AMB Property Corporation 1998 annual report building alliances building value AMB Property Corporation is one of the largest Real Estate Investment Trusts in the United States. The Company is active in markets across the country and focuses primarily on industrial properties located in major distribution markets. Through its Strategic Alliance Programs, AMB is creating innovative, mutually beneficial alliances with other real estate professionals that are expanding and enhancing the value of its property portfolio. The Company owns and operates 620 buildings and centers totaling 63.6 million square feet. AMB common stock trades on the New York Stock Exchange under the symbol AMB. TABL E OF CO NTENTS: 1 Financial Highlights 2 Letter to Shareholders 6 Strategic Alliance Programs 14 Financial Review 38 Report of Independent Auditors 39 Directors and Officers 40 Shareholder Information Financial Highlights A M B P R O P E R T Y C O R P O R A T I O N ( I n t h o u s a n d s , e x c e p t p e r s h a r e d a t a ) 1 9 9 4 1 9 9 5 1 9 9 6 H i s t o r i c a l P r o p e r t i e s ( 1 ) C o m p a n y P r o F o r m a ( 2 ) 1 9 9 7 1 9 9 8 nnnnnn 1 9 9 7 F o r t h e Ye a r s E n d e d D e c e m b e r 3 1 , Revenues $ 51,682 $ 108,249 $ 167,953 $ 235,225 $ 284,674 $ 358,887 Net operating income 34,938 71,358 112,632 154,367 EBITDA FFO FFO per share (diluted) 203,196 195,218 147,409 1.66 262,813 252,353 170,407 1.90 ( I n t h o u s a n d s ) 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 H i s t o r i c a l P r o p e r t i e s nnnnnnnnnnnnnnnnnnnnnnnnnnnnnnn C o m p a n y A s o f D e c e m b e r 3 1 , Total assets Debt Market equity Shares and units outstanding Square feet Occupancy $ 721,131 $1,117,181 $1,622,559 $2,506,255 $3,562,885 201,959 254,067 548,134 15,786 96.4% 24,897 96.7% 34,891 96.5% 685,652 1,368,196 2,221,469 1,988,038 88,417 43,545 95.8% 90,365 63,596 95.8% Revenues (dollars in millions) Net Operating Income (dollars in millions) FFO Per Share (diluted) (dollars per share) $359 $263 $1.90 $1.66 $235 $168 $108 $52 $154 $113 $71 $35 94 95 96 97 98 94 95 96 97 98 97 98 (1) The historical results for 1997 include the results of the Company for the period from November 26, 1997, the commencement of operations as a fully integrated REIT, to December 31, 1997 and the results achieved by the prior owners of the Properties for the period from January 1, 1997 to November 25, 1997, and the years ended December 31, 1994, 1995 and 1996. (2) The pro forma financial information has been prepared as if the formation transactions, initial public offering, property acquisitions and dispositions during 1997 and certain other transactions had occurred on January 1, 1997. to our shareholders No one has ever accused AMB of being a typical company. Over the past 15 years, we have made a point of differentiating ourselves. Our initial public offering in November 1997 is a case in point. Conventional wisdom said there was no compelling reason for us to go public. We were a successful investment manager, but we believed public ownership would maximize returns for our investors, improve our operating efficiency, and give us a valuable new form of currency to fuel our growth. In other words, we saw tremendous opportunity in public ownership, and now following our first full year as a public company, we can measure the financial and strategic impact of our decision. For the year, funds from operations per share grew 14.5% while same store net operating income grew 7.1%. We significantly strengthened our financial flexibility, raising $675 million in new capital in part by executing a large-scale unsecured debt financing. We acquired properties totaling $838 million, added 19.1 million square feet to our portfolio, and initiated $262 million in development projects. We ended the year with 620 industrial buildings and retail centers, totaling 63.6 million square feet, and a capitalization exceeding $3.7 billion, making us one 2 of the nation’s leading public REITs. AMB also took a key strategic step early in 1999 when we signed agreements to sell most of our retail properties for $663 million. This move underscores our belief that the growth of third party logistics, airfreight and e-commerce are driving a fundamental, long-term change in how goods are distributed. For industrial property leaders such as AMB, these trends will be highly favorable. Going forward, our port- folio will emphasize properties that are critical links in the supply chain, especially high-turnover warehouse/distribution facilities near major air cargo hubs and conve- nient to major freeways or ports. This market sector has been a growing area of focus and strength for AMB, and we intend to extend our leadership position in this area. AMB has made important progress in other areas of our business, as well. For example, we are steadily expanding the AMB brand in our target markets. Through our unique outsourcing model, we have continued to build strong ties with leading real estate organizations. Our national network of strategic alliances is a valuable com- petitive advantage for AMB that positions us as a partner, rather than a competitor of local real estate entrepreneurs. Our alliances give us access to properties not readily available to traditional REITs, and make us an efficient and flexible operator. For these and many other reasons we feel the future is very bright at AMB. We have a proven ability to create value and, looking to 1999 and beyond, we believe we can extend our solid track record and maximize the significant opportunities we see ahead. Our optimism is based not only on market trends, but also on two partic- ular strengths at AMB: our ability to generate growth internally and the valuable alliances we have forged with top real estate entrepreneurs throughout the country. G E N E R A T I N G G R O W T H I N T E R N A L L Y The importance of gener- ating internal growth is underscored by the changing financial dynamics of the public real estate market, especially the increasing cost of equity capital. In the past, most REITs fueled earnings growth through the spread between the cost of capital and the returns generated through acquisitions. At AMB we have not depended on that model. We have been highly selective in how we deploy capital, building a portfolio of quality properties that generate strong, steady and growing cash flow in both good and bad market cycles. In other words, we do not need to rely primarily on acquisitions to drive our profit growth. This strategy reflects several factors that are rapidly becoming AMB hallmarks. First, we have deployed capital carefully over the years in high quality properties in supply-constrained markets. Second, we have made – and continue 3 to make – the necessary investments in those properties to ensure that our tenants are satisfied. And third, we outsource on-site activities to top property management and brokerage firms that maximize each property’s operating efficiency and tenant satisfaction. The success of this strategy speaks for itself. Our 7.1% same store NOI growth in 1998 – among the highest in our industry – was largely fueled by a 14.3% increase in base rents. Another unique attribute of AMB that reduces our exposure to changing capital markets is our ability to access private funding. AMB was founded as an investment manager for private institutional investors and – unlike most other REITs – private capital continues to be a thriving part of our business under our Institutional Alliance Program. Private capital increases AMB’s return on investment, and provides access to alternative capital sources. This “stretches” our internally generated capital and allows AMB to participate in a wide array of high quality acquisitions without dilut- ing our current shareholders. S T R O N G A L L I A N C E S / N E W G R O W T H O P P O R T U N I T I E S The success of our Institutional Alliance Program is mirrored in AMB’s other Strategic Hamid R. Moghadam President and Chief Executive Officer Alliance Programs. The objective of our alliances is to strengthen the ties between AMB and other real estate professionals to create mutually beneficial relationships. In an industry of increasing specialization we believe that we can most effectively build shareholder value by focusing on our core strengths, investing and setting long-term strategy, while outsourcing and collaborating with firms that have complementary strengths in day-to-day leasing, management, and development. I encourage you to read the pages that follow for a more detailed look at our Strategic Alliance Programs and how they contribute to AMB’s success. These professional collaborations have proven very productive. In fact, 72% of AMB’s acquisition volume in 1998 was sourced through these programs, including $138 million through our Management Alliance Program and $216 mil- lion generated by our UPREIT Alliance Program. In addition, substantially all of our $262 million in development starts during 1998 were initiated through the Development Alliance Programs. 4 We are devoting a majority of our development efforts to industrial properties that serve the distribution and logistics markets. Airfreight distribution, in particular, is an especially fast growing sector – expanding at two-and-a half times the rate of GDP growth – and one of the drivers of its continued growth will be e-commerce. Web retailers depend on fast delivery to differentiate themselves from traditional and mail-order retailers and to build customer loyalty. Beyond the airfreight companies themselves, the key provider in the modern high-speed ful- fillment chain will be the physical warehouses on or near the runways of major air cargo facilities. With 15 years of experience serving the warehousing/trans- portation market, we have an excellent head start in this arena. We have already completed our first on-tarmac development, at the Dallas-Ft. Worth Airport, and we are actively seeking other key opportunities. In closing, I want to thank two AMB veterans who retired this past year: Dave Carniglia, our Chief Financial Officer, and Jean Hurley, who directed our corporate communications and investor relations efforts. Both played very impor- tant roles in the Company’s growth over the years, and we thank them for their contributions to AMB’s growth and success. I also want to welcome two new members of our senior management team: David Fries, our new Chief Administrative Officer and General Counsel, and Blake Baird who joined us recently from his position as a Managing Director at Morgan Stanley to become AMB’s Chief Investment Officer. David and Blake are the latest additions to what I firmly believe is the strongest group of professionals in the real estate industry. Indeed, for all of AMB’s innovative strategic thinking and strong industry alliances, our most important competitive advantage has always been and will continue to be our people. I want to express my pride and appreciation for the excellent job they have done embracing and managing change over the past year. Hamid R. Moghadam President and Chief Executive Officer March 31, 1999 5 strategic alliance p r o g r a m s AMB’s Strategic Alliance Programs are designed to build value by creating mutually beneficial relationships. Real estate is fundamentally a local business, and we believe the most effective way for a national company to operate is by forging alliances with the best available service providers in every market. Such collaborations enable AMB to leverage the expertise and resources of local developers, brokers, property managers, and other owners of real estate without incurring the risk and expense of doing everything ourselves. This attitude is counter to the conventional wisdom in our industry of integrating vertically; but, based on our successful history, outsourcing and alliance building is a winning 21st century business model for AMB. It has improved our operating efficiency and flexibility, strengthened our customer satisfaction and retention, and perhaps most important, provided a continuous pipeline of opportunities for growth in the years ahead. 6 Strategic Alliance Programs Investment Operational Development Management AMB’s six Strategic Alliance Programs are grouped in two categories. Investment Alliance Programs establish relationships with a variety of capital sources, enhancing our ability to source and finance attractive acqui- sitions. Operating Alliance UPREIT Customer Programs position AMB as an ally of rather than a competitor with service providers in our industry, giving us access to Institutional Broker local market insights, trends and investment opportunities. 7 development a l l i a n c e p r o g r a m Developing properties requires a special skill that is almost as much of an art as a science. At AMB we seek to work with those developers who have proven they have both the insight to recognize potential in an undervalued asset and the skill to realize that potential. The partners in our Development Alliance Program are typically successful entrepreneurs with the ability to execute a renovation or building project quickly and efficiently. Development collaboration allows AMB to expand its revenue potential without incurring undue risk, and it provides an avenue for sharing in high-value opportunities during strong market cycles without carrying the costly overhead that can quickly destroy margins and profitability. 8 u p r e i t a l l i a n c e p r o g r a m For certain property owners seeking ultimate liquidity and a strong alternative investment with tax advantages, we offer our UPREIT Alliance Program. Property owners contribute their assets to AMB and in return receive equity in the form of operating partnership units. Because the transaction provides a useful tax planning structure, the property owners gain valuable flexibility in liquidating their assets. Unique to AMB, owners may also continue to manage the properties they contribute. It’s another example of how we adopt flexible approaches to attract high quality assets to the AMB portfolio. 9 institutional a l l i a n c e p r o g r a m Given AMB’s origins as a manager of private real estate funds, it should be no surprise that we recognize the value of providing a private investment vehicle for many of our clients. These discrete relationships with institutional investors preclude the need for us to rely solely on the public markets for equity and debt capital, and they offer a valuable source of incremental fee income and investment returns for AMB. Our institutional partners gain significant benefits as well. The private co-investment format lets institutions unambiguously align their investment goals with those of their asset manager. Perhaps most importantly, the Institutional Alliance Program provides access to AMB’s proven expertise in acquiring and managing real estate portfolios for institutional investors of all sizes, types and investment perspectives. 10 management a l l i a n c e p r o g r a m The final determinant of each tenant’s satisfaction is how well a building is maintained and how quickly any needs are addressed. Most REITs and property owners handle this key function in-house. AMB has chosen to follow a different strategy. We believe real estate management requires a specialized skill set, so we outsource management of our properties to leading local firms, working closely with each to ensure optimum efficiency, quality control, and tenant satisfaction. Not only does this increase our flexibility, reduce our overhead, and improve customer service – a result borne out by our strong operating margins and high level of customer satisfaction – it also gives AMB highly influential allies at the grassroots level who can help us retain our existing tenants and develop new customer relationships. 11 customer a l l i a n c e p r o g r a m As a national property owner with a sharp focus on high-volume warehouse/distribution properties, AMB has built strong relationships over the past two decades with many of its larger, longer-term tenants. Our goal in the Customer Alliance Program is to build on the trust that we have established and deepen those relationships. After all, larger tenants generally have real estate needs throughout the country, not just in individual markets, and we are committed to making their property search/renovation/build-out in new markets as efficient and user-friendly as possible. This isn’t just a good customer relations tactic, it’s a key component of our strategy for financial growth. By working closely with our existing customers, we can generate a steadily growing stream of incremental revenue from internal sources. 12 b r o k e r a l l i a n c e p r o g r a m AMB works closely with the top local leasing companies in each of our markets. We understand that there is no better conduit to attracting the fast-growing small- and mid-sized firms in each region. In essence, through the Broker Alliance Program, top brokers become our local sales force and information source, and we give them every incentive – competitive commissions, rapid payment, and of course, excellent real estate – to direct high quality tenants to our properties. The result: AMB has a strong, responsive, productive, and cost-effective sales presence in each of its markets. 13 financial review > 14 Selected Company and Predecessor Financial and Other Data A M B P R O P E R T Y C O R P O R A T I O N The following table sets forth selected consolidated historical financial and other data for the Company and its Predecessor on an historical basis for the years ended December 31, 1994, 1995, 1996, 1997 and 1998. Prior to November 26, 1997 (the IPO date), the Company’s Predecessor provided real estate investment management services to institutional investors. ( I n t h o u s a n d s , e x c e p t s h a r e d a t a , P r e d e c e s s o r ( 1 ) nnnnnnnnnnnnnn H i s t o r i c a l ( 2 ) P r o F o r m a ( 3 ) p e r c e n t a g e s a n d n u m b e r o f P r o p e r t i e s ) 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 7 1 9 9 8 A s o f a n d f o r t h e Ye a r s E n d e d D e c e m b e r 3 1 , C o m p a n y O P E R AT I N G D ATA Total revenues Income from operations $ 12,865 $ 16,865 $ 23,991 $ 56,062 $ 284,674 $ 358,887 before minority interests 2,925 3,296 7,140 18,885 103,903 123,750 Net income available to common stockholders Net income per common share: Basic (4) Diluted (4) Dividends per common share Dividends per preferred share (5) O T H E R D ATA EBITDA(6) Funds from operations (7) Cash flows provided by (used in): Operating activities Investing activities Financing activities B A L A N C E S H E E T D ATA Investments in real estate at cost Total assets Total consolidated debt (8) Stockholders’ equity 2,925 3,262 7,003 18,228 99,508 108,954 0.59 0.59 0.64 0.64 1.38 1.38 1.39 1.38 1.16 1.15 1.37 – 1.27 1.26 1.37 0.99 $ 195,218 147,409 $ 252,353 170,407 131,621 (607,768) 553,199 177,180 (796,213) 604,202 $ – 4,092 – 3,848 $ – 4,948 – 4,241 $ – 7,085 – 6,300 $2,442,999 2,506,255 685,652 1,668,030 $3,369,060 3,562,885 1,368,196 1,765,360 (1) Represents the Predecessor’s historical financial and other data for the years ended December 31, 1994, 1995 and 1996. The Predecessor operated as an investment manager prior to November 26, 1997. (2) The historical 1997 results represent the Predecessor’s historical financial and other data for the period January 1, 1997 through November 25, 1997. The financial and other data of the Company, and the Properties acquired in the Formation Transactions, have been included subsequent to November 26, 1997 to December 31, 1997. (3) Pro forma 1997 financial and other data has been prepared as if the Formation Transactions, the IPO (as described in “Note 1 of Notes to Consolidated Financial Statements”) and certain property acquisitions and divestitures in 1997 had occurred on January 1, 1997. (4) Basic and diluted net income per share equals the pro forma net income divided by 85,874,513 and 86,156,556 shares, respectively, for 1997, and net income available to common stockholders divided by 85,876,383 and 86,235,176 shares, respectively, for 1998. (5) Dividends for the period commencing on July 27, 1998, the date of Series A Preferred Stock issuance. (6) EBITDA is computed as income from operations before divestiture of Properties and minority interests plus interest expense, income taxes, depreciation and amortization. We believe that in addition to cash flows and net income, EBITDA is a useful financial performance measure for assessing the operating performance of an equity REIT because, together with net income and cash flows, EBITDA provides investors with an additional basis to evaluate the ability of a REIT to incur and service debt and to fund acquisitions and other capital expenditures. Includes an adjustment to reflect the Company’s pro rata share of EBITDA in an unconsolidated joint venture. EBITDA is not a measurement of operating performance calculated in accordance with U.S. generally accepted accounting principles and should not be considered as a substitute for operating income, net income, cash flows from operations or other statement of operations or cash flow data prepared in accordance with U.S generally accepted accounting principles. EBITDA may not be indica- tive of our historical operating results, nor be predictive of potential future results. While EBITDA is frequently used as a measure of operations and the ability to meet debt service requirements, it is not necessarily comparable to other similarly titled captions of other REITs. (7) Funds from Operations (“FFO”) is defined as income from operations before minority interest, gains or losses from sale of real estate and extraordinary losses plus real estate depreciation and adjustment to derive the Company’s pro rata share of the FFO of unconsolidated joint ventures, less minority interests’ pro rata share of the FFO of consolidated joint ventures and perpetual preferred stock dividends. In accordance with the National Association of Real Estate Investment Trust (“NAREIT”) White Paper on FFO, the Company includes the effects of straight-line rents in FFO. We believe that FFO is an appropriate measure of performance for an equity REIT. While FFO is a relevant and widely used measure of operating performance of REITs, it does not represent cash flow from operations or net income as defined by U.S generally accepted accounting principles, and it should not be considered as an alternative to those indicators in evaluating liquidity or operating performance. Further, FFO as disclosed by other REITs may not be comparable. (8) Secured debt includes unamortized debt premiums of approximately $18,286, and $15,217 as of December 31, 1997 and 1998, respectively. See “Notes 2 and 5 of Notes to Consolidated Financial Statements.” 15 Selected Property Financial and Other Data A M B P R O P E R T Y C O R P O R A T I O N For comparative purposes, the table that follows provides selected historical financial and other data of the Properties. The historical results of the Properties for 1997 include the results achieved by the Company for the period from November 26, 1997 to December 31, 1997 and the results achieved by the prior owners of the Properties for the period from January 1, 1997 to November 25, 1997. The historical results of operations of the Properties for periods prior to November 26, 1997 include Properties that were managed by the Predecessor and exclude the results of four Properties that were contributed to the Company in the Formation Transactions that were not previously managed by the Predecessor. In addition, the historical results of operations include the results of Properties acquired after November 26, 1997, from the date of acquisition of such Properties to December 31, 1997. ( I n t h o u s a n d s , e x c e p t s h a r e d a t a , p e r c e n t a g e s a n d n u m b e r o f P r o p e r t i e s ) P r o p e r t i e s C o m b i n e d ( 1 ) nnnnnnnnnnnn H i s t o r i c a l ( 2 ) P r o F o r m a ( 3 ) 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 7 1 9 9 8 A s o f a n d f o r t h e Ye a r s E n d e d D e c e m b e r 3 1 , C o m p a n y O P E R AT I N G D ATA Rental revenues $ 50,893 $ 106,180 $ 166,415 $ 233,856 $ 282,665 $ 354,658 $ 666,672 $1,018,681 $1,616,091 $ 2,442,999 201,959 254,067 522,634 535,652 $3,369,060 734,196 B A L A N C E S H E E T D ATA Investment in real estate at cost Secured debt (4) P R O P E RT Y D ATA INDUSTRIAL PROPERTIES Property net operating income(5) Total rentable square footage at end of period 13,364 21,598 29,609 37,329 Occupancy rate at end of period RETAIL PROPERTIES Property net operating income(5) Total rentable square 96.9% 97.3% 97.2% 95.7% footage at end of period 2,422 3,299 5,282 6,216 Occupancy rate at end of period 93.7% 92.4% 92.4% 96.1% 137,955 181,832 56,611 96.0% 64,716 76,752 6,985 94.6% (1) Represents the Properties’ combined historical financial and other data for the years ended December 31, 1994, 1995 and 1996. The historical results of operations of the Properties for periods prior to November 26, 1997 include Properties that were managed by the Predecessor and exclude the results of four properties that were contributed to the Company in the Formation Transactions that were not previously managed by the Predecessor. (2) The historical results of the Properties for 1997 include the results of the Company for the period from November 26, 1997 (acquisition date) to December 31, 1997 and the results achieved by the prior owners of the Properties for the period from January 1, 1997 to November 25, 1997. (3) The pro forma financial and other data has been prepared as if the Formation Transactions, the IPO (see “Note 1 of Notes to Consolidated Financial Statements”), and certain 1997 property acquisitions and divestitures had occurred on January 1, 1997. (4) Secured debt as of December 31, 1997 and 1998 includes unamortized debt premiums of approximately $18,286 and $15,217, respectively. See “Notes 2 and 5 of Notes to Consolidated Financial Statements.” (5) Property net operating income (NOI) is defined as rental revenue, including reimbursements and straight-line rents, less property level operating expenses. See “Note 13 of Notes to Consolidated Financial Statements.” 16 Management’s Discussion and Analysis of Financial Condition and Results of Operations A M B P R O P E R T Y C O R P O R A T I O N You should read the following discussion and analysis of the consolidated financial condition and results of operations in con- junction with the Notes to Consolidated Financial Statements. Statements contained in this discussion which are not historical facts may be forward looking statements. You can identify forward-looking statements by the use of forward-looking terminology such as “believes,” “expects,” “may,” “will,” “should,” “seeks,” “approximately,” “intends,” “plans,” “pro forma,” “estimates” or “anticipates” or the negative of these words and phrases or similar words or phrases. You can also identify forward-looking state- ments by discussions of strategy, plans or intentions. Forward-looking statements involve numerous risks and uncertainties and you should not rely upon them as predictions of future events. There is no assurance that the events or circumstances reflected in forward-looking statements will be achieved or occur. Forward-looking statements are necessarily dependent on assumptions, data or methods that may be incorrect or imprecise and we may not be able to realize them. The following factors, among others, could cause actual results and future events to differ materially from those set forth or contemplated in the forward-looking statements: defaults or non-renewal of leases by tenants, increased interest rates and operating costs, our failure to obtain necessary outside financing, difficulties in identifying properties to acquire and in effecting acquisitions, our failure to successfully integrate acquired properties and operations, risks and uncertainties affecting property development and construction (including construction delays, cost overruns, our inability to obtain necessary permits and public opposition to these activities), our failure to qualify and main- tain our status as a real estate investment trust under the Internal Revenue Code of 1986, as amended, environmental uncertain- ties, risks related to natural disasters, financial market fluctuations, changes in real estate and zoning laws and increases in real property tax rates. Our success also depends upon economic trends generally, including interest rates, income tax laws, govern- mental regulation, legislation, population changes and certain other risk factors discussed in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Business Risks” in our Annual Report on Form 10-K for the fiscal year ended December 31, 1998. We caution you not to place undue reliance on forward-looking statements, which reflect our analysis only and speak only as of the date of this Annual Report or the dates indicated in the statements. General the years ended December 31, 1997 and 1996. As an investment manager, the Predecessor’s revenues con- Because of the significant impact of the Formation sisted primarily of fees earned in connection with real Transactions and our initial public offering (the “IPO”) estate management services. Management’s discussion on our results of operations, the discussion below is and analysis of the Company and Predecessor for the presented as follows: years ended December 31, 1997 and 1996 is limited to n results of the Company and its Predecessor for the investment management and other income and general years ended December 31, 1998, 1997 and 1996; and and administrative expenses, and excludes a discussion n results of the Properties for the years ended of rental revenues, operating expenses, interest expense December 31, 1998, 1997 and 1996. and depreciation and amortization because such analy- See Note 1 of Notes to Consolidated Financial sis is not comparable or meaningful given the differ- Statements for a discussion of the Formation Transactions. ences in lines of business between the Company and Company and Predecessor Results of Operations The year ended December 31, 1998 was the Company’s first full year operating as a real estate oper- ating company. The historical results of the Company for 1997 include its results, including property opera- tions, for the period from November 26, 1997 (the com- mencement of operations as a fully integrated real estate company) to December 31, 1997 and the results of the Company’s Predecessor, an investment manager, for the period from January 1, 1997 to November 25, 1997, and the Predecessor. COMPANY AND PREDECESSOR – YEARS ENDED DECEMBER 31, 1998 AND 1997 Total revenues. Total revenues, including straight- line rents, tenant reimbursements and other income, totaled $358.9 million for the year ended December 31, 1998. The Predecessor’s revenues consisted primarily of fees earned in connection with real estate management services. As such, no such rental revenues existed for the Predecessor for the years ended December 31, 1997. 17 Management’s Discussion and Analysis of Financial Condition and Results of Operations A M B P R O P E R T Y C O R P O R A T I O N Property operating expenses and real estate taxes. Property operating expenses, including asset management costs and real estate taxes, totaled $96.1 Properties Results of Operations million for the year ended December 31, 1998. The The historical results of operations of the Properties Predecessor’s expenses consisted primarily of salaries for periods prior to November 26, 1997 include Properties and other general and administrative costs. As such, no that were managed by the Predecessor and exclude such property operating expenses existed for the year the results of four properties that were contributed to ended December 31, 1997. the Company in the Formation Transactions that the Predecessor did not previously manage. The discussion General and administrative expenses. Our gen- below for the years ended December 31, 1997 and 1996 eral and administrative expenses were $11.9 million is limited to a discussion of rental revenues, property for the year ended December 31, 1998, as compared to operating expense and real estate taxes and excludes an the Predecessor’s investment management expenses of analysis of other income, interest expense and deprecia- $19.4 million for the period from January 1, 1997 to tion and amortization because such analysis is not com- November 25, 1997. Investment management expenses parable or meaningful given the differences in capital of the Predecessor consisted primarily of salaries and structures between the Company and the prior owners other general and administrative expenses. The 46.1% of the Properties and the impact of the Formation decrease on an annualized basis in general and admin- Transactions and the IPO on the Properties. istrative expenses is attributable to the change in our The historical property financial data presented in operations from an investment manager to a fully inte- this report show significant increases in revenues and grated real estate company, and the formation of AMB expenses principally attributable to the substantial port- Investment Management. In connection with the folio growth. As a result, we do not believe the year-to- Formation Transactions, AMB Investment Management year financial data are comparable. Therefore, the analysis assumed employment and other related costs of certain below shows changes resulting from Properties that the employees who transferred from the Predecessor to Predecessor owned as of January 1, 1997, excluding AMB Investment Management for the purpose of car- development projects (the “Same Store Properties”), rying on the investment management business. and changes attributable to acquisition and develop- COMPANY AND PREDECESSOR – YEARS ENDED DECEMBER 31, 1997 AND 1996 Investment management and other income. Invest- ment management and other income for the period from January 1, 1997 to November 25, 1997 was $29.0 million, which on an annualized basis represents a 34.1% increase over the year ended December 31, 1996. The increase reflects the growth in the portfolio under man- agement. Investment management and other income for the period from November 26, 1997 to December 31, 1997 was $0.6 million. General and administrative expenses. General ment activity during 1997 and 1998. For the comparison between the years ended December 31, 1998 and 1997, the Same Store Properties consist of properties aggregat- ing 31.1 million square feet. For the comparison between the years ended December 31, 1997 and 1996, the Same Store Properties consist of the 59 Properties acquired prior to January 1, 1996. Our future financial condition and results of operations, including rental revenues, may be impacted by the acquisition and divestiture of proper- ties. Our future revenues and expenses may vary materi- ally from their historical rates. PROPERTIES – YEARS ENDED DECEMBER 31, 1998 AND 1997 and administrative expenses for the period from January 1, Rental revenues. Rental revenues, including 1997 to November 25, 1997 were $19.4 million, which straight-line rents, tenant reimbursements and other represents a 27.7% increase on an annualized basis over property related income, increased by $72.0 million, or the year ended December 31, 1996. The increase was 25.5%, for the year ended December 31, 1998, to $354.7 attributable to an increase in staffing that resulted from million, as compared with the same period in 1997. the growth in the portfolio under management. Approximately $9.6 million, or 13.3%, of this increase was attributable to Same Store Properties, with the 18 remaining $62.4 million attributable to Properties Property operating expenses and real estate taxes. acquired in 1998. The growth in rental revenues in Same Property operating expenses and real estate taxes Store Properties resulted primarily from the incremental increased by $25.6 million, or 46.3%, for the year ended effect of rental rate increases and changes in occupancy December 31, 1997, to $80.9 million as compared to and reimbursement of expenses. During the year ended $55.3 million for the year ended December 31, 1996. December 31, 1998, the increase in average base rents Approximately $3.4 million of this increase was attrib- (cash basis) was 14.3% on 7.7 million square feet leased. utable to the Same Store Properties, with the remaining $22.2 million attributable to Properties acquired in 1997 Property operating expenses and real estate taxes. and 1996. Same Store Properties real estate taxes and Property operating expenses, including asset manage- insurance expense increased by approximately $1.4 mil- ment costs, increased by $14.6 million, or 17.9%, for lion from 1996 to 1997. Same Store Properties other the year ended December 31, 1998, to $96.1 million, property operating expenses (excluding real estate taxes as compared with the same period in 1997. Same Store and insurance) increased by $2.0 million from 1996 to Properties operating expenses decreased by approxi- 1997. The increases in expenses are primarily due to mately $0.7 million for the year ended December 31, increases in property tax assessment values and incentive 1998, while operating expenses attributable to Properties management fees expense. acquired in 1998 amounted to $15.3 million. The change in Same Store Properties operating expenses and real estate taxes relates to increases in Same Store Properties real estate taxes of approximately $1.0 million, offset by decreases in Same Store Properties other property operat- ing expenses, including insurance expenses and property management fees of approximately $1.7 million. The remaining decrease in property operating expenses is primarily attributable to lower asset management costs in 1998 as compared to 1997 resulting from the change in ownership structure. PROPERTIES – YEARS ENDED DECEMBER 31, 1997 AND 1996 Rental revenues. Rental income, including tenant reimbursements and other property related income, increased by $67.5 million, or 40.6%, for the year ended December 31, 1997, to $233.9 million as compared to $166.4 million for the year ended December 31, 1996. Approximately $8.8 million, or 13.0%, of this increase was attributable to the Same Store Properties, with the remaining $58.7 million attributable to Properties acquired in 1997 and 1996. The 6.3% growth in rental income in the Same Store Properties resulted primarily from the incremental effect of rental rate increases and reimbursement of expenses. In 1997, we increased average contractual or base rental rates on the Properties by 12% on 393 new and renewing leases totaling 7.5 million rentable square feet (representing 17.2% of the Properties’ aggregate rentable square footage). Liquidity and Capital Resources We currently expect that our principal sources of working capital and funding for acquisitions, develop- ment, expansion and renovation of the Properties will include cash flow from operations, borrowings under the Credit Facility, other forms of secured and unse- cured financing, proceeds from equity or debt offerings by the Company or the Operating Partnership (includ- ing issuances of units in the Operating Partnership or its subsidiaries), and net proceeds from divestiture of prop- erties. We presently believe that our sources of working capital and our ability to access private and public debt and equity capital are adequate for us to continue to meet liquidity requirements for the foreseeable future. CAPITAL RESOURCES Property divestitures. On March 9, 1999, we signed a series of definitive agreements with BPP Retail, LLC (“BPP Retail”), a co-investment entity between Burnham Pacific Properties (“BPP”) and the California Public Employees’ Retirement System (“CalPERS”), pursuant to which BPP Retail will acquire 28 of our retail shopping centers, totaling 5.1 million square feet, for an aggregate price of $663.4 million. BPP Retail will acquire the centers in separate transactions, which we currently expect to close on or about April 30, 1999, July 31, 1999 and December 1, 1999. In addition, we have entered into a definitive agreement, subject to a financing 19 Management’s Discussion and Analysis of Financial Condition and Results of Operations A M B P R O P E R T Y C O R P O R A T I O N confirmation, with BPP, pursuant to which BPP will Debt and equity financing. In June 1998, the acquire six additional retail centers, totaling 1.5 million Operating Partnership issued $400,000 aggregate square feet, for $284.4 million. Assuming satisfaction or principal amount of unsecured notes (“Senior Debt waiver of this condition, we currently expect this trans- Securities”) in an underwritten public offering, the net action to close by December 31, 1999. Assuming that proceeds of which the Operating Partnership used to the transactions with BPP Retail close as scheduled, the repay amounts outstanding under the Credit Facility. Company currently expects to reinvest approximately The Senior Debt Securities mature in June 2008, June $520 million in industrial properties and to reduce our 2015 and June 2018 and bear interest at a weighted secured indebtedness by approximately $100 million. average rate of 7.18%, which is payable in June and There can be no assurance, however, that the transac- December of each year, commencing in December 1998. tions will close as scheduled or close at all, and it is pos- The 2015 notes are putable and callable in June 2005. sible that the transactions may not close with respect to We received credit ratings for the Senior Debt Securities just one or more properties. In the event that one or of Baa1 from Moody’s Investors Service, BBB from more transactions fail to close, or a closing is signifi- Standard & Poor’s Corporation and BBB+ from Duff & cantly delayed, net proceeds from divestitures of proper- Phelps Credit Rating Co. As a result of the receipt of ties will not be available to the same extent to fund our these investment-grade credit ratings, the interest rate acquisitions and developments. Any such failure or delay on the Credit Facility was reduced by 20 basis points to in any of the closings may also make us unable to repay the current rate of LIBOR plus 90 basis points. certain of our indebtedness with the net proceeds as we In July 1998, the Company sold 4,000,000 shares currently intend, and could require us to borrow addi- of 81⁄2% Series A Cumulative Redeemable Preferred Stock tional funds or seek other forms of financing. at a price of $25.00 per share in an underwritten public offering. These shares are redeemable solely at the option Credit facility. We have a $500 million unsecured of the Company on or after July 27, 2003, subject to revolving credit agreement with Morgan Guaranty Trust certain conditions. The Company contributed the net Company of New York, as agent, and a syndicate of proceeds of $96.1 million to the Operating Partnership twelve other banks. The Credit Facility has a term of in exchange for 4,000,000 Series A Preferred Units with three years and is subject to a fee that accrues on the terms identical to the Series A Preferred Stock. The daily average undrawn funds, which varies between 15 Operating Partnership used the proceeds to repay borrow- and 25 basis points (currently 15 basis points) of the ings under the Credit Facility incurred in connection with undrawn funds based on our credit rating. We use the property acquisitions and for general purposes. Credit Facility principally for acquisitions and for gen- In November 1998, the Operating Partnership eral working capital requirements. Borrowings under issued and sold 1,300,000 8.625% Series B Cumulative the Credit Facility bear interest at LIBOR plus 90 to 120 Redeemable Preferred Units at a price of $50.00 per basis points (currently LIBOR plus 90 basis points), unit in a private placement. Distributions are cumula- depending on our debt rating at the time of the borrow- tive from the date of original issuance and are payable ings. As of December 31, 1998, the outstanding balance quarterly in arrears at a rate per unit equal to $4.3125 on the Credit Facility was $234 million and bore inter- per annum. The Series B Preferred Units are redeemable est at 6.10%. Monthly debt service payments on the by the Operating Partnership on or after November 12, Credit Facility are interest only. The Credit Facility 2003, subject to certain conditions, for cash at a redemp- matures in November 2000. The total amount available tion price equal to $50.00 per unit, plus accumulated under the Credit Facility fluctuates based upon the bor- and unpaid distributions thereon, if any, to the redemp- rowing base, as defined in the agreement governing the tion date. The Series B Preferred Units are exchangeable, Credit Facility. At December 31, 1998, the remaining at specified times and subject to certain conditions, on a amount available under the Credit Facility was approx- one-for-one basis, for shares of the Company’s Series B imately $266 million. We currently expect that the prop- Preferred Stock. The Operating Partnership used the pro- erty divestitures will not materially affect the terms and ceeds to repay borrowings under the Credit Facility, for conditions of the Credit Facility. property acquisitions and for general purposes. 20 In November 1998, a subsidiary of the Operating Market capitalization. In connection with the Partnership issued and sold 2,200,000 units of 8.75% Formation Transactions and property acquisitions con- Series C Cumulative Redeemable Preferred Units at a summated after the Formation Transactions, we have price of $50.00 per unit in a private placement. Distri- assumed various mortgages and other secured debt. As butions are cumulative from the date of original issuance of December 31, 1998, the aggregate principal amount and are payable quarterly in arrears at a rate per unit of this secured debt was $719 million, excluding unamor- equal to $4.375 per annum. The Series C Preferred Units tized debt premiums of $15.2 million. The secured debt are redeemable by the subsidiary of the Operating bears interest at rates varying from 4.0% to 10.4% per Partnership on or after November 24, 2003, subject to annum (with a weighted average of 7.9%) and final certain conditions, for cash at a redemption price equal maturity dates ranging from April 1999 to April 2014. to $50.00 per unit, plus accumulated and unpaid distrib- We believe that the carrying value of the debt approxi- utions thereon, if any, to the redemption date. The Series mates its fair value on December 31, 1998. C Preferred Units are exchangeable, at specified times In order to maintain financial flexibility and facil- and subject to certain conditions, on a one-for-one basis, itate the rapid deployment of capital through market for shares of the Company’s Series C Preferred Stock. cycles, we presently intend to operate with a debt-to- The subsidiary of the Operating Partnership used the total market capitalization ratio of approximately 45% proceeds to make a loan to the Operating Partnership, or less. Additionally, we presently intend to continue which used the funds to repay borrowings under the to structure our balance sheet in order to maintain an Credit Facility. investment grade rating on our senior unsecured debt. The tables below summarize our debt maturities and capitalization as of December 31, 1998. Debt ( I n t h o u s a n d s ) Year 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Thereafter Sub-total Unamortized premiums Total consolidated debt Our share of unconsolidated JV debt Total debt JV Partner’s share of consolidated JV debt Our share of total debt Market Equity ( I n t h o u s a n d s , e x c e p t s h a r e a m o u n t s ) Security Common Stock LP Units Total Secured Debt Unsecured Senior Debt Securities Unsecured Credit Facility Total Debt $0,014,061 $0,000,00– $0,000,00– $0,014,061 19,833 42,560 68,849 136,798 67,396 67,446 131,759 35,320 114,425 20,532 718,979 15,217 – – – – – 100,000 – – 175,000 125,000 400,000 – 234,000 – – – – – – – – – 234,000 – $0,0734,196 $0,400,000 $0,234,000 253,833 42,560 68,849 136,798 67,396 167,446 131,759 35,320 289,425 145,532 1,352,979 15,217 1,368,196 20,186 1,388,382 (40,275) $1,348,107 Outstanding At 12/31/98 Market Price At 12/31/98 Market Value At 12/31/98 85,917,520 4,447,839 90,365,359 $22.00 $1,890,185 nnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnn 22.00 nnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnn 97,853 $1,988,038 21 Management’s Discussion and Analysis of Financial Condition and Results of Operations A M B P R O P E R T Y C O R P O R A T I O N Preferred Stock and Units ( I n t h o u s a n d s , e x c e p t p e r c e n t a g e s ) Security Series A Preferred Stock Series B Preferred Units Series C Preferred Units Total/Weighted Average Capitalization Ratios Dividend Rate 8.50% 8.63% 8.75% 8.66% Liquidation Preference Redemption Provisions $100,000 July 2003 65,000 November 2003 110,000 November 2003 $275,000 Consolidated debt plus our share of unconsolidated JV debt-to-total market capitalization Consolidated debt plus our share of unconsolidated debt less JV partners’ share of consolidated debt-to-total market capitalization Consolidated debt plus our share of unconsolidated JV debt plus preferred-to-total market capitalization 38.0% 36.9% 45.6% LIQUIDITY On March 5, 1999, the Company and the Operating Partnership declared a quarterly cash distribution of As of December 31, 1998, we had approximately $0.35 per common share and operating partnership unit, $25.1 million in cash and cash equivalents and $266 for the quarter ending March 31, 1999, payable April 15, million of additional available borrowings under the 1999 to stockholders and unitholders of record as of Credit Facility. We intend to use cash flow from opera- March 31, 1999. This dividend (with an annualized rate tions, borrowings under the Credit Facility, other forms of $1.40 per share) represents a 2.2% increase from the of secured and unsecured financing, proceeds from dividend for the fourth quarter and is consistent with our equity or debt offerings by the Company or the Operat- philosophy of retaining as much cash flow as allowed ing Partnership (including issuances of units in the under the REIT tax rules while providing stockholders Operating Partnership or its subsidiaries), and proceeds with dividend growth. On March 5, 1999, the Company from divestiture of properties to fund acquisitions, declared a cash dividend of $0.53125 per share on its development activities and capital expenditures and to Series A Preferred Stock, and the Operating Partnership provide for general working capital requirements. declared a cash distribution of $0.53125 per unit on its On December 4, 1998, the Company and the Series A Preferred Units, for the three month period end- Operating Partnership declared a quarterly cash distri- ing April 14, 1999, payable on April 15, 1999 to stock- bution of $0.3425 per common share and operating part- holders and unitholders of record as of March 31, 1999. nership unit, payable January 15, 1999 to stockholders The anticipated size of our distributions, using only and unitholders of record on December 31, 1998. The cash from operations, will not allow us to retire all of annual distribution per common share and unit for 1998 our debt as it comes due. Therefore, we intend to also was $1.37. On December 4, 1998, the Company declared repay maturing debt with net proceeds from future debt a cash dividend of $0.53125 per share on its Series A and/or equity financings. However, we may not be able Preferred Stock, and the Operating Partnership declared to obtain future financings on favorable terms or at all. a cash distribution of $0.53125 per unit on its Series A Preferred Units, for the three month period ended CAPITAL COMMITMENTS January 14, 1999, payable on January 15, 1999 to stock- holders and unitholders of record as of December 31, In addition to recurring capital expenditures and 1998. The 1998 dividend for the Series A Preferred Stock costs to renew or re-tenant space, as of December 31, and Units was $0.9917, for the partial year commencing 1998, our development pipeline included 18 projects on July 27, 1998, which was the issuance date. representing a total estimated investment of $349.9 million upon completion. Of this total, approximately $156.0 million had been funded as of December 31, 22 1998, approximately $66.2 million is estimated to be Costs of addressing our year 2000 issues. Given required to complete projects under construction as of the information known at this time about our systems, December 31, 1998, and the remainder represents esti- coupled with ongoing, normal course-of-business efforts mated investments in either projects where construction to upgrade or replace critical systems, as necessary, we has not yet begun or future phases of projects under do not expect year 2000 compliance costs to have any construction. We presently expect to fund these expen- material adverse impact on our liquidity or ongoing ditures with cash flow from operations, borrowings results of operations. The costs of such assessment and under the Credit Facility, debt or equity issuances, and remediation will be included in our general and admin- net proceeds from property divestiture. Other than these istrative expenses. Although we can make no assurance, capital items, we have no material capital commitments. we currently do not expect that the year 2000 issue During the period from January 1, 1998 to Decem- will materially affect our operations due to problems ber 31, 1998, we invested: encountered by our suppliers, customers and lenders. n $738.6 million in 228 industrial buildings, aggregating 18.8 million rentable square feet, Risks of our year 2000 issues. In light of our n $31.8 million in 2 retail centers, aggregating 0.4 million assessment and remediation efforts to date, we believe rentable square feet, that any residual year 2000 risk is limited to non-criti- n $67.1 million in an unconsolidated limited partnership cal business applications and support hardware. No interest in an existing joint venture that owns 36 assurance can be given, however, that all of our systems industrial buildings aggregating 4.0 million square feet. will be year 2000 compliant or that compliance will We funded these acquisitions through borrowings not have a material adverse effect on our future liquidity, under the Credit Facility, cash, debt assumption and the results of operations or ability to service debt. issuance of units in the Operating Partnership. YEAR 2000 COMPLIANCE ing our contingency plan for all operations to address the most reasonably likely worst case scenarios regard- Our state of readiness. We utilize a number of ing year 2000 compliance. We expect such contingency computer software programs and operating systems plan to be completed by the end of the year. Our contingency plans. We are currently develop- across our entire organization, including applications used in financial business systems and various adminis- trative functions. To the extent that our software applica- tions contain source code that is unable to appropriately interpret the upcoming calendar year “2000” and beyond, some level of modification or replacement of such applications will be necessary. FUNDS FROM OPERATIONS We believe that Funds from Operations (“FFO”), as defined by the National Association of Real Estate Investment Trusts (“NAREIT”), is an appropriate measure of performance for an equity REIT. While FFO is a rele- We are currently conducting a company-wide test of vant and widely used measure of operating performance our financial and non-financial systems to ensure that our systems will adequately handle the year 2000 issue. Our current financial system generally provides for a four-digit year; however, the current system is not fully of REITs, it does not represent cash flow from operations or net income as defined by GAAP, and it should not be considered as an alternative to those indicators in evalu- ating liquidity or operating performance. Further, FFO as year 2000 compliant. We expect that our financial system disclosed by other REITs may not be comparable. will be fully year 2000 compliant once we complete a software upgrade in 1999. We are also currently surveying our property managers to determine if our non-financial systems (HVAC, security, lighting and other building sys- tems) at our Properties are year 2000 compliant and to determine the state of readiness of our tenants regarding their year 2000 compliance. 23 Management’s Discussion and Analysis of Financial Condition and Results of Operations A M B P R O P E R T Y C O R P O R A T I O N The following table reflects the calculation of our FFO for the fiscal years ended December 31, 1997 and 1998. The 1997 FFO was prepared on a pro forma basis (giving effect to the completion of the Formation Transactions, the IPO and certain 1997 property acquisitions and divestitures) as if they had occurred on January 1, 1997. ( I n t h o u s a n d s , e x c e p t s h a r e s ) Income from operations before minority interests Real estate depreciation and amortization: Total depreciation and amortization Furniture, fixtures and equipment depreciation FFO attributable to minority interests(1)(2) Adjustments to derive FFO in unconsolidated joint venture(3): Company’s share of net income Company’s share of FFO Series A preferred stock dividends Series B & C preferred unit distributions FFO(1) Weighted average shares and units outstanding (diluted) 1 9 9 7 1 9 9 8 $103,903 $123,750 45,886 (173) (2,207) – – – – 57,464 (463) (5,899) (1,750) 2,739 (3,639) (1,795) $147,409 $170,407 88,698,719 89,852,187 (1) Funds from Operations (“FFO”) is defined as income from operations before minority interest, gains or losses from sale of real estate and extraordinary losses plus real estate depreciation and adjustment to derive our pro rata share of the FFO of unconsolidated joint ventures, less minority interests’ pro rata share of the FFO of consolidated joint ventures and perpetual preferred stock dividends. In accordance with NAREIT White Paper on FFO, we include the effects of straight-line rents in FFO. (2) Represents FFO attributable to minority interests in consolidated joint ventures for the periods presented, which has been computed as minority interests’ share of net income before disposal of properties plus minority interests’ share of real estate-related depreciation and amortization of the consolidated joint ventures for such periods. Such minority interests are not exchangeable into shares of Common Stock. (3) Represents our pro rata share of FFO in unconsolidated joint ventures for the periods presented, which has been computed as our share of net income plus our share of real estate-related depreciation and amortization of the unconsolidated joint venture for such periods. QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company’s exposure to market risk includes the rising interest rates in connection with the Company’s unsecured credit facility and other variable-rate borrow- ings and the ability of the Company to incur more debt without stockholder approval, thereby increasing our debt service obligations, which could adversely affect the Company’s cash flows. See “Liquidity and Capital Resources – Capital Resources – Market Capitalization.” 24 Consolidated Balance Sheets A M B P R O P E R T Y C O R P O R A T I O N ( I n t h o u s a n d s , e x c e p t s h a r e a m o u n t s ) A S S E T S Investments in real estate: Land and improvements Buildings and improvements Construction in progress Total investments in properties Accumulated depreciation and amortization Net investments in properties Investment in unconsolidated joint venture Properties held for divestiture, net Net investments in real estate Cash and cash equivalents Other assets Total assets L I A B I L I T I E S A N D S T O C K H O L D E R S ’ E Q U I T Y Debt: Secured debt Unsecured senior debt securities Unsecured credit facility Total debt Other liabilities Payable to affiliates Total liabilities Commitments and contingencies (note 11) Minority interests Stockholders’ equity: Series A preferred stock, cumulative, redeemable, $.01 par value, 100,000,000 shares authorized, 4,000,000 issued and outstanding, $100,000 liquidation preference Common stock, $.01 par value, 500,000,000 shares authorized, 85,917,520 issued and outstanding Additional paid-in capital Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity The accompanying notes are an integral part of these consolidated financial statements. A s o f D e c e m b e r 3 1 , 1 9 9 7 1 9 9 8 $ 550,635 $ 740,680 1,822,516 69,848 2,442,999 2,445,104 183,276 3,369,060 (4,153) (58,404) 2,438,846 3,310,656 – – 57,655 115,050 2,438,846 3,483,361 39,968 27,441 25,137 54,387 $ 2,506,255 $3,562,885 $ 535,652 $ 734,196 – 150,000 685,652 49,350 38,071 773,073 – 65,152 400,000 234,000 1,368,196 104,305 – 1,472,501 – 325,024 – 859 96,100 859 1,667,171 1,668,401 – – 1,668,030 1,765,360 $ 2,506,255 $3,562,885 25 Consolidated Statements of Operations A M B P R O P E R T Y C O R P O R A T I O N ( I n t h o u s a n d s , e x c e p t s h a r e a m o u n t s ) 1 9 9 6 1 9 9 7 1 9 9 8 F o r t h e Ye a r s E n d e d D e c e m b e r 3 1 , R E V E N U E S Rental revenues Investment management and other income Total revenues O P E R AT I N G E X P E N S E S Property operating expenses Real estate taxes General and administrative Interest, including amortization Depreciation and amortization Investment management expenses Total operating expenses Income from operations before minority interests Minority interests’ share of net income Net income Series A preferred stock dividends $ – $ 26,465 23,991 23,991 – – – – – 16,851 16,851 7,140 (137) 29,597 56,062 5,312 3,587 1,197 3,528 4,195 19,358 37,177 18,885 (657) $354,658 4,229 358,887 47,856 48,218 11,929 69,670 57,464 – 235,137 123,750 (11,157) $ 7,003 $ 18,228 $112,593 – – (3,639) Net income available to common stockholders $ 7,003 $ 18,228 $108,954 I N C O M E P E R S H A R E O F C O M M O N S T O C K Basic Diluted $ $ 1.38 1.38 $ $ 1.39 1.38 $ $ 1.27 1.26 W E I G H T E D AV E R A G E C O M M O N S H A R E S O U T S TA N D I N G Basic Diluted The accompanying notes are an integral part of these consolidated financial statements. 5,079,855 5,079,855 13,140,218 85,876,383 13,168,036 86,235,176 26 Consolidated Statements of Cash Flows A M B P R O P E R T Y C O R P O R A T I O N ( I n t h o u s a n d s ) 1 9 9 6 1 9 9 7 1 9 9 8 F o r t h e Ye a r s E n d e d D e c e m b e r 3 1 , C A S H F L O W S F R O M O P E R AT I N G A C T I V I T I E S Net Income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization Straight-line rents Amortization of debt premiums and financing costs Minority interests’ share of net income Equity in (income) loss of AMB Investment Management Equity earnings of unconsolidated joint venture Changes in assets and liabilities: Other assets Other liabilities Net cash provided by operating activities C A S H F L O W S F R O M I N V E S T I N G A C T I V I T I E S Cash paid for property acquisitions Additions to properties Additions to buildings, development costs, and improvements Acquisition of interest in unconsolidated joint venture Distribution received from unconsolidated joint venture Reduction of payable to affiliates in connection with Formation Transactions Net cash used for investing activities C A S H F L O W S F R O M F I N A N C I N G A C T I V I T I E S Issuance of common stock Borrowings on unsecured credit facility Borrowings on secured debt Payment of unsecured credit facility Payments on secured debt Payment of financing fees Net proceeds from issuance of senior debt securities Net proceeds from issuance of Series A preferred stock Net proceeds from issuance of Series B & C preferred units Dividends paid to common stockholders and preferred stockholders Dividends paid to Predecessor stockholders Distributions to minority interests Principal payment of notes receivable from stockholders of Predecessor Net cash provided by (used in) financing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period The accompanying notes are an integral part of these consolidated financial statements. $ 7,003 $ 18,228 $ 112,593 – – – 137 – – (249) (25) 6,866 – – – – – – – – – – – – – – – – – (5,262) (34) 318 (4,978) 1,888 1,205 3,093 $ 4,195 (901) (266) 657 (61) – (11,873) 2,301 12,280 57,464 (10,921) (2,730) 11,157 313 (1,730) (9,377) 20,411 177,180 – (564,304) (228,432) – (4,375) – – – (232,807) 317,009 150,000 850 (182,000) (516) (900) – – – (11,506) (16,404) – 869 257,402 36,875 3,093 (137,913) (67,376) 11,451 (38,071) (796,213) – 745,000 58,725 (661,000) (79,380) (7,704) 399,166 96,100 167,993 (88,236) – (26,462) – 604,202 (14,831) 39,968 $ 39,968 $ 25,137 27 Consolidated Statements of Stockholders’ Equity A M B P R O P E R T Y C O R P O R A T I O N F o r t h e Ye a r s E n d e d D e c e m b e r 3 1 , 1 9 9 6 , 1 9 9 7 a n d 1 9 9 8 Series A Preferred Stock Common Stock Number of Shares Amount Additional Paid-in Capital Notes Receivable Retained From Earnings Stockholders Total ( I n t h o u s a n d s , e x c e p t s h a r e a m o u n t s ) PREDECESSOR Balance at December 31, 1995 $00,00– 5,079,855 $1,042 $0,001,298 $(002,781 $(880) $0,004,241 Net Income Dividends declared and paid Principal payment of notes receivable from stockholders Issuance of common stock for notes Balance at December 31, 1996 AMB PROPERTY CORPORATION Net Income Dividends declared and paid to Predecessor stockholders Principal payment of notes receivable from stockholders Exchange of Predecessor shares for shares of AMB Property Corporation, net Issuance of common stock for Properties Issuance of common stock, net of Offering costs of $38,068 Issuance of restricted stock Distributions paid to AMB Property Corporation stockholders Balance at December 31, 1997 Net Income Issuance of preferred stock, net of offering costs Issuance of restricted stock Reallocation of Limited Partners’ interests in Operating Partnership – – – – – – – – – – – – – – 3,639 96,100 – – Dividends declared (3,639) 7,003 (5,262) – – 7,003 (5,262) – – – – – – 101,595 307 – – – – 5,181,450 1,349 1,298 4,522 – – – – – – – 318 (307) (869) 318 – 6,300 – – 18,228 (16,404) 869 869 – – – – – – – – – – – – 1,370,391 300,032 120 (11,506) 1,668,030 112,593 96,100 930 7,215 (119,508) – – – – – 18,228 (990) (1,298) (14,116) – – (434,834) (312) 312 65,022,185 651 1,369,740 16,100,000 161 299,871 120 5,712 – – – (2,872) (8,634) 85,874,513 859 1,667,171 – – – 43,007 – – – – – – – – – 930 7,215 108,954 – – – (6,915) (108,954) Balance at December 31, 1998 $96,100 85,917,520 $0,859 $1,668,401 $(000,00– $(00– $1,765,360 The accompanying notes are an integral part of these consolidated financial statements. 28 Notes to Consolidated Financial Statements A M B P R O P E R T Y C O R P O R A T I O N ( I n t h o u s a n d s , e x c e p t s h a r e a n d s q u a r e f e e t d a t a ) N O T E 1 : per share, resulting in gross offering proceeds of Organization and Formation of Company AMB Property Corporation, a Maryland corpora- tion (the “Company”), commenced operations as a fully integrated real estate company effective with the completion of its initial public offering (the “IPO”) on November 26, 1997. The Company elected to be taxed as a real estate investment trust (“REIT”) under Sections 856 through 860 of the Internal Revenue Code of 1986 (the “Code”), commencing with its taxable year ended December 31, 1997, and believes its current organiza- tion and method of operation will enable it to main- tain its status as a REIT. The Company, through its controlling interest in its subsidiary, AMB Property, L.P., a Delaware limited partnership (the “Operating Partnership”), is engaged in the acquisition, ownership, operation, management, renovation, expansion and development of industrial buildings and community shopping centers in target markets nationwide. Unless the context otherwise requires, the “Company” means AMB Property Corporation, the Operating Partnership and its other controlled subsidiaries. The Company and the Operating Partnership were formed shortly before consummation of the IPO. AMB Institutional Realty Advisors, Inc., a California corpora- tion and registered investment advisor (the “Predecessor”) formed AMB Property Corporation, a wholly owned subsidiary, and merged with and into the Company (the “Merger”) in exchange for 4,746,616 shares of the Company’s Common Stock. In addition, the Company and the Operating Partnership acquired, through a series of mergers and other transactions, 31.8 million rentable square feet of industrial property and 6.3 million rentable square feet of retail property in exchange for 65,022,185 shares of the Company’s Common Stock, 2,542,163 limited partner interests (“LP Units”) in the Operating Partnership, the assumption of debt and, to a limited extent, cash. The net assets of the Predecessor and the properties acquired with Common Stock were contributed to the Operating Partnership in exchange for 69,768,801 LP Units. The purchase method of accounting was applied to the acquisition of the properties. Collectively, the Merger and the other formation transactions described above are referred to as the “Formation Transactions.” On November 26, 1997, the Company completed its IPO of 16,100,000 shares of Common Stock, $0.01 par value per share (the “Common Stock”), for $21.00 approximately $338,100. The net proceeds of approxi- mately $300,032 were used to repay indebtedness, to purchase interests from certain investors who elected not to receive shares or units in connection with the Formation Transactions, to fund property acquisitions, and for general corporate working capital requirements. As of December 31, 1998, the Company owned an approximate 95.1% general partner interest in the Operating Partnership. The remaining 4.9% limited partner interest is owned by nonaffiliated investors. For local law purposes, properties in certain states are owned through limited partnerships and limited liabil- ity companies owned 99% by the Operating Partnership and 1% by a wholly owned subsidiary of the Company. The ownership of such properties through such entities does not materially affect the Company’s overall owner- ship of the interests in the properties. As the sole gen- eral partner of the Operating Partnership, the Company has the full, exclusive and complete responsibility and discretion in the day-to-day management and control of the Operating Partnership. In connection with the Formation Transactions, the Operating Partnership formed AMB Investment Management, Inc., a Maryland corporation (“AMB Investment Management”). The Operating Partnership purchased 100% of AMB Investment Management’s non-voting preferred stock (representing a 95% eco- nomic interest therein). Certain current and former executive officers of the Company and an officer of AMB Investment Management collectively purchased 100% of the Investment Management Subsidiary’s vot- ing common stock (representing a 5% economic inter- est therein). The Operating Partnership accounts for its investment in AMB Investment Management using the equity method of accounting. AMB Investment Management was formed to succeed to the Predecessor’s investment management business of providing real estate investment management services on a fee basis to clients. The Operating Partnership also owns 100% of the non- voting preferred stock of Headlands Realty Corporation, a Maryland corporation (representing a 95% economic interest therein). Certain current and former executive officers of the Company and an officer of Headlands Realty Corporation collectively own 100% of the voting common stock of Headlands Realty Corporation (repre- senting a 5% economic interest therein). Headlands Realty Corporation invests in properties and interests in entities that engage in the management, leasing and development of properties and similar activities. 29 Notes to Consolidated Financial Statements A M B P R O P E R T Y C O R P O R A T I O N ( I n t h o u s a n d s , e x c e p t s h a r e a n d s q u a r e f e e t d a t a ) As of December 31, 1998, the Company owned (the commencement of operations as a fully integrated 582 industrial buildings (the “Industrial Properties”) and real estate company) to December 31, 1997 and the 38 retail centers (the “Retail Properties”) located in 30 results of the Company’s Predecessor, an investment markets throughout the United States. The Industrial manager, for the period from January 1, 1997 to Properties, principally warehouse distribution buildings, November 25, 1997. The consolidated financial state- encompass approximately 56.6 million rentable square ments for 1998 represent the results of operations of feet and, as of December 31, 1998, were 96.0% leased the Company for the year ended December 31, 1998. to over 1,600 tenants. The Retail Properties, principally grocer-anchored community shopping centers, encom- Investments in real estate. Investments in real pass approximately 7.0 million rentable square feet and, estate are stated at the lower of depreciated cost or net as of the same date, were 94.6% leased to over 900 ten- realizable value. Net realizable value for financial ants. The Industrial Properties and the Retail Properties reporting purposes is reviewed for impairment on a collectively are referred to as the “Properties.” property-by-property basis whenever events or changes N O T E 2 : Summary of Significant Accounting Policies Generally accepted accounting principles. These consolidated financial statements have been prepared in accordance with generally accepted accounting prin- ciples using the accrual method of accounting. The preparation of financial statements in conformity with generally accepted accounting principles requires man- agement to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclo- sure of contingent assets and liabilities at the date of the financial statements and the reported amounts of rev- enues and expenses during the reporting period. Actual in circumstances indicate that the carrying amount of a property may not be recoverable. Impairment is recog- nized when estimated expected future cash flows (undiscounted and without interest charges) are less than the carrying amount of the property. To the extent an impairment has occurred, the excess of the carrying amount of the property over its estimated fair value will be charged to income. As of December 31, 1998, we believe that there were no impairments of the carrying values of the Properties. Depreciation and amortization are calculated using the straight-line method over the estimated useful lives of the investments. The estimated lives are as follows: Land improvements Buildings and improvements Tenant improvements and 5 to 40 years 5 to 40 years results could differ from those estimates. leasing costs Term of the related lease Principles of consolidation. The accompanying The cost of buildings and improvements includes consolidated financial statements include the financial the purchase price of the property or interest in prop- position, results of operations and cash flows of the erty, legal fees and acquisition costs, and interest, prop- Company, its wholly owned qualified REIT subsidiaries, erty taxes, and other costs incurred during the period the Operating Partnership, and twenty-one joint ventures of construction. (the “Joint Ventures”) in which the Company has a Expenditures for maintenance and repairs are controlling interest. The Company also has a 56.1% charged to operations as incurred. Significant renova- non-controlling limited partnership interest in one tions or betterments that extend the economic useful unconsolidated real estate joint venture which is life of assets are capitalized. accounted for under the equity method. Third-party Project costs directly associated with the develop- equity interests in the Operating Partnership and the ment and construction of a real estate project are capi- Joint Ventures are reflected as minority interests in the talized as construction in progress. In addition, interest, consolidated financial statements. All significant inter- real estate taxes and other costs are capitalized during company amounts have been eliminated. the construction period. Basis of presentation. The consolidated financial Cash and cash equivalents. Cash and cash equiv- statements of the Company for 1997 include the results alents include cash held in financial institutions and of operations of the Company, including property other highly liquid short-term investments with original operations for the period from November 26, 1997 30 maturities of three months or less. Cash and cash the Operating Partnership, the Series B Preferred Unit equivalents as of December 31, 1997 and 1998 include holders’ interest in the Operating Partnership, and the restricted cash of $8,074 and $5,227, respectively, which Series C Preferred Unit holders’ interest in a subsidiary of represents amounts held in escrow in connection with the Operating Partnership, as of and for the year ended property purchases and capital improvements. December 31, 1998. Deferred financing. Costs incurred in connection with financing are capitalized and amortized to inter- Minority Interest Liability Minority Interest Share of Net Income est expense on a straight-line basis (which approxi- Minority Interest – mates the effective interest method) over the term of Joint Venture Partners $018,012 $01,491 the related loan. As of December 31, 1997 and 1998, Minority Interest – deferred financing fees were $871 and $7,318, respec- tively, net of accumulated amortization of $29 and $772, respectively. Such amounts are included in Other Assets on the consolidated balance sheet. Fair value of financial instruments. The Company’s financial instruments include short-term investments, accounts receivable, accounts payable, accrued expenses, construction loans payable, mortgage debt, secured debt, senior debt securities, unsecured notes payable, and an unsecured credit facility. The fair value of these instruments approximates its carrying or contract values. Debt premiums. In connection with the Formation Transactions, the Company assumed certain secured debt with an aggregate principal value of $517,031 and a fair value of $535,613. The difference between the principal value and the fair value was recorded as a debt premium. The debt premium is being amortized into interest expense over the term of the related debt instrument using the effective interest method. As of December 31, 1997 and 1998, the unamortized debt premium was $18,286 and $15,217, respectively. Minority interests. Minority interests in the Company represent the limited partnership interests in the Operating Partnership and interests held by certain third parties in twenty-one real estate joint ventures that are consolidated for financial reporting purposes. Such investments are consolidated because 1) the Company owns a majority interest, or 2) the Company holds sig- nificant control over the entity through a 50% or greater ownership interest combined with the ability to control major operating decisions, such as approval of budgets, selection of property managers and change in financing. The following table distinguishes the minority inter- est ownership held by certain Joint Venture Partners, Institutional Alliance Partners, the limited partners in Institutional Alliance Partners 52,381 2,987 Minority Interest – Limited Partners in the Operating Partnership Minority Interest – Series B Preferred Units (liquidation preference of $65,000) Minority Interest – Series C Preferred Units (liquidation preference of $110,000) 86,638 4,884 62,259 779 105,734 $325,024 1,016 $11,157 Revenues. The Company, as a lessor, retains sub- stantially all of the benefits and risks of ownership of the Properties and accounts for its leases as operating leases. Rental income is recognized on a straight-line basis over the term of the leases. Reimbursements from tenants for real estate taxes and other recoverable operating expenses are recog- nized as revenue in the period the applicable expenses are incurred. Investment management and other income. Investment management income consists primarily of professional fees generated from the Predecessors’ real estate investment management services for periods prior to the Formation Transactions and the Company’s equity in the earnings of AMB Investment Management for periods subsequent to the Formation Transactions. Other income consists primarily of interest income on cash and cash equivalents. Investment management expenses. Investment management expenses represent the operating expenses of the Predecessor for periods prior to November 26, 1997 and consist of salaries and benefits and other management related expenses. 31 Notes to Consolidated Financial Statements A M B P R O P E R T Y C O R P O R A T I O N ( I n t h o u s a n d s , e x c e p t s h a r e a n d s q u a r e f e e t d a t a ) Reclassifications. Certain items in the consolidated The following summarizes the condensed results of financial statements for prior periods have been reclas- operations of the properties held for divestiture for the sified to conform with current classifications with no period from November 26, 1997 to December 31, 1997 effect on results of operations. and for the year ended December 31, 1998: to these working capital distributions. Such amount was Secured debt, varying N O T E 3 : Transactions with Affiliates As discussed in Note 1, the Operating Partnership formed AMB Investment Management for the purpose of carrying on the operations of the Predecessor. The Company and AMB Investment Management have an agreement that allows for the sharing of certain costs and employees. Additionally, the Company provides AMB Investment Management with certain acquisi- tion-related services. As part of the Formation Transactions, the Operat- ing Partnership was required to pay an amount equal to the net working capital balances at November 25, 1997 of the Predecessor and the acquired Properties to the owners of said entities. As of December 31, 1997, the Company owed approximately $37,808 to owners related repaid in full in early 1998. The Company and AMB Investment Management share common office space under lease obligations of an affiliate of the Predecessor. Such lease obligations are charged to the Company and AMB Investment Management at cost. For the years ended December 31, 1997, and 1998, the Company paid approximately $700 and $1,160, respectively, for occupancy costs related to the lease obligations of the affiliate. N O T E 4 : Property Held for Divestiture The Company has determined to focus exclusively on properties that meet its strategic objectives. Therefore, as of December 31, 1998, the Company had decided to divest itself of four industrial buildings and four retail centers. As of December 31, 1998, the divestiture of the properties is subject to negotiation of acceptable terms and other customary conditions. 32 Income Property operating expenses Net operating income 1 9 9 7 1 9 9 8 $01,406 370 $01,036 $14,851 3,626 $11,225 As of December 31,1998, the net carrying value of the properties held for divestiture was $115,050, and two of the retail centers were encumbered by secured debt of $42,615. The net proceeds will be used to acquire addi- tional properties and pay down certain debts. N O T E 5 . Debt As of December 31, 1997 and 1998, debt, excluding unamortized debt premiums, consists of the following: coupon interest rates from 4.00% to 10.38%, due April 1999 to April 2014 Unsecured senior debt securities, weighted average interest rate of 7.18%, due June 2008, 2015, and 2018 Unsecured credit facility, variable interest at LIBOR plus 90 to 120 basis points (6.10% at December 31, 1998), due November 2000 Total Debt 1 9 9 7 1 9 9 8 $0,517,366 $0,718,979 – 400,000 150,000 $0,667,366 234,000 $1,352,979 Secured debt generally requires monthly principal and interest payments. The secured debt is secured by deeds of trust on certain Properties. As of December 31, 1998, the total gross investment value of those Properties secured by debt was $1,458,652. All of the secured debt bear interest at fixed rates, except for two loans with an aggregate principal amount of $9,155, which bear inter- est at a variable rate. The secured debt has various finan- cial and non-financial covenants. Additionally, certain of the secured debt is cross-collateralized. Interest on the senior debt securities is payable semiannually in each June and December commencing December 1998. The 2015 notes are putable and callable in June 2005. The senior debt securities are subject to 1998, respectively. These amounts are included as rental various financial and non-financial covenants. income and operating expenses in the accompanying The Company has a $500,000 unsecured revolving consolidated statements of operations. Certain of the credit agreement (the “Credit Facility”) with Morgan leases also provide for the payment of additional rent Guaranty Trust Company of New York, as agent, and a based on a percentage of the tenant’s revenues. For syndicate of twelve other banks. The Credit Facility has the period from November 26, 1997 to December 31, an original term of three years and is subject to a fee that 1997 and for the year ended December 31, 1998, the accrues on the daily average undrawn funds, which varies Company recognized percentage rent revenues of $185 between 15 and 25 basis points of the undrawn funds and $1,870, respectively. Some leases contain options to based on the Company’s credit rating. The Credit Facility renew. No individual tenant accounts for greater than has various financial and non-financial covenants. 2% of rental revenues. Capitalized interest related to construction projects for the period from November 26, 1997 to December 31, 1997, was $448 and for the year ended December 31, 1998 was $7,192. There was no capitalized interest for periods prior to the Formation Transactions. The scheduled maturities of the Company’s total debt, excluding unamortized debt premiums, as of December 31, 1998 are as follows: U n s e c u r e d S e n i o r D e b t S e c u r i t i e s U n s e c u r e d C r e d i t F a c i l i t y S e c u r e d D e b t N O T E 7 : Income Taxes The Company elected to be taxed as a REIT under the Code commencing with its taxable year ended December 31, 1997. To qualify as a REIT, the Company must meet a number of organizational and operational requirements, including a requirement that it currently distribute at least 95% of its taxable income to its stock- To t a l holders. It is management’s intention to adhere to these 1999 2000 2001 2002 2003 Thereafter $0,014,061 $0,000,00– $0,000,00– $0,014,061 253,833 42,560 68,849 136,798 836,878 $0,718,979 $0,400,000 $0,234,000 $1,352,979 19,833 42,560 68,849 136,798 436,878 234,000 – – – – – – – – 400,000 N O T E 6 : Leasing Activity Future minimum rental income due under non- cancelable leases with tenants in effect at December 31, 1998, is as follows: 1999 2000 2001 2002 2003 Thereafter $0,329,322 287,771 239,178 189,259 142,411 536,573 $1,724,514 In addition to minimum rental payments, certain tenants pay reimbursements for their pro rata share of specified operating expenses, which amounted to $5,267 and $68,071 for the period from November 26, 1997 to December 31, 1997 and for the year ended December 31, requirements and maintain the Company’s REIT status. As a REIT, the Company generally will not be subject to corporate level federal income tax on net income it dis- tributes currently to its stockholders. As such, no provi- sion for federal income taxes has been included in the accompanying consolidated financial statements. If the Company fails to qualify as a REIT in any taxable year, it will be subject to federal income taxes at regular cor- porate rates (including any applicable alternative mini- mum tax) and may not be able to qualify as a REIT for four subsequent taxable years. Even if the Company qual- ifies for taxation as a REIT, the Company may be subject to certain state and local taxes on its income and prop- erty and to federal income and excise taxes on its undis- tributed taxable income. For the years ended December 31, 1997 and 1998, 0% of the dividends paid to common stockholders represented a return of capital for income tax purposes. Prior to the Merger, the Predecessor conducted its business as an S corporation, and was not subject to federal income taxes under Subchapter S of the Internal Revenue Code. Under this election federal income taxes were paid by the stockholders of the Predecessor. 33 Notes to Consolidated Financial Statements A M B P R O P E R T Y C O R P O R A T I O N ( I n t h o u s a n d s , e x c e p t s h a r e a n d s q u a r e f e e t d a t a ) N O T E 8 : intrinsic value based method of accounting. Under this Stockholders’ Equity On July 27, 1998, the Company sold 4,000,000 shares of 8.5% Series A Cumulative Redeemable Preferred Stock at $25.00 per share for $100,000 in an underwrit- method, compensation cost is the excess, if any, of the quoted market price of the stock at the date of grant over the amount an employee must pay to acquire the stock. Accordingly, no compensation cost has been recognized for the Company’s Stock Incentive Plan, as ten public offering. These shares are redeemable solely at of December 31, 1998. the option of the Company on or after July 27, 2003. The net proceeds of $96,100 (after deducting underwriters’ discounts and commissions and offering costs) from the offering were contributed to the Operating Partner- ship in exchange for 4,000,000 Series A preferred units with terms identical to the Series A Preferred Stock. The Operating Partnership used these proceeds to repay bor- rowings under the Credit Facility. On December 4, 1998, the Company and the Operating Partnership declared a quarterly cash distri- bution of $0.3425 per common share and operating partnership unit, payable on January 15, 1999 to stock- As permitted by SFAS 123, “Accounting for Stock- based Compensation”, the Company has not changed its method of accounting for stock options but has provided the additional required disclosures. Had com- pensation cost for the Company’s stock-based compen- sation plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method of SFAS No. 123, the Company’s pro forma net income available to common stockholders would have been reduced by $1,767 and pro forma basic and diluted earnings per share would have been reduced to $1.25 and $1.24, respectively, for the year ended holders of record on December 31, 1998. On December 4, December 31, 1998. 1998, the Company declared a cash dividend of $0.53125 per share on its Series A Preferred Stock, and the Operat- ing Partnership declared a cash distribution of $0.53125 per unit of its Series A Preferred Units, payable on Janu- ary 15, 1999 to stockholders and unit holders of record as of December 31,1998. N O T E 9 : Stock Incentive Plan and 401(k) Plan The fair value of each option grant was estimated at the date of grant using the Black-Scholes option- pricing model with the following assumptions used for grants in 1997 and 1998, respectively: dividend yield of 6.52% and 6.31%, expected volatility of 18.75% and 23.10%, risk-free interest rate of 5.86% and 4.94%, and expected lives of 10 years for both years. Following is a summary of the option activity for the years ended December 31, 1997 and 1998: Stock incentive plan. In November 1997, the Company established a Stock Option and Incentive Plan (the “Stock Incentive Plan”) for the purpose of attracting and retaining eligible officers, directors and employees. The Company has reserved for issuance 5,750,000 shares of Common Stock under the Stock Incentive Plan. As of December 31, 1998, the Company had granted 4,384,037 non-qualified options, to certain directors, officers and employees. Each option is exchangeable for one share of the Company’s Common Stock and has a weighted Outstanding, 11/25/97 Granted Exercised Forfeited Outstanding, 12/31/97 Granted Exercised Forfeited Outstanding, 12/31/98 Options exercisable S h a r e s U n d e r O p t i o n ( 0 0 0 ) – 3,154 – (10) 3,144 1,508 – (268) 4,384 W e i g h t e d A v e r a g e E x e r c i s e P r i c e – $21.00 – – 21.00 21.69 – – 21.40 R e m a i n i n g C o n t r a c t u a l L i f e – 10 years – – 10 years 10 years – – 9.4 years average exercise price equal to $21.22. Each option’s at year-end 622 $ 21.00 exercise price is equal to the Company’s market price at Fair value of options the date of grant. The options had an original ten-year granted during the year $2.43 term and vest pro rata in annual installments over a three or four-year period from the date of grant. In 1997, under the Stock Incentive Plan, the The Company applies APB Opinion No. 25, Company sold 5,712 restricted shares of its Common “Accounting for Stock Issued to Employees” and related Stock to certain independent directors for $0.01 per interpretations in accounting for its Stock Incentive share in cash. In 1998, under the Stock Incentive Plan, Plan. Opinion 25 measures compensation cost using the the Company issued 43,007 restricted shares to certain 34 officers of the Company as part of the Performance Pay Program. The restricted shares are subject to a repurchase right held by the Company, which lapses one-third of such shares annually. The repurchase right lapses fully on January 1, 2002. 401(K) Plan. In November 1997, the Company established a Section 401(k) Savings/Retirement Plan (the “Section 401(k) Plan”), which is a continuation of the Section 401(k) plan of the Predecessor, to cover eligi- ble employees of the Company and any designated affili- ate. The Section 401(k) Plan permits eligible employees of the Company to defer up to 10% of their annual compensation, subject to certain limitations imposed by the Code. The employees’ elective deferrals are imme- diately vested and non-forfeitable upon contribution to the Section 401(k) Plan. The Company matches the employee contributions to the Section 401(k)Plan in an amount equal to 50% of the first 3.5% of annual com- pensation deferred by each employee and may also make discretionary contributions to the plan. As of December 31, 1997 and 1998, the Company’s accrual for 401(k) match was $140 and $153, respectively. Such amounts were included in Other liabilities on the con- solidated balance sheets. Except for the Section 401(k) Plan, the Company offers no other post-retirement or post-employment benefits to its employees. N O T E 1 1 : Commitments and Contingencies Litigation. In the normal course of business, from time to time, the Company is involved in legal actions relating to the ownership and operations of its Properties. In management’s opinion, the liabilities, if any, that may ultimately result from such legal actions are not expected to have a materially adverse effect on the consolidated financial position, results of operations, or cash flows of the Company. Environmental matters. The Company follows the policy of monitoring its properties for the presence of hazardous or toxic substances. The Company is not aware of any environmental liability with respect to the Properties that would have a material adverse effect on the Company’s business, assets or results of operations. There can be no assurance that such a material envi- ronmental liability does not exist. The existence of any such material environmental liability would have an adverse effect on the Company’s results of operations and cash flow. General uninsured losses. The Company carries comprehensive liability, fire, flood, environmental, extended coverage and rental loss insurance with policy specifications, limits and deductibles customarily carried N O T E 1 0 : for similar properties. There are, however, certain types Supplemental Information to Statement of Cash Flows of extraordinary losses that may be either uninsurable, or not economically insurable. Certain of the Properties are located in areas that are subject to earthquake activ- Ye a r s E n d e d D e c e m b e r 3 1 , ity; the Company has therefore obtained limited earth- 1 9 9 6 1 9 9 7 1 9 9 8 quake insurance. Should an uninsured loss occur, the Company could lose its investment in, and anticipated profits and cash flows, from a property. Cash paid for interest $(,000,00– $(0,002,509 $0,068,209 Non-cash transactions: Acquisitions of properties Assumption of debt Cash acquired Other assumed assets and liabilities Minority interest’s contribution, including units issued Shares issued Net cash paid, net of $(,000,00– – – $(2,438,634 (717,613) (43,978) $0,901,284 (221,017) – – – – (13,862) – (64,358) (1,370,391) (115,963) – cash acquired $(,000,00– $(0,228,432 $0,564,304 35 Notes to Consolidated Financial Statements A M B P R O P E R T Y C O R P O R A T I O N ( I n t h o u s a n d s , e x c e p t s h a r e a n d s q u a r e f e e t d a t a ) N O T E 1 2 : Quarterly Financial Data Selected quarterly financial data for 1998 is as follows (unaudited): Revenues Income from operations before minority interest Minority interests’ share of net income Net income Preferred stock dividends Net income available to common stockholders Net income per common share: Basic(1) Diluted Weighted average common shares outstanding: Q u a r t e r M a r c h 3 1 J u n e 3 0 S e p t e m b e r 3 0 D e c e m b e r 3 1 Ye a r $075,785 29,188 (1,282) $027,906 – $027,906 $085,014 30,382 (2,404) $027,978 – $027,978 $094,061 31,802 (2,930) $028,872 (1,514) $027,358 $104,027 32,378 (4,541) $027,837 (2,125) $025,712 $358,887 123,750 (11,157) $112,593 (3,639) $108,954 $0000.33 $0000.32 $0000.33 $0000.32 $0000.32 $0000.32 $0000.30 $0000.30 $0001.27 $0001.26 Basic Diluted 85,874,513 85,874,513 85,874,513 85,881,992 85,876,383 86,284,736 86,222,175 86,251,857 86,181,937 86,235,176 (1) The sum of quarterly financial data varies from the annual data due to rounding. N O T E 1 3 : Segment Information The Company has two reportable segments: Industrial Properties and Retail Properties. The Company believes that the most relevant information about the way that its business is managed is through disclosure of certain data at the operating division level. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. Significant information used by the Company for the reportable segments is as follows: Rental revenues 1996 1997 1998 Property net operating income and contribution to FFO (1) 1996 1997 1998 Investment in properties 1996 1997 1998(2) I n d u s t r i a l P r o p e r t i e s R e t a i l P r o p e r t i e s To t a l P r o p e r t i e s $000,00– 16,898 248,134 $000,00– 9,567 106,524 $000,00– 26,465 354,658 – 11,056 181,832 – 6,510 76,752 – 17,566 258,584 – 1,639,321 2,574,940 – 803,678 794,120 – 2,442,999 3,369,060 (1) Property net operating income (NOI) is defined as rental revenue, including reimbursements and straight-line rents, less property level operating expenses. (2) Excludes net properties held for divestiture of $115,050. See Note 4. 36 The Company uses property net operating income and FFO as operating performance measures. The following are reconciliations between total reportable segment revenue, property net operating income and funds from operations (“FFO”) contribution to consolidated revenues, net income and FFO: 1 9 9 6 1 9 9 7 1 9 9 8 Revenues Total rental revenues for reportable segments Investment management and other income Total consolidated revenues Net Income Property net operating income for reportable segments Investment management and other income Less: General and administrative Interest expense Depreciation and amortization Investment management expenses Minority interests Net income FFO(1) Net Income Minority interests’ share of net income Real estate depreciation and amortization: Total depreciation and amortization Furniture, fixtures and equipment depreciation FFO attributable to minority interests(2): Institutional Alliance Partners Other joint venture partners Adjustments to derive FFO in unconsolidated joint venture(3): Company’s share of net income Company’s share of FFO Preferred stock dividends Series B & C preferred unit distributions FFO $000,00– 23,991 $023,991 $000,00– 23,991 – – – 16,851 137 $007,003 $007,003 137 – – – – – – – – $007,140 $026,465 29,597 $056,062 $017,566 29,597 1,197 3,528 4,195 19,358 657 $018,228 $354,658 4,229 $358,887 $258,584 4,229 11,929 69,670 57,464 – 11,157 $112,593 $018,228 657 $112,593 11,157 4,195 (37) – (218) – – – – $022,825 57,464 (463) (3,828) (2,071) (1,750) 2,739 (3,639) (1,795) $170,407 (1) Funds from Operations (“FFO”) is defined as income from operations before minority interest, gains or losses from sale of real estate and extraordinary losses plus real estate depreciation and adjustment to derive our pro rata share of the FFO of unconsolidated joint ventures, less minority interests’ pro rata share of the FFO of consolidated joint ventures and perpetual preferred stock dividends. In accordance with NAREIT White Paper on FFO, we include the effects of straight-line rents in FFO. (2) Represents FFO attributable to minority interests in consolidated joint ventures for the periods presented, which has been computed as minority interests’ share of net income before disposal of properties plus minority interests’ share of real estate-related depreciation and amortization of the consolidated joint ventures for such periods. Such minority interests are not exchangeable into shares of Common Stock. (3) Represents our pro rata share of FFO in unconsolidated joint ventures for the periods presented, which has been computed as our share of net income plus our share of real estate-related depreciation and amortization of the unconsolidated joint venture for such periods. N O T E 1 4 : Subsequent Events (unaudited) On March 5, 1999, the Company and the Operat- ing Partnership declared a quarterly cash distribution of $0.35 per common share and operating partnership unit, for the quarter ending March 31, 1999, payable April 15, 1999 to stockholders and unitholders of record as of March 31, 1999. On March 5, 1999, the Company declared a cash dividend of $0.53125 per share on its Series A Preferred Stock, and the Operating Partnership declared a cash distribution of $0.53125 per unit on its Series A Preferred Units, for the three month period end- ing April 14, 1999, payable on April 15, 1999 to stock- holders and unitholders of record as of March 31, 1999. On March 9, 1999, the Company signed a series of definitive agreements with BPP Retail, LLC (“BPP Retail”), a co-investment entity between Burnham Pacific Properties (“BPP”) and the California Public Employees’ Retirement System (“CalPERS”), pursuant to which BPP Retail will acquire 28 retail shopping centers of the Company, totaling 5.1 million square feet, for an aggre- gate price of $663.4 million. BPP Retail will acquire the centers in separate transactions, which are currently expected to close on or about April 30, 1999, July 31, 1999 and December 1, 1999. In addition, the Company has entered into a definitive agreement, subject to a financing confirmation, with BPP, pursuant to which BPP will acquire six additional retail centers, totaling 1.5 million square feet, for $284.4 million. Assuming satisfaction or waiver of this condition, this trans- action is currently expected to close by December 31, 1999. In connection with these transactions, the Company has also granted CalPERS an option to pur- chase up to 2,000,000 original issue shares of AMB’s Common Stock for an exercise price of $25 per share that may be exercised on or before March 31, 2000. 37 Report of Independent Public Accountants To the Board of Directors of AMB Property Corporation: We have audited the accompanying consolidated In our opinion, the financial statements referred to balance sheets of AMB Property Corporation and sub- above present fairly, in all material respects, the financial sidiaries as of December 31, 1998 and 1997, and the position of AMB Property Corporation and subsidiaries as related consolidated statements of income, stockhold- of December 31, 1998 and 1997, and the results of their ers’ equity, and cash flows for each of the three years operations and their cash flows for each of the three years in the period ended December 31, 1998. These finan- in the period ended December 31, 1998, in conformity cial statements and the schedule referred to below are with generally accepted accounting principles. the responsibility of the Company’s management. Our Our audits were made for the purpose of forming responsibility is to express an opinion on these finan- an opinion on the basic financial statements taken as a cial statements and the schedule based on our audits. whole. The schedule listed in the index to the financial We conducted our audits in accordance with statements is presented for purposes of complying with generally accepted auditing standards. Those standards the Securities and Exchange Commission’s rules and require that we plan and perform the audit to obtain is not a required part of the basic financial statements. reasonable assurance about whether the financial This schedule has been subjected to the auditing proce- statements are free of material misstatement. An audit dures applied in the audits of the basic financial state- includes examining, on a test basis, evidence supporting ments and, in our opinion, fairly states in all material the amounts and disclosures in the financial statements. respects the financial data required to be set forth An audit also includes assessing the accounting principles therein in relation to the basic financial statements used and significant estimates made by management, as taken as a whole. well as evaluating the overall financial statement presen- tation. We believe that our audits provide a reasonable basis for our opinion. San Francisco, California February 2, 1999 38 AMB Directors and Officers A M B P R O P E R T Y C O R P O R A T I O N Independent Directors Daniel H. Case, III President & CEO, Hambrecht & Quist Group Robert H. Edelstein Co-Chairman, Fisher Center for Real Estate, UC Berkeley Lynn M. Sedway Principal, Sedway Group Jeffrey L. Skelton President & CEO, Symphony Asset Management Thomas W. Tusher Former President & COO, Levi Strauss & Co. Caryl B. Welborn Commercial Real Estate Attorney Executive Officers Douglas D. Abbey* Chairman, AMB Investment Management, Inc. Hamid R. Moghadam* President & Chief Executive Officer T. Robert Burke* Chairman of the Board W. Blake Baird Chief Investment Officer, Managing Director Luis A. Belmonte Managing Director Industrial Division Michael A. Coke Chief Financial Officer, Senior Vice President John H. Diserens Managing Director Retail Division Bruce H. Freedman Managing Director Industrial Division David S. Fries Chief Administration Officer, General Counsel, Managing Director Barbara J. Linn President & Chief Executive Officer, AMB Investment Management, Inc. John T. Roberts Director of Capital Markets, Senior Vice President Craig A. Severance Managing Director New Initiatives & Technology *Director 39 Shareholder Information A M B P R O P E R T Y C O R P O R A T I O N Corporate Headquarters AMB Property Corporation 505 Montgomery Street, 5th Floor San Francisco, CA 94111 Tel: 415-394-9000 Fax: 415-394-9001 Boston Office AMB Property Corporation 60 State Street, Suite 3700 Boston, MA 02109 Tel: 617-531-9000 Fax: 617-531-9001 Investor Relations & Shareholder Inquiries Tel: 415-394-9000 ext. 250 Fax: 415-394-9001 E-mail: ir@ambco.com Transfer Agent Boston Equiserve 1-800-730-6001 Counsel Latham & Watkins San Francisco, CA Auditors Arthur Andersen LLP San Francisco, CA Stock Listing New York Stock Exchange Symbol: AMB 10-K Report A copy of the Company’s Annual Report on Form 10-K as filed with the Securities and Exchange Commission may be obtained by contacting Investor Relations. 40 AMB Website http://www.amb.com News Releases News releases can be viewed on our website. Annual Meeting Shareholders of AMB Property Corporation are invited to attend the Annual Meeting of Shareholders, to be held at 9:00 a.m. Friday, May 7, 1999 The Ritz Carlton, San Francisco 600 Stockton at California Street Tel: 415-296-7465 Professional Associations International Council of Shopping Centers National Association of Industrial and Office Properties National Association of Real Estate Investment Managers National Association of Real Estate Investment Trusts National Council of Real Estate Investment Fiduciaries National Investor Relations Institute Pension Real Estate Association Real Estate Investment Advisory Council Society of Industrial and Office Realtors Urban Land Institute Market Information The Company’s initial public offering was completed in November 1997 at $21 per share. Prior to November 1997, no public market existed for the Company’s common stock. The following table sets forth, for the periods indicated, the high and low closing prices for the Company’s common stock as reported by the New York Stock Exchange. Ye a r E n d e d D e c e m b e r 3 1 , H i g h L o w 1997 (from November 21) 1998 $251⁄8 $2513⁄16 $221⁄4 $2015⁄16 AMB: a commitment to shareholder value AMB has distinguished itself as a leader by practicing shareholder-friendly corporate governance. All of our directors serve annual, not staggered, terms, and each of our six independent directors is compensated solely through annual stock option grants. Our goal is to ensure that the Company is managed in a way that maximizes value for all AMB shareholders. To that end, we have also chosen not to enact any poison pill or “shareholder rights” plan, and our corporate by-laws do not include the anti-takeover language usually adopted by other Maryland corporations. In addition, in March 1999, our Board of Directors adopted a provision that prohibits AMB from repricing stock options. Our approach is atypical, but our reasoning is simple: AMB is the property of its shareholders, and nothing should hinder a full and fair return on their investment. The following are trademarks of AMB: Strategic Alliance Program, Development Alliance Program, UPREIT Alliance Program, Institutional Alliance Program, Management Alliance Program, Customer Alliance Program, and Broker Alliance Program. 41 A W , E L T T A E S , Y E L O B R E L Y T : Y H P A R G O T O H P & A C , O C S I C N A R F N A S , . C N I , W O H C E N A H : N G I S E D AMB PROPERTY CORPORATION Building Alliances. Building Value.™ 505 Montgomery Street, 5th floor, San Francisco, CA 94111 Telephone: 415-394-9000 Fax: 415-394-9001 Website: www.amb.com