ITEM 1. BUSINESS
CAUTIONARY STATEMENT
Certain matters discussed in this Form 10-K and the information incorporated by reference herein contain "forward-looking statements" for purposes of Section 27A of the Securities Act of 1993, as amended (the "Securities Act") and Section 21E of the Securities Exchange Act of 1933, as amended (the "Exchange Act") relating to, without limitation, future economic performance, plans and objectives of management for future operations and projections of revenue and other financial items, demographic projections and federal income tax considerations, which can be identified by the use of forward-looking terminology such as "may," "will," "except," "anticipate," "estimate," or "continue" or the negative thereof or other variations thereon or comparable terminology. Such forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those described in such forward-looking statements.
THE COMPANY
The Mills Corporation (the "Company") owns, develops, redevelops, leases and manages a portfolio currently consisting of five super-regional, value and entertainment oriented malls (the "Mills") and 11 community shopping centers (the "Community Centers," and, together with the Mills, the "Properties"). The Company is a fully-integrated, self-managed real estate investment trust (a "REIT") with approximately 900 employees as of December 31, 1996 and provides all development, redevelopment, leasing, financing management and marketing services with respect to all Properties currently in operation. The Mills comprise the primary focus of the Company's operations, with approximately 7.9 million square feet of gross leasable area ("GLA") in five states, of which approximately 900,000 square feet is owned by certain anchor and tenants.
The Company was originally incorporated in Virginia on January 2, 1991. In 1994, the Company was reincorporated in Delaware. On April 21, 1994, the Company consummated an initial public offering ("IPO") of 14,380,000 shares of its common stock, par value $.01 per share (the "Common Stock"). The net proceeds of the IPO ($310.0 million) were used primarily to repay certain mortgage and other indebtedness and to purchase interests in the partnerships that owned the Properties. In connection with the IPO, the Company was authorized to issue 20,000,000 shares of preferred stock, par value $.01 per share (the "Preferred Stock"). As of December 31, 1996, there were no shares of Preferred Stock outstanding. Upon completion of the IPO, the Company became the sole general partner of The Mills Limited Partnership (the "Operating Partnership") and currently owns 50.9% of the outstanding partnership interests ("Units") therein. Units (other than those owned by the Company) are exchangeable under certain circumstances for Common Stock or, at the option of the Company, the cash equivalent thereof. As the sole general partner of the Operating Partnership, the Company has the exclusive power to manage and conduct the business of the Operating Partnership, subject to certain limited exceptions. The Operating Partnership either holds title to the Properties or directly or indirectly holds 100% of the general and limited partnership interests in the partnerships that own the Properties (the "Property Partnerships"), except for the Property Partnerships that own Franklin Mills and Ontario Mills, in which the Operating Partnership holds 77.6% (which represents 100% of the current income and cash flow from Franklin Mills) and 50%, respectively, as of December 31, 1996. The Operating Partnership has also formed joint ventures to develop additional properties.
The Company conducts all of its business through the Operating Partnership and the Operating Partnership's various subsidiaries (the "Operating Subsidiaries"), which include: (i) Management Associates Limited Partnership (the "Management Partnership"), which provides leasing and management services for the Properties, and (ii) MillsServices Corp. (the "Third-Party Services Corporation"), which provides management services to properties in which the Operating Partnership does not own an interest and provides development services for the Properties and new properties acquired by the Company. The Operating Partnership owns 100% of the interests in the Management Partnership and 99% of the non-voting preferred stock (representing a 99% economic interest) and 5% of the voting common stock of the Third Party Services Corporation. In addition,
Herbert S. Miller, a director of the Company, and an affiliate of Kan Am U.S., Inc. ("Kan Am", which owns approximately 39.9% of the outstanding Units in the Operating Partnership) each own .5% of the non-voting preferred stock (representing, in the aggregate, a 1% economic interest) and 47.5% of the voting common stock of the Third-Party Services Corporation.
BUSINESS STRATEGY
The Company intends to increase its cash flow and the value of its portfolio through active management of its existing Properties, expansion and remerchandising of existing Mills and the development of new Mills.
OPERATING STRATEGIES
The Company intends to pursue the following operating strategies:
MODIFY AND EXPAND EXISTING MILLS. The Company leases vacant and newly developed space with a view towards creating the most effective tenant mix and maximizing rental income. The Company is planning expansions of Potomac Mills, Sawgrass Mills and Gurnee Mills and is presently in the process of remerchandising Gurnee Mills and Franklin Mills, at an aggregate cost of approximately $115 million over the next three years. These expansion and remerchandising programs will result in new entertainment zones and, where appropriate, an upgrade of the tenant mix. The Company believes that the new entertainment zones will complement the Mills and will enhance productivity by attracting more shoppers and extending the shopping day.
POTOMAC MILLS: The Company is planning to add an entertainment zone to Potomac Mills. The Company anticipates that construction will begin in late 1997 for a late 1998 or early 1999 opening. In anticipation of the expansion, the Company is upgrading the tenant mix in the corridor near the expansion and is negotiating to lease expansion space to AMC Theatres and a variety of themed restaurants and other entertainment oriented tenants.
SAWGRASS MILLS: In November 1995, the Company completed the Phase II expansion of Sawgrass Mills. This expansion added approximately 136,000 square feet of GLA, which opened at 100% occupancy. The expansion cost approximately $24 million. In the third quarter of 1998, the Company expects to open Phase III of Sawgrass Mills to coincide with the opening of the new Florida Panthers Sports Arena located across the ring road from Sawgrass Mills. The Phase III expansion will consist of an approximately 270,000 square foot entertainment zone expected to be anchored by a 30-screen Cobb Theater. The Phase III expansion, which is presently in the pre-development stage, will be owned by a partnership formed by the Operating Partnership (50%) and Kan Am (50%) in which Kan Am has agreed to fund 100% of the project's initial required equity, for which Kan Am will receive a 9% annual preferred return. Under the terms of the partnership agreement, the Company has the right to buy out Kan Am's interest in this partnership prior to December 30, 1999, at 120% of Kan Am's capital contributions and accumulated preferred returns under certain terms and conditions set forth in the partnership agreement. The Company would provide all development, management and leasing services for the expansion, subject to the approval of Kan Am of certain major decisions, including a sale or refinancing of the project and the approval of the development and annual budgets. The Company would guarantee completion of the expansion within the parameters of the approved development budget.
GURNEE MILLS: As part of the Gurnee Mills expansion and remerchandising initiative, the Company expects to expand Gurnee Mills by over 150,000 square feet of GLA in addition to upgrading the tenant mix. The expansion will feature a 125,000 square foot Bass Pro Shops Outdoor World upon which construction began in early 1997. In addition, the Company expects to open two other anchor stores by the end of 1998. In 1996, Rainforest Cafe opened at
Gurnee Mills. The Company has signed a lease with another themed restaurant, Planet Hollywood, to open in 1997. In addition to these tenants, the Company expects to add additional entertainment type uses within the existing mall over the next two years.
FRANKLIN MILLS: The Company began its efforts to remerchandise Franklin Mills in 1996 by upgrading its tenant mix with such tenants as Tommy Hilfiger, Brooks Brothers and Nautica. In addition, the Company has signed leases with DKNY, Talbots, The Gap Outlet and Polo and has obtained a commitment from General Cinema for an 18-screen theatre on which the Company expects to begin construction by the second quarter of 1997. The theatre will be the cornerstone for an entertainment zone that will include at least two other entertainment concepts, such as themed restaurants and interactive entertainment venues.
CREATE ENTERTAINMENT ZONES. The Company intends to expand and reconfigure its first four Mills projects to include new entertainment zones. The entertainment zone at Ontario Mills, the Company's newest Mills, is the prototype for future Mills entertainment zones. Such entertainment zones will include multiplex theaters, virtual reality game rooms, educational environmental habitats, themed restaurants and participatory retailers in which the consumer is given the opportunity to test the products in a real-life setting. Ontario Mills currently includes a 30-screen AMC Theatres and a Virgin Megastore. Scheduled to open in 1997 are a Sega Gameworks, Dave & Busters and American Wilderness Experience. Phase III of Sawgrass Mills is expected to include a Cobb Theatre expanded from 18 to 30 screens. Franklin Mills has received a commitment from General Cinema for an 18-screen theater. Gurnee Mills opened a Rainforest Cafe in 1996 and plans to open a Planet Hollywood and a Bass Pro Shops Outdoor World in 1997. The Company believes these entertainment zones will lead to significant incremental customer traffic at the Mills, extend consumers' shopping day and lead to the creation of additional destination sites.
WORK WITH TENANTS TO DEVELOP NEW RETAIL CONCEPTS. The Company intends to continue to work with existing tenants and potential tenants to develop new retail concepts. This strategy has worked for retailers who have performed well in traditional retail formats but wanted to develop and expand into the outlet format. Ann Taylor, Calvin Klein, Last Call from Neiman Marcus and Saks Fifth Avenue are examples of retailers that opened their first outlet stores in a Mills and that later expanded their outlet format in other Mills. Ontario Mills is the site for Bernini's first Off Rodeo Drive outlet. In addition, the Mills also provide traditional urban retailers a growth vehicle for expanding into non-urban markets. Examples include Virgin Megastore, which opened its first non-urban location in Ontario Mills and Planet Hollywood, which has committed to open at Gurnee Mills in 1997.
BUILD BRAND NAME RECOGNITION FOR THE MILLS. The Company intends to continue to build brand name recognition for the Mills. The Company has created brand name recognition by developing a distinctive retail environment which offers innovative retail formats, value shopping and entertainment concepts that attract a wide variety of tenants and consumers. The Company coordinates its advertising programs to increase brand name recognition in its primary markets and to attract high a volume of consumers. The Company believes that its brand name recognition has not been duplicated within the shopping center industry in any U.S. market.
MAINTAIN STRONG TENANT RELATIONSHIPS. The Company intends to continue to maintain strong relationships with its existing tenants and high occupancy rates. The success of this strategy is evidenced by both its high tenant retention rate, with approximately 77% of expiring specialty store GLA being renewed upon lease expiration during 1996 and by the existing Mills being 95% leased as of December 31, 1996 (excluding Ontario Mills). One hundred and eighty-three of the Mills' tenants have stores located in more than one Mills, including Ontario Mills. Of the total GLA of each of the five existing Mills at December 31, 1996 (excluding GLA owned by anchor store tenants), 77% of Gurnee Mills, 67% of Potomac Mills, 67% of Sawgrass Mills, 62% of Ontario Mills, and 53% of Franklin Mills consist of tenants common to at least one other Mills. The Company has generated goodwill among many retailers who commit to future Mills projects years in advance of their completion. As of February 11, 1997, Grapevine Mills was approximately 55% pre-leased including nine executed leases and six lease commitments from anchor store tenants and Arizona Mills was approximately 62% pre-leased including nine executed leases and three lease commitments from anchor store tenants.
ACTIVELY MARKET PROPERTIES TO CONSUMERS. The Company intends to continue to actively market its Properties by formulating marketing plans based on research and tailored to each specific Property. Such plans include print, radio and television advertising, public relations, special events and the development of tour and travel programs. The Company believes that an aggressive marketing effort allows the Properties to maintain a loyal shopper base and attract new consumers.
PROVIDE ACTIVE PROPERTY MANAGEMENT SERVICES. The Company intends to continue to provide pro-active site management. The on-site property management team controls every aspect of the day-to-day needs of the Mills including operations, maintenance, security and merchant relations in order to enhance productivity and profitability. Further, where desirable and possible, such management team attempts to terminate the leases of under-performing tenants and renegotiate existing leases to expand, relocate or assemble space for more productive tenants.
DEVELOPMENT STRATEGIES
The Company's strategic business plan primarily consists of developing and opening an additional five Mills over the next three years with an aggregate of approximately 7.2 million square feet of GLA, including finishing construction on Grapevine Mills and Arizona Mills and developing three additional Mills, Mills City at Orange, Houston Mills and Meadowlands Mills. The Company also intends to pursue the development of Mills-type projects in selected metropolitan markets and has identified approximately 20 additional markets in the U.S. that could currently support a Mills project. The Company is also exploring the feasibility of developing additional Mills-type projects in selected international major metropolitan markets as a long-term growth strategy. The Company is focused on selected markets, where management believes population growth exceeds national rates, land is relatively abundant and development and entitlement processes are comparatively streamlined. Two projects are currently under construction and scheduled to open in the fourth quarter of 1997, Grapevine Mills, which will serve the Dallas/Fort Worth metropolitan market and Arizona Mills, which will serve the Phoenix metropolitan market. The remaining three sites under development, Mills City at Orange, Houston Mills and Meadowlands Mills, are in the early stages of development and are scheduled to open in 1998, 1999 and 1999, respectively.
To finance this rapid growth strategy, the Company has aligned itself with certain joint venture partners, including Kan Am, Simon DeBartolo Group, Inc. ("Simon) and Taubman Realty Group Limited Partnership ("Taubman"), and has reached an agreement in principle to form one or more such joint ventures with Cambridge Shopping Centres Ltd. of Canada ("Cambridge"). Additionally, the Company, subject to shareholder approval, is negotiating the terms of an agreement with Kan Am whereby Kan Am will provide approximately $50 million in preferred equity capital on what the Company believes would be attractive terms. There can be no assurance, however, that any such agreement will be entered into or that shareholder approval will be obtained. The Company believes that these alliances are very beneficial to the Company for the following reasons: (1) such joint ventures represent a clear endorsement by the Company's joint venture partners of the Mills concept and the Company's management, and its development, leasing and property management capabilities and (2) the joint venture partners provide the Company with additional sources of equity and additional financial strength and, as a result, facilitate construction and permanent financing. Although the Company believes it is now well-positioned to develop future projects on its own, it will continue to evaluate joint venture arrangements as a financing alternative. In addition, the Company will develop projects with Simon when required under the terms of the Simon Agreement. See "Simon Agreement." In connection with these joint ventures, the Company receives fees or reimbursements for its leasing, management, development and financing services.
In addition to the five projects currently under development, the Company or its joint venture partners control and are conducting due diligence on sites in Charlotte, North Carolina, Monee, Illinois, Columbus, Ohio and San Francisco, California, and is exploring many other locations, including Atlanta, Georgia, Cleveland, Ohio, Baltimore, Maryland, Tampa Bay, Florida, St. Louis, Missouri and San Diego, California. Furthermore, through its proposed alliance with Cambridge, the Company plans on beginning development of Mills projects in Canada. The Company is exploring Toronto, Ontario as the first site to be developed by this future venture.
MILLS UNDER DEVELOPMENT
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(1) Anticipated Construction Start Dates and Opening Dates may be subject to adjustment as a result of factors inherent in the development process, some of which may not be under the direct control of the Company. (2) Approximate GLA includes space that may be owned by certain anchor store tenants. (3) Estimated Aggregate Project Cost as of December 31, 1996 is based on the Company's best estimate of the underlying components, many of which may not be under the direct control of the Company. (4) The ownership structure and budgets for these properties have not yet been determined. (5) Leasing activity has not yet commenced for Houston Mills.
Following is a description of the five projects currently under development by the Company.
GRAPEVINE MILLS-GRAPEVINE, TEXAS. Development of Grapevine Mills commenced in the third quarter of 1996 on a 175-acre site in the City of Grapevine, Texas, two miles north of the Dallas/Fort Worth Airport. The project is expected to include approximately 1.5 million square feet of GLA of both retail space and large entertainment facilities. As of February 11, 1997, Grapevine Mills was approximately 55% pre-leased, including nine executed leases with anchor store tenants (Off 5th-Saks Fifth Avenue, Burlington Coat Factory, Bed, Bath and Beyond, Group USA, Rainforest Cafe, Books-A-Million, Sega Gameworks, American Wilderness Experience and AMC Theatres) and lease commitments from an additional six anchor store tenants for a total of approximately 661,000 square feet of GLA and has executed leases for approximately 157,000 square feet of specialty store space.
Grapevine Mills is being developed by a limited partnership consisting of the Operating Partnership (37.5%), Simon (37.5%) and Kan Am (25%). The Company is providing development, management and leasing services for the project, subject to the approval of Simon and Kan Am for certain major decisions, such as changes to the plan of development, the annual operating budget for the project and any proposed sale or refinancing. Kan Am has agreed to contribute 50% of the initial required equity capital. The Operating Partnership and Simon are responsible for the balance of the initial required equity capital on a pro rata basis and have agreed to guarantee any project cost overruns not funded by the initial equity capital and construction financing. The project is expected to cost a total of $203 million. In July 1996, the venture obtained a commitment from NationsBank to provide $140 million of construction financing, and expects this commitment to be increased to $155 million. The loan will have a term of four years, subject to a one-year extension at the Company's option, and will bear interest at a rate equal to the 30-day LIBOR ("LIBOR")
plus 165 basis points (subject to reduction to 135 basis points if certain debt service ratios are achieved). Development costs incurred through December 31, 1996 were approximately $34 million (net of tax increment financing).
Under the terms of the limited partnership agreement, after the tenth anniversary of the project's opening, any partner can exercise certain buy-sell provisions by which the offering partner can require the other partners to sell to the offering partner their respective interests in the partnership or alternatively, purchase the interest of the offering partner in the partnership.
ARIZONA MILLS-TEMPE, ARIZONA. Development of Arizona Mills commenced in the third quarter of 1996 on a 115-acre site located 20 minutes from downtown Phoenix, at the intersection of Interstate 10 and Superstition Freeway (Highway 60). Anticipated to open in the fourth quarter of 1997, Arizona Mills is expected to contain approximately 1.2 million square feet of GLA of both retail space and large entertainment facilities. As of February 11, 1997, Arizona Mills was approximately 62% pre-leased, including anchor store tenant leases with Burlington Coat Factory, Off 5th-Saks Fifth Avenue, Oshman's, Harkins Cinema, J.C. Penney, Rainforest Cafe, Group USA, Hi-Health and Sega Gameworks, and commitments had been obtained from an additional three anchor store tenants for a total anchor store tenant commitment of approximately 553,000 square feet. The Company has executed leases for approximately 216,000 square feet of GLA for specialty stores as of February 11, 1997.
Arizona Mills is being developed by a joint venture consisting of the Operating Partnership (36.8%), Taubman (36.8%) and Simon (26.4%). The Company is providing construction management, property management, marketing and leasing services for the project. Major decisions such as a sale or refinancing of the project and approval of annual budgets require approval of all joint venture partners. All joint venture partners are obligated to contribute required equity capital on a pro rata basis. The project is expected to cost approximately $183 million. In January 1997, the joint venture entered into a $145 million construction financing loan with United Bank of Switzerland. The loan has a term of five years and bears interest at a rate equal to LIBOR plus 130 basis points (subject to reduction to 115 basis points upon obtaining a rating of A- or better from a nationally recognized rating agency). Development costs through December 31, 1996 were approximately $54.7 million (net of tax increment financing).
Under the terms of the joint venture agreement, following the fifth anniversary of the project's opening (or, if later, the date that 90% of the project has been leased), if the joint venture partners are unable to agree upon certain major decisions, any joint venture partner can cause the project to be sold pursuant to certain required procedures. Upon such a sale, the proceeds would be distributed to the joint venture partners on a pro rata basis.
MILLS CITY AT ORANGE-ORANGE, CALIFORNIA. Mills City at Orange is proposed for development on an approximately 85-acre site located at the intersection of the Santa Ana Freeway (I-10), the Garden Grove Freeway and Orange Freeway (Highway 57) in the City of Orange, California, three miles from Disneyland. This project will be developed on the site of an existing shopping center located in what management believes to be one of the wealthiest areas and strongest retail markets in the country. The redeveloped Mills-type project will consist of an approximately 800,000 square foot open air shopping center that will feature a 30-screen AMC Theatres included in approximately 330,000 square feet of entertainment and dining facilities in addition to upscale value-retail stores. In addition to AMC Theatres, the Mills has obtained commitments from Off 5th-Saks Fifth Avenue and Borders Books.
The Company expects to begin demolition of the existing shopping center in the first quarter of 1997 and to open the project in the fourth quarter of 1998. The project is expected to cost approximately $167 million (net of tax increment financing). Development costs through December 31, 1996 were approximately $9 million.
The project will be owned by a partnership between the Operating Partnership (50%) and Kan Am (50%). The Company would provide all development, leasing and management services for the project, subject to the approval of
Kan Am for certain major decisions, including a sale or refinancing of the project and approval of annual budgets. The Company would guarantee completion of the project within the parameters of an approved budget. Kan Am has committed to fund up to $45 million (which represents 100% of the estimated equity required for this project) after the receipt of construction loan financing in the amount of $122 million.
Under the terms of the limited partnership agreement, following the tenth anniversary of the project's opening, either the Operating Partnership or Kan Am can exercise a buy-sell provision whereby the Operating Partnership, if it is the offeror, can require Kan Am to transfer its entire interest in the partnership or Kan Am, if it is the offeror, can require the Operating Partnership to acquire Kan Am's entire interest in the partnership.
HOUSTON MILLS-HOUSTON, TEXAS. The Company has acquired an option to acquire a 500-acre site located at the intersection of Katy-Fort Bend Road and I-10 in Fort Bend and Harris Counties. The approximately 1.6 million square foot project planned for this site will consist of a combination of specialty retailers, cinemas and themed restaurants. The Company expects to open this project in 1999.
MEADOWLANDS MILLS-CARLSTADT, NEW JERSEY. The Company has acquired a mortgage interest in a 595-acre site located on the New Jersey Turnpike (I-95) adjacent to the Meadowlands Sports Complex and approximately five miles from New York City and has signed certain preliminary agreements with Empire Ltd., the current owner of the site, concerning the development of Meadowlands Mills. The approximately 2.1 million square feet project planned for this site will combine more than 200 specialty retailers, cinemas and themed restaurants. Ogden Entertainment, DeBartolo Entertainment and Virgin Entertainment Group have agreed in principle to plan and jointly develop the entertainment component of the project which will occupy approximately 600,000 square feet. On November 19, 1996, the Company announced commitments from ten anchor store tenants, including Off 5th-Saks Fifth Avenue, The Sports Authority, Group USA, Off Rodeo Drive and Rainforest Cafe. The Company currently expects to open the project in 1999.
The preliminary agreements with the site owner contemplate that the project will be developed by a joint venture to be formed among the Operating Partnership (82%), Empire Ltd. (13%) and Bennett S. Lazare, an individual affiliated with Empire Ltd. (5%). The agreements further provide that upon receipt of a final fill permit for the project, the site is to be conveyed to the new joint venture, and the Operating Partnership is to contribute 75% of its mortgage interest to the new joint venture and is to receive a credit to its capital account in the amount of $12 million plus certain other predevelopment costs advanced on behalf of the project. The preliminary agreements also provide that the interests of the three joint venture partners may be diluted by as much as 50% if an additional equity partner is admitted to the joint venture. If all other permits required to develop the shopping center shall not have been obtained within two years following the receipt of the final fill permit, then the Operating Partnership shall have the right to sell the site, subject to certain buy/sell provisions.
SIMON AGREEMENT. The Operating Partnership entered into an agreement with Simon pursuant to which Simon and the Operating Partnership have agreed to examine the feasibility of joint development and ownership of Mills-type shopping centers in various metropolitan markets (the "Simon Agreement"). The Simon Agreement provides, generally, that Simon and the Operating Partnership would hold equal interests in each joint venture entity and contribute needed capital on a pro rata basis. Three joint ventures have been formed as of December 31, 1996 in connection with the development of Ontario Mills, Grapevine Mills and Arizona Mills and the parties have announced their intention to form a new joint venture in connection with the development of a site in Charlotte, North Carolina. The Operating Partnership generally acts as the managing member or managing general partner, as the case may be, of each entity. Primary responsibility for the development, management and leasing of each joint venture project formed as of the date hereof has been undertaken by the Operating Partnership. The Simon Agreement restricts Simon until December 2003 from competing with the Operating Partnership by developing or acquiring Mills-type projects, and places additional restrictions on Simon's ability to hire employees of the Operating Partnership or its affiliates and to acquire stock in the
Company above certain specified levels. In addition, the Operating Partnership has agreed that until December 2003 it will not develop a Mills-type shopping center within certain designated metropolitan areas without affording Simon a first right to jointly develop such project.
FINANCING STRATEGIES
The Company intends to continue to reduce its exposure to refinancing risk and interest rate fluctuations. Prior to the Potomac Mills-Gurnee Mills securitization (at December 1, 1996), the Company's debt portfolio consisted of 48.3% variable rate debt ($349.0 million), most of which was subject to tiered caps, and the portfolio had a weighted average maturity of 2.5 years. Following this refinancing (at December 31, 1996), only 10% of the Company's debt portfolio, or $72 million, was variable rate debt, and the weighted average maturity of the debt portfolio was extended to 4.5 years. In addition, the Company expects to refinance the $165 million mortgage on Franklin Mills in the first half of 1997, extending its maturity through a fixed rate securitization. The Company has also taken steps to increase its liquidity. In October 1996, the Company obtained a $40 million line of credit from Credit Suisse First Boston for the purpose of funding development activities and general working capital (the "Line of Credit") which has a variable interest rate equal to LIBOR plus 300 basis points and matures on October 31, 1998 (with an option for a one-year extension). The Company expects to increase the size of the Line of Credit in the second quarter of 1997. Through its refinancing efforts and the Offering, the Company will have significantly improved its balance sheet by lowering the Company's leverage, extending debt maturities and fixing interest rates.
Over the last two years, the Company formed joint ventures to finance the development of certain Mills projects. The Company has established certain joint ventures with Kan Am, Simon and Taubman and has reached an agreement in principle to form one or more such joint ventures with Cambridge. While the Company has utilized such joint ventures in the past, the Company may or may not continue to use joint ventures in the future as a financing vehicle, except when required under the terms of the Simon Agreement.
COMPETITION
There are other companies that are engaged in the development or ownership of value retail properties that compete with the Company in seeking tenants. This results in competition for acquisition of prime locations and for tenants who will lease space in the value retail properties that the Company and its competitors own or operate. The development of new super-regional outlet malls or other value retail shopping centers with more convenient locations or better rents may attract the Company's tenants or cause them to seek more favorable lease terms at or prior to renewal, and may accordingly adversely affect the business, revenues or value of the Properties. In addition, traditional retailers may increase their competition with value retailers for the limited pool of consumers by engaging in marketing and selling activities similar to those of value retailers, thus blurring the distinction between traditional retailers and value retailers.
SEASONALITY
The regional shopping center industry is seasonal in nature, with mall tenant sales peaking in the fourth quarter due to the Christmas season. As a result, a substantial portion of the percentage rents are not paid until the fourth quarter. Furthermore, most new lease-up occurs towards the later part of the year in anticipation of the holiday season and most vacancies occur toward the beginning of the year. In addition, the majority of the temporary tenants take occupancy in the fourth quarter. Accordingly, cash flow and occupancy levels are generally lowest in the first quarter and highest in the fourth quarter. This seasonality also impacts the quarter-by-quarter results of net operating income and FFO, although this impact is largely mitigated by accruing minimum and percentage rents on a straight line basis during the year in accordance with GAAP.
TAX STATUS
The Company has elected to be taxed as a real estate investment trust ("REIT") under the Internal Revenue Code of 1986 (the "Code"). The Company believes that it was organized and has operated in such a manner to qualify as a REIT, and the Company intends to continue to operate in such a manner, but no assurance can be given that it has operated in a manner so as to qualify, or will operate in a manner so as to continue to qualify as a REIT. If the Company qualifies for taxation as a REIT, the Company generally will not be subject to Federal income tax to the extent it distributes at least 95% of its REIT taxable income to its shareholders. If the Company fails to qualify as a REIT in any taxable year, the Company will be subject to Federal income tax (including any applicable alternative minimum tax) on its taxable income at regular corporate rates. Even if the Company qualifies for taxation as a REIT, the Company may be subject to certain state and local taxes on its income and property and to federal income and excise taxes on its undistributed income and gains from certain property sales. The Third-Party Services Corporation, which provides management services to properties in which the Operating Partnership does not own an interest and provides development services for properties which are not 100% owned by the Operating Partnership, is subject to corporate-level federal, state and local corporate income taxes on its income.
ENVIRONMENTAL MATTERS
The Company believes that the Properties are in compliance in all material respects with all federal, state and local ordinances and regulations regarding hazardous or toxic substances. The Company is not aware of any environmental condition which the Company believes would have a material adverse effect on the Company's financial condition or results of operations (before consideration of any potential insurance coverage). Nevertheless, it is possible that there are material environmental liabilities of which the Company is unaware. Moreover, no assurances can be given that (i) future laws, ordinances or regulations will not impose any material environmental liability or (ii) the current environmental condition of the Properties have not been or will not be affected by tenants and occupants of the Properties, by the condition of properties in the vicinity of the Properties or by third parties unrelated to the Company.
Phase I environmental reports or updates thereof were completed by independent environmental consultants on all Properties within the last four years. These reports did not reveal any material environmental concerns except as noted below with respect to the Western Hills Community Center. Concerns were raised in a September 1993 Phase I report on the Mount Prospect Plaza Community Center as to two offsite leaking underground storage tanks, but were rated as minimal on additional investigation performed for a February 1995 update. Since Phase I environmental reports do not involve invasive procedures such as soil sampling and underground analysis, no assurance can be given that these reports reveal all potential environmental liabilities.
Limited quantities of asbestos containing materials ("ACMs") are present in certain of the Properties. The ACMs found are generally non-friable (meaning that the ACMs are not easily crumbled and thus are less likely to release asbestos fibers into the air), in good condition and are unlikely to be disturbed. With certain exceptions, these ACMs will be removed by the Company in the ordinary course of renovation or reconstruction. Prior to removal, these ACMs will be monitored and maintained by the Company in accordance with procedures established by the Environmental Protection Agency, the Occupational Safety and Health Administration and other applicable governmental authorities.
The Phase I environmental assessment prepared for the Western Hills Community Center revealed that leaking underground storage tanks were removed from an adjacent BP service station. The site investigation BP's consultant conducted after the removal determined that groundwater contamination attributable to the BP site exists. The groundwater flow direction generally is cross-gradient to the Western Hills Community Center. The Phase I report noted that there is a potential that the southeastern corner of the Property that is closest to the BP station may have been contaminated by the leaking tank at the BP site. As a result, a recommended Phase II assessment of the Property was conducted in December 1993 which did not encounter groundwater and thus found no evidence of groundwater contamination. The Phase II assessment concluded that although low levels of petroleum hydrocarbons were detected in the soil, those levels were well below Ohio action levels.
UNINSURED LOSS
In February 1993, the Property Partnership that owns Sawgrass Mills filed a lawsuit against various parties seeking damages for the repair and replacement of the heating, ventilating and air conditioning systems (the "HVAC") at Sawgrass Mills as a result of the excessive corrosion of HVAC pipes. The partnership's insurance policy may not cover this loss. Currently, the Company believes that remediation or replacement of the HVAC systems may be phased in over several years. The partnership has established a cash reserve of $1.5 million pursuant to the terms of the Sawgrass Mills securitized debt financing. The reserve is pledged as additional security for the Sawgrass Mills debt and is required to be used in its entirety by no later than January 18, 2000 and only to fund the replacement of cooling water piping used in the HVAC systems. In December 1996, the partnership settled its claims for an aggregate sum of $2.8 million, the net proceeds of which have been accrued as a reserve to fund such repair or replacement.
CORPORATE HEADQUARTERS
The Company's executive offices are located at 1300 Wilson Boulevard, Arlington, VA 22209. The Company's telephone number is (703) 526-5000.
ITEM 2.

ITEM 2. PROPERTIES
THE MILLS
The following tables set forth certain information relating to the Mills as of December 31, 1996. The Company either holds title to the Properties or directly or indirectly holds 100% of the general and limited partnership interests in the Property Partnerships, except for the Property Partnerships that own Franklin Mills and Ontario Mills, in which the Company holds 77.6% (which represents 100% of the current income and cash flow from Franklin Mills) and 50%, respectively, either directly or indirectly, of the partnership interests.
THE MILLS
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*Tenant owns store within the Mills **Ground Lease
Notes:
(1) Anchor stores include all stores occupying more than 20,000 square feet. (2) Includes 914,947 square feet of GLA owned by certain anchor store tenants as follows: Potomac Mills-80,000 square feet of GLA; Franklin Mills-208,602 square feet of GLA; Sawgrass Mills-281,774 square feet of GLA; Gurnee Mills-219,571 square feet of GLA, and Ontario Mills-125,000 square feet of GLA. (3) Percent Leased is defined as all space leased and for which rent was being paid as of December 31, 1996, excluding tenants with leases having a term of less than one year. (4) Annualized base rent is the base rent payable in December 1996 multiplied by 12. (5) Ontario Mills, upon completion of space for eight anchor store tenants containing approximately 500,000 square feet of GLA, will contain approximately 1.7 million square feet of GLA, including GLA owned by certain anchor store tenants. (6) 1996 Sales Per Square Foot information is not available for Ontario Mills which has not completed its initial lease-up. (7) Excludes Ontario Mills which opened on November 14, 1996 and has not completed its initial lease-up.
AVERAGE ANNUAL EFFECTIVE RENT
The following table sets forth, for the past five years, certain information regarding minimum and percentage rents for the Mills (excluding Ontario Mills).
AVERAGE ANNUAL EFFECTIVE RENT PER SQUARE FOOT (1) POTOMAC MILLS FRANKLIN MILLS SAWGRASS MILLS GURNEE MILLS --------------- -------------- ---------------- ------------- 1996 $ 14.00 $ 11.40 $ 16.55 $ 13.62 1995 13.30 11.33 15.66 12.89 1994 13.00 11.64 14.54 12.83 1993 11.99 12.59 15.69 13.86 1992 12.02 12.92 14.70 13.76
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(1) Average annual effective rent per square foot is based on annual minimum rent and percentage rent dividend by average occupancy within each center.
The lease expirations, operating trends and rental rates for each Mills individually and the Community Centers in the aggregate follow this section. The Operating Trends and Rental Rates tables for existing Mills exclude Ontario Mills which opened on November 14, 1996 and has not yet completed its initial lease-up.
EXISTING MILLS LEASE EXPIRATIONS
The following table sets forth scheduled lease expirations during each of the next ten years and thereafter of leases for stores at the existing Mills including Ontario Mills in the aggregate, assuming that none of the tenants exercises available renewal options. At December 31, 1996, the average remaining lease term was 7.4 years for anchor store tenants and 4.8 years for specialty store tenants.
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(1) Annualized base rent is the base rent payable in December 1996 multiplied by 12.
EXISTING MILLS OPERATING TRENDS
The following table sets forth, for the last three years, certain information regarding operating trends with respect to the existing Mills in the aggregate.
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(1) Average percent leased is defined as all space leased and for which rent was being paid excluding tenants with leases having a term of less than one year.
EXISTING MILLS RENTAL RATES
The following table sets forth, for each of the last three years, the average base rent per leased square foot of store openings and closings during the given year with respect to the existing Mills in the aggregate.
- ----------- (1) The releasing spread is calculated as the difference between per square foot openings and per square foot closings.
POTOMAC MILLS - WOODBRIDGE, VIRGINIA
Potomac Mills contains approximately 1.6 million square feet of GLA, of which approximately 80,000 square feet is owned by one anchor store tenant. Potomac Mills opened in 1985 with a total of approximately 630,000 square feet of GLA. As a result of customer demand, Potomac Mills was expanded to approximately 1.2 million square feet of GLA in 1986. The Phase III expansion of Potomac Mills opened on September 30, 1993 and increased total GLA by approximately 355,208 square feet. The Company anticipates that construction of a new entertainment zone will begin in late 1997 with an opening in late 1998 or early 1999. Real estate taxes paid in 1996 totaled approximately $2.5 million, representing a tax rate of 1.6%. Potomac Mills has 17 anchors, including: IKEA, J.C. Penney Outlet, Waccamaw Pottery, Marshalls, Spiegel Outlet, AMC Theatres, The Sports Authority, Off 5th-Saks Fifth Avenue, TJ Maxx, Syms and Nordstrom Rack. Potomac Mills is situated on approximately 161 acres located approximately 20 miles southwest of Washington, D.C. Potomac Mills is adjacent to Interstate 95, which serves as one of the transportation backbones of the Washington metropolitan area. This location strategically positions Potomac Mills between the Washington/Baltimore metropolitan market to the north and Richmond, approximately 90 miles to the south. The Company owns 100% of Potomac Mills.
POTOMAC MILLS LEASE EXPIRATIONS
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(1) Annualized base rent is the base rent payable in December 1996 multiplied by 12.
POTOMAC MILLS OPERATING TRENDS
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(1) Average percent leased is defined as all space leased and for which rent was being paid excluding tenants with leases having a term of less than one year.
POTOMAC MILLS BASE RENTAL RATES
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(1) The releasing spread is calculated as the difference between per square foot openings and per square foot closings.
FRANKLIN MILLS - PHILADELPHIA, PENNSYLVANIA
Franklin Mills opened in 1989 and contains approximately 1.8 million square feet of GLA, of which approximately 209,000 square feet is owned by certain anchor store tenants. The Company began remerchandising Franklin Mills in 1996 by upgrading its tenant mix and plans to begin construction on an entertainment zone, including themed restaurants and interactive entertainment venues in the first half of 1997. Real estate taxes paid in 1996 totaled approximately $3.9 million, representing a tax rate of 2.6%. Franklin Mills has 18 anchors, including: Bed, Bath & Beyond, Filene's Basement, Last Call from Neiman Marcus, Marshalls, Nordstrom Rack, Office Max, Off 5th-Saks Fifth Avenue, Spiegel Outlet, Syms and TJ Maxx. Franklin Mills features, what the Company believes is, the largest concentration of outlet retailing in the Delaware Valley. With access from U.S. Highway 1 and the Pennsylvania Turnpike, Franklin Mills is strategically positioned approximately 15 miles northeast of Philadelphia's Center City and just west of Interstate 95, a major thoroughfare serving the greater Philadelphia/Wilmington metropolitan market. The Operating Partnership owns 77.6% of the partnership interests in the partnership that owns Franklin Mills (which represents 100% of the current income and cash-flow from Franklin Mills) and has signed agreements to acquire the remaining partnership interests in April 1997, in exchange for 195,295 Units.
FRANKLIN MILLS LEASE EXPIRATIONS
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(1) Annualized base rent is the base rent payable in December 1996 multiplied by 12.
FRANKLIN MILLS OPERATING TRENDS
- ----------- (1) Average percent leased is defined as all space leased and for which rent was being paid excluding tenants with leases having a term of less than one year.
FRANKLIN MILLS BASE RENTAL RATES
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(1) The releasing spread is calculated as difference between per square foot openings and per square foot closings.
SAWGRASS MILLS - SUNRISE, FLORIDA
Sawgrass Mills, which opened in 1990, contains approximately 1.9 million square feet of GLA, of which approximately 282,000 square feet is owned by certain anchor store tenants. As a result of customer demand, Sawgrass Mills was expanded by approximately 136,000 square feet of GLA in 1995. The Company expects to open a Phase III expansion of Sawgrass Mills in the third quarter of 1998 consisting of an approximately 270,000 square foot entertainment zone. Real estate taxes paid in 1996 totaled approximately $5.2 million, representing a tax rate of 3.8%. Sawgrass Mills has 21 anchors, including: Beall's Outlet Store, Burlington Coat Factory, Last Call from Neiman Marcus, Loehmanns, Rainforest Cafe, Spiegel Outlet, The Sports Authority and Waccamaw Pottery. Sawgrass Mills is located in Florida's "Gold Coast" market approximately 11 miles west of Fort Lauderdale. The site lies adjacent to both the Sawgrass Expressway and Flamingo Road, between Sunrise and Oakland Park Boulevards. The entire South Florida region is linked by the road network of the Sawgrass Expressway, Interstate 75 and Interstate 595, which intersect at an interchange located less than two miles southwest of Sawgrass Mills.
The Company owns 100% of Sawgrass Mills. The Phase III expansion will be owned by a partnership formed by the Operating Partnership (50%) and Kan Am (50%) in which Kan Am has agreed to fund 100% of the project's initial required equity for which Kan Am will receive a 9% annual preferred return. Under the terms of the partnership agreement, the Company has the right to buy out Kan Am prior to December 31, 1999 at 120% of Kan Am's equity contributions and accumulated preferred returns, under certain terms and conditions set forth in the partnership agreement. The Company would provide all development, management and leasing services for the expansion, subject to the approval of Kan Am of certain major decisions, including a sale or refinancing of the project and the approval of the development and annual budgets. The Company would guarantee completion of the expansion within the parameters of the approved development budget.
SAWGRASS MILLS LEASE EXPIRATIONS
(1) Annualized base rent is the base rent payable in December 1996 multiplied by 12.
SAWGRASS MILLS OPERATING TRENDS
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(1) Average percent leased is defined as all space leased and for which rent was being paid excluding tenants with leases having a term of less than one year.
SAWGRASS MILLS RENTAL RATES
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(1) The releasing spread is calculated as the difference between per square foot openings and per square foot closings.
GURNEE MILLS - GURNEE, ILLINOIS
Gurnee Mills opened in 1991 and contains approximately 1.5 million square feet of GLA, of which approximately 220,000 square feet is owned by certain anchor store tenants. The Company began construction of an expansion of over 150,000 square feet of GLA of Gurnee Mills to add entertainment venues to the existing mall and is also remerchandising the project which the Company expects will upgrade the tenant mix at Gurnee Mills. Real estate taxes paid in 1996 totaled approximately $2.7 million, representing a tax rate of 2.3%. Gurnee Mills has 14 anchors, including: J.C. Penney Outlet, Waccamaw Pottery, Marshalls, Spiegel Outlet, Bed Bath & Beyond, The Sports Authority, Off 5th-Saks Fifth Avenue, TJ Maxx and Syms. Gurnee Mills is located adjacent to Interstate 94, the major north/south thoroughfare linking Chicago and Milwaukee. Gurnee Mills is clearly visible from Interstate 94 and is situated directly across from Six Flags Great America, one of the largest amusement parks in the Midwest.
GURNEE MILLS LEASE EXPIRATIONS
- ----------- (1) Annualized base rent is the base rent payable in December 1996 multiplied by 12.
GURNEE MILLS OPERATING TRENDS
___________
(1) Average percent leased is defined as all space leased and for which rent was being paid excluding tenants with leases having a term of less than one year.
GURNEE MILLS RENTAL RATES
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(1) The releasing spread is calculated as the difference between per square foot openings and per square foot closings.
ONTARIO MILLS - ONTARIO, CALIFORNIA
Ontario Mills opened on November 14, 1996 with approximately 1.2 million square feet of GLA (including space owned by certain anchor store tenants) comprised of approximately 700,000 square feet of anchor space and approximately 500,000 square feet of specialty store space. The Company has plans to expand the project to a total of 1.7 million square feet at completion. Ontario Mills currently has 14 anchors, including: Off 5th-Saks Fifth Avenue Outlet, J.C. Penney Outlet, Burlington Coat Factory, The Sports Authority, Marshalls, Bed, Bath & Beyond, Mikasa, Off Rodeo Drive, TJ Maxx, AMC Theatres, Virgin Megastore, Group USA, Foozles, and Totally 4 Kids. American Wilderness Experience and IWERKS are scheduled to open by the third quarter of 1997 and an additional three anchors have executed leases and are scheduled to open later in 1997. Ontario Mills is located at the intersection of Interstate 10 and Interstate 15 in the heart of the Riverside/San Bernardino area known as the "Inland Empire." Ontario Mills serves the Los Angeles/Orange County metropolitan market.
Ontario Mills is owned by a joint venture among the Operating Partnership (50%) and affiliates of Kan Am (25%) and Simon (25%). The Company has the right to manage the development, property management and leasing of the Ontario Mills project, subject to the other joint venture partners' approval of certain major decisions, including sale or refinancing of the project and approval of an annual budget. The joint venture partners have agreed to contribute equally all initial required equity capital; provided, however, that the Company and Simon have agreed to guarantee any project cost overruns not funded by initial required equity capital and the partnership's construction financing. At any time following the tenth anniversary of the project's opening, either the Company, Simon or Kan Am can exercise a buy-sell provision whereby the Company or Simon, if it is the offeror, can require Kan Am to transfer its entire interest in the partnership or Kan Am, if it is the offeror, can require the Company or Simon to acquire Kan Am's entire interest in the partnership. Estimated net construction costs are approximately $150 million. In addition to its capital contributions from its joint venture partners, in November 1995, the joint venture entered into a construction loan for a $110 million loan that was funded in the first half of 1996. This loan was refinanced in February 1997 with a permanent loan of $120 million which matures in February 2002 with two one-year extensions. The interest rate is variable at LIBOR plus 100 basis points for the first $70 million and LIBOR plus 125 basis points for the remaining 50 million, and the Company has the right to fix the interest rate at any time.
ONTARIO MILLS LEASE EXPIRATIONS
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(1) Annualized base rent is the base rent payable in December 1996 multiplied by 12.
THE COMMUNITY CENTERS
The 11 Community Centers contain a total of approximately 2.2 million square feet of GLA and are located in Florida, Georgia, Illinois, Maryland, New Jersey, Ohio, Pennsylvania, South Carolina and Virginia. The Community Centers are open-air shopping centers containing traditional shopping center tenants, such as grocery, drug, video and greeting card stores, as well as a strong concentration of national value retailers. Anchor tenants of the Community Centers include Giant Food, Krogers, Marshalls, Safeway, TJ Maxx and Walgreens.
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(1) Anchor stores includes all stores occupying more than 20,000 square feet. (2) Percent leased is defined as all space leased and for which rent was being paid as of December 31, 1996, excluding tenants with leases having a term of less than one year. (3) Annualized base rent is the base rent payable in December 1996 multiplied by 12. (4) The low total percent leased figures for Liberty Plaza are due to the closing of Bradlees, a 149,000 square foot anchor store tenant, in October 1996 following its bankruptcy and one vacant 15,000 square foot specialty shop. (5) Tenants at Liberty Plaza are not required to report sales information.
(1) Annualized base rent is the base rent payable in December 1996 multiplied by 12.
COMMUNITY CENTERS OPERATING TRENDS
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(1) Average percent leased is defined as all space leased and for which rent was being paid excluding tenants with leases having a term of less than one year.
COMMUNITY CENTERS BASE RENTAL RATES
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(1) The releasing spread is calculated as the difference between per square foot openings and per square foot closings.
CAPITAL EXPENDITURES
The following tables set forth certain information regarding capital expenditures for the Mills and the Community Centers combined, the existing Mills and the Community Centers for each of the last three years.
EXISTING MILLS AND COMMUNITY CENTERS COMBINED
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(1) Includes annual costs divided by total GLA (excluding space owned by certain anchor store tenants) of the Properties (excluding Ontario Mills). (2) Tenant Improvements/Leasing Costs include tenant allowances and capitalized internal leasing costs. (3) Includes $1,487,754 incurred with respect to three significant tenants at Potomac Mills totaling approximately 53,000 square feet of GLA. Without these three tenants the per square foot improved and per square foot Recurring Tenant Improvements/Leasing Costs would have totaled $9.80 and $0.33, respectively. (4) Sawgrass Mills Phase II expansion costs have been excluded from this analysis. (5) Calculated as Recurring Tenant Improvements/Leasing Costs divided by GLA of all Recurring Store Openings (including spaces requiring no expenditures). (6) Calculated as Non-Recurring Tenant Improvements/Leasing Costs divided by GLA of all Non-Recurring Store Openings.
EXISTING MILLS
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(1) Includes annual costs divided by total GLA (excluding space owned by certain anchor store tenants) of the existing Mills. (2) Tenant Improvements/Leasing Costs include tenant allowances and capitalized internal leasing costs. (3) Includes $1,487,754 incurred with respect to three significant tenants at Potomac Mills totaling approximately 53,000 square feet of GLA. Without these three tenants the per square foot improved and per square foot recurring Tenant Improvements/Leasing Costs would have totaled $9.32 and $0.34, respectively. (4) Sawgrass Mills Phase II expansion costs have been excluded from this analysis. (5) Calculated as Recurring Tenant Improvements/Leasing Costs divided by GLA of all Recurring Store Openings (including spaces requiring no expenditures). (6) Calculated as Non-Recurring Tenant Improvements/Leasing Costs divided by GLA of all Non-Recurring Store Openings.
COMMUNITY CENTERS
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(1) Includes annual costs divided by total GLA (excluding space owned by certain anchor store tenants) of the Community Centers. (2) Tenant Improvements/Leasing Costs include tenant allowances and capitalized internal leasing costs. (3) Calculated as Recurring Tenant Improvements/Leasing Costs divided by GLA of all Recurring Store Openings (including spaces requiring no expenditures). (4) Calculated as Non-Recurring Tenant Improvements/Leasing Costs divided by GLA of all Non-Recurring Store Openings.
TENANTS
The following table sets forth certain information with respect to the Company's ten largest tenants (as measured by 1996 base rent) at December 31, 1996:
PERCENT OF NUMBER 1996 PERCENT OF OF TENANT BASE RENT TOTAL LEASED GLA STORES - ------ --------- ---------------- ------
TJ Maxx Group (1) . . . . . . . . 4.7% 6.7% 16 J.C. Penney . . . . . . . . . . . 2.3% 4.7% 4 Spiegel Group (2) . . . . . . . . 1.8% 3.0% 4 Bed, Bath & Beyond. . . . . . . . 1.5% 2.0% 3 Melville (3). . . . . . . . . . . 1.4% 1.1% 10 Levi's. . . . . . . . . . . . . . 1.3% 0.7% 4 Waccamaw Pottery. . . . . . . . . 1.3% 3.7% 3 Service Merchandise . . . . . . . 1.2% 1.8% 3 The Sports Authority. . . . . . . 1.2% 1.4% 3 Off 5th - Saks Fifth Avenue . . . 1.1% 1.7% 4 ----- ----- ----- Total . . . . . . . . . . . . . 17.8% 26.8% 54 ----- ----- ----- ----- ----- -----
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(1) Includes TJ Maxx, Marshalls and Hit or Miss. (2) Includes Spiegel Outlet, Spiegel and Eddie Bauer Outlet. (3) Includes Toy Works, Linens 'N Things, Footaction, KayBee Toys and Berman's.
INCOME PRODUCING PROPERTY - FEDERAL INCOME TAX BASIS
The following table sets forth certain information regarding federal income tax basis and depreciation of income producing property for the Mills (excluding Ontario Mills) as of December 31, 1996.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS
KRAMER LITIGATION
Mr. Richard Kramer ("Kramer") and certain of his affiliates, the AJ 1989 Trust ("A.J.") and Portals Development Associates Limited Partnership ("PDA"), filed an action on April 27, 1994, in New York state courts against the Operating Partnership, Herbert S. Miller ("Miller"), Kenwood Plaza Limited Partnership ("Kenwood") and Ernst & Young LLP for various alleged breaches of contract, breaches of fiduciary duties, fraudulent acts, and other violations of law relating primarily to the management and subsequent acquisition of the Properties acquired in the IPO in which Kramer and his affiliates owned an interest. The complaint sought damages from the Operating Partnership in excess of $4.5 million, trebled under a RICO claim. That complaint also sought a declaratory judgment that A.J. is entitled to retain $2.9 million sent to it by mistake upon the closing of the IPO as an offset against its claimed damages, and a declaratory judgment, specific performance and damages against Miller relating to his failure to sign certain guarantee affirmations and debt modifications with respect to PDA.
On May 10, 1994, the defendants removed this case from the New York state courts to the United States District Court for the Southern District of New York and the plaintiffs agreed to dismiss the claims against Ernst & Young LLP. Thereafter, the court granted the defendant's motion to dismiss certain of the complaint's claims and gave plaintiffs leave to replead. When the plaintiffs served their amended complaint, they added the Company as a defendant. In late February 1996, the plaintiffs moved to amend the amended complaint to delete the RICO claim without prejudice and to remand other claims to the state court for adjudication. Defendants crossmoved for summary judgment (a) on their counterclaim seeking the return of the $2.9 million mistakenly transferred to A.J. and (b) dismissing the remaining claims against the Company and the Operating Partnership. In addition, the defendants are asserting that the RICO claim should be dismissed only on a with-prejudice basis. These motions are still pending. Pending the outcome of the litigation, the Company is withholding partnership distributions that would otherwise be payable to A.J. from Kenwood as an offset against the $2.9 million mistakenly transferred to A.J. A.J. has filed an additional claim seeking payment of those distributions. The Company, the Operating Partnership and Mr. Miller intend to vigorously defend against whatever claims remain. The Company believes that it is unlikely that the ultimate outcome of the pending proceeding would have a material adverse effect on the Company's financial condition or results of operations.
KENWOOD LITIGATION
On June 15, 1994, ICSC Partners Limited Partnership filed in the Court of Common Pleas, Hamilton County, Ohio a derivative action on behalf of Kenwood Plaza Limited Partnership ("Kenwood") against Mr. Miller, Western Development ("WDC") and the Company seeking the return to Kenwood of $6.3 million paid by Kenwood to Mr. Miller, WDC and the Company, plus $5 million in punitive damages. The plaintiff subsequently filed an amended complaint which included a RICO claim that, if proven, would entitle the plaintiff to recover treble damages and attorney's fees in addition to compensatory and punitive damages. The defendants filed counterclaims against the plaintiff seeking $5.0 million in compensatory damages and $10.0 million in punitive damages.
In 1995, the parties to the lawsuit reached a settlement that resulted in no financial liability for the Company and no admission of liability by the Company. See "--Indemnity Claim." The settlement was submitted to the court for approval and sent to the non-party limited partners. A.J, a non-party limited partner, objected to the settlement, and, on October 13, 1995, the court entered an order and judgment overruling the objection and approving the settlement. A.J. appealed the order to the Court of Appeals of Arlington County, Ohio, which affirmed the trial court's approval of the settlement. A.J. has filed a motion asking the Supreme Court of Ohio to accept jurisdiction in this case. This motion is pending. The Company believes that it is unlikely that the ultimate outcome of the pending proceeding would have a material adverse effect on the Company's financial condition or results of operations.
HESS LITIGATION
On November 9, 1994, Gene E. Hess, a former officer of the Company whose employment was terminated after the IPO, filed a complaint in the United States District Court for the District of Columbia against the Company for fraud, breach of employment contract, and breach of covenant of good faith and fair dealing and against Mr. Miller for fraud and tortious interference with contractual relations. In January 1997, without admitting liability, the defendants agreed to settle the lawsuit in exchange for the issuance of an additional 13,650 shares of Common Stock of the Company.
INDEMNITY CLAIM
The Company and the Operating Partnership have notified Mr. Miller, Laurence Siegel, Harry Nick, Ronald Salerno and various Kan Am affiliates (collectively, "Indemnifying Parties") that they may be liable to the Company and the Operating Partnership due to the Kramer and Kenwood litigation under indemnity agreements entered into at the time of the IPO. The Company and the Operating Partnership have entered into a standstill agreement postponing a decision on liability under the indemnity agreements in consideration for the Indemnifying Parties creating an escrow account to fund the Company's cost of defense. On November 1, 1995, the Operating Partnership and the Indemnifying Parties entered into a Settlement Agreement whereby each Indemnifying Party agreed to contribute its pro-rata share of the amounts payable under the Kenwood Settlement, which was approved by the Court in October 1995.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
Item 5.

Item 5. Market for the Registrant's Common Equity and Related Shareholder Matters
MARKET INFORMATION
The Company's Common Stock trades on the New York Stock Exchange ("NYSE") under the symbol "MLS". The following table sets forth the high and low closing sale prices per share of Common Stock for the periods indicated as reported on the NYSE and the distributions per share paid by the Company with respect to the periods noted.
HIGH LOW DISTRIBUTIONS ---- --- -------------
1995: First Quarter. . . . . . $19 5/8 $16 $.4725 Second Quarter . . . . . 20 4/8 15 1/2 .4725 Third Quarter. . . . . . 19 7/8 17 7/8 .4725 Fourth Quarter . . . . . 18 3/4 16 7/8 .4725 1996:. . . . . . . . . . First Quarter. . . . . . $18 3/8 $16 5/8 $.4725 Second Quarter . . . . . 18 3/8 17 1/4 .4725 Third Quarter. . . . . . 20 5/8 17 5/8 .4725 Fourth Quarter . . . . . 24 3/8 19 4725
The last reported closing sale price on the NYSE on March 10, 1997 was $25.375 per share. As of March 10, 1997, there were 16,923,236 shares of Common Stock outstanding, held by 508 holders of record.
DISTRIBUTIONS
The Company has made consecutive quarterly distributions since the IPO. The indicated annual distribution rate is $1.89 per share of Common Stock based on the fourth quarter 1996 distribution. A portion of the Company's distribution may represent a non-taxable return of capital and/or a capital gain dividend. Approximately 65% of 1996 distributions of $1.89 per share of Common Stock was a non-taxable return of capital. There were no capital gain dividends in 1996. The Company's ability to make distributions depends on a number of factors, including its net cash provided by operating activities, its financial condition, capital commitments, debt repayment schedules and such other factors as the Board of Directors deems relevant.
Holders of Common Stock are entitled to receive distributions when, as and if declared by the Board of Directors out of any funds legally available for that purpose. The Company, as a REIT, is required to distribute annually to its shareholders at least 95% of its "real estate investment trust taxable income," which, as defined by the relevant tax statutes and regulations, is generally equivalent to net taxable ordinary income.
ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected consolidated financial data for the Company, the Operating Partnership and their subsidiaries (including the Third Party Services Corporation) for the periods after the IPO and combined historical financial data of the entities which owned the Properties and conducted the operations now performed by the Operating Partnership and its subsidiaries (the "Mills Entities") for the periods prior to the IPO. The historical financial data should be read in conjunction with the financial statements and notes thereto included herein and the discussion set forth in "Management's Discussion and Analysis of Financial Condition and Results of Operations."
SELECTED CONSOLIDATED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA)
- ----------------- (1) Per share data is reflected only for the Company. Per share data is not relevant for the historical combined financial statements of the Mills Entities since such financial statements are a combined presentation of partnerships and corporations. Historical operating results, including net income, may not be comparable to future operating results because of the historically greater leverage of the Mills Entities. (2) The Company generally considers Funds From Operations ("FFO") a widely used and appropriate measure of performance for an equity REIT which provides a relevant basis for comparison among REITs. FFO as defined by NAREIT means income (loss) before minority interest (determined in accordance with generally accepted accounting principles, referred to herein as "GAAP"), excluding gains (losses) from debt restructuring and sales of property, plus real estate related depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures. FFO is presented to assist investors in analyzing the performance of the Company. The Company's method of calculating FFO may be different from methods used by other REITs and, accordingly, may not be comparable to such other REITs. FFO (i) does not represent cash flows from operations as defined by GAAP, (ii) is not indicative of cash available to fund all cash flow needs and liquidity, including its ability to make distributions and (iii) should not be considered as an alternative to net income (as determined in accordance with GAAP) for purposes of evaluating the Company's operating performance. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Funds From Operations." (3) Excludes 125,000 square feet of GLA owned by one anchor store tenant. Includes Ontario Mills at 1.1 million square feet which, upon completion of space for eight anchor store tenants, will contain approximately 1.6 million square feet of GLA.
ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of the consolidated financial condition and results of operations should be read in conjunction with the Consolidated and Combined Financial Statements and Notes thereto.
The following discussion is based primarily on the consolidated financial statements of the Company for the years ended December 31, 1996 and December 31, 1995, and for the period April 22, 1994 to December 31, 1994, and the combined financial statements of the Mills Entities for the period from January 1, 1994 to April 21, 1994. The combined financial statements of the Mills Entities include the balance sheet data and results of operations of the management and leasing operations of the Management Partnership, the 15 Property Partnerships that owned the Properties and certain other affiliated entities, which were contributed to the Operating Partnership and are now consolidated in the Company's financial statements. The Mills Entities are considered the predecessor to the Company, and the combined financial statements do not include the effects of the IPO. For purposes of the discussion below, the term "Company" is used to refer to The Mills Corporation, the Operating Partnership and their subsidiaries, and/or their predecessor, the Mills Entities.
COMPARISON OF YEAR ENDED DECEMBER 31, 1996 TO YEAR ENDED DECEMBER 31, 1995
Income before minority interest for the year ended December 31, 1996, increased by approximately $1.2 million (8.3%) to $16.1 million as compared to the year ended December 31, 1995. The increase was the result of an increase in revenues of $7.3 million (4.8%), offset by an increase in expenses of $4.0 million (2.9%), an increase in equity of earnings of unconsolidated joint ventures of $2.7 million, and an increase in the extraordinary loss on debt extinguishment of $4.9 million.
REVENUES. Minimum rent for the year ended December 31, 1996, increased approximately $4.8 million (5.4%) compared to the year ended December 31, 1995. The increase was primarily due to the expansions of Sawgrass Mills and Liberty Plaza and higher lease renewal rates across the Properties.
Percentage rents decreased $0.2 million (5.5%) compared to the year ended December 31, 1995, due to fixed lease escalations in 1996 shifting revenues from percentage rents to minimum rent and to decreased sales for certain tenants which pay percentage rents, although aggregate tenant sales have increased over 1995.
Recoveries from tenants for the year ended December 31, 1996, increased approximately $1.5 million (3.4%) compared to the year ended December 31, 1995. The increase was due to the expansion of Sawgrass Mills and increases in the recoverable expenses across the remaining Mills mainly for real estate taxes .
Other revenue for the year ended December 31, 1996, increased $1.1 million (16.5%) compared to the year ended December 31, 1995. The increase was primarily due to increased revenues at the Company's pushcart program and in income from tenants who occupy space on a temporary basis.
Fee income for the year ended December 31, 1996, decreased $0.3 million (8.5%) compared to the year ended December 31, 1995. The decrease was due primarily to lower fees earned on the sale of third party peripheral land.
Interest income increased by approximately $0.4 million (17.2%) for the year ended December 31, 1996, compared to the year ended December 31, 1995. This increase was primarily due to $0.5 million of interest earned on a note receivable from an unconsolidated joint venture.
EXPENSES. Recoverable from tenants for the year ended December 31, 1996, increased approximately $2.0 million (5.1%) compared to the year ended December 31, 1995. The increase was due to the expansion of Sawgrass Mills and increases across the remaining Mills primarily for real estate taxes and snow removal.
Other operating expenses for the year ended December 31, 1996, increased approximately $0.9 million (18.0%) compared to the year ended December 31, 1995. This increase was primarily due to an increase in contributions to promotional programs of $0.8 million, an increase in bad debt of $0.3 million at certain properties, an increase of $0.3 million for the expansion of the Company's pushcart program, and an increase of $0.1 million for other taxes at Franklin Mills. These increases were offset by a decrease in non-recurring legal fees of $0.7 million at Sawgrass Mills.
General and administrative expenses increased by $0.9 million (11.7%) for the year ended December 31, 1996, compared to the year ended December 31, 1995. The increase was due to a $0.5 million legal settlement with a former officer of the Company and the Company's hiring additional employees in connection with its projects under development.
Interest expense increased by approximately $1.9 million (4.4%) for the year ended December 31, 1996, compared to the year ended December 31, 1995. This increase was primarily due to additional debt associated with the Phase II expansion of Sawgrass Mills which opened in November 1995, and interest expense associated with the opening of Ontario Mills in November 1996 that was capitalized prior to opening.
Depreciation and amortization decreased $1.8 million (4.4%) for the year ended December 31, 1996, compared to the year ended December 31, 1995. The decrease was due to a $1.4 million decrease in amortization of loan costs as a result of refinancing of certain mortgage indebtedness secured by the Community Centers and a $2.5 million decrease in depreciation relating to assets reaching the end of their depreciable lives. The decrease is partially offset by a $1.3 million increase in depreciation related to the Sawgrass expansion and a $0.9 million acceleration of amortization of leasing costs at Liberty Plaza in 1996.
Equity in earnings of unconsolidated joint ventures increased to $2.7 million in 1996 as the Company recognized its equity in the earnings in the Ontario Mills and Ontario Mills Residual joint ventures, which began operations in 1996.
The extraordinary loss on debt extinguishment for the year ended December 31, 1996, increased $4.9 million compared to the year ended December 31, 1995. The 1996 loss was due principally to the write off of unamortized deferred financing costs as a result of the refinancing of certain mortgage indebtedness secured by the Community Centers in January 1996 and Gurnee Mills and Potomac Mills in December 1996.
COMPARISON OF YEAR ENDED DECEMBER 31, 1995 TO YEAR ENDED DECEMBER 31, 1994
The following discussion compares the results of the Company for the year ended December 31, 1995, to the results of the Company for the period April 22, 1994 to December 31, 1994, combined with the results of the Mills Entities for the period January 1, 1994 to April 21, 1994. As a result of the IPO, the Company's capital structure and leverage changed substantially. However, as the effects of the IPO primarily impact other income and expense, such as interest expense, the comparison of 1995 to combined 1994 results of operations provides a reasonable basis for analysis of the results of recurring property operations. The impact of the IPO on the analysis of other income and expense is noted below.
Income before minority interest for the year ended December 31, 1995, increased by approximately $17.1 million to $14.8 million compared to a loss of $2.3 million for the year ended December 31, 1994. This increase was the result of an increase in revenues of $8.6 million (6.0%), a decrease in expenses of $1.3 million, an increase in other income of $2.3 million and a decrease in extraordinary loss on debt extinguishment of $4.9 million.
REVENUES. Minimum rent for the year ended December 31, 1995, increased by approximately $1.7 million (1.9%) compared to the year ended December 31, 1994. This increase was partly due to contractual rent increases and lease renewals. Additionally, the Company realized a full year of operations in 1995 of two community centers
acquired in 1994, resulting in a $1.2 million increase in rents. These increases were offset by the sale of one community center in 1994, resulting in a $0.4 million decrease in rents.
Percentage rents increased $0.5 million (13.2%) compared to the year ended December 31, 1994, due to increased tenant sales in aggregate at the Company's properties, particularly Sawgrass Mills.
Recoveries from tenants increased approximately $3.4 million (8.3%) for the year ended December 31, 1995, compared to the year ended December 31, 1994. This increase was due to a full year of operations of two community centers acquired in 1994 resulting in a $1.1 million increase, a utility income billing rate adjustment at Franklin Mills of $0.7 million, the elimination of management imposed caps at Gurnee Mills and Franklin Mills and overall increases in recoverable expenses.
Fee income increased by $0.9 million (31.1%) for the year ended December 31, 1995, primarily as a result of development and leasing fees earned from the Ontario Mills Limited Partnership.
EXPENSES. Recoverable from tenants for the year ended December 31, 1995, increased approximately $1.7 million (4.6%) compared to the year ended December 31, 1994. This increase was primarily attributable to an increase in real estate tax expense of $1.7 million at Franklin Mills due to the expiration of a tax abatement.
Other operating expenses for the year ended December 31, 1995, decreased approximately $1.5 million (21.9%) compared to the year ended December 31, 1994. This decrease was primarily due to greater advertising costs in 1994 at Gurnee Mills of $1.4 million which were funded by contributions to a promotion fund. Typically, advertising costs are funded solely by tenant contributions.
General and administrative expenses decreased by $0.5 million (6.0%) for the year ended December 31, 1995, primarily due to non-recurring costs incurred in 1994 combined with cost cutting measures implemented by the Company in 1995.
Interest expense decreased by approximately $2.4 million (5.2%) for the year ended December 31, 1995, compared to the year ended December 31, 1994. This decrease was primarily due to lower debt balances in 1995 (and subsequent to the IPO in 1994) as a result of the application of a substantial portion of the proceeds of the IPO to reduce outstanding borrowings.
Depreciation and amortization expense increased $1.3 million (3.4%) for the year ended December 31, 1995, due to the two new community centers acquired in 1994, a step-up in certain asset bases as a result of the acquisition of certain partnership interests at the time of the IPO and other increases in deferred assets.
Other income and expense increased approximately $2.3 million (161.2%) for the year ended December 31, 1995, as compared to the year ended December 31, 1994. The increase was mainly due to a 1994 write-down of Western Crossing to net realizable value of $3.4 million offset by the decrease in the gain on land sales of $0.7 million.
Extraordinary loss on debt extinguishment decreased approximately $4.9 million in 1995 due to the paydown of debt associated with the IPO in 1994
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1996, the Company's balance of cash and cash equivalents was $6.3 million, not including its proportionate share of cash held in partnerships which are not consolidated. In addition to its cash reserves, the Company had $20.3 million available under its $40.0 million Line of Credit (see below).
FINANCING ACTIVITIES. During 1996, the Company completed various financing and refinancing activities which extended the weighted average remaining term of the Company's total indebtedness from 3.5 years at
December 31, 1995 to 4.5 years at December 31, 1996, without increasing the weighted average interest rate (7.05% at December 31, 1996).
Loans totaling $349.9 million were refinanced during 1996 with the proceeds of new borrowings totaling $360.0 million. On January 31, 1996, the Company obtained a $76.0 million permanent mortgage loan secured by nine of the Community Centers to repay a $60.0 million loan maturing on March 31, 1996. The permanent mortgage loan bears interest at a fixed rate of 7.16% and matures on January 31, 2001. On December 17, 1996, the Company completed a $289.9 million refinancing of the existing mortgage indebtedness on Gurnee Mills and Potomac Mills. This refinancing was achieved through a $284 million all-investment grade securitization with a weighted average fixed coupon of 7.02% and an anticipated balloon repayment due in seven years. The shortfall in this refinancing was funded through a draw on the Line of Credit.
During 1996, three credit facilities were completed with Credit Suisse First Boston, summarized as follows (dollars in thousands):
The amounts available under the Line of Credit are subject to certain performance measurements and restrictive covenants. The Company was in compliance with the applicable covenants at December 31, 1996 and anticipates increasing the availability in 1997 under the facility.
In October 1996, the Company filed a universal shelf registration statement on Form S-3 for up to $250 million of common stock, preferred stock and common stock warrants which became effective October 28, 1996. The Company filed a Prospectus and preliminary Prospectus Supplement dated February 21, 1997 to sell 4,500,000 shares of Common Stock under the shelf registration statement. In December 1996, the Company filed a preliminary proxy statement seeking shareholder approval for up to $150 million of preferred equity capital from Kan Am. In connection therewith, the Company is currently negotiating an agreement, subject to such shareholder approval, with Kan Am to provide the Company (or the Operating Partnership) with approximately $50 million in preferred equity capital on terms the Company believes would be attractive. There can be no assurance that any such agreement will be entered into or that such shareholder approval will be obtained.
The Company had consolidated debt of approximately $730.1 million at December 31, 1996 of which $657.9 million is fixed-rate debt and $72.2 million is variable-rate debt. Scheduled principal repayments of consolidated indebtedness over the next four years is $254.8 million ($165.0 million of which relates to Franklin Mills which the Company expects to refinance in 1997 and the remainder of which the Company expects to refinance or repay with cash generated from operations, external borrowings or equity issuances), with $475.3 million due thereafter. The Company's pro rata share of unconsolidated joint venture debt at December 31, 1996 was $42.4 million (net of tax increment financing).
The Company's ratio of debt-to-total market capitalization was approximately 47.9% at December 31, 1996. If the Company's pro-rata share of indebtedness of all unconsolidated joint venture properties were included, the ratio of debt-to-total market capitalization would be approximately 49.3%.
DEVELOPMENT, REMERCHANDISING AND EXPANSION. The Company is involved in the following development, remerchandising and expansion efforts:
Five Mills projects are planned to be completed in the next three years. Grapevine Mills and Arizona Mills are expected to open in the fourth quarter of 1997. Construction loans and loan commitments, aggregating approximately $285 million (expected to increase to $300 million), equity commitments from the Company's joint venture partners
and the Company's remaining required equity contribution of approximately $15 million (as of December 31, 1996) are considered adequate to fund the remaining development efforts for these projects. The Company expects to obtain its required equity contributions from external borrowings, potential equity issuances and/or cash flow from operating activities.
Mills City at Orange and Houston Mills are scheduled to open in the fourth quarter of 1998 and in 1999, respectively. Both projects will be financed principally with external borrowings, potential preferred and other equity contributions from Kan Am and/or the potential equity issuances. The Company anticipates its required future equity requirements for Mills City at Orange and Houston Mills in the aggregate may total as much as $30 million.
The Company expects to commence construction in 1998 of Meadowlands Mills, with a targeted opening date in 1999. The Company is currently evaluating its financing options with respect to this project, including possibly obtaining an additional partner to provide equity.
In addition to these new Mills, the Company is planning to spend approximately $115 million on its existing portfolio during the next three years to complete its expansion and remerchandising programs in each of the Company's first four Mills. It is anticipated that these projects will be financed with external borrowings, equity contributions from Kan Am and other potential equity issuances.
CAPITAL RESOURCES. The Company anticipates that its operating expenses, interest expense on outstanding indebtedness, recurring capital expenditures and distributions to stockholders in accordance with REIT requirements will be provided by cash generated from operations, potential ancillary land sales and borrowings under its Line of Credit.
The Company believes that it will have the capital and access to additional capital resources sufficient to expand and develop its business in accordance with its operating, development and financing strategies.
DISTRIBUTIONS. The Company has paid and intends to continue to pay regular quarterly distributions to its stockholders. Distributions are payable at the discretion of the Board of Directors and depend on a number of factors, including net cash provided by operating activities, its financial condition, capital commitments, debt repayment schedules and such other factors as the Board of Directors deems relevant.
CASH FLOWS
COMPARISON OF YEAR ENDED DECEMBER 31, 1996 TO YEAR ENDED DECEMBER 31, 1995. Net cash provided by operating activities increased $1.4 million, or 2.3%, to $63.2 million for the year ended December 31, 1996 as compared to $61.8 million for the year ended December 31, 1995. Net cash used in investing activities increased $9.0 million, or 15.4%, to $67.5 million for the year ended December 31, 1996, as compared to $58.5 million for the year ended December 31, 1995, primarily as a result of capital invested by the Company for real estate and development assets. Net cash used in financing activities decreased $4.8 million, or 54.6%, to $4.0 million for the year ended December 31, 1996, as compared to $8.8 million for the year ended December 31, 1995, primarily as a result of a decrease in net borrowings.
COMPARISON OF YEAR ENDED DECEMBER 31, 1995 TO YEAR ENDED DECEMBER 31, 1994. Net cash provided by operating activities increased $16.8 million, or 37.2% to $61.8 million for the year ended December 31, 1995, as compared to $45.0 million for the year ended December 31, 1994 primarily due to increased rental revenues. Net cash used in investing activities decreased $91.8 million, or 61.1% to $58.4 million for the year ended December 31, 1995 as compared to $150.2 million for the year ended December 31, 1994, primarily as a result of decreased expenditures for real estate and development assets. Net cash provided by financing activities decreased $122.5 million, or 107.8% to $8.8 million for the year ended December 31, 1995 as compared to $113.7 million for the year ended December 31, 1994, primarily due to the IPO proceeds in 1994.
FUNDS FROM OPERATIONS
The Company generally considers Funds From Operations ("FFO") a widely used and appropriate measure of performance for an equity REIT which provides a relevant basis for comparison among REITs. FFO as defined by NAREIT means income (loss) before minority interest (determined in accordance with GAAP), excluding gains (losses) from debt restructuring and sales of property, plus real estate related depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures. FFO is presented to assist investors in analyzing the performance of the Company. The Company's method of calculating FFO may be different from methods used by other REITs and, accordingly, may not be comparable to such other REITs. FFO (i) does not represent cash flows from operations as defined by GAAP, (ii) is not indicative of cash available to fund all cash flow needs and liquidity, including its ability to make distributions and (iii) should not be considered as an alternative to net income (determined in accordance with GAAP) for purposes of evaluating the Company's operating performance.
FFO for the year ended December 31, 1996, increased to $56.3 million compared to $50.0 million for the comparable period in 1995. FFO amounts were calculated in accordance with NAREIT's definition of FFO as follows:
- ---------------- (1) The definition of FFO does not permit the add-back of amortization of loan costs, including amortization relating to buydown fees and interest rate caps. The annual amortization related to these items is not a cash expense to the Company, although it reduces FFO. Potomac Mills and Gurnee Mills were refinanced in December 1996 under a fixed rate securitization. Accordingly, the related caps were sold and the amortization on such caps will not recur in 1997. The impact of these items on the Company's historical effective interest rate and other relevant information is detailed below (Sawgrass Mills has no interest rate hedging instruments) (dollars in thousands):
(1) On April 21, 1994 (IPO date), the Company paid $17.5 million to reduce the interest rate on this mortgage to 7.125% from 9.625% and to extend the maturity date. (2) On October 19, 1994, the Company paid $5.8 million for an interest rate cap. Through October 19, 1997, LIBOR is capped at 6.00%, provided LIBOR is below 8.00%. If LIBOR is greater than 8.00%, the LIBOR cap increases to 8.00%. From October 20, 1997 through October 19, 1999, LIBOR is capped at 8.00%. (3) On April 21, 1994 (IPO date), the Company paid $4.6 million for an interest rate cap. Through April 1, 1997, LIBOR is capped at 5.25%, provided LIBOR is below 7.25%. If LIBOR is 7.25% or above, the LIBOR cap increases to 6.25%.
ECONOMIC TRENDS
Because inflation has remained relatively low during the last three years, it has had little impact on the operation of the Mills Entities and the Company during that period. Even in periods of higher inflation, however, tenant leases provide, in part, a mechanism to help protect the Company. As operating costs increase, leases permit a pass-through of the common area maintenance and other operating costs, including real estate taxes and insurance, to the tenants. Furthermore, most of the leases contain base rent steps and percentage rent clauses that provide additional rent after a certain minimum sales level is achieved. These provisions provide some protection to the Company during highly inflationary periods.
SUMMARY OF OUTSTANDING INDEBTEDNESS
As of December 31, 1996, the Company had outstanding indebtedness in an aggregate amount of approximately $730.1 million (excluding its pro rata share of unconsolidated joint venture debt) as set forth below:
(1) This indebtedness is a 30 year amortizing loan with a balloon payment on or about December 18, 2003. The maturity date of the note is December 17, 2026. Principal repayments are based on the scheduled amortization, assuming a 7% mortgage loan interest rate, over a 30 year period ending on December 17, 2006, of the principal amount of the mortgage loan, with the monthly amortization payments being applied sequentially, beginning with Tranche A, to reduce the principal balances. (2) Optional payments of principal are not permitted prior to December 17, 1999. After such date, prepayments, in whole or in part, are permitted upon at least 15 days notice. In addition, the Company is required to pay a prepayment penalty equal to the greater of (i) 1% of the remaining principal balance or (ii) a yield preservation payment. Generally, yield preservation payments are intended to compensate the lender for the total amount of interest it would have earned on the indebtedness but for the repayment, less the amount of interest that the lender could earn if it invested the repayment amount in United States Treasury obligations or other similar securities from the date of repayment through the maturity date of the indebtedness. (3) Prepayable, in whole but not in part, at any time upon 30 days prior notice to the lender. If prepaid prior to September 1, 1998 (other than as the result of a casualty loss or condemnation), the Company is required to pay a prepayment penalty equal to the greater of (i) 1% of the principal balance or (ii) a yield preservation payment. (4) Prepayable, in whole or in part, at any time upon payment of a prepayment penalty of .05% of the outstanding principal amount. (5) Optional prepayments of principal on Tranche A of this indebtedness are not permitted prior to June 20, 2000 other than in connection with certain casualty or condemnation events occurring with respect to Sawgrass Mills. On and after such date, Tranche A may be prepaid in full, but not in part, without any prepayment penalty. Optional prepayments of Tranches B and C of the indebtedness may be made, in whole or in part, at any time without any prepayment penalty, but only if payments of interest are current with respect to each outstanding Tranche and an event of default is not then continuing. (6) The loan agreement provides for a cap on LIBOR at 14% for the life of the loan. LIBOR is capped at 14% for Tranches B and C. (7) Calculated using 30-day LIBOR at 5.75%, which was the rate at December 16, 1996. (8) Prepayable, in whole or in part, at any time without prepayment penalty. (9) Optional prepayments of principal are not permitted, in whole or in part, prior to December 31, 1996. Thereafter, this indebtedness may be prepaid, in whole or in part, upon 30 days notice to the lender and the payment of a prepayment penalty. The penalty percentage due on prepayment at any time during the first six months after December 1, 1996 is 3% of the outstanding principal amount. Thereafter, the penalty decreases by 0.5% per six month period to a minimum of 1.5%. During the last three months of its term, the indebtedness may be prepaid without penalty. (10) Prepayable, in whole or in part, at any time, upon 60 days prior notice to the lender. Only in the case of a partial prepayment is the Company required to pay a prepayment penalty which would equal the greater of (i) 1% of the principal balance or (ii) a yield preservation payment. (11) Prepayable, in whole or in part, at any time without prepayment penalty. (12) Primarily corporate debt with maturities under one year. Prepayable, in whole or in part, at any time without prepayment penalty.
ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the index to Financial Statements and Schedules in Item 14.
ITEM 9.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The directors and executive officers of the Company and their positions and offices are set forth in the following table:
Biographical summaries of the directors and executive officers of the Company are included under the caption "Board of Directors" and "Executive Officers," respectively, in the Company's proxy statement for the 1997 Annual Meeting of Shareholders and are incorporated herein by reference. Information required by Item 405 of Regulation S-K is included under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's proxy statement for the 1997 Annual Meeting of Shareholders and is incorporated herein by reference.
CERTAIN PROCEEDINGS
Four partnerships in which Herbert S. Miller was a general partner or owned an interest in the general partner defaulted on mortgage obligations during the three-year period ended December 31, 1992 and the partnerships lost the properties they owned as a result. In two of these default situations the lender filed a foreclosure action and the partnerships deeded the properties to the lender in full satisfaction of the indebtedness. In one such default situation where the lender filed a foreclosure action, the partnership filed a petition for reorganization under Chapter 11 of the federal bankruptcy laws after the partnership was unable to secure an extension of the loan term. The bankruptcy proceeding was dismissed when the partnership reached an agreement with the mortgage lender to deed the property to the mortgage lender in satisfaction of the indebtedness. With respect to the other two partnership defaults, the lender sought a foreclosure and a deficiency judgment against Mr. Miller and the other general partners. Mr. Miller paid his portion of these obligations in full in December 1993.
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION
Information with respect to executive compensation is incorporated herein by reference to the information under the captions "Compensation of Directors" and "Executive Compensation" in the Company's proxy statement for the 1997 Annual Meeting of Shareholders.
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information with respect to security ownership of certain beneficial owners and management of the Company is incorporated herein by reference to the information under the caption "Voting Securities and Principal Holders Thereof" in the Company's proxy statement for the 1997 Annual Meeting of Shareholders.
ITEM 13.

ITEM 13. CERTAIN TRANSACTIONS
Information with respect to certain relationships and transactions is incorporated herein by reference to the information under the caption "Certain Relationships and Transactions" in the Company's proxy statement for the 1997 Annual Meeting of Shareholders.
PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS AND FORM 8-K
14(a)(1) AND (2) FINANCIAL STATEMENTS AND SCHEDULES
THE MILLS CORPORATION AND THE MILLS ENTITIES Page ----
Report of Independent Auditors Consolidated Balance Sheets Consolidated and Combined Statements of Operations Consolidated and Combined Statements of Stockholders' Equity Consolidated and Combined Statements of Cash Flows Notes to Consolidated Financial Statements
FINANCIAL STATEMENT SCHEDULES
Schedule III - Schedule of Consolidated Real Estate and Accumulated Depreciation Notes to Schedule III
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions, are included in the consolidated financial statements or are inapplicable and therefore have been omitted.
14(a)(3) EXHIBITS
NUMBER EXHIBIT ------ -------
1.1 None
2.1 None *3.1 Amended and Restated Certificate of Incorporation of the Company.
**3.2 Amended and Restated Bylaws of the Company
**3.3 Limited Partnership Agreement of the Operating Partnership (filed as part of Exhibit 10.3)
*4.1 Specimen Common Stock Certificate of Company
*4.2 Agreement dated March 15, 1994, among Richard L. Kramer, the A.J. 1989 Trust, the Irrevocable Intervivos Trust for the Benefit of the Kramer Children, the N Street Investment Trust, Equity Resources Associates, Herbert S. Miller, The Mills Corporation and The Mills Limited Partnership (filed as Exhibit 10.19)
**4.3 Non-Affiliate Registration Rights and Lock-Up Agreement
**4.4 Affiliate Registration Rights and Lock-Up Agreement
NUMBER EXHIBIT ------ -------
*10.1 Form of Employee Non-Compete/Employment Agreements
*10.2 1994 Executive Equity Incentive Plan
**10.3 Limited Partnership Agreement of Operating Partnership
*10.4 Option Agreement (Sunrise Residual/Parcels 4 and 5)
*10.5 Form of Noncompetition Agreement between the Company, the Operating Partnership and each of Kan Am and the Kan Am Partnerships
*10.6 Form of Noncompetition Agreement with Kan Am Directors
*10.7 Trust and Servicing Agreement, dated as of December 1, 1993, among Sawgrass Finance L.L.C., as depositor, The First National Bank of Chicago, as servicer, and State Street Bank and Trust Company, as Trustee
*10.8 Amended and Restated Mortgage, Security Agreement, Assignment of Lessee and Rents and Fixture filing, dated as of December 1, 1993, by Sunrise Mills Limited Partnership, as mortgagor, in favor of Sawgrass Finance L.L.C., as mortgagee
*10.9 Assignment of Leases and Rents, dated as of December 1, 1993, between Sunrise Mills Limited Partnership and Sawgrass Finance L.L.C.
*10.10 Assignment of Note, Mortgage, and Assignment of Rents dated as of December 21, 1993, by Sawgrass Finance L.L.C. in favor of State Street Bank & Trust Co.
*10.11 Promissory Note, dated as of November 16, 1993, by Western Hills Associates Limited Partnership in favor of Connecticut General Life Insurance Company
*10.12 Assignment of Rents and Leases, dated as of November 16, 1993, by Western Hills Associates Limited Partnership in favor of Connecticut General Life Insurance Company
*10.13 Open-End Mortgage, Security Agreement and Fixture Filing, dated as of November 16, 1993, by Western Hills Associates Limited Partnership in favor of Connecticut General Life Insurance Company
*10.19 Agreement dated March 15, 1994 among Richard L. Kramer, the A.J. 1989 Trust, the Irrevocable Intervivos Trust for the Benefit of the Kramer Children, the N Street Investment Trust, Equity Resources Associates, Herbert S. Miller, The Mills Corporation and The Mills Limited Partnership
*10.20 Form of Promissory Note made payable by Franklin Mills Associates Limited Partnership to and for the benefit of the Operating Partnership
*10.21 Form of Mortgage, Security Agreement and Assignment of Rents and Leases by Franklin Mills Associates Limited Partnership to and for the benefit of the Operating Partnership
*10.22 Form of Sale of Partnership Interests Agreement (Franklin Mills) by and between the Operating Partnership and Herbert S. Miller, Laurence C. Siegel, Harry H. Nick, Western Franklin Mills Corp., Kan Am USA IX Limited Partnership and Kan Am USA X Limited Partnership
*10.23 Form of Indemnification Agreement between the Company and each of its Directors and Executive Officers
NUMBER EXHIBIT ------ -------
*****10.24 Construction Loan Agreement dated November 9, 1995, by and between Ontario Mills Limited Partnership and Canadian Imperial Bank of Commerce, Bayerische Hypotheken-Und Wechsel-Bank Aktiengesellschaft and The Mitsubishi Bank of Commerce
*****10.25 Construction Deed of Trust, Security Agreement, Assignment of Leases and Rents, Fixture Filing and Financing Statement dated as of December 26, 1995 in favor of Canadian Imperial Bank of Commerce, Bayerische Hypotheken-Und Wechsel-Bank Aktiengesellschaft and The Mitsubishi Bank of Commerce
*****10.26 Loan Agreement dated as of January 31, 1996 by and among Coopers Crossing Associates (MLP) Limited Partnership, Crosswinds Center Associates of St. Petersburg (MLP) Limited Partnership, Echo Hills Center Associates (MLP) Limited Partnership, Fashion Center Associates of Illinois No. 1 (MLP) Limited Partnership, Fashion Place Associates (MLP) Limited Partnership, Germantown Development Associates (MLP) Limited Partnership, Gwinnett Market Fair Associates (MLP) Limited Partnership, Montgomery Village Associates (MLP) Limited Partnership, Montgomery Village Ground (MLP) Limited Partnership, Mount Prospect Plaza (MLP) Limited Partnership (collectively, "The Mills Corporation, et. al."), and PFL Life Insurance Company
*****10.27 First Amended and Restated Promissory Note dated as of January 31, 1996, made by and among The Mills Corporation, et al., and PFL Life Insurance Company
*****10.28 Absolute Assignment of Mortgage and Loan Documents dated January 31, 1996 by and between CS First Boston Mortgage Capital Corp., as assignor, and PFL Life Insurance Company, as assignee
10.29-10.47 Intentionally Omitted
******10.48 Note dated July 30, 1996 by Sawgrass Mills Phase II Limited Partnership in favor of CS First Boston Mortgage Capital Corporation.
******10.49 Mortgage, Security Agreement, Assignment of Leases and Rents and Fixture Filing dated as of July 30, 1996, between Sawgrass Mills Phase II Limited Partnership, as Mortgagor, and CS First Boston Mortgage Capital Corporation, as Mortgagee.
****10.50 First Amendment to Trust and Servicing Agreement (Exhibit 10.7) dated as of June 1, 1995, among Sawgrass Finance L.L.C., as depositor, The First National Bank of Chicago, as servicer, and State Street Bank and Trust Company, as trustee.
****10.51 Prepayment Premium Agreement dated as of June 1, 1995, between The Mills Limited Partnership and State Street Bank and Trust Company, as trustee.
NUMBER EXHIBIT ------ -------
10.52 Second Amendment and Restated Deed of Trust, Security Agreement, Assignment of Rents and Fixture Filing by Potomac Mills-Phase III (MLP) Limited Partnership and Washington Outlet Mall (MLP) Limited Partnership, collectively, as Grantor to R. Eric Taylor, a resident of Fairfax County, Virginia as Deed Trustee for the benefit of CS First Boston Mortgage Capital Corp., as Beneficiary dated as of December 17, 1996.
10.53 Form of Assignment of Leases and Rents and Security Deposits dated as of December 17, 1996 by Potomac Mills- Phase III (MLP) Limited Partnership and Washington Outlet Mall (MLP) Limited Partnership to CS First Boston Mortgage Capital Corp.
10.54 Mortgage Security Agreement, Assignment of Rents and Fixture Filing by Gurnee Mills (MLP) Limited Partnership to CS First Boston Mortgage Capital Corp., as Mortgagee dated as of December 17, 1996
10.55 Form of Assignment of Leases and Rents and Security Deposits dated as of December 17, 1996 by Gurnee Mills (MLP) Limited Partnership to CS First Boston Mortgage Capital Corp. (See Exhibit 10.53)
10.56 Trust and Servicing Agreement dated as of December 17, 1996 among Potomac Gurnee Finance Corp., as Depositor, AMRESCO Management, Inc., as Servicer, ABN AMRO Bank NY, as Fiscal Agent and LaSalle National Bank as Trustee.
10.57 Credit Agreement dated as of October 28, 1996, among The Mills Corporation, The Mills Limited Partnership, Sawgrass Mills Phase II Limited Partnership, Sunrise Mills (MLP) Limited Partnership, and CS First Boston Mortgage Capital Corp.
10.58 General Pledge and Security Agreement, dated as of October 28, 1996 made by The Mills Limited Partnership, in favor of CS First Boston Mortgage Capital Corp.
10.59 Intercompany Pledge and Security Agreement dated as of October 28, 1996, made by The Mills Limited Partnership, The Mills Corporation, Sunrise Mills (MLP) Limited Partnership and Sawgrass Mills Phase II Limited Partnership in favor of CS First Boston Mortgage Capital Corp.
10.60 Assignment of Partnership Interest dated as of the 28th day of October, 1996 from The Mills Limited Partnership, to CS First Boston Mortgage Capital Corp.
10.61 Revolving Note dated as of October 28, 1996 from The Mills Limited Partnership to CS First Boston Mortgage Capital Corp. in the maximum amount of $40,000,000.
11 Statement Re: Computation of Per Share Earnings.
21.1 List of Subsidiaries of the Registrant
23 Consent of Independent Auditors
* Incorporated by reference to the Registrant's Registration Statement on Form S-11, Registration No. 33-71524, which was declared effective by Securities and Exchange Commission on April 14, 1994.
** Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the first quarter ended March 31, 1994.
*** Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.
**** Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the second quarter ended June 30, 1995.
***** Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1995
****** Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the third quarter ended September 30, 1996.
14(b) REPORTS ON FORM 8-K
The Company filed two reports on Form 8-K during the last quarter of the year ended December 31, 1996.
The Company's Current Report on Form 8-K dated November 21, 1996, announced the Company's plans to refinance the indebtedness on Potomac Mills and Gurnee Mills. The Company's Current Report on Form 8-K dated December 17, 1996 announced the closing of the refinancing of the Potomac Mills and Gurnee Mills indebtedness through a fixed rate securitization.
14(c) EXHIBITS
The list of exhibits filed with this report is set forth in response to item 14(a)(3). The required exhibit index has been filed with the exhibits.
14(d) FINANCIAL STATEMENTS
Schedule III - Schedule of Consolidated Real Estate and Accumulated Depreciation Notes to Schedule III.
REPORT OF INDEPENDENT AUDITORS
Board of Directors The Mills Corporation
We have audited the accompanying consolidated balance sheets of The Mills Corporation as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity and cash flows for the years ended December 31, 1996 and 1995 and for the period from April 22, 1994 to December 31, 1994. We have also audited the combined statements of operations, owners' deficit, and cash flows of the Mills Entities for the period from January 1, 1994 to April 21, 1994. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial state- ments and schedule are the responsibility of the management of The Mills Corporation. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing stan- dards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of The Mills Corpora- tion as of December 31, 1996 and 1995, and the consolidated results of its operations and its cash flows for the years ended December 31, 1996 and 1995 and for the period from April 22, 1994 to December 31, 1994, and the combined results of operations and cash flows of The Mills Entities for the period from January 1, 1994 to April 21, 1994, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
ERNST & YOUNG LLP
Washington, D.C. February 21, 1997
THE MILLS CORPORATION CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
See Accompanying Notes to Consolidated Financial Statements.
THE MILLS CORPORATION (THE COMPANY) AND THE MILLS ENTITIES (THE PREDECESSOR TO THE COMPANY)
CONSOLIDATED STATEMENTS OF OPERATIONS OF THE COMPANY AND THE COMBINED STATEMENTS OF OPERATIONS OF THE PREDECESSOR (IN THOUSANDS, EXCEPT PER SHARE DATA)
See Accompanying Notes to Consolidated Financial Statements.
THE MILLS CORPORATION (THE COMPANY) AND THE MILLS ENTITIES (THE PREDECESSOR TO THE COMPANY)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY OF THE COMPANY AND THE COMBINED STATEMENTS OF OWNERS' DEFICIT OF THE PREDECESSOR (IN THOUSANDS)
See Accompanying Notes to Consolidated Financial Statements.
THE MILLS CORPORATION (THE COMPANY) AND THE MILLS ENTITIES (THE PREDECESSOR TO THE COMPANY)
CONSOLIDATED STATEMENTS OF CASH FLOWS OF THE COMPANY AND THE COMBINED STATEMENTS OF CASH FLOWS OF THE PREDECESSOR (IN THOUSANDS)
See Accompany Notes to Consolidated Financial Statements.
THE MILLS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 (DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED)
1. ORGANIZATION AND BASIS OF PRESENTATION
ORGANIZATION
The Mills Corporation (the "Company") was incorporated in Virginia on January 2, 1991 and was reincorporated in Delaware in 1994. The Company elected to be taxed as a real estate investment trust ("REIT") under the Internal Revenue Code of 1986, as amended, commencing with its year ended December 31, 1994. In connection with its re-incorporation, the Company completed its initial public offering of 14,380,000 shares of its common stock (the "Common Stock") on April 21, 1994 (the "Offering"). The net proceeds of the Offering of approximately $310 million and other assets of the Company were contributed to The Mills Limited Partnership (the "Operating Partnership") in exchange for a 51.3% interest therein, including a 1% interest as the sole general partner. Kan Am U.S., Inc. and certain of its affiliates ("Kan Am"), owned directly or indirectly 41.1% of the partnership interests ("Units") in the Operating Partnership. Also in connection with the Offering, the Company was authorized to issue 20,000,000 shares of preferred stock, par value $.01 per share (the "Preferred Stock"). The Board of Directors of the Company may determine the preferences, rights and other terms of Preferred Stock to be issued. As of December 31, 1996, there were no shares of Preferred Stock outstanding. In January 1996, Kan Am was issued 274,777 additional Units in exchange for an approximately 6.25% interest in Franklin Mills Associates Limited Partnership. This transaction resulted in an increase in Kan Am's interest in the Operating Partnership to 41.6% and a decrease in the Company's interest to 50.9%. The Operating Partnership was formed prior to consummation of the Offering and is the successor to the operations of the Mills Entities (the "Predecessor").
Simultaneously with the Offering, the individual property partnerships comprising the Predecessor transferred their assets to the Operating Partnership in exchange for Units and/or the assumption of their debt. Such Units are exchangeable into Common Stock of the Company or cash (at the option of the Company, as the general partner of the Operating Partnership) equal to the fair market value of the number of shares of Common Stock into which such Units are exchangeable. As of December 31, 1996, the Company has reserved 16,331,306 shares of Common Stock for the exchange of such Units. The Operating Partnership also acquired certain investors' interests in the Mills Entities for cash and Units. Purchase accounting was applied to the acquisition of all investor interests for which cash consideration was paid. Contributed assets and liabilities related to interests of all Mills Entities which received only Units and/or the assumption of debt by the Operating Partnership have been accounted for as a reorganization of entities under common control, and, accordingly, have been recorded at the Predecessor's cost.
The net effect of the REIT formation adjustments and the REIT formation settle- ment adjustments included in the accompanying statement of stockholders' equity consists of distributions of assets or return of capital not intended for inclusion in the REIT, conversion of debt due promoters to equity, contributions of interest not previously included in the Mills Entities and the effects of applying purchase accounting for acquisition of certain investors' interests in the Mills Entities for cash and Units.
Disclosures made herein with respect to any period ended prior to April 22, 1994, are to be read as disclosures of Predecessor. All disclosures made in reference to periods subsequent to April 21, 1994, are disclosures of the Company.
The Company, which conducts all of its business through the Operating Partnership, is engaged primarily in the ownership, development, redevelopment, leasing, and management of super-regional, value and entertainment-oriented outlet malls (the "Mills") and community shopping centers (the "Community Centers"). As of December 31, 1996, the Operating Partnership owns or holds an interest in the following operating properties:
THE MILLS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 (DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED)
PROPERTY NAME LOCATION ------------- -------- Franklin Mills Philadelphia, PA Gurnee Mills Gurnee, IL (Chicago) Potomac Mills Woodbridge, VA (Washington, DC) Sawgrass Mills Sunrise, FL (Ft. Lauderdale) Ontario Mills Ontario, CA (Los Angeles)
COMMUNITY CENTERS ----------------- Butterfield Plaza Downers Grove, IL Coopers Crossing Voorhees, NJ Crosswinds Center St. Petersburg, FL Fashion Place Columbia, SC Germantown Commons Germantown, MD Gwinnett Marketfair Duluth, GA Liberty Plaza Philadelphia, PA Montgomery Village Gaithersburg, MD Mount Prospect Plaza Mount Prospect, IL West Falls Church Outlet Center Falls Church, VA Western Hills Plaza Cincinnati, OH
In addition to the operating properties, the Company is actively involved in the development of a number of new Mills and sale of certain outparcels of land.
BASIS OF PRESENTATION
The accompanying consolidated financial statements of the Company include the accounts of the Company and its subsidiaries, including its majority owned subsidiary, the Operating Partnership. The accounts of the Operating Partnership include the accounts of all Properties which are wholly-owned or controlled by the Operating Partnership, as well as its wholly-owned subsidiaries Mills Management LLC ("Mills Management") and Management Associates Limited Partnership ("MALP"). In addition, the Operating Partnership owns 5% of the voting common stock and 99% of the preferred stock of the Mills Services Corporation ("MSC"), an entity formed in connection with the Offering to provide development, management, leasing and financing services to the Company and other entities owned by affiliates of the Company. As a result of the Operating Partnership's ownership of 99% of the economic interests, MSC is consolidated with the Operating Partnership. The Company's investments in the partnerships that own Ontario Mills, Ontario Mills Residual, Grapevine Mills, Grapevine Mills Residual, Arizona Mills, Columbus Mills and Mills City, which represent non-controlling ownership interests, are accounted for using the equity method of accounting (see Note 4).
All significant intercompany transactions and balances have been eliminated in consolidation. Minority interests represent the ownership interests in the Operating Partnership not held by the Company.
The financial statements for the period January 1, 1994 to April 21, 1994, reflect the results of operations of the Predecessor. Such financial statements have been presented on a combined basis because the properties were under common ownership and control and because the entities were the subject of the business combination described above. All significant intercompany transactions and accounts have been eliminated.
THE MILLS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 (DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
INCOME PRODUCING PROPERTY
Income producing property is stated at cost. The Company adopted SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" in 1995 whereby impairment losses will be recorded if events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by the assets are less than their carrying amount. The adoption of SFAS No. 121 had no material effect on the financial statements. Income producing property includes all costs related to acquisi- tion, development, leasing and construction, including tenant improvements, interest incurred during construction and certain direct and indirect costs of the development department. Maintenance and repairs are charged to expense as incurred. Depreciation expense is computed using the straight-line method over the estimated useful lives of the assets, as follows:
Buildings and improvements 40 years Land improvements 20 years Furniture, fixtures and equipment 7 years
Total interest expense capitalized to real estate and development assets was $7,171, $6,046 and $1,219 for the years ended December 31, 1996, 1995 and 1994, respectively.
INCOME RECOGNITION
The Company, as lessor, has retained substantially all the risks and benefits of ownership and accounts for its leases as operating leases. Minimum rent from income producing property are recognized on a straight-line basis over the terms of the respective leases. Percentage rents are recognized on an accrual basis. Recoveries from tenants for real estate taxes and other operating expenses are recognized as revenue in the period the applicable costs are incurred.
Management, leasing and development fees relating to entities not controlled by the Company are recognized as revenue as they are earned.
DEFERRED COSTS
Deferred costs consist of loan fees and related expenses which are amortized on a straight-line basis that approximates the interest method over the terms of the related notes and leasing charges, including tenant construction allowances and direct salaries and other costs incurred by the Company to obtain a lease, which are amortized over the terms of the related leases.
Total accumulated amortization of deferred costs was $57,608 and $70,740 at December 31, 1996 and 1995, respectively.
In connection with the 1996 refinancing of debt described in Note 5, unamortized deferred financing costs of $6,829 and a prepayment penalty of $600 net of the proceeds from the sale of interest rate cap agreements of $557 and the reversal of accruals for straight-line interest expense of $1,571 were written off and are included as extraordinary items for 1996. Deferred financing costs of $419 associated with a line of credit that was paid in full during 1995 were written off and included as an extraordinary item for 1995. In connection with the Offering, deferred financing costs aggregating $3,118, associated with debt that was retired or paid down with the proceeds of the Offering, as well as
THE MILLS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 (DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED)
prepayment penalties of $235 and payments of $2,061 to terminate interest rate swap agreements, were written off and are included as an extraordinary item in the accompanying statement of operations for the period from April 22, 1994 to December 31, 1994.
CASH AND CASH EQUIVALENTS
All highly liquid investments with an original maturity of three months or less are considered to be cash equivalents.
RESTRICTED CASH
Restricted cash primarily consists of funds invested in cash collateral ac- counts. The purpose of the cash collateral accounts is to hold proceeds from certain transactions and to fund maintenance reserves, interest, taxes and payments on debt. The cash collateral accounts are controlled by the lenders.
INCOME TAXES
Federal income taxes are not provided for because the Company believes it qualifies as a REIT under the provisions of the Internal Revenue Code ("IRC") and will distribute in excess of its taxable income to its shareholders. As a REIT, the Company is required to distribute at least 95% of its taxable income to shareholders and to meet certain other requirements. The differences between net income available to common shareholders for financial reporting purposes and taxable income before dividend deductions relate primarily to temporary differences, principally real estate depreciation.
MSC, the Company's consolidated (for GAAP purposes) IRC subchapter C corporate subsidiary, is subject to federal income taxes at the prevailing tax rates. However, MSC has no current provision for federal taxes due to its federal net operating loss carry forwards of approximately $15 million and $9.2 million at December 31, 1996 and 1995, respectively.
No provision for income taxes has been made in the financial statements of the Predecessor because the entities included in the combined financial statements were not subject to tax.
INTEREST RATE RISK MANAGEMENT
Prior to the refinancing of the Gurnee Mills and Potomac Mills debt in December 1996 (see Note 5), the Company used interest rate cap agreements to reduce the potential impact of increases in interest rates relating to the floating rate portion of certain of its borrowings. In addition, in connection with the Offering, the Company purchased an interest rate buy-down from the lender on one of its Mills properties. These costs are deferred and amortized on a straight- line basis that approximates the interest method over the terms of the related notes. Upon the refinancing of the Gurnee Mills and Potomac Mills debt, the interest rate caps were sold and the excess of the net unamortized costs were expensed and included in the extraordinary loss on debt extinguishment (see "Deferred Costs"). Unamortized costs related to these agreements aggregated approximately $7,219 and $17,434 at December 31, 1996 and 1995, respectively, and are included in deferred costs.
NET INCOME PER SHARE
Net income per share for the years ended December 31, 1996 and December 31, 1995, and for the period April 22, 1994 to December 31, 1994, is based on the weighted average number of common shares and common equivalent shares outstanding during such period (17,009,000 at December 31, 1996, and 16,906,000 at December 31, 1995
THE MILLS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 (DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED)
and prior). Units in the Operating Partnership (16,331,000 and 16,058,000 outstanding at December 31, 1996 and 1995, respectively) may be exchanged for shares of common stock of the Company on a one-for-one basis in certain circumstances (See Note 1). This exchange right has not been consid- ered in the computation of per share data as it does not have a dilutive effect.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
RECLASSIFICATIONS
Certain previously reported amounts have been reclassified to conform with the current year presentation.
3. NOTES RECEIVABLE
Notes receivable include $7,080 and $7,239 at December 31, 1996 and 1995, respectively, relating to a reimbursement and annexation agreement with the Village of Gurnee ("Village") to reimburse the owner of Gurnee Mills for the cost of certain public improvements. The Village has executed a non-interest bearing note for $15,000 to be paid from taxes collected from tenants of Gurnee Mills during a ten-year period beginning one year after Gurnee Mills opened in August 1991. In 1996, the note was amended to $17,500 to be paid over a thirteen year period. The note was recorded in 1991 at its net present value, based on the estimated taxes to be collected by the Village using a discount rate of 10%. Interest income accreted was approximately $700, $700 and $715 for the years ended December 31, 1996, 1995 and 1994, respectively. For the years ended December 31, 1996, 1995 and 1994, collections from the Village totaled $908, $880 and $808, respectively.
4. INVESTMENT IN UNCONSOLIDATED JOINT VENTURES
Certain Mills and Mills under development are partially owned through joint ventures ("Joint Ventures"). The Company is also a general partner of these Joint Ventures. The Company's interest in each Joint Venture is as follows:
Ownership % Joint Venture as of 12/31/96 ------------- -------------- Ontario Mills 50.0% Grapevine Mills 37.5% Arizona Mills 35.0% Columbus Mills 75.0% Mills City at Orange 50.0%
The Company does not control these Joint Ventures as major business decisions require the approval of at least one other general partner. As a result, its investments are accounted for under the equity method, where the investments are recorded at cost and subsequently adjusted for net equity in income (loss) and cash contributions and distributions. The Company eliminates intercompany profits on sales of services that are capitalized by the Joint Ventures.
THE MILLS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 (DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED)
In connection with the Joint Venture agreements, the Company is committed to providing certain levels of equity in addition to the amounts invested to date. The Company has guaranteed repayment of $84.7 million of the Joint Venture debt until certain debt service coverage tests are met. In addition, the Company is contingently liable for property taxes and assessments levied against Ontario Mills Limited Partnership by the City of Ontario Special Assessment District. The aggregate amount of the special tax assessment is approximately $26,000 and will be collected over a 25 year period to fund debt service on bonds issued by the City to fund the infrastructure improvements.
Combined balance sheet and results of operations information is presented below for all Joint Ventures at December 31, 1996 and for the year then ended:
December 31, 1996 ----------------- Assets: Income producing assets $124,208 Construction in progress 108,854 Other 65,938 --------
$299,000 -------- -------- Liabilities and partners' equity: Debt $ 99,021 Other liabilities 50,902 Operating Partnership's accumulated equity 41,959 Joint Venture partners' accumulated equity 107,118 --------
$299,000 -------- --------
Year Ended December 31, 1996 ----------------- Revenues $ 3,720 Recoverable and other property expenses (1,085) Interest expense (523) Depreciation and amortization (1,268) Other 5,489 -------- Net Income $ 6,333 -------- --------
Equity in earnings of unconsolidated joint ventures $ 2,661 -------- --------
The primary difference between the carrying value of the Company's investment in unconsolidated joint ventures and the Operating Partnership's accumulated equity noted above is due to capitalized interest on the investment balance, capitalized development and leasing costs which are recovered by the Operating Partnership through fees during construction and loans to the Joint Ventures included in other liabilities above.
THE MILLS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 (DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED)
5. BORROWINGS
Deed of Trusts, notes, and loans payable, which are secured by the Company's income producing properties, consist of the following at December 31, 1996 and 1995:
THE MILLS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 (DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED)
Pursuant to an interest rate cap protection agreement, the LIBOR rate on the Potomac Mills securitized bonds was capped through October 1997 at 6% if LIBOR was less than 8% and was capped at 8% if LIBOR was greater than 8%; from October 1997 through October 1999, LIBOR is capped at 8%. This cap was sold in December 1996 in conjunction with the refinancing of Potomac Mills (see Note 2).
The additional interest due on the Gurnee Mills mortgage loan was being accrued on a straight-line basis over the life of the loan. The Company also had an interest rate cap agreement relating to this debt whereby the Company received a spread payment from the swap counterparty to the extent that LIBOR exceeded 5.25%, provided LIBOR was below 7.25%. If LIBOR rose above 7.25%, then the spread payment would be limited to the extent LIBOR exceeded 6.25%. This cap was sold in December 1996 in conjunction with the refinancing of Gurnee Mills (see Note 2).
The weighted average interest rate at December 31, 1996 and 1995, was 7.05%. Of the Company's approximately $730.1 million of consolidated debt, $657.9 million was fixed rate at December 31, 1996.
As of December 31, 1996, debt of the Joint Ventures aggregating $84.7 million has been guaranteed by the Company.
In January 1992, in conjunction with improvements to one of the Mills, a Mills Entity obtained from a bank a 10 year letter of credit in the amount of $30,249 which serves as a credit enhancement for bonds sold by a municipality to the public. Proceeds from the bonds were used to reimburse the Mills Entity for the costs of public works which amounted to approximately $21,000. This reimburse- ment was recorded as a reduction of the costs previously capitalized to the income producing property. The bonds are payable from ad valorem taxes levied by the municipality against the assessed value of the real property owned by the Partnership and real property owned by outside parties. Funds can be drawn on the letter of credit for the purpose of repaying principal and interest on the bonds.
The aggregate maturities of the Company's borrowings at December 31, 1996 is as follows:
1997 $ 18,124 1998 204,881 1999 21,096 2000 10,697 2001 207,123 Thereafter 268,192 -------- $730,113 -------- --------
For the period from January 1, 1994 to April 21, 1994, debt obligations totaling $329 were forgiven through negotiations with certain creditors. The gain on extinguishment of debt, offset by prepayment penalties of $283 from early payment of mortgage indebtedness, is classified as an extraordinary item in the combined statements of operations.
6. LEASING ACTIVITIES
The Company has noncancellable leases with tenants with remaining terms ranging from one to 25 years and requiring monthly payments of specified minimum rents. A majority of the leases require reimbursement by the tenant of substantially all operating expenses of the properties. In addition, many of the leases provide for additional rental payments based on gross revenues of the tenant in excess of specified amounts. Future minimum rental commitments to be received under noncancellable leases for the Mills (excluding Ontario Mills) and the Community Centers are as follows:
THE MILLS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 (DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED)
Year ending December 31 ----------------------- 1997 $ 84,499 1998 77,214 1999 68,667 2000 59,529 2001 41,684 Thereafter 136,055 -------- $467,648 -------- --------
The Company has a noncancellable operating lease for its corporate headquarters in Arlington, Virginia. The lease commenced April 1, 1996 for a term of ten years. Minimum rental payments under this lease subsequent to December 31, 1996, are as follows:
Year ending December 31 ----------------------- 1997 $ 1,100 1998 1,288 1999 1,320 2000 1,353 2001 1,480 Thereafter 6,301 ------- $12,842 ------- -------
7. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosures of estimated fair value were determined by management, using available market information and appropriate valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimat- ed fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize on disposition of the financial instruments. The use of different market assumptions and/or estima- tion methodologies could have a material effect on the estimated fair value amounts.
Cash equivalents, rents receivable, accounts payable and accrued expenses and other liabilities are carried at amounts which reasonably approximate their fair values.
Fixed rate debt with an aggregate carrying value of $657,874 has an estimated aggregate fair value of $663,000 at December 31, 1996. Estimated fair value of fixed rate debt is based on interest rates currently available to the Company for issuance of debt with similar terms and remaining maturities. The estimated fair value of the Company's variable rate debt is estimated to be approximately equal to its carrying value of $ 72,239 at December 31, 1996.
Disclosure about fair value of financial instruments is based on pertinent information available to management at December 31, 1996. Although management is not aware of any factors that would significantly affect the reasonable fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since December 31, 1996, and current estimates of fair value may differ significantly from the amounts presented herein.
THE MILLS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 (DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED)
8. EMPLOYEE BENEFIT PLANS
The Company has a 401(k) defined contribution benefit plan that covers all employees who are age 21 or older and have at least one year of service. Contributions made by employees electing to participate in the plan under salary reduction agreements are recorded when paid into the plan, or alternatively, accrued if unpaid. Employer contributions are accrued and paid into the plan periodically. Employer contributions were $282, $297, and $272 in 1996, 1995 and 1994, respectively.
9. STOCK OPTION PLAN
In connection with the Offering, the Board of Directors approved the 1994 Executive Equity Incentive Plan (which plan, as amended in September 1996, is referred to herein as the "Plan") for the purpose of attracting and retaining directors, executive officers and other key personnel for the Company, the Operating Partnership and their subsidiaries. Pursuant to the Plan, 2,500,000 shares of common stock have been reserved for issuance of stock options at a price not less than 100% of fair market value at the date of grant and restricted stock. The options expire 10 years from the date of grant and will contain such other terms and conditions (including, without limitation, conditions to vesting) as may be determined by the Company's Executive Compensation Committee.
A summary of the Company's stock option activity, and related information for the years ended December 31 follows:
The range of excercise prices of options outstanding at December 31,1996 was $17.27 to $23.50. The weighted average remaining contractual life of options outstanding at December 31, 1996 was 8.62 years.
The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related Interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under FASB Statement No. 123, "Accounting for Stock-Based Compensation," requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. In 1996, the Company adopted pursuant to the Plan, its 1996 Long-Term Incentive Plan which granted restricted stock and certain options to the Company's executive officers and provided that such options would vest in 20% increments over a five-year period. Generally, other options granted under the Plan vest 50% and 100% on the third and fourth anniversaries, respectively, of the date of grant.
THE MILLS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 (DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED)
Pro forma information regarding net income and earnings per share is required by Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensations" which also requires that the information be determined as if the Company has accounted for its employee stock options granted subsequent to December 31, 1994 under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1995 and 1996, respectively: risk-free interest of 6.07% and 6.25%; expected life of the option of 4.16 years and 4.83 years; a dividend yield of 7.92%; and volatility factors of the expected market price of the Company's common stock of .138.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly differ- ent from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows (in thousands except for earnings per share informa- tion):
1996 1995 ---- ----
Pro forma income before minority interest $15,937 $14,818 Pro forma net income per common and common equivalent share .48 .45
Because Statement of Financial Accounting Standards No. 123 is applicable only to options granted subsequent to December 31, 1994, its pro forma effect will not be fully reflected until later years.
10. LEGAL MATTERS
Mr. Richard Kramer ("Kramer") and certain of his affiliates, the AJ 1989 Trust ("A.J.") and Portals Development Associates Limited Partnership ("PDA"), filed an action on April 27, 1994, in New York state courts against the Operating Partnership, Herbert S. Miller ("Miller"), Kenwood Plaza Limited Partnership ("Kenwood") and Ernst & Young LLP for various alleged breaches of contract, breaches of fiduciary duties, fraudulent acts, and other violations of law relating primarily to the management and subsequent acquisition of the Proper- ties acquired in the IPO in which Kramer and his affiliates owned an interest. The complaint sought damages from the Operating Partnership in excess of $4.5 million, trebled under a RICO claim. That complaint also sought a declaratory judgment that A.J. is entitled to retain $2.9 million sent to it by mistake upon the closing of the IPO as on offset against its claimed damages, and a declara- tory judgment, specific performance and damages against Miller relating to his failure to sign certain guarantee affirmations and debt modifications in regard to PDA.
On May 10, 1994, the defendants removed this case from the New York state courts to the United States District Court for the Southern District of New York and the plaintiffs agreed to dismiss the claims against Ernst & Young LLP. Thereaf- ter, the court granted the defendant's motion to dismiss certain of the com- plaint's claims and gave plaintiffs leave to replead. When the plaintiffs served their amended complaint, they added the Company as a defendant. In late February 1996, the plaintiffs moved to amend the amended complaint to delete the RICO claim without prejudice and to remand other claims to the state court for adjudication. Defendants crossmoved for summary judgment (a) on their counter- claim seeking the return of the $2.9 million mistakenly transferred to A.J. and (b) dismissing the remaining claims against the Company and the Operating Partnership. In addition, the
THE MILLS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 (DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED)
defendants are asserting that the RICO claim should be dismissed only on a with- prejudice basis. These motions are still pending. Pending the outcome of the litigation, the Company is withholding partnership distributions that would otherwise be payable to A.J. from Kenwood as an offset against the $2.9 million mistakenly transferred to A.J. A.J. has filed an additional claim seeking payment of those distributions. The Company, the Operating Partnership and Mr. Miller intend to vigorously defend against whatever claims remain. At this stage of the proceeding, the Company believes that it is unlikely that the ultimate outcome of the pending proceeding would have a material adverse effect on the Company's financial condition or results of operations.
On June 15, 1994, ICSC Partners Limited Partnership filed in the Court of Common Pleas, Hamilton County, Ohio a derivative action on behalf of Kenwood Plaza Limited Partnership ("Kenwood") against Mr. Miller, Western Development ("WDC") and the Company seeking the return to Kenwood of $6.3 million paid by Kenwood to Mr. Miller, WDC and the Company, plus $5 million in punitive damages. The plaintiff subsequently filed an amended complaint which included a RICO claim that, if proven, would entitle the plaintiff to recover treble damages and attorney's fees in addition to compensatory and punitive damages. The defen- dants filed counterclaims against the plaintiff seeking $5.0 million in compen- satory damages and $10.0 million in punitive damages.
In 1995, the parties to the lawsuit reached a settlement that resulted in no financial liability for the Company and no admission of liability by the Company. The settlement was submitted to the court for approval and sent to the non-party limited partners. A.J, a non-party limited partner, objected to the settlement, and, on October 13, 1995, the court entered an order and judgment overruling the objection and approving the settlement. A.J. appealed the order to the Court of Appeals of Arlington County, Ohio, which affirmed the trial court's approval of the settlement. A.J. has filed a motion asking the Supreme Court of Ohio to accept jurisdiction in this case. This motion is pending. The Company believes that it is unlikely that the ultimate outcome of the pending proceeding would have a material adverse effect on the Company's financial condition or results of operations.
On November 9, 1994, Gene E. Hess, a former officer of the Company whose employment was terminated after the IPO, filed a complaint in the United States District Court for the District of Columbia a complaint against the Company for fraud, breach of employment contract, and breach of covenant of good faith and fair dealing and against Mr. Miller for fraud and tortious interference with contractual relations. In January, 1997, without admitting liability, the defendants agreed to settle the lawsuit in exchange for the issuance of an additional 13,650 shares of Common Stock of the Company.
The Company is involved in other litigation incident to the operations of its income producing properties, the outcome of which is not expected to have a material effect on the consolidated financial position or results of operations of the Company.
11. TRANSACTIONS WITH AFFILIATES
MSC provides management, leasing, commissioned land sales, and related services to entities owned by partners of the Operating Partnership. Such services were provided by the Predecessor until April 21, 1994. Fees earned for the years ended December 31, 1996, 1995, and 1994, were $1,166, $1,588 and $1,748, respectively.
In addition, MSC provides development and leasing services for a Joint Venture. Fees earned during 1996 and 1995, net of amounts eliminated, were $2,473 and $2,546, respectively.
12. SUBSEQUENT EVENTS
On February 21, 1997, the Company filed a Prospectus and Preliminary Prospectus Supplement to issue 4,500,000 shares of Common Stock pursuant to a universal shelf registration statement on Form S-3 filed in October 1996.
THE MILLS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 (DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED)
13. PRO FORMA INFORMATION (UNAUDITED)
The following unaudited pro forma Condensed Consolidated Statement of Operations for 1994 is presented as if the consummation of the Offering and the other Formation Transactions had occurred on January 1, 1994. This statement should be read in conjunction with the financial statements and notes of the Company and the Predecessor included in this Form 10-K. In management's opinion, all adjustments necessary to reflect the effects of these transactions have been made.
This unaudited pro forma Condensed Consolidated Statement of Operations does not purport to represent what the actual results of operations of the Company would have been assuming such transactions had been completed as set forth above, nor do they purport to represent the results of operations for future periods.
----
Rental revenues $137,921 Property operating costs (44,478) Interest (38,660) Other (42,575) -------- Income before minority interests 12,208 Income allocated to minority interests 5,945 -------- Income before extraordinary items $ 6,263 -------- -------- Income before extraordinary items, per share $ .37 -------- --------
Pro forma adjustments to the statements of operations consist principally of recognizing the effects of debt repayments and refinancing at lower rates, the inclusion of third party investors' interests acquired, additional general and administrative expenses of the Company and the exclusion of non recurring charges.
14. UNAUDITED QUARTERLY RESULTS OF OPERATIONS
The following is a summary of results of operations for each of the fiscal quarters during 1996:
THE MILLS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 (DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED)
The following is a summary of results of operations for each of the fiscal quarters during 1995
THE MILLS CORPORATION
SCHEDULE III
CONSOLIDATED REAL ESTATE AND ACCUMULATED DEPRECIATION (IN THOUSANDS) DECEMBER 31, 1996
THE MILLS CORPORATION NOTES TO SCHEDULE III DECEMBER 31, 1996 (IN THOUSANDS)
(1) The Mills Corporation, through the Operating Partnership, owns super- regional, value and entertainment-oriented malls ("Mills") and community shopping centers ("Community Centers"). The geographic location of the Mills and Community Centers are as follows:
PROPERTY NAME LOCATION ------------- --------
MILLS: Franklin Mills. . . . . . . . . . . . . . . . . . . . . . Philadelphia, PA Franklin Mills - Residual . . . . . . . . . . . . . . . . Philadelphia, PA Gurnee Mills. . . . . . . . . . . . . . . . . . . . . . . . . . Gurnee, IL Hunt Club . . . . . . . . . . . . . . . . . . . . . . . . . . . Gurnee, IL Potomac Mills . . . . . . . . . . . . . . . . . . . . . . . Woodbridge, VA Sawgrass Mills. . . . . . . . . . . . . . . . . . . . . . . . .Sunrise, FL Sawgrass Mills - Phase II . . . . . . . . . . . . . . . . . . .Sunrise, FL
COMMUNITY CENTERS: Butterfield Plaza . . . . . . . . . . . . . . . . . . . .Downers Grove, IL Coopers Crossing. . . . . . . . . . . . . . . . . . . . . . . Voorhees, NJ Crosswinds Center . . . . . . . . . . . . . . . . . . . St. Petersburg, FL Fashion Place . . . . . . . . . . . . . . . . . . . . . . . . Columbia, SC Germantown Commons. . . . . . . . . . . . . . . . . . . . . Germantown, MD Gwinnett Marketfair . . . . . . . . . . . . . . . . . . . . . . Duluth, GA Liberty Plaza . . . . . . . . . . . . . . . . . . . . . . Philadelphia, PA Montgomery Village. . . . . . . . . . . . . . . . . . . . Gaithersburg, MD Mount Prospect Plaza. . . . . . . . . . . . . . . . . . Mount Prospect, IL West Falls Church Outlet Center . . . . . . . . . . . . . Falls Church, VA Western Hills Plaza . . . . . . . . . . . . . . . . . . . . Cincinnati, OH
(2) See description of mortgage, notes and loans payable in Note 5 of the Notes to Combined Financial Statements. The debt shown in regard to Hunt Club is unsecured. Certain corporate debt does not encumber real estate and is excluded.
(3) Initial cost of properties is cost at the end of the calendar year for the year of acquisition.
(4) The aggregate cost of land, land held for sale, buildings, improvements, equipment, and tenant improvement for federal income tax basis is $877,953 at December 31, 1996.
THE MILLS CORPORATION NOTES TO SCHEDULE III DECEMBER 31, 1996 (IN THOUSANDS)
(5) Reconciliation of Real Estate and Development Assets, excluding Investment in Partnerships
1996 1995 1994 ---- ---- ----
Balance at January 1. . . . . $880,150 $855,049 $760,757 Acquisitions. . . . . . . . . 23,177 58,541 85,751 Retirements . . . . . . . . . (1,618) (3,778) (5,430) Other . . . . . . . . . . . . (20,776) (29,662) 13,971 -------- -------- -------- Balance at December 31. . . . $880,933 $880,150 $855,049 -------- -------- -------- -------- -------- --------
(6) Reconciliation of Accumulated Depreciation
1996 1995 1994 ---- ---- ----
Balance at January 1. . . . . $152,713 $126,072 $102,557 Additions charged to costs and expenses. . . . . . . . 27,724 27,180 23,515 Removal of accumulated depreciation. . . . . . . . (779) (539) - -------- -------- --------
Balance at December 31. . . . $179,658 $152,713 $126,072 -------- -------- -------- -------- -------- --------
(7) In 1991, the city of Sunrise, Florida issued municipal bonds in the amount of $24,730 and reimbursed a Partnership for costs of public works which amounted to approximately $21,000. Costs previously capitalized to income producing property were reduced upon reimbursement.
In 1991, a note receivable of $5,925 was recorded pursuant to reimbursement and annexation agreements with the Village of Gurnee to reimburse the Partnership that owns Gurnee Mills for the cost of certain public improve- ments. The Village of Gurnee has executed a noninterest bearing note for $15,000, amended to $17,500 in 1996, to be paid from taxes collected from the tenants of the shopping mall during a ten-year period, amended to a thirteen year period in 1996, beginning one year after the mall opens. The note was recorded in 1991, based on the estimated taxes to be collected by the Village of Gurnee from the tenants using a discount rate of 10%.
(8) Depreciation is computed based upon the following estimated lives:
Building and improvements. . . . . . . . . . . . . . . . 40 years Land improvements. . . . . . . . . . . . . . . . . . . . 20 years Equipment. . . . . . . . . . . . . . . . . . . . . . . . .7 years Tenant improvements. . . Lesser of life of asset or life of lease
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 12, 1997.
THE MILLS CORPORATION, a Delaware corporation
By: /s/ Laurence C. Siegel _____________________________ Laurence C. Siegel Chairman of the Board of Directors, Chief Executive Officer and Director
Pursuant to the requirements of the Securities Act, this Registration Statement has been signed by the following persons in the capacities indicated below on March 11, 1997:
Name Title - ---- -----
/s/ Laurence C. Siegel ___________________________ Chairman of the Board, Chief Executive Officer Laurence C. Siegel and Director (principal executive officer)
/s/ Peter B. McMillan ___________________________ President, Chief Operating Officer and Director Peter B. McMillan
/s/ Kenneth R. Parent ___________________________ Senior Vice President and Chief Financial Officer Kenneth R. Parent (principal financial officer and principal accounting officer)
/s/ Dietrich von Boetticher ___________________________ Vice Chairman and Director Dietrich von Boetticher
/s/ John M. Ingram ___________________________ Vice Chairman and Director John M. Ingram
/s/ Charles R. Black, Jr. ___________________________ Director Charles R. Black, Jr.
/s/ James C. Braithwaite ___________________________ Director James C. Braithwaite
___________________________ Director Harry H. Nick
/s/ Joseph B. Gildenhorn ___________________________ Director Joseph B. Gildenhorn
___________________________ Director Peter A. Gordon
___________________________ Director Herbert S. Miller
/s/ Franz von Perfall ___________________________ Director Franz von Perfall
___________________________ Director Robert P. Pincus
THE MILLS CORPORATION EXHIBIT INDEX
(Pursuant to item 601 of Regulation S-K)
SEQUENTIALLY NUMBER EXHIBIT NUMBERED PAGE ------ ------- -------------
1.1 None
2.1 None
*3.1 Amended and Restated Certificate of Incorporation of the Company.
**3.2 Amended and Restated Bylaws of the Company
**3.3 Limited Partnership Agreement of the Operating Partnership (filed as part of Exhibit 10.3)
*4.1 Specimen Common Stock Certificate of Company
*4.2 Agreement dated March 15, 1994, among Richard L. Kramer, the A.J. 1989 Trust, the Irrevocable Intervivos Trust for the Benefit of the Kramer Children, the N Street Investment Trust, Equity Resources Associates, Herbert S. Miler, The Mills Corporation and The Mills Limited Partnership (filed as Exhibit 10.19)
**4.3 Non-Affiliate Registration Rights and Lock-Up Agreement
**4.4 Affiliate Registration Rights and Lock-Up Agreement
*10.1 Form of Employee Non-Compete/Employment Agreements
*10.2 1994 Executive Equity Incentive Plan
**10.3 Limited Partnership Agreement of Operating Partnership
*10.4 Option Agreement (Sunrise Residuals/Parcels 4 and 5)
*10.5 Form of Noncompetition Agreement between the Company, the Operating Partnership and each of Kan Am and the Kan Am Partnerships
*10.6 Form of Noncompetition Agreement with Kan Am Directors
*10.7 Trust and Servicing Agreement, dated as of December 1, 1993, among Sawgrass Finance L.L.C., as depositor, The First National Bank of Chicago, as servicer, and State Street Bank and Trust Company, as Trustee
*10.8 Amended and Restated Mortgage, Security Agreement, Assignment of Lessee and Rents and Fixture filing, dated as of December 1, 1993, by Sunrise Mills Limited Partnership, as mortgagor, in favor of Sawgrass Finance L.L.C., as mortgagee
*10.9 Assignment of Leases and Rents, dated as of December 1, 1993, between Sunrise Mills Limited Partnership and Sawgrass Finance L.L.C.
*10.10 Assignment of Note, Mortgage, and Assignment of Rents dated as of December 21, 1993, by Sawgrass Finance L.L.C. in favor of State Street Bank & Trust Co.
SEQUENTIALLY NUMBER EXHIBIT NUMBERED PAGE ------ ------- -------------
*10.11 Promissory Note, dated as of November 16, 1993, by Western Hills Associates Limited Partnership in favor of Connecticut General Life Insurance Company
*10.12 Assignment of Rents and Leases, dated as of November 16, 1993, by Western Hills Associates Limited Partnership in favor of Connecticut General Life Insurance Company
*10.13 Open-End Mortgage, Security Agreement and Fixture Filing, dated as of November 16, 1993, by Western Hills Associates Limited Partnership in favor of Connecticut General Life Insurance Company
*10.19 Agreement dated March 15, 1994 among Richard L. Kramer, the A.J. 1989 Trust, the Irrevocable Intervivos Trust for the Benefit of the Kramer Children, the N Street Investment Trust, Equity Resources Associates, Herbert S. Miller, The Mills Corporation and The Mills Limited Partnership
*10.20 Form of Promissory Note made payable by Franklin Mills Associates Limited Partnership to and for the benefit of the Operating Partnership
*10.21 Form of Mortgage, Security Agreement and Assignment of Rents and Leases by Franklin Mills Associates Limited Partnership to and for the benefit of the Operating Partnership
*10.22 Form of Sale of Partnership Interests Agreement (Franklin Mills) by and between the Operating Partnership and Herbert S. Miller, Laurence C. Siegel, Harry H. Nick, Western Franklin Mills Corp., Kan Am USA IX Limited Partnership and Kan Am USA X Limited Partnership
*10.23 Form of Indemnification Agreement between the Company and each of its Directors and Executive Officers
*****10.24 Construction Loan Agreement dated November 9, 1995, by and between Ontario Mills Limited Partnership and Canadian Bank of Commerce, Bayerische Hypotheken-Und Wechsel-Bank Aktiengesellschaft and The Mitsubishi Bank of Commerce
*****10.25 Construction Deed of Trust, Security Agreement, Assignment of Leases and Rents, Fixture Filing and Financing Statement dated as of December 26, 1995 in favor of Canadian Imperial Bank of Commerce, Bayerische Hypotheken-Und Wechsel-Bank Aktiengesellschaft and The Mitsubishi Bank of Commerce
SEQUENTIALLY NUMBER EXHIBIT NUMBERED PAGE ------ ------- -------------
*****10.26 Loan Agreement dated as of January 31, 1996 by and among Coopers Crossing Associates (MLP) Limited Partnership, Crosswinds Center Associates of St. Petersburg (MLP) Limited Partnership, Echo Hills Center Associates (MLP) Limited Partnership, Fashion Center Associates of Illinois No. 1 (MLP) Limited Partnership, Fashion Place Associates (MLP) Limited Partnership, Germantown Development Associates (MLP) Limited Partnership, Gwinnett Market Fair Associates (MLP) Limited Partnership, Montgomery Village Associates (MLP) Limited Partnership, Montgomery Village Ground (MLP) Limited Partnership, Mount Prospect Plaza (MLP) Limited Partnership (collectively, "The Mills Corporation, et. al."), and PFL Life Insurance Company
*****10.27 First Amended and Restated Promissory Note dated as of January 31, 1996, made by and among The Mills Corporation, ET AL., and PFL Life Insurance Company
*****10.28 Absolute Assignment of Mortgage and Loan Documents dated January 31, 1996 by and between CS First Boston Mortgage Capital Corporation as assignor and PFL Life Insurance Company as assignee
10.29-10.47 Intentionally Omitted
******10.48 Note dated July 30, 1996 by Sawgrass Mills Phase II Limited Partnership in favor of CS First Boston Mortgage Capital Corporation.
******10.49 Mortgage, Security Agreement, Assignment of Leases and Rents and Fixture Filing dated as of July 30, 1996, between Sawgrass Mills Phase II Limited Partnership, as Mortgagor, and CS First Boston Mortgage Capital Corporation, as Mortgagee.
****10.50 First Amendment to Trust and Servicing Agreement (Exhibit 10.7) dated as of June 1, 1995, among Sawgrass Finance L.L.C., as depositor, The First National Bank of Chicago, as servicer, and State Street Bank and Trust Company, as trustee.
****10.51 Prepayment Premium Agreement dated as of June 1, 1995, between The Mills Limited Partnership and State Street Bank and Trust Company, as trustee.
SEQUENTIALLY NUMBER EXHIBIT NUMBERED PAGE ------ ------- -------------
10.52 Second Amended and Restated Deed of Trust, Security Agreement, Assignment of Rents and Fixture Filing by Potomac Mills-Phase III (MLP) Limited Partnership and Washington Outlet Mall (MLP) Limited Partnership, collectively, as Grantor to R. Eric Taylor, a resident of Fairfax County, Virginia as Deed Trustee for the benefit of CS First Boston Mortgage Capital Corp., as Beneficiary dated as of December 17, 1996
10.53 Assignment of Leases and Rents and Security Deposits dated as of December 17, 1996 by Potomac Mills-Phase III (MLP) Limited Partnership and Washington Outlet Mall (MLP) Limited Partnership to CS First Boston Mortgage Capital Corp.
10.54 Mortgage, Security Agreement, Assignment of Rents and Fixture Filing by Gurnee Mills (MLP) Limited Partnership, as Mortgagor to CS First Boston Mortgage Capital Corp., as Mortagee dated as of December 17, 1996
10.55 Assignment of Leases and Rents and Security Deposits dated as of December 17, 1996 by Gurnee Mills (MLP) Limited Partnership to CS First Boston Mortgage Capital Corp.
10.56 Trust and Servicing Agreement dated as of December 1, 1996 among Potomac Gurnee Finance Corp., as Depositor, AMRESCO Management, Inc., as Servicer, ABN AMRO Bank N.V., as Fiscal Agent and LaSalle National Bank, as Trustee
10.57 Credit Agreement dated as of October 28, 1996, among The Mills Corporation, The Mills Limited Partnership, Sawgrass Mills Phase II Limited Partnership, Sunrise Mills (MLP) Limited Partnership, and CS First Boston Mortgage Capital Corp.
10.58 General Pledge and Security Agreement, dated as of October 28, 1996 made by The Mills Limited Partnership, in favor of CS First Boston Mortgage Capital Corp.
10.59 Intercompany Pledge and Security Agreement dated as of October 28, 1996, made by The Mills Limited Partnership, The Mills Corporation, Sunrise Mills (MLP) Limited Partnership and Sawgrass Mills Phase II Limited Partnership in favor of CS First Boston Mortgage Capital Corp.
10.60 Assignment of Partnership Interest dated as of the 28th day of October, 1996 from The Mills Limited Partnership, to CS First Boston Mortgage Capital Corp.
10.61 Revolving Note dated as of October 28, 1996 from The Mills Limited Partnership, to CS First Boston Mortgage Capital Corp. in the maximum amount of $40,000,000.
11 Statement Re: Computation of Per Share Earnings.
21.1 List of Subsidiaries of the Registrant
23 Consent of Independent Auditors
* Incorporated by reference to the Registrant's Registration Statement on Form S-11, Registration No. 33-71524, which was declared effective by Securities and Exchange Commission on April 14, 1994 (Commission File No. 1-12994).
** Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the first quarter ended March 31, 1994 (Commission File No. 1-12994).
*** Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.
**** Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the second quarter ended June 30, 1995.
***** Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1995.
****** Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the third quarter ended September 30, 1996.