-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, ComsN9wH76yp5wentFdrjv3BEUoixsRvsEpfkkI78EZiV+H8ys9zm3FxBZ2bnGg3 YuSMNMSuM2Y6HgmYNrs9+w== 0000911708-03-000012.txt : 20030514 0000911708-03-000012.hdr.sgml : 20030514 20030514171318 ACCESSION NUMBER: 0000911708-03-000012 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20030331 FILED AS OF DATE: 20030514 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PRIME RETAIL INC/BD/ CENTRAL INDEX KEY: 0000911708 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 382559212 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-13301 FILM NUMBER: 03700080 BUSINESS ADDRESS: STREET 1: 100 E PRATT ST STREET 2: 1900 FLOOR CITY: BALTIMORE STATE: MD ZIP: 21202 BUSINESS PHONE: 4102340782 MAIL ADDRESS: STREET 1: 100 EAST PRATT STREET STREET 2: 1900 FLOOR CITY: BALTIMORE STATE: MD ZIP: 21202 10-Q 1 a10q103.txt FORM 10-Q - PERIOD ENDED 3/31/2003 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 March 31, 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 001-13301 ------------------------ PRIME RETAIL, INC. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Maryland 38-2559212 - ------------------------------------ ------------------------------------ (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 100 East Pratt Street Nineteenth Floor Baltimore, Maryland 21202 - -------------------------------------------- ------------------------- (Address of principal executive offices) (Zip Code) (410) 234-0782 - -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) NOT APPLICABLE - -------------------------------------------------------------------------------- (Former name, former address, or former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ------ Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. As of May 14, 2003, the issuer had outstanding 43,577,916 shares of Common Stock, $.01 par value per share. Page - (2) Prime Retail, Inc. Form 10-Q INDEX PART I: FINANCIAL INFORMATION PAGE ---- Item 1. Financial Statements (Unaudited) Consolidated Balance Sheets as of March 31, 2003 and December 31, 2002............................................... 1 Consolidated Statements of Operations for the three months ended March 31, 2003 and 2002............................ 2 Consolidated Statements of Cash Flows for the three months ended March 31, 2003 and 2002............................ 3 Notes to the Consolidated Financial Statements.................... 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations......................... 23 Item 3. Quantitative and Qualitative Disclosures of Market Risk....... 43 Item 4. Controls and Procedures....................................... 44 PART II: OTHER INFORMATION Item 1. Legal Proceedings............................................. 45 Item 2. Changes in Securities......................................... 46 Item 3. Defaults Upon Senior Securities............................... 46 Item 4. Submission of Matters to a Vote of Security Holders........... 46 Item 5. Other Information............................................. 46 Item 6. Exhibits and Reports on Form 8-K.............................. 46 Signatures............................................................. 47 Certifications of Chief Executive Officer and Chief Financial Officer.. 48 Page - (3) PRIME RETAIL, INC. Unaudited Consolidated Balance Sheets (Amounts in thousands, except share information)
- ------------------------------------------------------------------------------------------------------------------------------------ March 31, December 31, 2003 2002 - ------------------------------------------------------------------------------------------------------------------------------------ Assets Investment in rental property: Land $ 100,246 $ 101,546 Buildings and improvements 739,972 740,024 Furniture and equipment 13,514 13,292 ---------- --------- 853,732 854,862 Accumulated depreciation (220,230) (213,604) ---------- --------- 633,502 641,258 Cash and cash equivalents 8,236 6,908 Restricted cash 105,674 107,037 Accounts receivable, net 1,024 3,049 Deferred charges, net 3,256 3,766 Investment in unconsolidated joint ventures 50,664 49,889 Other assets 6,183 6,181 ---------- --------- Total assets $ 808,539 $ 818,088 ========== ========= Liabilities and Shareholders' Equity Bonds payable $ 22,451 $ 22,495 Notes payable, including $41,601 in default in 2003 509,273 511,443 Defeased notes payable 74,509 74,764 Accrued interest 4,107 3,984 Real estate taxes payable 3,398 3,484 Accounts payable and other liabilities 38,231 43,059 ---------- --------- Total liabilities 651,969 659,229 Minority interests 1,487 1,487 Shareholders' equity: Shares of preferred stock, 24,315,000 shares authorized: 10.5% Series A Senior Cumulative Preferred Stock, $0.01 par value (liquidation preference of $77,877), 2,300,000 shares issued and outstanding 23 23 8.5% Series B Cumulative Participating Convertible Preferred Stock, $0.01 par value (liquidation preference of $251,845), 7,828,125 shares issued and outstanding 78 78 Shares of common stock, 150,000,000 shares authorized: Common stock, $0.01 par value, 43,577,916 shares issued and outstanding 436 436 Additional paid-in capital 709,373 709,373 Distributions in excess of earnings (554,827) (552,538) ---------- --------- Total shareholders' equity 155,083 157,372 ---------- --------- Total liabilities and shareholders' equity $ 808,539 $ 818,088 ========== ========= ====================================================================================================================================
See accompanying notes to consolidated financial statements. Page - (4) PRIME RETAIL, INC. Unaudited Consolidated Statements of Operations (Amounts in thousands, except per share information)
- ------------------------------------------------------------------------------------------------------------------------------------ Three Months Ended March 31, 2003 2002 - ------------------------------------------------------------------------------------------------------------------------------------ Revenues Base rents $ 18,993 $ 24,309 Percentage rents 977 1,320 Tenant reimbursements 10,958 12,834 Interest and other 4,012 2,860 -------- -------- Total revenues 34,940 41,323 Expenses Property operating 9,955 10,211 Real estate taxes 2,984 3,666 Depreciation and amortization 7,280 10,208 Corporate general and administrative 4,466 3,419 Interest 11,856 17,729 Other charges 688 2,472 -------- -------- Total expenses 37,229 47,705 -------- -------- Loss before gain on sale of real estate (2,289) (6,382) Gain on sale of real estate - 16,793 -------- -------- Income (loss) from continuing operations (2,289) 10,411 Discontinued operations, including loss of $9,623 on dispositions in 2002 - (8,730) -------- -------- Net income (loss) (2,289) 1,681 Allocations to preferred shareholders (5,668) (5,668) -------- -------- Net loss applicable to common shares $ (7,957) $ (3,987) ======== ======== Basic and diluted earnings per common share: Income (loss) from continuing operations $ (0.18) $ 0.11 Discontinued operations - (0.20) -------- -------- Net loss $ (0.18) $ (0.09) ======== ======== Weighted-average common shares outstanding - basic and diluted 43,578 43,578 ======== ======== ====================================================================================================================================
See accompanying notes to consolidated financial statements. Page - (5) PRIME RETAIL, INC. Unaudited Consolidated Statements of Cash Flows (Amounts in thousands)
- ------------------------------------------------------------------------------------------------------------------------------------ Three Months Ended March 31, 2003 2002 - ------------------------------------------------------------------------------------------------------------------------------------ Operating Activities Income (loss) from continuing operations $ (2,289) $ 10,411 Adjustments to reconcile income (loss) from continuing operations to net cash provided by operating activities: Gain on sale of real estate - (16,793) Equity in earnings of unconsolidated joint ventures (1,126) (153) Depreciation and amortization 7,280 10,208 Amortization of deferred financing costs 426 1,683 Amortization of debt premiums (519) (496) Bad debt expense 536 2,344 Discontinued operations - 3,299 Changes in operating assets and liabilities: Decrease in accounts receivable 1,489 432 Decrease in restricted cash 1,363 3,275 Decrease in other assets 282 334 Decrease in accounts payable and other liabilities (4,828) (8,155) Decrease in real estate taxes payable (86) (2,277) Increase in accrued interest 123 556 -------- -------- Net cash provided by operating activities 2,651 4,668 -------- -------- Investing Activities Additions to investment in rental property (769) (983) Distributions from unconsolidated joint ventures 311 - Proceeds from sales of operating properties and land 1,085 11,559 -------- -------- Net cash provided by investing activities 627 10,576 -------- -------- Financing Activities Principal repayments on notes payable (1,950) (16,691) -------- -------- Cash used in financing activities (1,950) (16,691) -------- -------- Increase (decrease) in cash and cash equivalents 1,328 (1,447) Cash and cash equivalents at beginning of period 6,908 7,537 -------- -------- Cash and cash equivalents at end of period $ 8,236 $ 6,090 ======== ======== ====================================================================================================================================
See accompanying notes to consolidated financial statements. Page - (6) PRIME RETAIL, INC. Unaudited Consolidated Statements of Cash Flows (continued) (Amounts in thousands) Supplemental Disclosure of Non-cash Investing and Financing Activities The following assets and liabilities were disposed in connection with the disposition of properties during the periods indicated: - -------------------------------------------------------------------------------- Three Months Ended March 31, 2002 - -------------------------------------------------------------------------------- Book value of net assets disposed $ 71,276 Notes payable paid (11,052) Notes payable assumed by buyer (46,862) Notes payable transferred to lender (15,621) Investment in unconsolidated joint ventures (2,975) Gain on sale of real estate 16,793 --------- Cash received, net $ 11,559 ========= ================================================================================ See accompanying notes to consolidated financial statements. Page - (7) Prime Retail, Inc. Notes to Unaudited Consolidated Financial Statements (Amounts in thousands, except share and unit information) Note 1 - Interim Financial Presentation The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP") for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments, consisting only of recurring accruals, considered necessary for a fair presentation have been included. Operating results for such interim periods are not necessarily indicative of the results that may be expected for a full fiscal year. For further information, refer to the consolidated financial statements and notes thereto included in Prime Retail, Inc.'s (the "Company") Annual Report on Form 10-K for the year ended December 31, 2002. Unless the context otherwise requires, all references to "we," "us," "our" or the Company herein mean Prime Retail, Inc. and those entities owned or controlled by Prime Retail, Inc., including Prime Retail, L.P. (the "Operating Partnership"). The consolidated financial statements include the accounts of the Company, the Operating Partnership and the partnerships in which it has a controlling financial interest. Profits and losses are allocated in accordance with the terms of the agreement of limited partnership of the Operating Partnership. The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the (i) reported amounts of assets and liabilities, (ii) disclosure of contingent liabilities at the date of the financial statements and (iii) reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Investments in unconsolidated joint ventures are accounted for under the equity method of accounting. Income (loss) applicable to minority interests and common shares as presented in the consolidated statements of operations is allocated based on income (loss) before minority interests after income allocated to preferred shareholders. Significant inter-company accounts and transactions have been eliminated in consolidation. Certain prior period financial information has been reclassified to conform to the current period presentation, which did not have an impact on our results of operations or financial position. Note 2 - Recent Accounting Pronouncements In October, 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("FAS") No. 144, "Accounting for Impairment of Disposal of Long-lived Assets." FAS No. 144 supercedes FAS No. 121, however it retains the fundamental provisions of that statement as related to the recognition and measurement of the impairment of long-lived assets to be "held and used." In addition, FAS No. 144 (i) provides further guidance regarding the estimation of cash flows in the performance of a recoverability test, (ii) requires that a long-lived asset to be disposed of other than by sale (e.g., abandoned) be classified as "held and used" until it is disposed of, and (iii) established more restrictive criteria to classify an asset as "held for sale." Effective January 1, 2002, we adopted FAS No. 144. Our adoption of FAS No. 144 effective January 1, 2002 did not have a material impact on our results of operations or financial position. Page - (8) In accordance with the requirements of FAS No. 144, we have classified the operating results, including gains and losses related to disposition, for certain properties either disposed of or classified as assets held for sale during 2002 as discontinued operations in the Consolidated Statements of Operations for all periods presented. See Note 3 - "Property Dispositions" for additional information. In December 2002, the FASB issued Interpretation ("FIN") No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN No. 45 elaborates on the disclosures to be made by a guarantor in interim and annual financial statements about the obligations under certain guarantees. FIN No. 45 also clarifies that a guarantor is required to recognize, at the inception of the guarantee, an initial liability for the fair value of the obligation undertaken in issuing the guarantee. The disclosure requirements of FIN No. 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. We adopted the disclosure provisions of FIN No. 45 effective December 31, 2002. The initial recognition and initial measurement provisions of FIN No. 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. We did not issue or modify any guarantees during the three months ended March 31, 2003. See "Guarantees and Guarantees of Indebtedness of Others" contained in Note 4 - "Debt" for additional information. In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest Entities." FIN No. 46 clarifies the application of existing accounting pronouncements to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The provisions of FIN No. 46 were immediately effective for all variable interests in variable interest entities created after January 31, 2003, and we will need to apply the provisions of FIN No. 46 to any existing variable interests in variable interest entities by no later than July 1, 2003. We did not create any variable interest entities during the three months ended March 31, 2003 and we do not believe that FIN No. 46 will have a significant impact on our financial statements. Note 3 - Property Dispositions We disposed of certain properties through various transactions (including sale, joint venture arrangements, foreclosure and transfer of ownership to the respective lender) during 2002. The following table summarizes these dispositions:
- ------------------------------------------------------------------------------------------------------------------------------------ Gain/ Provision (Loss) for Date of Property Sales Reduction Net on Sale/ Asset Disposition Type GLA Price of Debt Proceeds Disposition Impairment - ------------------------------------------------------------------------------------------------------------------------------------ Year 2002 Continuing Operations: Hagerstown Center January 2002 Outlet Center 487,000 $ 80,500 $ (57,914) $12,113 $ 16,793 $ - Bellport Outlet Center - Phases II/III April 2002 Outlet Center 197,000 6,500 - 522 (703) - Bridge Properties July 2002 Outlet Centers 1,304,000 118,650 (111,009) - (10,288) - --------- -------- --------- -------- ------- ------- Subtotal 1,988,000 205,650 (168,923) 12,635 5,802 - --------- -------- --------- -------- ------- ------- Discontinued Operations: Conroe Center January 2002 Outlet Center 282,000 - (15,621) (554) - - Edinburgh Center April 2002 Outlet Center 305,000 27,000 (16,317) 9,551 (9,623) - Western Plaza June 2002 Community Center 205,000 9,500 (9,467) 688 2,121 - Jeffersonville II August 2002 Outlet Center 314,000 - (17,938) - 17,121 - Vero Beach September 2002 Outlet Center 326,000 - (25,126) - - 12,200 Melrose Place October 2002 Community Center 27,000 2,500 (1,935) 555 990 - Puerto Rico Center December 2002 Outlet Center 176,000 36,500 (19,202) 13,958 - 15,557 Colorado Properties December 2002 Outlet Center 808,000 96,000 (74,849) 12,628 15,543 - --------- -------- --------- -------- ------- ------- Subtotal 2,443,000 171,500 (180,455) 36,826 26,152 27,757 --------- -------- --------- -------- ------- ------- Total 4,431,000 $377,150 $(349,378) $49,461 $ 31,954 $27,757 ========= ======== ========= ======= ======== ======= ====================================================================================================================================
Page - (9) 2002 Dispositions - Continuing Operations The operating results for certain properties that were sold to joint venture partnerships during 2002 and in which we still have a significant continuing involvement are not classified as discontinued operations in the Consolidated Statements of Operations. Such properties and/or their operating results through the dates of their respective disposition are collectively referred to as the "2002 Joint Venture Properties". The 2002 Joint Venture Properties consist of our sales of (i) Prime Outlets at Hagerstown (the "Hagerstown Center") and six outlet centers (collectively, the "Bridge Properties"). The following discussion summarizes the terms of such dispositions. Hagerstown Center On January 11, 2002, we completed the sale of the Hagerstown Center, an outlet center located in Hagerstown, Maryland, for aggregate consideration of $80,500 to an existing joint venture partnership (the "Prime/Estein Venture") between one of our affiliates and an affiliate of Estein & Associates USA, Ltd. ("Estein"), a real estate investment company. Our affiliate and Estein have 30% and 70% ownership interests, respectively, in the Prime/Estein Venture. In connection with the sale transaction, the Prime/Estein Venture assumed first mortgage indebtedness of $46,862 on the Hagerstown Center (the "Hagerstown First Mortgage"); however, our guarantee of the Hagerstown First Mortgage remains in place. Under the terms of the transaction, we manage, market and lease the Hagerstown Center for a fee on behalf of the Prime/Estein Venture. The operating results of the Hagerstown Center are reflected in our results from continuing operations through the date of disposition. In connection with the sale of the Hagerstown Center, we recorded a gain on the sale of real estate of $16,793 during the first quarter of 2002. Effective on the date of disposition, we have accounted for our 30% ownership interest in the Hagerstown Center in accordance with the equity method of accounting. Bellport Center II/III On April 19, 2002, we completed the sale of Phases II and III of the Bellport Outlet Center (the "Bellport Outlet Center"), an outlet center located in Bellport, New York. We had a 51% ownership interest in the joint venture partnership that owned the Bellport Outlet Center and accounted for our ownership interest in accordance with the equity method of accounting. The Bellport Outlet Center was sold to Sunrise Station, L.L.C., an affiliate of one of our joint venture partners, for cash consideration of $6,500. At closing, recourse first mortgage indebtedness of $5,500, which was scheduled to mature on May 1, 2002, was repaid in full. In connection with the sale of the Bellport Outlet Center, we recorded a loss on the sale of real estate of $703 during the second quarter of 2002. Bridge Properties On July 26, 2002, we completed the sale the Bridge Properties for aggregate consideration of $118,650 to affiliates of PFP Venture LLC, a new joint venture (the "PFP Venture") (i) 30.4% owned by PWG Prime Holdings LLC ("PWG"), a third party, and (ii) 69.6% owned by FP Investment LLC ("FPI"). FPI is a new joint venture between (i) FRIT PRT Bridge Acquisition LLC ("FRIT"), a third party, and (ii) an affiliate of ours. Through FPI, FRIT and we indirectly had initial ownership interests of 51.4% and 18.2%, respectively, in the PFP Venture. PWG is the managing member of the PFP Venture. FPI and PWG have certain protective rights over the operations of the Bridge Properties, which are pari passu. The Bridge Properties are located in Anderson, California; Calhoun, Georgia; Gaffney, South Carolina; Latham, New York; Lee, Massachusetts and Lodi, Ohio. Page - (10) Under the terms of the transaction, we manage, market and lease the Bridge Properties for a fee on behalf of the PFP Venture. The operating results of the Bridge Properties are reflected in our results from continuing operations through the date of disposition. In connection with the sale of the Bridge Properties, we recorded a loss on the sale of real estate of $10,288 during the second quarter of 2002. This loss represented the write-down of our carrying value of the Bridge Properties to their fair value less estimated costs to dispose, based on the terms of the sale agreement. Because PWG is the managing member of the PFP Venture and because of the pari passu nature of the protective rights of FPI and PWG, we are not deemed in control of the PFP Venture. Accordingly, we commenced accounting for our indirect ownership interest in the PFP Venture in accordance with the equity method of accounting effective on the date of disposition. We record our share of the operations of the Bridge Properties using an assumed book value liquidation model because both FPI and the PFP Venture have specific allocations for distribution. For the three months ended March 31, 2002 combined revenues were $6,694 and combined expenses were $7,902 for the Hagerstown Center and the Bridge Properties as reflected in our results from continuing operations through their respective dates of disposition. For the three months ended March 31, 2002, our equity in losses (included in interest and other income in the Consolidated Statements of Operations) for the Bellport Outlet Center was $218. 2002 Dispositions - Discontinued Operations We have classified the operating results, including gains and losses related to disposition, for certain properties either disposed of or classified as assets held for sale during 2002 as discontinued operations in the Consolidated Statements of Operations for the 2002 period. The following discussion summarizes the terms of such dispositions. Conroe Center During 2001, certain of our subsidiaries suspended regularly scheduled monthly debt service payments on two non-recourse mortgage loans held by New York Life Insurance Company ("New York Life") at the time of the suspension. These non-recourse mortgage loans were cross-defaulted and cross-collateralized by Prime Outlets at Conroe (the "Conroe Center"), located in Conroe, Texas, and Prime Outlets at Jeffersonville II (the "Jeffersonville II Center"), located in Jeffersonville, Ohio. Effective January 1, 2002, New York Life foreclosed on the Conroe Center and its related assets and liabilities, including $554 of cash and our carrying value of the indebtedness of $15,621 (principal outstanding of $15,467 and unamortized debt premium of $154), were transferred from our subsidiary that owned the Conroe Center to New York Life. The foreclosure of the Conroe Center did not have a material impact on our results of operations or financial condition. See "Jeffersonville II Center" below for additional information. The operating results of the Conroe Center are classified as discontinued operations in the Consolidated Statements of Operations through the date of disposition for the 2002 period. No gain or loss was recorded in connection with the foreclosure of the Conroe Center. Edinburgh Center On April 1, 2002, we completed the sale of Prime Outlets at Edinburgh (the "Edinburgh Center"), an outlet center located in Edinburgh, Indiana and additional undeveloped land. The Edinburgh Center was sold to CPG Partners, L.P. for cash consideration of $27,000. The net cash proceeds from the sale were $9,551, after (i) repayment in full of $16,317 of existing first mortgage indebtedness on the Edinburgh Center and (ii) prorations, closing costs and fees. Page - (11) The operating results of the Edinburgh Center through the date of disposition are classified as discontinued operations in the Consolidated Statements of Operations for the 2002 period. During the first quarter of 2002, we recorded a loss on the sale of real estate of $9,623 representing the write-down of our carrying value of the Edinburgh Center to its estimated fair value less estimated costs to dispose, based on the terms of the sale agreement. Western Plaza On June 17, 2002, we completed the sale of the Shops at Western Plaza ("Western Plaza"), a community center located in Knoxville, Tennessee. Western Plaza was sold to WP General Partnership for cash consideration of $9,500. The net proceeds from the sale were $688, after (i) repayment of $9,467 (of which $2,467 was scheduled to mature on October 31, 2002) of existing recourse mortgage indebtedness on Western Plaza, (ii) prorations, closing costs and fees and (iii) release of certain escrowed funds. The operating results of Western Plaza through the date of disposition are classified as discontinued operations in the Consolidated Statements of Operations for the 2002 period. In connection with the sale of Western Plaza, we recorded a gain on the sale of real estate of $2,121 during the second quarter of 2002. Jeffersonville II Center Effective July 18, 2002, New York Life sold its interest in the Jeffersonville II Center loan. On August 13, 2002, we transferred our ownership interest in the Jeffersonville II Center to New York Life's successor. As a result of the transfer of our ownership interest in the Jeffersonville II Center, we recorded a non-recurring gain of $17,121 (included in discontinued operations) during the third quarter of 2002, representing the difference between our carrying value of the Jeffersonville II Center and its related assets and liabilities, including our carrying value of the indebtedness of $17,938 (principal outstanding of $17,768 and unamortized debt premium of $170), as of the date of transfer. The transfer of our ownership interest in the Jeffersonville II Center did not have a material impact on our results of operations or financial condition. The operating results of the Jeffersonville II Center are classified as discontinued operations in the Consolidated Statements of Operations through the date of disposition for the 2002 period. See "Conroe Center" above for additional information. Vero Beach Center During August of 2002, certain of our subsidiaries suspended regularly scheduled monthly debt service payments on two non-recourse mortgage loans which were cross-collateralized by Prime Outlets at Vero Beach (the "Vero Beach Center"), located in Vero Beach, Florida, and Prime Outlets at Woodbury (the "Woodbury Center"), located in Woodbury, Minnesota (collectively, the "John Hancock Properties"). These non-recourse mortgage loans were held by John Hancock Life Insurance Company ("John Hancock"). Page - (12) During the second quarter of 2002, we incurred a provision for asset impairment of $12,200 to adjust our carrying value of the Vero Beach Center to its estimated fair value in accordance with the provisions of FAS No. 144. Effective September 9, 2002, John Hancock foreclosed on the Vero Beach Center and its related assets and liabilities, including our carrying value of the indebtedness of $25,126 (principal outstanding of $24,497 and unamortized debt premium of $629), were transferred to John Hancock. Additionally, we are currently negotiating a transfer of our ownership interest in the Woodbury Center to John Hancock. Foreclosure on the Vero Beach Center did not, and the expected transfer of our ownership interest in the Woodbury Center is not, expected to have a material impact on our results of operations or financial condition. The carrying value of the Woodbury Center was $15,615 as of March 31, 2003. Such value is exceeded by our carrying value of the associated indebtedness of $16,682_ (principal outstanding of $16,331 and unamortized debt premium of $351) as of March 31, 2003. If we were to transfer our ownership interest in the Woodbury Center to John Hancock, we would record a non-recurring gain for the difference between the carrying value of the Woodbury Center and its related net assets and the carrying value of the indebtedness as of the date of transfer. The operating results of the Vero Beach Center are classified as discontinued operations in the Consolidated Statements of Operations through the date of disposition for the 2002 period. No gain or loss was recorded in connection with the foreclosure of the Vero Beach Center. See Note 4 - "Debt" for additional information. Melrose Place On October 30, 2002, we completed the sale of Melrose Place, a community center located in Knoxville, Tennessee. Melrose Place was sold to Melrose Place Tennessee General Partnership for cash consideration of $2,500. The net proceeds from the sale were $555, after (i) repayment of $1,935 of existing recourse mortgage indebtedness on Melrose Place, (ii) prorations, closing costs and fees and (iii) release of certain escrowed funds. The operating results of Melrose Place are classified as discontinued operations in the Consolidated Statements of Operations for the 2002 period. In connection with the sale of Melrose, we recorded a gain on the sale of real estate of $990 during the fourth quarter of 2002. Puerto Rico Center On December 6, 2002, we completed the sale of (i) Prime Outlets of Puerto Rico, an outlet center located in Barceloneta, Puerto Rico and (ii) certain adjacent parcels of land being developed for non-outlet retail use (collectively, the "Puerto Rico Center"). The Puerto Rico Center was sold to PR Barceloneta, LLC for cash consideration of $36,500. The net proceeds from the sale were $13,958, after (i) repayment of $19,202 of existing first mortgage indebtedness on the Puerto Rico Center, (ii) pro-rations, closing costs and fees, (iii) establishment of certain escrows at closing and (iv) release of certain escrowed funds. At the closing of the sale of the Puerto Rico Center, we were required to fund $2,800 into an escrow account which will be returned to us only upon satisfaction of certain conditions no later than December 31, 2004. The escrow account is included in restricted cash and an offsetting deferred liability is included in accounts payable and other liabilities in the Consolidated Balance Sheet as of March 31, 2003. Under the terms of the transaction, we will continue to manage, market and lease the Puerto Rico Center for a fee on behalf of PR Barceloneta, LLC. The operating results of the Puerto Rico Center through the date of disposition are classified as discontinued operations in the Consolidated Statements of Operations for the 2002 period. During the third quarter of 2002, we recorded an impairment loss of $15,557 representing the write-down of our carrying value of the Puerto Rico Center to its fair value less estimated costs to sell, based on the terms of the sale agreement. Page - (13) Colorado Properties On December 6, 2002, we completed the sale of two outlet centers (together, the "Colorado Properties") to TGS (U.S.) Realty, Inc. for aggregate cash consideration of $96,000. The Colorado Properties are located in Castle Rock, Colorado and Loveland, Colorado. The net proceeds from the sale of the Colorado Properties were $12,628, after (i) required defeasance of $74,849 of mortgage indebtedness and the costs related to such defeasance (see Note 4 - "Debt for additional information), (ii) prorations, closing costs and fees and (iii) the release of certain escrowed funds. The operating results of the Colorado Properties through the date of disposition are classified as discontinued operations in the Consolidated Statements of Operations for the 2002 period. In connection with the sale of the Colorado Properties, we recorded a gain on the sale of real estate of $15,543 (also included in discontinued operations) during the fourth quarter of 2002. The following summary presents the operating results of those properties disposed of during 2002 whose results are classified as discontinued operations in the Consolidated Statements of Operations: - -------------------------------------------------------------------------------- Three Months Ended March 31, 2002 - -------------------------------------------------------------------------------- Revenues Base rents $ 6,097 Percentage rents 215 Tenant reimbursements 2,817 Interest and other 198 -------- Total revenues 9,327 Expenses Property operating 2,194 Real estate taxes 973 Depreciation and amortization 2,015 Interest 2,932 Other charges 320 -------- Total expenses 8,434 -------- Income before loss on sale of real estate 893 Loss on sale of real estate (9,623) -------- Discontinued operations $ (8,730) ======== ================================================================================ 2003 Disposition On March 31, 2003, the PFP Venture completed the sale of Prime Outlets at Latham (the "Latham Center"), an outlet center located in Latham, New York. The Latham Center, which was one of the Bridge Properties, was sold to 400 Old Loudon Road Realty, LLC for cash consideration of $2,200. The net cash proceeds from the sale were $184, after (i) repayment of $1,870 of existing mortgage indebtedness on the Bridge Properties and (ii) prorations, closing costs and fees. In connection with the sale of the Latham Center, the PFP Venture recorded a gain on the sale of real estate of $117 during the first quarter of 2003. As previously discussed, the Company accounts for its investment in the Bridge Properties in accordance with the equity method of accounting. Page - (14) Note 4 - Debt We have fixed rate tax-exempt revenue bonds collateralized by properties located in Chattanooga, Tennessee (the "Chattanooga Bonds") which contain (i) certain covenants, including a minimum debt-service coverage ratio financial covenant (the "Financial Covenant") and (ii) cross-default provisions with respect to certain of our other credit agreements. Based on the operations of the collateral properties, we were not in compliance with the Financial Covenant for the quarters ended June 30, September 30 and December 31, 2002. In the event of non-compliance with the Financial Covenant or default, the holders of the Chattanooga Bonds (the "Bondholders") had the ability to put such obligations to us at a price equal to par plus accrued interest. On January 31, 2003, we entered into an agreement (the "Forbearance Agreement") with the Bondholders. The Forbearance Agreement provides amendments to the underlying loan and other agreements that enable us to be in compliance with various financial covenants, including the Financial Covenant. So long as we continue to comply with the provisions of the Forbearance Agreement and are not otherwise in default of the underlying loan and other documents through December 31, 2004, the revised financial covenants will govern. Additionally, certain quarterly tested financial covenants and other covenants become effective June 30, 2004. Pursuant to the terms of the Forbearance Agreement, we were required to fund $1,000 into an escrow account to be used for conversion of certain of the retail space in the collateral properties to office space and agreed that an event of default with respect to the other debt obligations related to the property would also constitute a default under the Chattanooga Bonds. We funded this required escrow in February 2003. Notes payable included unamortized debt premiums of $7,355 in the aggregate at March 31, 2003. Our debt premiums are being amortized over the terms of the related debt instruments in accordance with the effective interest method. Amortization of debt premiums (included in interest expense in the Consolidated Statements of Operations) was $519 and $496 for the three months ended March 31, 2003 and 2002, respectively. Defaults on Certain Non-recourse Mortgage Indebtedness During 2001, certain of our subsidiaries suspended regularly scheduled monthly debt service payments on non-recourse mortgage loans which were cross-collateralized by the Jeffersonville II Center and the Conroe Center. At the time of suspension, these non-recourse mortgage loans were held by New York Life. Effective January 1, 2002, New York Life foreclosed on the Conroe Center. Effective July 18, 2002, New York Life sold its interest in the Jeffersonville II Center loan. On August 13, 2002, we transferred our ownership interest in the Jeffersonville II Center to New York Life's successor. See Note 3 - "Property Dispositions" for additional information. During August 2002, certain of our subsidiaries suspended regularly scheduled monthly debt service payments on non-recourse mortgage loans which were cross-collateralized by the Vero Beach Center and the Woodbury Center. These non-recourse mortgage loans were held by John Hancock. Effective September 9, 2002, John Hancock foreclosed on the Vero Beach Center. Additionally, we are currently negotiating a transfer of our ownership interest in the Woodbury Center to John Hancock. The aggregate carrying value of the Woodbury Center was $15,615 as of March 31, 2003. Such amount is exceeded by the aggregate carrying value of the non-recourse mortgage loan of $16,682 as of March 31, 2003. Upon the transfer of the Woodbury Center to John Hancock, we expect to record a non-recurring gain for the difference between the carrying value of the property and its related net assets and the outstanding loan balance and related liabilities. See Note 3 - "Property Dispositions" for additional information. Page - (15) In December 2002, we notified the servicer of certain non-recourse mortgage loans (cross-collateralized by Prime Outlets at Bend, Prime Outlets at Post Falls and Prime Outlets at Sedona) totaling $24,919 as of March 31, 2003 that the net cash flow from the properties securing the loans was insufficient to fully pay the required monthly debt service. At that time, certain of our subsidiaries suspended the regularly scheduled monthly debt service payments. Subsequent to our notification to the servicer, we have been remitting on a monthly basis all available cash flow from the properties, after a reserve for monthly operating expenses, as partial payment of the debt service. The failure to pay the full amount due constitutes a default under the loan agreements which allows the lender to accelerate the loan and to exercise various remedies contained in the loan agreements, including application of escrow balances to delinquent payments and, ultimately, foreclosure on the properties which collateralize the loans. The lender has notified us that it has accelerated the loans. Since that time we have initiated discussions with the servicer of the loans regarding restructuring of the loans. There can be no assurance that such discussions will result in any modification to the terms of the loans. However, any action by the lender with respect to these properties is not expected to have a material impact on our results of operations or financial condition because we are currently only remitting available cash flow. These non-recourse mortgage loans require the monthly funding of escrow accounts for the payment of real estate taxes, insurance and capital improvements. Such escrow accounts totaled $364 as of March 31, 2003, which is included in restricted cash in the Consolidated Balance Sheet. The aggregate carrying value of these properties was $21,719 as of March 31, 2003. Such amount is exceeded by the aggregate outstanding balance of the non-recourse mortgage loans of $24,919 as of March 31, 2003. If the lender were to foreclose on the collateral properties or we were to transfer our ownership interest in the collateral properties to the lender, we would record a non-recurring gain for the difference between the carrying value of the properties and their related net assets and the outstanding loan balances and related liabilities. Defeased Notes Payable On December 6, 2002, we completed the sale of our Colorado Properties, which were part of the 15 properties contained in the collateral pool securing a first mortgage and expansion loan (the "Mega Deal Loan"), which had a then outstanding balance of $338,940. In connection with the release of the Colorado Properties from the collateral pool, we were required to partially defease the Mega Deal Loan. Therefore, the Mega Deal Loan was bifurcated into (i) a defeased portion in the amount of $74,849 (the "Defeased Notes Payable") and (ii) an undefeased portion in the amount of $264,091, which is still referred to as the Mega Deal Loan. Both the Defeased Notes Payable and the Mega Deal Loan (i) bear interest at a fixed-rate of 7.782%, (ii) require monthly payments of principal and interest pursuant to a 30-year amortization schedule and (iii) mature on November 11, 2003. The Mega Deal Loan is now secured by the remaining 13 properties contained in the collateral pool. We used $79,257 of the gross proceeds from the sale of the Colorado Properties to purchase US Treasury Securities, which were placed into a trustee escrow (the "Trustee Escrow"). The Trustee Escrow is used to make the scheduled monthly debt service payments, including the payment of the then outstanding principal amount, together with all accrued and unpaid interest on the maturity date of November 11, 2003, under the Defeased Notes Payable. As of March 31, 2003, the outstanding balance of the Defeased Notes Payable was $74,509 and the balance of the Trustee Escrow was $77,365 (included in restricted cash in the Consolidated Balance Sheet). See Note 3 - "Property Dispositions" for additional information. Furthermore, in connection with the partial defeasance of the Mega Deal Loan we amended the Mega Deal Loan so that (i) we are required to fund 10 monthly payments of $500 into a lender escrow to be used as additional cash collateral and (ii) release prices for the remaining 13 properties in the collateral pool were amended to provide for a more orderly refinancing of the Mega Deal Loan. Page - (16) Debt Service Obligations The scheduled principal maturities of our debt, excluding (i) unamortized debt premiums of $7,435 and (ii) $41,250 of aggregate non-recourse mortgage indebtedness in default (see "Defaults on Certain Non-recourse Mortgage Indebtedness" above), and related average contractual interest rates by year of maturity as of March 31, 2003 are as follows:
- ------------------------------------------------------------------------------------------------------------------------------------ Bonds Payable (including sinking Defeased fund payments) Notes Payable Notes Payable Total Debt -------------------------- ----------------------- ----------------------- ------------------------ Average Average Average Average Interest Principal Interest Principal Interest Principal Interest Principal Years Ended December 31, Rates Maturities Rates Maturities Rates Maturities Rates Maturities - ------------------------------------------------------------------------------------------------------------------------------------ 2003 6.46% $ 636 7.79% $ 265,009 7.78% $ 74,509 7.78% $ 340,154 2004 6.34% 726 7.97% 4,571 7.75% 5,297 2005 6.34% 773 8.58% 11,574 8.44% 12,347 2006 6.34% 820 8.83% 120,437 8.81% 121,257 2007 6.34% 878 7.60% 1,002 7.02% 1,880 Thereafter 6.52% 18,618 7.59% 57,995 7.33% 76,613 ---- -------- ---- --------- ---- -------- ---- --------- 6.49% $ 22,451 8.06% $ 460,588 7.78% $ 74,509 7.96% $ 557,548 ==== ======== ==== ========= ==== ======== ==== ========= ====================================================================================================================================
Such indebtedness in the amount of $557,548 had a weighted-average maturity of 2.3 years and bore contractual interest at a weighted-average rate of 7.96% per annum. At March 31, 2003, all of such indebtedness bore interest at fixed rates. Our remaining scheduled principal payments during 2003 for such indebtedness aggregated $340,154. In addition to regularly scheduled principal payments, the remaining 2003 scheduled principal payments also reflect balloon payments of (i) $260,681 for the Mega Deal Loan and (ii) $73,882 due for the Defeased Notes Payable. Both the Mega Deal Loan and the Defeased Notes Payable are scheduled to mature on November 11, 2003. All debt service due under the Defeased Notes Payable, including the balloon payment due at maturity, will be made from the Trustee Escrow. See "Going Concern" for additional information. Interest Expense Interest costs are summarized as follows: - -------------------------------------------------------------------------------- Three Months Ended March 31, 2003 2002 - -------------------------------------------------------------------------------- Interest incurred $ 10,460 $ 16,542 Amortization of deferred financing costs 426 1,683 Amortization of debt premiums (519) (496) Interest expense - defeased debt 1,489 - -------- -------- Total $ 11,856 $ 17,729 ======== ======== ================================================================================ Defaults on Certain Non-recourse Mortgage Indebtedness of Unconsolidated Partnerships Two mortgage loans related to projects in which we, through subsidiaries, indirectly own joint venture interests have matured and are in default. The mortgage loans, at the time of default, were (i) a $10,389 first mortgage loan on Phase I of the Bellport Outlet Center, held by Union Labor Life Insurance Company ("Union Labor"); and (ii) a $13,338 first mortgage loan on Oxnard Factory Outlet, an outlet center located in Oxnard, California, held by Fru-Con. An affiliate of ours has a 50% ownership interest in the partnership, which owns Phase I of the Bellport Outlet Center. Fru-Con and us are each a 50% partner in the partnership that owns the Oxnard Factory Outlet. Page - (17) Union Labor filed for foreclosure on Phase I of the Bellport Outlet Center and a receiver was appointed March 27, 2001 by the court involved in the foreclosure action. Effective May 1, 2001, a manager hired by the receiver began managing and leasing Phase I of the Bellport Outlet Center. A judgment for foreclosure was entered on January 25, 2003 in the amount of $12,711. The foreclosure occurred on March 17, 2003 with Union Labor acquiring the property for $5,100. We continue to negotiate the terms of a transfer of our ownership interest in Oxnard Factory Outlet to Fru-Con. We do not manage or lease Oxnard Factory Outlet. We believe neither of these mortgage loans is recourse to us. It is possible, however, that either or both of the respective lenders will, after completing its foreclosure action, file a lawsuit seeking to collect from us the difference between the value of the mortgaged property and the amount due under the loan. If such an action is brought, the outcome, and our ultimate liability, if any, cannot be predicted at this time. In addition, we are currently not receiving, directly or indirectly, any cash flow from Oxnard Factory Outlet and were not receiving any cash flow from Phase I of the Bellport Outlet Center prior to the loss of control of such project. We account for our interests in (i) Phases I of the Bellport Outlet Center and (ii) the Oxnard Factory Outlet in accordance with the equity method of accounting. As of March 31, 2003, we had no carrying value for our investment in these properties. 2002 Debt Transactions We disposed of certain properties through various transactions, including sale, joint venture arrangements, foreclosure and transfer to lender, during the year ended December 31, 2002. In connection with these dispositions, we reduced our indebtedness by $349,378, including the partial defeasance of $74,849 of the Mega Deal Loan. This reduction also included (i) the repayment of associated mortgage indebtedness aggregating $168,982, (ii) debt assumed by the purchaser of $46,862 and (iii) debt associated with foreclosure or transfer of properties aggregating $58,685. See Note 3 - "Property Dispositions" for additional information. At the beginning of 2002, our mezzanine loan (the "Mezzanine Loan") had an outstanding balance of $62,079. During 2002 we repaid the Mezzanine Loan in full through (i) regularly scheduled monthly principal payments aggregating $9,295, (ii) additional principal payments aggregating $45,467 made with excess proceeds from our asset sales (see Note 3 - "Property Dispositions" for additional information) and (iii) a payoff of $7,317 with cash from escrows and operating cash. In connection with the early extinguishment of the Mezzanine Loan, we incurred a non-recurring loss of $525 in the fourth quarter of 2002 representing the write-off of remaining unamortized deferred financing costs. The Mezzanine Loan was obtained in December 2000 in the original amount of $90,000 and was scheduled to mature on September 30, 2003. Through a series of amendments and modifications to its terms, the Mezzanine Loan bore interest at a fixed-rate of 19.75% at the time of the retirement. Page - (18) Guarantees and Guarantees of Indebtedness of Others HGP Guarantees On July 15, 2002, Horizon Group Properties, Inc. and its affiliates ("HGP") announced they had refinanced a secured credit facility (the "HGP Secured Credit Facility") through a series of new loans aggregating $32,500. Prior to the refinancing, we were a guarantor under the HGP Secured Credit Facility in the amount of $10,000. In connection with the refinancing, our guarantee was reduced to a maximum of $4,000 as security for a $3,000 mortgage loan and a $4,000 mortgage loan (collectively, the "HGP Monroe Mortgage Loan") secured by HGP's outlet shopping center located in Monroe, Michigan. The HGP Monroe Mortgage Loan has a 3-year term, bears interest at the prime lending rate plus 2.50% (with a minimum of 9.90%) and requires monthly interest-only payments. The HGP Monroe Mortgage Loan may be prepaid without penalty after two years. Our guarantee with respect to the HGP Monroe Mortgage Loan will be extinguished if the principal amount of such obligation is reduced to $5,000 or less through repayments. Additionally, we are a guarantor with respect to certain mortgage indebtedness (the "HGP Office Building Mortgage") in the amount of $2,129 on HGP's corporate office building and related equipment located in Norton Shores, Michigan. The HGP Office Building Mortgage matures on May 31, 2003, bears interest at LIBOR plus 5.50%, and requires monthly debt service payments. On October 11, 2001, HGP announced that it was in default under two loans with an aggregate principal balance of approximately $45.5 million secured by six of its other outlet centers. Such defaults do not constitute defaults under the HGP Monroe Mortgage Loan or the HGP Office Building Mortgage nor did they constitute a default under the HGP Secured Credit Facility. We have not recorded any liability related to these guarantees and no claims have been made under our guarantees with respect to the HGP Monroe Mortgage Loan or the HGP Office Building Mortgage. HGP is a publicly traded company that was formed in connection with our merger with Horizon Group, Inc. ("Horizon") in June 1998. Prime/Estein Venture Guarantees Pursuant to Prime/Estein Venture-related documents to which affiliates of ours are parties, we are obligated to provide to, or obtain for, the Prime/Estein Venture fixed-rate financing at an annual rate of 7.75% (the "Interest Rate Subsidy Agreement") for Prime Outlets at Birch Run (the "Birch Run Center"), Prime Outlets at Williamsburg (the "Williamsburg Center") and the Hagerstown Center. In August 2001, we, through affiliates, completed a refinancing of $63,000 of first mortgage loans secured by the Birch Run Center. The refinanced loan (the "Birch Run First Mortgage") (i) has a term of 10-years, (ii) bears interest at an effective rate of 8.12% and (iii) requires monthly payments of principal and interest pursuant to a 25-year amortization schedule. Pursuant to the Interest Rate Subsidy Agreement, we are required to pay to the Prime/Estein Venture the difference between the cost of the financing at an assumed rate of 7.75% and the actual cost of such financing at the annual rate of 8.12% (the "Interest Rate Subsidy Obligation"). The net present value of the Interest Rate Subsidy Obligation (included in accounts payable and other liabilities in the Consolidated Balance Sheet) was $1,437 as of March 31, 2003. Page - (19) In October 2001, we, through affiliates, completed the refinancing of a $32,500 first mortgage loan secured by the Williamsburg Center. The new first mortgage loan (the "Williamsburg First Mortgage") (i) has a term of 10-years, (ii) bears interest at a fixed-rate of 7.69% and (iii) requires monthly payments of principal and interest pursuant to a 25-year amortization schedule. Pursuant to the Interest Rate Subsidy Agreement, the Prime/Estein Venture is required to pay to us the difference between the cost of the financing at an assumed rate of 7.75% and the actual cost of such financing at the annual rate of 7.69%. On January 11, 2002, we sold the Hagerstown Center to the Prime/Estein Venture. In connection with the sale, the Prime/Estein Venture assumed the Hagerstown First Mortgage in the amount of $46,862; however, our guarantee of such indebtedness remains in place. Additionally, we are obligated to refinance the Hagerstown First Mortgage on behalf of the Prime/Estein Venture on or before June 1, 2004, the date on which such indebtedness matures. Additionally, the Prime/Estein Venture's cost of the Hagerstown First Mortgage and any refinancing of it are fixed at an annual rate of 7.75% for a period of 10 years. If the actual cost of such indebtedness should exceed 7.75% at any time during the 10-year period, we will be obligated to pay the difference to the Prime/Estein Venture. If the actual cost of such indebtedness is less than 7.75% at any time during the 10-year period, however, the Prime/Estein Venture will be obligated to pay the difference to us. The actual cost of the Hagerstown First Mortgage is 30-day LIBOR plus 1.50%, or 2.84% as of March 31, 2003. Because the Hagerstown First Mortgage bears interest at a variable rate, we are exposed to the impact of interest rate changes. We have not recorded any liability related to our guarantee of the Hagerstown First Mortgage; however, in connection with the sale of the Hagerstown Center, we established a reserve for estimated refinancing costs in the amount of $937, which is included in accounts payable and other liabilities in the Consolidated Balance Sheet as of March 31, 2003. See Note 3 - "Property Dispositions" of the Notes to Consolidated Financial Statements for additional information. Mandatory Redemption Obligation On July 26, 2002, we sold the Bridge Properties to the PFP Venture. In connection with the sale, we guaranteed FRIT (i) a 13% return on its $17,236 of invested capital and (ii) the full return of its invested capital by December 31, 2003. As of March 31, 2003, our Mandatory Redemption Obligation with respect to the full return of FRIT's invested capital was $16,356 (included in accounts payable and other liabilities in the Consolidated Balance Sheet). On April 4, 2003, we made an additional payment with respect to the Mandatory Redemption Obligation of $1,085 with the net proceeds from the March 31, 2003 sale of certain excess land. See Note 3 - "Property Dispositions" for additional information with respect to the sale of the Bridge Properties. Going Concern Our liquidity depends on cash provided by operations and potential capital raising activities such as funds obtained through borrowings, particularly refinancing of existing debt, and cash generated through asset sales. Although we believe that estimated cash flows from operations and potential capital raising activities will be sufficient to satisfy our scheduled debt service and other obligations and sustain our operations for the next year, there can be no assurance that we will be successful in obtaining the required amount of funds for these items or that the terms of the potential capital raising activities, if they should occur, will be as favorable as we have experienced in prior periods. Page - (20) During 2003, our Mega Deal Loan matures on November 11, 2003. The Mega Deal Loan, which is secured by a 13 property collateral pool, had an outstanding principal balance of $262,890 as of March 31, 2003 and will require a balloon payment of $260,681 at maturity. Based on our initial discussions with various prospective lenders, we are currently projecting a potential shortfall with respect to refinancing the Mega Deal Loan. Nevertheless, we believe this shortfall may be alleviated through potential asset sales and/or other capital raising activities, including the placement of mezzanine level debt. We caution that our assumptions are based on current market conditions and, therefore, are subject to various risks and uncertainties, including changes in economic conditions which may adversely impact our ability to refinance the Mega Deal Loan at favorable rates or in a timely and orderly fashion and which may adversely impact our ability to consummate various asset sales or other capital raising activities. In connection with the completion of the sale of the Bridge Properties in July 2002, we guaranteed to FRIT (i) a 13% return on its $17,236 of invested capital, and (ii) the full return of the Mandatory Redemption Obligation by December 31, 2003. As of March 31, 2003, the Mandatory Redemption Obligation (included in accounts payable and other liabilities in the Consolidated Balance Sheet) was $16,356. See Note 3 - "Property Dispositions" for additional information. On April 4, 2003, we made an additional payment of $1,085 with net proceeds from the March 31, 2003 sale of certain excess land which reduced the balance of the Mandatory Redemption Obligation to $15,271. Although we continue to seek to generate additional liquidity to repay the Mandatory Redemption Obligation through (i) the sale of FRIT's ownership interest in the Bridge Properties and/or (ii) the placement of additional indebtedness on the Bridge Properties, there can be no assurance that we will be able to complete such capital raising activities by December 31, 2003 or that such capital raising activities, if they should occur, will generate sufficient proceeds to repay the Mandatory Redemption Obligation in full. Failure to repay the Mandatory Redemption Obligation by December 31, 2003 would constitute a default, which would enable FRIT to exercise its rights with respect to the collateral pledged as security to the guarantee, including some of our partnership interests in the 13 property collateral pool under the aforementioned Mega Deal Loan. Because the Mandatory Redemption Obligation is secured by some of our partnership interests in the 13 property collateral pool under the Mega Deal Loan, we may be required to repay the Mandatory Redemption Obligation before, or in connection with, the refinancing of the Mega Deal Loan. These conditions raise substantial doubt about our ability to continue as a going concern. The financial statements contained herein do not include any adjustment to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of these uncertainties. Note 5 - Shareholders' Equity To qualify as a real estate investment trust ("REIT") for federal income tax purposes, we are required to pay distributions to our common and preferred shareholders of at least 90% of our REIT taxable income in addition to satisfying other requirements. Although we intend to make distributions, if necessary, to remain qualified as a REIT under the Code, we also intend to retain such amounts as we consider necessary from time to time for our capital and liquidity needs. Our policy remains to pay distributions only to the extent necessary to maintain our status as a REIT for federal income tax purposes. During 2002, we were not required to pay any distributions in order to maintain our status as a REIT and based on our current federal income tax projections, we do not expect to pay any distributions during 2003. We are currently in arrears on 14 quarters of preferred stock distributions due February 15, 2000 through May 15, 2003, respectively. Page - (21) We may not make distributions to our common shareholders or our holders of common units of limited partnership interests in the Operating Partnership unless we are current with respect to distributions to our preferred shareholders. As of March 31, 2003, unpaid dividends for the period beginning on November 16, 1999 through March 31, 2003 on our Series A Senior Cumulative Preferred Stock ("Series A Senior Preferred Stock") and Series B Cumulative Convertible Participating Preferred Stock ("Series B Convertible Preferred Stock") aggregated $20,377 and $56,142, respectively. The annualized dividends on our 2,300,000 shares of Series A Senior Preferred Stock and 7,828,125 shares of Series B Convertible Preferred Stock outstanding as of March 31, 2003 are $6,037 ($2.625 per share) and $16,635 ($2.125 per share), respectively. Note 6 - Legal Proceedings Except as described below, neither we nor any of our properties are currently subject to any material litigation, nor to our knowledge, is any material or other litigation threatened against us, other than routine litigation arising in the ordinary course of business, some of which is expected to be covered by liability insurance and all of which collectively is not expected to have an adverse effect on our consolidated financial statements. The Company and its affiliates were defendants in a lawsuit filed by Accrued Financial Services ("AFS") on August 10, 1999 in the Circuit Court for Baltimore City. The lawsuit was removed to United States District Court for the District of Maryland (the "U.S. District Court") on August 20, 1999. AFS claimed that certain tenants had assigned to AFS their rights to make claims under leases such tenants had with affiliates of the Company and alleged that the Company and its affiliates overcharged such tenants for common area maintenance ("CAM") charges and promotion fund charges. The U.S. District Court dismissed the lawsuit on June 19, 2000. AFS appealed the U.S. District Court's decision to the United States Court of Appeals for the Fourth Circuit. Briefs were submitted and oral argument before a panel of judges of the United States Court of Appeals for the Fourth Circuit was held on October 30, 2001, during which the panel of judges requested further briefing of certain issues. On July 29, 2002, the Fourth Circuit affirmed the dismissal. AFS filed a request for further review by the Fourth Circuit which request was denied. In January 2003, AFS filed a petition for a writ of certiorari by the United States Supreme Court (the "Supreme Court") and the Company filed its opposition on February 24, 2003. The Supreme Court subsequently denied the writ of certiorari and the parties have agreed to dismiss any remaining claims, thereby terminating the AFS lawsuit. In addition, certain tenants in the Company's and its affiliates' outlet centers have made or may make allegations concerning overcharging for CAM and promotion fund charges because of varying clauses in their leases pursuant to which they claim under various circumstances that they were not required to pay some or all of the pass-through charges. Such claims if asserted and found meritorious, could have a material affect on the Company's financial condition. Determination of whether liability would exist to the Company would depend on interpretation of various lease clauses within a tenant's lease and all of the other leases at each center collectively. To date such issues have been raised and resolved with Dinnerware Plus Holdings, Inc. ("Mikasa"), Melru Corporation, Designs, Inc. and Brown Group Retail, Inc., all of which at one time or another were in litigation, or threatened litigation with the Company. Additionally, during the first quarter of 2003, Gap Inc. notified the Company that it believes it is entitled to a refund of certain pass-through charges as a result of certain clauses in its leases. Page - (22) In the second quarter of 2002, the Company recorded a non-recurring charge to establish a reserve in the amount of $3,000 for resolution of these matters, in addition to the Mikasa matter referred to above. This reserve was estimated in accordance with our established policies and procedures concerning loss contingencies for additional information). The balance of the unused reserve (which is included in the accounts payable and other liabilities in the Consolidated Balance Sheet) is $2,240 as of March 31, 2003. Based on presently available information, the Company believes it is probable the remaining reserve will be utilized over the next several years in resolving claims relating to the pass-through and promotional fund provisions contained in its leases, inclusive of amounts that may be owed, if any, to the Gap Inc. The Company cautions, however, that given the inherent uncertainties of litigation and the complexities associated with a large number of leases and other factual questions at issue, actual costs may vary from this estimate. No other such tenant, however, has filed a suit or indicated to the Company that it intends to file a suit. Nevertheless, it is too early to make any predictions as to whether the Company or its affiliates may be found liable with respect to other tenants, or to predict damages should liability be found. Affiliates of the Company routinely file lawsuits to collect past rent due from, and to evict, tenants which have defaulted under their leases. There are currently dozens of such actions pending. In addition to defending against the Company's affiliates' claims and eviction actions, some tenants file counterclaims against the Company's affiliates. A tenant who files such a counterclaim typically claims that the Company's affiliate which owns the outlet center in question defaulted under the tenant's lease, overcharged the tenant for CAM and promotion fund charges, made misrepresentations during the leasing process, or failed to maintain or market the outlet center in question as required by the lease. One such case involves a collections and eviction action in Puerto Rico captioned Outlet Village of Puerto Rico Limited Partnership, S.E. v. WEPA, Inc., and another, for instance, involves a collection case in San Marcos, Texas, captioned, San Marcos Factory Stores, Ltd. v. SM Collectibles, Inc. d/b/a Country Clutter. Usually such counterclaims are without merit. In response to such counterclaims the Company's affiliates usually continue to pursue their collection or eviction actions and defend against the counterclaims. Despite the fact that the Company and its affiliates believe such counterclaims are without merit and defend against them vigorously, the outcome of all such counterclaims, and, thus, the liability, if any, of the Company and its affiliates, cannot be predicted at this time. Page - (23) Several entities (the "eOutlets Plaintiffs") filed or stated an intention to file lawsuits (collectively, the "eOutlets Lawsuits") against the Company and its affiliates arising out of the Company's on-line venture, primeoutlets.com. inc., also known as eOutlets, an affiliate of the Company. The eOutlets Plaintiffs seek to hold the Company and its affiliates responsible under various legal theories for liabilities incurred by primeoutlets.com, inc., including the theories that the Company guaranteed the obligations of eOutlets and that the Company was the "alter-ego" of eOutlets. The Company believes that it is not liable to eOutlets Plaintiffs as there was no privity of contract between it and the various eOutlets Plaintiffs. In the case captioned Convergys Customer Management Group, Inc. v. Prime Retail, Inc. and primeoutlets.com inc. in the Court of Common Pleas for Hamilton County (Ohio), the Company prevailed in a motion to dismiss the plaintiff's claim that the Company was liable for primeoutlets.com inc.'s breach of contract based on the doctrine of piercing the corporate veil. In another matter, J. Walter Thompson, USA, Inc. v. Prime Retail, L.P. and Prime Retail, Inc. the Company succeeded in having the corporate veil piercing and alter ego claims dismissed and settled the remaining claims in February 2003. primeoutelts.com, inc. filed for protection under Chapter 7 of the United States Bankruptcy Code in November of 2000 under the name E-Outlets Resolution Corp. (the "Debtor"). On November 5, 2002, the bankruptcy trustee for the Debtor brought suit against Prime Retail, L.P., Prime Retail, Inc., and Prime Retail E-Commerce, Inc. (the "Entity Defendants") and certain former directors of the Debtor (the "Individual Defendants"). The Trustee has asserted claims of alter ego, promissory estoppel, breach of contract, breach of fiduciary duty, tortious interference with prospective business advantage, unjust enrichment and quantum meruit against the Entity Defendants and breach of fiduciary duty and gross negligence against the individual defendants. The Company has tendered the suit, both as to the Entity Defendants and Individual Defendants, to its Directors' and Officers' ("D&O") insurance carrier. Motions to dismiss the suit have been filed by all Defendants. All Defendants believe the suit is without merit and plan on defending it vigorously. Nevertheless, the outcome of this lawsuit, and the ultimate liability of the Company, if any, cannot be predicted at this time. In May 2001, the Company, through affiliates, filed suit against Fru-Con Construction, Inc. ("FCC"), the lender on Prime Outlets at New River ("New River") as a result of FCC's foreclosure of New River upon the maturation of the loan. The Company and its affiliates allege that they have been damaged because of FCC's failure to dispose of the collateral in a commercially reasonable manner and as a result of a violation of federal trademark laws. The Company, through affiliates, has also filed suit against The Fru-Con Projects, Inc. ("Fru-Con"), a partner in Arizona Factory Shops Partnership and an affiliate of FCC. The Company and its affiliates allege that Fru-Con failed to use reasonable efforts to assist in obtaining refinancing. Fru-Con has claims pending against the Company and its affiliates, as part of the same suit, alleging that the Company and its affiliates breached their contract with Fru-Con by not allowing Fru-Con to participate in an outlet project in Sedona, Arizona (the "Sedona Project") and breached a management and leasing agreement by managing and leasing the Sedona Project. The Company believes its affiliates and it acted property and FCC did not act properly. The Company and its affiliates will vigorously defend the claims filed against them and prosecute the claims they filed. Nevertheless, the ultimate outcome of the suit, including the liability, if any, of the Company and its affiliates, cannot be predicted at this time. Page - (24) Note 7 - Investment in Unconsolidated Partnerships We account for our investment in unconsolidated joint ventures in accordance with the equity method of accounting as we exercise significant influence, but do not control these entities. In all of our joint venture arrangements, the rights of the investors are both protective as well as participating. Therefore, these participating rights preclude us from consolidating our investments. Our investments are recorded initially at our cost and subsequently adjusted for equity in earnings (losses) and cash contributions and distributions. As of March 31, 2003 our interests in joint venture partnerships included (i) three outlet centers owned by the Prime/Estein Venture and (ii) five properties owned by the PFP Venture. The Prime/Estein Venture owns the Birch Run Center, the Williamsburg Center and the Hagerstown Center which contain an aggregate 1,485,000 square feet of GLA. The PFP Venture owns the Bridge Properties (Prime Outlets at Anderson, Prime Outlets at Calhoun, Prime Outlets at Gaffney, Prime Outlets at Lee and Prime Outlets at Lodi) which contain an aggregate 1,261,000 square feet of GLA. During the three months ended March 31, 2003 and 2002, respectively, our equity in earnings (loss) of unconsolidated joint venture partnerships was $1,126 and $153, respectively, which is included in interest and other income in the Consolidated Statements of Operations. The following summarizes unaudited condensed financial information for our investment in unconsolidated joint venture partnerships: - -------------------------------------------------------------------------------- Three Months Ended March 31, 2003 2002 - -------------------------------------------------------------------------------- Total revenues $ 15,510 $ 8,749 Total expenses 13,925 8,764 -------- ------- Net income (loss) $ 1,585 $ (15) ======== ======= ================================================================================ Page - (25) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Amounts in thousands, except share, unit and square foot information) The following discussion in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other sections of this Quarterly Report on Form 10-Q contain certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which reflect management's current views with respect to future events and financial performance. In addition, we may make forward-looking statements in future filings with the Securities and Exchange Commission and in written material, press releases and oral statements issued by us or on our behalf. Forward-looking statements include statements regarding the intent, belief, or current expectations of us or our officers, including statements preceded by, followed by, or including forward-looking terminology such as "may," "will," "should," believe," "expect," "anticipate," "estimate," "continue," "predict," or similar expressions with respect to various matters. These statements are subject to potential risks and uncertainties and, therefore, actual results may differ materially. Such forward-looking statements are subject to certain risks and uncertainties, including, but not limited to, the risk associated with our high level of leverage and our ability to refinance such indebtedness as it becomes due; the risk that we or one or more of our subsidiaries are not able to satisfy scheduled debt service obligations or will not remain in compliance with existing loan covenants; the risk of material adverse affects of future events, including tenant bankruptcies, abandonments and the non-payment by tenants of contractual rents and additional rents, on our financial performance; the risk related to the retail industry in which our outlet centers compete, including the potential adverse impact of external factors, such as inflation, consumer confidence, unemployment rates and consumer tastes and preferences; the risk associated with our potential asset sales; the risk of potential increases in market interest rates from current levels; the risk associated with real estate ownership, such as the potential adverse impact of changes in local economic climate on the revenues and the value of our properties; the risk associated with litigation; and the risk associated with competition from web-based and catalogue retailers. All forward-looking statements in this report are based on information available to us on the date of this report. We do not undertake to update any forward-looking statements that may be made by us or on our behalf in this report or otherwise. Introduction Unless the context otherwise requires, all references to "we," "us," "our" or the "company" herein mean Prime Retail, Inc. and those entities owned or controlled by Prime Retail, Inc., including Prime Retail, L.P. (the "Operating Partnership"). The following discussion and analysis of our consolidated financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and Notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q. Our operations are substantially conducted through the Operating Partnership. As of March 31, 2003, we had an 80% general partnership interest in the Operating Partnership with full and complete control over its management, not subject to removal by the limited partners. We are dependent upon the distributions or other payments from the Operating Partnership to meet our financial obligations. Historical results and percentage relationships set forth herein are not necessarily indicative of future operations. Page - (26) Critical Accounting Policies and Estimates Our discussion and analysis of our financial condition and results of operations are based upon our Consolidated Financial Statements and Notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q. These Consolidated Financial Statements and Notes thereto have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of such statements requires us to make certain estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent liabilities. We evaluate our estimates on an on-going basis; including those related to (i) revenue recognition, (ii) provisions for bad debt on accounts receivable, (iii) potential impairment of the carrying value of rental properties held for use, (iv) capitalization and depreciation of significant renovations and improvements and (v) contingencies for debt guarantees and litigation. We base our estimates on historical trends and certain other assumptions that we believe are reasonable under the particular circumstances. These estimates ultimately form the basis for making judgments about the carrying values of our assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. To assist you in understanding our financial condition and results from operations, we have identified our critical accounting policies and discussed them below. These accounting policies are most important to the portrayal of our financial condition and results from operations, either because of the significance of the financial statement items to which they relate or because they require our management's most difficult, subjective or complex judgments. Revenue Recognition Leases with tenants are accounted for as operating leases. Minimum rental income is recognized on a straight-line basis over the term of the lease and unpaid rents are included in accounts receivable, net in the accompanying Consolidated Balance Sheets. Certain lease agreements contain provisions, which provide for rents based on a percentage of sales or based on a percentage of sales volume above a specified threshold. These contingent rents are not recognized until the required thresholds are exceeded. In addition, the lease agreements generally provide for the reimbursement of real estate taxes, insurance, advertising and certain common area maintenance costs. These additional rents and tenant reimbursements are accounted for on the accrual basis. Bad Debt Expense We regularly review our accounts receivable to determine an appropriate amount for the allowance for doubtful accounts based upon the impact of economic conditions on ours tenants' ability to pay, past collection experience and such other factors which, in our judgment, deserve current recognition. In turn, a provision for uncollectible accounts receivable ("bad debt expense") is charged against the allowance to maintain the allowance level within this range. If the financial condition of our tenants were to deteriorate, resulting in impairment in their ability to make payments due under their leases, additional allowances may be required. Page - (27) Impairment of Rental Property We monitor our Properties for indicators of impairment on an on-going basis. We record a provision for impairment when we believe certain events and circumstances have occurred which indicate that the carrying value of our Properties might have experienced a decline in value that is other than temporary and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets. Impairment losses are measured as the difference between the carrying value and the estimated fair value for assets held in the portfolio. For assets held for sale, impairment is measured as the difference between the carrying value and fair value, less estimated costs to dispose. Fair value is based on estimated cash flows discounted at a risk-adjusted rate of return. Adverse changes in market conditions or deterioration in the operating results of our outlet centers and other rental properties could result in losses or an inability to recover the current carrying value of such assets. Such potential losses or the inability to recover the current carrying value may not be reflected in our Properties' current carrying value, thereby possibly requiring an impairment charge in the future. Capitalization and Depreciation of Significant Renovations and Improvements Depreciation is calculated on the straight-line basis over the estimated useful lives of the assets, based upon management's estimates. Significant renovations and improvements, which improve and/or extend the useful life of assets are capitalized and depreciated over their estimated useful lives, based upon management's estimates. Contingencies We are subject to proceedings, lawsuits, and other claims related to various matters (see Note 6 - "Legal Proceedings" of the Notes to the Consolidated Financial Statements for additional information). Additionally, we have guaranteed certain indebtedness of others (see Note 4 - "Debt" of the Notes to Consolidated Financial Statements for additional information). With respect to these contingencies, we assess the likelihood of any adverse judgments or outcomes to these matters and, if appropriate, potential ranges of probable losses. A determination of the amount of reserves required, if any, for these contingencies are made after careful analysis of each individual issue. Future reserves may be required because of (i) new developments or changes to the approach in which we deal with each matter or (ii) if unasserted claims arise. Outlet Center Portfolio Portfolio GLA and Occupancy Our outlet center portfolio size reflects (i) our past development (both new outlet centers and expansions to outlet centers) and acquisition activities and (ii) our more recent disposition activities. Our outlet portfolio (including properties owned through joint venture partnerships) consisted of 36 properties totaling 10,226,000 square feet of gross leasable area ("GLA") at March 31, 2003 compared to 44 properties totaling 12,388,000 square feet of GLA at March 31, 2002. The change in our outlet center GLA is because of certain property dispositions, which are discussed below. Our outlet center portfolio was 86.7% and 87.2% occupied as of March 31, 2003 and 2002, respectively. Additionally, our outlet center portfolio was 87.8% leased as of March 31, 2003. The weighted-average occupancy of our outlet center portfolio (excluding those properties disposed of whose results are included in discontinued operations) during the three months ended March 31, 2003 and 2002 was 87.5% and 87.7%, respectively. We disposed of certain properties through various transactions (including sale, joint venture arrangements, foreclosure and transfer of ownership to the applicable lender). These transactions have had a significant impact on the size of our portfolio for the periods presented and are summarized below. Page - (28) During 2002, we completed transactions involving 17 properties aggregating 4,431,000 square feet of GLA. These transactions included (i) the sale of seven outlet centers aggregating 1,791,000 square feet of GLA into joint venture arrangements, (ii) the sale of five (including one consisting of 197,000 square feet of GLA that we owned 51% through an unconsolidated joint venture) outlet centers aggregating 1,486,000 square feet of GLA to unrelated third parties, (iii) the foreclosure sale and/or transfer of three outlet centers aggregating 922,000 square feet of GLA to the applicable lender and (iv) the sale of two community centers aggregating 232,000 square feet of GLA to unrelated third parties. The seven centers sold into joint venture arrangements consisted of two separate transactions involving (i) Prime Outlets at Hagerstown (the "Hagerstown Center"), which was sold to an existing joint venture partnership (the "Prime/Estein Venture"), and (ii) six outlet centers (collectively, the Bridge Properties"). Such properties are collectively referred to as the "2002 Joint Venture Properties". Commencing on the date of disposition, we account for our ownership interest in the 2002 Joint Venture Properties in accordance with the equity method of accounting. The operating results of the 2002 Joint Venture Properties are reflected in our results from continuing operations for all periods presented through their respective dates of disposition. Their operating results have not been classified to discontinued operations because we have a significant continuing involvement in these properties. Additionally, we sold Phases II and III of the Bellport Outlet Center. We accounted for our ownership interest in the Bellport Outlet Center in accordance with the equity method of accounting through its date of disposition. The operating results of the remaining disposed properties have been classified as discontinued operations in the accompanying Consolidated Statements of Operations for all periods presented. On March 31, 2003, we completed the sale of Prime Outlets at Latham consisting of 43,000 square feet of GLA. This property was owned through a joint venture partnership. See Note 3 - "Property Dispositions" to the Notes to Consolidated Financial Statements. Effective January 1, 2002, we adopted Statement of Financial Accounting Standards ("FAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." In accordance with the requirements of FAS No. 144, we have classified the operating results, including gains and losses related to disposition, for certain properties either disposed of or classified as assets held for sale during 2002 as discontinued operations in the accompanying Consolidated Statements of Operations for all periods presented. The operating results for properties that were sold into joint venture partnerships during 2002 have not been classified to discontinued operations in the accompanying Consolidated Statements of Operations because we still retain a significant continuing involvement in their operations. Such properties and/or their operating results through the dates of their respective disposition are collectively referred to as the "2002 Joint Venture Properties". The following discussion and tables regarding operating results for the comparable periods are reflective of the classification requirements under FAS No. 144 and relate to operating results from continuing operations unless otherwise indicated. Page - (29) The table set forth below summarizes certain information with respect to our outlet centers as of March 31, 2003 (see Note 4 - "Debt" of the Notes to Consolidated Financial Statements contained herein for additional information with respect to indebtedness on our Properties):
- ------------------------------------------------------------------------------------------------------------------------------------ Grand GLA Occupancy Outlet Centers Opening Date (Sq. Ft.) Percentage (1) - ------------------------------------------------------------------------------------------------------------------------------------ Prime Outlets at Fremont-- Fremont, Indiana October 1985 229,000 86% Prime Outlets at Birch Run (2)-- Birch Run, Michigan September 1986 724,000 91 Prime Outlets at Williamsburg (2)-- Williamsburg, Virginia April 1988 274,000 97 Prime Outlets at Pleasant Prairie-- Kenosha, Wisconsin September 1988 269,000 95 Prime Outlets at Burlington-- Burlington, Washington May 1989 174,000 89 Prime Outlets at Queenstown-- Queenstown, Maryland June 1989 221,000 96 Prime Outlets at Hillsboro-- Hillsboro, Texas October 1989 359,000 88 Prime Outlets at Oshkosh-- Oshkosh, Wisconsin November 1989 260,000 97 Prime Outlets at Warehouse Row (4)-- Chattanooga, Tennessee November 1989 95,000 77 Prime Outlets at Perryville-- Perryville, Maryland June 1990 148,000 93 Prime Outlets at Sedona-- (5) Sedona, Arizona August 1990 82,000 92 Prime Outlets at San Marcos-- San Marcos, Texas August 1990 549,000 91 Prime Outlets at Anderson-- (3) Anderson, California August 1990 165,000 90 Prime Outlets at Post Falls-- (5) Post Falls, Idaho July 1991 179,000 61 Prime Outlets at Ellenton-- Ellenton, Florida October 1991 481,000 95 Prime Outlets at Morrisville-- Raleigh - Durham, North Carolina October 1991 187,000 77 Prime Outlets at Naples-- Naples/Marco Island, Florida December 1991 146,000 84 Prime Outlets at Niagara Falls USA-- Niagara Falls, New York July 1992 534,000 88 Prime Outlets at Woodbury-- (6) Woodbury, Minnesota July 1992 250,000 65 Prime Outlets at Calhoun-- (3) Calhoun, Georgia October 1992 254,000 85 Prime Outlets at Bend-- (5) Bend, Oregon December 1992 132,000 93 Prime Outlets at Jeffersonville I-- Jeffersonville, Ohio July 1993 407,000 92 Prime Outlets at Gainesville-- Gainesville, Texas August 1993 316,000 69 Prime Outlets at Grove City-- Grove City, Pennsylvania August 1994 533,000 97 Prime Outlets at Huntley-- Huntley, Illinois August 1994 282,000 68 Prime Outlets at Florida City-- Florida City, Florida September 1994 208,000 68 Prime Outlets at Pismo Beach-- Pismo Beach, California November 1994 148,000 98 Prime Outlets at Tracy-- Tracy, California November 1994 153,000 89 Prime Outlets at Odessa-- Odessa, Missouri July 1995 296,000 69
Page - (30)
- ------------------------------------------------------------------------------------------------------------------------------------ Grand GLA Occupancy Outlet Centers Opening Date (Sq. Ft.) Percentage (1) - ------------------------------------------------------------------------------------------------------------------------------------ Prime Outlets at Darien (7)-- Darien, Georgia July 1995 307,000 60% Prime Outlets at Gulfport (8)-- Gulfport, Mississippi November 1995 306,000 87 Prime Outlets at Lodi-- (3)Burbank, Ohio November 1996 313,000 84 Prime Outlets at Gaffney (3) (7)-- Gaffney, South Carolina November 1996 305,000 90 Prime Outlets at Lee-- (3) Lee, Massachusetts June 1997 224,000 95 Prime Outlets at Lebanon-- Lebanon, Tennessee April 1998 229,000 95 Prime Outlets at Hagerstown (2)-- Hagerstown, Maryland August 1998 487,000 98 ---------- -- Total Outlet Centers (9) 10,226,000 87% ========== == ====================================================================================================================================
Notes: (1) Percentage reflects occupied space as of March 31, 2003 as a percent of available square feet of GLA. (2) Through affiliates, we have a 30% ownership interest in the joint venture partnership that owns this outlet center. (3) Through affiliates, we have an 18.2% ownership interest in the joint venture partnership that owns this outlet center. (4) We own a 2% partnership interest as the sole general partner in this property, but are entitled to 99% of the property's operating cash flow and net proceeds from a sale or refinancing. This mixed-use development also includes approximately 154,000 square feet of office space, not included in this table, which was 95% occupied as of March 31, 2003. (5) Non-recourse mortgage loans cross-collateralized by Prime Outlets at Bend, Prime Outlets at Post Falls and Prime Outlets at Sedona are currently in default and we are in the process of negotiating a transfer of our ownership interests in these outlet centers to the lender. See Note 4 - "Debt" of the Notes to Consolidated Financial Statements for additional information. (6) Non-recourse mortgage loans on Prime Outlets at Vero Beach and Prime Outlets at Woodbury were cross-collateralized. The lender foreclosed on Prime Outlets at Vero Beach on September 9, 2002. We are currently negotiating the transfer of our ownership interest in Prime Outlets at Woodbury with the lender. See Note 4 - "Debt" of the Notes to Consolidated Financial Statements for additional information. (7) We operate this outlet center pursuant to a long-term ground lease under which we receive the economic benefit of a 100% ownership interest. (8) The real property on which this outlet center is located is subject to a long-term ground lease. (9) Excludes Oxnard Factory Outlet. Through an affiliate, we have a 50% legal ownership interest in the joint venture partnership that owns this outlet center. However, we are currently receiving no economic benefit from the Oxnard Factory Outlet. Page - (31) Results of Operations Table 1 - Consolidated Statements of Operations
- ------------------------------------------------------------------------------------------------------------------------------------ 2003 vs. 2002 ---------------------------- Three Months Ended March 31, 2003 2002 Change Change - ------------------------------------------------------------------------------------------------------------------------------------ Revenues Base rents $ 18,993 $ 24,309 $ (5,316) -21.9% Percentage rents 977 1,320 (343) -26.0% Tenant reimbursements 10,958 12,834 (1,876) -14.6% Interest and other 4,012 2,860 1,152 40.3% -------- -------- -------- ------- Total revenues 34,940 41,323 (6,383) -15.4% Expenses Property operating 9,955 10,211 (256) -2.5% Real estate taxes 2,984 3,666 (682) -18.6% Depreciation and amortization 7,280 10,208 (2,928) -28.7% Corporate general and administrative 4,466 3,419 1,047 30.6% Interest 11,856 17,729 (5,873) -33.1% Other charges 688 2,472 (1,784) -72.2% -------- -------- -------- ------- Total expenses 37,229 47,705 (10,476) -22.0% -------- -------- -------- ------- Loss before gain on sale of real estate (2,289) (6,382) 4,093 -64.1% Gain on sale of real estate, net - 16,793 (16,793) n/m -------- -------- -------- ------- Income (loss) from continuing operations (2,289) 10,411 (12,700) -122.0% Discontinued operations, including loss of $9,623 on dispositions in 2002 - (8,730) 8,730 n/m -------- -------- -------- ------- Net income (loss) (2,289) 1,681 (3,970) -236.2% Allocations to preferred shareholders (5,668) (5,668) - 0.0% -------- -------- -------- ------- Net loss applicable to common shares $ (7,957) $ (3,987) $ (3,970) 99.6% ======== ======== ======== ======= Basic and diluted earnings per common share: Income (loss) from continuing operations $ (0.18) $ 0.11 Discontinued operations - (0.20) -------- -------- Net loss $ (0.18) $ (0.09) ======== ======== Weighted-average common shares outstanding - basic and diluted 43,578 43,578 ======== ======== ====================================================================================================================================
Page - (32) Comparison of the three months ended March 31, 2003 to the three months ended March 31, 2002 Summary We reported income (loss) from continuing operations of $(2,289) and $10,411 for the three months ended March 31, 2003 and 2002, respectively. For the three months ended March 31, 2003, the net loss applicable to our common shareholders was $7,957, or $0.18 per common share. For the three months ended March 31, 2002, the net loss applicable to our common shareholders was $3,987, or $0.09 per common share. During the three months ended March 31, 2002, we reported a loss from discontinued operations of $8,730, or $0.20 per common share. This loss from discontinued operations included a loss related to dispositions of $9,623. Revenues Total revenues were $34,940 for the three months ended March 31, 2003 compared to $41,323 for the same period in 2002, a decrease of $6,383, or 15.4%. Base rents decreased $5,316, or 21.9%, to $18,993 in 2003 compared to $24,309 in 2002. These decreases are primarily due to (i) transactions involving the 2002 Joint Venture Properties, (ii) changes in economic rental rates and (iiii) the slight reduction in outlet center occupancy during the 2003 period. Straight-line rent expense, included in base rent was $138 and $33 for the three months ended March 31, 2003 and 2002, respectively. Percentage rents, which represent rents based on a percentage of sales volume above a specified threshold, decreased $343, or 26.0%, to $977 during the three months ended March 31, 2003 compared to $1,320 for the same period in 2002. This decrease was primarily due to (i) transactions involving the 2002 Joint Venture Properties and (ii) changes in economic rental rates. Tenant reimbursements, which represent the contractual recovery from tenants of certain operating expenses, decreased by $1,876, or 14.6%, to $10,958 during the three months ended March 31, 2003 compared to $12,834 for the same period in 2002. This decline is primarily due to (i) transactions involving the 2002 Joint Venture Properties, (ii) changes in economic rental rates and (iii) the slightly reduced aggregate outlet center weighted-average occupancy during the 2003 period. As shown in TABLE 2, tenant reimbursements as a percentage of recoverable property operating expenses and real estate taxes was 84.7% during the three months ended March 31, 2003 compared to 92.5% for the same period in 2002. The decline in tenant reimbursements as a percentage of recoverable property operating expenses and real estate taxes was primarily attributable to the aforementioned changes in economic rental rates and weighted-average occupancy. Table 2 - Tenant Recoveries as a Percentage of Total Recoverable Expenses - -------------------------------------------------------------------------------- Three Months Ended March 31, 2003 2002 - -------------------------------------------------------------------------------- Tenant reimbursements $ 10,958 $ 12,834 Recoverable Expenses: Property operating $ 9,955 $ 10,211 Real estate taxes 2,984 3,666 -------- -------- Total recoverable expenses $ 12,939 $ 13,877 ======== ======== Tenant reimbursements as a percentage of total recoverable expenses 84.7% 92.5% ======== ======== ================================================================================ Page - (33) Interest and other income increased by $1,152, or 40.3%, to $4,012 during the three months ended March 31, 2003 compared to $2,860 for the same period in 2002. The increase was primarily attributable to (i) higher equity in earnings of unconsolidated joint ventures of $973 and (ii) an increase in all other income of $179. The increase in equity in earnings of unconsolidated joint ventures is primarily associated with the transactions involving the 2002 Joint Venture Properties. Expenses Property operating expenses decreased by $256, or 2.5%, to $9,955 during the three months ended March 31, 2003 compared to $10,211 for the same period in 2002. Real estate taxes expense decreased by $682, or 18.6%, to $2,984 during the three months ended March 31, 2003 compared to $3,666 for the same period in 2002. The decrease in property operating expenses is primarily because of the transactions involving the 2002 Joint Venture Properties partially offset by higher marketing costs during the 2003 period. The decrease in real estate taxes expense is primarily because of the transactions involving the 2002 Joint Venture Properties. As shown in TABLE 3, depreciation and amortization expense decreased by $2,982, or 28.7%, to $7,280 during the three months ended March 31, 2003 compared to $10,208 for the same period in 2002. This decrease was primarily attributable to the depreciation and amortization of assets associated with the transactions involving the 2002 Joint Venture Properties. Table 3 - Components of Depreciation and Amortization Expense The components of depreciation and amortization expense for the three months ended March 31, 2003 and 2002 are summarized as follows: - -------------------------------------------------------------------------------- Three Months Ended March 31, 2003 2002 - -------------------------------------------------------------------------------- Building and improvements $ 3,447 $ 5,363 Land improvements 938 1,102 Tenant improvements 2,242 3,028 Furniture and fixtures 598 642 Leasing commissions 55 73 ------- -------- Total $ 7,280 $ 10,208 ======= ======== ================================================================================ As shown in TABLE 4, interest expense decreased by $5,873, or 33.1%, to $11,856 during the three months ended March 31, 2003 compared to $17,729 for the same period in 2002. This decrease reflects (i) lower interest incurred of $6,082, (ii) a decrease in amortization of deferred financing costs of $1,257 and (iii) higher amortization of debt premiums of $23. Partially offsetting these items was interest expense of $1,489 associated with certain mortgage debt that was defeased in December 2002. See Note 4 - "Debt" of the Notes to Consolidated Financial Statements for additional information. The decrease in interest incurred is primarily attributable to (i) a reduction of approximately $123,216 in our weighted-average debt outstanding, excluding debt premiums, during the three months ended March 31, 2003 compared to the same period in 2002 and (ii) a decrease in the weighted-average contractual interest rate on our debt for the three months ended March 31, 2003 compared to the same period in 2002. The decrease in weighted-average debt outstanding was primarily attributable to asset dispositions. The weighted-average contractual interest rates for the 2003 and 2002 periods were approximately 8.09% and 9.32%, respectively. Page - (34) Table 4 - Components of Interest Expense The components of interest expense for the three months ended March 31, 2003 and 2002 are summarized as follows: - -------------------------------------------------------------------------------- Three Months Ended March 31, 2003 2002 - -------------------------------------------------------------------------------- Interest incurred $ 10,460 $ 16,542 Amortization of deferred financing costs 426 1,683 Amortization of debt premiums (519) (496) Interest expense - defeased debt 1,489 - -------- -------- Total $ 11,856 $ 17,729 ======== ======== ================================================================================ Other charges decreased by $1,784, or 72.2%, to $688 for the three months ended March 31, 2003 compared to $2,472 for the same period in 2002. This decrease was primarily attributable to lower bad debt expense of $1,808 partially offset by an increase in all other expenses of $24. The decrease in bad debt expense resulted from (i) resolution of certain disputes with tenants and (ii) reduced tenant bankruptcies, abandonments and store closings during the 2003 period. Merchant Sales For the three months ended March 31, 2003, same-store sales in our outlet center portfolio decreased 7.5% compared to the same period in 2002. "Same-store sales" is defined as the weighted-average sales per square foot reported by merchants for stores open since January 1, 2002. The weighted-average sales per square foot reported as reported by our merchants were $245 for the year ended December 31, 2002. Liquidity and Capital Resources Sources and Uses of Cash For the three months ended March 31, 2003, net cash provided by operating activities was $2,651, net cash provided by investing activities was $627 and net cash used in financing activities was $1,950. The net cash provided by investing activities during the three months ended March 31, 2003 consisted of $1,085 of net proceeds from the disposition of excess land and $311 of distributions from unconsolidated joint venture partnerships partially offset by $769 of additions to rental property. The additions to rental property included costs incurred in connection with re-leasing space to new merchants and costs associated with renovations. During the three months ended March 31, 2003, we did not engage in any significant development activities, however, we continue to engage in certain consulting activities in Europe. Such activities do not have a significant impact on our liquidity or financial condition. The gross uses of cash for financing activities of $1,950 during three months ended March 31, 2003 consisted of scheduled principal amortization on debt. Page - (35) Guarantees and Guarantees of Indebtedness of Others HGP Guarantees On July 15, 2002, Horizon Group Properties, Inc. and its affiliates ("HGP") announced they had refinanced a secured credit facility (the "HGP Secured Credit Facility") through a series of new loans aggregating $32,500. Prior to the refinancing, we were a guarantor under the HGP Secured Credit Facility in the amount of $10,000. In connection with the refinancing, our guarantee was reduced to a maximum of $4,000 as security for a $3,000 mortgage loan and a $4,000 mortgage loan (collectively, the "HGP Monroe Mortgage Loan") secured by HGP's outlet shopping center located in Monroe, Michigan. The HGP Monroe Mortgage Loan has a 3-year term, bears interest at the prime lending rate plus 2.50% (with a minimum of 9.90%) and requires monthly interest-only payments. The HGP Monroe Mortgage Loan may be prepaid without penalty after two years. Our guarantee with respect to the HGP Monroe Mortgage Loan will be extinguished if the principal amount of such obligation is reduced to $5,000 or less through repayments. Additionally, we are a guarantor with respect to certain mortgage indebtedness (the "HGP Office Building Mortgage") in the amount of $2,129 (as of March 31, 2003) on HGP's corporate office building and related equipment located in Norton Shores, Michigan. The HGP Office Building Mortgage matures on May 31, 2003, bears interest at LIBOR plus 5.50%, and requires monthly debt service payments. On October 11, 2001, HGP announced that it was in default under two loans with an aggregate principal balance of approximately $45.5 million secured by six of its other outlet centers. Such defaults do not constitute defaults under the HGP Monroe Mortgage Loan or the HGP Office Building Mortgage nor did they constitute a default under the HGP Secured Credit Facility. We have not recorded any liabilities related to these guarantees and no claims have been made under our guarantees with respect to the HGP Monroe Mortgage Loan or the HGP Office Building Mortgage. HGP is a publicly traded company that was formed in connection with our merger with Horizon Group, Inc. ("Horizon") in June 1998. Prime/Estein Venture Guarantees We own three outlet centers through the Prime/Estein Venture. The Prime/Estein Venture is an unconsolidated joint venture partnership between one of our affiliates and an affiliate of Estein & Associates USA, Ltd. ("Estein"), a real estate investment company. Pursuant to Prime/Estein Venture-related documents to which affiliates of ours are parties, we are obligated to provide to, or obtain for, the Prime/Estein Venture fixed-rate financing at an annual rate of 7.75% (the "Interest Rate Subsidy Agreement") for the Birch Run Center, the Prime Outlets at Williamsburg (the "Williamsburg Center") and the Hagerstown Center. In August 2001, we, through affiliates, completed a refinancing of $63,000 of first mortgage loans secured by the Birch Run Center. The refinanced loan (the "Birch Run First Mortgage") (i) has a term of 10-years, (ii) bears interest at an effective rate of 8.12% and (iii) requires monthly payments of principal and interest pursuant to a 25-year amortization schedule. Pursuant to the Interest Rate Subsidy Agreement, we are required to pay to the Prime/Estein Venture the difference between the cost of the financing at an assumed rate of 7.75% and the actual cost of such financing at the annual rate of 8.12% (the "Interest Rate Subsidy Obligation"). The net present value of the Interest Subsidy Obligation (included in accounts payable and other liabilities in the accompanying Consolidated Balance Sheet) was $1,437 as of March 31, 2003. Page - (36) In October 2001, we, through affiliates, completed the refinancing of a $32,500 first mortgage loan secured by the Williamsburg Center. The new first mortgage loan (the "Williamsburg First Mortgage") (i) has a term of 10-years, (ii) bears interest at a fixed-rate of 7.69% and (iii) requires monthly payments of principal and interest pursuant to a 25-year amortization schedule. Pursuant to the Interest Rate Subsidy Agreement, the Prime/Estein Venture is required to pay to us the difference between the cost of the financing at an assumed rate of 7.75% and the actual cost of such financing at the annual rate of 7.69%. On January 11, 2002, we sold the Hagerstown Center to the Prime/Estein Venture. In connection with the sale, the Prime/Estein Venture assumed the Hagerstown First Mortgage in the amount of $46,862; however, our guarantee of such indebtedness remains in place. Additionally, we are obligated to refinance the Hagerstown First Mortgage on behalf of the Prime/Estein Venture on or before June 1, 2004, the date on which such indebtedness matures. Additionally, the Prime/Estein Venture's cost of the Hagerstown First Mortgage and any refinancing of it are fixed at an annual rate of 7.75% for a period of 10 years. If the actual cost of such indebtedness should exceed 7.75% at any time during the 10-year period, we will be obligated to pay the difference to the Prime/Estein Venture. If the actual cost of such indebtedness is less than 7.75% at any time during the 10-year period, however, the Prime/Estein Venture will be obligated to pay the difference to us. The actual cost of the Hagerstown First Mortgage is 30-day LIBOR plus 1.50%, or 2.84% as of March 31, 2003. Because the Hagerstown First Mortgage bears interest at a variable rate, we are exposed to the impact of interest rate changes. We have not recorded any liability related to our guarantee of the Hagerstown First Mortgage; however, in connection with the sale of the Hagerstown Center, we established a reserve for estimated refinancing costs in the amount of $937, which is included in accounts payable and other liabilities in the accompanying Consolidated Balance Sheet as of March 31, 2003. See Note 3 - "Property Dispositions" of the Notes to Consolidated Financial Statements for additional information. Mandatory Redemption Obligation In connection with our sale of the Bridge Properties in July 2002, we guaranteed FRIT PRT Bridge Acquisition LLC ("FRIT") (i) a 13% return on its $17,236 of invested capital and (ii) the full return of its invested capital (the "Mandatory Redemption Obligation") in FPI by December 31, 2003. As of March 31, 2003, our Mandatory Redemption Obligation with respect to the full return of FRIT's invested capital was $16,356 (included in accounts payable and other liabilities in the accompanying Consolidated Balance Sheet). On April 4, 2003, we made an additional payment with respect to the Mandatory Redemption Obligation of $1,085 with the net proceeds from the March 31, 2003 sale of certain excess land. See Note 3 - "Property Dispositions" of the Notes to Consolidated Financial Statements for additional information. Defaults on Certain Non-recourse Mortgage Indebtedness During 2001, certain of our subsidiaries suspended regularly scheduled monthly debt service payments on two non-recourse mortgage loans held by New York Life Insurance Company ("New York Life") at the time of the suspension. These non-recourse mortgage loans were cross-defaulted and cross-collateralized by Prime Outlets at Conroe (the "Conroe Center"), located in Conroe, Texas, and Prime Outlets at Jeffersonville II (the "Jeffersonville II Center"), located in Jeffersonville, Ohio. Effective January 1, 2002, New York Life foreclosed on the Conroe Center. Effective July 18, 2002, New York Life sold its interest in the Jeffersonville II Center loan. On August 13, 2002, we transferred our ownership interest in the Jeffersonville II Center to New York Life's successor. See Note 3 - "Property Dispositions" for additional information. Page - (37) The foreclosure of the Conroe Center did not have a material impact on our results of operations or financial condition because during 2001 all excess cash flow from the operations of the Conroe Center was utilized for debt service on its non-recourse mortgage loan. Additionally, the transfer of our ownership interest in the Jeffersonville II Center did not have a material impact on our results of operations or financial condition because during 2001 and through the transfer date in 2002, all excess cash flow from the operations of the Jeffersonville II Center was utilized for debt service on the non-recourse mortgage loan. During August of 2002, certain of our subsidiaries suspended regularly scheduled monthly debt service payments on two non-recourse mortgage loans which were cross-collateralized by Prime Outlets at Vero Beach (the "Vero Beach Center"), located in Vero Beach, Florida, and Prime Outlets at Woodbury (the "Woodbury Center"), located in Woodbury, Minnesota (collectively, the "John Hancock Properties"). These non-recourse mortgage loans were held by John Hancock Life Insurance Company ("John Hancock"). Effective September 9, 2002, John Hancock foreclosed on the Vero Beach Center. Additionally, we are currently negotiating a transfer of our ownership interest in the Woodbury Center to John Hancock. Foreclosure on the Vero Beach Center did not, and the expected transfer of our ownership interest in the Woodbury Center is not, expected to have a material impact on our results of operations or financial condition because during 2002, all excess cash flow from the operations of the John Hancock Properties was utilized for debt service on their non-recourse mortgage loans. In December 2002, we notified the servicer of certain non-recourse mortgage loans (cross-collateralized by Prime Outlets at Bend, Prime Outlets at Post Falls and Prime Outlets at Sedona) totaling $24,919 as of March 31, 2003 that the net cash flow from the properties securing the loans was insufficient to fully pay the required monthly debt service. At that time, certain of our subsidiaries suspended the regularly scheduled monthly debt service payments. Subsequent to our notification to the servicer, we have been remitting on a monthly basis all available cash flow from the properties, after a reserve for monthly operating expenses, as partial payment of the debt service. The failure to pay the full amount due constitutes a default under the loan agreements which allows the lenders to accelerate the loan and to exercise various remedies contained in the loan agreements, including application of escrow balances to delinquent payments and, ultimately, foreclosure on the properties which collateralize the loans. The lender has notified us that it has accelerated the loan. Since that time we have initiated discussions with the servicer of the loans regarding restructuring of the loans. There can be no assurance that such discussions will result in any modification to the terms of the loans. However, any action by the lender with respect to these properties is not expected to have a material impact on our results of operations or financial condition because we are currently only remitting available cash flow. Page - (38) Defeasance of Mega Deal Loan On December 6, 2002, we completed the sale of two outlet centers (together, the "Colorado Properties"), which were part of the 15 properties contained in the collateral pool securing a first mortgage and expansion loan (the "Mega Deal Loan"), which had a then outstanding balance of $338,940. In connection with the release of the Colorado Properties from the collateral pool, we were required to partially defease the Mega Deal Loan. Therefore, the Mega Deal Loan was bifurcated into (i) a defeased portion in the amount of $74,849 (the "Defeased Notes Payable") and (ii) an undefeased portion in the amount of $264,091, which is still referred to as the Mega Deal Loan. Both the Defeased Notes Payable and the Mega Deal Loan (i) bear interest at a fixed-rate of 7.782%, (ii) require monthly payments of principal and interest pursuant to a 30-year amortization schedule and (iii) mature on November 11, 2003. The Mega Deal Loan is now secured by the remaining 13 properties contained in the collateral pool. We used $79,257 of the gross proceeds from the sale of the Colorado Properties to purchase US Treasury Securities, which were placed into a trustee escrow (the "Trustee Escrow"). The Trustee Escrow is used to make the scheduled monthly debt service payments, including the payment of the then outstanding principal amount, together with all accrued and unpaid interest on the maturity date of November 11, 2003, under the Defeased Notes Payable. As of March 31, 2003, the outstanding balance of the Defeased Notes Payable was $74,509 and the balance of the Trustee Escrow was $77,365 (included in restricted cash in the accompanying Consolidated Balance Sheet). See Note 3 - "Property Dispositions" of the Notes to Consolidated Financial Statements for additional information. Furthermore, in connection with the partial defeasance of the Mega Deal Loan we amended the Mega Deal Loan so that (i) we are required to fund 10 monthly payments of $500 into a lender escrow to be used as additional cash collateral and (ii) release prices for the remaining 13 properties in the collateral pool were amended to provide for a more orderly refinancing of the Mega Deal Loan. Debt Service Obligations The scheduled principal maturities of our debt, excluding (i) unamortized debt premiums of $7,435 and (ii) $41,250 of aggregate non-recourse mortgage indebtedness in default (see "Defaults on Certain Non-recourse Mortgage Indebtedness" above), and related average contractual interest rates by year of maturity as of March 31, 2003 are as follows:
- ------------------------------------------------------------------------------------------------------------------------------------ Bonds Payable (including sinking Defeased fund payments) Notes Payable Notes Payable Total Debt ------------------------ ------------------------ ------------------------ ----------------------- Average Average Average Average Interest Principal Interest Principal Interest Principal Interest Principal Years Ended December 31, Rates Maturities Rates Maturities Rates Maturities Rates Maturities - ------------------------------------------------------------------------------------------------------------------------------------ 2003 6.46% $ 636 7.79% $ 265,009 7.78% $ 74,509 7.78% $ 340,154 2004 6.34% 726 7.97% 4,571 7.75% 5,297 2005 6.34% 773 8.58% 11,574 8.44% 12,347 2006 6.34% 820 8.83% 120,437 8.81% 121,257 2007 6.34% 878 7.60% 1,002 7.02% 1,880 Thereafter 6.52% 18,618 7.59% 57,995 7.33% 76,613 ---- -------- ---- --------- ---- -------- ---- --------- 6.49% $ 22,451 8.06% $ 460,588 7.78% $ 74,509 7.96% $ 557,548 ==== ======== ==== ========= ==== ======== ==== ========= ====================================================================================================================================
Such indebtedness in the amount of $557,548 had a weighted-average maturity of 2.3 years and bore contractual interest at a weighted-average rate of 7.96% per annum. At March 31, 2003, all of such indebtedness bore interest at fixed rates. Our remaining scheduled principal payments during 2003 for such indebtedness aggregated $340,154. In addition to regularly scheduled principal payments, the remaining 2003 scheduled principal payments also reflect balloon payments of (i) $260,681 for the Mega Deal Loan and (ii) $73,882 due for the Defeased Notes Payable. Both the Mega Deal Loan and the Defeased Notes Payable are scheduled to mature on November 11, 2003. All debt service due under the Defeased Notes Payable, including the balloon payment due at maturity, will be made from the Trustee Escrow. See "Going Concern" for additional information. Page - (39) Going Concern Our liquidity depends on cash provided by operations and potential capital raising activities such as funds obtained through borrowings, particularly refinancing of existing debt, and cash generated through asset sales. Although we believe that estimated cash flows from operations and potential capital raising activities will be sufficient to satisfy our scheduled debt service and other obligations and sustain our operations for the next year, there can be no assurance that we will be successful in obtaining the required amount of funds for these items or that the terms of the potential capital raising activities, if they should occur, will be as favorable as we have experienced in prior periods. During 2003, our Mega Deal Loan matures on November 11, 2003. The Mega Deal Loan, which is secured by a 13 property collateral pool, had an outstanding principal balance of $262,890 as of March 31, 2003 and will require a balloon payment of $260,681 at maturity. Based on our initial discussions with various prospective lenders, we are currently projecting a potential shortfall with respect to refinancing the Mega Deal Loan. However, we believe this shortfall may be alleviated through potential asset sales and/or other capital raising activities, including the placement of mezzanine level debt. We caution that our assumptions are based on current market conditions and, therefore, are subject to various risks and uncertainties, including changes in economic conditions which may adversely impact our ability to refinance the Mega Deal Loan at favorable rates or in a timely and orderly fashion, or which may adversely impact our ability to consummate various asset sales or other capital raising activities. In connection with the completion of the sale of the Bridge Properties in July 2002, we guaranteed to FRIT (i) a 13% return on its $17,236 of invested capital, and (ii) the full return the Mandatory Redemption Obligation by December 31, 2003. As of March 31, 2003, the Mandatory Redemption Obligation (included in accounts payable and other liabilities in the accompanying Consolidated Balance Sheet) was $16,356. On April 4, 2003, we made an additional payment of $1,085 with net proceeds from the March 31, 2003 sale of certain excess land which reduced the balance of the Mandatory Redemption Obligation to $15,271. Although we continue to seek to generate additional liquidity to repay the Mandatory Redemption Obligation through (i) the sale of FRIT's ownership interest in the Bridge Properties and/or (ii) the placement of additional indebtedness on the Bridge Properties, there can be no assurance that we will be able to complete such capital raising activities by December 31, 2003 or that such capital raising activities, if they should occur, will generate sufficient proceeds to repay the Mandatory Redemption Obligation in full. Failure to repay the Mandatory Redemption Obligation by December 31, 2003 would constitute a default, which would enable FRIT to exercise its rights with respect to the collateral pledged as security to the guarantee, including some of our partnership interests in the 13 property collateral pool under the aforementioned Mega Deal Loan. Because the Mandatory Redemption Obligation is secured by some of our partnership interests in the 13 property collateral pool under the Mega Deal Loan, we may be required to repay the Mandatory Redemption Obligation before, or in connection with, the refinancing of the Mega Deal Loan. These conditions raise substantial doubt about our ability to continue as a going concern. The financial statements contained herein do not include any adjustment to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of these uncertainties. Page - (40) Defaults on Certain Non-recourse Mortgage Indebtedness of Unconsolidated Partnerships Two mortgage loans related to projects in which we, through subsidiaries, indirectly own joint venture interests have matured and are in default. The mortgage loans, at the time of default, were (i) a $10,389 first mortgage loan on Phase I of the Bellport Outlet Center, held by Union Labor Life Insurance Company ("Union Labor"); and (ii) a $13,338 first mortgage loan on Oxnard Factory Outlet, an outlet center located in Oxnard, California, held by Fru-Con. An affiliate of ours has a 50% ownership interest in the partnership, which owns Phase I of the Bellport Outlet Center. Fru-Con and us are each a 50% partner in the partnership that owns the Oxnard Factory Outlet. Union Labor filed for foreclosure on Phase I of the Bellport Outlet Center and a receiver was appointed March 27, 2001 by the court involved in the foreclosure action. Effective May 1, 2001, a manager hired by the receiver began managing and leasing Phase I of the Bellport Outlet Center. A judgment for foreclosure was entered on January 25, 2003 in the amount of $12,711. The foreclosure occurred on March 17, 2003 with Union Labor acquiring the property for $5,100. We continue to negotiate the terms of a transfer of our ownership interest in Oxnard Factory Outlet to Fru-Con. We do not manage or lease Oxnard Factory Outlet. We believe neither of these mortgage loans is recourse to us. It is possible, however, that either or both of the respective lenders will, after completing its foreclosure action, file a lawsuit seeking to collect from us the difference between the value of the mortgaged property and the amount due under the loan. If such an action is brought, the outcome, and our ultimate liability, if any, cannot be predicted at this time. In addition, we are currently not receiving, directly or indirectly, any cash flow from Oxnard Factory Outlet and were not receiving any cash flow from Phase I of the Bellport Outlet Center prior to the loss of control of such project. We account for our interests in (i) Phases I of the Bellport Outlet Center and (ii) the Oxnard Factory Outlet in accordance with the equity method of accounting. As of March 31, 2003, the carrying value of our investment in these properties was $0. Dividends and Distributions To qualify as a REIT for federal income tax purposes, we are required to pay distributions to our common and preferred shareholders of at least 90% of our REIT taxable income in addition to satisfying other requirements. Although we intend to make distributions, if necessary, to remain qualified as a REIT under the Code, we also intend to retain such amounts as we consider necessary from time to time for our capital and liquidity needs. Our policy remains to pay distributions only to the extent necessary to maintain our status as a REIT for federal income tax purposes. During 2002, we were not required to pay any distributions in order to maintain our status as a REIT and based on our current federal income tax projections, we do not expect to pay any distributions during 2003. On May 15, 2003, we will be in arrears on 14 quarters of preferred stock distributions due February 15, 2000 through May 15, 2003, respectively. We may not make distributions to our common shareholders or our holders of common units of limited partnership interests in the Operating Partnership unless we are current with respect to distributions to our preferred shareholders. As of March 31, 2003, unpaid dividends for the period beginning on November 16, 1999 through March 31, 2003 on our Series A Senior Preferred Stock and Series B Convertible Preferred Stock aggregated $20,377 and $56,142, respectively. The annualized dividends on our 2,300,000 shares of Series A Senior Preferred Stock and 7,828,125 shares of Series B Convertible Preferred Stock outstanding as of March 31, 2003 are $6,037 ($2.625 per share) and $16,635 ($2.125 per share), respectively. Page - (41) Strategic Alternatives We have engaged Houlihan Lokey Howard & Zukin Capital to assist us in exploring recapitalization, restructuring, financing and other strategic alternatives designed to strengthen our financial position and address our long-term capital requirements. There can be no assurance as to the timing, terms or completion of any transaction. Costs incurred related to such activities are reflected in corporate general and administrative expense in the accompanying Consolidated Statements of Operations. Settlement of Tenant Matters During 2002, we entered into settlement agreements with respect to certain tenant matters providing for aggregate payments of $2,760. Through December 31, 2002, we made approximately $2,607 of such required payments. The 2002 payments were principally made from certain funds escrowed under a mezzanine loan, which was repaid in full in December 2002. The remaining payment of $153 was made in January 2003 with cash from operations. These settlement agreements did not have a material impact on our financial condition or our results from operations. We had previously established reserves aggregating $5,000 for the settlement of such matters. Development Activities and Capital Expenditures During 2003, we will continue to explore potential international opportunities and will selectively consider expansion and/or redevelopment of certain of our existing outlet centers. We do not currently expect such activities to have a significant impact on our liquidity or financial condition. Additionally, we expect to incur costs during the remainder of 2003 (i) in connection with releasing space to new tenants and (ii) for repairs and maintenance of our properties. However, we do not expect such expenditures to have a significant impact on our liquidity or financial condition because reserves for such costs are paid monthly into escrow accounts under many of our loans. Recent Accounting Pronouncements In October, 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("FAS") No. 144, "Accounting for Impairment of Disposal of Long-lived Assets." FAS No. 144 supercedes FAS No. 121, however it retains the fundamental provisions of that statement as related to the recognition and measurement of the impairment of long-lived assets to be "held and used." In addition, FAS No. 144 (i) provides further guidance regarding the estimation of cash flows in the performance of a recoverability test, (ii) requires that a long-lived asset to be disposed of other than by sale (e.g., abandoned) be classified as "held and used" until it is disposed of, and (iii) established more restrictive criteria to classify an asset as "held for sale." Effective January 1, 2002, we adopted FAS No. 144. Our adoption of FAS No. 144 effective January 1, 2002 did not have a material impact on our results of operations or financial position. In accordance with the requirements of FAS No. 144, we have classified the operating results, including gains and losses related to disposition, for certain properties either disposed of or classified as assets held for sale during 2002 as discontinued operations in the Consolidated Statements of Operations for all periods presented. See Note 3 - "Property Dispositions" for additional information. Page - (42) In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest Entities." FIN No. 46 clarifies the application of existing accounting pronouncements to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The provisions of FIN No. 46 were immediately effective for all variable interests in variable interest entities created after January 31, 2003, and we will need to apply the provisions of FIN No. 46 to any existing variable interests in variable interest entities by no later than July 1, 2003. We did not create any variable interest entities during the three months ended March 31, 2003 and we do not believe that FIN No. 46 will have a significant impact on our financial statements. Risk Management Activities We are subject to various market risks and uncertainties, including, but not limited to, the effects of current and future economic conditions, and the resulting impact on our tenants' sales and our revenue; the effects of increases in market interest rates from current levels (see below); the risks associated with existing vacancy rates or potential increases in vacancy rates because of, among other factors, tenant bankruptcies and store closures, and the resulting impact on our revenue; and risks associated with refinancing our current debt obligations or obtaining new financing under terms less favorable than we have experienced in prior periods. Interest Rate Risk In the ordinary course of business, we are exposed to the impact of interest rate changes. We employ established policies and procedures to manage our exposure to interest rate changes. Historically, we have used a mix of fixed and variable-rate debt to (i) limit the impact of interest rate changes on our results from operations and cash flows and (ii) lower our overall borrowing costs. In certain cases, we have used derivative financial instruments such as interest rate protection agreements to manage interest rate risk associated with variable-rate indebtedness. Nevertheless, as of March 31, 2003, all of our outstanding indebtedness bore interest at fixed rates. See Item 3 - "Quantitative and Qualitative Disclosures About Material Risk" for additional information. Also see "Guarantees of Debt and Indebtedness of Others" for additional information. Economic Conditions In general, the leases relating to our outlet centers have terms of three to five years and most contain provisions that somewhat mitigate the impact of inflation. Such provisions include clauses providing for increases in base rent and clauses enabling us to receive percentage rents for annual sales in excess of certain thresholds based on merchants' gross sales. In addition, lease agreements generally provide for (i) the recovery of a merchant's proportionate share of actual costs of common area maintenance ("CAM"), refuse removal, insurance, and real estate taxes, (ii) a contribution for advertising and promotion and (iii) an administrative fee. CAM includes items such as utilities, security, parking lot cleaning, maintenance and repair of common areas, capital replacement reserves, landscaping, seasonal decorations, public restroom maintenance and certain administrative expenses. We continually monitor our lease provisions in light of current and expected economic conditions and other factors. In this regard, we may consider alternative lease provisions (e.g., fixed CAM) where appropriate. Page - (43) Funds from Operations Industry analysts generally consider funds from operations ("FFO"), as defined by the National Association of Real Estate Investment Trusts ("NAREIT"), an alternative non-GAAP measure of performance of an equity REIT. In 1991, NAREIT adopted its definition of FFO. This definition was clarified in 1995, 1999 and 2002. FFO is currently defined by NAREIT as net income or loss (computed in accordance with GAAP), excluding gains or losses from provisions for asset impairment and sales of depreciable operating property, plus depreciation and amortization (other than amortization of deferred financing costs and depreciation of non-real estate assets) and after adjustment for unconsolidated partnerships and joint ventures and discontinued operations. FFO includes non-recurring events, except for those that are defined as "extraordinary items" in accordance with GAAP. FFO excludes the earnings impact of "cumulative effects of accounting changes" as defined by GAAP. Effective January 1, 2002, FFO related to assets held for sale, sold or otherwise transferred and included in results of discontinued operations (in accordance with the requirements of FAS No. 144) should continue to be included in FFO. We believe that FFO is an important and widely used non-GAAP measure of the operating performance of REITs, which provides a relevant basis for comparison to other REITs. Therefore, FFO is presented to assist investors in analyzing our performance. Our FFO is not comparable to FFO reported by other REITs that do not define the term using the current NAREIT definition or that interpret the current NAREIT definition differently than we do. Therefore, we caution that the calculation of FFO may vary from entity to entity and, as such the presentation of FFO by us may not be comparable to other similarly titled measures of other reporting companies. We believe that to facilitate a clear understanding of our operating results, FFO should be examined in conjunction with net income determined in accordance with GAAP. FFO does not represent cash generated from operating activities in accordance with GAAP and should not be considered as an alternative to net income as an indication of our performance or to cash flows as a measure of liquidity or ability to make distributions. FFO was $5,154 for the three months ended March 31, 2003 compared to $6,963 for the same period in 2002. The first quarter of 2003 FFO results include $964 of net interest expense attributable to mortgage indebtedness that was defeased in December 2002. This net interest expense had no impact on our operating cash flow during 2003 because such payments were made from previously established escrows. FFO adjusted ("Adjusted FFO") to exclude the impact of the net interest expense attributable to the defeased indebtedness was $6,118. The decrease in our Adjusted FFO results during the first quarter of 2003 compared to our FFO results for the same period in 2002 reflects (i) the reduced weighted-average portfolio occupancy during the 2003 period, (ii) changes in economic rental rates and (iii) the loss of net operating income resulting from the dispositions of properties, partially offset by interest savings attributable to the repayment of indebtedness. Page - (44) TABLE 5 provides a reconciliation of income (loss) from continuing operations to FFO and Adjusted FFO for the three months ended March 31, 2003 and 2002. Table 5 - Funds from Operations
- ------------------------------------------------------------------------------------------------------------------------------------ Three Months Ended March 31, 2003 2002 - ------------------------------------------------------------------------------------------------------------------------------------ Income (loss) from continuing operations $ (2,289) $ 10,411 Adjustments: Gain on sale of real estate - (16,793) Depreciation and amortization 7,280 10,208 Non-real estate depreciation and amortization (532) (554) Unconsolidated joint ventures' adjustments 695 783 Discontinued operations - 2,908 -------- -------- FFO per NAREIT Definition 5,154 6,963 Defeased debt adjustment(1) 964 - -------- -------- Adjusted FFO $ 6,118 $ 6,963 ======== ======== Other Data: Net cash provided by operating activities $ 2,962 $ 4,668 Net cash provided by investing activities 316 10,576 Net cash used in financing activities (1,950) (16,691) ====================================================================================================================================
Note: (1) In December 2002, we partially defeased our Mega Deal Loan in connection with the sale of the Colorado Properties. In connection with the defeasance, we purchased US Treasury Securities, which are maintained in a Trustee Escrow. All debt service due under the Defeased Notes Payable during the three months ended March 31, 2003 was made from the Trustee Escrow. During the three months ended March 31, 2003, the interest income earned on the Trustee Escrow was $525 and the interest expense on the Defeased Notes Payable was $1,489, which are included in our results from operations in the accompanying Consolidated Statements of Operations. These items had no impact on our operating cash flow during 2003 because the cash settlement with respect to the Defeased Notes Payable occurred during 2002 and the payments made in 2003 were from restricted cash. Accordingly, we believe it is appropriate to adjust for them in our Adjusted FFO calculation. Page - (45) Item 3. Quantitative and Qualitative Disclosures of Market Risk Market Risk Sensitivity We are subject to various market risks and uncertainties, including, but not limited to, the effects of current and future economic conditions, and the resulting impact on our revenue; the effects of increases in market interest rates from current levels (see below); the risks associated with existing vacancy rates or potential increases in vacancy rates because of, among other factors, tenant bankruptcies and store closures, and the resulting impact on our revenue; and risks associated with refinancing our current debt obligations or obtaining new financing under terms less favorable than we have experienced in prior periods. Interest Rate Risk In the ordinary course of business, we are exposed to the impact of interest rate changes. We employ established policies and procedures to manage our exposure to interest rate changes. Historically, we have used a mix of fixed and variable-rate debt to (i) limit the impact of interest rate changes on our results from operations and cash flows and (ii) lower our overall borrowing costs. Nevertheless, as of March 31, 2003, all of our outstanding indebtedness bore interest at fixed rates. The following table provides a summary of principal cash flows, excluding (i) unamortized debt premiums of $7,435 and (ii) non-recourse mortgage indebtedness aggregating $41,250 on certain properties which is in default (see "Defaults on Certain Non-recourse Mortgage Indebtedness" within "Liquidity and Capital Resources" of Item 2 - "Management's Discussion and Analysis of Financial Condition and Results of Operations" for additional information), and related contractual interest rates by fiscal year of maturity. See Note 4 - "Debt" of the Notes to Consolidated Financial Statements contained herein for additional information with respect to the terms of our debt instruments.
- ------------------------------------------------------------------------------------------------------------------------------------ Year of Maturity - ------------------------------------------------------------------------------------------------------------------------------------ 2003 2004 2005 2006 2007 Thereafter Total - ------------------------------------------------------------------------------------------------------------------------------------ Bonds Payable Principal $ 636 $ 726 $ 773 $ 820 $ 878 $ 18,618 $ 22,451 Average interest rate 6.46% 6.34% 6.34% 6.34% 6.34% 6.52% 6.49% Notes Payable Principal $ 265,009 $ 4,571 $ 11,574 $ 120,437 $ 1,002 $ 57,995 $ 460,588 Average interest rate 7.79% 7.97% 8.58% 8.83% 7.60% 7.59% 8.06% Defeased Notes Payable Principal $ 74,509 $ 74,509 Average interest rate 7.78% 7.78% ====================================================================================================================================
Page - (46) Additionally, we sold Prime Outlets at Hagerstown (the "Hagerstown Center") on January 11, 2002 to an existing joint venture partnership (the "Prime/Estein Venture"). In connection with the sale, the Prime/Estein Venture assumed the first mortgage loan on the Hagerstown Center (the "Hagerstown First Mortgage") in the amount of $46,862; however, our guarantee of such indebtedness remains in place. Additionally, we are obligated to refinance the Hagerstown First Mortgage on behalf of the Prime/Estein Venture on or before June 1, 2004, the date on which such indebtedness matures. Additionally, the Prime/Estein Venture's cost of the Hagerstown First Mortgage and any refinancing of it are fixed at an annual rate of 7.75% for a period of 10 years. If the actual cost of such indebtedness should exceed 7.75% at any time during the 10-year period, we will be obligated to pay the difference to the Prime/Estein Venture. If the actual cost of such indebtedness is less than 7.75% at any time during the 10-year period, however, the Prime/Estein Venture will be obligated to pay the difference to us. The actual cost of the Hagerstown First Mortgage is 30-day LIBOR plus 1.50%, or 2.84% as of March 31, 2003. Because the Hagerstown First Mortgage bears interest at a variable rate, we are exposed to the impact of interest rate changes. At March 31, 2003, a hypothetical 100 basis point move in the LIBOR rate would impact our guarantee by $469. See Note 3 - "Property Dispositions" of the Notes to Consolidated Financial Statements for additional information. Item 4. Controls and Procedures (a) Evaluation of Disclosure Controls and Procedures Within the 90 days prior to the date of this Form 10-Q, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chairman and Chief Executive Officer along with the Company's President, Chief Financial Officer and Treasurer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based upon that evaluation, the Company's Chairman and Chief Executive Officer along with the Company's President, Chief Financial Officer and Treasurer concluded that the Company's disclosure controls and procedures are effective. (b) Changes in Internal Controls There have been no significant changes in the Company's internal controls or in other factors which could significantly affect internal controls subsequent to the date the Company carried out its evaluation. Page - (47) PART II: OTHER INFORMATION Item 1. Legal Proceedings For a description of legal proceedings involving the Company and its properties, please see Part I, Item 3 - "Legal Proceedings" of the Company's Annual Report on Form K for the year ended December 31, 2002 and Note 6 - "Legal Proceedings" of the Notes to Consolidated Financial Statements contained herein. The following information updates such disclosure. The Company and its affiliates were defendants in a lawsuit filed by Accrued Financial Services ("AFS") on August 10, 1999 in the Circuit Court for Baltimore City. The lawsuit was removed to United States District Court for the District of Maryland (the "U.S. District Court") on August 20, 1999. AFS claimed that certain tenants had assigned to AFS their rights to make claims under leases such tenants had with affiliates of the Company and alleged that the Company and its affiliates overcharged such tenants for common area maintenance ("CAM") charges and promotion fund charges. The U.S. District Court dismissed the lawsuit on June 19, 2000. AFS appealed the U.S. District Court's decision to the United States Court of Appeals for the Fourth Circuit. Briefs were submitted and oral argument before a panel of judges of the United States Court of Appeals for the Fourth Circuit was held on October 30, 2001, during which the panel of judges requested further briefing of certain issues. On July 29, 2002, the Fourth Circuit affirmed the dismissal. AFS filed a request for further review by the Fourth Circuit which request was denied. In January 2003, AFS filed a petition for a writ of certiorari by the United States Supreme Court (the "Supreme Court") and the Company filed its opposition on February 24, 2003. The Supreme Court subsequently denied the writ of certiorari and the parties have agreed to dismiss any remaining claims, thereby terminating the AFS lawsuit. As previously disclosed by the Company, certain tenants in the Company's and its affiliates' outlet centers have made or may make allegations concerning overcharging for CAM and promotion fund charges because of varying clauses in their leases pursuant to which they claim under various circumstances that they were not required to pay some or all of the pass-through charges. Such claims if asserted and found meritorious, could have a material affect on the Company's financial condition. Determination of whether liability would exist to the Company would depend on interpretation of various lease clauses within a tenant's lease and all of the other leases at each center collectively. To date such issues have been raised and resolved with Dinnerware Plus Holdings, Inc. ("Mikasa"), Melru Corporation, Designs, Inc. and Brown Group Retail, Inc., all of which at one time or another were in litigation, or threatened litigation with the Company. Additionally, during the first quarter of 2003, Gap Inc. notified the Company that it believes it is entitled to a refund of certain pass-through charges as a result of certain clauses in its leases. In the second quarter of 2002, the Company recorded a non-recurring charge to establish a reserve in the amount of $3.0 million for resolution of these matters, in addition to the Mikasa matter referred to above. This reserve was estimated in accordance with our established policies and procedures concerning loss contingencies for additional information). The balance of the unused reserve (which is included in the accounts payable and other liabilities in the Consolidated Balance Sheet) is approximately $2.2 million as of March 31, 2003. Based on presently available information, the Company believes it is probable the remaining reserve will be utilized over the next several years in resolving claims relating to the pass-through and promotional fund provisions contained in its leases, inclusive of amounts that may be owed, if any, to the Gap Inc. The Company cautions, however, that given the inherent uncertainties of litigation and the complexities associated with a large number of leases and other factual questions at issue, actual costs may vary from this estimate. No other such tenant, however, has filed a suit or indicated to the Company that it intends to file a suit. Nevertheless, it is too early to make any predictions as to whether the Company or its affiliates may be found liable with respect to other tenants, or to predict damages should liability be found. Page - (48) Item 2. Changes in Securities None Item 3. Defaults Upon Senior Securities The Company is currently in arrears in the payment of distributions on its 10.5% Series A Senior Cumulative Preferred Stock ("Series A Senior Preferred Stock") and 8.5% Series B Cumulative Participating Convertible Preferred Stock ("Series B Convertible Preferred Stock"). As of March 31, 2003, the aggregate arrearage on the Series A Senior Preferred Stock and the Series B Convertible Preferred Stock was approximately $20.4 million and approximately $56.1 million, respectively. Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K (a) The following exhibits are included in this Quarterly Report on Form 10-Q: Exhibit 99.1 Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Exhibit 99.2 Certification by Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Reports on Form 8-K: None Page - (49) SIGNATURES Pursuant to the requirements 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. PRIME RETAIL, INC. Registrant Date: May 14, 2003 /s/ Robert A. Brvenik -------------------------------------------- Robert A. Brvenik President, Chief Financial Officer and Treasurer Page - (50) CERTIFICATION OF CHIEF EXECUTIVE OFFICER I, Glenn D. Reschke, Chairman and Chief Executive Officer of Prime Retail, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Prime Retail, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 14, 2003 /s/ Glenn D. Reschke -------------------- Glenn D. Reschke Chairman and Chief Executive Officer Page - (51) CERTIFICATION OF CHIEF FINANCIAL OFFICER I, Robert A. Brvenik, President, Chief Financial Officer and Treasurer of Prime Retail, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Prime Retail, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 14, 2003 /s/ Robert A. Brvenik --------------------- Robert A. Brvenik President, Chief Financial Officer and Treasurer -----END PRIVACY-ENHANCED MESSAGE-----