Item 4. Submission of Matters to a Vote of Security Holders.
We did not submit any matters to a vote of our security holders during the fiscal quarter ended December 31, 2003.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters
Market for Our Common Stock
Our common stock began regular trading on the New York Stock Exchange under the symbol “TRZ” on May 8, 2002, the effective date of the corporate reorganization. Prior to that time, there was no public market for our common stock. As of March 5, 2004, there were approximately 312 holders of record of our common stock. This does not include beneficial owners of our common stock whose shares are held in “street name” with a broker. The following table shows the high and low sale prices per share of our common stock as reported on the New York Stock Exchange, as well as dividends declared on our common stock, for the periods indicated:
Dividend Policy
Our policy is to make distributions to the holders of our common stock in an amount that is at least equal to the minimum amount required to maintain REIT status each year through regular dividends.
Under our existing credit facility, we are restricted from paying dividends or distributions that would exceed 90% of our funds from operations (as defined in the revolving credit facility agreement), except as necessary to maintain our REIT status.
Use of Proceeds
On May 8, 2002, we commenced an offering of up to 8,700,000 shares of our common stock that holders of our warrants may acquire upon exercise thereof. The warrants were issued in connection with the corporate reorganization to (1) certain holders of then outstanding TrizecHahn Corporation stock options in replacement of such options and (2) TrizecHahn Office Properties Ltd., an indirect, wholly owned subsidiary of Trizec Canada, in an amount sufficient to allow TrizecHahn Office Properties Ltd. to purchase one share of our common stock for each Trizec Canada stock option granted in the corporate reorganization.
The shares of common stock to be sold in the offering were registered under the Securities Act of 1933, as amended, on a Registration Statement on Form S-11 (Registration No. 333-84878) that was declared effective by the Securities and Exchange Commission on May 2, 2002. The Registration Statement was amended by a Post-Effective Amendment No. 1 to Form S-11 on Form S-3 (Registration No. 333-84878), which was declared effective on October 21, 2003. The shares of common stock are being offered on a continuing basis pursuant to Rule 415 under the Securities Act of 1933, as amended. We did not engage an underwriter for the offering and the aggregate price of the offering amount registered was $143,115,000.
During the period from May 8, 2002 to December 31, 2003, 936,656 shares of our common stock registered under the Registration Statement were acquired pursuant to the exercise of warrants. All of the shares of common stock were issued or sold by us and there were no selling stockholders in the offering.
During the period from May 8, 2002 to December 31, 2003, the aggregate net proceeds from the shares of common stock issued or sold by us pursuant to the offering upon exercise of the warrants were approximately $834,649. There have been no expenses incurred in connection with the offering to date. These proceeds were used for general corporate purposes.
None of the proceeds from the offering were paid, directly or indirectly, to any of our officers or directors or any of their associates, or to any persons owning ten percent or more of our outstanding common stock or to any of our affiliates.
Item 6.
Item 6. Selected Financial Data
The following financial data are derived from our audited consolidated financial statements. The financial data set forth below should be read in conjunction with “Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
In Item 7, the terms “we”, “us”, “our” and “our company” refer to Trizec Properties, Inc. as of December 31, 2003 and 2002 and for the year ended December 31, 2003 and to the combined operations of all of the former U.S. holdings of our former parent company, TrizecHahn Corporation (currently an indirect, wholly-owned subsidiary of Trizec Canada), substantially all of which are owned and operated by Trizec Properties, Inc., Trizec R & E Holdings, Inc. (formerly known as TrizecHahn Developments Inc.) and their respective consolidated subsidiaries for the years ended December 31, 2002 and 2001. On March 14, 2002, Trizec R & E Holdings, Inc. was contributed to Trizec Properties, Inc.
The following discussion should be read in conjunction with “Forward-Looking Statements” and the combined consolidated financial statements and the notes thereto that appear elsewhere in this Form 10-K. The following discussion may contain forward-looking statements within the meaning of the securities laws. Actual results could differ materially from those projected in such statements as a result of certain factors set forth in this Form 10-K for the year ended December 31, 2003.
Overview
We are one of the largest owners and managers of commercial property in the United States, with 64 office properties totaling approximately 42.5 million square feet.
Our office properties are concentrated primarily in seven U.S. markets - Atlanta, Chicago, Dallas, Houston, Los Angeles, New York and Washington, D.C. Our properties in these “core markets” comprise more than 80 percent of our portfolio and the majority of our portfolio is located in central business districts.
We were launched as a publicly traded U.S. office REIT in May 2002, as part of the reorganization of Canadian-based TrizecHahn Corporation. Concurrent with the reorganization, Trizec Canada Inc., a Canadian company that holds a 40 percent stake in us, was established. This ownership structure enables non-U.S. investors to invest in us through Trizec Canada.
Our overall goal is to increase stockholder value by creating sustained growth in operating cash flow and by maximizing the value of our assets. We believe we can accomplish this using the following strategies:
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intensively leasing and managing our properties to maximize property operations;
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vigorously engaging in asset management to enhance the value of our properties;
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actively managing our portfolio to maximize total value of our properties;
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improving the efficiency and productivity of our operations; and
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maintaining a prudent and flexible capital plan.
By intensively leasing and managing our properties, we seek to maximize property operations by increasing occupancy, achieving the highest possible rent levels, controlling operating and tenant improvements costs, and profiting from the delivery of certain tenant services.
Our asset management strategy is to invest capital in our existing portfolio to increase its value and marketability. We engage in such activities as renovating and upgrading office properties.
Job growth is the single most significant factor in the demand for more office space, and has a direct impact on our ability to do business profitably. Therefore, our portfolio strategy is to invest in office properties primarily in major metropolitan areas - and submarkets within those markets - that have historically demonstrated high job growth. As we continue to review emerging job trends and other economic trends, market-by-market, we believe we are positioned to reduce or increase our presence in some markets, and enter others that we believe have strong long-term potential. While we are focused on investing in office properties in a relatively small number of core markets, we maintain a national presence that we believe helps to insulate us from regional economic downturns and we maintain a diverse tenant base that reduces the impact of cyclical downturns in particular industries.
The careful control of property operating expenses, as well as general and administrative expenses, are key components in our efforts to maximize operating cash flow. Following our launch in 2002, we centralized several corporate functions. We continue to seek ways to generate general and administrative expense savings over time.
We seek to maximize our cash flow growth, and therefore maximize the return on our capital. In keeping with that, our capital strategy is to effectively manage both our cash on hand and line(s) of credit, employ an appropriate degree of leverage, and limit our exposure to interest rate volatility by obtaining fixed-rate debt and employing hedging strategies.
In the past, we have raised capital through a variety of methods in addition to obtaining secured debt. These methods have included selling assets or entering into joint ventures or partnerships with equity providers. We may employ any of these methods in the future, along with other strategies, such as issuing equity securities and unsecured debt.
2003 Accomplishments
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In anticipation of becoming a “pure” office REIT by early 2004, we sold two of our remaining non-office properties for amounts higher than their book values.
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We exited three non-core markets (Detroit, Memphis and West Palm Beach), along with the Los Angeles Airport submarket, and reduced our presence in Minneapolis. We selectively sold properties in our core markets that no longer meet our investment criteria.
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We avoided taking $766 million of debt onto our balance sheet by selling our interests in Sears Tower.
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We increased our liquidity to approximately $350 million.
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We reduced our outstanding debt, including our pro-rata share from unconsolidated real estate joint ventures, by nearly $600 million - a decrease from 73 percent of our total market capitalization to 57 percent.
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We reduced our exposure to variable rate debt by two-thirds - down to 12 percent of our overall debt, including our pro-rata share from unconsolidated real estate joint ventures.
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We leased 6.9 million square feet of space in our properties and finished the year at 86.6 percent occupancy, which was at the higher end of the range projected at the start of the year.
Current Economic Conditions and Outlook
As indicated above, job growth has a significant and direct impact on our business. We therefore look to indications of economic growth, and by correlation, resulting job growth, in developing our current strategies and future outlook. Strong economic growth in the second half of 2003 offered hope that a sustained economic recovery is indeed taking hold. Corporate profits, as measured by the constituents of the S&P 500, generated the strongest earnings growth in years during the latter half of 2003, and it is anticipated this will translate into more broad based job growth in the coming years.
In the real estate market in particular, we examine such indicators as vacancy rates, including sublease space availability and office construction. According to Cushman & Wakefield (C&W), the national office market hit a cyclical bottom at the end of 2003 with overall vacancy rates in both the Central Business Districts (CBD) and Suburban markets showing a decline for the first time since late 2000. C&W expects national overall vacancy to decline to 14.3% and 19.7% for the CBD and Suburbs, respectively, in 2004 from 15.2% and 20.8% at the end of 2003. In addition, the amount of sublease space continued to decline from the highs of mid-2002, leasing activity has been consistent for seven consecutive quarters and both direct and overall absorption showed a dramatic increase during the last quarter of 2003. Another positive sign is that the national construction pipeline has decreased substantially. According to C&W, 2003 witnessed the lowest amount of construction deliveries since 1997 at only 27.5 million square feet. Of the 35 million square feet currently under construction, only 23 million square feet is scheduled to be delivered in 2004.
We note, however, that some economic indicators such as consumer confidence have tempered somewhat in early 2004, reminding us that a stance of cautious optimism remains prudent. Therefore, while we hope that economic growth will translate into employment growth, and in particular office-using employment, we are cautious that there will not be a material amount of jobs created in 2004 in time to produce demand for office space. Furthermore, we believe that material growth in occupancies, and in particular rental rates, is more likely in 2005 and beyond rather than 2004 as landlords continue to offer aggressive leasing packages in many markets.
Risks
We face risks normally associated with the ownership and operation of office real estate properties. These include, but are not limited to, those set forth under “Risk Factors - Risks Relating to Our Business,” in Part I of this Form 10-K.
In addition, among the perceived risks we and our stockholders face are those set forth under “Risk Factors - Risks Relating to Our Capital Stock,” in Part I of this Form 10-K.
Critical Accounting Policies
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements. The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual amounts will differ from those estimates used in the preparation of these financial statements.
Critical accounting policies are defined as those that involve significant judgment and potentially could result in materially different results under different assumptions and conditions. We believe the following critical accounting policies are affected by our more significant judgments and estimates used in the preparation of our consolidated financial statements. For a detailed description of these and other accounting policies, see Note 2 in the notes to our consolidated financial statements included in this Form 10-K.
Real Estate - Held for the Long Term
We evaluate the recoverability of our real estate assets held for the long term and record an impairment charge when there is an indicator of impairment and the undiscounted projected cash flows of the property are less than the carrying amount. A significant, sustained decline in operating results for a particular property could be an indicator of impairment and therefore require a charge to income in the future.
Real Estate - Held for Disposition
With respect to real estate assets classified as held for disposition, the determination of such classification is based on our intention and ability to sell these properties within a stated timeframe. Real estate assets held for disposition are carried at the lower of their carrying values or estimated fair value, less costs to sell. Estimated fair value is determined based on management’s estimates of amounts that would be realized if the property were offered for sale in the ordinary course of business assuming a reasonable sales period and under normal market conditions. Fair values are determined using valuation techniques including third party appraisals when considered appropriate in the circumstances. Estimates of value include assumptions concerning future property cash flows, disposal dates and expected purchaser risk adjusted rates of return requirements. Different assumptions could result in significantly higher or lower estimates of fair value than those determined by management. In addition, changes in future market conditions could result in ultimate sale proceeds varying significantly from those assumed by management, resulting in future gains or losses being recorded.
Investments in Joint Ventures
We apply the equity method of accounting to joint ventures in which we do not have a controlling direct or indirect voting interest, but can exercise influence over the entity with respect to its operations and major decisions. These investments are recorded initially at cost, as investments in unconsolidated real estate joint ventures, and are
subsequently adjusted for equity in earnings and cash contributions and distributions. The joint venture agreements may designate different percentage allocations among the venturers for income and losses; however, our recognition of joint venture income or loss generally follows the distribution priorities. Any difference between the carrying amount of these investments on our balance sheet and the underlying equity in net assets is amortized as an adjustment to equity in earnings of unconsolidated joint ventures over the respective lives of the underlying assets, as applicable. Under the equity method of accounting, the net equity investment is reflected on our consolidated balance sheets, and our share of net income or loss from the joint ventures is included on our consolidated statements of operations.
We also consolidate joint ventures in which we own less than a 100% equity interest if we are deemed to be the primary beneficiary in such variable interest entities, as defined in the Financial Accounting Standards Board Interpretation No. 46, “Consolidation of Variable Interest Entities” (hereinafter defined).
Deferred Charges
We capitalize a portion of our internal costs related to our leasing activities. These costs generally include compensation and related costs. The portion capitalized is based on an estimate of time spent on successful leasing efforts.
Revenue Recognition
Estimates are used to establish amounts receivable from tenants for such things as common area maintenance, real estate taxes and other cost recoveries. In addition, an estimate is made with respect to our provision for allowance for doubtful accounts receivable. The allowance for doubtful accounts reflects our estimate of the amounts of the recorded accounts receivable at the balance sheet date that will not be realized from cash receipts in subsequent periods. If cash receipts in subsequent periods vary from our estimates, or if our tenants’ financial condition deteriorates as a result of operating difficulties, additional changes to the allowance may be required.
Fair Value of Financial Instruments
We are required to determine quarterly the fair value of our mortgage debt and unsecured notes. We are also required quarterly to adjust the carrying value of interest rate swaps and caps, as well as the underlying hedged liability, to its fair value. In determining the fair value of these financial instruments, we use third party quotations and internally developed models that are based on current market conditions. For example, in determining the fair value of our mortgage debt and unsecured notes, we discount the spread between the future contractual interest payments and the projected future interest payments based on a current market rate. In determining the current market rate, we add a market spread to the quoted yields on federal government debt securities with similar maturity dates to our own debt. The market spread estimate is based on our historical experience in obtaining either secured or unsecured financing and also is affected by current market conditions. In determining the fair value of interest rate swaps and caps, we rely on third party quotations to adjust the value of these instruments, as well as the hedged liability, to its fair value. Because our valuations of our financial instruments are based on these types of estimates, the fair value of our financial instruments may change if our estimates do not turn out to be accurate.
Income Taxes
Historically, prior to electing REIT status, as part of the process of preparing our consolidated financial statements we estimated our income tax expense and required liabilities. This process required us to estimate our tax expense taking into consideration our tax planning strategies. We used our judgment to determine our estimated tax liability, and ultimate liabilities for income taxes could be different from the amounts recorded.
Results of Operations
The following discussion is based on our consolidated financial statements for the years ended December 31, 2003, 2002 and 2001.
For the year ended December 31, 2002, the consolidated financial statements present TrizecHahn Corporation’s former U.S. holdings for the period January 1, 2002 through May 8, 2002, which are now owned and operated by us. For the year ended December 31, 2001, the consolidated financial statements present TrizecHahn Corporation’s former U.S. holdings for the period January 1, 2001 through December 31, 2001, which are now owned and operated by us. Prior to the corporate reorganization, we, along with our subsidiary Trizec R & E Holding Inc., or TREHI, (formerly known as TrizecHahn Developments Inc., which became our subsidiary on March 14, 2002), were TrizecHahn Corporation’s two primary U.S. operating and development companies. The combined entities and their subsidiaries were under the common control of TrizecHahn Corporation and have been presented utilizing the historical cost basis of TrizecHahn Corporation. For additional information about the corporate reorganization, see “Part I - Item 1. Business” in this Form 10-K.
We have had acquisition, disposition and development activity in our property portfolio in the periods presented. The table that follows is a summary of our acquisition and disposition activity from January 1, 2001 to December 31, 2003 and reflects our total portfolio at December 31, 2003. The buildings and total square feet shown include properties that we own in joint ventures with other partners and reflect the total square footage of the properties and the square footage owned by us based on our pro rata economic and legal ownership in the respective joint ventures or managed properties.
In the financial information that follows, property revenues include rental income, recoveries from tenants, parking and other income. Property operating expenses include costs that are recoverable from our tenants (including but not limited to real estate taxes, utilities, insurance, repairs and maintenance and cleaning) and other non-recoverable property-related expenses and exclude depreciation and amortization expense.
Comparison of Year Ended December 31, 2003 to Year Ended December 31,
The following is a table comparing our summarized operating results for the periods, including other selected information.
Property Revenue
Office property revenues increased by approximately $0.4 million for the year ended December 31, 2003 compared to the year ended December 31, 2002. Office property revenues increased by approximately $14.8 million due to acquiring the remaining 75% interest in Ernst & Young Plaza in Los Angeles, California that we did not already own and by approximately $3.5 million due to the acquisition of 151 Front Street in Toronto, Ontario. Office property revenues increased by approximately $6.3 million primarily due to new leasing in One Alliance Center in Atlanta, Georgia. In addition, management fee income increased by approximately $0.9 million for the year ended December 31, 2003 as compared to the year ended December 31, 2002. These increases were partially offset by a decrease of approximately $25.1 million due primarily to a decrease in average occupancy and average rental rates for the year ended December 31, 2003 as compared to the year ended December 31, 2002.
Lease termination fees are an element of ongoing real estate ownership. Included in the office property revenue analysis above, for the year ended December 31, 2003, we recorded approximately $5.6 million of termination fees for our office portfolio compared to approximately $6.2 million for the year ended December 31, 2002.
Retail property revenues decreased by approximately $25.3 million for the year ended December 31, 2003 compared to the year ended December 31, 2002. Approximately $16.4 million of the decrease resulted from the sale of Paseo Colorado in Pasadena, California in the first quarter of 2003. Approximately $5.9 million of the decrease primarily resulted from a decrease in average rental rates for the year ended December 31, 2003 compared to the year ended December 31, 2002. In addition, approximately $3.0 million of the decrease is due to the write-off of straight-line rent receivables related to vacated tenants at Hollywood & Highland.
Included in the retail property revenue analysis above, for the year ended December 31, 2003, we recorded approximately $0.4 million of lease termination fees for our retail portfolio compared to approximately $0.2 million for the year ended December 31, 2002.
Property Operating Expense
Office property operating expenses increased by approximately $13.8 million in the year ended December 31, 2003 compared to the year ended December 31, 2002. Office property expenses increased by approximately $8.5 million due to the office property acquisitions described above, approximately $3.0 million due to new leasing in One Alliance Center in Atlanta, Georgia, approximately $8.8 million due to an increase in insurance cost, approximately $1.9 million due to an increase in bad debt expense, and approximately $0.5 million due to an increase in real estate tax expense for the year ended December 31, 2003 compared to the year ended December 31, 2002. These increases were partially offset by a decrease in property operating expenses of approximately $8.9 million due to decreases in cleaning expenses, utilities expense, and repairs and maintenance expenses for the year ended December 31, 2003 compared to the year ended December 31, 2002.
Excluding the impact of lease termination fees on revenues, our office portfolio gross margin (property revenues, excluding lease termination fees, less property operating expenses) decreased to 53.6% for the year ended December 31, 2003 from 55.2% for the year ended December 31, 2002, reflecting our increased operating expenses.
Retail property operating expenses decreased by approximately $6.5 million for the year ended December 31, 2003 compared to the year ended December 31, 2002. Approximately $5.1 million of this decrease is due primarily to the sale of Paseo Colorado in Pasadena, California during the first quarter of 2003. Additionally, approximately $2.8 million of the decrease is due primarily to decreases in utilities expense, bad debt expense, and real estate taxes for the year ended December 31, 2003 compared to the year ended December 31, 2002. These decreases were partially offset by an increase in operating expenses of approximately $1.4 million due to increases in repairs and maintenance and insurance expense for the year ended December 31, 2003 compared to the year ended December 31, 2002.
General and Administrative Expense, Exclusive of Stock Option Grant Expense
General and administrative expense includes expenses for corporate and portfolio asset management functions. Expenses for property management and fee-based services are recorded as property operating expenses.
General and administrative expense decreased by approximately $5.6 million for the year ended December 31, 2003 compared to the year ended December 31, 2002. The decrease is due primarily to separation costs incurred and professional fees paid in connection with the corporate reorganization during the year ended December 31, 2002, offset by additional expense related to the net settlement of warrants during the year ended December 31, 2003.
Depreciation and Amortization
Depreciation expense increased by approximately $10.9 million for the year ended December 31, 2003 compared to the year ended December 31, 2002. The completion of two office development projects and the reclassification of retail properties from held for sale to held for the long term increased depreciation expense by approximately $8.0 million. The increase in ownership of the Ernst & Young Plaza resulted in an increase in depreciation expense of approximately $6.5 million. This increase is partially offset due to less accelerated depreciation of tenant improvements related to the early termination of leases for the year ended December 31, 2003 compared to the year ended December 31, 2002.
Stock Option Grant Expense
Stock option grant expense decreased by approximately $4.2 million for the year ended December 31, 2003 compared to the year ended December 31, 2002. This decrease is due primarily to accelerated expense for employees separated from the company during the year ended December 31, 2002. This non-cash cost incurred during the year ended December 31, 2002 relates to the intrinsic value, at the date of grant, of stock options granted upon the completion of the corporate reorganization. This decrease is partially offset by additional stock option expense related to adoption of Statement of Financial Accounting Standards No. 123, “Accounting for Stock Based Compensation” (“SFAS No. 123”) for stock options issued in 2003. This non-cash cost incurred during the year ended December 31, 2003 relates to the fair value, at the date of grant, of stock options granted during 2003.
Reorganization Recovery
During the year ended December 31, 2001, we recorded as reorganization costs a charge of approximately $15.9 million to provide for employee severance, benefits and other costs associated with implementing the reorganization plan. As a result of the completion of the reorganization and centralization, during the fourth quarter of 2002, we reviewed the remaining liability based on future estimated expenditures and, accordingly, have reduced our accrual for anticipated expenditures by approximately $3.3 million.
Provision for Loss on Real Estate
During the year ended December 31, 2002, we recorded a provision for loss on real estate in the amount of approximately $142.4 million for Hollywood & Highland to reduce the carrying value of the property to fair value. Fair value was based on internal valuations.
Loss on and Provision for Loss on Investment
During the year ended December 31, 2003, we recorded a loss on investment of approximately $15.5 million related to the sale of our interest in a subordinated mortgage collateralized by the Sears Tower in Chicago, Illinois.
During the year ended December 31, 2002, we determined that our investment in the subordinated mortgage collateralized by the Sears Tower was impaired. We estimated that the fair value of the Sears Tower was insufficient to cover encumbrances senior to our position and the entire carrying value of our investment.
Accordingly, we recorded a provision for loss on investment of approximately $48.3 million in the third quarter of 2002 to reduce the carrying value of our investment in the Sears Tower to its estimated fair value of approximately $23.6 million.
On December 5, 2002, we sold our interest in Chelsfield plc for approximately $76.6 million and recognized a loss on investment of approximately $12.7 million.
Interest and Other Income
Interest and other income increased by approximately $1.1 million for the year ended December 31, 2003 compared to the year ended December 31, 2002. Interest and other income increased by approximately $1.2 million due to death benefit proceeds received on an insurance policy, approximately $1.3 million due to a litigation refund and approximately $1.0 million due to dividends received in 2003 on the Chelsfield plc investment. These increases were partially offset by a decrease in interest income due primarily to lower average cash balances outstanding for the year ended December 31, 2003 compared to the year ended December 31, 2002.
Interest Expense
Interest expense decreased by approximately $4.1 million for the year ended December 31, 2003 compared to the year ended December 31, 2002. The impact of the disposal of Paseo Colorado in Pasadena, California decreased interest expense by approximately $3.4 million. Lower average debt balances outstanding due to regular principal amortization and lump sum repayments decreased interest expense by approximately $2.8 million. A lower outstanding balance on our $350 million revolving line of credit and associated standby fees resulted in a decrease in interest expense of approximately $3.4 million. These decreases were partially offset by the impact of office property acquisitions, primarily the increase in ownership of the Ernst & Young Plaza, resulting in an increase in interest expense of approximately $3.4 million. Additionally, the cessation of interest capitalization on our development projects resulted in an increase in interest expense of approximately $2.1 million for the year ended December 31, 2003 as compared to the year ended December 31, 2002.
Gain on Early Debt Retirement
During the year ended December 31, 2003, we recorded an approximately $2.3 million gain on early debt retirement. We recorded an approximately $3.6 million gain on early debt retirement related to the forgiveness of a $17.9 million construction facility on our remaining technology property. On June 30, 2003, we conveyed title of our remaining technology property to the lender and are no longer obligated to the lender under the $17.9 million construction facility. The $3.6 million gain on early debt retirement is net of approximately $0.5 million remitted to the lender in full satisfaction of any exposure related to the construction facility. This gain on early debt retirement is partially offset by the write-off of deferred financing costs as a result of the repayment of secured mortgages coinciding with the sale of the underlying properties of approximately $1.3 million.
Gain on Lawsuit Settlement
In July 2003, we reached an agreement in which we agreed to end litigation and resolve standing disputes concerning the development and subsequent bankruptcy of the hotel and casino adjacent to our Desert Passage project. In exchange for our agreement to end the development litigation and our agreement to permit and assist in the re-theming of the hotel and casino complex, the other parties to the litigation have agreed to dismiss all claims against us. In the third quarter of 2003, we recognized a gain on lawsuit settlement of approximately $26.7 million comprised primarily of the forgiveness of debt. We did not receive any cash proceeds from the litigation settlement.
Recovery on Insurance Claims
Beginning in late 2001 and during 2002, we replaced a chiller at One New York Plaza in New York that was damaged in 2001, and we expect total remediation and improvement costs will be approximately $19.0 million. During the year ended December 31, 2003, we received approximately $7.0 million in insurance proceeds related to
this chiller. During the year ended December 31, 2002, we received approximately $3.8 million in insurance proceeds related to this chiller. In 2001, we received approximately $1.2 million in insurance proceeds related to this chiller, which approximated the net book value of the chiller. We are preparing to file a claim for additional proceeds; however, we cannot assure you that we will be successful with such an effort.
Benefit (Provision) for Income and Other Corporate Taxes, Net
Income and other taxes includes franchise, capital, alternative minimum and foreign taxes related to ongoing real estate operations. Income and other taxes has decreased by approximately $46.7 million for the year ended December 31, 2003 compared to the year ended December 31, 2002, primarily due to the tax impact of the disposition of our investment in the Sears Tower in Chicago, Illinois of approximately $12.0 million, a tax settlement which resulted in a decrease of approximately $21.0 million, and the liquidation of the Hollywood TRS subsidiary which resulted in a decrease of approximately $13.5 million.
Minority Interest
Minority interest income decreased by approximately $3.4 million for the year ended December 31, 2003 compared to the year ended December 31, 2002. The decrease is due to an increase in the redemption value in the TrizecHahn Mid-Atlantic Limited Partnership redeemable units.
Income from Unconsolidated Real Estate Joint Ventures
Income from unconsolidated real estate joint ventures increased by approximately $71.0 million for the year ended December 31, 2003 compared to the year ended December 31, 2002. Approximately $38.8 million of the increase is due to the recognition of a provision for loss on investment in real estate during the year ended December 31, 2002 related to the Hollywood & Highland Hotel in Los Angeles, California and a provision for loss on investment in real estate in New Center One in Detroit, Michigan for approximately $20.1 million. Approximately $3.0 million of the increase is due to the gain on sale of real estate and a gain on early debt retirement from the sale of New Center One during the year ended December 31, 2003. In addition, income from unconsolidated real estate joint ventures increased due primarily to an increase in average rental rates in the New York market, partially offset by an increase in the net loss at the Bank One Center in Dallas, Texas.
Discontinued Operations
Income from properties classified as discontinued operations decreased during the year ended December 31, 2003 due to the disposition of several properties in 2003, which had a partial year of operations during the year ended December 31, 2003 and a full year of operations during the same period in 2002.
During the year ended December 31, 2003, we recognized a gain on disposition of discontinued real estate of approximately $58.8 million, net of the related tax effect, due to the sales of Goddard Corporate Park in Lanham, Maryland; Rosslyn Gateway in Arlington, Virginia; Clark Tower in Memphis, Tennessee; Esperante Office Building in West Palm Beach, Florida; Minnesota Center in Minneapolis, Minnesota; 9800 La Cienega in Los Angeles, California; Park Central II in Dallas, Texas and Desert Passage in Las Vegas, Nevada. The gain on sale of discontinued real estate is partially offset by a provision for loss on discontinued real estate of approximately $14.5 million relating to Clark Tower in Memphis, Tennessee and $3.6 million relating to Minnesota Center in Minneapolis, Minnesota. The fair values of both office properties were determined by a contract price, less transaction costs.
During the year ended December 31, 2002, we recognized a provision for loss on discontinued real estate of approximately $57.0 million for Desert Passage in Las Vegas, Nevada, which was recorded to reduce the carrying value of the property to fair value. Fair value was based on internal valuations. In addition, we recognized a provision for loss on discontinued real estate of approximately $9.8 million for a property held for disposition whose fair value less selling costs was less than carrying value. These losses were partially offset by a gain on disposition of discontinued real estate of approximately $14.7 million due to the sale of Warner Center in Los Angeles, California; Plaza West in Bethesda, Maryland and McKinney Place in Dallas, Texas.
Gain on Disposition of Real Estate
During the year ended December 31, 2003, we recognized a gain on disposition of real estate of approximately $13.6 million due to the sale of Paseo Colorado in Pasadena, California which was subject to the transition rules of Statement of Financial Accounting Standards No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” (“FASB No. 144”).
During the year ended December 31, 2002, we recognized a gain on disposition of real estate of approximately $3.0 million due to the sales of Hanover Office Park in Greenbelt, Maryland; Valley Industrial Park in Seattle, Washington; Perimeter Woods in Charlotte, North Carolina; a technology center in Chicago, Illinois and first refusal rights on an investment which were subject to the transition rules of FASB No. 144.
Cumulative Effect of Change in Accounting Principle
We have elected to adopt the implementation of FIN No. 46R (hereinafter defined) as of December 31, 2003 and applied the provisions of FIN No. 46R for all entities as of such date. In applying the provisions of FIN No. 46R to all entities, we have determined that the Hollywood & Highland Hotel is a variable interest entity (“VIE”) and we are its primary beneficiary. As such, we have consolidated the financial position and results of operations of the Hollywood & Highland Hotel as of December 31, 2003. Upon consolidation of the Hollywood & Highland Hotel, we recognized a cumulative effect of a change in accounting principle of approximately $3.8 million representing the minority member’s share of the Hollywood & Highland Hotel’s non-recoverable cumulative losses.
Comparison of Year Ended December 31, 2002 to Year Ended December 31, 2001
The following is a table comparing our summarized operating results for the periods, including other selected information.
Property Revenue
Office property revenues decreased by approximately $4.5 million for the year ended December 31, 2002 compared to the year ended December 31, 2001. Office property revenues decreased by approximately $36.0 million due to lower average occupancy which resulted from significant lease terminations in the year ended December 31, 2001. Property dispositions in 2002 and 2001 resulted in a decrease of approximately $10.4 million for the year ended December 31, 2002 compared to the year ended December 31, 2001. In addition, management fee income decreased by approximately $1.7 million for the year ended December 31, 2002 compared to the year ended December 31, 2001. These decreases were partially offset by an increase of approximately $9.4 million primarily due to new leasing in One Alliance Center in Atlanta, Georgia and by approximately $16.9 million due primarily to acquiring the remaining 75% interest in Ernst & Young Plaza in Los Angeles, California that we did not already own. In addition, office property revenues increased by approximately $17.3 million due primarily to the acquisition of 151 Front Street in Toronto, Ontario; Two Ballston Plaza in Arlington, Virginia; 550 West Washington in Chicago, Illinois, and 1225 Connecticut in Washington, D.C.
Included in the office property revenue analysis above, for the year ended December 31, 2002, we recorded approximately $6.2 million of lease termination fees for our office portfolio compared to approximately $20.6 million for the year ended December 31, 2001.
Retail property revenues increased by approximately $41.9 million for the year ended December 31, 2002 compared to the year ended December 31, 2001 primarily due to the completion of the retail/entertainment component of Hollywood & Highland in Los Angeles, California, which opened on November 8, 2001, and the completion of Paseo Colorado, which opened on September 28, 2001.
Included in the retail property revenue analysis above, for the year ended December 31, 2002, we recorded approximately $0.2 million of lease termination fees for our retail portfolio compared to approximately $0.3 million for the year ended December 31, 2001.
Property Operating Expense
Office property operating expenses increased by approximately $19.7 million in the year ended December 31, 2002 compared to the year ended December 31, 2001. Office property expenses increased by approximately $16.4 million due to the office property acquisitions described above, approximately $2.8 million due to new leasing in One Alliance Center in Atlanta, Georgia, approximately $1.2 million due to an increase in insurance cost, approximately $0.7 million due to an increase in repairs and maintenance expense, approximately $1.3 million due to an increase in real estate tax expense and approximately $7.1 million due to an increase in other recoverable expenses for the year ended December 31, 2002 compared to the year ended December 31, 2001. These increases were partially offset by property dispositions in 2001 and 2002 which resulted in a decrease of approximately $6.6 million for the year ended December 31, 2002 compared to the year ended December 31, 2001, and a decrease in bad debt expense of approximately $3.2 million.
Excluding the impact on revenues of lease termination fees, our office portfolio gross margin (property revenues, excluding lease termination fees, less property operating expenses) decreased to approximately 55.2% for the year ended December 31, 2002 from approximately 57.1% for the year ended December 31, 2001, reflecting our lower average occupancy, lower rental rates and increased operating expenses.
Retail property operating expenses increased by approximately $29.6 million for the year ended December 31, 2002 compared to the year ended December 31, 2001 primarily due to the completion of the retail/entertainment component of Hollywood & Highland in Los Angeles, California, which opened on November 8, 2001, and the completion of the Paseo Colorado in Pasadena, California, which opened on September 28, 2001.
General and Administrative Expense, Exclusive of Stock Option Grant Expense
General and administrative expense increased by approximately $19.1 million for the year ended December 31, 2002, compared to the year ended December 31, 2001. Separation costs associated with the departure of our former chief executive officer and other senior management accounted for approximately $9.2 million of this
increase. The remainder of the increase is due primarily to additional senior management costs and increased internal and external public company corporate compliance costs as a result of our becoming a publicly traded REIT.
Depreciation and Amortization
Depreciation expense increased by approximately $15.2 million for the year ended December 31, 2002 compared to the year ended December 31, 2001. The acquisition of three office properties and the increase in ownership of the Ernst & Young Plaza resulted in an increase of approximately $4.2 million. The completion of office and retail development properties increased depreciation expense by approximately $5.4 million. The increase in tenant improvements and the write off of unamortized tenant improvement costs for Enron and other early lease terminations increased depreciation expense by approximately $7.5 million. These increases were partially offset by a decrease of approximately $1.9 million due to property dispositions in 2002 and 2001.
Stock Option Grant Expense
During the year ended December 31, 2002, we recorded stock option grant expense of approximately $5.2 million, including approximately $1.4 million of accelerated expense for employees separated during the year. This non-cash cost relates to the intrinsic value at the date of grant of stock options granted upon the completion of the corporate reorganization. These options were granted on identical financial terms to the TrizecHahn Corporation options, which they replaced.
Reorganization Costs
During the year ended December 31, 2001, we recorded as reorganization costs a charge of approximately $15.9 million to provide for employee severance, benefits and other costs associated with implementing the reorganization plan. As a result of the completion of the corporate reorganization and centralization, during the fourth quarter of 2002, we reviewed the remaining liability based on future estimated expenditures and, accordingly, reduced our accrual for anticipated expenditures by approximately $3.3 million.
Provision for Loss on Real Estate
During the year ended December 31, 2002, we recorded a provision for loss in the amount of approximately $142.4 million for Hollywood & Highland to reduce the carrying value of the property to fair value. Fair value was based on internal valuations.
During the year ended December 31, 2001, we commissioned third-party appraisals of our retail/entertainment properties. These appraisals indicated a decline in the fair value of these assets, and, accordingly, for the year ended December 31, 2001, we recorded a provision for loss of approximately $170.1 million to reduce the carrying value of the Hollywood & Highland retail project and approximately $4.9 million to reduce the carrying value of certain remnant retail assets. During 2001, we recorded a provision for loss on our technology centers and for two U.S. office assets held for sale, for which we recorded a loss of approximately $65.5 million.
Loss on and Provision for Loss on Investment
During the year ended December 31, 2002, we determined that our investment in the second mortgage collateralized by the Sears Tower in Chicago, Illinois was impaired. We estimated that the fair value of the Sears Tower was insufficient to cover encumbrances senior to our position and the entire carrying value of the investment. Accordingly, we recorded a provision for loss on investment of approximately $48.3 million in the third quarter of 2002 to reduce the carrying value of our investment in the Sears Tower to its estimated fair value of approximately $23.6 million.
On December 5, 2002, we sold our interest in Chelsfield plc for approximately $76.6 million and recognized a net loss of approximately $12.7 million.
In 2001, we fully provided for our securities investment in certain building telecommunication and service providers, recording an approximate $15.4 million charge, net of approximately $3.5 million of deferred revenue, as events and circumstances confirmed that the decline in value of these assets was considered other than temporary. This provision comprised our investments in Allied Riser Communications Corporation, Broadband Office Inc., Cypress Communications Inc., OnSite Access Inc., and Captivate Network, Inc.
Interest and Other Income
Interest and other income decreased by approximately $6.9 million for the year ended December 31, 2002 compared to the year ended December 31, 2001 due primarily to lower cash balances and lower interest rates.
Interest Expense
Interest expense increased by approximately $39.6 million for the year ended December 31, 2002, compared to the year ended December 31, 2001. Cessation of interest capitalization for the three retail/entertainment development properties and One Alliance Center, which were completed in late 2001, increased interest expense by approximately $29.6 million. The impact of office acquisitions resulted in an increase of approximately $13.3 million. The draws outstanding during the year on our $350 million revolving line of credit, which was primarily used to fund distributions in connection with the corporate reorganization, added approximately $8.9 million of interest expense. Incremental borrowings, including the issuance of commercial mortgage backed securities in May 2001, and additional financing of retail and development office projects increased interest expense by approximately $6.5 million. These increases were partially offset by a decrease in average variable interest rates for the year ended December 31, 2002 compared to the year ended December 31, 2001, which resulted in a decrease in interest expense of approximately $18.7 million.
Loss on Early Debt Retirement
During the year ended December 31, 2001, we recorded a loss on early debt retirement of approximately $18.0 million related to the retirement of approximately $1.2 billion of debt which was funded by the issuance of approximately $1.4 billion in commercial mortgage backed securities. Approximately $4.2 million of the loss on early debt retirement relates to the write off of the unamortized deferred finance costs.
Recovery on Insurance Claim
Beginning in late 2001 and during 2002, we replaced a chiller at One New York Plaza in New York that was damaged in 2001, and we expect total remediation and improvement costs will be approximately $19.0 million. During the year ended December 31, 2002, we received approximately $3.8 million in insurance proceeds related to this chiller. In 2001, we received approximately $1.2 million in insurance proceeds related to this chiller, which approximated the net book value of the chiller. We are preparing to file a claim for additional proceeds; however, we cannot assure you that we will be successful with such an effort.
Provision for Income and Other Corporate Taxes
Income and other taxes includes franchise, capital, alternative minimum and foreign taxes related to ongoing real estate operations. Income and other taxes decreased by approximately $8.9 million for the year ended December 31, 2002 compared to the year ended December 31, 2001 principally because Trizec R & E Holdings, Inc. was subject to federal income taxes prior to its inclusion in Trizec Properties.
Minority Interest
Minority interest income increased by approximately $1.3 million for the year ended December 31, 2002 as compared to the year ended December 31, 2001 due to the decline in the redemption value in the TrizecHahn Mid-Atlantic Limited Partnership redeemable units.
Loss from Unconsolidated Real Estate Joint Ventures
Loss from unconsolidated real estate joint ventures increased by approximately $13.7 million for the year ended December 31, 2002 compared to the year ended December 31, 2001. Approximately $38.8 million of the increase is due to the recognition of a provision for loss on investment in real estate during the year ended December 31, 2002 related to the Hollywood & Highland Hotel in Los Angeles, California and a provision for loss on investment in real estate of approximately $20.1 million in New Center One in Detroit, Michigan. The increase was partially offset by the provision for loss on investment in real estate in 2001 for the Hollywood & Highland Hotel of approximately $46.9 million. Income before the provision for losses on these joint venture interests declined by approximately $1.7 million primarily due to Desert Passage being consolidated commencing April 1, 2001, Ernst & Young Plaza being consolidated commencing June 4, 2002 and a net loss on operations at the Hollywood & Highland hotel.
Discontinued Operations
Income from properties classified as discontinued operations decreased during the year ended December 31, 2002 due to the disposition of several properties in 2002, which had a partial year of operations during the year ended December 31, 2002 and a full year of operations during the year ended December 31, 2001.
During the year ended December 31, 2002, we recognized a provision for loss on discontinued real estate of approximately $57.0 million for Desert Passage in Las Vegas, Nevada, which was recorded to reduce the carrying value of the property to fair value. Fair value was based on internal valuations. In addition, we recognized a provision for loss on discontinued real estate of approximately $9.8 million for a property held for disposition whose fair value less selling costs was less than carrying value. These losses were partially offset by a gain on disposition of discontinued real estate of approximately $14.7 million due to the sale of Warner Center in Los Angeles, California; Plaza West in Bethesda, Maryland and McKinney Place in Dallas, Texas.
During the year ended December 31, 2001, we recognized a provision for loss on discontinued real estate of approximately $17.5 million for Desert Passage in Las Vegas, Nevada, which was recorded to reduce the carrying value of the property to fair value based on internal valuations at that time.
Gain (Loss) on Disposition of Real Estate
During the year ended December 31, 2002, we recognized a gain on disposition of real estate of approximately $3.0 million due to the sales of Hanover Office Park in Greenbelt, Maryland; Valley Industrial Park in Seattle, Washington; Perimeter Woods in Charlotte, North Carolina; a technology center in Chicago, Illinois and first refusal rights on an investment which were subject to the transition rules of FASB No. 144.
During 2001, we recorded a net loss on disposition of real estate of approximately $2.1 million due to the sales of Camp Creek Business Center in Atlanta, Georgia; First Stamford Place in Stamford, Connecticut; Fisher/Kahn in Detroit, Michigan and some other residual lands.
Cumulative Effect of Change in Accounting Principle
As a consequence of implementing Statement of Financial Account Standards No. 133 “Accounting for Derivative Instruments and Hedging Activities,” in the year ended December 31, 2001, we wrote off deferred financing charges of $0.3 million and reclassified an unrealized loss of approximately $4.3 million related to certain telecommunication securities from accumulated other comprehensive loss, a component of equity, to cumulative effect of a change in accounting principle.
Liquidity and Capital Resources
Our objective is to ensure, in advance, that there are ample resources to fund ongoing operating expenses, capital expenditures, debt service requirements and the distributions required to maintain REIT status.
We expect to meet our liquidity requirements over the next twelve months for scheduled debt maturities, normal recurring expenses, operational tax obligations, settlement of pre-REIT tax issues and distributions required to maintain REIT status through cash flows from operations, the refinancing of mortgage debt and our current cash and credit availability. Our net cash flow from operations is dependent upon the occupancy level of our properties, the collectibility of rent from our tenants, the level of operating and other expenses, and other factors. Material changes in these factors may adversely affect our net cash flow from operations.
We expect to meet our liquidity requirement for periods beyond twelve months for scheduled debt maturities, potential future acquisitions and developments, major renovations, ground lease payments or purchases, expansions, settlement of pre-REIT tax issues and other non-recurring capital expenditures through cash flows from operations, availability under our credit facility, the incurrence of secured debt, asset sales, entering into joint ventures or partnerships with equity providers, issuing equity securities or a combination of these methods.
We have a $350.0 million senior secured revolving credit facility that matures in December 2004. The amount available to be borrowed under the credit facility at any time is determined by the encumbered properties we, or our subsidiaries that guarantee the credit facility, own that satisfy certain conditions of eligible properties. These conditions are not uncommon for credit facilities of this nature. As of December 31, 2003, the amount eligible to be borrowed was approximately $217.0 million, none of which was outstanding. During 2004, the amount available to be borrowed will likely fluctuate. The capacity under the facility may decrease as we sell or place permanent debt on assets currently supporting the facility. In addition, the capacity may decrease if assets no longer meet certain eligibility requirements. Likewise, the capacity under the facility may increase as certain assets become encumbered by the facility or otherwise meet the eligibility requirements of the facility. During 2004, we expect the outstanding balance to fluctuate. The outstanding balance will likely increase from time to time as we use funds from the facility to meet a variety of liquidity requirements such as dividend payments, tenant installation costs, future tax payments and acquisitions that may not be fully met through operations. Likewise, any outstanding balance may be reduced as a result of proceeds generated from asset sales, secured borrowings, operating cash flow and other sources of liquidity.
Under our credit facility, we are subject to covenants, including financial covenants, restrictions on other indebtedness, restrictions on encumbrances of properties that we use in determining our borrowing capacity and certain customary investment restrictions. The financial covenants include the requirement for our total leverage ratio not to exceed 65%, with the exception that the total leverage ratio could reach 67.5% for one calendar quarter in 2003; the requirement for our interest coverage ratio to be greater than 2.0 times; and the requirement for our net worth to be in excess of $1.5 billion. Our financial covenants also include a restriction on dividends or distributions of more than 90% of our funds from operations (as defined in the revolving credit facility agreement). If we are in default in respect of our obligations under the credit facility, dividends will be limited to the amount necessary to maintain REIT status. At December 31, 2003, we were in compliance with these covenants.
After dividend distributions, our remaining cash from operations will not be sufficient to allow us to retire all of our debt as it comes due. Accordingly, we will be required to refinance maturing debt or repay it utilizing proceeds from property dispositions or the issuance of equity securities. Our ability to refinance maturing debt will be dependent on our financial position, the cash flow from our properties, the value of our properties, liquidity in the debt markets and general economic and real estate market conditions. There can be no assurance that such refinancing or proceeds will be available or be available on economical terms when necessary in the future.
Contractual Obligations
The following table summarizes our contractual obligations as of December 31, 2003:
(1)
Included on balance sheet.
(2)
Purchase obligations include agreements to purchase goods or services that are enforceable and legally binding and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction.
We have various standing or renewable service contracts with vendors related to our property management that provide for cancellation with insignificant or no cancellation penalties and, therefore, have not been included in the above table.
Off-Balance Sheet Arrangements
As part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Therefore, we do not believe that we currently have any off-balance sheet arrangements.
Cash Flow Activity
At December 31, 2003, we had $129.3 million in cash and cash equivalents as compared to $62.3 million at December 31, 2002. The increase is a result of the following cash flows:
Operating Activities
Cash provided by operating activities for the year ended December 31, 2003 was approximately $218.9 million compared to approximately $211.7 million for 2002, and approximately $462.9 million for 2001. Included with normal operating activities for 2003, we funded approximately $5.5 million into restricted cash related to the interest rate swaps we had in place at December 31, 2003. In addition, approximately $21.8 million of the increase in restricted cash for the year ended December 31, 2003 compared to the year ended December 31, 2002 was comprised of gross proceeds from the sale of an office property located in Los Angeles, California. These sales proceeds were intended to be disbursed as we exchanged into properties under Section 1031 of the Internal Revenue Code; however, we did not make such election. These increases were partially offset by the net release of escrows of approximately $1.2 million related to property tax escrows, capital expenditure escrows and various other escrows. During the year ended 2002, we funded approximately $18.6 million into escrow and restricted cash accounts primarily due to the consolidation of the Ernst & Young Plaza. During the year ended December 31, 2001, we received the benefit of a release in escrow and restricted cash of approximately $99.4 million, which had been used primarily to exchange into three properties under Section 1031 of the Internal Revenue Code. In addition, during the year ended December 31, 2003, we paid approximately $49.5 million related to pre-REIT tax matters.
Investing Activities
Net cash provided in investing activities reflects the ongoing impact of expenditures on tenant installation costs, capital expenditures, investments in and distributions from unconsolidated real estate joint ventures, and the impact of acquisitions, developments and dispositions. During the year ended December 31, 2003, approximately $442.8 million of cash was generated in our investing activities, which are described below. During the year ended December 31, 2002, we used approximately $15.9 million of cash in our investing activities as compared to approximately $597.0 million in 2001.
Tenant Installation Costs
Our office properties require periodic investments of capital for tenant installation costs related to new and renewal leasing. Overall market conditions for the year ended December 31, 2003 reflect an increase in vacancies over the prior year. This increase, combined with sublet space inventory in our major markets, has increased the downward pressure on rental rates and the upward pressure on tenant installation costs. For comparative purposes, the absolute total dollar amount of tenant installation costs in any given period is less relevant than the cost on a per square foot basis. This is because the total is impacted by the square footage both leased and occupied in any given period. Tenant installation costs consist of tenant allowances and leasing costs. Leasing costs include leasing commissions paid to third-party brokers representing tenants and costs associated with dedicated regional leasing teams who represent us and deal with tenant representatives. The following table reflects tenant installation costs for the total office portfolio, including our share of such costs incurred by unconsolidated joint ventures, for both new and renewal office leases that commenced during the respective periods, regardless of when such costs were actually paid. The square feet leased data in the table represents our pro rata owned share of square feet leased.
Capital Expenditures
To maintain the quality of our properties and preserve competitiveness and long-term value, we pursue an ongoing program of capital expenditures, certain of which are not recoverable from tenants. For the year ended December 31, 2003, capital expenditures for the total office portfolio, including our share of such expenditures incurred by unconsolidated joint ventures, was approximately $21.6 million (2002 - $35.9 million; 2001 - $30.3 million). Recurring capital expenditures include, for example, the cost of roof replacement and the cost of replacing heating, ventilation, air conditioning and other building systems. In addition to recurring capital expenditures, expenditures are made in connection with non-recurring events such as asbestos abatement or removal costs, any major mechanical attribute or system replacement, and any redevelopment or reconstruction costs directly attributable to extending or preserving the useful life of the base building. Furthermore, as part of our office acquisitions, we have routinely acquired and repositioned properties in their respective markets, many of which have required significant capital improvements due to deferred maintenance and the existence of shell space requiring initial tenant build-out at the time of acquisition. Some of these properties required substantial renovation to enable them to compete effectively. We take these capital improvement and new leasing tenant inducement costs into consideration at the time of acquisition when negotiating our purchase price.
Reconciliation to Consolidated Statements of Cash Flows
The above information includes tenant installation costs granted, including leasing costs, and capital expenditures for the total portfolio, including our share of such costs granted by unconsolidated joint ventures, for leases that commenced during the periods presented. The amounts included in our consolidated statements of cash flows represent the actual cash spent during the periods, excluding our share of such costs and expenditures incurred by unconsolidated joint ventures. The reconciliation between the above amounts and our consolidated statements of cash flows is as follows:
Acquisitions
On April 19, 2002, in connection with the corporate reorganization, TrizecHahn Corporation contributed its investment in Chelsfield plc, a UK real estate company whose shares are listed on the London Stock Exchange, to us at TrizecHahn Corporation’s value of approximately $89.0 million. We owned approximately 19.5 million or 6.9% of the outstanding ordinary shares of Chelsfield plc. In consideration for the ordinary shares of Chelsfield plc we received, we issued 49,330 shares of our Class C Convertible Preferred Stock to TrizecHahn Corporation at a value of approximately $54.0 million and TrizecHahn Corporation retired a $35.0 million non-interest bearing advance from us. On December 5, 2002, we sold our investment in Chelsfield plc for approximately $76.6 million and realized a loss of approximately $12.7 million.
On April 12, 2002, TrizecHahn Corporation transferred its interest in 151 Front Street in Toronto, Ontario, to us for approximately $29.6 million in cash. We have recorded the property at approximately $29.1 million, which is TrizecHahn Corporation’s historical cost basis. Consistent with TrizecHahn Corporation’s classification at December 31, 2001, we have classified 151 Front Street as held for disposition at December 31, 2003. In January 2004, we sold this property for gross proceeds of approximately $59.2 million.
TrizecHahn Corporation had investments in private equity and venture capital funds managed by Borealis Capital Corporation and in Borealis Capital Corporation, which we collectively refer to as Borealis. On April 30, 2002, TrizecHahn Corporation contributed its investment in Borealis to us in exchange for 3,909 shares of our Class C Convertible Preferred Stock valued at approximately $4.3 million. During the year, we received approximately $3.7 million related to the disposition of a portion of our interest in Borealis.
On June 4, 2002, we acquired the remaining 75% interest in Ernst & Young Plaza in Los Angeles for an aggregate of $115.1 million of which, after the assumption of debt and other net liabilities, we paid approximately $35.9 million. Additionally, we acquired the remaining ground leases related to two of our Chicago office properties for approximately $7.2 million, of which approximately $4.0 million was financed by new debt.
During 2001, we acquired three office properties within our core markets and partially acquired the ground leases at the two Chicago properties for $202.7 million with financing of $48.5 million.
Developments
For the year ended December 31, 2003 we spent approximately $0.9 million on the final payment requirements for the construction costs relating to developments that were completed in 2001 and 2002. Development expenditures were incurred during 2002 and 2001 primarily on Desert Passage in Las Vegas, Nevada; Paseo Colorado in Pasadena, California and the Hollywood & Highland complex in Los Angeles, California, and for the completion of One Alliance Center. The latter project, located in the Buckhead sub-market of Atlanta, Georgia, opened in early October 2001. This $100 million, 558,000 square foot building is the first phase of a four-building complex and is currently 96.6% occupied.
Dispositions
During the year ended December 31, 2003, we sold seven office properties and two retail properties (exclusive of joint venture sales) generating net proceeds of approximately $573.7 million or approximately $266.0 million after debt repayment. During the year ended December 31, 2002, we sold five office properties, two technology centers, refusal rights and remnant lands generating net proceeds of approximately $149.0 million, or $140.1 million after debt repayment. During the year ended December 31, 2001, we sold four office properties and a land site which generated net proceeds, after debt repayment, of approximately $110.2 million.
Consolidated Real Estate Joint Venture
We have elected to adopt the implementation of FIN No. 46R (hereinafter defined) as of December 31, 2003 and applied the provisions of FIN No. 46R for all entities as of such date. In applying the provisions of FIN No. 46R to all entities, we have determined that the Hollywood & Highland Hotel is a VIE and we are its primary beneficiary. As such, we have consolidated the financial position and results of operations of the Hollywood & Highland Hotel as of December 31, 2003.
The Hollywood & Highland Hotel is a 640-room hotel located in Los Angeles, California. At December 31, 2003, we had a 91.5% ownership and economic interest in an entity that owns the Hollywood & Highland Hotel. Prior to December 31, 2003, we accounted for the Hollywood & Highland Hotel as an investment in an unconsolidated real estate joint venture. On December 31, 2003, we consolidated the Hollywood & Highland Hotel. The net impact of the consolidation of the Hollywood & Highland Hotel was an increase in our consolidated assets of approximately $94.0 million, representing the net book value of the real estate, cash and cash equivalents and other assets. In addition, we consolidated approximately $81.5 million of mortgage debt related to the Hollywood & Highland Hotel. Our maximum exposure to loss is approximately $81.5 million, representing the amount of mortgage debt outstanding at December 31, 2003. Upon consolidation of the Hollywood & Highland Hotel, we recognized a cumulative effect of a change in accounting principle of approximately $3.8 million representing the minority member’s share of the Hollywood & Highland Hotel’s non-recoverable cumulative losses.
Unconsolidated Real Estate Joint Ventures
During the year ended December 31, 2003, we contributed to and made advances to our unconsolidated real estate joint ventures in the aggregate amount of approximately $27.1 million, and received distributions from our unconsolidated real estate joint ventures in the aggregate amount of approximately $21.7 million. During the year ended December 31, 2002, we contributed to and made advances to our unconsolidated real estate joint ventures in the aggregate amount of approximately $11.9 million, and received distributions from our unconsolidated real estate joint ventures in the aggregate amount of approximately $19.1 million. During the year ended December 31, 2001, we contributed to and made advances to our unconsolidated real estate joint ventures in the aggregate amount of approximately $30.1 million, and received distributions from our unconsolidated real estate joint ventures in the aggregate amount of approximately $15.4 million.
Investment in Sears Tower
On December 3, 1997, we purchased a subordinated mortgage collateralized by the Sears Tower in Chicago, Illinois, for approximately $70.0 million and became the residual beneficiary of the trust that holds title to the Sears Tower. At December 31, 2002, the Sears Tower was held by a trust established for the benefit of an affiliate of Sears, Roebuck and Co. The trust had a scheduled termination date of January 1, 2003, at which time the
assets of the trust, subject to a participating first mortgage, were to be distributed to us as the residual beneficiary. The subordinated mortgage was subordinate to an existing non-recourse participating first mortgage.
The subordinated mortgage held by us, which was to mature in July 2010, had certain participation rights to the extent of available cash flow. Since acquisition, we had not been accruing interest income on the subordinated mortgage due to the uncertainty regarding ultimate collectibility of accrued interest. In 2002, a loss provision of approximately $48.3 million was recorded to reduce the carrying value of our investment in the Sears Tower to its estimated fair value of approximately $23.6 million.
On August 28, 2003, we sold our interest in the subordinated mortgage to Metropolitan Life Insurance Company, the holder of the first mortgage, for approximately $9.0 million. During the third quarter of 2003, we recognized a loss on the sale of our interest in the subordinated mortgage to Metropolitan Life Insurance Company of approximately $15.5 million. In addition, we recognized a tax benefit related to this transaction of approximately $12.0 million which is included in benefit (provision) for income and other corporate taxes. Metropolitan Life Insurance Company has retained us as leasing and management agent for the Sears Tower on a third-party basis.
Financing Activities
During the year ended December 31, 2003, we used approximately $594.7 million in our financing activities, which primarily consisted of an approximate $90.0 million net pay-down of our revolving credit facility, approximately $307.7 million of mortgage debt and other loans repaid on property dispositions, approximately $2.5 million on refinancing fees and approximately $105.3 million of principal repayments, net of an increase in property financing. Additionally, we incurred and paid approximately $3.4 million in settlement of forward rate contracts. We also paid approximately $94.1 million in dividends to our stockholders.
During the year ended December 31, 2002, we used approximately $430.9 million in our financing activities. During 2002, property refinancing generated proceeds of approximately $189.2 million. Reflecting the completion of development activities in 2002, we had development financing of approximately $70.6 million. Debt repaid on disposition was approximately $8.8 million during 2002 relating to the disposition activity discussed previously. During the year ended December 31, 2002, we drew, on a net basis, approximately $90.0 million on our revolving line of credit and collected approximately $112.7 million on our advances to parent which, when combined with existing cash, was used primarily to fund distributions to TrizecHahn of approximately $643.2 million for a net distribution of approximately $530.5 million in connection with the corporate reorganization. Additionally, we paid approximately $40.2 million of dividends to our stockholders subsequent to the reorganization and advanced approximately $35.0 million to our parent during the first quarter of 2002.
During the year ended December 31, 2001, we generated approximately $361.3 million of cash related to our financing activities. During 2001, property refinancing generated proceeds of approximately $1.4 billion due primarily to the issuance of approximately $1.4 billion of commercial mortgage backed securities, the proceeds of which were used to retire approximately $1.2 billion of existing debt. Reflecting the completion of development activities in 2001, we had development financing of approximately $227.2 million. Debt repaid on disposition was approximately $1.3 million in 2001 relating to the disposition activity discussed previously. In 2001, we had no draws on our revolving line of credit but did pay approximately $499.0 million in cash dividends and advanced $384.1 million to our parent.
At December 31, 2003 our consolidated debt was approximately $2.9 billion. The weighted average interest rate on our debt was 5.78% and the weighted average maturity was approximately 4.0 years. The table that follows summarizes the mortgage and other loan debt at December 31, 2003 and December 31, 2002:
At December 31, 2003, we had fixed interest rates on $150.0 million (December 31, 2002 - $150.0 million) of the debt classified as fixed in the above table by way of interest rate swap contracts with a weighted average interest rate of 6.02% and maturing on March 15, 2008. In accordance with these interest rate swap agreements, we have placed approximately $5.5 million of cash into an interest-bearing escrow account as security under the contracts. Additionally, in January 2003, we entered into interest rate swap contracts to fix the LIBOR interest rates on $500.0 million of variable rate debt with a weighted average fixed rate of 2.61% plus various spreads effective July 1, 2003. At December 31, 2003, the $500.0 million of debt is classified as fixed in the above table. The fair value of all the above interest rate swaps was approximately $20.3 million at December 31, 2003 (December 31, 2002 - $18.5 million).
In December 2003, we entered into forward rate swap agreements to lock into a maximum interest rate on $110.0 million of $120.0 million of mortgage debt that we intend to refinance in 2004. The forward rate swap agreements were entered into at current market rates and, therefore, had no initial cost. The cost to unwind these interest rate swap contracts is approximately $1.6 million at December 31, 2003. Upon settlement of the swaps, we may be obligated to pay the counterparties a settlement payment, or alternatively, to receive settlement proceeds from the counterparties. Any monies paid or received will be recorded in other comprehensive income and amortized to interest expense over the term of the respective debt. We refinanced this mortgage loan in January 2004.
We have entered into interest rate cap contracts expiring June 2004 on $120.0 million of variable rate debt, which limit the underlying LIBOR interest rate to 6.5%. At December 31, 2003, the fair value of these interest rate cap contracts was nominal. In addition, and not reclassified in the table above, we have entered into an interest rate cap contract expiring April 2004 on approximately $584.7 million of U.S. dollar variable rate debt, which limits the underlying LIBOR rate to 11.01%. The fair value of this interest rate cap contract was nominal at December 31, 2003.
The variable rate debt shown above bears interest based primarily on various spreads over LIBOR. The leverage ratio is the ratio of mortgage and other debt to the sum of mortgage and other debt and the book value of stockholders’ equity. The decrease in our leverage ratio from December 31, 2002 to December 31, 2003 resulted primarily from the pay-down of existing debt upon the sale of non-core properties.
At December 31, 2002, a non-recourse loan secured by New Center One in Detroit, Michigan, which was held in a joint venture, was in default. On February 25, 2003, the joint venture sold the property and the loan was extinguished through repayment and forgiveness.
During the first quarter of 2003, the lender for our remaining technology property forwarded a notice of default related to debt service on the $17.9 million construction facility. On June 30, 2003, we conveyed title for such property to the lender and are no longer obligated to the lender under the $17.9 million construction facility. In addition, we remitted approximately $0.5 million to the lender in full satisfaction of any amounts owed to the lender related to the construction facility. On June 30, 2003, we recorded a gain on early debt retirement of approximately $3.6 million related to this transaction. This loan was not cross-defaulted to any other of our loans and was scheduled to mature in October 2003.
In June 2003, we refinanced the approximately $55.1 million variable rate development loan on One Alliance Center in Atlanta, Georgia, which was scheduled to mature in October 2003, with a $70.0 million, 4.78% fixed rate mortgage that matures in June 2013. In May 2003, we, through a third party, arranged to set a maximum rate on this loan through a forward rate agreement. Upon closing of this loan, we paid approximately $3.4 million in settlement of this forward rate agreement, which we have recorded in other comprehensive income. The amount paid on settlement will be amortized into interest expense over the life of the loan.
The consolidated mortgage and other debt information presented above does not reflect indebtedness secured by property owned in joint venture partnerships as they are accounted for under the equity method. At December 31, 2003, our pro rata share of this debt amounted to approximately $232.7 million (December 31, 2002 - $343.7 million).
We were contingently liable for a certain obligation related to the Hollywood & Highland Hotel, one of our consolidated real estate joint ventures. All of the assets of the venture were available for the purpose of satisfying this obligation. We had guaranteed or were otherwise contingently liable for approximately $74.0 million at December 31, 2003. In April 2003, the joint venture amended and restated this loan, which had been scheduled to mature in April 2003. As part of the amended contract, on April 11, 2003, the Hollywood & Highland Hotel joint venture paid approximately $15.3 million to reduce the outstanding balance to approximately $78.0 million. The joint venture was also required to make a further payment of approximately $4.0 million in October 2003 and was required to make another payment of approximately $4.0 million in April 2004, so that the balance of the loan outstanding in April 2004 would be approximately $70.0 million. In April 2004, the loan would have been subject to a potential additional paydown based on a new appraisal. This obligation was paid off and retired in conjunction with the sale of the Hollywood & Highland complex on February 27, 2004.
At December 31, 2002, the total amount we guaranteed or were otherwise contingently liable for was approximately $100.9 million. This included the approximately $93.3 million related to the Hollywood & Highland Hotel and approximately $7.6 million related to our New Center One joint venture that was retired upon the sale of the property in the New Center One joint venture.
The table below segregates debt repayments between loans collateralized by our office and retail properties and our other loans.
Some of our collateralized loans are cross-collateralized or subject to cross-default or cross-acceleration provisions with other loans.
Dividends
On March 18, 2003, we declared a quarterly dividend of $0.20 per common share, payable on April 15, 2003, to the holders of record at the close of business on March 31, 2003. On June 17, 2003, we declared a quarterly dividend of $0.20 per common share, payable on July 15, 2003, to the holders of record at the close of business on June 30, 2003. On September 16, 2003, we declared a quarterly dividend of $0.20 per common share, payable on October 15, 2003, to the holders of record at the close of business on September 30, 2003. On December 10, 2003, we declared a quarterly dividend of $0.20 per common share, payable on January 15, 2004, to the holders of record at the close of business on December 31, 2003. The dividends paid on April 15, 2003, July 15, 2003, October 15, 2003 and January 15, 2004 totaled approximately $30.0 million, $30.1 million, $30.1 million and $30.2 million, respectively.
On March 18, 2003, we declared an aggregate dividend of approximately $0.006 million for the Class F convertible stock, payable on April 15, 2003. We accrued an additional aggregate dividend of approximately $0.001 million on March 31, 2003, June 30, 2003, September 30, 2003 and December 31, 2003, respectively.
On March 18, 2003, we declared an aggregate dividend of approximately $0.8 million for the special voting stock, payable on April 15, 2003. On June 17, 2003, we declared an aggregate dividend of approximately $0.6 million for the special voting stock, payable on July 15, 2003. On September 16, 2003, we declared an aggregate dividend of approximately $2.5 million for the special voting stock, payable on October 15, 2003. On December 10, 2003, we declared an aggregate dividend of approximately $1.3 million for the special voting stock, payable on January 15, 2004.
Market Risk - Quantitative and Qualitative Information
Market risk is the risk of loss from adverse changes in market prices and interest rates. Our future earnings, cash flows and fair values relevant to financial instruments are dependent upon prevailing market interest rates. The primary market risk facing us is long-term indebtedness, which bears interest at fixed and variable rates. The fair value of our long-term debt obligations is affected by changes in market interest rates. We manage our market risk by matching long-term leases on our properties with long-term fixed rate non-recourse debt of similar durations. At December 31, 2003, approximately 95.2% or approximately $2.7 billion of our outstanding debt had fixed interest
rates (including variable rate debt subject to interest rate caps and interest rate swap agreements), which minimizes the interest rate risk until the maturity of such outstanding debt.
We utilize certain derivative financial instruments at times to limit interest rate risk. Interest rate protection agreements are used to convert variable rate debt to a fixed rate basis or to hedge anticipated financing transactions. Derivatives are used for hedging purposes rather than speculation. We do not enter into financial instruments for trading purposes. We have entered into hedging arrangements with financial institutions we believe to be creditworthy counterparties. Our primary objective when undertaking hedging transactions and derivative positions is to reduce our floating rate exposure, which, in turn, reduces the risks that variable rate debt imposes on our cash flows. Our strategy partially protects us against future increases in interest rates. At December 31, 2003, we had hedge contracts totaling $650.0 million. Hedging agreements totaling $150.0 million convert variable rate debt at LIBOR plus various spreads to a fixed rate of 6.02% and mature on March 15, 2008. In January 2003, we entered into forward interest rate hedging contracts to convert $500.0 million of variable rate debt into fixed rate debt effective July 2003 and maturing between July 1, 2005 and January 1, 2006. The hedging agreements convert variable rate debt at LIBOR plus various spreads to a fixed rate of 2.61%. In December 2003, we entered into forward rate swap agreements to lock into a maximum interest rate on $110.0 million of $120.0 million of mortgage debt we intend to refinance in 2004. We may consider entering into additional hedging agreements with respect to all or a portion of our variable rate debt. We may borrow additional money with variable rates in the future. Increases in interest rates could increase interest expense in unhedged variable rate debt, which, in turn, could affect cash flows and our ability to service our debt. As a result of the hedging agreements, decreases in interest rates could increase interest expense as compared to the underlying variable rate debt and could result in us making payments to unwind such agreements.
At December 31, 2003, our total outstanding debt was approximately $2.9 billion, of which approximately $138.1 million (exclusive of debt subject to interest rate caps) was variable rate debt after the impact of the hedge agreements. At December 31, 2003, the average interest rate on variable rate debt was approximately 4.2%. Taking the hedging agreements into consideration, if market interest rates on our variable rate debt were to increase by 10% (or approximately 42 basis points), the increase in interest expense on the variable rate debt would decrease future earnings and cash flows by approximately $0.6 million annually. If market rates of interest increased by 10%, the fair value of the total debt outstanding would decrease by approximately $74.4 million.
Taking the hedging agreements into consideration, if market rates of interest on the variable rate debt were to decrease by 10% (or approximately 42 basis points), the decrease in interest expense on the variable rate debt would increase future earnings and cash flows by approximately $0.6 million annually. If market rates of interest decrease by 10%, the fair value of the total outstanding debt would increase by approximately $0.5 million.
These amounts were determined solely by considering the impact of hypothetical interest rates on our financial instruments. These analyses do not consider the effect of the reduced level of overall economic activity that could exist in an environment with significantly fluctuating interest rates. Further, in the event of significant change, management would likely take actions to further mitigate our exposure to the change. Due to the uncertainty of specific actions we may undertake to minimize possible effects of market interest rate increases, this analysis assumes no changes in our financial structure.
Related Party Transactions
In connection with the corporate reorganization, we entered into a tax cooperation agreement with TrizecHahn Office Properties, Ltd., a wholly-owned, Canadian subsidiary of TrizecHahn Corporation. Under the agreement, we have agreed to continue to conduct our business activities with regard to the consequences under Canadian tax legislation to TrizecHahn Office Properties Ltd., related Canadian corporations and Trizec Canada. Compliance with this agreement may require us to conduct our business in a manner that may not always be the most efficient or effective because of potential adverse Canadian tax consequences. Furthermore, we may incur incremental costs due to the need to reimburse these entities for any negative tax consequences.
In connection with the corporate reorganization, we have agreed to provide shared services to TrizecHahn and therefore continue to provide certain services to assist TrizecHahn in fulfilling its public disclosure obligations and conducting investor, media and public relations. TrizecHahn has agreed to and continues to provide accounting services in conjunction with the corporate reorganization. For the year ended December 31, 2003, we have recorded other
income of approximately $0.4 million for such services provided to TrizecHahn. In addition, we have recorded general and administrative expense of approximately $0.4 million for such services provided to us. Both amounts were outstanding at December 31, 2003.
For the years 2002 and 2001, we, in the normal course of business, reimbursed TrizecHahn and/or affiliates for direct third party purchased services and a portion of salaries for certain employees for direct services rendered. A significant portion of the reimbursements had been for allocated or direct insurance premiums, which amounted to approximately $10.9 million and approximately $7.1 million for the years ended December 31, 2002 and 2001, respectively. For the year ended December 31, 2003, we were reimbursed by TrizecHahn for insurance premiums that amounted to approximately $0.2 million.
In connection with the corporate reorganization, some outstanding TrizecHahn employee stock options were cancelled and replaced with options to acquire subordinate voting shares of Trizec Canada. For every outstanding option to acquire one Trizec Canada subordinate voting share, Trizec Canada, directly or indirectly, holds one of our warrants entitling Trizec Canada to one share of our common stock at any time prior to the respective warrant’s expiration date. We expect that Trizec Canada will exercise these warrants whenever and to the extent that one or more options to acquire Trizec Canada subordinate voting shares are exercised. Trizec Canada’s anticipated acquisition of one share of our common stock whenever one of its stock options is exercised is intended to maintain economic equivalence between shares of our common stock and Trizec Canada subordinate voting shares.
In July 2003, we issued 173,006 shares of our common stock to our Chairman of the Board as a net settlement of the exercise of 1,000,000 warrants. We recognized compensation expense of approximately $2.1 million related to the net settlement of such warrants, which is included in general and administrative expense.
On October 9, 2003, 4172352 Canada, Inc., an affiliate of Trizec Canada, Inc., contributed approximately $4.0 million to us in exchange for preferred membership units in an entity that holds a 91.5% interest in an entity that owns the Hollywood & Highland Hotel. The holders of the preferred membership units are entitled to an initial dividend of 8% per annum, increasing to 12% per annum, as well as any unrecovered capital contribution at the time of liquidation.
Subsequent Events
In January 2004, we disposed of 151 Front Street, a mixed use office property comprised of approximately 272,000 square feet located in Toronto, Canada for gross proceeds of approximately $59.2 million. Included in the sale was the adjacent retail concourse, comprising approximately 39,000 square feet. In conjunction with the sale, we paid off and retired approximately $20.4 million of mortgage debt related to 151 Front Street.
In January 2004, we refinanced a $120.0 million mortgage loan bearing an interest rate at LIBOR plus 2.75% and scheduled to mature in June 2004, with a $120.0 million mortgage loan maturing in February 2014. In December 2003, we, through a third party, arranged to set a maximum rate on $110.0 million of this loan through forward swap rate agreements. Upon closing of this loan, we paid approximately $3.9 million in settlement of these forward rate swap agreements, which we have recorded in other comprehensive income. The amount paid on settlement will be amortized into interest expense over the life of the mortgage loan.
In February 2004, we paid off and retired the mortgage debt on Galleria Towers in Dallas, Texas. The mortgage debt had a principal balance of approximately $133.5 million, bore interest at 6.79% and had a maturity date of May 2004.
On February 27, 2004, we sold the Hollywood & Highland complex in Los Angeles, California for gross proceeds of approximately $201.0 million. In conjunction with the sale, we paid off and retired approximately $214.1 million of mortgage debt related to the Hollywood & Highland complex.
Newly Issued Accounting Standards
In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46 (“FIN No. 46”), “Consolidation of Variable Interest Entities”. The objective of this interpretation is to provide guidance on how to identify a variable interest entity (“VIE”) and determine whether the assets, liabilities, non-controlling interests, and results of operations of a VIE need to be included in a company’s consolidated financial statements. A company that holds variable interests in an entity will need to consolidate the entity if the company’s interest in the VIE is such that the company will absorb a majority of the VIE’s expected losses and/or receive a majority of the entity’s expected residual returns, if they occur. FIN No. 46 also requires additional disclosures by primary beneficiaries and other significant variable interest holders. In connection with any of our unconsolidated real estate joint ventures that may qualify as a VIE, provisions of this interpretation were originally to be effective for financial reports that contain interim periods beginning after June 15, 2003. On October 9, 2003, the FASB issued FASB No. FIN 46-6 “Effective Date of FASB Interpretation No. 46, Consolidation of Variable Interest Entities” (“FSP FIN 46-6”). The provisions of FSP FIN No. 46-6 defer the effective date for applying the provisions of FIN No. 46 to an interest held in a VIE or a potential VIE until the end of the first interim or annual period ending after December 15, 2003 (as of December 31, 2003, for an entity with a calendar year-end or quarter-end of December 31) if (1) the VIE was created before February 1, 2003 and (2) the public entity has not issued financial statements reporting the VIE in accordance with FIN No. 46, other than the disclosures required by paragraph 26 of FIN No. 46. On December 17, 2003, the FASB granted a partial deferral on the implementation of FIN No. 46. The partial deferral addressed all non-special purpose entities created prior to February 1, 2003. Public entities with these types of entities will be required to adopt FIN No. 46 at the end of the first interim or annual reporting period ending after March 15, 2004. This partial deferral has been incorporated into FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities” - an interpretation of ARB 51 (referred to as FIN No. 46R) issued on December 24, 2003. We have elected to adopt the implementation of FIN No. 46R as of December 31, 2003 and applied the provisions of FIN No. 46R for all entities as of such date. In applying the provisions of FIN No. 46R to all entities, we have determined that the Hollywood & Highland Hotel is a VIE and we are its primary beneficiary. As such, we have consolidated the financial position and results of operations of the Hollywood & Highland Hotel as of December 31, 2003.
In April 2003, the FASB issued Statement of Financial Accounting Standards No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (“SFAS No. 149”). SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”. SFAS No. 149 amends SFAS No. 133 for decisions made (1) as part of the Derivatives Implementation Group process that effectively required amendments to SFAS No. 133, (2) in connection with other FASB projects dealing with financial instruments, and (3) in connection with implementation issues raised in relation to the application of the definition of a derivative, in particular, the meaning of an initial investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors, the meaning of underlying, and the characteristics of a derivative that contains financing components. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003. The provisions of SFAS No. 149 are to be applied prospectively. SFAS No. 149 does not impact our results of operations, financial position or liquidity.
In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity” (“SFAS No. 150”). SFAS No. 150 establishes standards for how an issuer classifies and measures in its statement of financial position certain instruments with characteristics of both liabilities and equity. SFAS No. 150 requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) because that financial instrument embodies an obligation of the issuer. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. On October 29, 2003, the FASB elected to defer the provisions of paragraphs 9 and 10 of SFAS No. 150 as they apply to mandatorily redeemable non-controlling interests. The FASB’s decisions with respect to the deferral, early adoption, and restatement will likely be issued in conjunction with the finalization of the proposed FASB Staff Position 150-c, “Effective Date and Transition for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities of SFAS No. 150”. SFAS No. 150 does not impact our results of operations, financial position or liquidity.
On January 1, 2003, we adopted the FASB’s Statement of Financial Accounting Standards No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections” (“SFAS No. 145”). SFAS No. 145 rescinds SFAS 4, SFAS 44 and SFAS 64 and amends SFAS 13 to modify the accounting for sales-leaseback transactions. SFAS 4 required the classification of gains and losses resulting from extinguishment of debt to be classified as extraordinary items. Pursuant to the adoption of SFAS No. 145, we classified the gain on early debt retirement for the year ended December 31, 2003 to continuing operations, and reclassified the amounts shown as extraordinary for the years ended December 31, 2002 and 2001 to continuing operations.
Inflation
Substantially all of our leases provide for separate property tax and operating expense escalations over a base amount. In addition, many of our leases provide for fixed base rent increases or indexed increases. We believe that inflationary increases may be at least partially offset by these contractual rent increases.
Funds from Operations
Funds from operations, or FFO, is a non-GAAP financial measure. FFO is defined by the Board of Governors of the National Association of Real Estate Investment Trusts, or NAREIT, as net income, computed in accordance with accounting principles generally accepted in the United States, or GAAP, excluding gains or losses from sales of properties and cumulative effect of a change in accounting principle, plus real estate related depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. Adjustments for unconsolidated partnerships and joint ventures are calculated to reflect FFO on the same basis. Effective as of the fourth quarter of 2003, we adopted the NAREIT calculation of FFO. Prior to our adoption of the NAREIT methodology for calculating FFO, we historically excluded certain items in calculating FFO, such as gain on lawsuit settlement, gain on early debt retirement, minority interest, recovery on insurance claims, effects of provision for loss on real estate and loss on and provision for loss on investments, net of the tax benefit, that are required to be factored into the calculation of FFO under the NAREIT methodology. We have revised our current and historical calculation of FFO in accordance with the NAREIT calculation in the table set forth below. Therefore, prior year amounts also reflect the revised guidance.
We believe that FFO is helpful to investors as one of several measures of the performance of an equity REIT. We further believe that by excluding the effect of depreciation, amortization and gains or losses from sales of real estate, all of which are based on historical costs and which may be of limited relevance in evaluating current performance, FFO can facilitate comparisons of operating performance between periods and between other equity REITs. Investors should review FFO, along with GAAP net income and cash flow from operating activities, investing activities and financing activities, when trying to understand an equity REIT’s operating performance. As discussed above, we compute FFO in accordance with current standards established by NAREIT, which may not be comparable to FFO reported by other REITs that do not define the term in accordance with the current NAREIT definition or that interpret the current NAREIT definition differently than we do. While FFO is a relevant and widely used measure of operating performance of equity REITs, it does not represent cash generated from operating activities in accordance with GAAP, nor does it represent cash available to pay distributions and should not be considered as an alternative to net income, determined in accordance with GAAP, as an indication of our financial performance, or cash flow from operating activities, determined in accordance with GAAP, as a measure of our liquidity, nor is it indicative of funds available to fund our cash needs, including our ability to make cash distributions.
The following table reflects the calculation of funds from operations for the years ended December 31, 2003, 2002 and 2001:
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Information about quantitative and qualitative disclosure about market risk is incorporated herein by reference from “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Market Risk - Quantitative and Qualitative Information”.
Item 8.
Item 8. Financial Statements and Supplementary Data
See “Index to Financial Statements” on page of this Form 10-K.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
(a) Evaluation of disclosure controls and procedures. Our chief executive officer and chief financial officer are responsible for establishing and maintaining “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) for our company. Management, under the supervision and with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this annual report and has concluded that our disclosure controls and procedures are adequate and effective in timely alerting them to material information relating to us (including our consolidated subsidiaries) required to be included in our periodic SEC filings.
(b) Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2003 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. During our financial reporting process for the year ended December 31, 2002, we identified an internal control deficiency in our consolidated process relating to the reconciliation of intercompany accounts, which our independent accountants deemed to be a “reportable condition” under standards established by the American Institute of Certified Public Accountants. We evaluated this matter and concluded that it has not had any material impact on our financial statements. We have developed procedures to address this deficiency, and do not anticipate that this internal control deficiency will occur in the future. Consistent with the provisions and spirit of the Sarbanes-Oxley Act and the rules and regulations of
the SEC thereunder, we maintain a process of continuous review of our internal controls to improve and enhance them, with the assistance of both our internal audit staff and our independent accountants.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Information relating to our executive officers, directors and nominees for director is incorporated by reference to “Proposal 1 - Election of Directors” in our definitive Proxy Statement for the 2004 Annual Meeting of Stockholders, to be held on May 20, 2004. Information concerning compliance with Section 16(a) of the Securities Exchange Act is incorporated by reference to “Section 16(a) Beneficial Ownership Reporting Compliance” in the 2004 Proxy Statement. Information relating to the audit committee of our board of directors and our audit committee financial expert is incorporated by reference to “Meetings and Committees of the Board of Directors - The Audit Committee” in the 2004 Proxy Statement.
Our board of directors has adopted a Code of Business Conduct and Ethics, applicable to all employees and directors of Trizec. This Code also applies to our senior financial executives, including our Chief Executive Officer and our Chief Financial Officer (who is both our principal financial and principal accounting officer). The Code of Business Conduct and Ethics is posted on our website at www.trz.com under the headings “Investors - Corporate Governance”. We will also provide a print copy of the Code to any stockholder upon request. We intend to disclose any amendments to the Code of Business Conduct and Ethics, as well as any waivers for senior financial executives, on our website at www.trz.com.
Information relating to executive compensation is set forth under the captions “Compensation of Directors and Executive Officers”, and “Compensation Committee Report on Executive Compensation - Compensation Committee Interlocks and Insider Participation” in the 2004 Proxy Statement and is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information relating to ownership of our common stock by certain persons is set forth under the caption “Security Ownership of Certain Beneficial Owners and Management” in the 2004 Proxy Statement and is incorporated herein by reference.
Equity Compensation Plan Information
The following table gives information about our common stock that may be issued under all of our existing equity compensation plans as of December 31, 2003, which include the Trizec Properties, Inc. 2002 Long Term Incentive Plan and escrowed share grants made on November 9, 2000. The 2002 Long Term Incentive Plan was approved by our stockholders.
Item 13.
Item 13. Certain Relationships and Related Transactions
Information relating to existing or proposed relationships or transactions between us and any of our affiliates is set forth under the caption “Certain Relationships and Related Transactions” in the 2004 Proxy Statement and is incorporated herein by reference.
Item 14.
Item 14. Principal Accountant Fees and Services
Information relating to the fees and services provided by our principal accountant and our audit committee’s pre-approval policies and procedures is set forth under the caption “Principal Accountant Fees and Services” in the 2004 Proxy Statement and is incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) Financial Statements and Financial Statement Schedules
See “Index to Financial Statements” on page of this Form 10-K.
We filed a current report on Form 8-K on November 6, 2003 under Item 5 of the Form pursuant to which we filed a press release announcing the appointment of two new independent members to our board of directors.

Filed herewith.

Furnished herewith.
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.
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.
Date: March 12, 2004
/s/ Timothy H. Callahan
Timothy H. Callahan
President, Chief Executive Officer and Director
(Principal executive officer)
/s/ Michael C. Colleran
Michael C. Colleran
Executive Vice President and Chief Financial Officer
(Principal financial and accounting officer)
/s/ Peter Munk
Peter Munk
Chairman of the Board of Directors
/s/ L. Jay Cross
L. Jay Cross
Director
/s/ Brian Mulroney
Brian Mulroney
Director
/s/ James J. O’Connor
James J. O’Connor
Director
/s/ Glenn Rufrano
Glenn Rufrano
Director
/s/ Richard Thomson
Richard Thomson
Director
/s/ Polyvios Vintiadis
Polyvios Vintiadis
Director
/s/ Stephen Volk
Stephen Volk
Director
/s/ Casey Wold
Casey Wold
Executive Vice President, Chief Operating Officer, Chief Investment
Officer and Director
INDEX OF EXHIBITS

Filed herewith.

Furnished herewith.
The Corporation is providing financial statements for TrizecHahn Hollywood Hotel LLC (“Hollywood Hotel”) for the years ended December 31, 2002 and 2001 for the purpose of complying with Rule 3-09 of Securities and Exchange Commission Regulation S-X. The Corporation has determined that Hollywood Hotel was a significant subsidiary for the years ended December 31, 2002 and 2001 as the Corporation’s equity in the income from continuing operations before income taxes, extraordinary items and cumulative effect of a change in accounting principle of Hollywood Hotel exceeded 20% of such income of the Corporation for such periods.
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.
Report of Independent Auditors
To the Board of Directors and Stockholders of
Trizec Properties, Inc.
In our opinion, the consolidated financial statements listed in the accompanying index on page present fairly, in all material respects, the financial position of Trizec Properties, Inc. (the “Corporation”) at December 31, 2003 and December 31, 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the consolidated financial statement schedule listed in the accompanying index on Page presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and the financial statement schedule are the responsibility of the Corporation’s management; our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 2 to the consolidated financial statements, the Corporation, on January 1, 2001, adopted Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended and interpreted; on January 1, 2003 adopted the provisions of Statement of Financial Accounting Standards No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections”; on July 1, 2003 adopted the provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock Based Compensation, “ as amended by Statement of Financial Accounting Standards No. 148, “Accounting for Stock Based Compensation - Transition and Disclosure”; and on December 31, 2003 adopted the provisions of Financial Accounting Standards Board Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities - an interpretation of ARB 51.”
/s/ PricewaterhouseCoopers LLP
Chicago, Illinois
February 27, 2004
Consolidated Balance Sheets at December 31, 2003 and 2002
See accompanying notes to the financial statements.
Consolidated Statements of Operations
See accompanying notes to the financial statements.
Consolidated Statements of Operations (Continued)
See accompanying notes to the financial statements.
Consolidated Statements of Comprehensive Income (Loss)
See accompanying notes to the financial statements.
Consolidated Statements of Changes in Stockholders’ Equity
$ thousands, except share amounts
[Additional columns below]
[Continued from above table, first column(s) repeated]
See accompanying notes to the financial statements.
Consolidated Statements of Changes in Stockholders’ Equity (Continued)
$ thousands, except share amounts
[Additional columns below]
[Continued from above table, first column(s) repeated]
See accompanying notes to the financial statements.
Consolidated Statements of Cash Flows
See accompanying notes to the financial statements.
Consolidated Statements of Cash Flows (Continued)
See accompanying notes to the financial statements.
Consolidated Statements of Cash Flows (Continued)
See accompanying notes to the financial statements.
Notes to the Financial Statements
$ thousands, except share and per share amounts
1.
ORGANIZATION AND DESCRIPTION OF THE BUSINESS
Organization
Trizec Properties, Inc. (“Trizec Properties” or “the Corporation”, formerly known as TrizecHahn (USA) Corporation) is a corporation organized under the laws of the State of Delaware and is approximately 40% indirectly owned by Trizec Canada Inc. On February 14, 2002, the amended registration statement on Form 10 of Trizec Properties was declared effective by the Securities and Exchange Commission and, accordingly, Trizec Properties became subject to the reporting requirements of the Securities Exchange Act of 1934, as amended. Trizec Properties was a substantially wholly-owned subsidiary of TrizecHahn Corporation (“TrizecHahn”), an indirect wholly-owned subsidiary of Trizec Canada Inc. A plan of arrangement (the “Reorganization”) was approved by the TrizecHahn shareholders on April 23, 2002 and on May 8, 2002, the effective date of the Reorganization, the common stock of Trizec Properties commenced regular trading on the New York Stock Exchange.
The accompanying financial statements include, on a consolidated basis (as of December 31, 2003 and 2002, and for the year ended December 31, 2003) and a combined consolidated basis (for the years ended December 31, 2002 and 2001), the U.S. assets of TrizecHahn, substantially all of which are owned and operated by Trizec Properties and Trizec R & E Holdings, Inc. (“TREHI”, formerly known as TrizecHahn Developments Inc.), TrizecHahn’s two primary U.S. operating and development companies prior to March 14, 2002. As described in Note 16, on March 14, 2002, TREHI was contributed to Trizec Properties. Prior to March 14, 2002, TREHI was a wholly-owned subsidiary of TrizecHahn. Accordingly, the organization presented in these financial statements was not a legal entity for 2001 or the entire 2002 year.
The Corporation operated as a separate stand alone entity prior to the Reorganization date and, as such, no additional expenses incurred by TrizecHahn or its related entities were, in management’s view, necessary to be allocated to the Corporation for the periods prior to the Reorganization. However, the financial results prior to the Reorganization are not necessarily indicative of future operating results and no adjustments were made to reflect possible incremental changes to the cost structure as a result of the Reorganization. The incremental charges will include, but are not limited to, additional senior management compensation expense to supplement the existing senior management team and internal and external public company corporate compliance costs.
The Corporation operates primarily in the U.S. where it owns, manages and develops office buildings and one mixed-use property. At December 31, 2003, it had ownership interests in a high-quality portfolio of 64 U.S. office properties concentrated in the metropolitan areas of seven major U.S. cities and one office property located in Toronto, Canada. In addition, the Corporation owns one retail/entertainment project. At the end of 2000, Trizec Properties decided that it would elect to be taxed as a real estate investment trust (“REIT”) pursuant to Sections 856 through 860 of the Internal Revenue Code of 1986, as amended, (the “Code”), commencing in 2001.
2.
SIGNIFICANT ACCOUNTING POLICIES
a.
Basis of Presentation
The accompanying financial statements as of December 31, 2003 and 2002 and for the year ended December 31, 2003 include the accounts and operating results of Trizec Properties and all of its subsidiaries. The accompanying financial statements for the years ended December 31, 2002 and 2001 include the combined accounts of Trizec Properties and TREHI and of all subsidiaries. Prior to the contribution of TREHI to Trizec Properties, both Trizec Properties and TREHI were indirect wholly-owned subsidiaries under the common control of TrizecHahn.
Assets that were transferred at the date of the Reorganization are reflected in the accompanying financial statements and have been presented using TrizecHahn’s historical cost basis.
The Corporation consolidates certain entities in which it owns less than a 100% equity interest if it is deemed to be the primary beneficiary in a variable interest entity, as defined in
Notes to the Financial Statements
$ thousands, except share and per share amounts
FIN No. 46R (hereinafter defined).
2.
SIGNIFICANT ACCOUNTING POLICIES, continued
a.
Basis of Presentation, continued
FIN No. 46R (hereinafter defined). The Corporation will re-evaluate and apply the provisions of FIN No. 46R to existing entities if certain reconsideration events warrant re-evaluation of such entities. In addition, the Corporation will apply the provisions of FIN No. 46R to all new entities in the future. The Corporation also consolidates entities in which it has a controlling direct or indirect voting interest. The equity method of accounting is applied to entities in which the Corporation does not have a controlling direct or indirect voting interest, but can exercise influence over the entity with respect to its operations and major decisions. The cost method is applied when (i) the investment is minimal (typically less than 5%) and (ii) the Corporation’s investment is passive. All significant intercompany balances and transactions have been eliminated.
For presentation purposes, the Corporation refers to and describes the accompanying financial statements for each year ended December 31, 2002 and 2001 as consolidated.
b.
Accounting Estimates
The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual amounts will differ from those estimates used in the preparation of these financial statements.
c.
Real Estate
Rental properties are recorded at cost, less accumulated depreciation. Depreciation of rental properties acquired prior to the adoption of SFAS No. 141 (hereinafter defined) is determined using the straight-line method over periods not exceeding a 40-year estimated life, subject to the terms of any respective ground leases. Tenant improvements are deferred and amortized on a straight-line basis over the term of the respective lease.
Maintenance and repair costs are expensed against operations as incurred. Planned major maintenance activities (for example: roof replacement and the replacement of heating, ventilation, air conditioning and other building systems), significant building improvements, replacements and major renovations, all of which improve or extend the useful life of the properties, are capitalized to rental properties and amortized over their estimated useful lives.
Furniture, equipment and certain improvements are depreciated on a straight-line basis over periods of up to 10 years.
In accordance with Statement of Financial Accounting Standards No. 141, “Business Combinations” (“SFAS No. 141”), the Corporation allocates the purchase price of real estate to land, building, tenant improvements and, if determined to be material, intangibles, such as the value of above, below and at-market leases, origination costs associated with the in-place leases, and the value of tenant relationships, if any. The Corporation depreciates the amount allocated to building and other intangible assets over their estimated useful lives, which generally range from one to 40 years. The values of the above and below market leases are amortized and recorded as either an increase (in the case of below market leases) or a decrease (in the case of above market leases) to rental income over the remaining term of the associated lease. The value associated with in-place leases and tenant relationships is amortized over the expected term of the relationship, which includes an estimate of probability of the lease renewal, and its estimated term. If a tenant vacates its space prior to the contractual termination of the lease and no rental payments are being made on the lease, any unamortized balance of the related intangible will be written off. The tenant improvements and origination costs are amortized as an expense over the remaining life of the lease (or charged against earnings if the lease is terminated prior to its contractual expiration date).
In accordance with SFAS No. 141, the Corporation performs (or engages a third party to perform) the following procedures for properties it acquires:
Notes to the Financial Statements
$ thousands, except share and per share amounts
2.
SIGNIFICANT ACCOUNTING POLICIES, continued
c.
Real Estate, continued
1)
estimate the value of the property “as if vacant” as of the acquisition date;
2)
allocate the fair value of the property among land, site improvement, building, and equipment and determine the associated asset life for each;
3)
estimate the fair value of the tenant improvements and calculate the associated asset life;
4)
compute the value of the difference between the “as if vacant” value of the property plus tenant improvements and the purchase price, which will represent the total intangible assets;
5)
allocate the value of the above and below market leases to the intangible assets and determine the associated life of the above/below market leases;
6)
allocate the value of the lease origination costs to the intangible assets and calculate the associated asset life;
7)
calculate the value and associated life of the tenant relationships, if any; and
8)
calculate the intangible value to the in-place leases and the associated life of these assets.
Properties under development consist of rental properties under construction and are recorded at cost, reduced for impairment losses where appropriate. Properties are classified as properties under development until the property is substantially completed and available for occupancy, at which time such properties are classified as rental properties and depreciation commences. The cost of properties under development includes costs incurred in connection with their acquisition, development and construction. Such costs consist of all direct costs including interest on general and specific debt and other direct expenses.
If events or circumstances indicate that the carrying value of a completed rental property, a rental property under development, or a property held for development may be impaired, a recoverability analysis is performed based on estimated undiscounted future cash flows to be generated from property operations and its projected disposition. If the analysis indicates that the carrying value is not recoverable from future cash flows, the property is written down to estimated fair value and an impairment loss is recognized.
Pursuant to the provisions of Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”), properties held for disposition are carried at the lower of their carrying values (i.e., cost less accumulated depreciation and any impairment loss recognized, where applicable) or estimated fair values less costs to sell. Estimated fair value is determined based on management’s estimate of amounts that would be realized if the property were offered for sale in the ordinary course of business assuming a reasonable sales period and under normal market conditions. Carrying values are reassessed at each balance sheet date. Implicit in management’s assessment of fair values are estimates of future rental and other income levels for the properties and their estimated disposal dates. Due to the significant uncertainty in determining fair value, actual proceeds realized on the ultimate sale of these properties will differ from estimates and such differences could be material. Depreciation ceases once a property is classified as held for disposition.
d.
Revenue Recognition
The Corporation has retained substantially all of the benefits and risks of ownership of its rental properties and therefore accounts for leases with its tenants as operating leases. Rental revenues include minimum rents and recoveries of operating expenses and property taxes. Recoveries of operating expenses and property taxes are recognized in the period the expenses are incurred.
The Corporation reports minimum rental revenue on a straight-line basis, whereby the known amount of cash to be received under a lease is recognized into income, over the term of the respective lease. The
Notes to the Financial Statements
$ thousands, except share and per share amounts
2.
SIGNIFICANT ACCOUNTING POLICIES, continued
d.
Revenue Recognition, continued
amount by which straight-line rental revenue exceeds minimum rents collected in accordance with the lease agreements is included in deferred rent receivables. When a property is acquired, the term of existing leases is considered to commence as of the acquisition date for purposes of this calculation. The impact of the straight-line adjustment increased rental revenue by $26,909, $33,275 and $20,888 for the years ended December 31, 2003, 2002 and 2001, respectively.
Certain tenants are required to pay overage rents based on sales over a stated base amount during the lease year. The Corporation recognizes overage rents only when each tenant’s actual sales exceed the stated base amount.
Parking and other revenue includes income from parking spaces leased to tenants, income from tenants for additional services provided by the Corporation, income from tenants for early lease termination and income from ancillary operations from the retail/entertainment properties.
Revenue is recognized on payments received from tenants for early lease terminations after the Corporation determines that all the necessary criteria have been met in accordance with SEC Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements”.
The Corporation provides an allowance for doubtful accounts representing that portion of tenant, other and deferred rent receivables which are estimated to be uncollectible. Such allowances are reviewed periodically based upon the recovery experience of the Corporation.
The Corporation recognizes property sales in accordance with Statement of Financial Accounting Standards No. 66, “Accounting for Sales of Real Estate.” The Corporation generally records the sales of operating properties using the full accrual method at closing when the earnings process is deemed to be complete. Sales not qualifying for full recognition at the time of sale are accounted for under other appropriate deferral methods.
Deferred revenue in respect of building telecommunication and service provider license agreements is recognized to income over the effective term of the license agreements. If a license agreement is terminated early, any remaining unamortized balance is recognized in income at that time.
e.
Investments
Investments in joint ventures in which the Corporation does not have a controlling direct or indirect voting interest, but can exercise significant influence over the entity with respect to its operations and major decisions, are accounted for using the equity method of accounting whereby the cost of an investment is adjusted for the Corporation’s share of equity in net income or loss from the date of acquisition and reduced by distributions received. The income or loss of each entity is allocated in accordance with the provision of the applicable operating agreements. The allocation provisions in these agreements may differ from the ownership interest held by each investor. Differences between the carrying amount of the Corporation’s investment in the respective entities and the Corporation’s share of the underlying equity of such unconsolidated entities are amortized over the respective lives of the underlying assets, as applicable.
Investments in which the Corporation’s investment is minimal (typically less than 5%) and passive are accounted for by the cost method of accounting. Income is recognized only to the extent of dividends or cash received.
The carrying value of investments which the Corporation determines to have an impairment in value considered to be other than temporary are written down to their estimated realizable value.
Notes to the Financial Statements
$ thousands, except share and per share amounts
2.
SIGNIFICANT ACCOUNTING POLICIES, continued
e.
Investments, continued
Marketable equity securities are accounted for in accordance with Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS No. 115”). Unrealized gains and losses on marketable equity securities that are designated as available-for-sale are included in accumulated other comprehensive (loss) income.
Investments in securities of non-publicly traded companies are recorded at cost as they are not considered marketable under SFAS No. 115. The equity securities which relate to building telecommunication and service provider license agreements and other non-publicly traded investments are included in prepaid expenses and other assets.
Mortgages receivable collateralized by real estate are carried at cost. The Corporation reviews, on a regular basis but not less than annually, or when events or circumstances occur, its mortgages receivable for impairment. Impairment is recognized when the carrying values of the mortgages receivable will not be recovered either as a result of the inability of the underlying assets’ performance to meet the contractual debt service terms of the underlying debt or the fair values of the collateral assets are insufficient to cover the obligations and encumbrances, including the carrying values of the mortgages receivable, in a sale between unrelated parties in the normal course of business. When a mortgage is considered impaired, an impairment charge is measured based on the present value of the expected future cash flows discounted at the effective rate of the mortgage or if the cash flows cannot be predicted with reasonable reliability, then the impaired mortgage is valued at the fair value of the underlying collateral. Interest income is generally recognized based on the terms and conditions of the mortgages receivable. Interest income ceases to be recognized when the underlying assets do not meet the contractual terms of the mortgages receivable, and are delinquent for a 90 day period. At such time interest income is generally recognized on a cash basis as payments are received.
f.
Income Taxes
In December 2000, Trizec Properties determined that it would elect to be taxed as a REIT pursuant to Sections 856 through 860 of the Code, commencing in 2001. The REIT election was effective with the filing of the Corporation’s 2001 tax return. In general, a corporation that distributes at least 90% of its REIT taxable ordinary income to its shareholders in any taxable year, and complies with certain other requirements (relating primarily to its organization, the nature of its assets, the sources of its revenues and ownership rules) is not subject to United States federal income taxation to the extent of the income which it distributes. Trizec Properties believes that it meets the qualifications for REIT status as of December 31, 2003 and 2002. For the years ended December 31, 2003, 2002 and 2001, the Corporation distributed 100% of its REIT taxable income to its shareholders. Accordingly, no provision has been made in the consolidated financial statements for federal income taxes for REIT purposes for the years ended December 31, 2003, 2002 and 2001 in respect of the Corporation.
The Corporation is subject to state and local income taxes and to federal income tax and excise tax on its undistributed income. In addition, taxable income from non-REIT activities managed through taxable REIT subsidiaries (“TRS”), and from foreign entities, are subject to federal, state, local and foreign income taxes.
In connection with its election to be taxed as a REIT, Trizec Properties also elected to be subject to the “built-in gain” rules. Under these rules, taxes may be payable at the time and to the extent that the net unrealized gains on Trizec Properties’ assets at the date of conversion to REIT status are recognized in taxable dispositions of such assets in the ten-year period following conversion. Management currently believes that Trizec Properties will not incur a material amount of such taxes on built-in gains during the ten-year period as substantially all of its assets are not held for disposition and due to the potential for Trizec Properties to make non-taxable asset dispositions, such as like-kind exchanges.
Notes to the Financial Statements
$ thousands, except share and per share amounts
2.
SIGNIFICANT ACCOUNTING POLICIES, continued
f.
Income Taxes, continued
TRS deferred income taxes, where applicable, are accounted for using the asset and liability method. Under this method, deferred income taxes are recognized for temporary differences between the financial reporting basis of assets and liabilities and their respective tax basis and for operating loss and tax credit carryforwards based on enacted tax rates expected to be in effect when such amounts are realized or settled. However, deferred tax assets are recognized only to the extent that it is more likely than not that they will be realized based on consideration of available evidence, including tax planning strategies and other factors.
g.
Cash and Cash Equivalents
Cash and cash equivalents consist of currency on hand, demand deposits with financial institutions, and short-term highly-liquid investments with an original maturity of 90 days or less.
h.
Escrows and Restricted Cash
Escrows consist primarily of amounts held by lenders to provide for future property tax expenditures and tenant improvements. In addition, during the years 2003 and 2002, escrows included net proceeds, intended to be reinvested, from sale of real estate assets intended to qualify for tax deferred gain recognition under Section 1031 of the Code. Restricted cash represents amounts committed for various utility deposits and security deposits. Certain of these amounts may be reduced upon the fulfillment of specific obligations.
i.
Deferred Charges
Deferred charges include deferred finance and leasing costs. Costs incurred to obtain financing are capitalized and amortized into interest expense on a straight-line basis, which approximates the effective yield method, over the term of the related debt.
All direct and indirect leasing costs, including a portion of estimated internal leasing costs associated with the rental of properties, are capitalized and amortized over the term of the related lease. Unamortized costs are charged to expense upon the early termination of the related lease.
j.
Derivative Instruments
The Corporation uses interest rate cap and swap agreements to manage risk from fluctuations in interest rates. Prior to January 1, 2001 the Corporation accounted for interest rate cap contracts as hedges and, as a result, the carrying values of the financial instruments were not adjusted to reflect their current market values. Any amounts receivable or payable arising from interest rate cap contracts were recognized as an adjustment of interest expense. Premiums paid to arrange interest rate cap contracts were deferred and amortized to interest expense over the term of the contracts. Under interest rate swap agreements, payments or receipts were recognized as adjustments to interest expense. The Corporation believes these agreements are with counterparties who are creditworthy financial institutions.
The Corporation adopted Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” as amended by Statement of Financial Accounting Standards No. 137 and Statement of Financial Accounting Standards No. 138 (collectively, “SFAS No. 133”), as of January 1, 2001. SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and hedging activities. It requires the recognition of all derivative instruments as assets or liabilities in the Corporation’s combined consolidated balance sheet at fair value. Changes in the fair value of derivative instruments that are not designated as hedges or that do not meet the hedge accounting criteria in SFAS No. 133 are required to be reported through the statement of operations. For derivatives designated as hedging instruments in qualifying cash flow hedges, the effective portion of changes in fair value of the derivatives is recognized in other comprehensive (loss) income until the forecasted transactions occur, and the ineffective portions are recognized in the statement of operations.
Notes to the Financial Statements
$ thousands, except share and per share amounts
2.
SIGNIFICANT ACCOUNTING POLICIES, continued
j.
Derivative Instruments, continued
Upon early termination of a derivative instrument that has been designated as a hedge, the resulting gains or losses are deferred and amortized as adjustments to interest expense of the related debt over the remaining period covered by the terminated instrument.
The Corporation uses certain interest rate protection agreements to manage risks from fluctuations in variable interest rates, as well as to hedge anticipated future financing transactions. Upon adoption of SFAS No. 133 in 2001, the Corporation expensed deferred charges of $280 related to these agreements. This was reflected in net income as a cumulative effect of a change in accounting principle. The Corporation’s derivatives also include investments in warrants to purchase shares of common stock of other public companies. Based on the terms of the warrant agreements, the warrants meet the definition of a derivative and accordingly must be marked to fair value with the impact reflected in the statement of operations. Prior to January 1, 2001, the Corporation had been recording the warrants at fair value through accumulated other comprehensive (loss) income as available-for-sale securities under SFAS No. 115. Upon adoption of SFAS No. 133 in 2001, the Corporation reclassified $4,351, the unrealized holding loss in respect of the warrants, from accumulated other comprehensive (loss) income to a cumulative effect of a change in accounting principle.
For the year ended December 31, 2003, the Corporation recorded unrealized derivative losses through other comprehensive income of $4,256 (2002 - $15,229, 2001 - $1,818). For the year ended December 31, 2002, the Corporation recorded derivative losses of $180 (2001 - $456) through the statement of operations, which included the total ineffectiveness of all cash flow hedges. The Corporation also recorded a derivative loss and write-down of $15,371 for the year ended December 31, 2001, that has been included in provision for and loss on investments in the statement of operations. The Corporation expects to amortize approximately $12.5 million from other comprehensive (loss) income into earnings within the next twelve months. In addition, the Corporation will record a loss of approximately $2.0 million in connection with the ineffective portion of certain interest rate swap agreements that were used to hedge variable rate debt that has been paid off and retired subsequent to year end.
k.
Fair Value of Financial Instruments
The estimated fair value of mortgage debt and other loans is based on the values derived using market interest rates of similar instruments. In determining estimates of the fair value of financial instruments, the Corporation must make assumptions regarding current market interest rates, considering the term of the instrument and its risk. Current market interest rates are generally selected from a range of potentially acceptable rates and, accordingly, other effective rates and/or fair values are possible.
The carrying amounts of cash and cash equivalents, escrows and restricted cash, accounts receivable, other assets, and accounts payable and accrued liabilities approximate their fair value due to the short maturities of these financial instruments.
l.
Minority Interest
The Corporation owns 100% of the general partner units and 98% of the limited partnership units (“Units”) of TrizecHahn Mid-Atlantic Limited Partnership (the “Partnership”) at December 31, 2003 and 2002. The remaining Units are held by unrelated limited partners who have a right to redeem their Units before 2012, at a redemption value equal to the fair market value of an equivalent number of shares of common stock of Trizec Properties. Upon redemption of the Units, the Partnership is required to pay cash to the holder in an amount equal to the redemption value, or the Corporation has the option of triggering the effective issuance of freely tradable shares of common stock of Trizec Properties. The redemption value of the outstanding Units is approximately $4,166 at December 31, 2003 (December 31, 2002 - $2,540). The change in redemption value is recorded as an allocation to minority interest in the consolidated statements of operations.
Notes to the Financial Statements
$ thousands, except share and per share amounts
2.
SIGNIFICANT ACCOUNTING POLICIES, continued
l.
Minority Interest, continued
On October 9, 2003, 4172352 Canada, Inc., an affiliate of Trizec Canada Inc., contributed approximately $4,000 to the Corporation in exchange for preferred membership units in an entity that holds a 91.5% interest in an entity that owns the Hollywood & Highland Hotel. The holders of the preferred membership units are entitled to an initial dividend of 8% per annum, increasing to 12% per annum, as well as any unrecovered capital contribution at the time of liquidation.
m.
Stock Based Compensation
Effective July 1, 2003, the Corporation adopted Statement of Financial Accounting Standards No. 123 “Accounting for Stock Based Compensation” (“SFAS No. 123”), as amended by Statement of Financial Accounting Standards No. 148 “Accounting for Stock Based Compensation - Transition and Disclosure” (“SFAS No. 148”). The Corporation is applying the fair value recognition provisions of SFAS No. 123, as amended by SFAS No. 148, prospectively to all employee stock options granted after December 31, 2002. For employee stock option grants accounted for under SFAS No. 123, compensation cost is measured as the fair value of the stock option at the date of grant. This compensation cost is charged to earnings over the vesting period. For stock options issued prior to January 1, 2003, the Corporation will continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations (“APB No. 25”). For employee stock option grants accounted for under APB No. 25, compensation cost is measured as the excess, if any, of the quoted market price of the Corporation’s common stock at the date of grant over the exercise price of the options granted. This compensation cost, if any, is charged to earnings over the vesting period. Except as detailed in Note 18 (a) with respect to options that were granted in connection with the Reorganization, the Corporation’s policy is to grant options with an exercise price equal to the quoted market price of the Corporation’s common stock. Stock option grant expense of approximately $1,054, $5,214 and $0 was recognized for the years ended December 31, 2003, 2002 and 2001, respectively.
The following reconciles net income (loss) available to common stockholders to pro forma net income (loss) available to common stockholders as if the fair value based method of accounting for employee stock options as prescribed under the provision of SFAS No. 123 had been applied to all outstanding and unvested employee stock options, and presents reported earnings per share (“EPS”) and pro forma EPS.
Notes to the Financial Statements
$ thousands, except share and per share amounts
2.
SIGNIFICANT ACCOUNTING POLICIES, continued
m.
Stock Based Compensation, continued
The pro forma stock option expense presented above may not be indicative of future periods expense due to the effects of the options issued in connection with the Reorganization.
n.
Recent Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46 “Consolidation of Variable Interest Entities” (“FIN No. 46”). The objective of this interpretation is to provide guidance on how to identify a variable interest entity (“VIE”) and determine whether the assets, liabilities, non-controlling interests, and results of operations of a VIE need to be included in a company’s consolidated financial statements. A company that holds variable interests in an entity will need to consolidate the entity if the company’s interest in the VIE is such that the company will absorb a majority of the VIE’s expected losses and/or receive a majority of the entity’s expected residual returns, if they occur. FIN No. 46 also requires additional disclosures by primary beneficiaries and other significant variable interest holders. In connection with any of the Corporation’s unconsolidated real estate joint ventures that may qualify as a VIE, provisions of this interpretation were originally to be effective for financial reports that contain interim periods beginning after June 15, 2003. On October 9, 2003, the FASB issued FASB No. FIN 46-6 “Effective Date of FASB Interpretation No. 46, Consolidation of Variable Interest Entities” (“FSP FIN 46-6”). The provisions of FSP FIN 46-6 defer the effective date for applying the provisions of FIN No. 46 to an interest held in a VIE or a potential VIE until the end of the first interim or annual period ending after December 15, 2003 (as of December 31, 2003, for an entity with a calendar year-end or quarter-end of December 31) if (1) the VIE was created before February 1, 2003 and (2) the public entity has not issued financial statements reporting the VIE in accordance with FIN No. 46, other than the disclosures required by paragraph 26 of FIN No. 46. On December 17, 2003, the FASB granted a partial deferral on the implementation of FIN No. 46. The partial deferral addressed all non-special purpose entities created prior to February 1, 2003. Public entities with these types of entities will be required to adopt FIN No. 46 at the end of the first interim or annual reporting period ending after March 15, 2004. This partial deferral has been incorporated into FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities” - an interpretation of ARB 51 (referred to as FIN No. 46R) issued on December 24, 2003. The Corporation has elected to adopt the implementation of FIN No. 46R as of December 31, 2003 and applied the provisions of FIN No. 46R for all entities as of such date. In applying the provisions of FIN No. 46R to all entities, the Corporation has determined that the Hollywood & Highland Hotel is a VIE and the Corporation is its primary beneficiary. As such, the Corporation has consolidated the financial position and results of operations of the Hollywood & Highland Hotel as of December 31, 2003. See Note 5 to the Consolidated Financial Statements for a detailed discussion and related disclosures as required by FIN No. 46R.
In April 2003, the FASB issued Statement of Financial Accounting Standards No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (“SFAS No. 149”). SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”. SFAS No. 149 amends SFAS No. 133 for decisions made (1) as part of the Derivatives Implementation Group process that effectively required amendments to SFAS No. 133, (2) in connection with other FASB projects dealing with financial instruments, and (3) in connection with implementation issues raised in relation to the application of the definition of a derivative, in particular, the meaning of an initial investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors, the meaning of underlying, and the characteristics of a derivative that contains financing components. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003. The provisions of SFAS No. 149 are to be applied prospectively. SFAS No. 149 does not impact the Corporation’s results of operations, financial position or liquidity.
Notes to the Financial Statements
$ thousands, except share and per share amounts
Notes to the Financial Statements
$ thousands, except share and per share amounts
3.
REAL ESTATE
The Corporation’s investment in real estate is comprised of:
a.
Properties - Held for the Long Term
b.
Properties - Held for Disposition
Properties held for disposition include certain properties that the Corporation has decided to dispose of in an orderly manner over a reasonable sales period.
(i)
The Corporation had properties designated as held for disposition at December 31, 2001. These assets were subject to the transition rules of SFAS No. 144, and, accordingly, the Corporation continues to account for these properties pursuant to Statement of Financial Accounting Standards No. 121 “Accounting for the Impairment of Long-Lived Assets to be Disposed Of” (“SFAS No. 121”).
Properties held for disposition at December 31, 2001 included three retail/entertainment properties, three technology center development properties, two non-core office properties and certain retail non-operating assets. During the year ended December 31, 2002, two of the retail/entertainment properties and one of the technology properties were reclassified to properties held for the long term, and the two non-core office properties, two of the technology properties and the retail non-operating assets were sold. In addition, the Corporation acquired 151 Front Street from TrizecHahn which had been designated as held for disposition in accordance with SFAS No. 121. As a result, at December 31, 2002, one retail/entertainment property and 151 Front Street remained as held for disposition in accordance with SFAS No. 121 with the results of operations included in continuing operations. During the year ended December 31, 2003, the
Notes to the Financial Statements
$ thousands, except share and per share amounts
3.
REAL ESTATE, continued
b.
Properties - Held for Disposition, continued
(ii)
Subsequent to January 1, 2002, the Corporation designated five office properties as held for disposition pursuant to SFAS No. 144. During 2002, three of these properties were sold, and at December 31, 2002, two of the properties remained as held for disposition. During the first quarter of 2003 these two office properties were sold and one additional office property located in West Palm Beach, Florida was designated as held for disposition pursuant to SFAS No. 144. During the second quarter of 2003, one additional office property located in Memphis, Tennessee was designated as held for disposition pursuant to SFAS No. 144. During the second quarter of 2003, the Corporation recognized a provision for loss on disposition on discontinued real estate of approximately $14,592 relating to such office property, which is included in provision for loss on disposition of discontinued real estate. The fair value was determined by a contract price less transaction costs. During the third quarter of 2003, the office property located in Memphis, Tennessee and the office property located in West Palm Beach, Florida were sold and one additional office property located in Minneapolis, Minnesota was designated as held for disposition pursuant to SFAS No. 144. During the third quarter of 2003, the Corporation recognized a provision for loss on disposition on discontinued real estate of approximately $3,572 relating to the office property located in Minneapolis, Minnesota, which is included in provision for loss on disposition of discontinued real estate. The fair value was determined by a contract price less transaction costs. During the fourth quarter of 2003, the office property located in Minneapolis, Minnesota was sold. Additionally, one office property located in Los Angeles, California, one building of an office property located in Dallas, Texas and the retail property located in Las Vegas, Nevada were designated as held for disposition pursuant to SFAS No. 144 and were sold during the quarter. As a result, no properties are held for disposition in accordance with SFAS No. 144 at December 31, 2003.
The results of operations, through the date of sale, and the gains on disposition for these eleven sold properties, for all periods presented, have been reported as discontinued operations. The following summarizes the condensed results of operations for these properties, excluding the gain on disposition.
Notes to the Financial Statements
$ thousands, except share and per share amounts
3.
REAL ESTATE, continued
b.
Properties - Held for Disposition, continued
Notes to the Financial Statements
$ thousands, except share and per share amounts
Notes to the Financial Statements
$ thousands, except share and per share amounts
4.
UNCONSOLIDATED REAL ESTATE JOINT VENTURES
The Corporation participates in unconsolidated real estate joint ventures in various operating properties which are accounted for using the equity method. In most instances, these projects are managed by the Corporation.
a.
The following is a summary of the Corporation’s ownership in unconsolidated real estate joint ventures at December 31, 2003 and December 31, 2002:
(1)
The amounts shown above approximate the Corporation’s economic and legal ownership interest as of December 31, 2003 and 2002. Cash flow from operations, capital transactions and net income are allocated to the joint venture partners in accordance with their respective partnership agreements. The Corporation’s share of these items is subject to change based on, among other things, the operations of the property and the timing and amount of capital transactions.
(2)
This property was sold on February 25, 2003.
(3)
This property has not been consolidated as the minority member has substantive participating rights that afford the minority member equal voting rights on all major operating decisions as well as final approval of the operating and capital expenditures budgets.
(4)
This property has been consolidated as of December 31, 2003 in accordance with FIN No. 46R. This property was sold on February 27, 2004.
Notes to the Financial Statements
$ thousands, except share and per share amounts
4.
UNCONSOLIDATED REAL ESTATE JOINT VENTURES, continued
b.
Unconsolidated Real Estate Joint Venture Financial Information
The following represents combined summarized financial information of the unconsolidated real estate joint ventures. The individual joint ventures that contribute more than 10% of net income have been itemized in the table below.
Balance Sheets
Notes to the Financial Statements
$ thousands, except share and per share amounts
4.
UNCONSOLIDATED REAL ESTATE JOINT VENTURES, continued
Statements of Operations
[Additional columns below]
[Continued from above table, first column(s) repeated]
Notes to the Financial Statements
$ thousands, except share and per share amounts
5.
CONSOLIDATED REAL ESTATE JOINT VENTURES
Consolidation of the Hollywood & Highland Hotel
As discussed in Note 2, the Corporation applied the provisions of FIN No. 46R for all entities as of December 31, 2003. The Corporation determined that the Hollywood & Highland Hotel was a VIE in which the Corporation was the primary beneficiary.
The Hollywood & Highland Hotel is a 640-room hotel located in Los Angeles, California. At December 31, 2003, the Corporation had a 91.5% ownership and economic interest in an entity that owns the Hollywood & Highland Hotel. Prior to December 31, 2003, the Corporation accounted for the Hollywood & Highland Hotel as an investment in an unconsolidated real estate joint venture. On December 31, 2003, the Corporation consolidated the Hollywood & Highland Hotel. The net impact of the consolidation of the Hollywood & Highland Hotel was an increase in the Corporation’s consolidated assets of approximately $93,979, representing the net book value of the real estate, cash and cash equivalents and other assets. In addition, the Corporation consolidated approximately $81,517 of mortgage debt related to the Hollywood & Highland Hotel. The Corporation’s maximum exposure to loss was approximately $81,517, representing the amount of mortgage debt outstanding at December 31, 2003. Upon consolidation of the Hollywood & Highland Hotel, the Corporation recognized a cumulative effect of a change in accounting principle of approximately $3,845 representing the minority member’s share of the Hollywood & Highland Hotel’s non-recoverable cumulative losses. On February 27, 2004, the Corporation sold the Hollywood & Highland Hotel (see Note 24).
6.
INVESTMENT IN SEARS TOWER
Mortgage Receivable
On December 3, 1997, the Corporation purchased a subordinated mortgage collateralized by the Sears Tower in Chicago, Illinois, for approximately $70,000 (the “Subordinated Mortgage”) and became the residual beneficiary of the trust that holds title to the Sears Tower. The outstanding balance of the Subordinated Mortgage, including accrued interest, was approximately $294.0 million at acquisition. At December 31, 2002, the Sears Tower was held by a trust established for the benefit of an affiliate of Sears, Roebuck and Co. The trust had a scheduled termination date of January 1, 2003, at which time the assets of the trust, subject to a participating first mortgage, were to be distributed to the Corporation as the residual beneficiary. The Subordinated Mortgage was subordinate to an existing non-recourse participating first mortgage (the “First Mortgage”).
The Subordinated Mortgage held by the Corporation, which was to mature in July 2010, had certain participation rights to the extent of available cash flow. Since acquisition, the Corporation had not been accruing interest income on the Subordinated Mortgage due to the uncertainty regarding ultimate collectibility of accrued interest. In 2002, a loss provision of approximately $48,292 was recorded to reduce the carrying value of the Corporation’s investment in the Sears Tower to its estimated fair value of approximately $23,600.
On August 28, 2003, the Corporation sold its interest in the Subordinated Mortgage to Metropolitan Life Insurance Company, the holder of the First Mortgage, for approximately $9,000. During the third quarter of 2003, the Corporation recognized a loss on the sale of its interest in the Subordinated Mortgage to Metropolitan Life Insurance Company of approximately $15,491. In addition, the Corporation recognized a tax benefit related to this transaction of approximately $12,000 which is included in benefit (provision) for income and other corporate taxes. Metropolitan Life Insurance Company has retained the Corporation as leasing and management agent for the Sears Tower on a third-party basis.
Notes to the Financial Statements
$ thousands, except share and per share amounts
7.
DEFERRED CHARGES
Deferred charges consist of the following:
8.
MORTGAGE DEBT, OTHER LOANS AND REVOLVING CREDIT FACILITY
[Additional columns below]
[Continued from above table, first column(s) repeated]
Notes to the Financial Statements
$ thousands, except share and per share amounts
8.
MORTGAGE DEBT, OTHER LOANS AND REVOLVING CREDIT FACILITY, continued
b.
Principal Repayments
Principal repayments of debt outstanding at December 31, 2003 are due as follows:
Notes to the Financial Statements
$ thousands, except share and per share amounts
8.
MORTGAGE DEBT, OTHER LOANS AND REVOLVING CREDIT FACILITY, continued
d.
Revolving Credit Facility
The Corporation entered into a three-year, $350,000 unsecured revolving credit facility with a group of banks in the fourth quarter of 2001. During the third quarter of 2002, while the Corporation believed it was in compliance with the financial covenants contained in the credit facility, the Corporation obtained from the lenders a temporary modification of the financial covenants and began active discussions to permanently modify these covenants and certain other terms. In the fourth quarter of 2002, the credit facility was amended and restated. The group of banks unanimously agreed to amend and restate the facility as a collateralized facility. Generally, in exchange for the receipt of collateral, the banks agreed to provide more flexible financial covenants than had been originally negotiated. The financial covenants, as defined in the credit facility, include the quarterly requirements for total leverage ratio not to exceed 65%, with the exception that the total leverage ratio could reach 67.5% for one calendar quarter in 2003, the requirement for the interest coverage ratio to be greater than 2.0 times and the requirement for the net worth to be in excess of $1.5 billion. The Corporation’s financial covenants also include a restriction on dividends or distributions of more than 90% of its funds from operations (as defined in the revolving credit facility agreement). If the Corporation is in default in respect of its obligations under the credit facility, dividends will be limited to the amount necessary to maintain REIT status. At December 31, 2003, the Corporation was in compliance with these financial covenants. Certain conditions of the amended credit facility may restrict the amount eligible to be borrowed at any time. At December 31, 2002, the amount eligible to be borrowed under the Corporation’s line of credit was approximately $320,000 and approximately $90,000 was outstanding under this facility. At December 31, 2003, the amount eligible to be borrowed was approximately $217,005, none of which was outstanding.
e.
Limitations on Indebtedness
The Corporation conducts its operations through various subsidiaries which are party to loan agreements containing provisions that require the maintenance of financial ratios and impose limitations on additional indebtedness and possible distributions in respect of capital stock.
f.
Liability for Obligations of Partners
The Corporation was contingently liable for certain obligations related to the Hollywood & Highland Hotel, one of the Corporation’s consolidated real estate joint ventures. At December 31, 2003, the Corporation had guaranteed or was otherwise contingently liable for an approximate $74,000 mortgage loan that was scheduled to mature in April 2003. All of the assets of the Hollywood & Highland Hotel were available for the purpose of satisfying this obligation. In April 2003, the joint venture amended and restated this loan, extending its maturity to April 2005. In addition, as part of the new agreement, the Hollywood & Highland Hotel joint venture paid approximately $15,267 to reduce the outstanding balance to approximately $78,000. The joint venture was also required to make a further payment of approximately $4,000 in October 2003 and was required to make another payment of approximately $4,000 in April 2004, so that the balance of the loan outstanding in April 2004 would be approximately $70,000. In April 2004, the loan was to be subject to a potential additional paydown based on a new appraisal. At December 31, 2002, the total amount the Corporation had guaranteed or was otherwise contingently liable for was approximately $100,867. This included approximately $93,267 related to the Hollywood & Highland Hotel and approximately $7,600 related to our New Center One joint venture that was retired upon the sale of the property in the New Center One joint venture. On February 27, 2004, the Corporation sold the Hollywood & Highland complex and is no longer contingently liable for obligations related to the Hollywood & Highland Hotel (see Note 24).
9.
REORGANIZATION COSTS
Based on the strategic plan adopted at the end of 2000, the Corporation targeted general and administrative expense savings from the benefits to be derived from both functional and office location consolidations. As a result of a comprehensive review of its operations during 2001 for this purpose, the Corporation initiated a reorganization plan to simplify its management structure and centralize accounting, payroll and information services functions in Chicago. The reorganization plan resulted in the separation of approximately 150 employees, exclusive of any new hires, by the end of 2002.
Notes to the Financial Statements
$ thousands, except share and per share amounts
Notes to the Financial Statements
$ thousands, except share and per share amounts
11.
PROVISION FOR AND LOSS ON INVESTMENTS
On August 28, 2003, the Corporation sold its interest in the Subordinated Mortgage collateralized by the Sears Tower to Metropolitan Life Insurance Company for approximately $9,000. The Corporation recorded a loss on the sale of the Subordinated Mortgage of approximately $15,491.
In 2002, the Corporation recorded a loss on its investment in the Sears Tower of approximately $48,292 to reduce the carrying value of the Corporation’s investment in the Sears Tower to its estimated fair value of approximately $23,600. In addition, on December 5, 2002, the Corporation sold its interest in Chelsfield plc for approximately $76,622, resulting in a loss of approximately $12,679.
During the year ended December 31, 2001, the Corporation fully provided for the cost of securities investments in certain building telecommunication and service providers, recording a $15,371 charge, which was net of the recognition of $3,542 of deferred license revenue on licenses that were terminated, as events and circumstances confirmed that the decline in value of these assets was considered to be other than temporary. This provision included the Corporation’s investment in Allied Riser Communications Corporation, Broadband Office Inc., Cypress Communications Inc. and OnSite Access Inc., which were originally received at no cash cost in exchange for providing licenses for building access rights.
In addition, included in the provision for loss is the investment in Captivate Network Inc., a privately held company, which was the Corporation’s only other investment in a building service provider. This investment consisted of common stock and warrants convertible into common stock. In November 2001, the Corporation’s subordinate ownership equity interest was significantly diluted as a result of preferential funding by other investors.
12.
INCOME AND OTHER CORPORATE TAXES
a.
Reconciliation of Net Income to Taxable Income
REIT taxable income differs from net income reported for financial reporting purposes due to differences for U.S. federal tax purposes in the estimated useful lives and methods used to compute depreciation and the carrying value of the investments in properties and the timing of revenue recognition, among other things. The following table reconciles the Corporation’s net income/(loss) available to common stockholders to taxable income for the years ended December 31, 2003, 2002 and 2001.
Notes to the Financial Statements
$ thousands, except share and per share amounts
12.
INCOME AND OTHER CORPORATE TAXES, continued
b.
Benefit/Provision for Income and Other Corporate Taxes
The benefit (provision) for income and other corporate taxes is as follows:
Deferred income taxes resulted primarily from temporary differences and the timing of recognition of net operating loss carry-forwards and asset cost bases, as well as differences in asset useful lives and depreciation methods, for financial and tax reporting purposes. Deferred taxes have been provided for the following:
•
For TREHI, prior to being contributed to Trizec Properties; and
•
For taxable REIT subsidiaries.
Notes to the Financial Statements
$ thousands, except share and per share amounts
Notes to the Financial Statements
$ thousands, except share and per share amounts
At December 31, 2002, the fair value less selling costs of an office property held for disposition, located in Lanham, Maryland, was approximately $9,782 less than the carrying value of the property.
15.
LAWSUIT SETTLEMENT
In July 2003, the Corporation reached an agreement in which the Corporation agreed to end litigation and resolve standing disputes concerning the development and subsequent bankruptcy of the hotel and casino adjacent to our Desert Passage project. In exchange for the Corporation’s agreement to end the development litigation and the Corporation’s agreement to permit and assist in the re-theming of the hotel and casino complex, the other parties to the litigation agreed to dismiss all claims against the Corporation. This settlement agreement was approved by the United States Bankruptcy Court for the District of Nevada in August 2003. In the third quarter of 2003, the Corporation recognized a gain on lawsuit settlement of approximately $26,659 comprised primarily of the forgiveness of debt. The Corporation did not receive any cash proceeds from the litigation settlement.
16.
RELATED PARTY INFORMATION
a.
Transactions During 2003
In July 2003, the Corporation issued 173,006 shares of its common stock to its Chairman of the Board as a net settlement of the exercise of 1,000,000 warrants held by the Chairman. The Corporation recognized compensation expense of approximately $2,080 related to the net settlement of such warrants, which is included in general and administrative expense.
b.
Transactions During 2002
Notes to the Financial Statements
$ thousands, except share and per share amounts
(ii)
Acquisition of 151 Front Street
On April 12, 2002, TrizecHahn transferred its interest in 151 Front Street, Toronto, Ontario, to the Corporation for approximately $29.6 million in cash. As a result of this related party transaction, the Corporation has recorded property value of approximately $29,115, which is TrizecHahn’s historical cost basis. The difference between cash paid and the historic book value has been recorded as a distribution of additional paid-in capital. 151 Front Street has been classified as a property held for disposition pursuant to the transition rules of SFAS No. 144.
(iii)
Contribution of Chelsfield plc
On April 19, 2002, in connection with the Reorganization, TrizecHahn contributed its investment in Chelsfield plc, a UK real estate company whose shares are listed on the London Stock Exchange, to the Corporation at TrizecHahn’s value of approximately $89,266. The Corporation owned approximately 19,512 ordinary shares, or approximately 6.9% of the outstanding ordinary shares, of Chelsfield plc as a result of this contribution. In consideration for the ordinary shares of Chelsfield plc received, TrizecHahn was issued 49,330 shares of Trizec Properties Class C Convertible Preferred Stock at a value of approximately $54,263 and retired a $35,000 non-interest bearing advance from the Corporation.
The Corporation’s investment in Chelsfield plc had been designated as an equity investment available for sale. The investment was carried at fair value with the resulting unrealized gain or loss, including any unrealized foreign currency exchange gain or loss, being recorded in other comprehensive income. On December 5, 2002, the Corporation sold its interest in Chelsfield plc for approximately $76,622. The Corporation recorded a loss of approximately $12,679.
(iv)
Contribution of Borealis
TrizecHahn had investments in private equity and venture capital funds managed by Borealis Capital Corporation and in Borealis Capital Corporation (collectively referred to as “Borealis”). On April 30, 2002, TrizecHahn contributed its investment in Borealis to the Corporation in exchange for 3,909 shares of Trizec Properties Class C Convertible Preferred Stock valued at approximately $4,300. During the year ended December 31, 2002, the Corporation received approximately $3,653 related to the disposition of a portion of its interest in Borealis.
Notes to the Financial Statements
$ thousands, except share and per share amounts
•
On December 11, 2001 certain U.S. technology center assets that were included in these combined consolidated financial statements but held directly by TrizecHahn were transferred to the Corporation. Pursuant to the Reorganization, these assets, net of related debt and other liabilities, which were held by a separate subsidiary of TrizecHahn (“823 Inc.”), were contributed to the Corporation in consideration for issuing to TrizecHahn 180,000 shares of Trizec Properties Common Stock, par value $0.01 per share. As a result of this transaction, Trizec Properties Common Stock and additional paid-in capital was increased by $2 and $16,548 respectively, with a corresponding decrease to advances to parent and affiliated companies. As a consequence, 823 Inc. became a wholly-owned subsidiary of Trizec Properties.
(ii)
In connection with the Reorganization, the Corporation completed the following transactions during 2001.
d.
Other Related Party Information
As part of the Reorganization, TrizecHahn repaid its remaining advances from the Corporation. At December 31, 2001, the non-interest bearing advances from and to the parent and affiliated companies were unsecured and due on demand.
For the periods presented, the Corporation, in the normal course of business, reimbursed its parent and/or affiliates for direct third party purchased services and a portion of salaries for certain employees for direct services rendered. A significant portion of the reimbursements had been for allocated or direct insurance premiums which amounted to approximately $10,915 and $7,102, for the years ended December 31, 2002 and 2001, respectively. For the year ended December 31, 2003, the Corporation was reimbursed by its parent for insurance premiums which amounted to approximately $196.
In connection with the Reorganization, the Corporation entered into a tax cooperation agreement with TrizecHahn Office Properties, Limited. Under the agreement, the Corporation has agreed to continue to conduct its business activities with regard to the consequences under Canadian tax legislation to TrizecHahn Office Properties, Limited, related Canadian corporations and Trizec Canada. Compliance with this agreement may require the Corporation to conduct its business in a manner that may not always be the most efficient or effective because of potential adverse Canadian tax consequences. Furthermore, incremental costs may be incurred due to the need to reimburse these entities for any negative tax consequences.
Notes to the Financial Statements
$ thousands, except share and per share amounts
16.
RELATED PARTY INFORMATION, continued
d.
Other Related Party Information, continued
In connection with the Reorganization, the Corporation has agreed to provide shared services to TrizecHahn, and therefore continues to provide certain services to assist TrizecHahn in fulfilling its public disclosure obligations and conducting investor, media and public relations. TrizecHahn has agreed to and continues to provide accounting services in conjunction with the Reorganization. For the year ended December 31, 2003, the Corporation has recorded other income of approximately $0.4 million for such services provided to TrizecHahn. In addition, the Corporation has recorded general and administrative expense of approximately $0.4 million for such services provided to the Corporation. Both amounts were outstanding at December 31, 2003.
17.
REDEEMABLE STOCK
The following classes of stock have been presented on the balance sheet outside of stockholders’ equity as a result of the redemption features available to the holders of the stock.
a.
Class F Convertible Stock
On December 3, 2001 the Corporation issued 100,000 shares (authorized 100,000 shares) of Class F Convertible Stock with a par value of $0.01 per share.
The Class F Convertible Stock is held by a subsidiary of Trizec Canada Inc. and is non-voting, entitled to cumulative dividends at a fixed rate per annum of $0.05 per share, redeemable at the Corporation’s option or the holder’s option after the expiration of the conversion period for $1.00 per share plus unpaid declared dividends and convertible at the holder’s option only upon the occurrence of certain defined events during a defined conversion period into a number of shares of common stock based on a defined formula.
The stock is convertible into additional shares of the Corporation’s common stock so that the Corporation and its stockholders, and Trizec Canada Inc. and its shareholders, may share the burden if tax pursuant to the Foreign Investment in Real Property Tax Act of 1980, or FIRPTA, is payable in connection with the Reorganization or other limited types of transactions or events.
The Corporation cannot declare or pay dividends on any of the other classes of stock nor can the Corporation redeem or purchase for cancellation any of the other classes of stock unless all unpaid and undeclared cumulative dividends have been declared and paid or set apart for payment.
The Corporation has recorded the holder’s redemption feature at $100 at December 31, 2003 and 2002.
b.
Special Voting Stock
On December 3, 2001, the Corporation issued 100 shares (authorized 100 shares) of Special Voting Stock with a par value of $0.01 per share. All shares of Special Voting Stock are held by a subsidiary of Trizec Canada Inc.
The Special Voting Stock has special voting rights that give the holder, when aggregated with the voting rights of Trizec Canada Inc. and its subsidiaries pursuant to ownership of common stock, a majority of votes in elections of directors to the Board of Directors of the Corporation at any time prior to January 1, 2008, so long as Trizec Canada Inc. and its subsidiaries hold at least 5% of the Corporation’s common stock. Thereafter, the Special Voting Stock is non-voting. In addition, for 66 months after the effective date of the Reorganization, this stock will entitle its holder to cash dividends that reflect non-Canadian taxes, principally cross-border withholding taxes, payable in respect of common stock dividends and special voting stock dividends paid to Trizec Canada Inc. or its subsidiaries. The Special Voting Stock is redeemable at the Corporation’s or the holder’s option after a defined date at $1,000 per share plus unpaid declared dividends.
The Corporation has recorded the holder’s redemption feature at $100 at December 31, 2003 and 2002.
Notes to the Financial Statements
$ thousands, except share and per share amounts
Notes to the Financial Statements
$ thousands, except share and per share amounts
Notes to the Financial Statements
$ thousands, except share and per share amounts
Notes to the Financial Statements
$ thousands, except share and per share amounts
19.
LONG TERM INCENTIVE PLAN AND OTHER AWARDS, continued
a.
Stock Options, continued
In connection with the Reorganization, employees, former employees and non-employee directors holding options to purchase subordinate voting shares of TrizecHahn that were cancelled in exchange for options received such options under the Plan. The vesting periods for these options range from immediately upon grant to up to four years. The options have a life of between 5.5 and 7 years.
The table below shows the movements during the years ended December 31, 2003 and 2002 in the stock options that the Corporation has granted. Prior to Reorganization, the Corporation did not have a stock option plan.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:
Notes to the Financial Statements
$ thousands, except share and per share amounts
19.
LONG TERM INCENTIVE PLAN AND OTHER AWARDS, continued
b.
Restricted Stock and Restricted Units
During the year ended December 31, 2003, the Corporation awarded 172,500 shares of restricted common stock to certain employees. These shares of restricted common stock had a fair value of approximately $1,894 on the date of grant. The restricted stock vests ratably over five years. Compensation expense will be charged to earnings over the vesting period. In December 2003, certain employees elected to have 116,500 shares of restricted common stock cancelled and were issued 116,500 restricted units in their place. The restricted units vest over the same five year period and have the same fair value as the restricted common shares cancelled. Holders of the restricted units have the option to defer settlement of the restricted units for a period of at least three additional years. Compensation expense will be charged to earnings over the vesting period.
During the year ended December 31, 2003, the Corporation awarded 172,500 shares of performance based restricted common stock to certain employees. These shares of performance based restricted common stock had a fair value of approximately $1,894 on the date of grant. The performance based restricted stock vests over periods from one to five years provided that specific performance objectives are achieved. Compensation expense will be charged to earnings over the vesting period. In December 2003, certain employees elected to have 116,500 shares of performance based restricted common stock cancelled and were issued 116,500 performance based restricted units in their place. The performance based restricted units vest over the same one to five year period, provided that specific performance objectives are achieved, and have the same fair value as the performance based restricted common shares cancelled. Holders of the restricted units have the option to defer settlement of the restricted units for a period of at least three years. Compensation expense will be charged to earnings over the vesting period.
c.
Warrants
In connection with the Reorganization, the Corporation issued 8,772,418 warrants. The table below summarizes the movement in the warrants outstanding during the years ended December 31, 2003 and 2002. Prior to Reorganization, the Corporation did not have warrants outstanding.
Notes to the Financial Statements
$ thousands, except share and per share amounts
Notes to the Financial Statements
$ thousands, except share and per share amounts
Notes to the Financial Statements
$ thousands, except share and per share amounts
21.
EMPLOYEE BENEFIT PLANS, continued
b.
Deferred Compensation Plan, continued
Under the plan, employees are permitted to defer up to 100% of their base salary and/or bonus on a pre-tax basis and to invest the deferred amount in various investment options. Additionally, the Corporation may make discretionary contributions under the plan on behalf of participants. Upon completion of a minimum deferral period of four years, participants’ may elect to release a portion of the deferred amount. In connection with the deferred compensation plan, a grantor trust has been established and contributions are made to the trust in amounts equal to participants’ deferrals and any discretionary contributions. Amounts deferred, and discretionary contributions if any, are expensed as funded. The amount expensed for the period ended December 31, 2003 was $38 (December 31, 2002 - $38; 2001 - $25). As of December 31, 2003, the Corporation had assets, included in prepaid expenses and other assets, of approximately $5,610 and accounts payable of approximately $3,528, representing the contributions to the plan and obligations to the plan, respectively. As of December 31, 2002, the Corporation had assets, included in prepaid and other assets, together with an equal amount in accounts payable, of approximately $3,360 representing the contributions to the plan and obligations to the employees.
c.
Employee Stock Purchase Plan
On March 18, 2003, the Board of Directors of the Corporation approved an employee stock purchase plan (the “ESPP”) that became effective upon approval by the Corporation’s stockholders on May 29, 2003. A total of 2,250,000 shares of the Corporation’s common stock are available for purchase under the ESPP. All employees of the Corporation and certain designated subsidiaries of the Corporation are eligible to participate in the ESPP as of the first month following the completion of six months of continuous employment. The ESPP provides for an offering period which generally runs from March 1 to February 28 or 29 of each year; however, the initial offering period under the ESPP runs from September 2, 2003 through February 29, 2004. Eligible employees may purchase shares worth up to $25 in fair market value per calendar year. The purchase price of the common stock under the ESPP is 85% of the lower of the fair market value of the common stock on (a) the first day of the offering period or (b) the date when the shares are purchased. Shares are purchased on the last trading day of each calendar month. For the year ended December 31, 2003, 35,925 shares had been issued to employees under the ESPP.
22.
ESCROWED SHARE GRANTS
On November 9, 2000, TrizecHahn Corporation made grants of escrowed shares to 26 U.S. employees under which an escrow agent purchased a total of 904,350 TrizecHahn Corporation subordinate voting shares in the open market and deposited them in escrowed accounts. The grants were made for the purpose of retaining key employees. In connection with the Reorganization, the TrizecHahn Corporation subordinate voting shares in escrow were exchanged in the same manner that all other subordinate voting shares of TrizecHahn Corporation were exchanged. The employee is entitled to the voting rights and dividends paid on the shares during the escrow period. One-third of the share grant vests and is released to the employee on each of the anniversary dates of the grant over a three-year period. Under the terms of the grants, an employee who voluntarily terminated his employment, unless such termination was the result of the alteration by the Corporation of the essential terms of employment without the employee’s consent in a manner materially adverse to the employee, or whose employment was terminated for cause, forfeited any entitlement to the shares not yet released from escrow. Fully accelerated vesting occurred if an employee’s employment was terminated by the Corporation without cause, by an employee as a result of the alteration by the Corporation of the essential terms of employment without the employee’s consent in a manner materially adverse to the employee, or due to the death of the employee. Upon a change of control, some employees were also entitled to receive fully accelerated vesting. The first and second tranches of shares vested on November 9, 2001 and November 9, 2002, respectively. Prior to the vesting of the third tranche, a limited number of the employees who received grants were given the opportunity to defer the vesting until a later date. Five of the eligible employees deferred their vesting, so that on November 9, 2003, 174,034 shares that had not been deferred fully vested and 55,004 shares remained unvested due to these deferrals. On February 22, 2004, all of the remaining grants vested. The cost of acquiring the shares of $12,402 was being amortized to compensation expense, on a straight-line basis, over the vesting period. Amounts expensed in respect of the escrowed share grants totaled $2,598 for the year ended December 31,
Notes to the Financial Statements
$ thousands, except share and per share amounts
22.
ESCROWED SHARE GRANTS, continued
2003 (for the year ended December 31, 2002 - $3,856, 2001 - $5,012). During the year ended December 31, 2003, 14,365 shares reverted back to the Corporation with an unamortized unearned compensation amount of approximately $197. During the year ended December 31, 2002, 3,646 shares reverted back to the Corporation with an unamortized unearned compensation amount of approximately $40.
23.
CONTINGENCIES
a.
Litigation
The Corporation is contingently liable under guarantees that are issued in the normal course of business and with respect to litigation and claims that arise from time to time. While the final outcome with respect to claims and litigation pending at December 31, 2003, cannot be predicted with certainty, in the opinion of management, any liability which may arise from such contingencies would not have a material adverse effect on the consolidated financial position, results of operations or liquidity of the Corporation.
b.
Concentration of Credit Risk
The Corporation maintains its cash and cash equivalents at financial institutions. The combined account balances at each institution typically exceed Federal Deposit Insurance Corporation (“FDIC”) insurance coverage and, as a result, there is a concentration of credit risk related to amounts on deposit in excess of FDIC insurance coverage. Management believes that this risk is not significant.
The Corporation performs ongoing credit evaluations of tenants and may require tenants to provide some form of credit support such as corporate guarantees and/or other financial guarantees. Although the Corporation’s properties are geographically diverse and tenants operate in a variety of industries, to the extent the Corporation has a significant concentration of rental revenue from any single tenant, the inability of that tenant to make its lease payment could have an adverse effect on the Corporation.
c.
Environmental
The Corporation, as an owner of real estate, is subject to various federal, state and local laws and regulations relating to environmental matters. Under these laws, the Corporation is exposed to liability primarily as an owner or operator of real property and, as such, it may be responsible for the cleanup or other remediation of contaminated property. Contamination for which the Corporation may be liable could include historic contamination, spills of hazardous materials in the course of its tenants’ regular business operations and spills or releases of hydraulic or other toxic oils. An owner or operator can be liable for contamination or hazardous or toxic substances in some circumstances whether or not the owner or operator knew of, or was responsible for, the presence of such contamination or hazardous or toxic substances. In addition, the presence of contamination or hazardous or toxic substances on property, or the failure to properly clean up or remediate such contamination or hazardous or toxic substances when present, may materially and adversely affect the ability to sell or lease such contaminated property or to borrow using such property as collateral.
Asbestos-containing material (“ACM”) is present in some of the Corporation’s properties. Environmental laws govern the presence, maintenance and removal of asbestos. The Corporation believes that it manages ACM in accordance with applicable laws and plans to continue managing ACM as appropriate and in accordance with applicable laws and believes that the cost to do so will not be material.
Compliance with existing environmental laws has not had a material adverse effect on the Corporation’s financial condition and results of operations, and the Corporation does not believe it will have such an impact in the future. In addition, the Corporation has not incurred, and does not expect to incur any material costs or liabilities due to environmental contamination as properties it currently owns or has owned in the past. However, the Corporation cannot predict the impact of new or changed laws or regulations on its properties or on properties that it may acquire in the future. The Corporation has no current plans for substantial capital expenditures with respect to compliance with environmental laws.
Notes to the Financial Statements
$ thousands, except share and per share amounts
23.
CONTINGENCIES, continued
d.
Insurance
The Corporation carries insurance on its properties of types and in amounts that it believes are in line with coverage customarily obtained by owners of similar properties. The Corporation believes all of its properties are adequately insured. The property insurance that has been maintained historically has been on an “all risk” basis, which until 2003 included losses caused by acts of terrorism. Following the terrorist activity of September 11, 2001 and the resulting uncertainty in the insurance market, insurance companies generally excluded insurance against acts of terrorism from their “all risk” policies. As a result, the Corporation’s “all risk” insurance coverage contained specific exclusions for losses attributable to acts of terrorism. In light of this development, for 2003 the Corporation purchased stand-alone terrorism insurance on a portfolio-wide basis with annual aggregate limits that it considers commercially reasonable, considering the availability and cost of such coverage. Such terrorism coverage carried an aggregate limit of $250 million on a portfolio-wide basis. Effective December 31, 2003, the Corporation amended its insurance coverage for acts of terrorism as a result of the Terrorism Risk Insurance Act of 2002 (“TRIA”) enacted by Congress and signed into law by President Bush in November 2002. The Corporation’s expired terrorism insurance program that provided a limit of $250,000 in the aggregate per year was replaced with a terrorism insurance program with a limit of $500,000 per occurrence. This current terrorism insurance program provides coverage for certified nuclear, chemical and biological exposure, whereas the previous insurance coverage excluded this exposure. Under TRIA, the Corporation has a per occurrence deductible of $100 and retains 10% of each nuclear, chemical and biological certified event up to a maximum of $50,000 per occurrence. If the certified terrorism event is not found to be a nuclear, chemical or biological event, the Corporation’s 10% exposure is limited to the $100 deductible. The federal government is obligated to cover the remaining 90% of the loss above the deductible up to $100 billion in the aggregate annually. Since the limit with respect to the Corporation’s portfolio may be less than the value of the affected properties, terrorist acts could result in property damage in excess of our current coverage, which could result in significant losses to the Corporation due to the loss of capital invested in the property, the loss of revenues from the impacted property and the capital that would have to be invested in that property. Any such circumstance could have a material adverse effect on our financial condition and results of operations of the Corporation. In the future, the Corporation may obtain different coverage depending on the availability and cost of third party insurance in the marketplace.
During 2003, the Corporation received notices to the effect that its insurance coverage against acts of terrorism may not comply with loan covenants under certain debt agreements. The Corporation reviewed its coverage and believed that it complied with these documents and that its insurance coverage adequately protected the lenders’ interests. The Corporation initiated discussions with these lenders to satisfy their concerns and assure that their interests and its interests are adequately protected. As a result of the Corporation’s discussions, the lenders who sent notices in 2003 accepted the insurance coverage that it provided, one of whom did so with a formal irrevocable waiver for the 2003 policies.
The new terrorism insurance program described above was effective December 31, 2003. Because the program relies upon TRIA, which was not signed into law until November 2002, it does not conform to the formal insurance requirements of the loan covenants that pre-dated TRIA. If a lender takes the position that the Corporation’s new insurance program is not in compliance with covenants in a debt agreement, the Corporation could be deemed to be in default under the agreement. In that case, the Corporation may decide to obtain insurance to replace or supplement its new insurance program in order to comply with the covenants. To date, however, the Corporation has not received any notices from any lenders stating that its insurance program is not in compliance with the loan covenants. In the future, the Corporation’s ability to obtain debt financing, or the terms of such financing, may be adversely affected if lenders insist upon additional requirements or greater insurance coverage against acts of terrorism than may be available to the Corporation in the marketplace at rates or on terms that are commercially reasonable.
Notes to the Financial Statements
$ thousands, except share and per share amounts
23.
CONTINGENCIES, continued
d.
Insurance, continued
The Corporation will continue to monitor the state of the insurance market, but it does not currently expect that coverage for acts of terrorism on terms comparable to pre-2002 policies will become available on commercially reasonable terms.
The Corporation’s earthquake insurance on its properties located in areas known to be subject to earthquakes is in an amount and subject to deductibles that the Corporation believes are commercially reasonable. However, the amount of earthquake insurance coverage may not be sufficient to cover all losses from earthquakes. Since the limit with respect to the Corporation’s portfolio may be less than the value of the affected properties, earthquakes could result in property damage in excess of our current coverage, which could result in significant losses to the Corporation due to the loss of capital invested in the property, the loss of revenues from the impacted property and the capital that would have to be invested in that property. Any such circumstances could have a material adverse effect on the Corporation’s financial condition and results of the Corporation’s operations. As a result of increased costs of coverage and decreased availability, the amounts of the third party earthquake insurance the Corporation may be able to purchase on commercially reasonable terms may be reduced. In addition, the Corporation may discontinue earthquake insurance on some or all of its properties in the future if the premiums exceed the Corporation’s estimation of the value of the coverage.
There are other types of losses, such as from wars, acts of bio-terrorism or the presence of mold at the Corporation’s properties, for which coverage is not available in the market to the Corporation or other purchasers of commercial insurance products. With respect to such losses and losses from acts of terrorism, earthquakes or other catastrophic events, if the Corporation experiences a loss that is uninsured or that exceeds policy limits, it could lose the capital invested in the damaged properties, as well as the anticipated future revenues from those properties. Depending on the specific circumstances of each affected property, it is possible that the Corporation could be liable for mortgage indebtedness or other obligations related to the property. Any such loss could materially and adversely affect the Corporation’s business and financial condition and results of operations.
Additionally, although the Corporation generally obtains owners’ title insurance policies with respect to its properties, the amount of coverage under such policies may be less than the full value of such properties. If a loss occurs resulting from a title defect with respect to a property where there is no title insurance or the loss is in excess of insured limits, the Corporation could lose all or part of its investment in, and anticipated income and cash flows from, such property.
24.
SUBSEQUENT EVENTS
In January 2004, the Corporation disposed of 151 Front Street, a mixed use office property comprised of approximately 272,000 square feet located in Toronto, Canada for gross proceeds of approximately $59,178. Included in the sale was the adjacent retail concourse, comprising approximately 39,000 square feet. In conjunction with the sale, the Corporation paid off and retired approximately $20.4 million of mortgage debt related to 151 Front Street.
In January 2004, the Corporation refinanced a $120,000 mortgage loan bearing an interest rate at LIBOR plus 2.75% and scheduled to mature in June 2004, with a $120,000 mortgage loan maturing in February 2014. In December 2003, the Corporation, through a third party, arranged to set a maximum rate on this loan through forward rate swap agreements. Upon closing of this loan, the Corporation paid approximately $3.9 million in settlement of these forward rate swap agreements, which the Corporation has recorded in other comprehensive income. The amount paid on settlement will be amortized into interest expense over the life of the mortgage loan.
Notes to the Financial Statements
$ thousands, except share and per share amounts
24.
SUBSEQUENT EVENTS, continued
In February 2004, the Corporation paid off and retired the mortgage debt on Galleria Towers in Dallas, Texas. The mortgage debt had a principal balance of approximately $133,490, bore interest at 6.79% and had a maturity date of May 2004.
On February 27, 2004, the Corporation sold the Hollywood & Highland complex in Los Angeles, California for gross proceeds of approximately $201,000. In conjunction with the sale, the Corporation paid off and retired approximately $214,115 of mortgage debt related to the Hollywood & Highland complex.
25.
SEGMENTED INFORMATION
The Corporation has determined that its reportable segments are those that are based on the Corporation’s method of internal reporting, which classifies its office operations by regional geographic area. This reflects a management structure with dedicated regional leasing and property management teams. The Corporation’s reportable segments by major metropolitan areas for office operations in the United States are: Atlanta, Chicago, Dallas, Houston, Los Angeles, New York, Washington D.C. and secondary markets. A separate management group heads the retail/entertainment development segment. The Corporation primarily evaluates operating performance based on internal property operating income, which is defined as total revenue including tenant recoveries, parking, fee and other income less operating expenses and property taxes including properties that have been designated as held for disposition and reported as discontinued operations. Of the eight properties reported as discontinued operations, one is in Dallas, one is in Los Angeles, two are in Washington, D.C., one is a retail property in Las Vegas and three are in the secondary markets of West Palm Beach, Florida; Memphis, Tennessee; and Minneapolis, Minnesota, respectively. Internal property operating income excludes property related depreciation and amortization expense. The accounting policies for purposes of internal reporting are the same as those described for the Corporation in Note 2 - Significant Accounting Policies, except that real estate operations conducted through joint ventures are consolidated on a proportionate line-by-line basis, as opposed to the equity method of accounting. All key financing, investing, capital allocation and human resource decisions are managed at the corporate level.
The following presents internal property operating income by reportable segment for the years ended December 30, 2003, 2002 and 2001.
Notes to the Financial Statements
$ thousands, except share and per share amounts
Notes to the Financial Statements
$ thousands, except share and per share amounts
25.
SEGMENTED INFORMATION, continued
The following is a reconciliation of internal property operating income to income (loss) from continuing operations.
The following is a reconciliation of internal property assets to consolidated total assets.
Notes to the Financial Statements
$ thousands, except share and per share amounts
Schedule III - Real Estate and Accumulated Depreciation as at December 31, 2003
($ thousands)
Schedule III - Real Esate and Accumulated Depreciation as at December 31, 2003
($ thousands)
Schedule III - Real Estate and Accumulated Depreciation as at December 31, 2003
($ thousands)
Schedule III - Real Estate and Accumulated Depreciation as at December 31, 2003
($ thousands)
Schedule III - Real Estate and
Accumulated Depreciation as at December 31, 2003
NOTES
SUMMARY OF ACTIVITY
A summary of activity of investment in real estate and accumulated depreciation is as follows:
The changes in investment in real estate for the years ended December 31, 2003, 2002 and 2001 are as follows:
Schedule III - Real Estate and
Accumulated Depreciation as at December 31, 2003
The changes in accumulated depreciation for the years ended December 31, 2003, 2002 and 2001 are as follows:
SCHEDULE
TRIZECHAHN HOLLYWOOD HOTEL LLC
(a Delaware limited liability company)
CONSOLIDATED FINANCIAL STATEMENTS
AND
REPORT OF INDEPENDENT ACCOUNTANTS
YEARS ENDED DECEMBER 31, 2002 and 2001
Report of Independent Accountants
To the Members of
TrizecHahn Hollywood Hotel LLC
In our opinion, the accompanying consolidated statements of financial position and the related consolidated statements of operations, of members’ capital and of cash flows present fairly, in all material respects, the financial position of TrizecHahn Hollywood Hotel LLC (the “Company”) at December 31, 2002 and 2001, 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. 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 audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
February 25, 2003
TRIZECHAHN HOLLYWOOD HOTEL LLC
(a Delaware limited liability company)
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
See accompanying notes to financial statements.
TRIZECHAHN HOLLYWOOD HOTEL LLC
(a Delaware limited liability company)
CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying notes to financial statements.
TRIZECHAHN HOLLYWOOD HOTEL LLC
(a Delaware limited liability company)
CONSOLIDATED STATEMENTS OF MEMBERS’ CAPITAL
For the years ended December 31, 2002 and 2001
See accompanying notes to financial statements.
TRIZECHAHN HOLLYWOOD HOTEL LLC
(a Delaware limited liability company)
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to financial statements.
TRIZECHAHN HOLLYWOOD HOTEL LLC
(a Delaware limited liability company)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
See accompanying notes to financial statements.
TRIZECHAHN HOLLYWOOD HOTEL LLC
(a Delaware limited liability company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A.
Organization and Basis of Presentation:
TrizecHahn Hollywood Hotel LLC (the “Company”) is a Delaware limited liability company, consisting of TrizecHahn Hollywood Inc. (“THH”) and REN Hollywood, LLC (“REN”) as members, and was formed in 1999 to develop, own and operate a hotel in Hollywood, California. The hotel is located in the heart of Hollywood, California at Hollywood & Highland Avenues and opened on December 26, 2001. It is a full-service hotel and has approximately 637 rooms, extensive banquet facilities as well as other amenities including pool, restaurants, and valet parking. An affiliate of REN, Renaissance Hotel Management, LLC (“Manager”), provides hotel management services pursuant to a management agreement.
On September 26, 2002, the Company entered into a lease transaction (“Lease”) whereby the hotel is leased to Hollywood Hotel TRS No. 2 LLC (“TRS No. 2”), which is wholly-owned by the Company. The Lease expires on September 30, 2007, but is automatically extended for four renewal terms of five years each provided no event of default has occurred and is continuing. Rent is payable monthly and is an amount equal to the greater of the calculated amount of minimum rent for the month or the amount of percentage rent calculated based on gross room revenues, gross food and beverage revenues and gross other revenues. Minimum rent is $3,214,000 for the first year, $5,142,000 for the second year and is increased by an inflation factor annually thereafter. The monthly amount of minimum rent is determined based on the percentage that budgeted gross revenues for the month are of the total year’s budgeted gross revenues.
THH is wholly-owned by Hollywood Hotel TRS No. 1 LLC, which is wholly-owned by Trizec R&E Holdings, Inc. (“TREHI”). TREHI became, as of March 14, 2002, a wholly owned subsidiary of Trizec Properties, Inc. (“TPI”), a publicly traded U.S. office REIT. Prior to September 26, 2002, THH was directly wholly-owned by TREHI.
REN is an indirect wholly-owned subsidiary of Marriott International Inc., a U.S. public company. At December 31, the Member interests are as follows:
The financials statements include all of the accounts of TrizecHahn Hollywood Hotel LLC and TRS No. 2. All significant intercompany balances and transactions have been eliminated.
Certain prior period figures have been reclassified to conform to current year presentation.
B.
Summary of Significant Accounting Policies:
Cash and Cash Equivalents
Short-term liquid investments with an original maturity of three months or less are considered cash equivalents.
TRIZECHAHN HOLLYWOOD HOTEL LLC
(a Delaware limited liability company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
B.
Summary of Significant Accounting Policies (Continued):
Restricted Cash
Under the terms of the management agreement, a minimum of 1% gross revenue, as defined, in the first fiscal year, and 2% for all subsequent fiscal years is required to be deposited into a reserve for the replacement of furniture, fixtures and equipment. At December 31, 2002 and 2001, $169,135 and $0, respectively, were included in cash restricted for furniture, fixtures and equipment. Restricted cash of $4,888,638 at December 31, 2001 represented cash amounts to be used to fund development expenditures.
Inventories
Supplies and food and beverage inventory consists primarily of short-term supplies and furnishings. Inventory that was purchased during the three months ended March 31, 2002 was added to the base inventory from December 31, 2001. Inventory is being depreciated based on a three-year life. Replacement purchases are expensed as incurred.
Hotel Property and Equipment
Hotel property is recorded at cost and includes direct construction costs, interest, construction loan fees, property taxes and related costs capitalized during the construction period. Chilled water systems were acquired under a capital lease arrangement. The costs of hotel buildings and improvements are depreciated using the straight-line method over an estimated useful life of 39 years. Equipment, furniture, and other assets have varying lives ranging from 3 to 15 years. Major improvements and replacements significantly extending the useful lives of the assets are capitalized, while ordinary maintenance and repairs are expensed as incurred.
Carrying Values of Hotel Property
The Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, on January 1, 2002. Under the provisions of SFAS No. 144, the Company assesses its hotel property for impairment whenever events or changes in circumstances indicate that the carrying amount of the property may not be recoverable. Estimated fair value is determined based on management’s estimate of amounts that would be realized if the property were offered for sale in the ordinary course of business assuming a reasonable sales period and under normal market conditions. Carrying value is reassessed at each balance sheet date. Implicit in management’s assessment of fair value is estimates of future rental and other income levels for the property and its estimated disposal dates. Due to the significant uncertainty in determining fair value, actual proceeds realized on the ultimate sale of the property will differ from estimates and such differences could be material.
The hotel property depends on tourism for a significant portion of its visitors. The September 11, 2001 terrorist attacks and the continuing threat of terrorism have impacted the levels of tourism at the hotel. As part of a valuation analysis performed on the hotel, an independent third party appraisal was obtained that indicated the value of the hotel had declined as of December 31, 2001. Accordingly, an impairment charge of approximately $31.6 million for the year ended December 31, 2001 was recorded to reduce the carrying value of the property.
The result of operations of the hotel did not meet the levels expected in 2002 and the Company believes that the fair value of the property has declined further. Accordingly, an additional impairment charge of approximately $42.4 million was recorded for the year ended December 31, 2002, based on an internal valuation of the hotel.
TRIZECHAHN HOLLYWOOD HOTEL LLC
(a Delaware limited liability company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
B.
Summary of Significant Accounting Policies (Continued):
At December 31, 2001, the property was considered as held for disposition pursuant to the provisions of SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of”. The Company anticipates that it will take longer than originally expected to stabilize this property. The Company plans to hold the property until it can determine that it can realize an acceptable level of value on disposition. The property is no longer considered as held for disposition and accordingly, depreciation commenced on October 1, 2002.
Prepaid Expenses and Other Assets
Costs incurred to obtain construction financing are amortized to interest expense over the life of the loan. At December 31, 2002 and 2001, total deferred finance charges, net of accumulated amortization was as follows.
Revenue Recognition
Revenues are recognized when earned upon facility use or food and beverage consumption. Room sales are recognized upon guest check-out. An allowance of 3% of the weighted average monthly accounts receivable balance is provided for potential credit losses.
Promotion Expense
Initial start up costs and opening costs are expensed as incurred.
Use of Estimates
The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual amounts will differ from those estimates used in the preparation of these financial statements.
Income Taxes
Taxable income or loss of the Company is reported by, and is the responsibility of, the respective members. Accordingly, the Company has no provision for income taxes.
Concentrations of Credit Risk
The Company’s financial instruments that are exposed to concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable. Accounts receivable includes amounts due from credit card companies, group travel organizations and others for the use of banquet facilities. The Company places its temporary cash investments with high credit quality institutions and cash accounts with federally insured institutions. Cash balances with any one institution may be in excess of the federally insured limits. The Company has not experienced any losses in such investments or accounts and believes it is not exposed to any significant credit risk with respect to cash and cash equivalents.
TRIZECHAHN HOLLYWOOD HOTEL LLC
(a Delaware limited liability company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
C.
Mortgage Debt and Other Loans
Construction Loan
On April 13, 2000, the Company entered into a construction loan agreement (“Loan Agreement”) with various financial institutions, as the Lenders, collateralized by the hotel property and a building loan deed of trust. The Company can borrow up to $98,000,000 (the “Note”). At December 31, 2002, $93,277,192 (December 31, 2001 - $77,582,969) had been drawn on the construction loan.
The Loan Agreement provides for an interest-only payment and accrues at either a LIBOR Rate or Base Rate, as defined, plus a margin (at Company’s option). At December 31, 2002, the LIBOR based rate was utilized at an all-in-one rate of 4.1875% (December 31, 2001 - 4.94%). In addition, the Company is required to pay a fee on the unused portion of the loan in the amount of .25% per annum. The note is due on April 13, 2003, unless extended by four six-month options, subject to certain financial requirements. Principal repayments are only required if the note is extended. Management is currently in the process of amending and restating this loan. The Company will likely repay a portion of the loan to reduce the balance to $78.0 million by April 2003 and likely repay an additional $8.0 million by April 2004, so that the balance at April 2004 will be approximately $70.0 million. At April 30, 2004, the loan will be subject to a potential paydown based on a new appraisal. The Company expects that the amended and restated loan will mature in April 2005.
The Loan Agreement requires the Company to meet an ongoing debt service coverage ratio of at least 1.4 beginning after the Initial Maturity Date, April 2003. If the minimum debt coverage ratio is not maintained, the lender will require excess cash flow, as defined in the Loan Agreement, to be applied to the outstanding loan balance. These terms are being modified as part of the loan amendment. Also required by the Loan Agreement are a number of covenants, including a requirement to submit annual audited financial statements 120 days after the Company’s fiscal year end.
In connection with the Note, TPI serves as guarantor with respect to the repayment of interest and principal. As payment guarantor, TPI is required to maintain a minimum net worth requirement and is required to maintain certain leverage and interest coverage ratios, as defined.
Loan from Member
Under the operating agreement (the “Agreement”), provided that REN has contributed the maximum development contribution, REN has the right to cause the Company to redeem $5 million of REN’s contribution. This right is exercisable only if, concurrently with such redemption, REN or its affiliates makes a $5 million loan to the Company on the terms and conditions outlined in the operating agreement. On September 26, 2002, REN exercised its redemption right and concurrently, an affiliate of REN, MICC (California), LLC, loaned to the Company $5 million (“MICC Loan”). The redemption was effective retroactive to January 31, 2002.
The loan is subordinate to the Note, is non-recourse and is collateralized by the pledge of Members’ interests. Interest accrues at 13% per annum and is payable at 10% per annum in monthly installments. All principal and accrued interest is payable on April 1, 2007.
The terms of this loan were subsequently amended to waive the requirement for monthly payments of interest effective November 1, 2002 and to reduce the interest accrual rate from 13% to 3%. If the MICC loan becomes due and payable prior to maturity, the amount required to repay the loan will be the amount due under the terms of the loan less an amount equal to the sum of monthly payments that would have been payable under the terms of the original loan agreement, prior to this amendment, from the date of the early repayment to the maturity date.
TRIZECHAHN HOLLYWOOD HOTEL LLC
(a Delaware limited liability company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
D.
Member Contributions, Distributions and Allocation of Net Income (Loss):
Through December 31, 2002, THH had made cash contributions of approximately $61.3 million and REN had made its maximum required cash contribution of $10.5 million. The Agreement provides that the managing member, THH, will issue a Cash Notice to each member as required. If the required contribution is not made within the parameters of the agreement, then the funding member can loan the amount to the partnership (“Deficit Loans”) or the non-funding member’s ownership is subject to a proportionate percentage of dilution. Deficit Loans bear interest at prime + 6%.
Amounts advanced by THH during 2002 and 2001 to fund initial working capital needs, unfunded development costs and debt servicing amounts have been recorded as capital contributions as the Company expects that these amounts may be repaid from the eventual sale of the hotel property. Current operating amounts paid for by THH or REN are recorded as due to affiliates.
During 2002, of the $3,038,558 advanced by THH, $797,349 was contributed as Deficit Loans pursuant to the Agreement and, accordingly, $27,609 of interest was recorded.
The Agreement includes a provision for REN to redeem $5 million of its capital contribution and concurrently loan the redeemed amount to the Company. REN exercised the redemption right on September 26, 2002, which was effective retroactive to January 31, 2002.
Member distributions, to the extent allowable, will be made monthly, first to repay any Deficit Loans made by any Member, if any, as defined in the Agreement (prorata based on the relative amounts outstanding under those loans), then to each Member based on each Member’s respective ownership interest at the date of distribution.
Net income and loss is allocated as defined in the Agreement. Generally, it provides for specific allocations of net income and loss based on each member’s proportionate share. To the extent net income or losses were previously allocated, net income is first allocated to net losses, then remaining amounts are applied in proportion with the member interests.
TRIZECHAHN HOLLYWOOD HOTEL LLC
(a Delaware limited liability company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
E.
Fair Value of Financial Instruments:
The carrying amount of cash and cash equivalents, accounts receivable and accounts payable are reasonable estimates of their fair values due to the short-term nature of those instruments. The carrying amount of accounts receivable and mortgage debt and other loans also approximates their fair value at December 31, 2002 and 2001.
F.
Commitments and Contingencies:
Construction Cost to Complete
The hotel was substantially complete on December 26, 2001. Estimated costs to complete were $0 at December 31, 2002 ($13 million at December 31, 2001).
Legal
The Company, from time to time, is involved in various claims and legal actions arising in the ordinary course of business. Although the final outcome of these matters cannot be determined, it is management’s opinion, based in part upon advice from legal counsel, that the final resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations, or liquidity.
Insurance
The insurance on the property is part of the portfolio-wide insurance obtained by TPI. All references to insurance obtained by the Company refer to the hotel property coverage under TPI’s portfolio-wide policy. The Company carries insurance on the property of types and in amounts that it believes are in line with coverage customarily obtained by owners of similar properties. The Company believes the property is adequately insured. The property insurance that has been maintained historically has been on an “all risk” basis which, until 2003, included losses caused by acts of terrorism. Following the terrorist activity of September 11, 2001 and the resulting uncertainty in the insurance market, insurance companies generally excluded insurance against acts of terrorism from their “all risk” policies. As a result, the Company’s “all risk” insurance coverage currently contains specific exclusions for losses attributable to acts of terrorism. In light of this development, for 2003, the Company purchased stand-alone terrorism insurance with annual aggregate limits that it considers commercially reasonable, considering the availability and cost of such coverage.
The Company’s earthquake insurance is in an amount and subject to deductibles that the Company believes are commercially reasonable. However, the amount of earthquake insurance coverage may not be sufficient to cover losses from earthquakes. As a result of increased costs of coverage and decreased availability, the amounts of the third party earthquake insurance the Company may be able to purchase on commercially reasonable terms may be reduced.
The Company has workers’ compensation and general liability insurance with self-insurance retention of $25,000 per occurrence for 2002 and 2001. An estimate of the amount due and payable claims for which the Company is liable is included in accounts payable and accrued liabilities.
TRIZECHAHN HOLLYWOOD HOTEL LLC
(a Delaware limited liability company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
G.
Related-Party Transactions:
THH and its affiliates provided development and various legal services to the Company during development. The development fee was computed at 4% of hard construction costs, as defined. A summary of costs and fees incurred and capitalized during 2001 are as follows: