 9 to 25 years. Future minimum rentals on non-cancelable tenant leases at December 31, 2003 are as follows (in thousands):
5. LONG-TERM DEBT
Long term debt at December 31, 2003 and 2002 consists of the following (in thousands):
(1) The Company's secured variable rate credit facility due February 28, 2006 is secured by one theatre property, several retail and restaurant properties and other land parcels, which had a net book value of approximately $35.8 million at December 31, 2003. The note requires monthly payments of interest with the outstanding principal due at maturity. Principal amounts bear interest at LIBOR plus 400 basis points (5.125% at December 31, 2003).
Entertainment Properties Trust Notes to Consolidated Financial Statements December 31, 2003, 2002, and 2001
(2) The Company's secured revolving variable rate credit facility due May 1, 2005 is secured by four theatre properties and two theatre and retail mix properties, which had a net book value of approximately $66.4 million at December 31, 2003. There was no outstanding balance on the revolving credit facility at December 31, 2003. The note requires monthly payments of interest with the outstanding principal due at maturity. Principal amounts bear interest at LIBOR plus 300 basis points (4.125% at December 31, 2003).
(3) The Company's mortgage notes payable due February 1, 2005 is secured by three theatre properties, which had a net book value of approximately $38.7 million at December 31, 2003. The note requires monthly principal and interest payments of approximately $158 thousand with a final principal payment at maturity of approximately $18.7 million.
(4) The Company's mortgage notes payable due February 10, 2006 are secured by nine theatre properties, which had a net book value of approximately $184.3 million at December 31, 2003, and by $6.5 million in cash escrow deposits. The escrow deposits are recorded as restricted cash in the accompanying consolidated balance sheets at December 31, 2003 and 2002. The escrow deposits are required by the terms of the mortgage notes and are available to pay debt service on the mortgage notes if certain triggering events occur, or they may be applied to the principal amount at maturity. The note requires monthly principal and interest payments of approximately $1.1 million with a final principal payment at maturity of approximately $109.0 million.
(5) The Company's mortgage note payable due July 11, 2028 is secured by eight theatre properties, which had a net book value of approximately $142.4 million at December 31, 2003. The note requires monthly principal and interest payments of approximately $689 thousand. This mortgage agreement contains a "hyper-amortization" feature, in which the principal payment schedule is rapidly accelerated, and our principal payments are substantially increased, if we fail to pay the balance of approximately $89.9 million on the anticipated prepayment date of July 11, 2008.
(6) The Company's mortgage note payable due June 15, 2018 is secured by one theatre property, which had a net book value of approximately $22.3 million at December 31, 2003. The notes require monthly principal and interest payments of approximately $151 thousand with a final principal payment at maturity of approximately $0.8 million.
(7) The Company's mortgage notes payable due February 10, 2013 are secured by fourteen theatre properties, which had a net book value of approximately $230.6 million at December 31, 2003. The note requires monthly principal and interest payments of approximately $1.1 million with a final principal payment at maturity of approximately $99.2 million.
(8) The Company's mortgage note payable due September 1, 2013 is secured by one theatre property, which had a net book value of approximately $24.3 million at December 31, 2003. The note requires monthly principal and interest payments of approximately $98 thousand with a final principal payment at maturity of approximately $11.5 million.
(9) The Company's variable rate mortgage note payable due April 9, 2004 is secured by one theatre and
Entertainment Properties Trust Notes to Consolidated Financial Statements December 31, 2003, 2002, and 2001
retail mix property, which had a net book value of approximately $100.5 million at December 31, 2003. The note requires monthly payments of interest with the outstanding principal due at maturity. Principal amounts bear interest at LIBOR plus 250 basis points (3.625% at December 31, 2003). In February of 2004, the Company entered into an agreement to refinance this note payable (see note 17).
Certain of the Company's long-term debt agreements contain customary restrictive covenants related to financial and operating performance. At December 31, 2003, the Company was in compliance with all restrictive covenants.
Principal payments due on long term debt obligations subsequent to December 31, 2003 are as follows (in thousands):
The Company capitalizes a portion of interest costs as a component of land held for development. The following is a summary of interest costs during 2003, 2002 and 2001 (in thousands):
6. SHARE INCENTIVE PLAN
The Company maintains a Share Incentive Plan (the Plan) under which Common Shares and options to purchase up to 1,500,000 of the Company's Common Shares, subject to adjustment in the event of certain corporate events, may be granted. At December 31, 2003, there were 350,769 shares available for grant under the Plan.
SHARE OPTIONS
Share options granted under the Plan have exercise prices equal to the fair market value of a Common Share at the date of grant. The options may be granted for any reasonable term, not to exceed 10 years, and typically become exercisable at a rate of 20% per year over a five-year period. For Trustees, share options
Entertainment Properties Trust Notes to Consolidated Financial Statements December 31, 2003, 2002, and 2001
become exercisable at a rate of one-third per year over a three-year period. A summary of the Company's share option activity and related information is as follows:
The weighted average fair value of options granted was $.41, $.58, and $1.41 during 2003, 2002 and 2001, respectively.
The following table summarizes outstanding and exercisable options at December 31, 2003:
RESTRICTED SHARES
During 2003, 2002 and 2001, the Company issued 30,453, 37,275, and 37,336, respectively, restricted common shares for bonus compensation to executives and other employees of the Company. During 2003, 2002 and 2001, the Company also issued 24,027, 22,855 and 26,458, respectively, restricted common shares to executives under a long-term compensation plan. Based upon the market price of the Company's common shares on the grant dates, approximately $1.3 million, $1.2 million, and $860 thousand were recognized as non-vested shares issued in 2003, 2002 and 2001 respectively.
Entertainment Properties Trust Notes to Consolidated Financial Statements December 31, 2003, 2002, and 2001
The holders of these restricted shares have voting rights and are eligible to receive dividends from the date of grant. These shares vest over a period of three years for bonus compensation and five years for long-term compensation from the date of grant. The Company records compensation expense pertaining to these restricted shares ratably over the period of vesting. Total expenses related to the restricted shares recorded during 2003, 2002 and 2001 amounted to $926 thousand, $1.05 million, and $330 thousand, respectively. At December 31, 2003, there were 123,619 non-vested restricted shares issued and outstanding.
7. RELATED PARTY TRANSACTIONS
In 2000, the Company loaned an aggregate of $3.5 million to Company executives. The loans were made in order for the executives to purchase Common Shares of the Company at the market value of the shares on the date of the loan, as well as to repay borrowings on certain amounts previously loaned. The loans are recourse to the executive's assets and bear interest at 6.24%, are due on January 1, 2011 and interest is payable at maturity. These loans were issued with terms that include a Loan Forgiveness Program, under which the Compensation Committee of the Board of Trustees may forgive a portion of the above referenced indebtedness after application of proceeds from the sale of shares, following a change in control of the Company. The Compensation Committee may also forgive the debt incurred upon termination of employment by reason of death, disability, normal retirement or without cause. At December 31, 2003 and 2002, accrued interest receivable on these loans, included in other assets in the accompanying consolidated balance sheets, totaled $1.37 and $1.1 million, respectively.
8. EARNINGS PER SHARE
The following table sets forth the computation of the basic and diluted earnings per Common Share for the years ended December 31, 2003, 2002 and 2001 (amounts in thousands except per share information):
Entertainment Properties Trust Notes to Consolidated Financial Statements December 31, 2003, 2002, and 2001
9. DERIVATIVE FINANCIAL INSTRUMENTS
The Company holds one interest rate cap instrument with a notional amount of $10 million and a strike rate of 6.0% on three-month LIBOR which expires on December 20, 2004. The $6,500 cost of the rate cap is amortized over the life of the agreement. The fair value of the interest rate cap is immaterial to the Company's financial statements at December 31, 2003.
In 1998, the Company entered into a forward contract in connection with a mortgage note payable due July 2008 to essentially fix the base rate of interest on a notional amount of $105 million. The forward contract settled on June 29, 1998, the closing date of the long-term debt issuance, and the Company incurred a loss of $1.4 million, which is being amortized as an increase to interest expense over the ten year term of the long-term debt and will result in an effective interest rate of 6.84%. The remaining unamortized amount of $776 thousand and $947 thousand is included in other assets in the accompanying 2003 and 2002 consolidated balance sheets, respectively.
Entertainment Properties Trust Notes to Consolidated Financial Statements December 31, 2003, 2002, and 2001
10. COMPLETED PROPERTY ACQUISITIONS
The Company acquired a 71.4% ownership interest in New Roc Associates, LP ("New Roc") on October 27, 2003 in exchange for cash of $25 million. New Roc owns an entertainment retail center encompassing 446 thousand square feet located in New Rochelle, New York. The results of New Roc's operations have been included in the consolidated financial statements since the date of acquisition.
The fair value of New Roc's real property was approximately $105 million and New Roc had mortgage debt of $70 million at the date of acquisition. Other assets and liabilities of New Roc were insignificant. The net assets of New Roc have been recorded in the accompanying consolidated financial statements at their fair values to the extent of the Company's ownership interest in New Roc, and at carryover basis (predecessor cost) to the extent of the minority ownership interest retained by the former owner of New Roc. Rental property of $103.7 million and minority interest of $7 million were recorded by the Company in its consolidated financial statements at the date of acquisition.
The following unaudited pro forma result of operations reflects the Company's acquisition as if it had occurred on January 1, 2002:
In connection with the acquisition, the Company loaned $5 million to the minority partner in New Roc. That note is included in other assets, bears interest at 10% per year, matures on the earlier to occur of May 9, 2004 or the refinancing of the $66 million note (see note 17), and is secured by the minority partner's interest in the partnership. If the property achieves certain operating performance levels, the minority partner can, after two years, convert it's ownership interest to cash or Company Common Stock of approximately $10 million.
During 2003 and 2002, the Company acquired various other rental and development properties. Those acquisitions were recorded at the Company's cost of acquisition. Rental properties acquired generally consisted of properties subject to triple-net leases.
11. SHARE OFFERINGS
On September 23, 2003, the Company issued 2.4 million common shares in a registered public offering for net proceeds of $72.2 million. A portion of the proceeds were used to fund the acquisition of rental
Entertainment Properties Trust Notes to Consolidated Financial Statements December 31, 2003, 2002, and 2001
properties and land held for development.
12. FAIR VALUE OF FINANCIAL INSTRUMENTS
Management compares the carrying value and the estimated fair value of our financial instruments. The following methods and assumptions were used by the Company to estimate the fair value of each class of financial instruments at December 31, 2003 and 2002:
CASH AND CASH EQUIVALENTS:
Due to the highly liquid nature of our short term investments, the carrying value of our cash approximates the fair market value of our cash equivalents.
ACCOUNTS RECEIVABLE:
The carrying value of our accounts receivable approximates the fair market value due to the short term maturities of these amounts.
DEBT INSTRUMENTS:
The fair value of the Company's debt as of December 31, 2003, 2002 and 2001 is estimated by discounting the future cash flows of each instrument using current market rates. At December 31, 2003, the Company had a carrying value of $86 million in variable rate debt outstanding, which management believes represents fair value. At December 31, 2003, the Company had a carrying value of $420.55 million in fixed rate long-term debt outstanding with an average weighted interest rate of approximately 6.6%. Discounting the future cash flows for fixed rate debt using a 6% rate, or a change of 0.6 percentage points, management estimates that the fixed rate debt would have a fair value of approximately $425.3 million at December 31, 2003.
At December 31, 2002 the Company had a carrying value of $255.6 million in fixed rate long-term debt outstanding with an average weighted interest rate of approximately 7.5%. Discounting the future cash flows for fixed rate debt using a 6% rate, management estimates that the fixed rate debt would have had a fair value of approximately $270.0 million at December 31, 2002.
ACCOUNTS PAYABLE AND ACCRUED LIABILITIES:
The carrying value of accounts payable and accrued liabilities approximates fair value due to the short term maturities of these amounts.
13. OPERATING LEASES
The Company leases its executive office from a third party landlord through December, 2009. Rental expense for this lease totaled approximately $137 thousand, $114 thousand, and $111 thousand in 2003, 2002 and 2001, respectively, and is included as a component of general and administrative expense in the accompanying consolidated statements of income. Future minimum lease payments under this lease at December 31, 2003 are (in thousands):
Entertainment Properties Trust Notes to Consolidated Financial Statements December 31, 2003, 2002, and 2001
14. QUARTERLY FINANCIAL INFORMATION (unaudited)
Summarized quarterly financial data for the years ended December 31, 2003 and 2002 are as follows (in thousands, except per share data):
Entertainment Properties Trust Notes to Consolidated Financial Statements December 31, 2003, 2002, and 2001
15. DIVIDENDS
COMMON SHARES
The Board of Trustees declared cash dividends totaling $2.00 per Common Share for the year ended December 31, 2003 and $1.90 per Common Share for the year ended December 31, 2002.
Of the total dividends calculated for tax purposes, the amounts characterized as ordinary income, return of capital and capital gain for 2003 and 2002 are as follows:
Cash dividends paid per Common Share for the year ended December 31, 2003:
Cash dividends paid per Common Share for the year ended December 31, 2002:
PREFERRED SHARES
On May 29, 2002, the Company issued 2.3 million 9.5% Series A cumulative Preferred Shares in a registered public offering. The Board of Trustees declared cash dividends totaling $2.375 and $0.80855 per Preferred Share for the years ended December 31, 2003 and December 31, 2002, respectively.
Of the total dividends calculated for tax purposes, the amounts characterized as ordinary income, return of capital and capital gain for 2003 and 2002 are as follows:
Entertainment Properties Trust Notes to Consolidated Financial Statements December 31, 2003, 2002, and 2001
Cash dividends paid per Preferred Share for the year ended December 31, 2003:
Cash dividends paid per Preferred Share for the Year ended December 31, 2002:
16. SUBSEQUENT DEVELOPMENTS
On February 3, 2004, the Company announced a pending acquisition of four Canadian entertainment and retail centers, anchored by movie theatres, with a value in Canadian dollars of approximately C$200 million (approximately US$152 million). In connection with those acquisitions, the Company will issue common shares to the sellers with an aggregate value in Canadian dollars of C$36 million (approximately US$27 million). Also in connection with those acquisitions, the Company has obtained Canadian dollar denominated loan commitments which total approximately C$128.6 million (approximately US$97 million). The acquisitions are expected to close in connection with the funding of those loan commitments during the first quarter of 2004.
In February of 2004, the Company entered into an agreement to refinance the $66 million in variable rate debt, which matures in 2003 and is secured by the New Roc property. The refinancing is expected to be completed in March 2004. The new debt will have a ten year term and its interest will be fixed at a rate of 5.68%.
Entertainment Properties Trust Notes to Consolidated Financial Statements December 31, 2003, 2002, and 2001
17. COMMITMENTS AND CONTINGENCIES
As of December 31, 2003, the Company had five theatre projects under construction. These theatres will have a total of 86 screens and their development costs will be approximately $66 million. The Company has already purchased the development land for $16.3 million as of December 31, 2003, and plans to fund the remaining estimated development costs of these properties through new debt facilities and additional equity. The cost of development is paid by the Company either in periodic draws or upon successful completion of construction. If management of the Company determines the construction is not being completed per the executed development agreement, the Company can discontinue funding of periodic draws or refuse to purchase the completed theatre. Upon successful completion of construction, the Company will lease these theatres to already established theatre operators for approximately $7.6 million in annual rentals.
The Company and wholly-owned subsidiary, EPT Gulf States, LLC ("Gulf States") issued preferred interest in connection with the acquisition of certain rental properties by Gulf States in 2002. Those preferred interests earn annual dividends of 10%, are presented in minority interests in the accompanying consolidated balance sheets, and are convertible into 857,142 Common Shares of the Company.
ENTERTAINMENT PROPERTIES TRUST
Schedule III - Real Estate and Accumulated Depreciation
December 31, 2003
ENTERTAINMENT PROPERTIES TRUST
Continued Schedule III - Real Estate and Accumulated Depreciation
December 31, 2003
ENTERTAINMENT PROPERTIES TRUST
Schedule III - Real Estate and Accumulated Depreciation
December 31, 2002
ENTERTAINMENT PROPERTIES TRUST
Schedule III - Real Estate and Accumulated Depreciation (continued) Reconciliation
December 31, 2003
See accompanying independent auditor's report.
ENTERTAINMENT PROPERTIES TRUST
Schedule III - Real Estate and Accumulated Depreciation (continued) Reconciliation
December 31, 2002
See accompanying independent auditor's report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
The Company previously reported a change in certifying accountants for 2002 in its current report on Form 8-K filed on April 12, 2002.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
A review and evaluation was performed by the Company's management, including the Company's Chief Executive Officer (the "CEO") and Chief Financial Officer (the "CFO"), of the effectiveness of the design and operation of the Company's disclosure controls and procedures as of the end of the period covered by this annual report. Based on that review and evaluation, the CEO and CFO have concluded that the Company's current disclosure controls and procedures, as designed and implemented, were effective. There have been no significant changes in the Company's internal controls subsequent to the date of their evaluation. There were no significant material weaknesses identified in the course of such review and evaluation and, therefore, no corrective measures were taken by the Company.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The Company's definitive Proxy Statement for its Annual Meeting of Shareholders to be held on May 12, 2004 (the "Proxy Statement"), contains under the captions "Election of Trustees", "Officers", and "Section 16(a) Beneficial Ownership Reporting Compliance" the information required by Item 10 of this Form 10-K, which information is incorporated herein by this reference.
We have adopted a Code of Business Conduct and Ethics that applies to our Chief Executive Officer, Chief Financial Officer, and all other officers, employees and trustees. A copy of the Code may be viewed on our website at www.eprkc.com.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The Proxy Statement contains under the captions "Election of Trustees -- Compensation of Trustees", "Executive Compensation", "Compensation Committee", and "Company Performance" the information required by Item 11 of this Form 10-K, which information is incorporated herein by this reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The Proxy Statement contains under the captions "Share Ownership" and "Equity Compensation Plan Information" the information required by Item 12 of this Form 10-K, which information is incorporated herein by this reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Proxy Statement contains under the caption "Transactions Between the Company and Trustees, Officers or their Affiliates" the information required by Item 13 of this Form 10-K, which information is incorporated herein by this reference.
PART IV
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The Proxy Statement contains under the caption "Ratification of Appointment of Independent Auditors" the information required by Item 14 of this Form 10-K, which information is incorporated herein by this reference.
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Exhibits, Financial Statements and Financial Statement Schedules:
Financial Statements:
Reports of Independent Auditors
Consolidated Balance Sheets as of December 31, 2003 and 2002.
Consolidated Statements of Income for the years ended December 31, 2003, 2002 and 2001.
Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 2003, 2002 and 2001.
Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002, and 2001.
Notes to Consolidated Financial Statements
(b) Reports on Form 8-K:
Form 8-K filed October 23, 2003 in connection with the release of the Company's earnings for the quarter ended September 30, 2003
Form 8-K filed November 12, 2003 announcing the acquisition of interest in New Roc Associates, LP, which occurred on October 27, 2003, and as amended by Form 8-K/A on January 12, 2004.
(c) Exhibits
21 Subsidiaries of the Company
23.1 Consent of KPMG LLP
23.2 Consent of Ernst & Young LLP
31 Certifications pursuant to Section 302 of the Sarbanes-Oxley Act
32 Certifications furnished pursuant to Section 906 of the Sarbanes-Oxley Act.
(d) Financial Statement Schedules
Schedule III - Real Estate and Accumulated Depreciation
No other schedules meet the requirement for disclosure.
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.
ENTERTAINMENT PROPERTIES TRUST
Dated: March 5, 2004 By /s/ David M. Brain ------------------------------------------- David M. Brain, President - Chief Executive Officer
Dated: March 5, 2004 By /s/ Fred L. Kennon ------------------------------------------- Fred L. Kennon, Vice President - Chief Financial Officer Treasurer and Controller
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 dates indicated:
EXHIBIT INDEX