**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

**ý****Quarterly Report Pursuant toSection 13 OR 15(d)of the Securities Exchange Act of 1934**

 

**For thequarterly period ended March 31, 2003**

 

**OR**

 

**o****Transition Report Pursuantto Section 13 or 15(d)of the Securities Exchange Act of 1934**

 

**Commissionfile number: 1-14307**

 

| **Great Lakes REIT**                                                        |
|-----------------------------------------------------------------------------|
|                                                                        |
| (Exact name of  Registrant as specified in its Charter)                     |
|                                                                        |
| **Maryland**                                                                |   | **36-4238056** |
| (State or other  jurisdiction  of incorporation or organization)            |   | (IRS employer  identification no.) |
|                                                                        |   |   |
| **823  Commerce Drive, Suite 300, Oak Brook, IL 60523**                     |
| (Address of principal  executive offices)    (Zip Code) |
|                                                                        |
| **(630)  368 - 2900**                                                       |
| (Registrant’s telephone  number, including area code)                  |

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past90 days.  Yes  ý  No  o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act).  Yes  ý No  o

 

Number of shares of the registrant’s common shares of beneficialinterest, $.01 par value per share, outstanding as of April 22, 2003:16,078,411

 

 

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Great Lakes REIT

Index to Form 10-Q

March 31, 2003

 
| Part I - Financial Information |
|--------------------------------|
|                           |
|                           | Item 1. | Financial Statements (unaudited): |
|                           |   |   |
|                           |   | Consolidated Balance Sheets  as of March 31, 2003 and December 31, 2002 |
|                           |   |   |
|                           |   | Consolidated Statements  of Income for the three months ended March 31, 2003 and 2002 |
|                           |   |   |
|                           |   | Consolidated  Statement of Changes in Shareholders’ Equity for the three months ended March  31, 2003 |
|                           |   |   |
|                           |   | Consolidated  Statements of Cash Flows for the three months ended March 31, 2003 and 2002 |
|                           |   |   |
|                           |   | Notes to  Consolidated Financial Statements |
|                           |   |   |
|                           | Item 2. | Management’s  Discussion and Analysis of Results of Operations and Financial Condition |
|                           |   |   |
|                           | Item 3. | Quantitative and Qualitative  Disclosures about Market Risk |
|                           |   |   |
|                           | Item 4. | Controls and  Procedures |
|                           |   |   |
| Part II - Other Information    |
|                           |   |   |
|                           | Item  6. | Exhibits  and Reports on Form 8-K |
|                           |   |   |
|                           | Signatures |
|                           |   |   |
|                           | Certifications |

 

2

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Great Lakes REIT

Consolidated Balance Sheets

(unaudited)

(In Thousands, except pershare data)

 
|                                                                                                                                                                                                                   |   | **March 31,  2003** |    | **December  31,  2002** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|---------|-------------------------|--------|
| **Assets**                                                                                                                                                                                                             |   |                |    |                    |   |
| Properties:                                                                                                                                                                                                            |   |                |    |                    |   |
| Land                                                                                                                                                                                                                   |   | $                   | 65,245  |                    | $      | 65,245 |   |
| Buildings and  improvements                                                                                                                                                                                            |   | 517,722             |    | 516,662                 |   |
|                                                                                                                                                                                                                   |   | 582,967             |    | 581,907                 |   |
| Less accumulated  depreciation                                                                                                                                                                                         |   | 68,175              |    | 65,030                  |   |
|                                                                                                                                                                                                                   |   | 514,792             |    | 516,877                 |   |
| Assets held for  sale, net                                                                                                                                                                                             |   | 9,137               |    | 8,928                   |   |
| Cash and cash  equivalents                                                                                                                                                                                             |   | 5,910               |    | 5,061                   |   |
| Real estate tax  escrows                                                                                                                                                                                               |   | 137                 |    | 69                      |   |
| Rents receivable                                                                                                                                                                                                       |   | 6,586               |    | 6,261                   |   |
| Deferred  financing and leasing costs, net of accumulated amortization                                                                                                                                                 |   | 9,034               |    | 9,110                   |   |
| Goodwill                                                                                                                                                                                                               |   | 1,061               |    | 1,061                   |   |
| Other assets                                                                                                                                                                                                           |   | 2,130               |    | 1,614                   |   |
| Total assets                                                                                                                                                                                                           |   | $                   | 548,787 |                    | $      | 548,981 |   |
|                                                                                                                                                                                                                   |   |                |    |                    |   |
| **Liabilities and shareholders’  equity**                                                                                                                                                                         |   |                |    |                    |   |
| Bank loan  payable                                                                                                                                                                                                     |   | $                   | 155     |                    | $      | 36,000 |   |
| Mortgage loans  payable                                                                                                                                                                                                |   | 315,392             |    | 275,050                 |   |
| Bonds payable  secured by assets held for sale                                                                                                                                                                         |   | 3,620               |    | 3,620                   |   |
| Accounts payable  and accrued liabilities                                                                                                                                                                              |   | 2,568               |    | 3,740                   |   |
| Accrued real  estate taxes                                                                                                                                                                                             |   | 12,788              |    | 14,872                  |   |
| Dividends  payable                                                                                                                                                                                                     |   | 2,539               |    | 2,539                   |   |
| Prepaid rent                                                                                                                                                                                                           |   | 4,845               |    | 4,044                   |   |
| Security  deposits                                                                                                                                                                                                     |   | 1,671               |    | 1,617                   |   |
| Total  liabilities                                                                                                                                                                                                     |   | 343,578             |    | 341,482                 |   |
| Minority  interests                                                                                                                                                                                                    |   | 665                 |    | 677                     |   |
| Commitments and  contingencies                                                                                                                                                                                         |   |                |    |                    |   |
| Shareholders’  equity:                                                                                                                                                                                            |   |                |    |                    |   |
| Preferred shares  of beneficial interest ($0.01 par value, 10,000 shares authorized; 1,5009  3/4% Series A Cumulative Redeemable shares, with a $25.00 per share  Liquidation Preference, issued and outstanding) |   | 37,500              |    | 37,500                  |   |
| Common shares of  beneficial interest ($0.01 par value, 60,000 shares authorized; 16,553 and  16,550 shares issued and outstanding in 2003 and 2002, respectively)                                                     |   | 166                 |    | 165                     |   |
| Paid-in-capital                                                                                                                                                                                                        |   | 208,329             |    | 208,319                 |   |
| Retained  earnings (deficit)                                                                                                                                                                                           |   | (23,739             | )       | (19,765                 | )      |
| Employee share  purchase loans                                                                                                                                                                                         |   | (14,601             | )       | (16,154                 | )      |
| Deferred  compensation                                                                                                                                                                                                 |   | (1,963              | )       | (2,035                  | )      |
| Accumulated  other comprehensive income (loss)                                                                                                                                                                         |   | (1,148              | )       | (1,208                  | )      |
| Total  shareholders’ equity                                                                                                                                                                                       |   | 204,544             |    | 206,822                 |   |
| Total  liabilities and shareholders’ equity                                                                                                                                                                       |   | $                   | 548,787 |                    | $      | 548,981 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

3

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Great Lakes REIT

Consolidated Statements of Incomeand Comprehensive Income

(unaudited)

(In Thousands, except pershare data)

 
|                                                          |   | **Three  months ended March 31,** |   |
|---------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                          |   | **2003**                          |   | **2002** |   |
| Revenues:                                                     |   |                              |   |   |   |
| Rental                                                        |   | $                                 | 20,439 |   | $ | 18,222 |   |
| Reimbursements                                                |   | 5,493                             |   | 5,392 |   |
| Parking                                                       |   | 106                               |   | 121 |   |
| Telecommunications                                            |   | 72                                |   | 73 |   |
| Tenant service                                                |   | 78                                |   | 63 |   |
| Interest                                                      |   | 254                               |   | 341 |   |
| Other                                                         |   | 290                               |   | 185 |   |
| Total revenues                                                |   | 26,732                            |   | 24,397 |   |
| Expenses:                                                     |   |                              |   |   |   |
| Real estate  taxes                                            |   | 4,330                             |   | 3,938 |   |
| Other property  operating                                     |   | 7,775                             |   | 6,365 |   |
| General and  administrative                                   |   | 1,327                             |   | 1,109 |   |
| Interest                                                      |   | 4,504                             |   | 3,737 |   |
| Depreciation and  amortization                                |   | 5,213                             |   | 4,491 |   |
| Total expenses                                                |   | 23,149                            |   | 19,640 |   |
| Income before  allocation to minority interests               |   | 3,583                             |   | 4,757 |   |
| Minority  interests                                           |   | 9                                 |   | 13 |   |
| Income from  continuing operations                            |   | 3,574                             |   | 4,744 |   |
| Discontinued  operations, net                                 |   | 70                                |   | 438 |   |
| Net income                                                    |   | 3,644                             |   | 5,182 |   |
| Income allocated  to preferred shareholders                   |   | 914                               |   | 914 |   |
| Net income  applicable to common shares                       |   | $                                 | 2,730  |   | $ | 4,268 |   |
| Earnings per  common share from continuing operations- basic. |   | $                                 | 0.16   |   | $ | 0.23 |   |
| Earnings per  common share–basic                         |   | $                                 | 0.17   |   | $ | 0.26 |   |
| Weighted average  common shares outstanding-basic             |   | 16,386                            |   | 16,368 |   |
| Diluted earnings  per common share from continuing operations |   | $                                 | 0.16   |   | $ | 0.23 |   |
| Diluted earnings  per common share                            |   | $                                 | 0.17   |   | $ | 0.26 |   |
| Weighted average  common shares outstanding–diluted      |   | 16,487                            |   | 16,472 |   |
| Dividends  declared per common share                          |   | $                                 | 0.405  |   | $ | 0.40 |   |
|                                                          |   |                              |   |   |   |
| Comprehensive  income:                                        |   |                              |   |   |   |
| Net income                                                    |   | $                                 | 3,644  |   | $ | 5,182 |   |
| Change in fair  value of interest rate swap agreements        |   | 60                                |   | 299 |   |
| Total  comprehensive income                                   |   | $                                 | 3,704  |   | $ | 5,481 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

4

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Great Lakes REIT

Consolidated Statements of Changesin Shareholders’ Equity

For the three monthsended March 31, 2003

(unaudited)

(Dollars in Thousands)

 
| *Preferred Shares*                                     |   |    |    |
|--------------------------------------------------------|--------|---------|---------|
| Balance at  beginning of period                        |   | $       | 37,500  |   |
| Balance at end  of period                              |   | 37,500  |    |
| *Common Shares*                                        |   |    |    |
| Balance at  beginning of period                        |   | 165     |    |
| Exercise of  share options                             |   | 1       |    |
| Balance at end  of period                              |   | 166     |    |
| *Paid-in capital*                                      |   |    |    |
| Balance at  beginning of period                        |   | 208,319 |    |
| Exercise of  share options                             |   | 10      |    |
| Balance at end  of period                              |   | 208,329 |    |
| *Retained earnings (deficit)*                          |   |    |    |
| Balance at  beginning of period                        |   | (19,765 | )       |
| Net income                                             |   | 3,644   |    |
| Distributions/dividends                                |   | (7,618  | )       |
| Balance at end  of period                              |   | (23,739 | )       |
| *Employee share purchase loans*                        |   |    |    |
| Balance at  beginning of period                        |   | (16,154 | )       |
| Repayment of  loans                                    |   | 1,553   |    |
| Balance at end  of period                              |   | (14,601 | )       |
| *Deferred compensation*                                |   |    |    |
| Balance at  beginning of period                        |   | (2,035  | )       |
| Amortization of  deferred compensation                 |   | 72      |    |
| Balance at end  of period                              |   | (1,963  | )       |
| *Accumulated other comprehensive  income (loss)*       |   |    |    |
| Balance at  beginning of period                        |   | (1,208  | )       |
| Change in fair  value of interest rate swap agreements |   | 60      |    |
| Balance at end  of period                              |   | (1,148  | )       |
| *Total shareholders’ equity*                      |   | $       | 204,544 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

5

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Great Lakes REIT

Consolidated Statements of Cash Flows

(unaudited)

(Dollars in Thousands)

 
|                                                                         |   | **Three  months ended March 31,** |   |
|------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                         |   | **2003**                          |   | **2002** |   |
| CASH FLOWS FROM  OPERATING ACTIVITIES                                        |   |                              |   |   |   |
| Net income                                                                   |   | $                                 | 3,644  |   | $ | 5,182 |   |
| Adjustments to  reconcile net income to cash flows from operating activities |   |                              |   |   |   |
| Depreciation and  amortization                                               |   | 5,334                             |   | 4,857 |   |
| Other non-cash  items                                                        |   | 82                                |   | 78 |   |
| Net changes in  assets and liabilities:                                      |   |                              |   |   |   |
| Rents receivable                                                             |   | (325                              | )      | 141 |   |
| Real estate tax  escrows and other assets                                    |   | (513                              | )      | (865 | ) |
| Accounts  payable, accrued expenses and other liabilities                    |   | (317                              | )      | 339 |   |
| Accrued real  estate taxes                                                   |   | (2,084                            | )      | (1,889 | ) |
| Payment of  deferred leasing costs                                           |   | (553                              | )      | (714 | ) |
| Net cash  provided by operating activities                                   |   | 5,268                             |   | 7,129 |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES                                        |   |                              |   |   |   |
| Purchase of  properties                                                      |   | —                            |   | (8,095 | ) |
| Additions to  buildings and improvements                                     |   | (2,836                            | )      | (2,660 | ) |
| Other investing  activities, net                                             |   | (37                               | )      | (12 | ) |
| Net cash  provided by (used in) investing activities                         |   | (2,873                            | )      | (10,767 | ) |
| CASH FLOWS FROM  FINANCING ACTIVITIES                                        |   |                              |   |   |   |
| Proceeds from  exercise of share options                                     |   | 11                                |   | 59 |   |
| Proceeds from  repayment of employee share loans                             |   | 1,553                             |   | 1,406 |   |
| Proceeds from  bank and mortgage loans payable                               |   | 42,155                            |   | 5,000 |   |
| Distributions /  dividends paid                                              |   | (7,618                            | )      | (914 | ) |
| Distributions to  minority interests                                         |   | (21                               | )      | (16 | ) |
| Payment of bank  and mortgage loans and bonds                                |   | (37,658                           | )      | (903 | ) |
| Other                                                                        |   | 32                                |   | — |   |
| Net cash  provided by (used in) financing activities                         |   | (1,546                            | )      | 4,632 |   |
| Net increase  (decrease) in cash and cash equivalents                        |   | 849                               |   | 994 |   |
| Cash and cash  equivalents, beginning of year                                |   | 5,061                             |   | 2,896 |   |
| Cash and cash  equivalents, end of year                                      |   | $                                 | 5,910  |   | $ | 3,890 |   |
|                                                                         |   |                              |   |   |   |
| Supplemental  disclosure of cash flow:                                       |   |                              |   |   |   |
| Interest paid                                                                |   | $                                 | 4,333  |   | $ | 3,785 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

6

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Great Lakes REIT

Notes to ConsolidatedFinancial Statements

(Unaudited)

Dollars in thousands,except per share data

 

1.             Basis ofPresentation

 

Great Lakes REIT, a Maryland real estate investment trust (the“Company”), was formed in 1992 to invest in income-producing realproperty.  The principal business of theCompany is the ownership, management, leasing, renovation and acquisition ofsuburban office properties, primarily located in the Midwest region of theUnited States.  At March 31, 2003, theCompany owned and operated 46 properties, primarily located in suburban areasof Chicago, Milwaukee, Detroit, Columbus, Minneapolis, Denver andCincinnati.  The Company leases officespace to over 650 tenants that are engaged in a variety of businesses.

 

The consolidated financial statements include the accounts of theCompany and its wholly owned subsidiaries and controlled partnership.  Intercompany accounts and transactions havebeen eliminated in consolidation.

 

The accompanying consolidated financial statements have been preparedin accordance with the instructions to Form 10-Q and do not include allinformation and footnotes necessary for a fair presentation of financialposition, results of operations and cash flows in conformity with accountingprinciples generally accepted in the United States. These statements should beread in conjunction with the Company’s most recent year-end audited financialstatements, which are contained in the Company’s Annual Report on Form 10-K forthe year ended December 31, 2002 (the “2002 10-K”).  In the opinion of management, the financial statements hereincontain all adjustments (which are normal and recurring) necessary for a fairstatement of financial results for the interim periods.  For further information, refer to theconsolidated financial statements and notes thereto included in the 2002 10-K.

 

2.                                       Derivativesand Hedging Activities

 

The Company recognizes all derivatives on its balance sheet at fairvalue.  Derivatives that are not hedgesmust be adjusted to fair value through income. If the derivative is a hedge,depending on the nature of the hedge, changes in the fair value of thederivatives are either offset against the change in fair value of the assets,liabilities or firm commitments through earnings or recognized in othercomprehensive income until the hedged item is recognized in earnings. The ineffectiveportion of a derivative’s change in fair value will be immediately recognizedin earnings.

 

Approximately $68,750 of the Company’s long-term debt bears interest ata variable rate based on LIBOR ($50,000 at LIBOR plus 1.35% and $18,750 atLIBOR plus 1.6%).  In 2001, the Companyentered into two separate interest rate swap agreements with notional amountsof $25,000 each.  One agreementeffectively fixes the interest rate on $25,000 of variable rate debt at amaximum of 4.27% until December 2003.  The second swap agreement effectively fixes the interest rate on$25,000 of

 

7

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variable rate debt at a maximum of 4.88% per annum until December2004.  The Company is exposed to creditloss in the event of non-performance by counterparties under the agreement, butthe Company does not expect non-performance by any of these counterparties. Theamount of such exposure is generally limited to the amount of any payments duebut not yet received from the counterparty.

 

At March 31, 2003, the fair value of the swap agreements was aliability of $1,148 and is reflected as accumulated other comprehensive income(loss) in the consolidated balance sheet as of March 31, 2003.  The change in fair value of the interest rateswap agreements has been reflected entirely in other comprehensive income in2003 and 2002, as they are fully effective cash flow hedges.

 

3.             Segment Information

 

The Company had three reportable segments at March 31, 2003,distinguished by property type.  Theproperty types are office, office/service center and medical office.  Office buildings are generally single-storyor multi-story buildings used by tenants for office activities. The buildingsgenerally have common area lobbies and other amenities including food serviceareas, atriums and limited underground parking facilities.  Office/service center buildings generallyare one-story buildings with no common areas. Tenant spaces generally have less than 100% office use with thenon-office space used for showroom, technical or light storage purposes.  Medical office properties are generallyconnected to or located near hospitals, and most tenants in those propertiesare health-care providers.

 

Interest expense incurred by the Company is a combination of propertyspecific long-term debt and long-term debt that is secured by properties acrossthe Company’s reportable segments. Interest expense incurred on property-specific debt is allocated to thatproperty’s segment.  Interest expenseincurred on long-term debt that is secured by properties across the Company’sreportable segments is allocated to the reportable segments based on the squarefootage of properties in that segment that are associated with the long-termdebt.

 

The Company evaluates performance and allocates resources based on netoperating income, which the Company defines as property revenues (rental,reimbursement, parking, telecommunications, tenant service and other income)less property operating expenses and real estate taxes.

 

The following is a summary report of segment information for the threemonths ended March 31, 2003 and 2002:

 

8

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|                                             |   | **2003** |   | **2002** |   |
|--------------------------------------------------|--------|----------|--------|----------|--------|
| Revenues:                                        |   |     |   |     |   |
| Office                                           |   | $        | 22,615 |     | $      | 22,828 |   |
| Office/service  center                           |   | 941      |   | 1,191    |   |
| Medical office                                   |   | 2,648    |   | —   |   |
| Deferred rental  revenues                        |   | 274      |   | 37       |   |
| Interest                                         |   | 254      |   | 341      |   |
| Total                                            |   | $        | 26,732 |     | $      | 24,397 |   |
|                                             |   |     |   |     |   |
| Net operating  income:                           |   |     |   |     |   |
| Office                                           |   | $        | 12,253 |     | $      | 12,991 |   |
| Office/service  center                           |   | 401      |   | 725      |   |
| Medical office                                   |   | 1,445    |   | —   |   |
| Total                                            |   | $        | 14,099 |     | $      | 13,716 |   |
|                                             |   |     |   |     |   |
| Depreciation and  amortization                   |   |     |   |     |   |
| Office                                           |   | $        | 4,467  |     | $      | 4,110 |   |
| Office/service  center                           |   | 264      |   | 257      |   |
| Medical office                                   |   | 375      |   | —   |   |
| Other                                            |   | 107      |   | 124      |   |
| Total                                            |   | $        | 5,213  |     | $      | 4,491 |   |
|                                             |   |     |   |     |   |
| Interest expense                                 |   |     |   |     |   |
| Office                                           |   | $        | 3,784  |     | $      | 3,557 |   |
| Office/service  center                           |   | 215      |   | 180      |   |
| Medical office                                   |   | 505      |   | —   |   |
| Total                                            |   | $        | 4,504  |     | $      | 3,737 |   |
|                                             |   |     |   |     |   |
| Income before  allocation to minority interests: |   |     |   |     |   |
| Office net  operating income                     |   | $        | 12,253 |     | $      | 12,991 |   |
| Office  depreciation                             |   | (4,467   | )      | (4,110   | )      |
| Office interest  expense                         |   | (3,784   | )      | (3,557   | )      |
| Office service  center net operating income      |   | 401      |   | 725      |   |
| Office service  center depreciation              |   | (264     | )      | (257     | )      |
| Office service  center interest expense          |   | (215     | )      | (180     | )      |
| Medical office  net operating income             |   | 1,445    |   | —   |   |
| Medical office  depreciation                     |   | (375     | )      | —   |   |
| Medical office  interest expense                 |   | (505     | )      | —   |   |
| Deferred rental  revenue                         |   | 274      |   | 37       |   |
| Interest income                                  |   | 254      |   | 341      |   |
| General and  administrative                      |   | (1,327   | )      | (1,109   | )      |
| Other  depreciation                              |   | (107     | )      | (124     | )      |
| Income before  allocation to minority interests  |   | $        | 3,583  |     | $      | 4,757 |   |

 
|                       |   | **March 31,  2003** |    | **December  31,  2002** |   |
|----------------------------|--------|---------------------|---------|-------------------------|--------|
| Assets                     |   |                |    |                    |   |
| Office                     |   | $                   | 442,297 |                    | $      | 444,642 |   |
| Office/service  center     |   | 18,045              |    | 18,246                  |   |
| Medical office             |   | 60,609              |    | 61,814                  |   |
| Assets held for  sale, net |   | 9,137               |    | 8,928                   |   |
| Other                      |   | 18,699              |    | 15,351                  |   |
| Total                      |   | $                   | 548,787 |                    | $      | 548,981 |   |

 

9

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|                     |   | **Three  months ended March 31,** |   |
|--------------------------|--------|-----------------------------------|--------|
|                     |   | **2003**                          |   | **2002** |   |
| Additions to  properties |   |                              |   |   |   |
| Office                   |   | $                                 | 2,645  |   | $ | 10,517 |   |
| Office/service  center   |   | 37                                |   | 238 |   |
| Medical office           |   | 154                               |   | — |   |
| Total                    |   | $                                 | 2,836  |   | $ | 10,755 |   |

 

4.             Long-Term Debt

 

On January 16, 2003, the Company entered into a 10-year mortgage loanin an amount of $40,000 secured by the medical office properties.  This loan accrues interest at 5.43% perannum payable monthly along with monthly principal payments based on a 30-yearamortization schedule.

 

On March 24, 2003, the Company entered into a $29,200 secured creditfacility.  The facility bears interestat LIBOR plus 1.45% payable monthly, has a term of three years and is securedby the Company’s properties located in Dublin and Columbus, Ohio.  Borrowings at March 31, 2003 totaled $155.

 

5.             Goodwill

 

Goodwill is subject to periodic impairment tests.  The Company has performed the required impairmenttests of goodwill as of March 31, 2003, and has determined that goodwill is notimpaired as of that date.

 

6.             Impairment ofAssets

 

The Company recognizes impairment losses for its properties whenindicators of impairment are present and a property’s expected undiscountedcash flows are not sufficient to recover the property’s carrying amount.

 

7.             Earnings per Share

 

The unvested restricted common share grants (166,664 shares at March31, 2003) are excluded from the common shares used to compute basic earningsper share.  The unvested restrictedcommon shares are included in the shares used to compute fully diluted earningsper share using the treasury stock method whereby the unamortized deferredcompensation related to these shares is assumed to be the exercise value ofthese shares.

 

The Company has 40,199 operating partnership units held bynon-affiliates of the Company outstanding at March 31, 2003, which areconvertible to common shares on a one-for-one basis at the option of theholder.

 

8.             DiscontinuedOperations

 

The components of discontinued operations for the three months endedMarch 31, 2003 and 2002 are outlined below and include the results ofoperations through the date of each respective sale for the three months endedMarch 31, 2003 (or all operations of properties held for sale) and alloperations for the three months ended March 31, 2002 for the following:

 

10

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•              the properties sold in 2002

•           the properties held for sale at March 31,2003.

 
|                                               |   | **2003** |   | **2003** |   |
|----------------------------------------------------|--------|----------|--------|----------|--------|
| Revenues                                           |   | $        | 445    |     | $      | 1,615 |   |
| Expenses:                                          |   |     |   |     |   |
| Real estate  taxes and property operating expenses |   | 370      |   | 788      |   |
| Interest                                           |   | 5        |   | 23       |   |
| Depreciation and  amortization                     |   | —   |   | 366      |   |
| Total expenses.                                    |   | 375      |   | 1,177    |   |
| Discontinued  operations, net                      |   | $        | 70     |     | $      | 438 |   |

 

 

9.             Pro Forma OperatingResults for Expensing Fair Value of Options Granted

 

For purposes of pro forma disclosures, the estimated fair value of theoptions was amortized to expense over the options’ vesting period. TheCompany’s unaudited pro forma information follows:

 
|                                                   |   | **Three  months ended March 31,** |   |
|--------------------------------------------------------|--------|-----------------------------------|--------|
|                                                   |   | **2003**                          |   | **2002** |   |
| Net income as  reported                                |   | $                                 | 2,730  |   | $ | 4,268 |   |
| Less employee  share option compensation at fair value |   | 41                                |   | 45 |   |
| Pro forma net  income                                  |   | $                                 | 2,689  |   | $ | 4,223 |   |
| Pro forma basic  earnings per common share             |   | $                                 | 0.16   |   | $ | 0.26 |   |
| Pro forma  diluted earnings per common share           |   | $                                 | 0.16   |   | $ | 0.26 |   |

 

10.           Subsequent Events

 

The Company hasengaged Cushman & Wakefield, Inc. as a real estate advisor to assist it inanalyzing alternatives to improve shareholder value. As a result, the Board ofTrustees has adopted a policy prohibiting employees from engaging in anytrading of Company securities while the process is ongoing. Twenty-eightemployees of the Company, including members of senior management who areaffected by the provisions of the 2002 Sarbanes-Oxley Act, are required torepay certain maturing loans. These loans were made before 2001 under theCompany’s employee loan program, which was established in 1996 in connectionwith the Company’s option plan.  Inorder to permit an orderly retirement of a portion of the outstanding loansduring the trading blackout period in compliance with the Sarbanes-Oxley Act,the Company’s Board of Trustees approved a voluntary share repurchase plan forall employees with outstanding loans.

 

The plan providedfor loan retirement in consideration for the shares securing the loans. Fifteenemployees elected to participate in the repurchase program and the Company hasrepurchased an aggregate of 497,000 shares from those officers and employeesthat were securing an aggregate of $7,700 in outstanding loans. The price usedin connection with the repurchase program was $14.67 per common share, whichwas the average of the closing prices of the common shares on the NYSE for thefive-day period ending April 10, 2003. As part of the Board-approved repurchaseprogram,

 

11

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the Company hasforgiven loan balances totaling $475. Such loan forgiveness ($475), or $0.03 per common share, will bereflected as compensation expense in the second quarter of 2003 and will befully taxable to participants at ordinary tax rates.

 

After giving effect to the repurchase of shares, approximately $3,500of employee loans will mature during the remainder of 2003. Thereafter, during2004, 2005 and 2006, $1,200, $2,300 and $100 of employee loans mature,respectively.  The Company’s Board ofTrustees does not anticipate offering a similar repurchase program in thefuture.  The officers and employees thatcontinue to have loans under the employee loan program will be obligated torepay those loans at maturity in order to comply with the policies of theCompany and the Sarbanes-Oxley Act.

 

In addition, the Board of Trustees granted an aggregate of 264,000options to purchase common shares to those employees who elected to participatein the repurchase program.  Of theoptions granted, 233,000 have an exercise price of $14.50 per share, theclosing price of the common shares on April 17, 2003, and 31,000 have anexercise price of $16.55 per share.  TheCompany follows Accounting Principles Board Opinion No. 25 (APB 25) inaccounting for option grants.  Under APB25, no compensation expense is recognized upon the grant of share purchaseoptions at fair market value

 

ITEM 2. Management’s Discussion and Analysis of Results ofOperations and Financial Condition

(Dollars in thousands)

 

The following is a discussion and analysis of the consolidatedfinancial condition and results of operations for the Company for the threemonths ended and as of March 31, 2003. The following should be read in conjunction with the consolidatedfinancial statements and related notes appearing elsewhere herein and theconsolidated financial statements and related notes contained in the 2002 10-K.

 

**Trends**

 

The Company’s Board of Trustees has engaged Cushman & Wakefield,Inc. as a real estate advisor to assist it in analyzing alternatives to improveshareholder value. These alternatives may include a sale of the Company, a saleof some or all of the Company’s properties, or a business combination or othersimilar transaction. Such activities are in the early stages, and there can beno assurance that any such transaction will occur.

 

In 2002, occupancy rates in the current markets in which the Companyoperates declined due to increases in supply and decreases in demand for officespace.  The market trend of occupancydeclines has impacted the Company’s portfolio performance and, as a result, theoverall portfolio occupancy of the Company’s properties declined to 81% atMarch 31, 2003 as compared to 83% at the end of 2002.  During 2002, the Company averaged approximately 30,000 squarefeet of new leasing activity per month. The Company believes that the trend of vacancy increases is slowing, butthe Company anticipates that the difficult leasing environment that currentlyexists in its markets will persist throughout 2003 as improvement in demand foroffice space usually lags the beginning of an economic recovery.  At March 31, 2003, Great Lakes REIT had 832,000 square feet of leases,or 14% of the portfolio, expiring in 2003. The Company currently expects to retain or renew 250,000 to 380,000square feet of the remaining 832,000 square feet of leases rolling over during2003. The

 

12

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Company anticipates it will average 30,000square feet per month of new leasing activity in 2003, basically the same levelas was experienced in the difficult environment of 2002. Based on the tenantretention and new leasing activity expectations noted above, the Companyexpects that average portfolio occupancy during 2003 will be in the range of79% to 80%. Occupancy at January 1, 2004 is expected to be in the range of 76%to 78% assuming no significant tenant defaults occur during the year.  Based on these occupancy expectations, theCompany expects that revenues and results of operations will decline in 2003 ascompared to 2002.

 

As of March 1, 2003, several tenants were in default under their leasesfor failure to make rent payments. Several other tenants that are not currently in default are experiencingfinancial difficulties which may lead to lease defaults. These tenant defaultsmay adversely impact the Company’s revenue in 2003.

 

Legion Insurance Company, which leases 58,000 square feet of space atMilwaukee Center and represented 1.53% of the Company’s aggregate portfolioannualized base rent as of December 31, 2002, was placed in rehabilitation bythe Pennsylvania Department of Insurance on April 1, 2002.  After completing its review, thePennsylvania Department of Insurance has recommended to the Commonwealth Courtthat Legion Insurance Company be liquidated. The Commonwealth Court has not yet approved the recommendation of thePennsylvania Department of Insurance. Based on currently available information, the Company believes expectsthat Legion will fulfill all terms of its lease in 2003. The lease with LegionInsurance Company expires February 28, 2006. As of April 1, 2003, Legion Insurance Company is current on its rentalpayments.

 

Three months ended March 31, 2003 compared to 2002

 

During 2002, the Company acquired 11 properties. The operating resultsof these properties were included in the Company’s financial statements fromthe dates of acquisition.  In analyzingthe 2003 operating results of the Company, the changes in rental andreimbursement income, real estate taxes and other property operating expensesfrom 2002 were principally due to: (i) the addition of a full year’soperating results in 2003 of the properties acquired in 2002 and(ii) increases or decreases on properties owned in both 2003 and 2002.Other property operating expenses include contract services, repairs,maintenance, utilities, personnel, insurance and other costs directlyassociated with the leasing, management and operation of the properties.  A summary of these changes as they impactrental income, reimbursement income, real estate taxes and other propertyoperating expenses for 2003 follows:

** **
|                                                                   |   | **Rental  Income** |   | **Reimbursement  Income** |   | **Real  Estate  Taxes** |   | **Other  Property  Operating Expenses** |   |
|------------------------------------------------------------------------|--------|--------------------|--------|---------------------------|--------|-------------------------|--------|-----------------------------------------|--------|
|                                                                   |   |               |   |                      |   |                    |   |                                    |   |
| Increase due to  inclusion of full year of properties acquired in 2002 |   | $                  | 3,337  |                      | $      | 667                     |   | $                                       | 632    |   | $ | 1,292 |   |
| Increase  (decrease) in 2003 compared to 2002                          |   | (1,120             | )      | (566                      | )      | (240                    | )      | 118                                     |   |
| Total                                                                  |   | $                  | 2,217  |                      | $      | 101                     |   | $                                       | 392    |   | $ | 1,410 |   |

 

Tenant service income increased by $15, or 24%, in the quarter endedMarch 31, 2003 as compared to 2002 primarily due to the sale of tenant servicesto the tenants in the medical office properties

 

13

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Interest income decreased by $87, or 26% during the quarter ended March31, 2003, as compared to 2002 primarily because certain interest-bearingemployee share loans were repaid during the second half of 2002 and prior toMarch 31, 2003.

 

General and administrative expenses increased by $218, or 20%, duringthe quarter ended March 31, 2003 as compared to 2002 due to increases ininsurance costs ($31), increased compensation costs ($33), increases in franchisetaxes ($32), timing of the payment of trustee fees ($42), and other items($80).

 

Interest expense increased by $767, or 22%, during the quarter endedMarch 31, 2003 as compared to 2002 due to higher amounts of long-term debtoutstanding during 2003.

 

Depreciation and amortization expenses increased by $722, or 16%,during the quarter ended March 31, 2003 as compared to 2002 because the Companyhad a gross book value of depreciable assets of $517,722 at March 31, 2003 ascompared to $467,422 at March 31, 2002.

 

Segment Operations

 

The Company has three reportable segments, distinguished by propertytype.  The property types are office,office service center and medical office properties.  Office buildings are generally single-story or multi-storybuildings used by tenants for office activities. The buildings generally havecommon area lobbies and other amenities including food service areas, atriumsand limited underground parking facilities. Office service center buildings generally are one-story buildings withno common areas. Tenant spaces generally have less than 100% office use withthe non-office space used for showroom, technical or light storagepurposes.  Medical office properties aregenerally connected to or located near hospitals, and most tenants in thoseproperties are health-care providers.

 

Interest expense incurred by the Company is a combination of propertyspecific long-term debt and long-term debt that is secured by properties acrossthe Company’s reportable segments. Interest expense incurred on property-specific debt is allocated to thatproperty’s segment.  Interest expenseincurred on long-term debt that is secured by properties across the Company’sreportable segments is allocated to the reportable segments based on the squarefootage of properties in that segment that are associated with the long-termdebt.

 

The net income forthe office segment was as follows:

 
|                  |   | **Three  months ended March 31,** |   |
|-----------------------|--------|-----------------------------------|--------|
|                  |   | **2003**                          |   | **2002** |   |
| Net operating  income |   | $                                 | 12,253 |   | $ | 12,991 |   |
| Interest expense      |   | (3,784                            | )      | (3,557 | ) |
| Depreciation          |   | (4,467                            | )      | (4,110 | ) |
| Segment net  income   |   | $                                 | 4,002  |   | $ | 5,324 |   |

 

The decrease in segment net income for the three months ended March 31,2003 as compared to 2002 resulted from declining occupancy in this propertysegment was partially offset by increases due to inclusion of a full year ofoperations in 2003 of properties acquired in 2002.

 

14

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The net income forthe office service center segment was as follows:

 
|                       |   | **Three  months ended March 31,** |   |
|----------------------------|--------|-----------------------------------|--------|
|                       |   | **2003**                          |   | **2002** |   |
| Net operating  income      |   | $                                 | 401    |   | $ | 725 |   |
| Interest expense           |   | (215                              | )      | (180 | ) |
| Depreciation.              |   | (264                              | )      | (257 | ) |
| Segment net  income (loss) |   | $                                 | (78    | ) | $ | 288 |   |

 

The decrease in segment net income for the three months ended March 31,2003 as compared to 2002 resulted from declining occupancy.

 

The net income forthe medical office segment was as follows:

 
|                  |   | **Three  months ended March 31,** |   |
|-----------------------|--------|-----------------------------------|--------|
|                  |   | **2003**                          |   | **2003** |   |
| Net operating  income |   | $                                 | 1,445  |   | — |   |
| Interest expense      |   | (505                              | )      | — |   |
| Depreciation          |   | (375                              | )      | — |   |
| Segment net  income   |   | $                                 | 565    |   | — |   |

 

The increase in segment net income for the year ended the three monthsended March 31, 2003 resulted from the acquisition of the medical officeproperties on October 1, 2002.

 

Non-GAAP Financial Measures

 

Although not a GAAP measure, the Company believes that the inclusion ofinformation regarding funds from operations (FFO) provides importantinformation to shareholders and potential investors.  The GAAP measure, net income applicable to common shares,includes depreciation and amortization expenses, gains or losses on propertysales and minority interests.  Inpresenting FFO, the Company eliminates substantially all of these items inorder to provide an indication of the results from the Company’s propertyoperations.  FFO is a widely recognizedmeasure in the Company’s business and is presented by nearly all publiclytraded REITs. The Company’s calculation of FFO may differ from the methodologyfor calculating FFO utilized by other real estate companies.

 
|                                                 |   | **Three months ended March 31,** |   |
|------------------------------------------------------|--------|----------------------------------|--------|
|                                                 |   | **2003**                         |   | **2002** |   |
| Net income  applicable to common shares              |   | $                                | 2,730  |   | $ | 4,268 |   |
| Adjustments to  calculate funds from operations:     |   |                             |   |   |   |
| Minority  interests                                  |   | 9                                |   | 13 |   |
| Adjusted  depreciation and amortization (a)          |   | 5,174                            |   | 4,697 |   |
| Funds from  operations                               |   | $                                | 7,913  |   | $ | 8,978 |   |
|                                                 |   |                             |   |   |   |
| Weighted average  common shares outstanding- diluted |   | 16,487                           |   | 16,472 |   |

 

15

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(a) Adjusted depreciation and amortization is calculated as follows:

 
|                                                                    |   | **Three months ended March 31,** |   |
|-------------------------------------------------------------------------|--------|----------------------------------|--------|
|                                                                    |   | **2003**                         |   | **2002** |   |
| Depreciation and  amortization in consolidated statements of cash flows |   | $                                | 5,334  |   | $ | 4,857 |   |
| Less  depreciation and amortization unrelated to properties             |   | 160                              |   | 160 |   |
| Adjusted  depreciation and amortization                                 |   | $                                | 5,174  |   | $ | 4,697 |   |

 

EBITDA (earnings before interest, taxes, depreciation and amortization),a non-GAAP financial measure, represents net income before allocation tominority interests and before any deduction for interest expense, federalincome tax expense (if any) and depreciation and amortization expense.

 

EBITDA is notintended to represent cash flow for the period, is not presented as analternative to operating income as an indicator of operating performance,should not be considered in isolation or as a substitute for measures of performanceprepared in accordance with GAAP and is not indicative of operating income orcash provided by operating activities as determined under GAAP.

 

EBITDA ispresented solely as a supplemental disclosure with respect to liquidity becausethe Company believes it provides useful information regarding the Company’sability to service or incur debt. Because all companies do not calculate EBITDA the same way, thepresentation of EBITDA may not be comparable to similarly titled measures ofother companies.

 

The Companybelieves that net income and cash provided by operating activities are thefinancial measures calculated and presented in accordance with GAAP that aremost directly comparable to EBITDA.  Thefollowing is a reconciliation of EBITDA to each of net income and cash providedby operating activities for each of the periods for which EBITDA is presentedin this earnings release:

 
|                                                                      |   | **For the three months ended March 31,** |   |
|---------------------------------------------------------------------------|--------|------------------------------------------|--------|
|                                                                      |   | **2003**                                 |   | **2002** |   |
| Calculation of EBITDA:                                                    |   |                                     |   |   |   |
| Income before  allocation to minority interests                           |   | $                                        | 3,583  |   | $ | 4,757 |   |
| Depreciation and  amortization from consolidated statements of cash flows |   | 5,334                                    |   | 4,857 |   |
| Interest expense                                                          |   | 4,504                                    |   | 3,737 |   |
| Interest expense  from discontinued operations                            |   | 5                                        |   | 23 |   |
| Discontinued  operations, net                                             |   | 70                                       |   | 438 |   |
|                                                                      |   |                                     |   |   |   |
| EBITDA                                                                    |   | $                                        | 13,496 |   | $ | 13,812 |   |
|                                                                      |   |                                     |   |   |   |
| Reconciliation  of EBITDA to Cash Provided by Operating Activities:       |   |                                     |   |   |   |
| EBITDA                                                                    |   | $                                        | 13,496 |   | $ | 13,812 |   |
| Interest expense                                                          |   | (4,504                                   | )      | (3,737 | ) |
| Interest expense  from discontinued operations                            |   | (5                                       | )      | (23 | ) |
| Other  adjustments from Consolidated Statements of Cash Flows:            |   |                                     |   |   |   |
| Other non-cash  items                                                     |   | 82                                       |   | 78 |   |
| Minority  interests                                                       |   | (9                                       | )      | (13 | ) |
| Net changes in  assets and liabilities:                                   |   |                                     |   |   |   |
| Rents receivable                                                          |   | (325                                     | )      | 141 |   |
| Real estate tax  escrows and other assets                                 |   | (513                                     | )      | (865 | ) |
| Accounts  payable, accrued expenses and other liabilities                 |   | (317                                     | )      | 339 |   |
| Accrued real  estate taxes                                                |   | (2,084                                   | )      | (1,889 | ) |
| Payment of  deferred leasing costs                                        |   | (553                                     | )      | (714 | ) |
|                                                                      |   |                                     |   |   |   |
| Cash provided by  operating activities                                    |   | $                                        | 5,268  |   | $ | 7,129 |   |

 

16

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Liquidity and Capital Resources

 

The Company expects to meet its short-term liquidity requirementsprincipally through its working capital and net cash provided by operatingactivities. The Company considers its cash provided by operating activities tobe adequate to meet operating requirements and to fund the payment of dividendsto the extent necessary to comply with certain federal income tax requirementsapplicable to real estate investment trusts (“REITs”).  Cash flow from operating activities for thethree months ended March 31, 2003 was $5,268. This amount was less than common and preferred share dividends paid forthe first quarter of 2003 due to the timing of payments of real estate taxes(which are not paid ratably during the year). The Company expects that cash provided by operating activities in 2003will exceed common and preferred share dividends paid in 2003.

 

The Board of Trustees determines the Company’s dividend policy.  The Board of Trustees has indicated that itexpects to maintain the current level of common share monthly dividends ($0.135per share) and preferred share quarterly dividends ($0.609375 per share)through 2003.  The payment of dividends,other than those declared to date, is subject to future action of the Board ofTrustees and will depend upon a variety of factors, including, but not limitedto, the Company’s cash position, operating results and general financialcondition.

 

The Company expects to meet its short-term liquidity requirements forproperty acquisitions and significant capital improvements through targetedproperty dispositions and additional borrowings. On March 24, 2003, the Companyentered into a $29,200 secured credit facility.  The facility bears interest at LIBOR plus 1.45% payable monthly,has a term of three years and is secured by the Company’s four propertieslocated in Dublin and Columbus, Ohio. Borrowings at March 31, 2003 totaled $155.  Future borrowings can be used for property acquisitions, tenantimprovements, significant capital improvements, leasing costs and workingcapital.  The Company has approximately$50,000 of additional borrowing capacity through two secured credit facilities(including the $29,200 secured credit facility described above).  Declining occupancies in the Company’sproperties expected in 2003 may cause the Company to limit future acquisitionactivity funded by long-term borrowings to maintain liquidity for significantcapital improvements and working capital. The Company expects to invest approximately $1,850 for certainimprovements at its property located at 1111 Touhy Avenue, Des Plaines,Illinois, over the next several years. While the Company expects to complete these improvements later in 2003and 2004, the Company does have the option of limiting or curtailing theseimprovements as conditions warrant.  Inaddition, there can be no assurance that the Company will complete anyacquisitions in 2003.

 

On January 16, 2003, the Company entered into a 10-year mortgage loanin an amount of $40,000 secured by the medical office properties.  This loan accrues interest at 5.43% perannum payable monthly along with monthly principal payments based on a 30-yearamortization schedule.  The

 

17

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proceeds of the loan were used to repay the $36,000 bank loan payablesecured by the medical office properties that was outstanding at December 31,2002.

 

The Company has identified certain assets that it expects will be soldduring the remainder of 2003 in addition to those assets classified as held forsale at March 31, 2003, and may consider selling additional properties ifmarket conditions warrant. The Company has not entered into any definitiveagreements with respect to any such additional disposition opportunities andthere can be no assurances that the Company will consummate any dispositions inthe remainder of 2003.

 

The Company expects to meet its long-term liquidity requirements (suchas scheduled mortgage debt maturities, property acquisitions, and significantcapital improvements) through long-term collateralized and uncollateralizedborrowings, the issuance of debt or equity securities, subject to satisfactoryconditions in the capital markets generally and real estate capital and financemarkets, specifically, and targeted property dispositions.

 

Forward-Looking Statements

 

This report contains “forward-looking statements” within the meaning ofthe Private Securities Litigation Reform Act of 1995 that involve risks anduncertainties. Statementsin this document regarding the Company’s expectations for: cash provided byoperating activities, common and preferred share dividends, tenant retention,new tenant leasing activity; vacancy trends; occupancy rates; acquisition anddisposition volume and timing; the performance of the economy and the officemarkets; the level and effect of tenant defaults; the funding of short andlong-term liquidity requirements; and anticipated market and other economicconditions are forward-looking within the meaning of the Private SecuritiesLitigation Reform Act of 1995. Such forward-looking statements are based onwhat the Company believes to be reasonable assumptions and management’s currentexpectations; however, actual results may vary from those implied by suchforward-looking statements. Key factors that may cause actual results to differfrom projected results include: changes in interest rates; conditions in thecapital and financial markets generally and the market for real estate financespecifically; local and/or national economic conditions; the pace of officespace development and sub-lease availability; tenant office space demand; thefinancial position of the Company’s tenants, including changes in suchfinancial position that may lead to increases in tenant defaults; actual tenantdefault rates compared to anticipated default rates; performance of the medicaloffice market generally and the local markets for the Company’s medical officeproperties specifically;  performance ofthe hospitals adjacent to the Company’s medical office properties; and otherrisks inherent in the real estate business. The Company assumes noobligation to update or supplement forward-looking statements.

 

ITEM 3. MARKETRISK (Dollars in thousands)

 

The Company’s interest income is sensitive to changes in the generallevels of U.S. short-term interest rates.

 

The Company’s interest expense is sensitive to changes in the generallevel of U.S. short-term and long-term interest rates as the Company hasoutstanding indebtedness at fixed and variable rates.  A change in variable interest rates of 1% per annum wouldincrease or decrease the Company’s interest expense by $225 per annum based onthe amount of variable rate debt outstanding at March 31, 2003 ($22,525).

 

18

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Approximately $68,750 of the Company’s long-term debt bears interest ata variable rate based on LIBOR ($50,000 at LIBOR plus 1.35% and $18,750 atLIBOR plus 1.6%).  In 2001, the Companyentered into two separate interest rate swap agreements with notional amountsof $25,000 each.  One agreementeffectively fixes the interest rate on $25,000 of variable rate debt at amaximum of 4.27% until December 2003. The second swap agreement effectively fixes the interest rate on $25,000of variable rate debt at a maximum of 4.88% per annum until December 2004.

 

At March 31, 2003, the Company had $296,642 of fixed rate debtoutstanding at an average rate of 5.76% (after giving effect to the two swapagreements).  The Company has long-termdebt outstanding at fixed rates in the range of 4.3% to 7.44%.  The general level of interest rates in theUnited States as of April 1, 2003 is such that refinancing this debt at currentrates would be unlikely due to prepayment restrictions and penalties on itsfixed rate debt.  Accordingly, if thegeneral level of interest rates in the United States were to fall further, theCompany would not likely have the opportunity to refinance this fixed rate debtat lower interest rates.

 

In general, the Company believes long-term fixed rate debt ispreferable as a financing vehicle for its operations due to the long-term fixedcontractual rental income the Company receives from its tenants. As a result,the Company has 93% of its long-term debt outstanding at March 31, 2003 atfixed rates (including the debt affected by the swap agreements). The Companymay, as market conditions warrant, enter into additional fixed rate long-termdebt instruments on either a secured or unsecured basis.

 

A tabular presentation of interest rate sensitivity is as follows:

 

Interest Rate Sensitivity

Principal Amount byExpected Maturity

Average Interest Rate

 
|                                                                          |   | **2003(1)** |   | **2004** |   | **2005** |   | **2006** |   | **2007** |   | **Thereafter** |   |
|-------------------------------------------------------------------------------|--------|-------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------------|--------|
|                                                                          |   |        |   |     |   |     |   |     |   |     |   |           |   |
| Liabilities:                                                                  |   |        |   |     |   |     |   |     |   |     |   |           |   |
| Fixed Rate                                                                    |   |        |   |     |   |     |   |     |   |     |   |           |   |
| Mortgage loans  payable                                                       |   | $           | 4,383  |     | $      | 6,167    |   | $        | 6,555  |     | $      | 26,699         |   | $ | 16,492 |   | $ | 186,822 |   |
| Average interest  rate of principal maturities                                |   | 6.08        | %      | 6.09     | %      | 6.10     | %      | 6.51     | %      | 6.69     | %      | 5.81           | %      |
| Fixed Rate                                                                    |   |        |   |     |   |     |   |     |   |     |   |           |   |
| Variable rate  debt fixed by interest rate swap expiring in December 2003 (2) |   | $           | 549    |     | $      | 730      |   | $        | 749    |     | $      | 770            |   | $ | 791 |   | $ | 21,250 |   |
| Variable rate  debt fixed by interest rate swap expiring in December 2004 (3) |   | $           | 549    |     | $      | 730      |   | $        | 749    |     | $      | 770            |   | $ | 791 |   | $ | 21,250 |   |
| Variable Rate                                                                 |   |        |   |     |   |     |   |     |   |     |   |           |   |
| Mortgage loans  payable                                                       |   | $           | 1      |     | $      | 1        |   | $        | 1      |     | $      | 1              |   | $ | 1 |   | $ | 18,745 |   |
| Average interest  rate (4)                                                    |   |        |   |     |   |     |   |     |   |     |   |           |   |
| Bank loan  payable                                                            |   | —      |   | —   |   | —   |   | $        | 155    |     | — |           | — |   |
| Average interest  rate (5)                                                    |   |        |   |     |   |     |   |     |   |     |   |           |   |
| Bonds payable                                                                 |   | $           | 375    |     | $      | 415      |   | $        | 460    |     | $      | 505            |   | $ | 560 |   | $ | 1,305 |   |
| Average interest  rate (6)                                                    |   |        |   |     |   |     |   |     |   |     |   |           |   |
|                                                                               |        |             |        |          |        |          |        |          |        |          |        |                |        |  |  |  |  |  |  |  |

 

 

19

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(1) Period from April 1, 2003 to December 31, 2003.

(2) The maximum interest rate is 4.27% per annum untilDecember 2003.  The average rate in thefirst quarter of 2003 was 4.27%.

(3) The maximum interest rate is 4.88% per annum untilDecember 2004.  The average interestrate in the first quarter of 2003 was 4.88%.

(4) At March 31, 2003, the interest rate was LIBORplus 1.6% per annum.  The averageinterest rate in the first quarter of 2003 was 2.99% per annum.

(5) The interest rate at March 31, 2003, was LIBORplus 1.45%.  The average interest ratein the first quarter of 2003 was 2.75%.

(6) The average interest rate in the first quarter of2003 was 2.2%.

 

Item 4.  Controls and Procedures

 

The Company maintains a set of disclosure controls and proceduresdesigned to ensure that information required to be disclosed by the Company inreports that it files or submits under the Securities Exchange Act of 1934 isrecorded, processed, summarized and reported within the time periods specifiedin Securities and Exchange Commission rules and forms.  Within the 90-day period prior to the filingof this report, an evaluation was carried out under the supervision and withthe participation of the Company’s management, including the Chief ExecutiveOfficer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness ofthe Company’s disclosure controls and procedures.  Based on that evaluation, the CEO and CFO have concluded that theCompany’s disclosure controls and procedures are effective.

 

Subsequent to the date of their evaluation, there have been nosignificant changes in the Company’s internal controls or in other factors thatcould significantly affect these controls.

 

Part II OtherInformation

 

ITEM 6.                  Exhibits and Reports on Form8-K

 

(a)           Exhibits

10.1                           PromissoryNote with a principal amount of $40 million between the Company andMetropolitan Life Insurance Company dated January 16, 2003 (incorporated byreference to Exhibit 10.2 of the Company’s Current Report on Form 8-K datedJanuary 16, 2003).

 

99.1                           CertificationPursuant to § 906 of the Sarbanes-Oxley Act of 2002

 

(b)           Reports of Form 8-K

 

Item 5 Form 8-K dated January 16, 2003, and filed onJanuary 31, 2003, reporting Other Events.

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

 
|                 |   | Great Lakes REIT.                             |
|----------------------|--------|-----------------------------------------------|
|                 |   |                                          | (Registrant) |
|                 |   |                                          |
|                 |   |                                          |
| Date: April 25, 2003 |   | /s/ James Hicks                               |
|                 |   | Chief Financial Officer and Treasurer         |
|                 |   | (Principal Financial and  Accounting Officer) |

 

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**CERTIFICATIONS**

 

I, Richard A. May, certify that:

 

1.             Ihave reviewed this quarterly****report on Form 10-Q of Great Lakes REIT;

 

2.             Basedon my knowledge, this quarterly****report does not contain any untruestatement of a material fact or omit to state a material fact necessary to makethe statements made, in light of the circumstances under which such statementswere made, not misleading with respect to the period covered by this quarterly****report;

 

3.             Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly****report, fairly present in all materialrespects the financial condition, results of operations and cash flows of theregistrant as of, and for, the periods presented in this quarterly****report;

 

4.             Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)                                      Designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b)                                     Evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly****report(the “Evaluation Date”); and

 

c)                                      Presentedin this quarterly****report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

 

5.             Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)                                      Allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

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b)                                     Anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

** **

6.             Theregistrant’s other certifying officers and I have indicated in this quarterly****reportwhether or not there were significant changes in internal controls or in otherfactors that could significantly affect internal controls subsequent to thedate of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

 
| Date:   April 25, 2003 |   |                                  | /s/  Richard  A. May |
|---------------------------------------|--------|---------------------------------------|---------------------------|
|                                  |   | Richard A. May                        |
|                                  |   | Chairman and Chief  Executive Officer |
|                                  |   |                                  |
|                                  |   | (Principal Executive  Officer)        |

 

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**CERTIFICATIONS**

 

I, James Hicks, certify that:

 

1.             Ihave reviewed this quarterly****report on Form 10-Q of Great Lakes REIT;

 

2.             Basedon my knowledge, this quarterly****report does not contain any untruestatement of a material fact or omit to state a material fact necessary to makethe statements made, in light of the circumstances under which such statementswere made, not misleading with respect to the period covered by this quarterly****report;

 

3.             Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly****report, fairly present in all materialrespects the financial condition, results of operations and cash flows of theregistrant as of, and for, the periods presented in this quarterly****report;

 

4.             Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)                                      Designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b)                                     Evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly****report(the “Evaluation Date”); and

 

c)                                      Presentedin this quarterly****report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

 

5.             Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)                                      Allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)                                     Anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.             Theregistrant’s other certifying officers and I have indicated in this quarterly****reportwhether or not there were significant changes in internal controls or in otherfactors that

 

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could significantly affect internal controls subsequent to the date ofour most recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 

 
| Date:   April 25, 2003 |   |                           | /s/  James  Hicks |
|---------------------------------------|--------|--------------------------------|------------------------|
|                                  |   | James Hicks                    |
|                                  |   | Chief Financial Officer        |
|                                  |   |                           |
|                                  |   | (Principal Financial  Officer) |

 

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