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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
-------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________.
COMMISSION FILE NUMBER: 0-20016
-------------------------
CAREY INSTITUTIONAL PROPERTIES INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MARYLAND 13-3602400
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
50 ROCKEFELLER PLAZA 10020
NEW YORK, NEW YORK 10020 (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
REGISTRANT'S TELEPHONE NUMBERS:
INVESTOR RELATIONS (212) 492-8920
(212) 492-1100
-------------------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12 (g) OF THE ACT:
COMMON STOCK, $.001 PAR VALUE
-------------------------
CIP(R) has SHARES OF COMMON STOCK registered pursuant to Section 12(g) of the
Act.
CIP(R) HAS NO SECURITIES registered on any exchanges.
CIP(R) does not have any Securities registered pursuant to Section 12(b) of the
Act.
CIP(R) (1) has filed all reports required by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes [X] No [ ].
CIP(R) has no active market for common stock at August 11, 2003.
CIP(R) has 28,009,424 shares of common stock, $.001 par value outstanding at
August 11, 2003.
CAREY INSTITUTIONAL PROPERTIES INCORPORATED
INDEX
Page No.
--------
PART I
Item 1. - Financial Information*
Condensed Consolidated Balance Sheets, as of June 30, 2003
and December 31, 2002 2
Condensed Consolidated Statements of Income for the three and six
months ended June 30, 2003 and 2002 3-4
Condensed Consolidated Statements of Comprehensive Income
for the three and six months ended June 30, 2003 and 2002 4
Condensed Consolidated Statements of Cash Flows for the six months
ended June 30, 2003 and 2002 5-6
Notes to Condensed Consolidated Financial Statements 7-12
Item 2. - Management's Discussion and Analysis of Financial
Condition and Results of Operations 13-19
Item 3. - Quantitative and Qualitative Disclosures About Market Risk 20
Item 4. - Controls and Procedures 20
PART II - Other Information
Item 4. - Submission of Matters to a Vote of Security Holders 21
Item 6. - Exhibits and Reports on Form 8-K 21
Signatures 22
Certifications 23-24
* The summarized condensed financial statements contained herein are unaudited;
however, in the opinion of management, all adjustments necessary for a fair
presentation of such financial statements have been included.
-1-
CAREY INSTITUTIONAL PROPERTIES INCORPORATED
PART I
Item 1. - FINANCIAL INFORMATION
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, 2003 December 31, 2002
------------- -----------------
(Unaudited) (Note)
----------- ------
ASSETS:
Land and buildings, net of accumulated depreciation of $34,109,845 at
June 30, 2003 and $30,938,834 at December 31, 2002 $303,879,206 $300,808,511
Net investment in direct financing leases 130,376,975 133,955,555
Real estate under construction - 5,725,416
Assets held for sale 5,592,634 2,500,000
Equity investments 60,413,798 58,578,685
cash and cash equivalents 25,966,479 25,782,304
Marketable securities 12,020,195 11,014,711
Other assets 12,349,895 11,861,713
------------ ------------
Total assets $550,599,182 $550,226,895
============ ============
LIABILITIES, MINORITY INTEREST AND SHAREHOLDERS' EQUITY:
Liabilities:
Limited recourse mortgage notes payable $245,975,360 $248,519,101
Limited recourse mortgage note payable on assets held for sale 3,014,999 3,060,478
Accrued interest 1,823,271 1,550,184
Accounts payable and accrued expenses 1,071,119 1,832,633
Due to affiliates 2,668,972 2,552,528
Dividends payable 5,984,994 5,938,632
Other liabilities 5,868,275 6,259,707
------------ ------------
Total liabilities 266,406,990 269,713,263
------------ ------------
Minority interest 13,797,247 13,703,146
------------ ------------
Commitments and contingencies
Shareholders' equity:
Common stock, $.001 par value; authorized, 40,000,000 shares;
29,030,388 and 28,833,385 shares issued and outstanding at June
30, 2003 and December 31, 2002 29,030 28,833
Additional paid-in capital 311,349,367 308,659,610
Dividends in excess of accumulated earnings (31,656,502) (31,519,364)
Accumulated other comprehensive income 2,646,354 956,456
------------ ------------
282,368,249 278,125,535
Less, common stock in treasury at cost, 1,035,038 and 984,755 shares
at June 30, 2003 and December 31, 2002 (11,973,304) (11,315,049)
------------ ------------
Total shareholders' equity 270,394,945 266,810,486
------------ ------------
Total liabilities, minority interest and shareholders' equity $550,599,182 $550,226,895
============ ============
The accompanying notes are an integral part of the condensed
consolidated financial statements.
Note: The balance sheet at December 31, 2002 has been derived from the audited
consolidated financial statements at that date.
-2-
CAREY INSTITUTIONAL PROPERTIES INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2003 2002 2003 2002
---- ---- ---- ----
Revenues:
Rental income $ 9,507,451 $ 8,412,834 $19,002,111 $15,018,523
Interest income from direct financing
leases 3,925,516 3,355,347 7,797,358 6,197,380
Interest and other income 557,540 25,352 1,072,157 59,556
----------- ----------- ----------- -----------
13,990,507 11,793,533 27,871,626 21,275,459
----------- ----------- ----------- -----------
Expenses:
Interest 4,827,978 3,594,627 9,716,436 6,557,247
Depreciation 1,733,989 1,253,205 3,444,273 2,371,802
General and administrative 944,466 1,079,992 1,936,274 1,889,839
Property expenses 2,584,332 2,353,775 4,827,832 3,827,854
Impairment charge on real estate - - 674,370 -
Charge on early extinguishment of debt - - - 2,086,383
----------- ----------- ----------- -----------
10,090,765 8,281,599 20,599,185 16,733,125
----------- ----------- ----------- -----------
Income from continuing operations
before minority interest, equity
investments and gains and losses 3,899,742 3,511,934 7,272,441 4,542,334
Minority interest in (income) loss,
including charge on early
extinguishment of debt of $771,962 in
2002 (711,126) (456,530) (1,466,841) 68,892
Income from equity investments 2,485,964 2,069,856 5,491,028 3,968,444
----------- ----------- ----------- -----------
Income from continuing operations
before gains and losses 5,674,580 5,125,260 11,296,628 8,579,670
Unrealized loss on interest rate cap
derivative instrument (444) (28,794) (1,362) (28,794)
Reversal of unrealized gain on warrants in
connection with disposition - - - (2,128,000)
Gain on sale of warrants, net - - - 1,992,678
----------- ----------- ----------- -----------
Income from continuing operations 5,674,136 5,096,466 11,295,266 8,415,554
----------- ----------- ----------- -----------
Discontinued operations:
Income from operations of discontinued
properties 99,371 52,336 255,022 78,882
Gain on sale of real estate 257,599 8,774 257,599 8,774
----------- ----------- ------------ -----------
Income from discontinued operations 356,970 61,110 512,621 87,656
----------- ----------- ------------ -----------
Net income $ 6,031,106 $ 5,157,576 $11,807,887 $ 8,503,210
=========== =========== =========== ===========
The accompanying notes are an integral part of the condensed
consolidated financial statements.
-3-
CAREY INSTITUTIONAL PROPERTIES INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(continued)
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2003 2002 2003 2002
---- ---- ---- ----
Basic earnings per share:
Earnings from continuing operations $ .21 $ .20 $ .40 $ .35
Earnings from discontinued operations .01 - .02 -
----------- ----------- ----------- -----------
Net income $ .22 $ .20 $ .42 $ .35
=========== =========== =========== ===========
Diluted earnings per share:
Earnings from continuing operations $ .20 $ .19 $ .39 $ .35
Earnings from discontinued operations .01 - .02 -
----------- ----------- ----------- -----------
Net income $ .21 $ .19 $ .41 $ .35
=========== =========== =========== ===========
Weighted average common shares
outstanding-basic 27,987,525 26,057,433 27,941,653 24,162,174
=========== =========== =========== ===========
Weighted average common shares
outstanding-diluted 28,551,206 26,621,114 28,505,334 24,725,855
=========== =========== =========== ===========
The accompanying notes are an integral part of the condensed
consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2003 2002 2003 2002
---- ---- ---- ----
Net income $ 6,031,106 $5,157,576 $11,807,887 $8,503,210
----------- ---------- ----------- ----------
Other comprehensive income:
Change in unrealized gain on marketable
securities 637,440 - 1,100,836 -
Change in foreign currency translation
adjustment 515,494 671,910 589,062 526,420
----------- ---------- ----------- ----------
Other comprehensive income 1,152,934 671,910 1,689,898 526,420
----------- ---------- ----------- ----------
Comprehensive income $ 7,184,040 $5,829,486 $13,497,785 $9,029,630
=========== ========== =========== ==========
The accompanying notes are an integral part of the condensed
consolidated financial statements.
-4-
CAREY INSTITUTIONAL PROPERTIES INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended June 30,
-------------------------
2003 2002
---- ----
Cash flows from operating activities:
Net income $ 11,807,887 $ 8,503,210
Adjustments to reconcile net income to net cash provided by
continuing operations:
Income from discontinued operations (512,621) (87,656)
Depreciation and amortization 3,650,414 2,469,997
Income from equity investments in excess of distributions received (2,102,590) (1,104,591)
Charge on extinguishment of debt - 2,086,383
Minority interest in income 1,466,841 (68,892)
Straight-line rent adjustments (40,792) (92,753)
Provision for uncollected rent 224,803 310,000
Unrealized loss on interest rate cap 1,362 28,794
Reversal of unrealized gain on warrants in connection with disposition - 2,128,000
Gain on sale of warrants - (1,992,678)
Impairment charge on real estate 675,466 -
Issuance of shares in satisfaction of performance fees 1,792,939 1,382,063
Net change in operating assets and liabilities, net of assets and
liabilities acquired (1,473,881) (1,782,100)
------------ ------------
Net cash provided by continuing operations 15,489,828 11,779,777
Net cash provided by discontinued operations 264,079 317,587
------------ ------------
Net cash provided by operating activities 15,753,907 12,097,364
------------ ------------
Cash flows from investing activities:
Distributions from operations of equity investments in excess
of equity income 267,477 365,574
Proceeds from sale of warrants - 1,992,678
Proceeds from sale of real estate 2,361,741 301,317
Payment of leasing costs - (244,237)
Acquisition of real estate and additional capitalized costs (1,575,324) (2,553,166)
Redemption of dissenter interests with acquisition of business operations - (1,774,385)
Costs incurred in connection with acquisition of business operations - (615,766)
Cash acquired on acquisition of business operations - 765,493
------------ ------------
Net cash provided by (used in) investing activities 1,053,894 (1,762,492)
------------ ------------
Cash flows from financing activities:
Purchase of treasury stock (658,255) (1,236,704)
Repayment of mortgage payable (1,264,892) (33,404,478)
Payments of mortgage principal (2,929,585) (2,323,047)
Proceeds from mortgages 582,522 36,472,511
Proceeds from stock issuance 897,015 1,038,115
Distributions to minority partners (1,382,577) (724,689)
Contributions from minority partners - 250,375
Prepayment premium on extinguishment of debt - (2,086,383)
Payment of financing costs - (1,409,945)
Dividends paid (11,898,663) (9,439,849)
------------ ------------
Net cash used in financing activities (16,654,435) (12,864,094)
------------ ------------
Effect of exchange rate changes on cash 30,809 7,702
------------ ------------
Net increase (decrease) in cash and cash equivalents 184,175 (2,521,520)
Cash and cash equivalents, beginning of period 25,782,304 7,388,480
------------ ------------
Cash and cash equivalents, end of period $ 25,966,479 $ 4,866,960
============ ============
- continued -
-5-
CAREY INSTITUTIONAL PROPERTIES INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(continued)
Noncash investing activities:
A. The purchase of Corporate Property Associates 10 Incorporated on May 1,
2002 consisted of the acquisition of certain assets and liabilities at fair
value in exchange for the issuance of shares, notes payable and a cash
payment to dissenters as follows:
Real estate assets $127,721,807
Equity investment in Marcourt Investments, Inc., a real estate
investment trust 11,993,899
Cash 765,493
Other assets 5,204,479
Mortgage notes payable, net of discount of $294,273 (52,077,045)
Other liabilities (5,231,182)
Minority interest (2,092,437)
------------
Net assets acquired $ 86,285,014
============
Shares issued $ 73,155,478
Notes payable issued, net of discount of $383,737 11,355,151
Cash paid for redemption of dissenter interests 1,774,385
------------
Consideration paid $ 86,285,014
============
The accompanying notes are an integral part of the condensed
consolidated financial statements.
-6-
CAREY INSTITUTIONAL PROPERTIES INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 1. Basis of Presentation:
The accompanying unaudited condensed consolidated financial statements of Carey
Institutional Properties Incorporated (the "Company") have been prepared in
accordance with accounting principles generally accepted in the United States of
America for interim financial information and with the instructions to Article
10 of Regulation S-X of the Securities and Exchange Commission. Accordingly,
they do not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. All significant intercompany balances and transactions
have been eliminated. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation of
the results of the interim periods presented have been included. The results of
operations for the interim periods are not necessarily indicative of results for
the full year. These condensed consolidated financial statements should be read
in conjunction with the audited consolidated financial statements and footnotes
thereto included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2002.
Certain prior year amounts have been reclassified to conform to current year
financial statement presentation.
Note 2. Interest in Mortgage Loan Securitization:
The Company is accounting for its subordinated interest in the Carey Commercial
Mortgage Trust mortgage securitization as an available-for-sale security, which
is measured at fair value with all gains and losses from changes in fair value
reported as a component of other comprehensive income as part of shareholders'
equity. As of June 30, 2003, the fair value of the Company's interest was
$12,020,195, reflecting an aggregate unrealized gain of $1,552,568 and
cumulative net amortization of $149,018 ($95,352 for the six months ended June
30, 2003). The fair value of the Company's interests in the trust is determined
using a discounted cash flow model with assumptions of market rates and the
credit quality of the underlying lessees.
One of the key variables in determining the fair value of the subordinated
interest is current interest rates. As required by SFAS No. 140, "Accounting for
Transfer and Servicing of Financial Assets and Extinguishments of Liabilities,"
a sensitivity analysis of the current value of the interest based on adverse
changes in the market interest rates of 1% and 2% is as follows:
Fair Value as of June 30, 2003 1% Adverse Change 2% Adverse Change
------------------------------ ----------------- -----------------
Fair value of the interests $12,020,195 $11,416,055 $10,857,599
The above sensitivity is hypothetical and changes in fair value, based on a 1%
or 2% variation, should not be extrapolated because the relationship of the
change in assumption to the change in fair value may not always be linear.
-7-
CAREY INSTITUTIONAL PROPERTIES INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(Continued)
Note 3. Earnings Per Share:
Basic and diluted earnings per common share for the Company for the three-month
and six-month periods ended June 30, 2003 and 2002 were calculated as follows:
Three Months Ended June 30,
---------------------------
2003 2002
---- ----
Net income $ 6,031,106 $5,157,576
=========== ==========
Weighted average shares - basic 27,987,525 26,057,433
Effect of dilutive securities: Stock warrants 563,681 563,681
----------- ----------
Weighted average shares - diluted 28,551,206 26,621,114
=========== ==========
Basic earnings per share from continuing operations $ .21 $ .20
Basic earnings from discontinued operations .01 -
----------- ----------
Basic earnings per share $ .22 $ .20
=========== ==========
Diluted earnings per share from continuing operations $ .20 $ .19
Diluted earnings from discontinued operations .01 -
----------- ----------
Diluted earnings per share $ .21 $ .19
=========== ==========
Six Months Ended June 30,
-------------------------
2003 2002
---- ----
Net income $11,807,887 $ 8,503,210
=========== ===========
Weighted average shares - basic 27,941,653 24,162,174
Effect of dilutive securities: Stock warrants 563,681 563,681
----------- -----------
Weighted average shares - diluted 28,505,334 24,725,855
=========== ===========
Basic earnings per share from continuing operations $ .40 $ .35
Basic earnings from discontinued operations .02 -
----------- -----------
Basic earnings per share $ .42 $ .35
=========== ===========
Diluted earnings per share from continuing operations $ .39 $ .35
Diluted earnings from discontinued operations .02 -
----------- -----------
Diluted earnings per share $ .41 $ .35
=========== ===========
Note 4. Transactions with Related Parties:
In connection with performing services on behalf of the Company, the Advisory
Agreement between the Company and Carey Asset Management Corp, a wholly-owned
subsidiary of W. P. Carey & Co. LLC (the "Advisor"), provides that the Advisor
receive asset management and performance fees, each of which are 1/2 of 1/% of
Average Invested Assets as defined in the Advisory Agreement. The Advisor has
elected at its option to receive the performance fee in restricted shares of
common stock of the Company rather than cash. The Advisor is also reimbursed for
the actual cost of personnel needed to provide administrative services necessary
to the operation of the Company. The Company incurred asset management fees of
$892,070 and $837,207 for the three months ended June 30, 2003 and 2002,
respectively, and $1,785,766 and $1,540,957 for the six months ended June 30,
2003 and 2002, respectively, with performance fees in like amount. The Company
incurred personnel cost reimbursements of $407,567 and $411,293 for the three
months ended June 30, 2003 and 2002 and $819,633 and $698,807 for the six months
ended June 30, 2003 and 2002, respectively.
-8-
CAREY INSTITUTIONAL PROPERTIES INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(Continued)
Note 5. Lease Revenues:
The Company's operations consist of the direct and indirect investment in and
the leasing of industrial and commercial real estate. The financial reporting
sources of the lease revenues for the six-month periods ended June 30, 2003 and
2002 are as follows:
2003 2002
---- ----
Per Statements of Income:
Rental income from operating leases $19,002,111 $15,018,523
Interest from direct financing leases 7,797,358 6,197,380
Adjustments:
Share of leasing revenue applicable to
minority interest (2,736,073) (1,245,221)
Share of leasing revenue from equity
investments 9,192,039 7,481,043
----------- -----------
$33,255,435 $27,451,725
=========== ===========
For the six-month periods ended June 30, 2003 and 2002, the Company earned its
net lease revenues from its investments as follows:
2003 % 2002 %
---- - ---- -
Marriott International, Inc. (a) $ 4,657,376 14% $ 3,067,793 11%
Omnicom Group, Inc. 2,183,018 7 2,132,689 8
Information Resources, Inc. (b) 1,709,111 5 569,704 2
Advanced Micro Devices, Inc. (a) 1,629,306 5 1,629,469 6
Electronic Data Systems Corporation 1,503,465 5 1,369,514 5
Best Buy Co., Inc. (b) 1,481,614 4 1,492,100 5
Titan Corporation (b) 1,113,337 3 371,477 1
ShopRite Supermarkets, Inc. (b) 1,050,558 3 1,040,761 4
Lucent Technologies, Inc. 1,017,652 3 972,033 3
UTI Holdings, Inc. 883,023 3 893,077 3
EnviroWorks, Inc. 870,955 3 290,318 1
New WAI, L.P./Warehouse Associates 860,031 3 286,677 1
Garden Ridge, Inc. 803,603 2 778,217 3
Q Clubs, Inc. 741,673 2 710,098 3
Del Monte Corporation (a) 738,857 2 643,125 2
Sicor, Inc. (a) 736,368 2 736,368 3
Merit Medical Systems, Inc. 732,701 2 732,701 3
Barnes & Noble, Inc. 732,508 2 722,688 3
The Upper Deck Company (a) 726,110 2 726,110 3
Compucom Systems, Inc. (a) 704,022 2 678,178 2
Michigan Mutual Insurance Company 681,254 2 681,506 2
Plexus Corp. 634,346 2 634,346 2
Bell Sports Corp. 596,111 2 587,536 2
Other 6,468,436 20 5,705,240 22
----------- --- ----------- ---
$33,255,435 100% $27,451,725 100%
=========== === =========== ===
(a) Represents the Company's proportionate share of lease revenues from
its equity investments.
(b) Net of amounts applicable to minority interests.
For the six-month period ended June 30, 2003, lessees were responsible for the
direct payment of approximately $3,145,000 of real estate taxes on behalf of the
Company.
-9-
CAREY INSTITUTIONAL PROPERTIES INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(Continued)
Note 6. Equity Investments:
The Company owns a 47.3% interest in Marcourt Investments, Inc., a real estate
investment trust which net leases 13 hotel properties to a wholly-owned
subsidiary of Marriott International, Inc., with the remaining interests owned
by a third-party. The Company also owns interests with affiliates in properties
leased to corporations through equity interests in various partnerships and
limited liability companies and a tenancy-in-common interest subject to joint
control. The ownership interests range from 33.33% to 50%, and the underlying
investments are owned with affiliates that have similar investment objectives as
the Company. The lessees are Sicor Inc., The Upper Deck Company, Advanced Micro
Devices, Inc., Compucom Systems, Inc. and Del Monte Corporation.
Summarized financial information of the Company's equity investees is as
follows:
(in thousands) June 30, 2003 December 31, 2002
------------- -----------------
Assets (primarily real estate) $342,104 $343,846
Liabilities (primarily mortgage notes payable) 208,590 212,820
Shareholders' and members' equity 133,514 131,026
Six Months Ended June 30,
-------------------------
2003 2002
---- ----
Revenues (primarily rental income and interest income from
direct financing leases) $21,305 $21,809
Expenses (primarily interest on mortgage and depreciation) 10,347 10,724
------- -------
Net income $10,958 $11,085
======= =======
Note 7. Assets Held for Sale and Discontinued Operations:
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets," the net income
(or loss) and gain or loss on sale of real estate for properties sold or held
for sale are to be reflected in the consolidated statements of income as
"Discontinued Operations" for all periods presented. The provisions of SFAS No.
144 are effective for disposal activities initiated by the Company's commitment
to a plan of disposition after the date it is initially applied (January 1,
2002).
The Company owns a property in Maple Heights, Ohio leased to Nicholson
Warehouse, L.P. and a vacant property in Austin, Texas which are held for sale
as of June 30, 2003.
The results of operations of the two properties held for sale as of June 30,
2003 and properties in Broken Arrow, Oklahoma and Little Rock, Arkansas that
were sold in April 2003 and June 2002, respectively, are included as
"Discontinued Operations" and are summarized as follows:
Six Months Ended June 30,
-------------------------
2003 2002
---- ----
Revenues (primarily rental revenues and miscellaneous income) $ 511,935 $ 496,402
Expenses (primarily interest on mortgages, depreciation and
property expenses) (256,913) (417,520)
Gain on sale of real estate 257,599 8,774
--------- ---------
Income from discontinued operations $ 512,621 $ 87,656
========= =========
As a result of classifying the properties as held for sale, no depreciation has
been incurred from the date of reclassification. The effect of suspending
depreciation expense was to reduce the expense by $66,870 and $8,853 for the
three-month periods ended June 30, 2003 and 2002, respectively and $133,738 and
$17,705 for the six-month periods ended June 30, 2003 and 2002, respectively.
-10-
CAREY INSTITUTIONAL PROPERTIES INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(Continued)
Note 8. Impairment Charge on Real Estate:
The Company determined that an other than temporary decline in estimated
residual value had occurred at two properties which are included in net
investment in direct financing leases in the accompanying condensed consolidated
financial statements. The accounting for the direct financing leases was revised
using the changed estimates, which resulted in the recognition of impairment
charges of (i) $436,831 on the Company's property in Owingsville, Kentucky
leased to Custom Foods Products, Inc. and (ii) $237,539 on its property in the
United Kingdom leased to Gloystarne, Inc. ("Gloystarne"). During the six months
ended June 30, 2003, Gloystarne entered into receivership and is attempting to
sell its business.
Note 9. Accounting Pronouncements:
In June 2001, FASB issued SFAS No. 143 "Accounting for Asset Retirement
Obligations." SFAS No. 143 was issued to establish standards for the recognition
and measurement of an asset retirement obligation. SFAS No. 143 requires
retirement obligations associated with tangible long-lived assets to be
recognized at fair value as the liability is incurred with a corresponding
increase in the carrying amount of the related long-lived asset. SFAS No. 143 is
effective for financial statements issued for fiscal years beginning after June
15, 2002. SFAS No. 143 was adopted on January 1, 2003 and did not have a
material effect on the financial statements.
In May 2002, FASB issued SFAS No. 145 "Rescission of SFAS Nos. 4, 44 and 64,
Amendment of SFAS No. 13 and Technical Corrections" which eliminates the
requirement that gains and losses from the extinguishment of debt be classified
as extraordinary items unless it can be considered unusual in nature and
infrequent in occurrence. The Company adopted this Statement effective January
1, 2003 and the adoption did not have a material effect on the Company's
financial statements. The Company will no longer classify gains and losses for
the extinguishment of debt as extraordinary items and will adjust comparative
periods presented.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or Disposal
Activities". SFAS No. 146 addresses significant issues regarding the
recognition, measurement, and reporting of costs that are associated with exit
and disposal activities, including restructuring activities that are currently
accounted for pursuant to the guidance that the Emerging Issues Task Force
("EITF") has set forth in EITF Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)". The provisions of this
Statement are effective for exit or disposal activities that are initiated after
December 31, 2002, with early application encouraged. SFAS No. 146 was adopted
on January 1, 2003 and did not have a material effect on the Company's financial
statements.
In October 2002, the FASB issued SFAS No. 147, "Acquisition of Certain Financial
Institutions" which amends SFAS No. 72, SFAS No. 144 and FASB Interpretation No.
9. SFAS No. 147 provides guidance on the accounting for the acquisitions of
certain financial institutions and includes long-term customer relationships as
intangible assets within the scope of SFAS No. 144. SFAS No. 147 was adopted on
January 1, 2003 and did not have a material effect on the financial statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others," ("FIN 45") which changes the accounting for, and
disclosure of certain guarantees. Beginning with transactions entered into after
December 31, 2002, certain guarantees are required to be recorded at fair value,
which is different from prior practice, under which a liability was recorded
only when a loss was probable and reasonably estimable. In general, the change
applies to contracts or indemnification agreements that contingently require the
Company to make payments to a guaranteed third-party based on changes in an
underlying asset, liability, or an equity security of the guaranteed party. The
adoption of the accounting provisions of FIN 45 on January 1, 2003 did not have
a material effect on the Company's financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," which amends SFAS No. 123, Accounting
for Stock Based Compensation. SFAS No. 148 provides alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock based compensation (i.e., recognition of a charge for issuance of
stock options in the determination of income.). However, SFAS No. 148 does not
permit the use of the original SFAS No. 123 prospective method of transition for
changes to the fair value based method made in fiscal years beginning after
December 15, 2003. In addition, this Statement amends the
-11-
CAREY INSTITUTIONAL PROPERTIES INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(Continued)
disclosure requirements of SFAS No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for stock
based employee compensation, description of transition method utilized and the
effect of the method used on reported results. The transition and annual
disclosure provisions of SFAS No. 148 are to be applied for fiscal years ending
after December 15, 2002. The Company does not have any employees nor any
stock-based compensation plans.
On January 17, 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), the primary objective of which is to
provide guidance on the identification of entities for which control is achieved
through means other than voting rights ("variable interest entities" or "VIEs")
and to determine when and which business enterprise should consolidate the VIE
(the "primary beneficiary"). This new model applies when either (1) the equity
investors (if any) do not have a controlling financial interest or (2) the
equity investment at risk is insufficient to finance that entity's activities
without additional financial support. In addition, FIN 46 requires both the
primary beneficiary and all other enterprises with a significant variable
interest in a VIE make additional disclosures. The Company's maximum loss
exposure is the carrying value of its equity investments. The Company has
evaluated and believes this interpretation will not have a material impact on
its accounting for its investments in unconsolidated joint ventures as none of
these investments are VIEs.
On April 30, 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging under SFAS No. 133. The
changes in the statement improve financial reporting by requiring that contracts
with comparable characteristics be accounted for similarly. In particular, the
statement (1) clarifies under what circumstances a contract with an initial net
investment meets the characteristics of a derivative instrument discussed in
paragraph 6(b) of SFAS No. 133, (2) clarifies when a derivative contains a
financing component, (3) amends the definition of an underlying to conform it to
language used in FIN 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others", and (4)
amends certain other existing pronouncements. SFAS No. 149 is generally
effective for contracts entered into or modified after June 30, 2003 and for
hedging relationships designated after June 30, 2003. The guidance is to be
applied prospectively.
On May 30, 2003, the FASB issued SFAS No. 150 "Accounting for Certain Financial
Instruments with Characteristics of both Liability and Equity." SFAS No. 150
establishes standards to classify as liabilities certain financial instruments
that are mandatorily redeemable or include an obligation to repurchase. Such
financial instruments will be measured at fair value with changes in fair value
included in the determination of net income. 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. The Company is currently evaluating whether this will have an impact
on the financial statements.
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CAREY INSTITUTIONAL PROPERTIES INCORPORATED
Item 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following information should be read in conjunction with Carey Institutional
Properties Incorporated's ("CIP(R)") condensed consolidated financial statements
and notes thereto as of June 30, 2003 included in this quarterly report and
CIP(R)'s Annual Report on Form 10-K for the year ended December 31, 2002. This
quarterly report contains forward looking statements. Such statements involve
known and unknown risks, uncertainties, and other factors that may cause the
actual results, performance, or achievement of CIP(R) to be materially different
from the results of operations or plans expressed or implied by such forward
looking statements. Accordingly, such information should not be regarded as
representations by CIP(R) that the results or conditions described in such
statements or the objectives and plans of CIP(R) will be achieved. Item 1 of the
Annual Report on Form 10-K for the year ended December 31, 2002 provides a
description of CIP(R)'s business objectives, acquisition and financing
strategies and risk factors which could affect future operating results.
CRITICAL ACCOUNTING POLICIES:
Certain accounting policies are critical to the understanding of CIP(R)'s
financial condition and results of operations. Management believes that an
understanding of financial condition and results of operations requires an
understanding of CIP(R)'s accounting policies.
The preparation of financial statements requires that Management make estimates
and assumptions that affect the reported amount of assets, liabilities, revenues
and expenses. For instance, CIP(R) must assess its ability to collect rent and
other tenant-based receivables and determine an appropriate charge for
uncollected amounts. Because CIP(R)'s real estate operations have a limited
number of lessees, Management believes that it is necessary to evaluate specific
situations rather than solely use statistical methods. CIP(R) generally
recognizes a provision for uncollected rents which typically ranges between
0.25% and 1% of lease revenues (rental income and interest income from direct
financing leases) and will measure its allowance against actual rent arrearages
and adjust the percentage applied.
Operating real estate is stated at cost less accumulated depreciation. Costs
directly related to build-to-suit projects, primarily interest, if applicable,
are capitalized. No interest was capitalized in the six months ended June 30,
2003. CIP(R) considers a build-to-suit project as substantially completed upon
the completion of improvements, but no later than a date that is negotiated and
stated in the lease. If portions of a project are substantially completed and
occupied and other portions have not yet reached that stage, the substantially
completed portions are accounted for separately. CIP(R) allocates costs incurred
between the portions under construction and the portions substantially completed
and only capitalizes those costs associated with the portion under construction.
CIP(R) also uses estimates and judgments when evaluating whether long-lived
assets are impaired. When events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable, Management performs
projections of undiscounted cash flows, and if such cash flows are insufficient,
the assets are adjusted (i.e., written down) to their estimated fair value. An
analysis of whether a real estate asset has been impaired requires Management to
make its best estimate of market rent, residual value and holding period. As
CIP(R)'s investment objective is to hold properties on a long-term basis,
holding periods will range from five to ten years. In its evaluations, CIP(R)
obtains market information from outside sources; however, such information
requires Management to determine whether the information received is appropriate
to the circumstances. Depending on the assumptions made and estimates used, the
estimated cash flow projected in the evaluation of long-lived assets can vary
within a range of outcomes. Because CIP(R)'s properties are leased to single
tenants, CIP(R) is more likely to incur significant writedowns when
circumstances affecting a tenant deteriorate because of the possibility that a
property will be vacated in its entirety. This makes the risk different than the
risks faced by companies that own multi-tenant properties. Events or changes in
circumstances can result in further writedowns and impact the gain or loss
ultimately realized upon sale of the asset. For its direct financing leases,
CIP(R) performs a review of its estimated residual values of properties at least
annually to determine whether there has been an other than temporary decline in
CIP(R)'s current estimate of residual value. If the review indicates a decline
in residual value that is other than temporary, a loss is recognized and the
accounting for the direct financing lease will be revised using the changed
estimate, that is, a portion of the future cash flow from the lessee will be
recognized as a return of principal rather than as revenue.
-13-
CAREY INSTITUTIONAL PROPERTIES INCORPORATED
Item 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
When assets are identified by management as held for sale, CIP(R) discontinues
depreciating the assets and estimates the sales price, net of selling costs, of
such assets. If in Management's opinion, the net sales price of the assets which
have been identified for sale is less than the net book value of the assets, an
impairment charge is recognized, and a valuation allowance is established. If
circumstances arise that previously were considered unlikely and, as a result,
the Company decides not to sell a property previously classified as held for
sale, the property is reclassified as held and used. A property that is
reclassified is measured and recorded individually at the lower of (a) its
carrying amount before the property was classified as held for sale, adjusted
for any depreciation expense that would have been recognized had the property
been continuously classified as held and used, or (b) the fair value at the date
of the subsequent decision not to sell.
In 2002, CIP(R) acquired a subordinated interest in a mortgage trust that
consists of limited recourse loans on 62 properties that are owned by CIP(R) or
three of its affiliates. The fair value of the interests in the trust is
determined using a discounted cash flow model with assumptions of market rates
and the credit quality of the underlying lessees. If there are adverse changes
in either market rates or the credit quality of the lessees, the model and,
therefore, the income recognized from the subordinated interests and the fair
value will be adjusted.
CIP(R) measures derivative instruments, including certain derivative instruments
embedded in other contracts, if any, at fair value and records them as an asset
or liability, depending on CIP(R)'s right or obligations under the applicable
derivative contract. For derivatives designated as fair value hedges, the
changes in the fair value of both the derivative instrument and the hedged item
are recorded in earnings (i.e., the forecasted event occurs). For derivatives
designated as cash flow hedges, the effective portions of the derivatives would
be reported in other comprehensive income and are subsequently reclassified into
earnings when the hedged item affects earnings. Changes in the fair value of
derivative instruments not designated as hedging and ineffective portions of
hedges are recognized in earnings in the affected period.
CIP(R) and affiliated REITs are investors in certain real estate ventures.
Certain of the investments are held through incorporated or unincorporated
jointly held entities and certain investments are held directly as tenants in
common. Substantially all of these investments represent jointly purchased
properties which were net leased to a single tenant and were structured to
provide diversification and reduce concentration of a risk from a single lessee
for CIP(R) and the affiliated REIT. The placement of an investment in a jointly
held entity or tenancy in common requires the approval of the Independent
Directors. All of the jointly held investments are structured so that CIP(R) and
the affiliated REIT contribute equity, receive distributions and are allocated
profit or loss in amounts that are proportional to their ownership interests. No
fees are payable to affiliates under any of the partnership or joint venture
agreements. All of the jointly held investments are subject to contractual
agreements. The presentation of these jointly held investments and their related
results in the accompanying consolidated financial statements is based on
factors such as controlling interest, significant influence and whether each
party has the ability to make independent decisions. Equity method investments
are reviewed for impairment in the event of a change in circumstances that is
other than temporary. An investment is only impaired if Management's estimate of
the net realizable value of the investment is less than the carrying value of
the investment. To the extent that an impairment has occurred, the loss shall be
measured as the excess of the carrying amount of the investment over the fair
value of the investment.
Stated rental revenue and interest income from direct financing leases are
recognized on a straight-line basis and a constant rate of interest,
respectively, over the terms of the respective leases. Unbilled rents receivable
represents the amount by which straight-line rental revenue exceeds rents
currently billed in accordance with the lease agreements. The majority of
CIP(R)'s leases provide for periodic rent increases based on formulas indexed to
increases in the CPI. CPI-based and other contingent-type rents are recognized
currently. CIP(R) recognizes rental income from sales overrides, after the level
of sales requiring a rental payment to CIP(R) is reached.
CIP(R) classifies its directly-owned leased assets for financial reporting
purposes as either real estate leased under the operating method or net
investment in direct financing leases at the inception of a lease based on
several criteria, including, but not limited to, estimates of the remaining
economic life of the leased assets and the calculation of the present value of
future minimum rents. In determining the classification of a lease, CIP(R) uses
estimates of remaining economic life provided by independent appraisals of the
leased assets. The calculation of the present value of future minimum rents
includes determining a lease's implicit interest rate which requires an estimate
of the residual value of leased assets as of the end of the non-cancelable lease
term. Different estimates of residual value result in different
-14-
CAREY INSTITUTIONAL PROPERTIES INCORPORATED
Item 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
implicit interest rates and could possibly affect the financial reporting
classification of leased assets. The general terms of CIP(R)'s leases are not
necessarily different for operating and direct financing leases; however the
classification is based on accounting pronouncements which are intended to
indicate whether the risks and rewards of ownership are retained by the lessor
or transferred to the lessee. Management believes that it retains certain risks
of ownership regardless of accounting classification.
Costs incurred in connection with leases are capitalized and amortized on a
straight-line basis over the terms of the related leases and included in
property expense. Unamortized leasing costs are also charged to property expense
upon early termination of the lease. Costs incurred in connection with obtaining
mortgages and debt financing are capitalized and amortized over the term of the
related debt and included in interest expense. Unamortized financing costs are
written off and included in charges for early extinguishment of debt if a loan
is retired.
CIP(R) consolidates its foreign subsidiaries. To the extent that these
investments and subsidiaries account for their financial position and results of
operations in a functional currency other than U.S. dollars, it is necessary for
the Company to translate from the functional currency to U.S. dollars. The
functional currency is the currency of the primary economic environment in which
the real estate investments or subsidiary operates. The translation of the
functional currency for assets and liabilities uses the current exchange rate as
of the balance sheet date and for revenues and expenses uses a weighted average
exchange rate during the period. Gains and losses resulting from foreign
currency translation adjustments are reported as a component of other
comprehensive income as part of shareholders' equity.
Foreign currency transactions may produce receivables or payables that are fixed
in terms of the amount of foreign currency that will be received or paid. A
change in the exchange rates between the functional currency and the currency in
which a transaction is denominated increases or decreases the expected amount of
functional currency cash flows upon settlement of that transaction. That
increase or decrease in the expected functional currency cash flows is a foreign
currency transaction gain or loss that generally is included in determining net
income for the period in which the exchange rate changes. Likewise, a
transaction gain or loss measured from the transaction date or the most recent
intervening balance sheet date, whichever is later, realized upon settlement of
a foreign currency transaction generally is included in net income from the
period in which the transaction is settled. Foreign currency transactions are
not included in determining net income but are accounted for in the same manner
as foreign currency translation adjustments and reported as a component of other
comprehensive income as part of shareholders' equity if (i) they are designated
as, and are effective as, economic hedges of a net investment or are (ii)
intercompany foreign currency transactions that are of a long-term nature (that
is, settlement is not planned or anticipated in the foreseeable future), when
the entities to the transactions are consolidated or accounted for by the equity
method in the Company's financial statements.
Public business enterprises are required to report financial and descriptive
information about their reportable operating segments. Operating segments are
components of an enterprise about which financial information is available that
is evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and in assessing performance. Management evaluates the
performance of its portfolio of properties as a whole, rather than by
identifying discrete operating segments. This evaluation includes assessing
CIP(R)'s ability to meet distribution objectives, increase the dividend and
increase value by evaluating potential investments in single tenant net lease
real estate and by seeking opportunities such as refinancing mortgage debt at
lower rates of interest, restructuring leases or paying off lenders at a
discount to the face value of the outstanding mortgage balance. As of June 30,
2003 and 2002, CIP(R) owned real estate in the United States, the United Kingdom
and France.
RESULTS OF OPERATIONS:
CIP(R)'s results of operations for the three-month and six-month periods ended
June 30, 2003 and 2002 are not directly comparable because the results for 2003
reflect a company whose asset base is approximately 50% greater than the assets
of CIP(R) prior to its merger with Corporate Property Associates 10 Incorporated
("CPA(R):10"), an affiliate, and includes income generated from assets acquired
in CIP(R)'s merger. On May 1, 2002, CIP(R) acquired the business operations of
CPA(R):10 with investments in net lease real estate and with the same objectives
as CIP(R)'s, through a merger approved by the shareholders of both companies.
CIP(R) increased its asset base by acquiring interests in 45 properties with a
fair value of $139,716,000 and assumed interests in 17 leases with 14 tenants.
CIP(R) also acquired limited recourse mortgage debt with a fair value of
$52,077,000 as of the date of acquisition.
-15-
CAREY INSTITUTIONAL PROPERTIES INCORPORATED
Item 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Net income for the three-month and six-month periods ended June 30, 2003
increased by $874,000 and $3,305,000 as compared with for the three-month and
six-month periods ended June 30, 2002, respectively. The results for the six
months ended June 30, 2002 included a charge on the early extinguishment of debt
of $2,086,000 of which $772,000 was applicable to a minority interest owner. The
increases in income for the comparable periods also reflect an increase in lease
revenues, interest income and income from equity investments resulting from the
increase in assets and were partially offset by increases in interest expense,
depreciation and property expenses. These increases are primarily due to the
merger with CPA(R):10 and, an increase in interest income, to the placement of
mortgages in connection with a mortgage securitization transaction that was
completed in August 2002.
Lease revenues increased by $1,665,000 and $5,584,000 for the three-month and
six-month periods ended June 30, 2003, respectively, of which, for the
three-month and six-month periods, $1,104,000 and $4,622,000, respectively, was
attributable to the property interests acquired from CPA(R):10. Lease revenues
benefited from scheduled rent increases on eighteen leases in 2002 and 2003 and
from the completion of a build-to-suit project for a Holiday Inn in Toulouse,
France in February 2002 and a further expansion of the property which was
completed in February 2003. Lease revenues also increased as a result of
consolidating investments in properties leased to Childtime Childcare, Inc. and
ShopRite Supermarkets, Inc. as a result of contributing CIP(R)'s majority
tenancy-in-common interests in the properties to limited partnerships in August
2002. Prior to the contribution CIP(R) recorded its share of revenues and
expenses from these properties on a pro-rata basis. The change in ownership
increased lease revenues by $933,000 for the comparable six-month periods;
however, this had no overall effect on net income or cash flow. These increases
in lease revenues were partially offset by a lease termination and the
subsequent sale of a property leased to Waban, Inc. and the termination of a
lease with Bolder Technologies Corporation, both in 2002. The Waban and Bolder
leases contributed annual lease revenues of $1,779,000. Twenty-one leases have
rent increases scheduled for 2003 and 2004. The majority of these rent increases
are based on formulas indexed to increases in the CPI. The annual increase in
the CPI over the past several years has ranged between 1.5% and 3%. CIP(R)'s
leases generally have increases scheduled in intervals of between one and five
years.
In April 2003, Kmart Corporation terminated its lease for its Denton, Texas
store in connection with its bankruptcy reorganization. Annual rent from the
Denton store was $215,000. Kmart affirmed its leases for its properties in
Drayton Plains, Michigan and Citrus Hills, California, which contribute
aggregate annual lease revenues of $390,000. Kmart's plan of reorganization was
confirmed by the bankruptcy court and it emerged from bankruptcy on May 6, 2003.
CIP(R) is seeking to re-lease the Denton property. CIP(R) leases a property in
the United Kingdom to Gloystarne & Co., Ltd. at an annual rent of approximately
$610,000. In January 2003, Gloystarne entered into receivership and is selling
its business. Although Gloystarne is current in its rent obligation through June
24, 2003, there is no assurance that its future rent obligations will be met or
that a purchaser of Gloystarne's operations will rent the property on similar
terms.
Interest and other income increased from $25,000 to $558,000 for the comparable
three-month periods and from $60,000 to $1,072,000 for the comparable six-month
periods, primarily as a result of interest income earned from CIP(R)'s
subordinated interest in Carey Commercial Mortgage Trust. Interest income from
the mortgage trust participation was $342,000 and $712,000 for the three-month
and six-month periods ended June 30, 2003, respectively. Interest income was
also affected by higher cash balances which increased from proceeds received
from placing mortgages on previously unencumbered properties in connection with
the mortgage securitization in August 2002.
Income from equity investments increased by $416,000 and $1,523,000 for the
three-month and six-month periods ended June 30, 2003, respectively, primarily
because CIP(R)'s ownership interest in Marcourt Investments, Inc., a lessee of
13 Courtyard by Marriott hotels, increased from 24% to 47% as a result of the
merger with CPA(R):10. Income from equity investments also benefited from rent
increases at properties leased to Del Monte Corporation and Compucom Systems,
Inc.
Interest expense increased by $1,233,000 to $4,828,000 for the three-month
period and by $3,159,000 to $9,716,000 for the six-month period as the result of
obtaining $83,667,000 of new loans in August 2002 in connection with a mortgage
securitization and assuming $52,077,000 of existing mortgages on the properties
acquired from CPA(R):10 in May 2002.
The increase in property expense of $229,000 and $999,000 for the three-month
and six-month periods, respectively, was due to an increase in asset management
fees and performance fees and to carrying costs of a property in Golden,
Colorado formerly leased to Bolder Technologies. Included in property expense
for the six months ended June 30, 2003 are $536,000 of costs for the Golden
property, including environmental cleanup costs at the property. The cleanup was
-16-
CAREY INSTITUTIONAL PROPERTIES INCORPORATED
Item 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
undertaken voluntarily and was not subject to any regulatory requirements. Asset
management and performance fees are based on the appraised value of CIP(R)'s
real estate assets, which increased as a result of the assets acquired in the
merger. During the six months ended June 30, 2003, CIP(R) recognized impairment
charges totaling $674,000 on properties leased to Custom Foods Products, Inc.
and Gloystarne as a result of an other than temporary decline in the estimated
residual values of its direct financing leases.
The results for the six months ended June 30, 2002 included a charge of
$1,314,000, net of a 37% minority interest for early extinguishment of debt in
connection with the refinancing in January 2002 of a mortgage on properties
leased to Best Buy Co., Inc. which was refinanced at a lower rate of interest.
Financial Condition:
There has been no material change in CIP(R)'s financial condition since December
13, 2002. Cash flows from operations of $15,754,000 and equity investments of
$267,000 were $190,000 less than the total of dividends to shareholders of
$11,899,000, scheduled mortgage principal installments of $2,929,000 and
distributions to minority partners of $1,383,000. As of June 30, 2003, CIP(R)
has in excess of $11,000,000 available for investment. CIP(R) and its affiliates
are evaluating potential acquisitions in order to invest its available cash in
new real estate investments to further diversify its portfolio, and projects
that it will have sufficient cash flow from operations and equity investments to
meet its cash flow objectives.
During 2003, CIP(R)'s investing activities included receiving $2,362,000 from
the sale of a property in Broken Arrow, Oklahoma leased to Hobby Lobby, Inc.,
using $838,000 to purchase land at CIP(R)'s property and assuming an existing
ground lease, as lessor, in Conway, Arkansas leased to Kroger Co. and using
$734,000 to fund construction of an expansion at its hotel property in Toulouse,
France. The Hobby Lobby lease had contributed annual rental revenues of
$254,000. The ground lease on the Conway property is an obligation of Kroger and
will generate additional annual rent of $62,000 for CIP(R). The expansion of the
Toulouse hotel was completed in February 2003; however, CIP(R) is not currently
receiving rent from the lessee until cash flows from hotel operations are in
excess of certain obligations of the lessee. Based on current cash flow
projections, CIP(R) expects to start receiving rents before the end of the year.
The current occupancy rate at the Toulouse hotel is 56%. There is no assurance
that current projections will be met.
In addition to the payment of dividends, scheduled principal mortgage payments
and operating distributions to minority interest partners, CIP(R)'s financing
activities for the six months ended June 30, 2003 included using $1,265,000 to
pay off a mortgage loan in January 2003 and obtaining $583,000 from advances on
a construction loan for the completion of the Toulouse hotel expansion. Annual
debt service on the retired loan was $180,000.
In July 2003, CIP(R) used $6,525,000 to pay off its proportionate share of a
mortgage loan on a property leased to Titan Corporation which it owns with an
affiliate. Annual debt service on the retired loan was $1,332,000, of which
CIP(R)'s share was $1,085,000. Balloon payments of approximately $12,928,000 are
scheduled in 2004. CIP(R) expects to refinance the maturing loans but may use
its available cash to satisfy the balloon payments. CIP(R)'s financing strategy
has been to purchase substantially all of its properties with a combination of
equity and limited recourse mortgage debt. A lender on a limited recourse
mortgage loan has recourse only to the property collateralizing such debt and
not to any of CIP(R)'s other assets. The use of limited recourse mortgage debt,
therefore, allows CIP(R) to limit its exposure of all of its assets, and this
strategy has allowed CIP(R) to diversify its portfolio of properties and,
thereby, limit its risk. In the event that a balloon payment comes due, CIP(R)
may seek to refinance the loan, restructure the debt with existing lenders,
evaluate its ability to pay the balloon payment from its cash reserves or sell
the property and use the proceeds to satisfy the mortgage debt. CIP(R) may seek
to finance its unencumbered properties and use the proceeds to make additional
investments in real estate. To the extent that CIP(R) obtains such financing, it
may increase CIP(R)'s overall leverage. CIP(R)'s equity investees use the same
financing strategy and have purchased their properties with a combination of
equity and limited recourse mortgage debt.
CIP(R) expects to meet its capital requirements to fund future property
acquisitions, capital expenditures on existing properties and scheduled debt
maturities through long-term limited recourse mortgages and possibly unsecured
indebtedness as well as use of its existing cash balances. CIP(R) is not
currently seeking additional sources of refinancing such as an unsecured line of
credit; however, its financing strategies could change in the future. Unsecured
financing, if obtained, would require CIP(R) to meet financial covenants such as
maintaining specific operating ratios and leverage ratios.
-17-
CAREY INSTITUTIONAL PROPERTIES INCORPORATED
Item 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
CIP(R) has reached an agreement-in-principle to sell its property leased to
Nicholson Warehouse, L.P. for $4,350,000. Because of Nicholson's financial
difficulties, it has not been able to pay rent in excess of CIP(R)'s debt
service on the property. The proposed sale, if completed, therefore, would have
little effect on CIP(R)'s operating cash flow.
OFF-BALANCE SHEET ARRANGEMENTS, GUARANTEES AND AGGREGATE CONTRACTUAL AGREEMENTS:
A summary of CIP(R)'s contractual obligations and commitments is as follows:
(in thousands) Total 2003 2004 2005 2006 2007 Thereafter
----- ---- ---- ---- ---- ---- ----------
Obligations:
Limited recourse mortgage notes
payable (1) $248,990 $11,004 $18,980 $11,578 $5,065 $15,006 $ 187,357
Subordinated disposition fees 1,080 1,080
Commitments:
Share of minimum rents payable
under office cost-sharing
agreement 642 73 207 207 155
-------- ------- ------- ------- ------ ------- ---------
$250,712 $11,077 $19,187 $11,785 $5,220 $15,006 $188,437
======== ======= ======= ======= ====== ======= =========
(1) The limited recourse mortgage notes payable were obtained in connection
with the acquisition of properties in the ordinary course of business.
ACCOUNTING PRONOUNCEMENTS:
In June 2001, FASB issued SFAS No. 143 "Accounting for Asset Retirement
Obligations." SFAS No. 143 was issued to establish standards for the recognition
and measurement of an asset retirement obligation. SFAS No. 143 requires
retirement obligations associated with tangible long-lived assets to be
recognized at fair value as the liability is incurred with a corresponding
increase in the carrying amount of the related long-lived asset. SFAS No. 143 is
effective for financial statements issued for fiscal years beginning after June
15, 2002. SFAS No. 143 was adopted on January 1, 2003, and did not have a
material effect on the financial statements.
In May 2002, FASB issued SFAS No. 145 "Rescission of SFAS Nos. 4, 44 and 64,
Amendment of SFAS No. 13 and Technical Corrections" which eliminates the
requirement that gains and losses from the extinguishment of debt be classified
as extraordinary items unless it can be considered unusual in nature and
infrequent in occurrence. CIP(R) adopted this statement effective January 1,
2003, and the adoption did not have a material affect on CIP(R)'s financial
statements. CIP(R) will no longer classify gains and losses for the
extinguishment of debt as extraordinary items and will adjust comparative
periods presented.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or Disposal
Activities". SFAS No. 146 addresses significant issues regarding the
recognition, measurement, and reporting of costs that are associated with exit
and disposal activities, including restructuring activities that are currently
accounted for pursuant to the guidance that the Emerging Issues Task Force
("EITF") has set forth in EITF Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)". The provisions of this
Statement are effective for exit or disposal activities that are initiated after
December 31, 2002, with early application encouraged. SFAS No. 146 was adopted
on January 1, 2003, and did not have a material effect on CIP(R)'s financial
statements.
In October 2002, the FASB issued SFAS No. 147, "Acquisition of Certain Financial
Institutions" which amends SFAS No. 72, SFAS No. 144 and FASB Interpretation No.
9. SFAS No. 147 provides guidance on the accounting for the acquisitions of
certain financial institutions and includes long-term customer relationships as
intangible assets within the scope of SFAS No. 144. SFAS No. 147 was adopted on
January 1, 2003, and did not have a material effect on the financial statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others," ("FIN 45") which changes the accounting for, and
disclosure of certain guarantees. Beginning with transactions entered into after
December 31, 2002, certain guarantees
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CAREY INSTITUTIONAL PROPERTIES INCORPORATED
Item 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
are required to be recorded at fair value, which is different from prior
practice, under which a liability was recorded only when a loss was probable and
reasonably estimable. In general, the change applies to contracts or
indemnification agreements that contingently require CIP(R) to make payments to
a guaranteed third-party based on changes in an underlying asset, liability, or
an equity security of the guaranteed party. The adoption of the accounting
provisions of FIN 45 on January 1, 2003 did not have a material effect on
CIP(R)'s financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," which amends SFAS No. 123, Accounting
for Stock Based Compensation. SFAS No. 148 provides alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock based compensation (i.e., recognition of a charge for issuance of
stock options in the determination of income.). However, SFAS No. 148 does not
permit the use of the original SFAS No. 123 prospective method of transition for
changes to the fair value based method made in fiscal years beginning after
December 15, 2003. In addition, this Statement amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for stock based
employee compensation, description of transition method utilized and the effect
of the method used on reported results. The transition and annual disclosure
provisions of SFAS No. 148 are to be applied for fiscal years ending after
December 15, 2002. CIP(R) does not have any employees nor any stock-based
compensation plans.
On January 17, 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), the primary objective of which is to
provide guidance on the identification of entities for which control is achieved
through means other than voting rights ("variable interest entities" or "VIEs")
and to determine when and which business enterprise should consolidate the VIE
(the "primary beneficiary"). This new model applies when either (1) the equity
investors (if any) do not have a controlling financial interest or (2) the
equity investment at risk is insufficient to finance that entity's activities
without additional financial support. In addition, FIN 46 requires both the
primary beneficiary and all other enterprises with a significant variable
interest in a VIE make additional disclosures. CIP(R)'s maximum loss exposure is
the carrying value of its equity investments. CIP(R) has evaluated and believes
this interpretation will not have a material impact on its accounting for its
investments in unconsolidated joint ventures as none of these investments are
VIEs.
On April 30, 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging under SFAS No. 133. The
changes in the statement improve financial reporting by requiring that contracts
with comparable characteristics be accounted for similarly. In particular, the
statement (1) clarifies under what circumstances a contract with an initial net
investment meets the characteristics of a derivative instrument discussed in
paragraph 6(b) of SFAS No. 133, (2) clarifies when a derivative contains a
financing component, (3) amends the definition of an underlying to conform it to
language used in FIN 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others", and (4)
amends certain other existing pronouncements. SFAS No. 149 is generally
effective for contracts entered into or modified after June 30, 2003 and for
hedging relationships designated after June 30, 2003. The guidance is to be
applied prospectively.
On May 30, 2003, the FASB issued SFAS No. 150 "Accounting for Certain Financial
Instruments with Characteristics of both Liability and Equity." SFAS No. 150
establishes standards to classify as liabilities certain financial instruments
that are mandatorily redeemable or include an obligation to repurchase. Such
financial instruments will be measured at fair value with changes in fair value
included in the determination of net income. 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. CIP(R) is currently evaluating whether this will have an impact on the
financial statements.
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CAREY INSTITUTIONAL PROPERTIES INCORPORATED
Item 3. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the exposure to loss resulting from changes in interest rates,
foreign currency exchange rates and equity prices. In pursuing its business
plan, the primary market risks to which CIP(R) is exposed are interest rate risk
and foreign currency exchange risk.
The value of CIP(R)'s real estate is subject to fluctuations based on changes in
interest rates and foreign currency exchange rates, local and regional economic
conditions, changes in the creditworthiness of lessees and may affect CIP(R)'s
ability to refinance its debt when balloon payments are scheduled.
CIP(R) owns marketable securities through its ownership interests in Carey
Commercial Mortgage Trust ("CCMT"). The value of the marketable securities is
subject to fluctuations based on changes in interest rates, economic conditions
and the creditworthiness of lessees at the mortgaged properties. As of June 30,
2003 the interests in CCMT had a fair value of $12,020,195.
Approximately $230,617,000 of CIP(R)'s long-term debt bears interest at fixed
rates, and therefore the fair value of these instruments is affected by changes
in the market interest rates. The following table presents principal cash flows
based upon expected maturity dates of the debt obligations and the related
weighted-average interest rates by expected maturity dates for the fixed rate
debt. The annual interest rates on the fixed rate debt as of June 30, 2003
ranged from 6.95% to 10.00%. The annual interest rates on the variable rate debt
as of June 30, 2003 ranged from 3.97% to 5.625%.
(in thousands) 2003 2004 2005 2006 2007 Thereafter Total Fair Value
---- ---- ---- ---- ---- ---------- ----- ----------
Fixed rate debt $10,259 $14,637 $7,532 $4,841 $14,726 $ 178,622 $230,617 $237,949
Weighted average
interest rate 9.38% 9.38% 8.32% 7.78% 8.44% 7.53%
Variable rate debt $ 745 $ 4,343 $4,046 $ 224 $ 280 $ 8,735 $ 18,373 $ 18,373
CIP(R) has one interest rate cap agreement contract, a derivative financial
instrument, with a notional amount of $6,750,000, and a strike of 8% based on
the one-month London Inter-Bank Offered Rate. The use of derivative financial
instruments is not currently significant to CIP(R)'s risk management.
CIP(R) has foreign operations. Accordingly, CIP(R) is subject to foreign
currency exchange risk from the effects of exchange rate movements of foreign
currencies and this may affect future costs and cash flows; however, exchange
rate movements to date have not had a significant effect on CIP(R)'s financial
position or results of operations. To date we have not entered into any foreign
currency forward exchange contracts or other derivative financial instruments to
hedge the effects of adverse fluctuations in foreign currency exchange rates.
Item 4. - CONTROLS AND PROCEDURES
The Co-Chief Executive Officers and Chief Financial Officer of the Company have
conducted a review of the Company's disclosure controls and procedures as of
June 30, 2003.
The Company's disclosure controls and procedures include the Company's controls
and other procedures designed to ensure that information required to be
disclosed in this and other reports filed under the Securities Exchange Act of
1934, as amended (the "Exchange Act") is accumulated and communicated to the
Company's management, including its Co-Chief Executive Officers and Chief
Financial Officer, to allow timely decisions regarding required disclosure and
to ensure that such information is recorded, processed, summarized and reported,
within the required time periods.
Based upon this review, the Company's Co-Chief Executive Officers and Chief
Financial Officer have concluded that the Company's disclosure controls (as
defined in Rule 13a-14(c) promulgated under the Exchange Act) are sufficiently
effective to ensure that the information required to be disclosed by the Company
in the reports it files under the Exchange Act is recorded, processed,
summarized and reported with adequate timeliness.
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CAREY INSTITUTIONAL PROPERTIES INCORPORATED
PART II
Item 4. - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
An annual Shareholders' meeting was held on June 10, 2003, at which time a vote
was taken to elect the Company's directors through the solicitation of proxies.
The following directors were elected for a one-year term:
Name Of Director Total Shares Voting Shares Voting Yes Shares Voting No Shares Abstaining
- ---------------- ------------------- ----------------- ---------------- -----------------
William P. Carey 16,339,689 16,261,969 5,039 72,681
Francis X. Diebold 16,339,689 16,246,373 20,635 72,681
William Ruder 16,339,689 16,227,446 39,562 72,681
George E. Stoddard 16,339,689 16,213,623 53,385 72,681
Ralph F. Verni 16,339,689 16,258,719 8,289 72,681
Warren G. Wintrub 16,339,689 16,261,969 5,039 72,681
Item 6. - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
31.1 Certification of Co-Chief Executive Officers.
31.2 Certification of Chief Financial Officer.
32.1 Certification of Co-Chief Executive Officers Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K:
During the quarter ended June 30, 2003, the Company was not required to
file any reports on Form 8-K.
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CAREY INSTITUTIONAL PROPERTIES INCORPORATED
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CAREY INSTITUTIONAL PROPERTIES INCORPORATED
8/11/2003 By: /s/ John J. Park
----------- ----------------------------------
Date John J. Park
Managing Director and
Chief Financial Officer
(Principal Financial Officer)
8/11/2003 By: /s/ Claude Fernandez
----------- ----------------------------------
Date Claude Fernandez
Managing Director and
Chief Accounting Officer
(Principal Accounting Officer)
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