C E N T R E F U N D 1 9 9 9 a n n u a l r e p o r t C O R P O R A T E P R O F I L E Centrefund Realty Corporation is a growth-oriented, publicly traded real estate investment company that focuses exclusively on the ownership of neighbourhood and community shopping centres in Canada and the United States. The Company’s primary investment objective is the creation of value through the long-term maximization of cash flow and capital appreciation from its growing shopping centre portfolio. This objective is achieved by proactively managing Centrefund’s exist- ing shopping centre portfolio, by seeking appropriate, opportunistic acquisitions and by undertaking selective development activities. The Company is managed by experienced real estate professionals who, through entities related to them, have a significant equity invest- ment in the Company. Centrefund completed its initial public offering of securities and commenced operations on March 29, 1994. The Company’s common shares and convertible debentures trade on the Toronto Stock Exchange. The common shares are part of the real estate group of the TSE 300 composite index. Financial Highlights Report to Shareholders Centrefund Development Group Operational Review Shopping Centre Portfolio Management’s Discussion & Analysis Estimated Current Value Responsibility of Management Auditors’ Report Consolidated Financial Statements Corporate Information 1 2 6 10 16 18 31 32 33 34 55 F I N A N C I A L H I G H L I G H T S Cash Flow in millions of dollars Total Assets in millions of dollars Gross Leasable Area in millions of square feet * 5 . 6 4 $ 2 . 1 1 $ 99 . 5 7 3 $ 7 . 6 1 $ . 3 1 2 $ 0 . 0 1 $ 3 . 4 1 $ 1 . 8 $ 97 96 Net Earnings 98 . 7 6 $ 3 . 4 $ 95 * before provision for termination of advisory services 3 1 1 1 $ , 9 0 0 1 $ , 9 3 6 $ 4 3 4 $ 6 6 2 $ 2 . 0 1 4 9 . 5 7 . 0 . 5 . 7 2 95 96 97 98 99 95 96 97 98 99 (in thousands of dollars, except per share amounts) 1999 1998 1997 1996 1995 I n c o m e S t a t e m e n t Gross rental income Earnings (loss) Per common share Cash flow before provision for termination of advisory services Per common share Per fully diluted common share Cash flow from operations Per common share Per fully diluted common share Dividends declared per common share B a l a n c e S h e e t Total assets Total liabilities Shareholders’ equity C o m m o n S h a r e s Weighted average number outstanding Outstanding at December 31 $ 137,097 $ 112,827 $ 71,798 $ 47,477 $ 30,098 $ $ $ $ $ $ $ $ $ 11,233 (0.17) 46,451 3.21 1.62 19,601 1.36 0.82 0.89 $ 1,112,533 $ 690,995 $ 421,538 14,469,728 15,070,323 $ $ $ $ $ $ $ $ $ 16,662 $ 10,020 0.45 $ 0.47 $ $ 8,045 0.63 37,453 $ 21,311 $ 14,291 2.69 1.49 $ $ 1.59 1.22 $ $ 1.14 1.08 37,453 $ 21,311 $ 14,291 2.69 1.49 0.85 $ $ $ 1.59 1.22 0.81 $ $ $ 1.14 1.08 0.77 $ $ $ $ $ $ $ $ $ 4,263 0.66 6,676 1.09 0.99 6,676 1.09 0.99 0.75 $ 1,008,847 $ 638,735 $ 433,677 $ 266,430 $ 575,806 $ 422,463 $ 275,040 $ 192,913 $ 433,041 $ 216,272 $ 158,637 $ 73,517 13,947,169 13,387,996 12,502,759 6,122,762 14,307,706 13,455,501 13,353,036 7,614,194 1 T O O U R S H A R E H O L D E R S T h e f u n d a m e n t a l s o f o u r b u s i n e s s r e m a i n s o u n d TO O U R S H A R E H O L D E R S in every previous Centrefund annual report, F I N A N C I A L R E S U LT S we can again report strong financial results, We are pleased to report that for the year ended Decem- As the expansion of our portfolio of quality shopping centres ber 31, 1999 cash flow from operations, the best measure and the completion of value creation initiatives at a number of our financial performance, amounted to $46.451 million of our existing properties. or $3.21 per common share before the provision for the ter- We can also report that Centrefund Development Group, mination of advisory services. This represents an increase our development arm established in the fall of 1997, has of 24% above the $37.453 million or $2.69 per common more than a dozen projects under active development share reported in 1998. On a fully diluted basis, assuming and has established a significant pipeline of new shopping the conversion of all outstanding convertible debentures, centres that we anticipate will generate strong financial cash flow before the aforementioned provision was $1.62 returns to augment our future growth. per common share in 1999 as compared to $1.49 per common In spite of our consistent performance, the trading price of share reported in 1998. our common shares has recently declined below our initial public The provision for the termination of the advisory services, offering price of $10 per share and the trading prices of our con- resulting from the internalization of management, as described vertible debentures have reacted accordingly. Our current share in Note 13(b) to the consolidated financial statements, should price seems to ignore the fact that our annual fully diluted cash be considered separately as a non-recurring charge when flow, before the provision for the internalization of management, evaluating Centrefund’s financial performance for 1999. has grown at a compound annual rate of 18% and our quar- Net earnings and cash flow from operations in 1999 were terly dividend has grown by 28% since we first issued shares reduced by a charge of $26.850 million to reflect the aforesaid to the public in 1994. As a result, our common shares are one provision. Accordingly, cash flow from operations in 1999, after of the highest yielding stocks on the Toronto Stock Exchange. the provision, was $19.601 million or $1.36 per share and $0.82 Although the fundamentals of our business remain sound, on a fully diluted basis. Net earnings for fiscal 1999, after the there is no question that investment in publicly traded real aforementioned provision, were $11.233 million or a per share estate securities is currently out of favour. The investing loss of $0.17 as compared to $16.662 million or earnings per public appears often distracted by the technology sector and share of $0.45 for the year ended December 31, 1998. seems relatively unimpressed by the sustainable, growing In calculating earnings per share, reported earnings have cash flow that can be generated from quality real estate. been reduced by $13.717 million in 1999, as compared to Nevertheless, we remain confident that our business will $10.368 million in 1998, to reflect the interest and accretion continue to generate growing cash flow which, over the long on the equity component of the Company’s outstanding run, should be recognized in the trading value of our securities. convertible debentures. Our achievements to date, strategies for growth and outlook These financial results were generated from gross rental for the future are further outlined throughout the balance of income in fiscal 1999 of $137.1 million, an increase of 21.5% this report where we share with you our vision for Centrefund. over the $112.8 million reported in 1998. 3 TO O U R S H A R E H O L D E R S P O R T F O L I O G R OW T H At our current level of capital and in line with our policy of We remain confident that the disciplined expansion of our limiting overall mortgage financing to 60% of the fair market shopping centre portfolio will allow us to meet our overall value of our assets, we have unused financial capacity. We strategic objective of generating strong, consistent growth intend to selectively utilize this capacity to create value for in cash flow from operations per share. In addition to the our shareholders by opportunistically expanding our portfolio acquisition and development of new properties, we focus on of shopping centres, as well as taking advantage of the internal growth generated by pro-actively managing each acquisition and development opportunities that the current and every one of our assets with a view to enhancing value. market conditions are bound to create. Our recent value enhancement activities are described in some detail in the Operational Review section of this report. I N T E R N A L I Z AT I O N O F M A N A G E M E N T We continue to believe that the ownership of a large Since it was formed in March 1994 with an initial portfolio portfolio of pro-actively managed quality assets will not only of five shopping centres, Centrefund has been managed generate sustainable, increasing cash flow, but will also pursuant to a long-term advisory agreement. This agree- enhance our platform for development and redevelopment ment called for the Advisor to be compensated for services activities which in turn should fuel further cash flow growth. based on the size of Centrefund’s asset base and the level In addition, a meaningfully sized portfolio should allow us to of acquisition and disposition activity. In addition, the Advisor efficiently utilize the debt and when available, capital mar- is entitled to earn an incentive fee once the Company earns kets, to generate a lower cost of capital – a key ingredient a cumulative priority return on the equity invested in the in our overall financial success. Company’s real estate and related assets. In 1999, we completed the acquisition of interests in At a meeting held on January 18, 2000, shareholders of the eight new properties containing 633,000 square feet of Company approved a resolution by the Board of Directors to gross leasable area. Our average initial annual yield on terminate the advisory fee component of the Advisory Agree- the cost of the properties acquired was just under 11%, ment effective January 1, 2000 in consideration for a $25 million excluding one property that represents a substantial termination payment to the advisor. In addition, the incentive redevelopment opportunity. The full impact of these acquisi- fee component of the Advisory Agreement was revised in tions on operating results will begin to be felt in fiscal 2000, consideration for the future issue of warrants to purchase when operating results will reflect a full year of ownership. Centrefund common shares. The details of the transaction are Also in 1999, Centrefund Development Group contributed included in Note 13(b) to the consolidated financial statements. five new shopping centres to our overall portfolio, with This transaction effectively internalizes the Company’s an additional eight projects under construction and three management and from the investment community’s per- projects under active development. spective, more clearly aligns the interests of management C A P I TA L B A S E with those of Centrefund shareholders. This fundamental change should benefit both our shareholders and our Our decision to return to the capital markets in 1998 with two Management Team, as we continue to create value and $100 million convertible debt issues was fortuitous. As previ- generate strong returns, and as the market recognizes ously mentioned, the capital markets have been very hard the real value of our common shares. on the real estate sector over the past 18 months, which has resulted in declining prices for all real estate securities. Very few T H E I N T E R N E T A N D “ E - R E TA I L I N G ” real estate entities have been able to raise new equity and There is little doubt that the Internet continues to provide those that have, have done so at discounts to net asset value. us all with the ability to dramatically improve the flow of 4 TO O U R S H A R E H O L D E R S information. It is also apparent that a growing number of We intend to continue to focus on running our business business functions will be conducted electronically. However, with a view to maximizing the net cash flow generated from we are confident that this emerging technology will not our growing portfolio of shopping centres. We already have have a detrimental effect on the core of our business – several value enhancement initiatives planned for 2000. the neighbourhood shopping centre. This is the place where We will continue to selectively grow our portfolio when you eat lunch or dinner, get a haircut, visit your dentist, opportunistic acquisitions become available. and conveniently buy your groceries, drug store items and We may also seek to realize on some of the surplus value other basic necessities. This is because the most efficient that has been created within our portfolio by selling interests in and cost effective, and in many cases the only way, for some of our mature properties to investors who appreciate the consumers to purchase most of these types of goods and quality of the growing cash flow that these properties offer. services is for them to go to their local neighbourhood We will continue to expand our development business by shopping centre. creating quality shopping centres that offer attractive risk- In the future, consumers who choose to order groceries adjusted rates of return. This part of our business truly has and other products over the Internet may likely have them the potential to create a long-term franchise for Centrefund. delivered from their conveniently located shopping centre. All of this activity will be carefully balanced against our We believe that shopping cen- tres will effectively become the fulfillment centres for the Internet shopper We continue to focus on running our business to maximize net cash flow available financial capacity in light of the current state of the public real estate equities markets. We are, because their proximity to the customer will minimize the after all, in a capital-intensive business that today must rely cost and time of delivery. In addition, by using existing on its existing capital base to efficiently operate and grow. store locations as fulfillment centres both during and after We have always treated our capital as a scarce resource, normal operating hours, the retailer can capture Internet- so we remain confident that we will successfully adjust to based sales without incurring the additional costs of new the current constrained capital environment. distribution centres and incremental inventory. In closing, I would like to thank all of our fellow share- We foresee that the leading e-retailers will emerge from holders for the confidence they continue to demonstrate today’s leading “bricks and mortar” retailers and that these through their investment, as well as our Management leaders will integrate the new technology with their existing Team and our Board of Directors for their tireless efforts distribution assets, including their neighbourhood stores to and constant support. create an efficient and cost effective delivery system. This We must all remember that real estate is a long-term should also augment and improve the customer’s shopping investment; and consistently strong performance will be experience, and enhance the value of well-located, properly rewarded in the long term. designed and well-maintained neighbourhood shopping cen- tres that house these retailers. O U T L O O K As we enter the new millennium, we face a dynamic Sincerely, [Peter F. Cohen] environment within which to operate. Nevertheless, Peter F. Cohen, C.A. we believe our long established strategic plan Chairman, President and Chief Executive Officer remains sound. March 21, 2000 5 [ S E C T I O N T I T L E G O E S H E R E ] C E N T R E F U N D D E V E L O P M E N T G R O U P O u r d e v e l o p m e n t b u s i n e s s h a s t h e p o t e n t i a l t o c r e a t e a l o n g - t e r m f r a n c h i s e f o r C e n t r e f u n d 6 C E N T R E F U N D D E V E LO P M E N T G R O U P was a successful year for Centrefund dominant food retailers in their markets, as well as Home Development Group (“CDG”). We Depot, Bed Bath & Beyond, Borders Books, Eckerds, 1999 completed a number of developments, commenced con- Canadian Tire, Shoppers Drug Mart, and others. Our goal is struction on several projects, identified several new to continue to nurture these valued relationships, and to potential development opportunities and cultivated mean- establish new ones, with a view to becoming the developer ingful new relationships with anchor retailers, which of choice for these and other expansion minded retailers. should provide us with a significant pipeline for future development opportunities. T R E N D S I N T H E M A R K E T P L A C E There have been a number of trends occurring among D E V E L O P M E N T A C T I V I T Y retailers and in the financing markets that have impacted Shopping centre developments were completed in Lethbridge, the development landscape, both positively and negatively. Alberta (Safeway, Home Hardware), London, Ontario (Sobeys), These have resulted from among other factors, mergers Longueuil, Quebec (Bank of Nova Scotia, Blockbuster, or acquisitions between a number of dominant retailers Moore’s), Gainesville, Florida (Bed Bath & Beyond, Borders and changes in both the equity and mortgage markets. Books); and Palm Beach Gardens, Florida (Wilmington Trust, The past two years have been a time of significant Morgan Stanley, Palm Beach National Bank). consolidation affecting a number of national and regional Construction has started on centres being developed in chains. Examples are Loblaws’ purchase of Provigo, Port St. Lucie, Florida (Albertsons), Cambridge, Ontario (Taco Sobeys’ purchase of IGA, Albertsons’ purchase of Bell, Wendy’s, Country Style), and Pickering, Ontario (Sobeys). American Stores, and Safeway’s purchase of Randalls. Construction will commence later this year in Lachenaie, The purpose of consolidation is growth and the eventual Quebec (Home Depot, Business Depot, and numerous realization of financial synergies. However, a by-product fashion box retailers), Windsor, Ontario (Sobeys), Jupiter, is generally a less competitive market. Florida (Publix), Palm Beach Gardens, Florida (Albertsons), Another trend has emerged as a result of consolidation Plano, Texas (Office Max), and Dallas, Texas (Tom and other factors. Until recently, many of our anchors Thumb – Safeway). traditionally had a preference for leasing their own premises. CDG has a number of additional properties under con- In many instances this has changed, and their preference ditional purchase agreements in Canada and the United and often their requirement is to own due to their current States, providing the Company with a substantial pipeline strong financial positions. for new development opportunities in the coming years. Certainly, our preference is to lease space to our anchors, In addition, in the past year, we made major strides in but at the same time, we recognize the importance of cultivating new relationships and strengthening existing attracting key anchor tenants in each of our developments. relationships with many of our retailer clients. These include Accordingly, we expect that an increasing number of our Loblaws, A&P, Sobeys, Albertsons, Safeway and Publix, the projects will be co-developed with our major retailers. 7 C E N T R E F U N D D E V E LO P M E N T G R O U P In Canada, the construction, acquisition and long-term In Canada, our Ottawa and Vancouver offices were financial markets are becoming more challenging. The char- closed, as we felt that these markets could be more tered banks, once the traditional source for construction efficiently served from our Toronto and Edmonton offices. and acquisition financing, have somewhat curtailed their In the United States, the Newport Beach office was closed lending activities as they increase their focus on the capital because we determined that land prices there were market and equity sides of their business. At the same extremely high, development yields unappealing, and the time, there has been substantial consolidation among life development process exhausting. We concluded that this insurers, who have been the traditional source of long-term market is better suited to local players. financing for real estate projects. Some of these insurance On the negative side, five of our offices to date have not companies have also gone public and as a result have become more focused on quarterly results than on matching investment returns to We continue to nurture our valued tenant relationships contributed to an actual new devel- opment transaction. However, of these five offices, three presently have sites under option with exe- annuity payment requirements. This has resulted in the cuted purchase agreements in place. I expect that we will long-term mortgage becoming a somewhat less attractive close on the purchase of all three of these properties in investment for them. As a result, the life insurance com- the near future. panies that remain in the mortgage market are much more conservative and restricted in their lending practices. M A R K E T C O N D I T I O N S Fortunately, our long-standing relationships with several Although market conditions are not perfect, they are, on financial institutions have somewhat insulated us from the balance, reasonably propitious. Current interest rates allow changes that are occurring in the mortgage markets. for positive leverage even though we believe that long-term In the United States, the financing market has become interest rates are artificially high. Housing starts are almost more favourable to our business. The main reason for this at an all-time high. Retailers are expanding aggressively. All is the maturing of the mortgage backed securities market in all, we have certainly experienced more difficult times. (the conduit market). Conduit lenders are collaborating with All of us at Centrefund Development Group are com- Wall Street to raise substantial mortgage funds. This, in mitted to building CDG into one of the most successful retail turn, has created a more competitive lending environment. development companies in North America, one shopping 1999 saw a number of U.S. lenders and some Canadian centre at a time. chartered banks establish mortgage backed securities busi- On behalf of my partners, I would like to take this oppor- nesses in Canada. Given the current lending environment tunity to recognize the dedication and commitment of all of in Canada, we expect that the mortgage backed securities our CDG co-workers. market will expand rapidly, providing significant competition to institutional lenders and resulting in a more developer- Sincerely, friendly mortgage market. O U R M A R K E T S [John W.S. Preston] CDG operates out of 10 regional offices, in Montreal, Toronto John W.S. P reston and Edmonton in Canada, and in Palm Beach Gardens, Chairman, President and Chief Executive Officer Orlando, Raleigh, Houston, Dallas, Phoenix and Denver in Centrefund Development Group the United States. March 21, 2000 8 C E N T R E F U N D D E V E LO P M E N T G R O U P S H O P P I N G C E N T R E D E V E L O P M E N T C O M P L E T E D P R O J E C T S Name and Location C A N A D I A N P R O P E R T I E S West Lethbridge Towne Square, Lethbridge, Alberta Commissioners Road Plaza, London, Ontario Longueuil Centre, Longueuil, Quebec U . S . P R O P E R T I E S Oaks Square, Gainesville, Florida (1) City Centre, Palm Beach Gardens, Florida (1) T O TA L C O M P L E T E D P R O J E C T S Gross Leasable Area Developed Expansion Potential Gross Leasable Area Upon Full Development Major or Anchor Tenants 78,000 36,000 35,000 149,000 119,000 94,000 213,000 362,000 25,000 35,000 9,000 69,000 – 75,000 75,000 144,000 103,000 71,000 44,000 218,000 119,000 169,000 288,000 506,000 Safeway, Home Hardware Price Chopper (Sobeys) Bank of Nova Scotia, Blockbuster Bed Bath & Beyond, Borders Books Wilmington Trust P R O J E C T S U N D E R D E V E L O P M E N T Name and Location Construction Development Leasable Area Major or Anchor Tenants Gross Leasable Area Under Future Total Project Gross C A N A D I A N P R O P E R T I E S Steeple Hill Shopping Centre, Pickering, Ontario Huron Church & Todd Lane, Windsor, Ontario Delta Centre, Cambridge, Ontario Hwy 12 & Hwy 93, Midland, Ontario Lachenaie Power Centre, Repentigny, Quebec U . S . P R O P E R T I E S Cashmere Corners, Port St. Lucie, Florida Abacoa Plaza, Jupiter, Florida (1) Northmil Plaza, Palm Beach Gardens, Florida (2) Donald Ross & Central, Palm Beach Gardens, Florida (2) Thornbridge Crossing, Dallas, Texas Plano Parkway & Hwy 544, Plano, Texas 60,000 – 24,000 – – 84,000 80,000 62,000 81,000 – – – 223,000 7,000 75,000 67,000 200,000 362,000 711,000 58,000 37,000 9,000 200,000 92,000 144,000 540,000 67,000 75,000 91,000 200,000 362,000 795,000 138,000 99,000 90,000 200,000 92,000 144,000 763,000 Price Chopper (Sobeys) Sobeys Taco Bell, Wendy’s, Country Style Home Depot, Business Depot Albertsons Publix Albertsons Tom Thumb (Safeway) Walgreens, Office Max T O TA L P R O J E C T S U N D E R D E V E L O P M E N T 307,000 1,251,000 1,558,000 T O TA L D E V E L O P M E N T P O R T F O L I O 669,000 1,395,000 2,064,000* (1) 50% interest (2) 50.1% interest * Excludes 180,000 square feet of GLA owned by anchor tenants. 9 [ S E C T I O N T I T L E G O E S H E R E ] O P E R A T I O N A L R E V I E W G r o s s L e a s a b l e A r e a 61% 39% Centrefund’s shopping centre portfolio consisted of 70 properties containing 10.2 million square feet of gross leasable area as at December 31, 1999, including those prop- erties owned by Centrefund Development Group. Operations are directed in Canada from offices in Toronto and in the United States from offices located in Palm Beach Gardens, Florida. Regional operational offices are located in Edmonton, Ottawa, Montreal, Halifax, Dallas and Houston. Centrefund’s development activities are carried out through its 50.1% ownership interest in Centrefund Development Group (“CDG”). CDG is a distinct entity under the direction of John W.S. Preston, who together with his senior management team, own the remaining interest in CDG. Centrefund and CDG adhere to similar operating principles. A review of CDG’s oper- ations is detailed in a separate section of this annual report. All aspects of the Company’s operations are under the overall direction of a management committee, comprised of Peter F. Cohen, our Chairman, President and Chief Executive Officer, John W.S. Preston, the Chairman, President and Chief Executive Officer of Centrefund Development Group and Robert S. Green, the President of Centrecorp, our Property Manager. This management committee reports in detail to our Board of Directors no less than quarterly. In managing its shopping centres, the Company focuses on securing retail tenants that provide consumers with basic necessities and amenities, as distinct from those which cater to more discretionary fashion demands. This tends to make the Company’s shopping centre portfolio less susceptible to general economic swings, as even during economic down- turns consumers continue to purchase necessities such as groceries, basic clothing and services. The Company also seeks to lease a large portion of the gross leasable area of each of its properties on a long-term basis to successful national or regional anchor tenants, such as discount department stores, food supermarkets and promotional retailers. These tenants, in addition to creating a stable source of long-term rental income, generate customer traffic for the benefit of the smaller retail and service tenants. The nature and relationship of anchors to small shop tenants and the balance between national, regional and local tenants are key ingredients in establishing stable and sustainable revenue for each of Centrefund’s properties. 10 O P E R AT I O N A L R E V I E W C A N A D I A N O P E R A T I O N S I n 1999, C e n t re f u nd c o n t i nu e d t o a c qu i re s ho p p i n g c e n t re s w i t h at t ra c t ive i n i t i a l rat e s of re t u r n Centrefund’s Canadian shopping centre portfolio, excluding currently vacant space. The final acquisition completed those properties owned by Centrefund Development during the current year in Canada is a food supermarket- Group, consisted of 36 properties containing approximately anchored 217,000-square-foot community centre located 6,091,000 square feet of gross leasable area as at in Ajax, Ontario and anchored by a Food Basics (A&P) December 31, 1999. The Company’s Canadian shopping supermarket. This property presents a redevelopment centres average 169,000 square feet in size (1998 – opportunity that we are actively pursuing. 175,000 square feet) and have an average net book value During 1999 the Company also acquired a 37% interest of $91 per square foot (1998 – $77 per square foot). As at in a food supermarket-anchored shopping centre located in December 31, the portfolio can be summarized as follows: St. Hubert, Quebec, a suburb of Montreal, to increase its 1999 1998 overall interest in the property to 71%. Number of Properties Square Footage (thousands) Number of Properties Square Footage (thousands) 18 11 4 3 36 3,450 1,831 558 252 6,091 17 8 4 3 32 3,277 1,630 558 252 5,717 Province Ontario Western Canada Quebec Maritimes Total A c q u i s i t i o n s S a l e s During 1999 the Company completed the sale of a shop- ping centre located in Orillia, Ontario. The property was originally acquired with a view to creating value through an expansion of one of the existing tenants. As it turned out, the tenant wanted to expand to a size that would virtually eliminate the balance of the remaining leasable During 1999 Centrefund completed the acquisition of area. As a result, it made sense to both the Company interests in five new properties and increased its interest and the tenant for the tenant to acquire the property. in one existing property in Canada. Three of the A $6 million sale was completed in the first quarter newly acquired properties are food supermarket- of 1999 to realize a net gain of $1.5 million. anchored neighbourhood shopping centres acquired at attractive initial rates of return. Two of these properties Redevelopment, renovation and remerchandising are located in Regina, Saskatchewan and are anchored by During 1999 the Company completed a major redevelopment Safeway, and the remaining property is located in Waterloo, project at Cedarbrae Mall in Toronto. The property has Ontario and is anchored by Sobeys. been repositioned through the re-anchoring of the centre The fourth acquisition in Canada is a shopping centre with the addition of Loblaws, Canadian Tire, Zellers and located in Red Deer, Alberta that is anchored by a number Toys ‘R’ Us. As part of the redevelopment, the balance of mini box promotional retailers. This property offers of the existing mall was completely renovated and a food value enhancement potential through the lease up of court was added. The Company was also able to add four 11 O P E R AT I O N A L R E V I E W free-standing buildings to create an additional 32,000 square facilitate the expansion of one of the property’s anchor feet of highly desirable space. These new buildings have tenants. In addition, efforts to date have already allowed been leased to the Liquor Control Board of Ontario, the the Company to accelerate the process of increasing the Beer Store, the Bank of Nova Scotia and Burger King. below-market rents on the property’s small shop space. These substantial improvements have created The redevelopment plan for the Company’s a very valuable institutional-grade retail asset Northwood Mall project in Edmonton, Alberta that is generating a high-quality, sustainable and was finalized in 1999. The two-level Zellers store growing cash flow. was relocated to the former single-floor K-Mart store, At South Park Village in Edmonton, the second phase and negotiations were finalized for a 23,000-square-foot of a three-phase expansion and redevelopment plan was expansion of the new Zellers scheduled to open in the completed in 1999 with the fall opening of a new 80,000- spring of 2001. The demolition of the former Zellers store square-foot Canadian Tire store. The former Canadian Tire will allow for the construction of a new 55,000-square-foot store is being demolished to allow for the construction of Safeway food supermarket. Once the new supermarket three new buildings. This new construction will accommodate is open, the existing Safeway store will be demolished to We c o n t i nu e d t o ad d s h a re ho l d e r va l u e t h ro u g h t h e s t rat e g i c re d evelo p m e n t of ex i s t i n g s ho p p i n g c e n t re s an expansion of the existing SportChek store, the addition make way for two or more new large-format retailers. To of a Linens ’n Things store and up to 30,000 square improve the project’s curb appeal and in order to accom- feet of new retail space. As part of this program, a major modate two or three new free-standing buildings, a portion renovation, including the addition of new store facades, of the existing parking deck no longer required will be new entranceways and pylon signs as well as increased demolished. Like many of the Company’s previous major landscaping, has been completed. On completion, this redevelopment projects, Northwood Mall con- property will have been retooled for the future tinues to deliver an attractive cash flow yield and will generate a significant return on the while the planned repositioning is finalized and incremental capital invested. implemented. The redevelopment plan will enhance In 1999 the reconfiguration of the Company’s the Company’s return on investment and also create a Stanley Park Mall project in Kitchener, Ontario was com- strong retail project properly positioned to better serve menced. Several tenants have been relocated in order to its trade area. accommodate expansions and some 12,000 square feet of small shop space has been demolished to eliminate a L e a s i n g second mall corridor. This space will be replaced with a Leasing activity in Canada in 1999 resulted in the completion 10,000-square-foot free-standing building pre-leased on of agreements to lease covering more than 168,000 square a long-term basis to the Liquor Control Board of Ontario. feet of space, down from the 435,000 square feet leased A minor renovation of the property, including new mall in 1998. These new leases will generate annual net rental entrances, is also being undertaken. The reconfiguration income of approximately $3.0 million as compared to the of this project will replace mediocre space with highly desir- $5.9 million in annual net rent generated by 1998 leasing able space and improve the parking area. This may in turn activities. In addition, lease renewals on 299,000 square 12 O P E R AT I O N A L R E V I E W feet were completed in 1999, as compared to 332,000 square A n c h o r Te n a n t S a l e s feet of space in 1998. The 1999 renewals will generate Anchor tenant sales performance is a good barometer of the annual net rental income of almost $4.6 million, repre- quality and success of the Company’s shopping centres. senting an increase of 4.5% above the pre-renewal net Not only is it indicative of the quality and sustainability of annual rent as compared to $4.1 million in income attributable to 1998 renewals, which represented a 6.2% increase over the anchor tenants’ rent but it is also a reliable measure of customer traffic which benefits the shopping centre’s ancillary pre-renewal rental rates. The occupancy level of the tenants. In addition, the majority of the Company’s anchor Canadian portfolio, excluding projects currently under tenant leases include a percentage rent clause which redevelopment, increased to 97% of total gross leasable entitles the Company to participate in the tenants’ sales area as at December 31, 1999. success above a predetermined level of sales. The following Square Footage Leased Square Footage Leased thousands thousands Net Rental Income Net Rental Income C$ millions C$ millions 7 7 6 6 7 7 0 0 . . 0 0 1 1 6 6 7 7 . . 2 2 0 0 5 5 7 7 6 6 4 4 8 8 . . 5 5 • • • • • • $ $ 99 99 98 98 97 97 New Leases New Leases Renewals Renewals • • • • 99 99 98 98 97 97 New Leases New Leases Renewals Renewals chart summarizes average comparable anchor tenant sales per square foot for reporting tenants by major use category for the Company’s Canadian portfolio: Junior department stores Food supermarkets 1999 $205 $523 1998 $197 $504 For the year ended December 31, 1999 the Company earned $830 thousand (1998 – $733 thousand) in percentage rent from its anchor tenants in Canada. 13 O P E R AT I O N A L R E V I E W U. S . O P E R A T I O N S C e n t re f u nd w i l l c o n t i nu e t o g e ne rat e s t ro n g o p e rat io n a l re s u l t s i n 20 0 0 a nd b e yo nd Centrefund’s U.S. shopping centre portfolio, excluding the market rental rates for the property. The benefit of this those properties owned by Centrefund Development Group, improvement in rental rates will be enjoyed on the lease up consisted of 29 properties containing approximately of existing vacancies and the renewal of existing tenancies. 3,709,000 square feet of gross leasable area as at December 31, 1999. The Company’s American shopping centres Municipal approval has recently been received to allow for the expansion of the existing Publix supermarket by 10,000 square feet. average 128,000 square feet in size (1998 – 133,000 square In the longer term, the Company will also look to take feet) and have an average net book value of U.S.$69 advantage of the potential to develop two six-storey office per square foot (1998 – U.S.$65 per square foot). As at buildings on the site. December 31, the portfolio can be summarized as follows: In Texas, the repositioning and remerchandizing of the 1999 1998 Company’s Plymouth Park project in Irving, a suburb of Dallas, State Florida Texas Total Number of Properties Square Footage (thousands) Number of Properties Square Footage (thousands) 12 17 29 1,284 2,425 3,709 12 15 27 1,284 2,303 3,587 A c q u i s i t i o n s continued. This four-centre project comprises a total of approximately 741,000 square feet of gross leasable area sit- uated on 60 acres of land in a mature residential community. The initial phase of the renovation program, which entailed the addition of two free-standing buildings, the re-cladding of a number of existing buildings and the addition of new In Texas, two food supermarket-anchored shopping centres signage, paving and landscaping, has been completed. containing an aggregate of approximately 122,000 square The results are very encouraging. Returns on incremental feet were acquired during 1999. In Dallas, a 59,000-square- capital invested in this program are exceeding 25% based foot property was acquired and rede- veloped to accommodate Minyards, a regional food supermarket operator. In on leases signed to date. Negotiations to add additional new anchor tenants to the complex are also underway. San Antonio, a 63,000-square-foot centre anchored by The low cost base of this asset allows the Company Albertsons that offers further upside through the rollover to be the “low-cost provider” of basic retail space in this of below-market rents was acquired on attractive terms. market. Market research indicates that the project’s rents still are 30% – 40% below market for comparable space. Redevelopment, renovation and remerchandising This has been confirmed by rents achieved on renewals In Palm Beach Gardens, Florida, the redevelopment of the to date. Without spending a substantial amount of capital Company’s Oakbrook Square property was substantially to redevelop the site, returns have been significantly completed, which has resulted in a significant increase in enhanced as the available space is leased. 14 O P E R AT I O N A L R E V I E W L e a s i n g A n c h o r Te n a n t S a l e s Leasing activity in the United States was strong in 1999 As detailed above under Canadian Operations, anchor tenant with the completion of agreements to lease covering sales performance is a good barometer of the quality and approximately 313,000 square feet of space, up from the success of the Company’s shopping centres. In the United 139,000 square feet leased in 1998. These new leases will States many of the Company’s anchor leases were created generate annual net rental income of U.S.$2.7 million as more than 10 years ago and as a result many of these compared to the U.S.$1.7 million coming from 1998 leasing anchor tenants have surpassed the break-through point of activities. In addition lease renewals covering 150,000 square annual sales revenue. Accordingly the Company is directly feet in 1999 have been completed, up from 124,000 square benefiting from these tenants’ sales success through the feet in 1998. The 1999 renewals will generate annual receipt of percentage rent payments. The following chart net rental income of U.S.$2.1 million, representing a 13.7% summarizes average comparable anchor tenant sales per increase over the pre-renewal annual net rent, as compared square foot for reporting tenants by major use category to a 2.1% increase on U.S.$1.5 million of renewals completed for the Company’s U.S. portfolio: in 1998. Occupancy levels, excluding projects under redevel- opment, decreased to 92% of total gross leasable area as at December 31, 1999 as compared to 94% occupancy at Department stores Food supermarkets Drug stores 1999 U.S.$264 U.S.$417 U.S.$494 1998 U.S.$246 U.S.$379 U.S.$461 the end of 1998. Square Footage Leased thousands Net Rental Income C$ millions 3 6 4 8 . 4 7 5 2 3 6 2 2 . 3 . 7 2 • • • $ 99 98 97 New Leases Renewals • • 99 98 97 New Leases Renewals For the year ended December 31, 1999 the Company earned U.S.$947 thousand (1998 – U.S.$923 thousand) in percent- age rent from its anchor tenants in the United States. We are pleased with the Company’s operational results for the past year. During this period, strong individual property occupancy levels throughout our portfolio were maintained and remerchandising and redevelopment activities were commenced and completed at a number of our existing projects. All of this is a function of the high quality of the Company’s retail portfolio and the hard work of our motivated operational team. We remain confident that Centrefund will continue to generate strong operational results in 2000 and beyond. Sincerely, [Peter F. Cohen], [Robert S. Green], [John W.S. Preston] Peter F. Cohen, Robert S. Green, John W.S. Preston Members of the Management Committee March 21, 2000 15 S H O P P I N G C E N T R E P O R T F O L I O C A N A D I A N P R O P E R T I E S Name and Location O N TA R I O Cedarbrae Mall, Toronto, Ontario Fairview Mall, St. Catharines, Ontario Brantford Mall, Brantford, Ontario Tillsonburg Town Centre, Tillsonburg, Ontario Zellers Festival Marketplace, Stratford, Ontario Harwood Place Mall, Ajax, Ontario Zellers Plaza, Waterloo, Ontario Stanley Park Mall, Kitchener, Ontario Stoney Creek Plaza, Hamilton, Ontario Parkway Centre, Peterborough, Ontario Zellers Plaza at Sheridan Mall, Toronto, Ontario Ambassador Plaza, Windsor, Ontario Thickson Place, Whitby, Ontario Orleans Gardens, Ottawa, Ontario (1) Orleans Place, Ottawa, Ontario Eagleson Place, Ottawa, Ontario Northfield Centre, Waterloo, Ontario Office Place, St. Catharines, Ontario W E S T E R N C A N A D A Northwood Mall, Edmonton, Alberta South Park Village, Edmonton, Alberta Sherwood Towne Square, Sherwood Park, Alberta Leduc Towne Square, Edmonton, Alberta Village Market, Sherwood Park, Alberta Red Deer Village, Red Deer, Alberta Gateway Village, St. Albert, Alberta Sherwood Centre, Sherwood Park, Alberta London Place West, Calgary, Alberta Regent Park Shopping Centre, Regina, Saskatchewan Registan Shopping Centre, Regina, Saskatchewan Q U E B E C La Porte de Gatineau, Gatineau, Quebec Zellers Plaza, Chateauguay, Quebec Les Galeries de Repentigny, Repentigny, Quebec Les Promenades du Parc, St. Hubert, Quebec (2) M A R I T I M E S Cole Harbour Shopping Centre, Dartmouth, Nova Scotia Ropewalk Lane, St. John’s, Newfoundland Highfield Park, Dartmouth, Nova Scotia Gross Leasable Area Anchor- Owned Net Leasable Area Major or Anchor Tenants 478,000 432,000 299,000 244,000 225,000 217,000 215,000 190,000 173,000 172,000 170,000 137,000 134,000 111,000 90,000 75,000 52,000 36,000 3,450,000 542,000 429,000 135,000 127,000 119,000 109,000 105,000 102,000 71,000 66,000 26,000 1,831,000 194,000 134,000 119,000 111,000 558,000 149,000 90,000 13,000 252,000 – 478,000 78,000 – – 99,000 – – – – – – – 49,000 – 60,000 – – – 286,000 – 48,000 – 83,000 – – – – – – – 131,000 44,000 – – 55,000 99,000 106,000 35,000 – 141,000 354,000 299,000 244,000 126,000 217,000 215,000 190,000 173,000 172,000 170,000 137,000 85,000 111,000 30,000 75,000 52,000 36,000 3,164,000 542,000 381,000 135,000 44,000 119,000 109,000 105,000 102,000 71,000 66,000 26,000 1,700,000 150,000 134,000 119,000 56,000 459,000 43,000 55,000 13,000 111,000 Zellers, Loblaws, Canadian Tire, Toys ‘ R’ Us Zellers, Zehrs, Cineplex, A&P, Chapters, Future Shop, Mark’s Work Wearhouse Wal-Mart, Zehrs, Cineplex Zellers, Valu-Mart, Canadian Tire Zellers, Sears, Canadian Tire Food Basics (A&P), Shoppers Drug Mart Zellers, Sobeys Zellers, Zehrs, LCBO Zellers, Office Place, Mark’s Work Wearhouse Zellers, IGA Zellers, Food Basics (A&P) Zellers, LCBO A&P, Toys ‘ R’ Us Loblaws Loblaws Loblaws Sobeys, Pharma Plus Office Place Zellers, Safeway Zellers, Canadian Tire, Toys ‘ R’ Us, Office Depot Zellers, Staples Safeway, Canadian Tire Safeway, London Drugs Mark’s Work Wearhouse, Sportmart Safeway CIBC, Rogers Video London Drugs Safeway Safeway Loblaws, Toys ‘ R’ Us, Future Shop Zellers Metro Richelieu, Pharmaprix IGA, Canadian Tire Sobeys, Canadian Tire Loblaws Tim Horton’s, Ultramart T O TA L C A N A D A 6,091,000 657,000 5,434,000 16 U . S . P R O P E R T I E S Name and Location F L O R I D A Oakbrook Square, Palm Beach Gardens, Florida Bluffs Square Shoppes, Jupiter, Florida Prosperity Center, Palm Beach Gardens, Florida Harbour Financial Center, Palm Beach Gardens, Florida Marco Town Center, Marco Island, Florida Sawgrass Promenade, Deerfield Beach, Florida Boynton Plaza, Boynton Beach, Florida Boca Village Square, Boca Raton, Florida Kirkman Shoppes, Orlando, Florida Ross Plaza, Tampa, Florida The Shoppes of Jonathan’s Landing, Jupiter, Florida The Shoppes at Westburry, Miami, Florida T E X A S Plymouth Park North, Dallas, Texas Kingwood Center, Houston, Texas Benbrook Square, Fort Worth, Texas Townsend Square, Desoto, Texas Plymouth Park West, Dallas, Texas Copperfield Crossing, Houston, Texas Mission Bend Center, Houston, Texas Grogan’s Mill Center, Houston, Texas Steeplechase Center, Houston, Texas Village By The Parks, Dallas, Texas Woodforest Center, Houston, Texas Beechcrest Center, Houston, Texas Sterling Plaza, Dallas, Texas Wurzbach Center, San Antonio, Texas Eckerd Plaza, Dallas, Texas Minyards Center, Garland, Texas Kroger Plaza, Dallas, Texas Gross Leasable Area Anchor- Owned Net Leasable Area Major or Anchor Tenants 216,000 129,000 122,000 121,000 109,000 107,000 98,000 93,000 89,000 86,000 81,000 33,000 1,284,000 441,000 257,000 247,000 199,000 182,000 159,000 129,000 118,000 104,000 99,000 94,000 91,000 65,000 63,000 62,000 59,000 56,000 2,425,000 – – – – – – – – – – 54,000 – 54,000 – – – 50,000 – – – – – 54,000 – – – – 13,000 – – 117,000 216,000 129,000 122,000 121,000 109,000 107,000 98,000 93,000 89,000 86,000 27,000 33,000 1,230,000 441,000 257,000 247,000 149,000 182,000 159,000 129,000 118,000 104,000 45,000 94,000 91,000 65,000 63,000 49,000 59,000 56,000 2,308,000 Jacobson’s, Publix, Eckerd Publix, Walgreens Office Depot, T.J. Maxx, Barnes & Noble, Bed Bath & Beyond Fidelity, Comerica, Prudential Publix Publix, Walgreens, Blockbuster Publix, Eckerd Publix, Eckerd Eckerd Ross Dress for Less, Walgreens Albertsons Pizza Hut Fazio’s, U.S. Post Office Randalls Food Market Under redevelopment Albertsons, Beall’s Under redevelopment Gerland’s Food Fair Randalls Food Market Randalls Food Market Randalls Food Market Toys ‘ R’ Us, Pier 1 Imports Randalls Food Market Randalls Food Market, Walgreens Bank One, Wherehouse Music Albertsons Eckerd Minyards Kroger T O TA L U N I T E D S TAT E S 3,709,000 171,000 3,538,000 T O TA L C O M P A N Y P O R T F O L I O 9,800,000 828,000 8,972,000 C E N T R E F U N D D E V E L O P M E N T G R O U P C O M P L E T E D P R O J E C T S 362,000 – 362,000 T O TA L P O R T F O L I O 10,162,000 828,000 9,334,000 (1) 50% interest (2) 71% interest 17 M A N A G E M E N T ’ S D I S C U S S I O N & A N A L Y S I S T h e C o m p a n y h a s e x p a n d e d i t s p o r t f o l i o o f s h o p p i n g c e n t r e s i n e a c h y e a r o f i t s e x i s t e n c e M A N AG E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S B U S I N E S S OV E RV I E W centres under active development and holds options to Centrefund Realty Corporation was incorporated under the laws acquire a number of additional sites. of the Province of Ontario by articles of incorporation dated November 10, 1993. The Company, directly and through sub- F I N A N C I A L G U I D E L I N E S sidiaries, operates exclusively in the shopping centre segment Centrefund is dedicated to creating significant growth and of the real estate industry in Canada and the United States. value for its shareholders and adheres to sound, conserva- Centrefund is engaged in the business of owning and oper- tive financial and operating practices which should allow it ating a growing portfolio of neighbourhood and community-sized to operate effectively, notwithstanding volatility which may shopping centres with the objective of maximizing operating occur in the economic and retail environment. These prac- cash flow and generating long-term capital appreciation. tices are based on operating within the following guidelines: Since its formation, the affairs of the Company have been managed by an experienced, financially com- ✧ mortgage debt will be limited to 60% of the fair market mitted Management Team comprised of an Advisor and a value of total assets with not more than 33% of such Property Manager, subject to the overall supervision of debt bearing interest at floating rates. the Board of Directors. On January 18, 2000 shareholders debt will be managed to attempt to ensure that maturi- of the Company approved a transaction to terminate ties occurring in any six-month period do not exceed 15% the advisory fee component and revise the incentive of the fair market value of total assets. fee component of the Advisory Agreement effective the Company will not engage in speculative development January 1, 2000. As part of the transaction, employees activities and will only undertake shopping centre devel- of the Advisor were retained directly by the Company, opment and expansion once appropriate zoning and an thus internalizing management. acceptable level of pre-leasing is in place. The Company has experienced significant growth through the acquisition of additional shopping centres. Since the Centrefund seeks to exploit selective acquisition and devel- commencement of operations on March 29, 1994 the Com- opment opportunities that meet its defined investment pany has expanded its initial portfolio of five shopping criteria, including the expectation of appropriate risk-adjusted centres containing approximately 933,000 square feet of rates of return. These criteria are designed to maximize gross leasable area to 70 properties containing approxi- returns through development, redevelopment, remerchan- mately 10.2 million square feet as at December 31, 1999. This dising, renovation and expansion and to minimize risk, growth has been substantially financed with three issues of principally by completing substantial pre-leasing programs common stock, five issues of convertible debentures and and utilizing fixed-price construction contracts. the issue of both common stock and convertible deben- tures or equivalents on the acquisition of the Company’s R E S U LT S O F O P E R AT I O N S wholly-owned U.S. subsidiary in 1994. Since mid-1996, the Company has raised $360 million in cap- In 1997, the Company entered into an exclusive partner- ital through the issue of four series of convertible debentures. ship arrangement for the development of neighbourhood As a result, as detailed below under the caption “Earnings and community shopping centres in Canada and the United and Cash Flow Per Share,” there are a substantial number States. The partnership is carrying on business under the of common shares attached to the conversion rights of the name Centrefund Development Group (“CDG”). As detailed in Company’s outstanding convertible debentures. Accordingly, a separate section of this annual report, CDG has completed it is important when assessing the financial performance of the development of five properties, has eight shopping the Company to review the fully diluted per share data. 19 ✧ ✧ M A N AG E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S The Company believes that for public real estate compa- the Company’s outstanding convertible debentures. This nies cash flow from operations is a commonly accepted and resulted in the Company reporting a per share loss of $0.17 more meaningful indicator of financial performance than net per common share for the year ended December 31, 1999 income. This is because cash flow from operations does as compared to earnings of $0.45 per common share for not recognize depreciation and amortization as operating the year ended December 31, 1998. expenses or recognize deferred income taxes until they are These financial results were generated from gross rental actually paid. Management believes that reductions for income of $137.1 million in 1999, which represents a 21.5% these charges are not meaningful in evaluating income- increase above the $112.8 million in gross rental income producing real estate, which has historically not depreciated. reported in 1998. Cash flow before provision for the termination of advisory Net income in 1998 was reduced by a one-time charge in services amounted to $46.451 million or $3.21 per common the amount of $7.447 million related to the settlement of share for fiscal 1999, a 24% increase over the $37.453 million the 1994 Convertible Participating Debentures. As more fully or $2.69 per common share generated for 1998. On a fully described in Note 14 to the consolidated financial statements, diluted basis cash flow before the aforementioned provision this one-time payment eliminated the future participation for the year ended December 31, 1999 was $1.62 per common component of these securities and accordingly, should not share as compared to $1.49 per common share in fiscal 1998. be considered in the evaluation of the Company’s overall In 1999, net earnings and cash flow from operations financial performance for 1998. In determining reported cash were reduced by the provision for the termination of advi- flow from operations for the year this charge was eliminated. sory services in the amount of $26.85 million. Accordingly, cash flow from operations in 1999, after the provision, was G r o s s R e n t a l I n c o m e $19.601 million or $1.36 per share, or $0.82 per share on a fully A substantial portion of the Company’s growth can be diluted basis. Net earnings for the year ended December 31, attributed to the acquisition of additional shopping centres. 1999, after the aforementioned provision, were $11.233 mil- The following chart summarizes the sources of the Company’s lion as compared to $16.662 million in 1998. growth and the impact on gross rental income over the The Company believes that the provision for the past five years, in thousands of dollars. termination of advisory services that is described in Note 13(b) to the consolidated financial state- ments, should be considered separately in the evaluation of the Company’s financial operating performance in 1999. This provision represents the cost of restructuring the manner in which the Company is managed and evaluating it separately will allow for meaningful comparisons of relative financial performance. In calculating earnings per share, in accordance with Generally Accepted Accounting Principles, 1999 1997 1996 1998 1994 Acquisitions 1995 Acquisitions 1996 Acquisitions 1997 Acquisitions 1998 Acquisitions 1995 $ 38,804 $ 36,666 $ 32,249 $ 30,861 $ 28,710 1,388 – – – – – – Annual gross rental income $137,097 $112,827 $ 71,798 $ 47,477 $ 30,098 13,522 27,323 28,977 25,364 591 1,601 915 9,401 22,753 7,395 – – – – 11,253 25,620 27,860 11,428 – – – 7,496 9,120 – – – – – 1999 Acquisitions Developments Developments Number of shopping centres: acquired during year developed during year 8 4 14 1 18 – 10 – 5 – reported earnings have been reduced by $13.717 million The Company has expanded its portfolio in each year of its in 1999, as compared to $10.368 million in 1998, to reflect existence. As the growth in the size of the Company’s shop- the interest and accretion on the equity component of ping centre portfolio occurs throughout the year, the full impact 20 M A N AG E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S of these acquisitions and developments is only fully reflected The $1.440 million dollar increase in depreciation sub- in the years after the properties are acquired or completed. stantially results from additions to the book value of shop- The shopping centres developed represent those proper- ping centres due to new acquisitions and redevelopments. ties developed by Centrefund Development Group. The $1.604 million increase in amortization results from The Company’s business involves the redevelopment increases in the level of leasing and financing costs incurred and remerchandizing of retail space. As a result, it is com- in connection with the increase in the Company’s leasing mon for the Company to generate income from payments and financing activities. received from tenants as compensation for the cancellation of leases. In 1999, the Company received net lease cancella- I n t e r e s t a n d O t h e r I n c o m e tion payments of $2.7 million as compared to $2.5 million Interest and other income, expressed in thousands of dollars, in 1998. In each year, these payments were received comprises the following: from several different tenants and were included in gross rental income. I n t e r e s t E x p e n s e o n M o r t g a g e s The increase of $8.538 million in interest on mortgages Interest and other income Gains on sale Dividend income Non-recoverable pre-development costs Total 1999 $ 6,238 1,906 750 (442) $ 8,452 1998 $ 5,894 – – (286) $ 5,608 incurred in 1999 as compared to 1998 is substantially as a The Company earns interest income from funds invested in result of an increase in the level of borrowing by the Company. three types of investments: short-term bankers’ accep- In addition to the $105.7 million increase in borrowing during tances, advances made to the Company’s development 1999, the Company incurred a full year’s interest on the partner and an investment in a portfolio of short-term mort- increase in mortgage financing in 1998. The average interest gages, and other receivables including a note due from a rate on the Company’s mortgage borrowings, as detailed on municipality. These three types of investments contributed page 23 under the caption Mortgages Payable, declined from approximately equal amounts to the interest income earned 7.61% in 1998 to 7.44% in 1999. This reduction resulted from by the Company in 1999. The increase in interest income in the fact that new borrowings, either initiated by the Company 1999 over the level earned in 1998 results from a decrease or assumed with property acquisitions, bear interest at in the level of investment in lower interest rate bankers’ mortgage rates lower than the Company’s average interest acceptances and an increase in the level of investment in rate. The average interest rate remains relatively constant higher yielding interest-bearing investments. due to the fact that a substantial portion of these out- The gains on sale represent gains generated on the sale standing liabilities bear interest at fixed interest rates. of a parcel of land and a shopping centre held for redevelop- ment to anchor tenants. Although the Company’s business is D e p r e c i a t i o n a n d A m o r t i z a t i o n not focused on the sale of assets, on occasion, the most effi- Depreciation and amortization for the years ended Decem- cient way to satisfy a tenant’s space requirements, and at ber 31, expressed in thousands of dollars, is summarized the same time create and realize value, involves the sale of all as follows: Depreciation Amortization Total 1999 $ 6,608 3,980 $10,588 1998 $ 5,168 2,376 $ 7,544 or a portion of one of the Company’s shopping centre sites. Dividend income represents semi-annual dividends earned by the Company on its investment in the common shares of Revenue Properties Company Limited, a Toronto Stock 21 M A N AG E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S Exchange listed company involved in the ownership of reduction in the average liability component of the Company’s shopping centres in Canada and the United States. outstanding convertible debentures. Non-recoverable pre-development costs represent the Interest incurred on debentures was $1.753 million lower in Company’s share of such costs incurred by Centrefund 1999 than the level incurred in 1998. This was due to the fact Development Group. C o r p o r a t e E x p e n s e s that in 1998 interest included participating interest on the 1994 Participating Debentures incurred at the rate of 12% per annum until November 30, 1998, the date on which these debentures Advisory fees expensed, which vary with the magnitude of were settled and replaced by the 7.5% Debentures. the Company’s asset base, increased in 1999 by $1.118 mil- lion above the level expensed in 1998 as a result of asset I n c o m e a n d O t h e r Ta x e s growth. In 1999, $930 thousand of the advisory fees incurred Current taxes, expressed in thousands of dollars, comprise were capitalized to shopping centres under redevelopment the following: and land held for development as compared to $852 thou- sand in 1998. The Company determines the portion of the advisory fees to be capitalized from time to time based on the book value of the assets under redevelopment or devel- Canadian federal Large Corporations Tax United States withholding taxes Federal, state and provincial minimum taxes Total 1999 $1,170 475 1,650 $3,295 1998 $ 1,075 490 1,305 $ 2,870 opment. The increase in the level of capitalization in 1999 The increase in the Canadian federal Large Corporations Tax reflects an increase in redevelopment and development results from the increase in the size of the Company’s asset base. activity undertaken. The United States withholding taxes represent taxes Capital taxes, net of recoveries from tenants, increased paid to the Internal Revenue Service on interest paid by the by $242 thousand above the level incurred in 1998 as a Company’s U.S. subsidiary to one of the Company’s Canadian result of an increase in the size of the Company’s capital subsidiaries. These taxes were fully credited against taxes base deployed in the provinces of Ontario and Quebec. otherwise due on this income in Canada. The U.S. federal General and administrative costs incurred in 1999 minimum taxes paid increased in the current year as a result exceeded the level incurred in 1998 by $179 thousand as a of the increase in net income reported for 1999. result of increases in the size of the Company’s operations. Additional professional fees were also incurred in connec- E a r n i n g s a n d C a s h F l o w P e r S h a r e tion with potential acquisitions and the Company’s growing Earnings and cash flow per share are calculated based on activities in the United States. the weighted average number of outstanding common shares during a reporting period. Basic per share informa- I n t e r e s t o n D e b e n t u r e s tion has been calculated for the year ended December 31, Interest on the Company’s outstanding debentures, 1999 based on a weighted average of 14,469,728 common expressed in thousands of dollars, comprises the following: shares outstanding (1998 – 13,947,169 common shares). Interest on convertible debentures Interest on debentures Total 1999 $ 6,614 3,430 $10,044 1998 $ 7,342 5,183 $ 12,525 Fully diluted per share calculations reflect the conversion by the holders of the Company’s outstanding convertible debentures and the exercise of the outstanding common share purchase warrants and options, and amount to a Interest on convertible debentures declined in 1999 as weighted average of 33,541,412 common shares outstanding compared to the level incurred in 1998 as a result of the (1998 – 30,717,772 common shares). 22 M A N AG E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S In accordance with the recommendations of the Canadian without risking the stability of the long-term prospects Institute of Chartered Accountants relating to the presentation of the Company. The chart at the bottom of the page illus- and disclosure of convertible debentures in calculating earn- trates Centrefund’s capital structure. ings per share, earnings have been reduced by $13.717 million (1998 – $10.368 million), representing interest and accretion M o r t g a g e s P a y a b l e on the equity component of the convertible debentures. The Company currently maintains a policy of restricting Q u a r t e r l y R e s u l t s total mortgages payable to 60% of the fair market value of its assets. As at December 31, 1999, total mortgages The growth experienced in the Company’s shopping centre payable represented 46.8% of the total book value of the portfolio makes a review of the Company’s quarterly results Company’s assets, excluding future income tax assets, as meaningful in relation to expected future financial per- compared to 40.3% in 1998. Management believes that the formance. The following chart summarizes the Company’s fair market value of the Company’s assets is in excess of unaudited quarterly results: book value as outlined in the section of this report entitled Gross rental income Interest and other income Real estate operating income before depreciation Net earnings (loss) Cash flow before provision for 1st quarter $ 34,585 $ 2,601 2nd quarter 3rd quarter 4th quarter Total 1999 $ 31,931 $ 1,908 $ 33,634 $ 36,947 $ 2,199 $ 1,744 $ 137,097 8,452 $ Total 1998 $ 112,827 $ 5,608 $ 14,466 $ 8,046(1) $ 11,451 $ 6,526 $ 11,833 $ 11,996 $ 6,538 $ (9,877)(2) $ 11,233(1)(2) $ 16,662(3) $ 49,746 $ 40,323 termination of advisory services Cash flow from operations $ 13,276(1) $ 13,276(1) $ 10,561 $ 10,561 $ 11,283 $ 11,283 $ 11,331 $ 46,451(1) $ 37,453 $ (15,519)(2) $ 19,601(1)(2) $ 37,453 “Estimated Current Value.” As a result, the Company has significant unused mortgage capacity which, together with the Company’s cash resources, is available to fund the future growth of the Company’s shopping centre portfolio. (1) During the first quarter the Company received a net lease cancellation payment of $1.7 million and completed the sale of a property to an anchor tenant to realize a net gain of $1.5 million. (2) Net earnings and cash flow from operations includes a provision for the termination of advisory services in the amount of $26.850 million (see Note 13(b) to the consoli- dated financial statements). (3) Net earnings in 1998 include a non-recurring charge in the amount of $7.447 million related to the settlement of the 1994 Convertible Participating Debentures (see Note 14 to the consolidated financial statements). In Canada, the Company had fixed rate mortgages out- standing as at December 31, 1999 in the aggregate amount of $262.2 million bearing interest at an average interest rate of 7.5% as compared to $205.7 million in outstanding C A P I TA L S T R U C T U R E mortgages with an average interest rate of 7.6% at the The real estate business is capital-intensive by nature, end of 1998. The increase in the outstanding balance is the requiring Centrefund to focus on its capital structure to net result of $33.0 million in repayments and $89.5 million maintain stability and finance growth. Possessing a stable in new financing related to the acquisition of additional prop- capital structure can also create a competitive advantage erties and refinancing. in the acquisition arena. Prudent financial leverage is a key In Canada the Company maintains revolving credit ingredient in generating competitive rates of return on facilities in the aggregate amount of $58.2 million (1998 – Fixed interest rate mortgages 37% equity in the real estate industry. Accord- ingly, Centrefund concentrates on maintaining a proper blend of debt, convertible debt and equity in its capital base in order to minimize income taxes and to generate acceptable equity returns Shareholders’ equity 41% $48.2 million) which are secured by first mortgages on eight of the Floating interest rate mortgages 12% Debentures payable 10% Company’s Canadian shopping centres. As at December 31, 1999, $15.8 million (1998 – $32.8 million) remained undrawn under these facilities. 23 M A N AG E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S The Company’s U.S. shopping centre portfolio is financed, short-term volatility in the debt markets. At December 31, in part, by U.S. dollar denominated mortgages. The debt 1999 the Company had mortgages aggregating $54.4 million service requirements of these mortgages are fully funded maturing in 2000 and $32.1 million maturing in 2001. The by the cash flow generated by the Company’s U.S. opera- average interest rate on the mortgages maturing in each of tions, substantially mitigating the Company’s exposure these years is 7.5%. The Company is in the midst of negoti- to fluctuations in foreign currency exchange rates. As at ating early renewals on these mortgages and anticipates no December 31, 1999 the outstanding principal balances of difficulty in replacing these mortgages at current interest the mortgages were $204.2 million (U.S.$141.5 million) bear- rates, which are about 50 basis points higher than the exist- ing interest at an average interest rate of 7.3%, as com- ing mortgage rates. pared to $172.1 million (U.S.$112.2 million) bearing interest The net cash flow generated by each shopping centre owned at an average interest rate of 7.6% in 1998. by the Company is more than sufficient to support refinancing The increase in outstanding balance of mortgages any outstanding mortgage liability on any such project. resulted from the net effect of $16.9 million (U.S.$11.6 mil- lion) in repayments and the assumption of $59.1 million D e b e n t u r e s P a y a b l e (U.S.$40.9 million) in mortgages related to the acquisition During 1999 the 7.5% U.S. Dollar Denominated Debentures of additional shopping centres and refinancings. were repaid in full and the holders of these debentures In the United States, the Company maintains revolving utilized the proceeds of the repayment to exercise their credit facilities in the aggregate amount of $134.6 million or warrants to purchase common shares of the Company. U.S.$93.3 million (1998 – $76.6 million or U.S.$50 million). As a result, as at December 31, 1999 the 7.5% Debentures These facilities are secured by first mortgages on twelve of (formerly the 1994 Convertible Participating Debentures) are the Company’s U.S. shopping centres, bear interest at a the only remaining issue of outstanding debentures that are floating rate linked to the London Inter-Bank Rate (LIBOR) not convertible into common stock of the Company. These and mature in 2003. As at December 31, 1999 and 1998 the debentures are direct subordinated obligations of the Company full amount had been drawn under this facility. The Company that are secured by a floating charge on four of the Company’s has entered into an interest rate swap arrangement cover- shopping centres and mature on December 1, 2003. ing $62.5 million (U.S.$43.3 million) of this facility and as such has fixed the interest rate until 2001. C o n v e r t i b l e D e b e n t u r e s Centrefund’s policy of restricting floating rate debt to Centrefund believes that the use of long-term convertible 33% of the total amount of mortgages payable outstanding debentures as a source of capital is a tax-effective method of from time to time minimizes the impact of volatility in the financing a portion of the equity component of its expand- interest rate markets. In addition to the Company’s revolv- ing shopping centre portfolio. ing credit facilities, floating rate financings are utilized to Accordingly, a large portion of the Company’s capital is finance projects that are in the process of being expanded, in the form of convertible debentures that mature between renovated, or developed. Centrefund does not speculate on 2006 and 2008. The debentures require interest payable interest rates and attempts to fix interest rates once a proj- semi-annually at rates ranging from 7% to 8.5%. In addition ect is at a stage of completion making it suitable for long- to being convertible at the holders’ option at common share term mortgage financing. As at December 31, 1999, 23.7% prices that range from $11 to $25.25 per share the Company (1998 – 24.6%) of the Company’s total mortgage debt has the option on redemption or maturity of repaying the included floating interest rates. debentures through the issue of common stock. The Company also attempts to manage its long-term debt It is anticipated that the holders of these debentures will by staggering maturity dates in order to mitigate against exercise their rights to convert them into an aggregate of 24 M A N AG E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S 18,231,444 common shares on or before maturity. If the Also during 1999, 275,774 common shares (1998 – holders of the debentures do not exercise their conversion 200,253 common shares) were issued pursuant to the rights, the Company has the option of repaying the deben- Dividend and Interest Reinvestment Plan initiated in 1995. tures on maturity by way of the issue of common shares The issue of these shares added $3.654 million (1998 – at 95% of the then trading price of the Company’s common $3.338 million) to the Company’s stated capital. During 1999 stock. Accordingly, the Company views these convertible the Company terminated the Dividend and Interest Reinvest- debentures as equity instruments issued on a tax-effective ment Plan because it was no longer in the best interests basis and at a premium to the trading price of the of the Company to issue shares trading at a significant dis- Company’s common stock when issued. count to estimated net asset value per share. In addition, in The two $100 million issues of 7.0% and 7.25% debentures 1999 the Company purchased and cancelled 456,682 com- completed in 1998 also provide the Company with the option, mon shares pursuant to its Normal Course Issuer Bid that subject to regulatory approval, to pay semi-annual interest gave rise to a charge of $6.226 million to stated capital. through the issue of common stock. Shareholders’ equity as at December 31, 1999 also includes In 1996, the Company retroactively adopted the new $2 million representing the proceeds to be received by recommendations of the Canadian Institute of Chartered the Company for the warrants to be issued as part of Accountants relating to the presentation and disclosure of the consideration for amendments made to the Advisory financial instruments. In accordance with these recommenda- Agreement detailed in Note 13(b) to the 1999 consolidated tions, each series of the Company’s convertible debentures is financial statements. presented in its debt and equity component parts, measured Shareholders’ equity as at December 31, 1999 includes a at its respective issue dates, as more thoroughly detailed cumulative, unrealized currency translation adjustment in the in Note 1(g) to the Company’s 1999 consolidated financial amount of $2.473 million (1998 – $17.169 million). This amount statements. The details of the Company’s outstanding represents the difference between the U.S. dollar exchange convertible debentures are summarized in Note 7 to the rate in effect at the date of the acquisition of the Company’s Company’s 1999 consolidated financial statements. U.S. net assets, and the U.S. dollar exchange rate, as at S h a r e h o l d e r s ’ E q u i t y December 31, 1999 and 1998 respectively. The significant reduction to shareholders’ equity from this source during 1999 Shareholders’ equity amounted to $421.538 million as at resulted from the fact that the U.S. dollar exchange rate in December 31, 1999 as compared to $433.041 million at the effect at December 31, 1999 had dropped to U.S.$1.00 = end of 1998. This decrease resulted from changes in each $1.44 from U.S.$1.00 = $1.53 as at December 31, 1998. of the component parts of shareholders’ equity. Shareholders’ equity as at December 31, 1999 includes Shareholders’ equity as at December 31, 1999 includes a deficit of $27.347 million (1998 – $11.917 million), which $294.119 million (1998 – $286.208 million) which represents the substantially arises as a result of the Company’s policy of equity component of convertible debentures as discussed above. paying dividends on common shares by reference to cash As at December 31, 1999 the Company had 15,070,323 flow from operations as opposed to net income. Centrefund (1998 – 14,307,706) issued and outstanding common shares considers this an appropriate policy as charges for deprecia- with a stated capital of $150.293 million (1998 – $141.581 mil- tion are not meaningful in light of the fact that, historically, lion). During 1999, 943,525 common shares (1998 – 651,952 properly maintained income-producing real estate has not common shares) were issued in connection with the exercise depreciated, and deferred income taxes only impact cash of warrants and the conversion of convertible debentures. flow in the year they become currently payable. In addition The issue of these shares added $11.284 million (1998 – net income for the current year was reduced by $16 million, $8.826 million) to stated capital. representing the after-income-tax impact of the provision 25 M A N AG E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S for the termination of advisory services resulting from addition to meeting all property-related costs, including the management restructuring as more fully described in interest and regular amortization on mortgages, cash is Note 13(b) to the consolidated financial statements. required to fund interest payments due on the Company’s L I Q U I D I T Y various issues of outstanding debentures. After all such payments are made, Centrefund maintains a policy of The Management Team believes liquidity to be a key to paying regular quarterly dividends to the Company’s com- Centrefund’s vitality and an essential ingredient in the mon shareholders. process of portfolio growth and the creation of significant As at December 31, 1999, Centrefund had undrawn avail- long-term value. The Company considers liquidity to be able credit facilities totaling $15.8 million (1998 – $32.8 million), comprised of cash flow from operations plus the amount of and has the capacity to borrow in excess of $100 million available undrawn credit facilities. Longer-term liquidity is of additional borrowings and still remain in compliance positively impacted by the Company’s capacity to incur with its maximum debt level policy. The actual level of long-term mortgage debt within the limits of the overall pol- future borrowings will be determined based upon the level icy of restricting such debt to 60% of the fair market value of liquidity required and the prevailing interest rate and debt of total assets. market conditions. Until recently, Centrefund’s ability to access the capital The financial guidelines that Centrefund follows have markets, which it has successfully demonstrated in each been established in order to assist the Company in main- year of its existence until 1999, also significantly bol- taining a strong liquidity position. This in turn should con- stered its long-term liquidity and its capacity to expand its tinue to provide the Company with the necessary financial shopping centre portfolio. But the dramatic fall in the stability required to give it a competitive advantage in trading prices of all publicly traded real estate equities, operating its business and in seeking to selectively expand Centrefund’s included, since the beginning of 1999, has its shopping centre portfolio. all but eliminated the opportunity for Centrefund to raise equity capital in a cost-effective manner. Accordingly, until D I V I D E N D S the trading price of the Company’s common stock improves The Company has maintained a policy of paying regular to a level that recognizes net asset value, the capital quarterly dividends to common shareholders since it was markets will be all but shut off to the Company. In spite of formed in 1994. Dividends are set annually by the Board the deterioration in the public real estate equity markets, of Directors in November of each year, having regard to the Centrefund’s policy of raising capital when it was available Company’s capital requirements and with due consideration on favourable terms has left the Company with unused to the Company’s alternative sources of capital. financial capacity. In 1999, the Company paid dividends of $0.89 per com- Long-term liquidity can also be augmented through the mon share. These dividends represented 55% of the $1.62 sale of partial or full interests in shopping centres. To date the Company reported in fully diluted cash flow per share Centrefund has not sold interests in any of its operating before the provision for the termination of advisory services. shopping centres. Over the course of the next year the The Company is currently paying a quarterly dividend of Company intends to determine whether the sale of inter- $0.23 per common share. To date, the annual dividend rate ests in mature properties is a course of action that should has grown at a compound rate of approximately 5% since be considered to realize on value created and augment the Company was formed in March 1994. long-term liquidity. In 1995, the Company implemented a Dividend and The level of the Company’s liquidity must be measured Interest Reinvestment Plan to provide those stakeholders against its short and long-term requirements for cash. In wishing to reinvest their Centrefund earnings in the Company 26 M A N AG E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S with an efficient way of doing so. The Plan allowed share- The Advisor has also been paid a fee on the successful holders to elect to receive their dividends, and debenture- completion of acquisitions, which substantially covers the holders to elect to receive their interest, in common shares cost of identifying and evaluating acquisition opportunities of the Company issued at a 5% discount to the applicable and the completion of all due diligence procedures. market price. In 1999, 275,774 common shares were issued These financial arrangements have allowed the Company pursuant to the Plan (1998 – 200,253 common shares). to operate effectively, maintain a competitive administra- The issue of these shares raised $3.654 million (1998 – tive cost structure and provide its Management Team with $3.338 million) of additional capital for the Company. an incentive for performance. The Company believes that However, as the trading price of the Company’s common this has historically been a cost-effective manner in which shares declined during 1999 to well below estimated net asset to grow a significant real estate portfolio. value, it was no longer in the interest of the Company to raise In 1999, the Board of Directors of the Company deter- capital by issuing common shares pursuant to the Plan. Accord- mined that it would be in the best long-term interest of the ingly, the Plan was terminated in the second half of 1999. Company to terminate the Advisory Agreement in order to internalize management of the Company. The internalization M A N A G E M E N T S T R U C T U R E of management is expected to: (i) establish a management Since the formation of the Company, the affairs of Centrefund structure more typical of an operating real estate entity have been managed by a Management Team comprised of an of comparable size and ensure that the goodwill created Advisor and a Property Manager. These arrangements are by the Company’s success will accrue to the benefit of pursuant to five-year renewable contracts. Both the Advisor the Company; (ii) allow the Company to capture the effi- and the Property Manager have a major financial stake in ciencies and cost savings resulting from the growth in the affairs of Centrefund by virtue of the significant share- the Company’s asset base that previously accrued to the holdings of related entities. As at December 31, 1999, entities Advisor; (iii) better align the interests of the Company’s related to the Management Team owned more than 15% of management and its public shareholders as well as provide the outstanding common shares of the Company. This man- for continuity of management; (iv) render the Company’s agement structure has allowed Centrefund to use the securities a more attractive investment, thus allowing extensive personnel resources of its Management Team, which the Company to broaden its shareholder base and in the includes more than 150 trained real estate professionals, long term assist the Company in raising capital on a cost- whenever required, while only paying for those services effective basis. provided, on an as needed basis. Centrefund pays an annual A Special Committee of the Board, with the assistance advisory fee based on the size of its asset base, and property of numerous professionals, negotiated and recommended management and leasing fees based on fair market rates. to the public shareholders of the Company a transaction In addition, the Management Team is entitled to earn an for the termination of the advisory fee component and incentive fee of 20% of the amount by which the actual modifications to the terms of the incentive arrangements cash flow return, including any proceeds of sale, generated included in the Advisory Agreement. The recommendation by the shopping centre portfolio exceeds a 10% annual return of the Special Committee was approved by the public share- on the equity invested in the portfolio. On termination of holders of the Company at a meeting called for such purpose the contract, the Management Team is also entitled to earn on January 18, 2000. The transaction takes effect from an incentive fee equal to 20% of the appreciation in value of January 1, 2000 and is scheduled to close during the second the Company’s shopping centre portfolio. quarter of 2000. 27 M A N AG E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S R I S K M A N A G E M E N T leases also require tenants to be responsible for the pay- Centrefund is exposed to numerous business risks in the ment of realty taxes and the costs of operating and manag- normal course of its business that can impact both short- ing the property within which they are located. As such, and long-term performance. It is the responsibility of the these leases are considered to be net leases to the Company. Management Team, under the supervision of the Board of Directors, to identify, and to the extent possible, mitigate or N a t u r e o f Te n a n c i e s minimize the impact of all such business risks. The major Centrefund seeks to lease a large portion of the gross categories of risk Centrefund encounters in conducting its leasable area of each of its properties on a long-term basis business and the manner in which it takes actions to mini- to successful anchor tenants such as discount department mize their impact are outlined below: O p e r a t i n g R i s k The most significant operating risk affecting Centrefund’s performance is the potential for reductions in revenue resulting from the Company’s inability to maintain acceptable Local 18.1% Anchor, national and regional tenants 76.4% stores, food supermarkets and promotional retailers. These tenants, in addition to creating a stable source of long- term rental income, generate customer traffic for the bene- fit of smaller retail and service levels of occupancy and stable or increasing rental rates. Centrefund focuses on securing Available 5.5% tenants. The nature and relationship of the anchors to small shop tenants and the retail tenants that provide consumers with basic necessi- balance between national and local retailers is a key ingre- ties and amenities as distinct from those which cater to dient in establishing stable, sustainable revenue from each more discretionary fashion demands. This makes the of Centrefund’s properties. As the adjacent chart illustrates, Company’s shopping centre portfolio less susceptible to more than 76% of Centrefund’s total gross leasable area is general economic swings, as even during economic down- occupied by anchor and national retail tenants. turns, consumers continue to purchase necessities such as groceries and basic clothing. This type of retail property L e a s e M a t u r i t i e s is less vulnerable and more adaptable to changes in retail Centrefund attempts to stagger lease maturities on a format, such as the advent of the large-format or big-box property-by-property basis, which helps to generate a retailer. In fact, these large-format or big-box retailers have more stable flow of revenue and mitigate risks related become excellent additional anchors for some of Centrefund’s to changing market conditions. The Company’s leasing larger shopping centres. philosophy is directed at obtaining long-term tenancies with The financial success of Centrefund’s tenants, operating contractual rent escalations as well as participation in sales in well located, properly maintained and successfully mer- success through tenancies with percentage rent clauses. chandised and positioned properties, will minimize the impact The Company has a very stable shopping centre portfolio, of this risk on the Company. Centrefund seeks out tenants with lease expirations in each of the next five years consti- that are well-capitalized, and who offer the consumer goods tuting an annual average of less than 10% of the total and services at fair prices. Centrefund’s lease arrangements leased area in the Centrefund portfolio. with many of its tenants provide for income protection and growth through rent escalations and through a participation G e o g r a p h i c D i v e r s i f i c a t i o n in the tenants’ sales success in the form of percentage rents As the chart on the next page shows, the existing Centrefund which are payable in addition to minimum rents. Centrefund’s portfolio is somewhat geographically diversified, although 28 M A N AG E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S major concentrations exist in Ontario, Alberta, Florida and rates of return. The Company’s acquisition criteria are Texas. There is a trade-off between operational efficiencies stringent and its due diligence procedures are rigorous. and market influence that can be achieved by geographic Centrefund uses a team of trained professionals, including concentration, and vulnerability to local market influences lawyers, engineers, accountants and architects, to thor- that can be avoided by geographic diversification. As oughly analyze each proposed acquisition prior to its com- Centrefund expands its portfolio, it will seek to further pletion. No acquisition is committed to without a detailed diversify the location of properties by selectively entering analysis and a personal inspection being completed by the new markets. However, it will also seek to add properties most senior officers of the Management Team. Centrefund in areas where it currently owns shopping centres to take believes that acquisitions should only be undertaken if advantage of local market knowledge, anchor tenant rela- the subject property has the potential for meaningful long- tionships and synergies in both management Ontario 34.3% term growth in operating cash flow. Distressed and leasing. The Company, through Centrefund Development Group, is Florida 12.6% currently contemplating expand- ing into the North Carolina, Arizona and Colorado markets. Texas 26.0% properties will only be acquired if the Company is satisfied, through pre- Western Canada 18.8% leasing, that the property can become economically viable in a short, predictable period of time. During 1997, the Company F i n a n c i a l R i s k Maritimes 2.5% Quebec 5.8% formed an exclusive partnership for the As outlined above, Centrefund operates in compliance with development of neighbourhood and community-sized shop- conservative financial guidelines in order to mitigate the ping centres in Canada and the United States. The partner- financial risks inherent in the real estate industry. Limits on ship, operating under the name Centrefund Development financial leverage and strong cash flow reduce the risk that Group, will generally not participate in land speculation or replacement financing may not be available upon the matu- long-term land banking but rather will generally only commit rity of long-term debt. To further limit the Company’s expo- to acquire land once it is fully zoned for the intended retail sure to overall reductions in credit availability in poor economic use and only when an acceptable level of pre-leasing is times, the Company attempts to stagger its long-term debt achieved. Construction risk is mitigated through the use of maturities and maintain an adequate level of cash or undrawn general contractors engaged pursuant to fixed-price contracts. credit capacity. Centrefund also attempts to arrange stand- The Company believes that it can enjoy the rewards of higher alone, limited recourse project financing to further mitigate investment yields on newly constructed shopping centres the potential risk of a lack of replacement financing. In addi- without increasing the risk profile of the investment. tion, the Company limits the amount of floating rate debt it will incur at any one time in order to insulate itself from E n v i r o n m e n t a l R i s k interest rate volatility. Shopping centres generally involve less environmental risk than other classes of commercial real estate as very few Acquisition Expansion and Development Risk tenants manufacture, process or store substances that The key to the Company’s ongoing success will be its ability would be considered environmentally unsafe. The major to create and enhance value through the skill, creativity and exceptions to this general rule can be gas stations situated energy of its Management Team. Centrefund will continue on out-parcels adjacent to shopping centre properties and to seek out acquisition, expansion and selective develop- some dry cleaning establishments. The primary responsibil- ment opportunities that offer acceptable risk-adjusted ity for any environmental remediation rests with the party 29 M A N AG E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S responsible for creating the contamination, although the E F F E C T S O F I N F L AT I O N Company may also be liable. Centrefund maintains a pro- Inflation has remained relatively low since Centrefund com- gram of periodically reviewing and testing its properties to menced operations in March 1994. As a result, inflation has determine if environmental problems exist and includes as a had a minimal impact on the Company’s operating perfor- standard covenant in its leases a prohibition against environ- mance to date. Nevertheless, most of Centrefund’s long-term mentally unsound activities. The Company undertakes a leases contain provisions designed to mitigate the adverse professionally conducted environmental audit before it com- impact of inflation. These provisions include a pass-through pletes the acquisition of any property in order to mitigate of operating costs, including realty taxes and management environmental risk. expenses, which insulates the Company from inflationary price increases. In addition, most leases include clauses that E C O N O M I C C O N D I T I O N S allow the Company to receive percentage rents based on The economic conditions in the markets in which the tenants’ gross sales, which generally increase as prices rise. Company operates can have a significant impact on the Most of the Company’s long-term leases include rent esca- Company’s financial success. Adverse changes in general or lation clauses, which increase rental rates over the term of local economic conditions can result in some retailers being the lease at either pre-negotiated levels or levels determined unable to sustain viable businesses and meet their lease by reference to increases in the Consumer Price Index. Many obligations to the Company, and may also limit the of the Company’s non-anchor leases are for terms of five Company’s ability to attract new or replacement tenants. years or less, providing the Company with the opportunity to However, Centrefund’s shopping centres are generally less achieve rent increases on renewal or when re-renting the space. susceptible to economic downturns, as they cater to the Centrefund is also concerned with the impact of rising basic needs of the retail customer by offering food super- interest rates that are symptomatic of periods of inflation. markets, drug stores, financial services, discount depart- As previously described, the Company limits its floating rate ment stores and promotional retailers as tenants. debt, seeks to obtain long-term fixed-rate financing, when- In addition, the impact of economic conditions on the over- ever available, and attempts to avoid concentrations of all Centrefund portfolio has been mitigated through the debt maturities, in order to mitigate its exposure to volatil- long-term nature of its existing leases and through geo- ity in the interest rate markets. The combination of rising graphic diversification. rents and fixed-rate financing can significantly enhance the The Company operates a capital-intensive business and value of a well-leased shopping centre portfolio. as such is sensitive to changes in long-term interest rates. The Company mitigates its exposure to rising interest rates T H E Y E A R 2 0 0 0 by fixing interest rates on most of its long-term debt. How- The computer system utilized by the Company and its Prop- ever, although long-term interest rates have increased by erty Manager are Year 2000 compliant. To date, the Company approximately 150 basis points over the past year, they has not experienced any problems with tenant or supplier remain 15-20 percent below the average yield that can be computer systems that may not be Year 2000 compliant. The obtained on acquisitions, and 25-30 percent below the aver- Company is sensitive to the potential issues that could arise age yield on the development of the Company’s type of in the event of a third party’s computer system not being shopping centre. If long-term interest rates remain below Year 2000 compliant. Accordingly, the Company continues 9%, as is predicted by many economists, the environment to monitor transactions with a view to minimizing the potential within which the Company operates will remain positive. impact of a breakdown in a third party’s computer systems. 30 E S T I M AT E D C U R R E N T VA L U E It is generally accepted in the real estate industry that current value information is an important supplement to historic cost financial statements. At Centrefund we provide this information annually to assist shareholders in the evaluation of their invest- ment and the measurement of the effectiveness of the Company’s business plan in light of its overall objective of creating significant long-term shareholder value. Centrefund’s Management Team believes the most appropriate method of determining the estimated current value of the individual properties that comprise its shopping centre portfolio is the Income Capitalization Method. This method estimates value based on capitalizing the current year’s annualized income before debt service at a rate equal to the yield a prospective purchaser would expect to earn if they were to acquire the subject property at the determined price. In determining the value of Centrefund’s properties, including those which are currently under redevelopment or develop- ment and scheduled for completion within 12 months, each property’s stabilized annualized income has been capitalized after providing a reserve for vacancies and non-recoverable expenses. The resulting value is then adjusted to reflect the estimated cost to complete the projects under redevelopment and development. We believe that based on the nature, quality and size of the Company’s properties, the appropriate capitalization rate for the Company’s portfolio in today’s market is in the range of 9.5%. In the estimate of net asset value, no recognition has been given to any benefit which may accrue to shareholders from the fair value of the Company’s existing liabilities, including the outstanding convertible debentures, which are currently trading at a substantial discount to their face amount. We have also detailed the per share incentive fee which would be payable to the Company’s Management Team if the appreciation calculated were to be realized. Capitalization Rate 9.25% 9.50% 9.75% Pre-tax current value, per common share: Basic Fully diluted Management incentive fee per fully diluted share $17.73 $16.43 $ 1.16 $16.20 $15.50 $ 1.09 $14.75 $14.47 $ 0.84 The current values included in the above table are estimates; the actual amounts that might be realized on the sale of the Company’s portfolio of shopping centres could be higher or lower than the level indicated. Any costs of a potential disposition, and any income tax which may be exigible on a disposition, have not been reflected. 31 M A N AG E M E N T ’ S R E S P O N S I B I L I T Y F O R F I N A N C I A L S TAT E M E N T S The accompanying consolidated financial statements and all of the information included in this annual report have been prepared by and are the responsibility of management and the Board of Directors of the Company. The consolidated financial statements have been prepared in accordance with generally accepted accounting principles appropriate for the real estate industry in Canada, and reflect management’s best estimates and judgements based on currently available information. The significant accounting policies which management believes are appropriate for the Company are described in Note 1 to the consolidated financial statements. The Company has developed and maintains an appropriate system of internal control in order to assure, on a reasonable and cost-effective basis, that relevant and reliable financial information is produced. The Board of Directors is responsible for reviewing and approving the consolidated financial statements and overseeing management’s performance of its financial reporting responsibilities. The Board has appointed an Audit Committee comprised of three Directors, who are independent from management. The Audit Committee reviews the financial statements, adequacy of internal controls, the audit process and financial reporting with management and the external auditors. The Audit Committee reports to the Directors prior to the approval of the audited financial statements for publication. Deloitte & Touche LLP have been appointed by the shareholders as external auditors to perform an audit of the consolidated financial statements in accordance with generally accepted auditing standards to enable them to express to the shareholders their opinion on the consolidated financial statements as set out below. [Peter F. Cohen] [Percy A. Fink] Peter F. Cohen, C.A. Percy A. Fink, C.A. Chairman, President and Chief Executive Officer Chief Financial Officer 32 A U D I T O RS ’ R E P O R T To the Shareholders of Centrefund Realty Corporation: We have audited the consolidated balance sheets of Centrefund Realty Corporation as at December 31, 1999 and 1998 and the consolidated statements of operations, deficit, cash flow from operations and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We have conducted our audits in accordance with auditing standards generally accepted in Canada. Those standards require that we plan and perform an audit to obtain reasonable assurance 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. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Company as at December 31, 1999 and 1998 and the results of its operations and its cash flows for the years then ended in accordance with accounting principles generally accepted in Canada. [Deloitte & Touche LLP] Chartered Accountants Toronto, Canada March 3, 2000 33 C O N S O L I DAT E D B A L A N C E S H E E T S December 31 (in thousands of dollars) A s s e t s 1999 1998 Shopping centres (Note 2) $ 932,942 $ 863,754 25,111 28,469 47,396 40,280 38,335 17,983 45,522 29,083 28,169 24,336 $ 1,112,533 $ 1,008,847 $ 502,921 $ 397,203 55,955 66,463 38,166 27,490 690,995 421,538 31,422 73,671 48,254 25,256 575,806 433,041 $ 1,112,533 $ 1,008,847 Land and shopping centres under development (Note 3) Cash and cash equivalents Amounts receivable (Note 4) Other assets (Note 5) Future income tax assets (Note 15) L i a b i l i t i e s Mortgages payable (Note 6) Accounts payable and accrued liabilities Convertible debentures payable (Note 7) Debentures payable (Note 8) Future income tax liabilities (Note 15) S h a r e h o l d e r s’ E q u i t y (Note 9) See accompanying Notes to Consolidated Financial Statements Approved by the Board of Directors: [Peter F. Cohen] Peter F. Cohen Director [Robert S. Green] Robert S. Green Director 34 C O N S O L I DAT E D S TAT E M E N T S O F O P E RAT I O N S Years ended December 31 (in thousands of dollars except per share amounts) Gross rental income Property operating costs Rental income Interest and other income Interest expense: Mortgages (Note 11) Debentures Corporate expenses (Note 12) Real estate operating income before depreciation and amortization Depreciation and amortization Real estate operating income Provision for termination of advisory services (Note 13(b)) Settlement of 1994 convertible participating debentures (Note 14) Earnings before income and other taxes Income and other taxes: (Note 15) Current Deferred Net earnings for the year Net (loss) earnings per common share (Note 16) See accompanying Notes to Consolidated Financial Statements 1999 1998 $ 137,097 $ 112,827 49,571 87,526 8,452 95,978 29,117 10,044 39,161 7,071 49,746 10,588 39,158 26,850 – 12,308 3,295 (2,220) 1,075 $ 11,233 $ (0.17) 39,398 73,429 5,608 79,037 20,579 12,525 33,104 5,610 40,323 7,544 32,779 – 7,447 25,332 2,870 5,800 8,670 $ 16,662 $ 0.45 35 C O N S O L I DAT E D S TAT E M E N T S O F D E F I C I T Years ended December 31 (in thousands of dollars) Deficit, beginning of the year Net earnings for the year Interest and accretion on equity component of convertible debentures (net of tax of $9,122; 1998 – $6,854) Dividends Deficit, end of the year 1999 1998 $ (11,917) $ (6,341) 11,233 16,662 (13,717) (12,946) (10,368) (11,870) $ (27,347) $ (11,917) C O N S O L I DAT E D S TAT E M E N T S O F C A S H F L O W F R O M O P E R AT I O N S Years ended December 31 (in thousands of dollars except per share amounts) Real estate operating income Add: depreciation and amortization Deduct: current taxes Cash flow before provision for termination of advisory services Provision for termination of advisory services (Note 13(b)) Cash flow from operations Cash flow before provision for termination of advisory services per common share: (Note 16) Basic Fully diluted Cash flow from operations per common share: (Note 16) Basic Fully diluted See accompanying Notes to Consolidated Financial Statements 36 1999 1998 $ 39,158 $ 32,779 10,588 (3,295) 46,451 26,850 7,544 (2,870) 37,453 – $ 19,601 $ 37,453 $ $ $ $ 3.21 1.62 1.36 0.82 $ $ $ $ 2.69 1.49 2.69 1.49 C O N S O L I DAT E D S TAT E M E N T S OF CASH FLOW S Years ended December 31 (in thousands of dollars) O p e ra t i n g A c t iv i t i e s Net earnings for the year Items not affecting cash: Depreciation and amortization Deferred income taxes Settlement of 1994 convertible participating debentures Cash flow from operations Net change in non-cash operating items Cash provided by operating activities I nve s t i n g A c t iv i t i e s Acquisition of shopping centres Expansion and redevelopment of shopping centres Acquisition and development of land Acquisition of loans and mortgages Advances to development partner Investment in mortgage Investment in marketable securities Cash used in investing activities F i n a n c i n g A c t iv i t i e s Proceeds of mortgage financings Repayment of mortgages payable Issue of debentures, net of issue costs Repayment of debentures Repayment of convertible debentures Issue of common shares Common shares purchased and cancelled Dividends paid Interest paid on equity component of debentures Settlement of 1994 convertible participating debentures Cash provided by financing activities (Decrease) increase in cash and cash equivalents Cash and cash equivalents, beginning of the year Cash and cash equivalents, end of the year S u p p l e m e n t a r y I n fo r m a t i o n Cash income taxes paid Cash interest paid See accompanying Notes to Consolidated Financial Statements 37 1999 1998 $ 11,233 $ 16,662 10,588 (2,220) – 19,601 18,663 38,264 (27,001) (58,789) (7,568) – (14,232) (4,835) (7,567) (119,992) 154,634 (53,446) – (10,088) (6,474) 13,471 (6,226) (12,946) (14,250) – 64,675 (17,053) 45,522 7,544 5,800 7,447 37,453 (11,785) 25,668 (158,702) (57,875) (13,177) (8,140) (6,562) – (8,478) (252,934) 162,373 (57,195) 193,080 (1,254) (5,984) 4,618 – (11,870) (7,202) (7,447) 269,119 41,853 3,669 $ 28,469 $ 45,522 $ 2,420 $ 53,496 $ 1,726 $ 40,939 N O T E S T O C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S D e c e m b e r 3 1 , 1 9 9 9 & 1 9 9 8 1 . S i g n i f i c a n t A c c o u n t i n g Po l i c i e s The Company was incorporated under the laws of Ontario on November 10, 1993 to engage in the business of acquiring, expanding, developing and redeveloping, and owning neighbourhood and community shopping centres. The Company’s financial statements are presented in accordance with generally accepted accounting principles in Canada and are substantially in accordance with the recommendations of the Canadian Institute of Public Real Estate Companies. The Company’s significant accounting policies are as follows: (a) Principles of Consolidation The consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries, and the Company’s proportionate share of assets, liabilities, revenues and expenses of partnership and limited liability corporate ventures, which are accounted for using the proportionate consolidation method. (b) Shopping Centres, Shopping Centres Under Redevelopment and Land and Shopping Centres Under Development Shopping centres are stated at the lower of cost less accumulated depreciation, and net recoverable amounts. Shopping centres under development and redevelopment and land held for development are stated at the lower of cost and net recoverable amounts. The cost of shopping centres, shopping centres under development and redevelopment and land held for development includes all expenditures incurred in connection with the acquisition, development, redevelopment and initial leasing of the properties. These expenditures include acquisition costs (including acquisition fees paid to the Advisor), construction costs, initial leasing costs, other direct costs, building improvement costs and carrying costs. Carrying costs (including property taxes and interest, net of operating results) are capitalized to the cost of the properties until the accounting completion date (which is based on achieving a satisfactory occupancy level within a predetermined time limit). Net recoverable amounts represent the estimated future net cash flow expected to be received from the ongoing use and residual worth of a property. To arrive at this amount, the Company projects the cash flow for each property on an undiscounted basis and reviews the current market value of its land holdings. These projections take into account the specific business plan for each property and management’s best estimate of the most probable set of economic conditions anticipated to prevail in the market area. (c) Gross Rental Income Gross rental income includes rents earned from tenants under lease agreements, including percentage participation rents, property tax and operating cost recoveries, and incidental income, including lease cancellation payments. (d) Depreciation and Amortization The Company follows the sinking-fund method of depreciating its buildings and improvements. Under this method, depreciation is charged to income in increasing annual amounts consisting of fixed annual sums, together with interest compounded at the rate of 5% per annum, so as to fully depreciate the properties over their estimated useful lives, which vary but do not exceed 40 years. 38 N OT E S TO C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S The Company amortizes commitment fees and other costs incurred in connection with debt financing over the term of such financing. Leasing fees and tenant inducements incurred on securing leases, other than initial leases, are amortized over the term of such leases on a straight-line basis. (e) Investment in Marketable Securities The Company’s investment in a public real estate company is stated at cost unless there is a decline in value which is considered to be other than temporary, in which case the investment would be written down to estimated realizable value. (f ) Foreign Currency The Company carries on business in the United States through operationally and financially self-sustaining wholly- owned subsidiaries. Assets and liabilities denominated in United States dollars are translated into Canadian dollars at year-end exchange rates. The resulting net gains or losses are accumulated as a separate component of shareholders’ equity. Revenues and expenses denominated in United States dollars are translated at the average exchange rate for the year. (g) Convertible Debentures The Company presents its convertible debentures in their debt and equity component parts where applicable, as follows: 1. The debt component represents the value of the semi-annual interest obligations to be satisfied by cash, discounted at the rate of interest that would have been applicable to a debt-only instrument of comparable term and risk at the date of issue. As a result, a portion of the semi-annual interest payments has been treated as a reduction of the debt component and the remainder as interest expense. 2. The equity component of the convertible debentures is presented under “Shareholders’ Equity” in the consolidated balance sheets. A value is ascribed to the equity component as a result of the issuer’s ability upon maturity to con- vert the debentures into common shares, and is increased over its term to the full face value of the debentures by an annual charge to retained earnings. In addition, debentures which provide the issuer the ability to satisfy the interest payments through the issuance of common shares are also included in the equity component of convertible debentures. A value is also ascribed to the conversion right granted to the holder, which remains a fixed amount over the term of the debentures. 3. Debenture issue costs are proportionately allocated to their respective debt and equity components. The debt compo- nent of the issue costs is classified as deferred financing costs, and is amortized over the term of the debentures. The equity component of the issue costs reduces the carrying value of the equity component of the convertible debentures. (h) Income Taxes The Company adopted the new recommendations of the Canadian Institute of Chartered Accountants (“CICA”) concerning accounting for income taxes for 1999 with restatement of the 1998 comparative information. The adoption of the new standards changes the Company’s focus when accounting for income taxes from a statement of earnings to a balance sheet approach. Previously, the Company recorded deferred income taxes based on timing differences in the recognition of income and expense for tax and financial reporting purposes. The new standards require the recognition of future income taxes for the expected future tax consequences of differences between the carrying amount of balance sheet items and their corresponding tax values. 39 N OT E S TO C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S These new standards also require the Company to compute future income taxes using the enacted corporate income tax rates for the years in which the differences will reverse. Previously, deferred income tax balances reflected the rates in effect when the differences arose. ( i ) Financial Instruments The fair value of the Company’s financial instruments is estimated based on the amount at which these instruments could be exchanged in a transaction between knowledgeable and willing parties. Fair value is estimated using market values where available or using present value techniques and assumptions concerning the amount and the timing of expected future cash flows and discount rates which reflect the appropriate level of risk of the instrument. The estimated fair values may differ from those which could be realized in an immediate settlement of the instruments. The fair value of cash and short-term deposits approximates their carrying value. Certain amounts receivable, other assets, accounts payable and accrued liabilities are assumed to have a fair value that approximates their historical cost carrying amount due to their short-term nature. The fair value of loans receivable, mortgages payable, and debentures payable has been determined by discounting the cash flows of these financial obligations using market rates for debt of similar corresponding terms and risk. ( j ) Use of Estimates The preparation of the Company’s financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the balance sheet date and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from such estimates. (k) Stock-Based Compensation Plan The Company has a stock-based compensation plan which is described in Note 9. No compensation expense is recognized for the plan when stock options are granted. Any consideration paid by employees on the exercise of stock options is credited to share capital. ( l ) Statement of Cash Flows The Company adopted the new recommendations of the CICA for cash flow statements for 1999 with restatement of the 1998 comparative information. Under the new standards, investing and financing activities that do not require the use of cash or cash equivalents are excluded from the statements of cash flows and disclosed separately. Cash and cash equivalents consist of cash on hand, balances with banks, and investments in money market instruments. As is common practice within the real estate industry, the Company has also included statements of cash flow from operations in its financial statements. This measurement, which is an important component of cash flow, is considered a meaningful and useful indicator of real estate operating performance. Cash flow from operations is the equivalent of income before extraordinary items adjusted for future income taxes, depreciation and amortization of capital items and any gain or loss on sale of or provision against capital items. For the year ended December 31, 1999, cash flow from operations was affected by the provision for the termination of advisory services (see Note 13(b)). This provision, although an operating expense, is not considered by management to be a normal or recurring part of operations. The statements disclose cash flow from operations, both before and after the provision for termination of advisory services. 40 N OT E S TO C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S 2 . S h o p p i n g C e n t r e s Shopping centres, expressed in thousands of dollars, consist of the following: Shopping Centres in Operation Land Buildings and improvements Deferred leasing costs Accumulated amortization and depreciation Shopping Centres under Redevelopment Acquisition costs Development costs Interest costs Other net carrying costs Total Shopping Centres Geographic Segmentation Canada United States 1999 1998 $ 157,282 $ 145,866 747,676 16,697 921,655 (24,537) $ 897,118 672,055 10,559 828,480 (15,443) $ 813,037 $ 27,450 $ 35,184 4,723 1,692 1,959 35,824 $ 932,942 $ 551,690 381,252 $ 932,942 10,250 3,332 1,951 50,717 $ 863,754 $ 488,401 375,353 $ 863,754 During the year the Company acquired shopping centres at a cost of $41.6 million (1998 – $180.8 million) and assumed mortgages payable in the amount of $14.6 million (1998 – $22.1 million) in connection with these acquisitions. 3 . L a n d a n d S h o p p i n g C e n t r e s u n d e r D eve l o p m e n t Land and shopping centres under development, expressed in thousands of dollars, consist of the following: Acquisition costs Development costs Interest costs Geographic Segmentation Canada United States 1999 $ 14,632 8,006 2,473 1998 $ 10,374 6,652 957 $ 25,111 $ 17,983 $ 11,724 13,387 $ 25,111 $ 10,492 7,491 $ 17,983 41 N OT E S TO C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S 4 . A m o u n t s R e c e iva b l e Amounts receivable, expressed in thousands of dollars, consist of the following: Amounts receivable Cash flow loans and mortgages receivable (a) Loan receivable from municipality (b) Loans receivable from development partner (c) Mortgage receivable (d) 1999 $ 10,323 6,358 1,316 24,564 4,835 1998 $ 9,271 8,140 1,340 10,332 – $ 47,396 $ 29,083 (a) In connection with the 1997 acquisition of a portfolio of shopping centres, the Company acquired a 50% interest in various cash flow loans and mortgages receivable. The loans and mortgages receivable bear interest at varying rates ranging from 10% to prime plus 0.75% per annum and mature in 1999 and 2000. (b) The loan receivable from a municipality bears interest at the rate of 8% per annum, calculated and compounded quarterly, and is repayable quarterly over a 25-year period, maturing in December, 2021. (c) The Company has advanced funds to its development partner, North American Realty Group and affiliates (see Note 13(d)), to finance a portion of its capital requirements in the development partnership. The loans bear interest at rates varying from the Company’s cost of funds to 10% and are repayable from the development partner’s share of proceeds generated from refinancings or sales. The Company has taken assignments of the development partner’s debt and equity interests in the development partnership as security for the loans receivable. (d) The mortgage receivable from a joint venture in which Centrefund Development Group has a 50% interest bears interest at the rate of 10% per annum, calculated and compounded monthly, and matures in January, 2004. The fair value of the loans and mortgages receivable at December 31, 1999 and 1998, approximates their carrying costs. The Company is exposed to credit risk to the extent that debtors fail to meet their obligations. This risk is alleviated by minimizing the amount of exposure the Company has to any one tenant, ensuring a diversified tenant mix, acquiring properties in superior geographic locations, and by the hypothecated properties. 5 . O t h e r A s s e t s Other assets, expressed in thousands of dollars, consist of the following: Deferred financing and issue costs Deferred interest rate hedge costs Investment in Revenue Properties Company Limited Purchase contract deposits Sundry assets 1999 $ 5,666 7,897 16,045 2,983 7,689 1998 $ 5,609 6,433 8,478 2,243 5,406 $ 40,280 $ 28,169 Based on its publicly listed trading price, as at December 31, 1999 the market value of the Company’s investment in the common shares of Revenue Properties Company Limited, representing a 9.9% interest (1998 – 4.9% interest), was $13.6 million (1998 – $8.8 million). 42 N OT E S TO C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S 6 . M o r t g a g e s Paya b l e Mortgages payable secured by shopping centres presented by geographic segment, expressed in thousands of dollars, consist of the following: Canada 1999 U.S. Total Canada 1998 U.S. Total $ 262,167 $ 121,387 $ 383,554 $ 205,691 $ 93,589 $ 299,280 36,540 82,827 119,367 19,412 78,511 97,923 $ 298,707 $ 204,214 $ 502,921 $ 225,103 $ 172,100 $ 397,203 Fixed rate Floating rate Canada: Fixed rate financing bears interest at an average fixed rate of 7.5% (1998 – at an average fixed rate of 7.6%) and matures in years ranging from 2000 to 2019. Floating rate financing bears interest at floating rates determined by reference to Canadian prime lending and bankers’ acceptance rates and matures in 2000 and 2001. At December 31, 1999 property collateralized credit facilities in the amount of $15.8 million (1998 – $32.8 million) were undrawn and available. In addition, as at December 31, 1999, property collateralized credit facilities arranged by Centrefund Development Group (see Notes 13(d) and 18), in the amount of $21.8 million (1998 – $20.0 million), were undrawn and available. United States: Fixed rate financing bears interest at an average fixed rate of 7.3% (1998 – at an average fixed rate of 7.6%) and matures in years ranging from 2000 to 2013. Floating rate financing bears interest at a floating rate determined by reference to the London Inter-Bank Offering Rate and matures in years ranging from 2001 to 2004. At December 31, 1999, property collateralized credit facilities were fully drawn. In connection with these facilities, the Company had pledged $2.6 million (U.S.$1.8 million) of cash as additional security for the lender (1998 – $13.2 million (U.S.$8.6 million)). Subsequent to year-end cash security of $1.9 million (U.S.$1.3 million) was released by the lender. As at December 31, principal repayments of mortgages payable, expressed in thousands of dollars, are due as follows: 1999 2000 2001 2002 2003 2004 Thereafter Canada $ – $ 53,381 34,163 41,655 12,244 8,305 148,959 $ 298,707 1999 U.S. – 7,843 4,585 7,910 89,413 52,803 41,660 $ Total – 61,224 38,748 49,565 101,657 61,108 190,619 $ 204,214 $ 502,921 1998 Total $ 50,507 60,892 17,686 47,572 93,393 – 127,153 $ 397,203 The fair value of mortgages payable at December 31, 1999, has been estimated to be $492.0 million (1998 – $405.1 million). 43 N OT E S TO C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S The Company is subject to the risk of interest rate fluctuations. The Company minimizes its interest rate risk by ensuring that debt maturities are spread out over a number of years. This allows the Company to reduce the risk of unfavourable interest rate changes. Also, the Company ensures that its mortgage portfolio contains debt with both fixed and floating interest rates. 7 . C o nve r t i b l e D e b e n t u r e s The Company has issued and has currently outstanding five series of convertible debentures. All of the debentures are unsecured subordinated debentures, require interest payable semi-annually and are convertible into common stock of the Company at the holders’ option at the earlier of maturity or redemption date. In addition the Company has the right to settle its obligations to repay principal upon redemption or maturity by issuing common stock. If the company chooses to issue common stock, with the exception of the 7.5% series, where the value of the common stock is fixed at $11 per common share, the stock is to be valued at 95% of the weighted average trading price for the 20 consecutive trading days ending five days prior to the redemption or maturity date, as may be applicable. In the case of the 7.0% and the 7.25% series the Company also has the option, subject to regulatory approval, of settling interest due from time to time by way of the issue of common shares valued in the same fashion as with respect to the repayment of principal on those debentures. The debentures are redeemable at par value plus accrued interest after specified dates or by tender to all holders in the case of the 7.5% debentures. The other terms of the convertible debentures are summarized as follows: Series Conversion Price Maturity Redemption Date 8.5% Convertible Debentures $15.50 per common share November 30, 2006 November 30, 2002 7.875% Convertible Debentures $17.00 per common share January 31, 2007 January 31, 2003 7.0% Convertible Debentures $23.50 per common share February 28, 2008 February 28, 2004 7.25% Convertible Debentures $25.25 per common share June 30, 2008 June 30, 2004 7.5% Convertible Debentures $11.00 per common share December 31, 2009 – The components of the convertible debentures, expressed in thousands of dollars, are classified as follows: Series Principal 1999 Liability Equity Liability Equity 1998 8.5% Convertible Debentures $ 57,516 $ 24,056 $ 33,735 $ 26,452 $ 31,003 7.875% Convertible Debentures 7.0% Convertible Debentures 7.25% Convertible Debentures 7.5% Convertible Debentures 97,547 100,000 100,000 6,237 39,337 – – 3,070 58,948 99,163 98,917 3,356 43,206 – – 4,013 54,467 98,554 98,339 3,845 $ 361,300 $ 66,463 $ 294,119 $ 73,671 $ 286,208 In October 1999, the Company filed and was granted a Notice of Intention to renew its Normal Course Issuer Bid with the Toronto Stock Exchange. This program allows the Company to purchase up to $5,750,000 principal amount of 8.5% con- vertible unsecured subordinated debentures, $9,700,000 principal amount of 7.875% convertible unsecured subordinated debentures, $10,000,000 principal amount of 7.0% convertible unsecured subordinated debentures and $10,000,000 44 N OT E S TO C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S principal amount of 7.25% convertible unsecured subordinated debentures over the next year. As at December 31, 1999, no debentures have been purchased under this Issuer Bid. Based on publicly listed trading prices, as at December 31, 1999, the market value on the principal amount of the convertible debentures was $292.7 million (1998 – $339.6 million). 8 . D e b e n t u r e s Paya b l e Debentures payable, expressed in thousands of dollars, consist of the following: 7.5% Debentures 7.5% U.S. Dollar Denominated Debentures 1999 $ 38,166 – $ 38,166 1998 $ 38,166 10,088 $ 48,254 The 7.5% Debentures (formerly the 1994 Convertible Participating Debentures (see Note 14)) mature on December 1, 2003 and bear interest at a rate of 7.5% per annum, payable semi-annually. These debentures are subordinated direct obligations of the Company, secured by a floating charge on real and immoveable property comprising four of the Company’s shopping centres. The 7.5% U.S. Dollar Denominated Debentures matured on December 31, 1999 and bore interest at the rate of 7.5% per annum payable semi-annually. These debentures were subordinated direct unsecured obligations of Centrefund Realty (U.S.) Corporation, the Company’s indirect wholly-owned U.S. subsidiary. The debentures were fully repaid prior to their maturity and holders of these debentures utilized the proceeds received on redemption to exercise their warrants to purchase common shares of the Company (see Note 9). Based on its publicly listed trading price, as at December 31, 1999, the market value of the 7.5% Debentures was $33.6 mil- lion (1998 – $34.3 million) and the fair value of the 7.5% U.S. Dollar Denominated Debentures was $nil (1998 – $10.6 million). 9 . S h a r e h o l d e r s ’ E q u i t y Shareholders’ equity, expressed in thousands of dollars, consists of the following: Equity component of convertible debentures (Note 7) Share capital Advisory warrants (Note 13(b)) Cumulative currency translation adjustment (Note 10) Deficit 1999 $ 294,119 150,293 2,000 2,473 (27,347) $ 421,538 1998 $ 286,208 141,581 – 17,169 (11,917) $ 433,041 The Company has an unlimited number of authorized preference shares and common shares. The preference shares may be issued from time to time in one or more series, each series comprising the number of shares, designations, rights, privileges, restrictions and conditions which the Board of Directors determines by resolution; preference shares are non-voting and rank in priority to the common shares with respect to dividends and distributions upon dissolution. The common shares carry one vote each and participate equally in the earnings of the Company and the net assets of the Company upon dissolution. Dividends are payable on the common shares as and when declared by the Board of Directors. 45 N OT E S TO C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S The following table sets forth the particulars of the issued and outstanding shares of the Company: Issued and outstanding at December 31, 1997 Issued in connection with exercise of warrants and convertible debenture conversions Issued in connection with the Dividend and Interest Reinvestment Plan Issued and outstanding at December 31, 1998 Issued in connection with exercise of warrants and convertible debenture conversions Issued in connection with the Dividend and Interest Reinvestment Plan Common shares purchased and cancelled Issued and outstanding at December 31, 1999 Number of Common Shares Stated Capital (thousands) 13,455,501 $129,417 651,952 200,253 8,826 3,338 14,307,706 141,581 943,525 275,774 (456,682) 11,284 3,654 (6,226) 15,070,323 $150,293 In connection with the acquisition of Centrefund America Holding Corp. on December 31, 1994, the Company issued 1,149,000 warrants for the acquisition of 1,149,000 common shares at an exercise price of U.S.$8.12 per share exercisable on or before December 31, 1999. During 1999 the balance of the outstanding warrants were exercised and as a result, at December 31, 1999 no warrants remained issued and outstanding (1998 – 810,140). During fiscal 1999 the Company purchased 456,682 shares (1998 – nil) under its Normal Course Issuer Bid. In October 1999 the Company filed and was granted a Notice of Intention to renew its Normal Course Issuer Bid with the Toronto Stock Exchange. This program allows the Company to purchase up to 962,500 of its common shares over the next year. In October 1998 the Company received securities’ commission approval to issue 1,250,000 stock options to its directors, officers and the management personnel of both the Advisor and Property Manager (see Note 13). As at December 31, 1999 the Company had granted 837,500 stock options (1998 – 845,000) at an exercise price of $14.30, which vest 20% annually and expire in October, 2008. As at December 31, 1999, no stock options had yet been exercised. During 1999, 7,500 stock options were cancelled. 10 . Fo r e i g n C u r r e n cy The Company maintains its accounts in Canadian dollars. However, a portion of its operations are located in the United States and therefore the Company is subject to foreign currency fluctuations which may, from time to time, impact its financial position and results. The Company’s U.S. shopping centre portfolio is financed in part by U.S. dollar denominated mortgages payable, which are fully serviced by the cash flow generated by the Company’s U.S. operations. This substan- tially mitigates the Company’s exposure to fluctuations in foreign currency exchange rates. The cumulative currency translation adjustment represents the cumulative unrecognized exchange adjustment on the net assets of the Company’s subsidiaries which operate in the United States. The change for the year reflects the impact of U.S. currency movements at December 31, 1999 relative to the exchange rate in effect as at December 31, 1998 on these net assets. The rate of exchange in effect on December 31, 1999 was U.S.$1.00 = $1.44 (1998 – $1.53). The average rate of exchange during 1999 was U.S.$1.00 = $1.48 (1998 – $1.49). 46 N OT E S TO C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S 11 . I n t e r e s t E x p e n s e o n M o r t g a g e s Interest expense incurred on mortgages, expressed in thousands of dollars, consists of the following: Total interest cost Less interest capitalized: Shopping centres under redevelopment Land and shopping centres under development 12 . C o r p o ra t e E x p e n s e s Corporate expenses, expressed in thousands of dollars, consist of the following: Advisory fees (see Note 13(a)) Capital taxes General and administrative 13 . R e l a t e d Pa r t y Tra n s a c t i o n s (a) Advisory and Incentive Fees Advisory Fees 1999 $ 34,910 1998 $ 25,525 (3,763) (2,030) (4,200) (746) $ 29,117 $ 20,579 1999 $ 5,333 842 896 1998 $ 4,293 600 717 $ 7,071 $ 5,610 Dawsco Realty Advisory Corp. (the “Advisor”), a private Ontario corporation controlled by two of the Company’s directors, one of whom is the Chairman, President and Chief Executive Officer of the Company, has been engaged to manage and administer the affairs of the Company, pursuant to an Advisory Agreement made February 15, 1994 (the “Advisory Agreement”). The Advisory Agreement is for a five-year term and is automatically renewable for additional five-year terms unless terminated in accordance with the terms thereof. The Advisor is paid an annual advisory fee equal to 0.65% of the total cost of the first $150 million of the Company’s assets and 0.6% of the total cost of the Company’s assets in excess of $150 million. The Advisor is also paid an acquisition fee of 1.5% of the total acquisition price upon the purchase of any property by the Company and a disposition fee of 0.5% of the aggregate sale price of any property sold by the Company (see Note 13(b)). The annual advisory fees, acquisition fees and disposition fees are referred to collectively in these financial statements as the “Advisory Fees”. Incentive Fees The Advisor is entitled to earn an annual incentive fee equal to 20% of the amount by which the aggregate net property cash flow and the aggregate net sale proceeds generated by the Company’s shopping centre portfolio, and other related assets exceed 10% of the aggregate equity invested in such portfolio and other assets. If the agreement is terminated, in accordance with its terms, the Advisor is also entitled to receive an incentive fee equal to 20% of the excess of the fair market value of the Company’s shopping centre portfolio and other related assets over the aggregate of: (i) the recorded cost of such portfolio and assets, determined at the termination date, and (i i) the aggregate amount required to have provided the Company since March 29, 1994 and with a 10% compound, cumulative annual return on the average aggregate equity allocable to such portfolio and assets, net of annual incentive fees paid to the Advisor and after 47 N OT E S TO C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S taking into consideration aggregate net property cash flow and aggregate net sale proceeds received with respect to such portfolio and assets. This latter amount is referred to in these financial statements as the “Fair Value Incentive Amount” (see Note 19(a)). The fees earned by the Advisor, expressed in thousands of dollars, are summarized as follows: Advisory fees Acquisition and disposition fees, net of payments to the Property Manager Incentive fees, net of payments to the Property Manager 1999 $ 6,263 445 1,327 $ 8,035 1998 $ 5,145 1,449 1,353 $ 7,947 During the year, $930 thousand (1998 – $852 thousand) in advisory fees included above were capitalized to shopping centres under redevelopment and land and shopping centres under development. (b) Provision for termination of advisory services In November 1999 the Board of Directors of the Company approved a transaction to terminate the Advisory Fees component and revise the incentive fee provisions of the Advisory Agreement. Pursuant to the transaction, the Advisory Agreement may be terminated by the Company at the expiration of the current term on March 29, 2004, subject to obtaining shareholder approval or upon the expiration of any subsequent term. In addition, the Advisor has agreed to continue to provide the strategic services of the Company’s Chairman, President and Chief Executive Officer. The transaction, which takes effect from January 1, 2000, was formally approved by shareholders on January 18, 2000 and is scheduled to close during the second quarter of 2000. A provision for the transaction has been recorded in the financial statements at December 31, 1999. The provision includes $25 million for the advisory termination payment in respect of the termination of the Advisory Fees component of the Advisory Agreement. If the amended Advisory Agreement is terminated effective March 29, 2004, then: ✧ Effective January 1, 2000 and for the balance of the current term, the annual incentive fees will be calculated solely with reference to the shopping centre portfolio and related assets owned by the Company as at September 30, 1999; ✧ The Fair Value Incentive Amount (see Note 19(a)), payable upon termination of the amended Advisory Agreement, will be calculated solely with reference to the shopping centre portfolio and related assets owned by the Company as at September 30, 1999; ✧ The Company will have the option to satisfy the Fair Value Incentive Amount in a combination of cash and common shares provided that the cash portion of such combined payment represents at least 50% thereof, the common shares forming part of such combined payment are issued on a tax-deferred basis to the Advisor and certain other conditions are met; and ✧ The property management agreement will be terminated effective March 29, 2004 (see Note 13(c)). As consideration for the amendments to the Advisory Agreement and in consideration for the Advisor continuing to provide the strategic services of the Company’s Chairman, President and Chief Executive Officer, the Advisor will receive the following: ✧ The advisory termination fee of $25 million referred to above, and in this regard, the Advisor has agreed to use $2 million of the termination payment to purchase advisory warrants having a 10-year term which entitle the holder to purchase 1,000,000 common shares at an exercise price of $14 per share; 48 N OT E S TO C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S ✧ An annual base incentive fee of $2 million (which will increase by 10% calculated and compounded annually commencing January 1, 2001 to the end of the term of the amended Advisory Agreement); ✧ A stock appreciation package which represents the appreciation in the value of 3,600,000 common shares measured with reference to a base price of $14 per share, which will be satisfied by the payment of: a) a fee of $5,400,000 which will, except in certain circumstances, be used to purchase incentive warrants of the Company (“Incentive Warrants”) entitling the holder thereof to purchase an aggregate of 3,600,000 common shares at an exercise price of $14 per share (as adjusted), having a term expiring on January 1, 2005; and b) if applicable, a fee of $1,800,000 which will, except in certain circumstances, be used to purchase common share purchase warrants of the Company, having a term of five years from the date of their issuance and representing a right to subscribe for 3,600,000 common shares less the aggregate number of common shares acquired by the holders of the Incentive Warrants, for an exercise price equal to the greater of the fair market value of the common shares on the date of issuance of such warrants and $14 per share (as adjusted). If the amended Advisory Agreement is not terminated effective March 29, 2004, then: ✧ The amended Advisory Agreement and the property management agreement will be automatically renewed for successive five-year terms until terminated in accordance with their respective terms; ✧ The annual incentive fees and the Fair Value Incentive Amount will be calculated with reference to the shopping centre portfolio and related assets in existence at that date; ✧ The Fair Value Incentive Amount (see Note 19(a)) will be satisfied entirely in cash; and ✧ The stock appreciation package will be satisfied in cash and will be equal to the greater of: a) $7.2 million; and b) the product of (x) 3,600,000 (subject to certain adjustments) and (y) the amount, if any, by which the fair market value of the common shares on March 29, 2004 exceeds $14 per share (as adjusted), together with interest thereon at the Company’s cost of funds from March 29, 2004 to the date of payment. The payment of the various fees referred to above and the issuance of the warrants may be accelerated in certain circumstances, such as a change in control of the Company or the death or permanent disability of the Company’s Chairman, President and Chief Executive Officer. The Property Manager will receive a portion of all of the consideration received by the Advisor, except for the annual base incentive fee. The Company has incurred third-party professional and consulting costs of $1.85 million in connection with the negotia- tion and preparation of the documents implementing the amendments to the Advisory Agreement described above. (c) Property Management Fees Centrecorp Management Services Limited (the “Property Manager”), a private Ontario corporation controlled by two of the Company’s directors, has been engaged to act as the Company’s property manager, pursuant to a Property Management Agreement made February 15, 1994. The current term of the Property Management Agreement expires March 29, 2004. The Agreement will renew automatically for an additional five years if the Advisory Agreement is renewed. In addition, the Property Manager has also been retained by Centrefund Development Group to act as the 49 N OT E S TO C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S Partnership’s property manager, pursuant to a Memorandum of Agreement made September 15, 1997. The agreement is for an initial term of 10 years and is automatically renewable for successive five-year terms. The Property Manager is responsible for all property management functions, including property administration, maintenance and leasing, and assists the Company and the Advisor in acquisition and management decisions. The fees earned by the Property Manager, expressed in thousands of dollars, are summarized as follows: Property management fees, net Acquisition and disposition fees, paid by the Advisor Construction supervision fees Leasing fees Incentive fees, paid by the Advisor 1999 $ 1,074 445 1,385 3,123 1,327 1998 $ 696 1,449 1,332 3,347 1,353 $ 7,354 $ 8,177 Property management fees are net of $3.6 million (1998 – $2.6 million) recovered directly from tenants. For the year ended December 31, 1999, the Company’s share of development overhead cost reimbursements paid to the Property Manager was in the amount of $1.5 million (1998 – $449 thousand). (d) Centrefund Development Group The Company holds a 50.1% interest in an exclusive partnership with North American Realty Group and affiliates (“NARG”), to engage in the development of neighbourhood and community-sized shopping centres in Canada and the United States. NARG is an Ontario partnership controlled by North American Development Corporation, a private corporation related to the Company’s Property Manager. The Company has advanced $24.6 million in loans to its development partner, NARG, to partially finance its investment in the development partnership. The loans bear interest at rates varying from the Company’s cost of funds to 10%. For the year ended December 31, 1999, the Company earned interest of $1.8 million (1998 – $595 thousand) from loans to the development partner which will be repaid from cash flows generated from the development properties and from the development partner’s share of proceeds generated from refinancings or sales. 14 . S e t t l e m e n t o f 19 9 4 C o nve r t i b l e Pa r t i c i p a t i n g D e b e n t u r e s On November 30, 1998, the Company and the holders of the 1994 Convertible Participating Debentures agreed to settle on the terms of these debentures and replace them with 7.5% Debentures (see Note 8). As a result of this settlement, the participation and convertibility features as well as the covenant restricting the level of senior indebtedness were removed. The cost of the settlement aggregated $7.4 million and is included in the 1998 consolidated statement of opera- tions as a one-time charge. 15 . I n c o m e Ta xe s The Company’s activities are carried out directly and through operating subsidiaries and partnership ventures in Canada and the United States. The income tax effect on operations depends on the tax legislation in each country and the operating results of each subsidiary and partnership venture and the parent Company. 50 N OT E S TO C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S The provision for income and other taxes, expressed in thousands of dollars, is calculated as follows: Provision for income taxes on income at the combined Canadian federal and provincial income tax rates Increase (decrease) in the provision for income taxes due to the following items: Large Corporations Tax Foreign operations United States withholding taxes Other 1999 1998 $ 5,490 $11,300 1,170 (6,370) 475 310 1,075 (3,705) 490 (490) $ 1,075 $ 8,670 Future income tax assets and liabilities result primarily from: (i) the difference between depreciation recorded for accounting purposes and that claimed for income tax purposes; (i i) certain development, leasing and carrying costs capitalized or deferred for accounting purposes which are claimed for income tax purposes; and (iii) issue costs charged to the equity accounts and other assets, which are deductible over five years for income tax purposes. As at December 31, 1999, the Company’s future income tax assets and liabilities, expressed in thousands of dollars, are as follows: Future income tax assets Losses available for carry-forward Other assets Canadian and U.S. minimum tax credits Other Future income tax liabilities Shopping centres Other 1999 1998 $ 23,551 12,748 1,573 463 $ 19,217 3,213 1,343 563 $ 38,335 $ 24,336 $ 27,371 119 $ 27,490 $ 25,137 119 $ 25,256 At December 31, 1999 the Company has tax-loss carry-forwards for Canadian income tax purposes of approximately $53 million prior to the recognition of the provision for termination of the advisory services, which have been recognized as future income tax assets and are available to reduce future Canadian taxable income. These tax-loss carry-forwards expire at various dates between December 31, 2001 and December 31, 2006. 16 . Pe r S h a r e C a l c u l a t i o n s Basic per share information is calculated based on a weighted average of 14,469,728 common shares outstanding during the year (1998 – 13,947,169 common shares). The determination of basic earnings per share reflects a reduction of $13.7 million (1998 – $10.4 million) to reported net earnings, which represents interest and accretion on the equity component of convertible debentures, net of tax. 51 N OT E S TO C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S Fully diluted per share information is calculated based on a weighted average of 33,541,412 common shares (1998 – 30,717,772 common shares), which reflects the conversion of the convertible debentures and the exercise of the outstanding warrants and issued options. 17. S e g m e n t e d I n fo r m a t i o n The Company and its subsidiaries operate in the retail-related real estate industry in both Canada and the United States. Real estate operating income by geographic segment for the year ended December 31, 1999, expressed in thousands of dollars, is summarized as follows: Gross rental income Property operating costs Rental income Interest and other income Interest expense: Mortgages Debentures Corporate expenses Real estate operating income before depreciation and amortization Depreciation and amortization Real estate operating income Canada $ 78,365 30,295 48,070 5,378 53,448 14,929 9,476 24,405 4,024 25,019 5,742 U.S. Total $ 58,732 $ 137,097 19,276 39,456 3,074 42,530 14,188 568 14,756 3,047 24,727 4,846 49,571 87,526 8,452 95,978 29,117 10,044 39,161 7,071 49,746 10,588 $ 19,277 $ 19,881 $ 39,158 Real estate operating income by geographic segment for the year ended December 31, 1998, expressed in thousands of dollars, is summarized as follows: Gross rental income Property operating costs Rental income Interest and other income Interest expense: Mortgages Debentures Corporate expenses Real estate operating income before depreciation and amortization Depreciation and amortization Real estate operating income 52 Canada $ 71,943 U.S. Total $ 40,884 $ 112,827 26,276 45,667 4,154 49,821 11,075 11,766 22,841 3,665 23,315 4,623 13,122 27,762 1,454 29,216 9,504 759 10,263 1,945 17,008 2,921 39,398 73,429 5,608 79,037 20,579 12,525 33,104 5,610 40,323 7,544 $ 18,692 $ 14,087 $ 32,779 N OT E S TO C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S 18. Pa r t n e r s h i p Ve n t u r e s The Company participates in partnership ventures that own land, shopping centres, and shopping centres under development. The following amounts expressed in thousands of dollars, are included in the consolidated financial statements and represent the Company’s proportionate interest in the financial accounts of the partnership ventures: Assets Liabilities Revenues Expenses Cash flow provided by (used in) Operating activities Financing activities Investing activities 1999 $ 48,193 $ 34,053 $ 1,872 $ 1,663 $ 115 $ 25,365 $ (25,457) 1998 $ 20,647 $ 18,349 $ $ $ – 286 933 $ 12,322 $ (12,618) The Company is contingently liable for certain of the obligations of the partnership ventures and all of the assets of the partnership ventures are available for the purpose of satisfying such obligations and guarantees (See Note 19(c)). 19 . C o n t i n g e n t L i a b i l i t i e s The Company is contingently liable for the following: (a) The Company is contingently liable to the Advisor for certain payments if it terminates the amended Advisory Agreement (see Note 13(b)). If the Advisory Agreement is terminated and the Fair Value Incentive Amount becomes payable, such amount will be charged to earnings in the year in which the termination occurs or the event becomes likely. Any amount payable will be calculated in accordance with the terms of the Advisory Agreement, based on the fair market value of the shopping centre portfolio and related assets, at the termination date. If the Advisory Agreement had been terminated effective December 31, 1999, the Company estimates that the Fair Value Incentive Amount payable to the Advisor would have been approximately $23 million (1998 – $38 million), based on the Company’s estimate of the fair market value of its shopping centre portfolio and related assets as at that date. In estimating the value of the shopping centre portfolio, an independent appraisal has not been performed; however, management has used the Income Capitalization Method utilizing an average 9.5% (1998 – 9.0%) capitalization rate. The estimate may not be reflective of any actual amount payable, should the agreement be terminated. The amount payable is dependent on various factors such as interest rates, vacancy rates, capitalization rates, U.S.$ exchange rates and general market and economic conditions at the date of termination, as well as the method of valuation used to estimate value. Furthermore, any changes in the Company’s shopping centre portfolio, including those resulting from the acquisition or sale of properties would change the amount of this contingent obligation. At this time, the likelihood of the termination of the Advisory Agreement is not determinable. If the amended Advisory Agreement is terminated effective March 29, 2004, the Fair Value Incentive Amount would be calculated solely with reference to the shopping centre portfolio and certain related assets owned by the Company as at September 30, 1999. At the Company’s option, up to one-half of the amount due to the Advisor could be settled by the issuance of common shares and the remainder paid in cash. 53 N OT E S TO C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S If the amended Advisory Agreement is terminated subsequent to March 29, 2004, the Fair Value Incentive Amount will be calculated with reference to the shopping centre portfolio and related assets in existence as at the effective date of termination and will be satisfied entirely in cash. (b) In addition, if the amended Advisory Agreement is terminated before, on or subsequent to March 29, 2004, the Company will be contingently liable to pay the Advisor the Stock Appreciation Package (see Note 13(b)). (c) The Company has provided guarantees for approximately $33.7 million (1998 – $nil) to various lenders in connection with loans advanced to Centrefund Development Group. Subsequent to the year ended December 31, 1999, new financings arranged by Centrefund Development Group released the Company from $12.3 million of guarantees it had previously provided. (d) The Company is also contingently liable for letters of credit in the amount of $9.2 million (1998 – $2.2 million) issued in the ordinary course of business. 2 0 . U n c e r t a i n t y d u e t o t h e Ye a r 2 0 0 0 I s s u e The Year 2000 Issue arises because many computerized systems use two digits rather than four to identify a year. Date- sensitive systems may recognize the year 2000 as 1900 or some other date, resulting in errors when information using year 2000 dates is processed. In addition, similar problems may arise in some systems which use certain dates in 1999 to represent something other than a date. Although the change in date has occurred, it is not possible to conclude at this time that all aspects of the Year 2000 Issue that may affect the Company, including those related to tenants, suppliers, or other third parties, have been fully resolved. 21. C o m p a ra t ive F i g u r e s Certain comparative figures have been reclassified to reflect the current year’s presentation. 54 C O R P O R AT E I N F O R M AT I O N D i r e c t o r s & O f f i c e r s D i r e c t o r s O f f i c e r s Peter F. Cohen, C.A.(1) Peter F. Cohen, C.A. Chairman, President and Chief Executive Officer, Chairman, President and Chief Executive Officer Steven E. Cohen Senior Vice-President Percy A. Fink, C.A. Chief Financial Officer Robert S. Green Secretary Errol G. Jones Vice-President L e g a l C o u n s e l Goodman Phillips & Vineberg Toronto, Ontario Au d i t o r s Deloitte & Touche LLP Toronto, Ontario B a n ke r s Bank of Nova Scotia Bank of Montreal Comerica Bank First Union National Bank Centrefund Realty Corporation Ricky B. Stupp Cohen Vice-President, Dawsco Realty Advisory Corp. A. Ephraim Diamond (2) President, Whitecastle Investments Limited Robert S. Green (1) President and Chief Operating Officer, Centrecorp Management Services Limited Jay S. Hennick (2) President and Chief Executive Officer, FirstService Corporation John W.S. Preston (1) Chairman, President and Chief Executive Officer, Centrefund Development Group Stanley B. Swartzman (2) Retired Business Executive Lorie Waisberg (2) Partner, Goodman Phillips & Vineberg (1) Management Committee (2) Audit Committee 55 S H A R E H O L D E R I N F O R M AT I O N H e a d O f f i c e 30 St. Clair Avenue West, Suite 1400 Toronto, Ontario M4V 3A1 Tel: (416) 515-1400 1-800-240-5711 Fax: (416) 515-1401 S t o ck E x ch a n g e L i s t i n g s Common Shares: CFE 7.5% Debentures: CFE.DB Tra n s f e r A g e n t Montreal Trust Company of Canada 151 Front Street West, 8th Floor Toronto, Ontario M5J 2N1 Tel: (416) 981-9633 A n n u a l M e e t i n g Shareholders are invited to attend the Annual Shareholders’ Meeting 8.5% Convertible Debentures: CFE.DB.A to be held at 10:00 a.m. on June 26, 2000 7.875% Convertible Debentures: CFE.DB.B 7.0% Convertible Debentures: CFE.DB.C 7.25% Convertible Debentures: CFE.DB.D at the Design Exchange located at 234 Bay Street, Toronto, Ontario 1997 First Quarter Second Quarter Third Quarter Fourth Quarter 1998 First Quarter Second Quarter Third Quarter Fourth Quarter 1999 First Quarter Second Quarter Third Quarter Fourth Quarter C o m m o n S h a r e M a r ke t Q u o t a t i o n s High Low Dividends paid Volume $ 15.50 $ 16.60 $ 17.35 $ 20.40 $ 22.45 $ 22.30 $ 19.25 $ 17.50 $ 17.00 $ 15.65 $ 14.25 $ 13.50 $ 13.85 $ 13.90 $ 15.65 $ 16.00 $ 17.60 $ 18.90 $ 13.25 $ 13.50 $ 14.00 $ 13.20 $ 12.70 $ 11.05 56 $ 0.20 $ 0.20 $ 0.20 $ 0.21 $ 0.21 $ 0.21 $ 0.21 $ 0.22 $ 0.22 $ 0.22 $ 0.22 $ 0.23 3,143,300 1,589,733 2,278,090 4,165,995 2,546,811 1,474,635 968,352 1,643,001 1,902,977 1,112,183 1,949,989 1,780,592 C E N T R E F U N D R E A LT Y C O R P O R AT I O N 30 St. Clair Avenue West, Suite 1400 Toronto, Ontario M4V 3A1 Tel: (416) 515-1400 1-800-240-5711 Fax: (416) 515-1401 C E N T R E F U N D D E V E L O P M E N T G RO U P, C A N A D A 2851 John Street, Suite One Markham, Ontario L3R 5R7 Tel: (905) 477-9200 Fax: (905) 477-7390 C E N T R E F U N D D E V E L O P M E N T G RO U P, U . S . 2401 PGA Boulevard, Suite 280 Palm Beach Gardens, Florida 33410 Tel: (561) 624-9500 Fax: (561) 624-9507 w w w. c e n t r e f u n d . c o m C E N T R E F U N D R E A L T Y C O R P O R A T I O N