AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 16, 2003 REGISTRATION NO. 333- ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM S-4 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 CRESCENT REAL ESTATE EQUITIES COMPANY (Exact Name of Registrant as Specified in its Charter) TEXAS 6798 52-1862813 (State or Other Jurisdiction of (Primary Standard Industrial (I.R.S. Employee Incorporation or Organization) Classification Code Number) Identification No.) 777 MAIN STREET SUITE 1200 FORTH WORTH, TEXAS 76102 (817) 321-2100 (Address, including zip code, and telephone number, including area code, of Registrant's principal executive offices) ------------------ JOHN C. GOFF CHIEF EXECUTIVE OFFICER 777 MAIN STREET SUITE 1200 FORT WORTH, TEXAS 76102 (817) 321-2100 (Name, address, including zip code, and telephone number, including area code, of agent for service) ---------------------------- Copies to: SYLVIA M. MAHAFFEY, ESQ DAVID M. DEAN SHAW PITTMAN CRESCENT REAL ESTATE EQUITIES COMPANY 2300 N STREET, N.W. 777 MAIN STREET, SUITE 2100 WASHINGTON, D.C. FORT WORTH, TEXAS 76102 (202) 663-8000 (817) 321-2100 ---------------------------- APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after the effective date of this Registration Statement. If the securities being registered on this form are being offered in connection with the formation of a holding company and there is compliance with General Instruction G, check the following box. If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration for the same offering. If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. CALCULATION OF REGISTRATION FEE PROPOSED MAXIMUM PROPOSED MAXIMUM TITLE OF EACH CLASS OF AMOUNT TO BE OFFERING PRICE PER AGGREGATE OFFERING AMOUNT OF SECURITIES TO BE REGISTERED REGISTERED SHARE PRICE REGISTRATION FEE Common stock, par value $.01 $10,828,497 (1) $ 10,828,497 $ 996.23(2) (1) Omitted pursuant to Rule 457(o) of the rules and regulations under the Securities Act of 1933, as amended. (2) Calculated pursuant to Rule 457(o) of the rules and regulations under the Securities Act of 1933, as amended. ------------------------ THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. ================================================================================ THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED. SUBJECT TO COMPLETION, DATED JANUARY 16, 2003 PROXY STATEMENT/PROSPECTUS CRESCENT OPERATING, INC. CRESCENT REAL ESTATE EQUITIES COMPANY 777 MAIN STREET, SUITE 1240 Issuer of the common shares that FORT WORTH, TEXAS 76102 may be issued to stockholders of Crescent (817) 321-1601 Operating, Inc., as described in this proxy statement/prospectus THE PROXY STATEMENT/PROSPECTUS IS DATED JANUARY __, 2003 AND IS FIRST BEING MAILED TO STOCKHOLDERS OF CRESCENT OPERATING ON OR ABOUT JANUARY __, 2003. NOTICE OF SPECIAL MEETING OF STOCKHOLDERS The special meeting of stockholders of Crescent Operating, Inc., a Delaware corporation, or Crescent Operating, will be held at The Fort Worth Club, located at 306 West 7th Street, Fort Worth, Texas, on Thursday, March 6, 2003 at 10:00 a.m., Central Time, to vote on a proposal to accept a bankruptcy plan of Crescent Operating to be implemented under Chapter 11 of the United States Bankruptcy Code. The Crescent Operating bankruptcy plan provides as follows: - Crescent Real Estate Equities Company and its affiliates, or Crescent Real Estate, will make sufficient funds available to Crescent Operating to pay in full or otherwise resolve the claims of those creditors of Crescent Operating that Crescent Operating identified in the original Settlement Agreement, other than Crescent Real Estate, and to cover the budgeted expenses of implementing the Settlement Agreement and seeking to confirm the bankruptcy plan. - If the bankruptcy plan is accepted by holders of at least two-thirds of the shares of Crescent Operating common stock voted at the special meeting and is confirmed by the bankruptcy court, then Crescent Operating will cancel all outstanding shares of its common stock and Crescent Real Estate will issue to each holder of Crescent Operating common stock a number of common shares of Crescent Real Estate equal to: - the ownership percentage of Crescent Operating held by such holder on the confirmation date of the bankruptcy plan, multiplied by - $16.0 million less the aggregate amount of claims and expenses, including the expenses of Crescent Real Estate but excluding payments to satisfy an approximately $15.5 million potential claim against Crescent Operating by Bank of America, that Crescent Real Estate pays in connection with the Crescent Operating bankruptcy and the reorganization transactions, divided by - the average of the daily closing prices per Crescent Real Estate common share as reported on the New York Stock Exchange Composite Transactions reporting system for the 10 consecutive trading days immediately preceding the date of confirmation of the bankruptcy plan. As of December 31, 2002, Crescent Real Estate had incurred approximately $8.5 million in claims and expenses in connection with the Crescent Operating bankruptcy and the reorganization transactions and expects to incur an aggregate of $10.6 million to $13.8 million in total claims and expenses. Accordingly, the total value of the Crescent Real Estate common shares issuable to Crescent Operating's stockholders is currently expected to be between $5.4 million and $2.16 million or $0.50 to $0.20 per share of Crescent Operating common stock. Regardless of the total amount of claims and expenses that are paid by Crescent Real Estate in connection with the bankruptcy plan and the reorganization transactions, if the bankruptcy plan is accepted by the requisite vote of Crescent Operating stockholders and is confirmed by the bankruptcy court, then the stockholders of Crescent Operating will receive common shares of Crescent Real Estate with a value of at least $2.16 million, or $0.20 per share of Crescent Operating common stock. In no event will the Crescent Operating stockholders be entitled to reconsider their approval of the bankruptcy plan. Crescent Real Estate common shares are listed on the New York Stock Exchange under the symbol "CEI." THE SOLE DIRECTOR OF CRESCENT OPERATING HAS APPROVED THE BANKRUPTCY PLAN AND, AFTER CONSULTATION WITH OUTSIDE ADVISORS, HAS DETERMINED THAT THE BANKRUPTCY PLAN IS FAIR TO, AND IN THE BEST INTERESTS OF, CRESCENT OPERATING'S STOCKHOLDERS. ACCORDINGLY, THE SOLE DIRECTOR RECOMMENDS THAT YOU VOTE "FOR" ACCEPTANCE OF THE BANKRUPTCY PLAN. INVESTING IN CRESCENT REAL ESTATE COMMON SHARES INVOLVES RISK. SEE "RISK FACTORS" BEGINNING ON PAGE 23. Only stockholders of record of Crescent Operating at the close of business on January 8, 2003 will be entitled to notice of, and to vote at, the special meeting or any adjournment or postponement thereof. Dated January __, 2003 By order of the Sole Director /s/ JEFFREY L. STEVENS Jeffrey L. Stevens, Chief Executive Officer YOUR VOTE IS VERY IMPORTANT. WHETHER OR NOT YOU EXPECT TO ATTEND THE MEETING, PLEASE SIGN AND DATE THE ENCLOSED PROXY AND MAIL IT PROMPTLY IN THE POSTAGE-PAID ENVELOPE PROVIDED OR VOTE BY TELEPHONE IN ACCORDANCE WITH THE DIRECTIONS CONTAINED ON THE PROXY CARD. PROXIES ARE REVOCABLE, AND YOU MAY WITHDRAW YOUR PROXY AND VOTE IN PERSON AT THE SPECIAL MEETING. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this proxy statement/prospectus is truthful or complete. Any representation to the contrary is a criminal offense. WHERE YOU CAN FIND MORE INFORMATION CRESCENT OPERATING, INC. Crescent Operating files annual, quarterly, and special reports, proxy statements, and other information with the Securities and Exchange Commission. You may read and copy any document on the Securities and Exchange Commission's website at http://www.sec.gov or at the Securities and Exchange Commission's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549 and at the Securities and Exchange Commission's Regional Office at Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. Crescent Operating's common stock is traded on the Over The Counter Bulletin Board, or the OTC Bulletin Board, market under the symbol "COPI.OB." WHO CAN HELP ANSWER MY QUESTIONS? If you have additional questions about the Crescent Operating bankruptcy plan, you should contact: Crescent Operating, Inc. Attention: Jeffrey L. Stevens or Kiersten Thompson 777 Main Street, Suite 1240 Fort Worth, Texas 76102 Phone Number: (817) 321-1602 CRESCENT REAL ESTATE EQUITIES COMPANY Crescent Real Estate files annual, quarterly, and special reports, proxy statements and other information with the Securities and Exchange Commission. You may read and copy any document on the Securities and Exchange Commission's website at http://www.sec.gov or at the Securities and Exchange Commission's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549 and at the Securities and Exchange Commission's Regional Office at Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. In addition, Crescent Real Estate's common shares are listed on the New York Stock Exchange, or NYSE, under the symbol "CEI". You can inspect any reports, proxy statements and other information at the offices of the NYSE, 20 Broad Street, New York, NY 10005. Crescent Real Estate has filed with the Securities and Exchange Commission a registration statement under the Securities Act of 1933, as amended, that registers the distribution to Crescent Operating stockholders of the Crescent Real Estate common shares to be issued in connection with the Crescent Operating bankruptcy plan. In addition to serving as a proxy statement of Crescent Operating for the special meeting of Crescent Operating's stockholders, this document also serves as a prospectus for the Crescent Real Estate common shares to be issued under the Crescent Operating bankruptcy plan. The registration statement, including the attached exhibits and schedules, contains additional relevant information about Crescent Real Estate. The rules and regulations of the Securities and Exchange Commission permit Crescent Real Estate to omit from this document some of the information included in the registration statement. Copies of the registration statement, including exhibits, may be inspected without charge at the offices of the Securities and Exchange Commission at 450 Fifth Street, N.W., Washington, D.C. 20549 and copies may be obtained from the Securities and Exchange Commission at prescribed rates. The registration statement is also available from the Securities and Exchange Commission's website. The Securities and Exchange Commission allows Crescent Real Estate to "incorporate by reference" information into this document. This means that Crescent Real Estate can disclose important information to you by referring you to another document filed with the Securities and Exchange Commission. The information incorporated by reference is considered to be part of this proxy statement/prospectus, except to the extent it has been superceded by information that is included in this document or in a document subsequently filed with the Securities and Exchange Commission that is incorporated by reference. Crescent Real Estate incorporates by reference important business and financial information not otherwise included in this proxy statement/prospectus but contained in the following documents, and any additional documents filed by Crescent Real Estate with the Securities and Exchange Commission under Sections 13(a), 14 or 15(d) of the Securities Exchange Act of 1934, as amended, between the date of this proxy statement/prospectus and the date of the Crescent Operating special meeting: - Crescent Real Estate's Quarterly Report on Form 10-Q for the quarter ended September 30, 2002; - Crescent Real Estate's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002; - Amendment No. 1 to Crescent Real Estate's Quarterly Report on Form 10-Q for the quarter ended March 31, 2002. - Crescent Real Estate's Quarterly Report on Form 10-Q for the quarter ended March 31, 2002; - Amendment No. 3 to Crescent Real Estate's Annual Report on Form 10-K/A for the fiscal year ended December 31, 2001. - Amendment No. 2 to Crescent Real Estate's Annual Report on Form 10-K/A for the fiscal year ended December 31, 2001; - Amendment No. 1 to Crescent Real Estate's Annual Report on Form 10-K/A for the fiscal year ended December 31, 2001; - Crescent Real Estate's Annual Report on Form 10-K for the fiscal year ended December 31, 2001; - Crescent Real Estate's Current Report on Form 8-K filed June 26, 2002; - Crescent Real Estate's Current Report on Form 8-K filed May 14, 2002; - Amendment No. 1 to Crescent Real Estate's Current Report on Form 8-K/A filed April 29, 2002; - Crescent Real Estate's Current Report on Form 8-K filed April 25, 2002; - Crescent Real Estate's Current Report on Form 8-K filed April 16, 2002; - Crescent Real Estate's Current Report on Form 8-K filed April 1, 2002; - Crescent Real Estate's Definitive Proxy Statement on Schedule 14A filed May 16, 2002; - Crescent Real Estate's Registration Statement on Form 8-B filed on March 24, 1997 registering the Crescent Common Shares under Section 12(b) of the Exchange Act. Documents incorporated by reference are available from Crescent Real Estate, without charge, excluding any exhibits to those documents, unless the exhibit is specifically incorporated by reference as an exhibit in this proxy statement/prospectus. You can obtain documents incorporated by reference in this proxy statement/prospectus by requesting them in writing or by telephone from Crescent Real Estate at the following address: Crescent Real Estate Equities Company 777 Main Street, Suite 2100 Fort Worth, Texas 76102 Attention: Keira B. Moody (817) 321-2100 If you would like to request documents, please do so by February 27, 2003 to receive them before the special meeting. If you request any incorporated document, Crescent Real Estate will mail it to you by first-class mail, or another equally prompt means, as soon as practicable following receipt of your request. TABLE OF CONTENTS NOTICES TO STOCKHOLDERS......................................................................................... vii QUESTIONS AND ANSWERS ABOUT THE CRESCENT OPERATING BANKRUPTCY PLAN AND THE SPECIAL MEETING...................... 1 SUMMARY......................................................................................................... 12 The Companies............................................................................................... 12 Agreement for Transfer of Crescent Operating Assets to Crescent Real Estate................................. 16 Settlement Agreement........................................................................................ 16 Other Crescent Operating Recent Developments................................................................ 18 Summary of the Plan of Reorganization....................................................................... 19 Release and Waiver of Claims by Crescent Operating and Stockholders of Crescent Operating................... 21 Special Meeting and Voting.................................................................................. 23 Recommendation of Sole Director of Crescent Operating....................................................... 23 No Dissenters' Appraisal Rights............................................................................. 24 Tax Considerations.......................................................................................... 24 Interests of Certain Persons in the Reorganization Transactions............................................. 24 RISK FACTORS.................................................................................................... 27 Risks Associated with the Crescent Operating Bankruptcy Plan................................................ 27 Risks Associated with an Investment in Crescent Real Estate Common Shares................................... 33 COMPARATIVE PER SHARE MARKET PRICE INFORMATION.................................................................. 46 SELECTED HISTORICAL FINANCIAL INFORMATION OF CRESCENT REAL ESTATE............................................... 46 SELECTED HISTORICAL FINANCIAL INFORMATION OF CRESCENT OPERATING................................................. 48 SELECTED PRO FORMA FINANCIAL AND OPERATING INFORMATION OF CRESCENT REAL ESTATE.................................. 48 COMPARATIVE PER SHARE DATA...................................................................................... 50 THE SPECIAL MEETING OF CRESCENT OPERATING STOCKHOLDERS.......................................................... 51 Proxy Statement/Prospectus.................................................................................. 51 Date, Time, and Place of Special Meeting.................................................................... 51 Purpose of the Special Meeting.............................................................................. 51 Stockholder Record Date for the Special Meeting............................................................. 53 Vote of Crescent Operating Stockholders Required for Acceptance of the Crescent Operating Bankruptcy Plan................................................................... 53 Proxies..................................................................................................... 53 Proxy Solicitation.......................................................................................... 54 Effect of Abstentions and Broker Non-Votes.................................................................. 54 i THE REORGANIZATION TRANSACTIONS................................................................................. 54 Reasons for the Reorganization Transactions................................................................. 54 Summary of the Reorganization Transactions.................................................................. 56 Analysis of Alternatives.................................................................................... 67 Liquidation Analyses........................................................................................ 70 Events Leading to the Reorganization Transactions........................................................... 78 Recommendation of the Sole Director of Crescent Operating................................................... 85 Opinion of Crescent Operating's Financial Advisor........................................................... 85 Interests of Certain Persons in the Reorganization Transactions............................................. 92 Restrictions on Sales of Crescent Real Estate Common Shares by Affiliates of Crescent Operating............. 94 Listing on the New York Stock Exchange of Crescent Real Estate Common Shares to be Issued in the Reorganization Transactions................................................................................. 94 No Dissenters' Appraisal Rights............................................................................. 94 THE PLAN OF REORGANIZATION...................................................................................... 94 Overview and Incorporation by Reference..................................................................... 94 Brief Explanation of Chapter 11............................................................................. 95 Classification and Treatment of Claims and Interests........................................................ 95 Conditions to Occurrence of the Effective Date.............................................................. 97 Executory Contracts and Unexpired Leases.................................................................... 98 Modifications of Plan of Reorganization; Severability of Provisions......................................... 98 Confirmation of the Plan of Reorganization.................................................................. 98 Implementation of the Plan of Reorganization................................................................ 102 Manner of Distribution of Property under the Plan of Reorganization......................................... 104 Effects of Confirmation of the Plan of Reorganization....................................................... 106 The Solicitation; Voting.................................................................................... 110 Acceptance or Cramdown...................................................................................... 111 FEDERAL INCOME TAX CONSIDERATIONS............................................................................... 112 Tax Consequences of the Crescent Operating Bankruptcy Plan.................................................. 112 Taxation of Crescent Real Estate............................................................................ 113 Taxation of Taxable U.S. Shareholders....................................................................... 121 Taxation of Tax-Exempt U.S. Shareholders.................................................................... 123 ii Taxation of Non-U.S. Shareholders........................................................................... 123 State and Local Tax Consequences............................................................................ 126 Tax Aspects of Crescent Real Estate's Investment in Crescent Partnership and Subsidiary Partnerships........ 126 DESCRIPTION OF CRESCENT OPERATING'S BUSINESS.................................................................... 128 Overview of Crescent Operating.............................................................................. 128 Business Segments........................................................................................... 129 Equipment Sales and Leasing............................................................................ 130 Hospitality............................................................................................ 133 Temperature-Controlled Logistics....................................................................... 136 Land Development....................................................................................... 140 Other Investments...................................................................................... 143 Employees................................................................................................... 145 Properties.................................................................................................. 145 Legal Proceedings........................................................................................... 145 DESCRIPTION OF CRESCENT REAL ESTATE'S BUSINESS.................................................................. 147 Overview of Crescent Real Estate............................................................................ 147 Industry Segments........................................................................................... 147 Resort/Hotel Segment................................................................................... 153 Residential Development Segment........................................................................ 154 Temperature-Controlled Logistics Segment............................................................... 155 Employees................................................................................................... 157 Properties.................................................................................................. 157 Legal Proceedings........................................................................................... 171 CRESCENT OPERATING MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS........ 171 Overview.................................................................................................... 171 Recent Developments......................................................................................... 176 Results of Operations....................................................................................... 176 Three and Nine Months ended September 30, 2002, as Compared to Three and Nine Months Ended September 30, 2001............................................................................... 176 Year Ended December 31, 2001, as Compared to 2000...................................................... 179 Year Ended December 31, 2000, as Compared to 1999...................................................... 182 Liquidity and Capital Resources............................................................................. 186 Three and Nine Months ended September 30, 2002......................................................... 187 Year ended December 31, 2001........................................................................... 189 iii Critical Accounting Policies................................................................................ 193 Quantitative and Qualitative Disclosures About Market Risk.................................................. 193 CRESCENT REAL ESTATE MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS...... 194 Segment Information......................................................................................... 194 Office Segment......................................................................................... 194 Resort/Hotel Segment................................................................................... 196 Residential Development Segment........................................................................ 197 Temperature-Controlled Logistics Segment............................................................... 200 Behavioral Healthcare Segment.......................................................................... 201 Results of Operations....................................................................................... 203 Three Months Ended September 30, 2002 as Compared to Three Months Ended September 30, 2001............. 206 Nine Months Ended September 30, 2002 as Compared to Nine Months Ended September 30, 2001............... 211 Year Ended December 31, 2001 as Compared to 2000....................................................... 217 Year Ended December 31, 2000 as Compared to 1999....................................................... 219 Liquidity and Capital Resources............................................................................. 222 Nine Months Ended September 30, 2002................................................................... 222 Year ended December 31, 2001........................................................................... 226 Debt Financing Arrangements................................................................................. 256 Quantitative and Qualitative Disclosure about Market Risk................................................... 261 PRICE RANGE OF CRESCENT OPERATING COMMON STOCK, DIVIDENDS AND RELATED STOCKHOLDER MATTERS....................... 263 PRICE RANGE OF CRESCENT REAL ESTATE COMMON SHARES, DIVIDENDS AND RELATED SHAREHOLDER MATTERS.................... 265 SHARE OWNERSHIP BY PRINCIPAL STOCKHOLDERS, MANAGEMENT AND DIRECTORS OF CRESCENT OPERATING....................... 267 CRESCENT REAL ESTATE MANAGEMENT AND ADDITIONAL INFORMATION...................................................... 268 DESCRIPTION OF CAPITAL STOCK OF CRESCENT REAL ESTATE............................................................ 273 Description of Crescent Real Estate Common Shares........................................................... 273 Description of Series A Preferred Shares.................................................................... 276 Description of Common Share Warrants........................................................................ 283 COMPARISON OF RIGHTS OF HOLDERS OF CRESCENT OPERATING COMMON STOCK AND CRESCENT REAL ESTATE COMMON SHARES....................................................................................... 283 Form of Entity.............................................................................................. 284 Capitalization.............................................................................................. 284 iv Classified Board of Directors/Trust Managers; Number of Directors/Trust Managers............................ 284 Removal of Directors/Trust Managers......................................................................... 284 Filling Vacancies on the Board of Directors/Trust Managers.................................................. 285 Limits on Stockholder Action by Written Consent............................................................. 285 Ability to Call Special Meetings............................................................................ 286 Advance Notice Provisions for Stockholder Nominations and Proposals......................................... 286 Vote Required for Certain Stockholder Actions............................................................... 287 Amendment of Certificate of Incorporation/Declaration of Trust.............................................. 288 Amendment of Bylaws......................................................................................... 288 Restrictions on Business Combinations....................................................................... 289 Control Share Acquisition................................................................................... 289 Dividends................................................................................................... 291 Appraisal Rights............................................................................................ 292 Limitation of Personal Liability of Directors/Trust Managers and Officers................................... 293 Indemnification of Directors/Trust Managers and Officers.................................................... 293 Excess Share Provisions..................................................................................... 295 Anti-Takeover Provisions.................................................................................... 296 MATERIAL CONTACTS BETWEEN CRESCENT REAL ESTATE AND CRESCENT OPERATING........................................... 299 Intercompany Agreement...................................................................................... 299 LEGAL MATTERS................................................................................................... 300 EXPERTS......................................................................................................... 300 NOTICE REGARDING ARTHUR ANDERSEN LLP............................................................................ 301 STATEMENTS REGARDING FORWARD-LOOKING INFORMATION................................................................ 301 Crescent Operating, Inc. ................................................................................... 302 Crescent Real Estate Equities Company....................................................................... 304 Additional Information...................................................................................... 305 INDEX TO FINANCIAL STATEMENTS................................................................................... F-1 v ANNEX INDEX Annex A - Plan of Reorganization Annex B - Settlement Agreement and First Amendment to Settlement Agreement Annex C - Fairness Opinion of Houlihan Lokey Howard & Zukin Financial Advisors, Inc. vi NOTICES TO STOCKHOLDERS THE CRESCENT OPERATING BANKRUPTCY PLAN IS TO BE FILED IN CONNECTION WITH A CASE TO BE COMMENCED IN THE FUTURE BY CRESCENT OPERATING UNDER CHAPTER 11 OF THE U.S. BANKRUPTCY CODE. AT THIS TIME, CRESCENT OPERATING HAS NOT COMMENCED A CHAPTER 11 CASE. IF SUFFICIENT VOTES ARE RECEIVED ACCEPTING THE CRESCENT OPERATING BANKRUPTCY PLAN, IT IS CRESCENT OPERATING'S PRESENT INTENTION TO COMMENCE A CHAPTER 11 CASE AND SEEK TO HAVE THE CRESCENT OPERATING BANKRUPTCY PLAN CONFIRMED BY THE BANKRUPTCY COURT AS PROMPTLY AS PRACTICABLE. IF THE CRESCENT OPERATING BANKRUPTCY PLAN IS NOT ACCEPTED BY THE REQUIRED VOTE, CRESCENT OPERATING WILL STILL FILE THE CHAPTER 11 CASE AND REQUEST THAT THE BANKRUPTCY COURT CONFIRM THE CRESCENT OPERATING BANKRUPTCY PLAN UNDER THE PROVISION OF THE BANKRUPTCY CODE WHICH IS COMMONLY REFERRED TO AS THE "CRAMDOWN PROVISION." THIS PROVISION WOULD PERMIT CONFIRMATION OF THE CRESCENT OPERATING BANKRUPTCY PLAN IF THE COURT FINDS THAT THE CRESCENT OPERATING BANKRUPTCY PLAN DOES NOT DISCRIMINATE UNFAIRLY AGAINST, AND IS FAIR AND EQUITABLE TO, CRESCENT OPERATING'S STOCKHOLDERS. THE CRESCENT OPERATING BANKRUPTCY PLAN PROVIDES THAT, IF THE CRESCENT OPERATING BANKRUPTCY PLAN IS NOT ACCEPTED BY THE REQUIRED VOTE OF THE CRESCENT OPERATING STOCKHOLDERS, AND IF THE CRESCENT OPERATING BANKRUPTCY PLAN IS CONFIRMED BY THE BANKRUPTCY COURT PURSUANT TO THE "CRAMDOWN PROVISION," THEN THE STOCKHOLDERS OF CRESCENT OPERATING WILL NOT RECEIVE ANY COMMON SHARES OF CRESCENT REAL ESTATE. THIS PROXY STATEMENT/PROSPECTUS GIVES YOU DETAILED INFORMATION ABOUT THE PROPOSED CRESCENT OPERATING BANKRUPTCY PLAN. YOU ARE ENCOURAGED TO READ THIS PROXY STATEMENT/PROSPECTUS CAREFULLY. IN PARTICULAR, YOU SHOULD READ THE "RISK FACTORS" SECTION BEGINNING ON PAGE 23 FOR A DESCRIPTION OF THE VARIOUS RISKS YOU SHOULD CONSIDER IN EVALUATING THE PROPOSED CRESCENT OPERATING BANKRUPTCY PLAN. ON FEBRUARY 14, 2002, CRESCENT OPERATING AND CERTAIN OF ITS AFFILIATED ENTITIES EXECUTED THE SETTLEMENT AGREEMENT, WHICH HAS SINCE BEEN AMENDED AND WHICH IS ATTACHED TO THIS PROXY STATEMENT/PROSPECTUS AS ANNEX B. CONTEMPORANEOUSLY WITH EXECUTION OF THE SETTLEMENT AGREEMENT, CRESCENT OPERATING AND CRESCENT REAL ESTATE EXCHANGED MUTUAL RELEASES. IN PERTINENT PART, CRESCENT OPERATING RELEASED ANY AND ALL CLAIMS THAT IT MIGHT HAVE AGAINST CRESCENT REAL ESTATE AND CERTAIN AFFILIATES ARISING AT ANY TIME PRIOR TO EXECUTION OF THE SETTLEMENT AGREEMENT. PRIOR TO ENTERING INTO THE SETTLEMENT AGREEMENT, CRESCENT OPERATING, ANALYZED WHETHER IT HAD CLAIMS AGAINST CRESCENT REAL ESTATE THAT SHOULD BE PURSUED AS AN ALTERNATIVE TO THE PROPOSED SETTLEMENT AGREEMENT. CRESCENT OPERATING CONSULTED ITS COUNSEL WHO REVIEWED, AMONG OTHER MATTERS, THE ORIGIN OF CRESCENT OPERATING'S INDEBTEDNESS TO CRESCENT REAL ESTATE AND THE BUSINESS RELATIONSHIP BETWEEN CRESCENT OPERATING AND CRESCENT REAL ESTATE THAT BEGAN IN 1997 WHEN THE SHARES OF CRESCENT OPERATING COMMON STOCK WERE DISTRIBUTED TO CRESCENT REAL ESTATE SHAREHOLDERS. CRESCENT OPERATING INDEPENDENTLY EVALUATED WHETHER THE BENEFIT TO CRESCENT OPERATING CREDITORS AND STOCKHOLDERS IN CONSUMMATING THE SETTLEMENT AGREEMENT OUTWEIGHED THE BENEFIT THAT MIGHT BE OBTAINED FROM NOT ENTERING INTO THE PROPOSED SETTLEMENT AGREEMENT AND INSTEAD PURSUING CLAIMS AGAINST CRESCENT REAL ESTATE. IN MAKING THIS EVALUATION, CRESCENT OPERATING TOOK INTO CONSIDERATION THE RELATIVE CERTAINTY OF ITS CREDITORS AND STOCKHOLDERS REALIZING THE BENEFITS PROVIDED FOR IN THE SETTLEMENT AGREEMENT AND THE RELATIVE UNCERTAINTY OF RECOVERY IN, AS WELL AS THE COSTS AND DELAY ASSOCIATED WITH, PROSECUTING ANY CLAIMS, AND PARTICULARLY CLAIMS OF UNCERTAIN MERIT. BASED UPON THE TOTALITY OF THE CIRCUMSTANCES, CRESCENT OPERATING MADE THE INDEPENDENT JUDGMENT THAT THE BEST INTERESTS OF ITS CREDITORS AND STOCKHOLDERS WOULD BE SERVED BY ENTERING INTO THE SETTLEMENT AGREEMENT. CRESCENT OPERATING CONCLUDED THAT THE BENEFITS TO ITS CREDITORS AND STOCKHOLDERS THAT COULD BE REALIZED THROUGH THE SETTLEMENT AGREEMENT OUTWEIGHED THE COST TO CRESCENT OPERATING OF GRANTING THE RELEASES TO CRESCENT REAL ESTATE. THE SETTLEMENT AGREEMENT AND THE MUTUAL RELEASES vii EXECUTED IN CONNECTION WITH THE SETTLEMENT AGREEMENT, INCLUDING CRESCENT OPERATING'S RELEASE OF ALL CLAIMS IT MAY HAVE AGAINST CRESCENT REAL ESTATE, ARE ENFORCEABLE WHETHER OR NOT THE BANKRUPTCY PLAN IS APPROVED BY CRESCENT OPERATING'S STOCKHOLDERS AND WHETHER OR NOT THE BANKRUPTCY PLAN IS CONFIRMED BY THE BANKRUPTCY COURT. THE SETTLEMENT AGREEMENT ALSO PROVIDES THAT CRESCENT OPERATING AND CRESCENT REAL ESTATE AND THE DIRECTORS OR TRUST MANAGERS, OFFICERS, AGENTS AND EMPLOYEES OF EACH WILL BE RELEASED FROM ALL LIABILITIES AND CLAIMS ARISING PRIOR TO THE EFFECTIVE DATE OF THE BANKRUPTCY PLAN. IF THE BANKRUPTCY PLAN IS ACCEPTED BY THE STOCKHOLDERS AND CONFIRMED BY THE BANKRUPTCY COURT, THEN, ON THE EFFECTIVE DATE OF THE CRESCENT OPERATING BANKRUPTCY PLAN, EACH STOCKHOLDER OF CRESCENT OPERATING WHO IS A MEMBER OF A CLASS THAT VOTES TO ACCEPT THE BANKRUPTCY PLAN OR WHO RECEIVES A DISTRIBUTION UNDER THE BANKRUPTCY PLAN, WILL BE DEEMED TO UNCONDITIONALLY RELEASE CRESCENT OPERATING AND CRESCENT REAL ESTATE AND ALL CURRENT AND FORMER OFFICERS AND DIRECTORS OR TRUST MANAGERS OF CRESCENT OPERATING AND CRESCENT REAL ESTATE FROM ALL CLAIMS AND LIABILITIES, EXCEPT FOR PERFORMANCE OR NONPERFORMANCE UNDER THE SETTLEMENT AGREEMENT OR THE BANKRUPTCY PLAN AND EXCEPT FOR ANY ACTION OR OMISSION THAT CONSTITUTES ACTUAL FRAUD OR CRIMINAL BEHAVIOR. THE RELEASE OF CRESCENT OPERATING STOCKHOLDER CLAIMS WILL NOT APPLY IF THE HOLDERS OF THE CRESCENT OPERATING COMMON STOCK, VOTING AS A CLASS, VOTE AGAINST THE BANKRUPTCY PLAN. IN ADDITION, THE RELEASE OF CRESCENT OPERATING STOCKHOLDER CLAIMS WILL NOT APPLY TO THE CLAIMS, IF ANY, OF A PERSON WHO SOLD ITS CRESCENT OPERATING STOCK BEFORE THE RECORD DATE FOR THE VOTE, OR WHO EITHER VOTED AGAINST THE BANKRUPTCY PLAN OR DID NOT VOTE AND THEREAFTER EITHER DID NOT RECEIVE OR REFUSED TO ACCEPT A DISTRIBUTION OF CRESCENT REAL ESTATE COMMON SHARES. THE RELEASE OF CRESCENT OPERATING STOCKHOLDER CLAIMS WILL APPLY TO CRESCENT OPERATING STOCKHOLDERS ONLY IN THEIR CAPACITY AS CRESCENT OPERATING STOCKHOLDERS, AND WILL NOT AFFECT THEIR RIGHTS AS HOLDERS OF CRESCENT REAL ESTATE COMMON SHARES. THIS RELEASE WILL BE SUBJECT TO THE EFFECT OF SECTION 29 OF THE SECURITIES EXCHANGE ACT OF 1934, WHICH PROVIDES THAT ANY AGREEMENT BINDING ANY PERSON TO WAIVE COMPLIANCE WITH THE EXCHANGE ACT IS VOID. YOU SHOULD BE AWARE THAT IT IS THE POSITION OF THE SECURITIES AND EXCHANGE COMMISSION THAT THE RELEASE WILL NOT BE EFFECTIVE WITH RESPECT TO CERTAIN CLAIMS ARISING UNDER FEDERAL SECURITIES LAWS. IN ADDITION, IT IS THE POSITION OF THE SECURITIES AND EXCHANGE COMMISSION THAT THE RELEASE OF AFFILIATES OF CRESCENT OPERATING AND THE CURRENT AND FORMER OFFICERS AND DIRECTORS OR TRUST MANAGERS OF CRESCENT OPERATING AND CRESCENT REAL ESTATE VIOLATES SECTION 524(E) OF THE BANKRUPTCY CODE UNLESS SEPARATE CONSIDERATION IS PROVIDED BY THESE PARTIES OR THE RELEASE IS VOLUNTARY. EFFECTIVE OCTOBER 1, 2002, CRESCENT OPERATING AND CRESCENT REAL ESTATE AMENDED THE SETTLEMENT AGREEMENT. THE AMENDMENT PROVIDES FOR, AMONG OTHER THINGS, A MINIMUM VALUE OF CRESCENT REAL ESTATE COMMON SHARES TO BE ISSUED IN CONNECTION WITH THE BANKRUPTCY PLAN IF THE BANKRUPTCY PLAN IS ACCEPTED BY THE REQUISITE VOTE OF CRESCENT OPERATING STOCKHOLDERS AND CONFIRMED BY THE BANKRUPTCY COURT. NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THE CRESCENT OPERATING BANKRUPTCY PLAN, PASSED ON THE MERITS OR FAIRNESS OF THE CRESCENT OPERATING BANKRUPTCY PLAN OR PASSED ON THE ADEQUACY OR ACCURACY OF THIS PROXY STATEMENT/PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. THIS PROXY STATEMENT/PROSPECTUS HAS NOT BEEN APPROVED BY THE BANKRUPTCY COURT WITH RESPECT TO ADEQUACY OF INFORMATION. HOWEVER, IF THE CRESCENT OPERATING BANKRUPTCY PLAN IS ACCEPTED BY THE REQUIRED VOTE, CRESCENT OPERATING WILL SEEK BANKRUPTCY COURT APPROVAL OF THIS PROXY STATEMENT/PROSPECTUS AS PART OF THE ORDER CONFIRMING THE CRESCENT OPERATING BANKRUPTCY PLAN. THE DELIVERY OF THIS PROXY STATEMENT/PROSPECTUS SHALL NOT UNDER ANY CIRCUMSTANCES CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF OR THAT THERE HAS BEEN NO CHANGE IN THE INFORMATION SET FORTH HEREIN OR ANY ATTACHMENTS viii HERETO OR IN THE AFFAIRS OF CRESCENT REAL ESTATE, CRESCENT OPERATING, OR ANY OF THEIR SUBSIDIARIES SINCE THE DATE HEREOF. PRIOR TO VOTING, STOCKHOLDERS ARE ENCOURAGED TO READ AND CONSIDER CAREFULLY THIS ENTIRE PROXY STATEMENT/PROSPECTUS INCLUDING THE BANKRUPTCY PLAN OF REORGANIZATION ATTACHED HERETO AS ANNEX A AND THE MATTERS DESCRIBED IN THIS PROXY STATEMENT/PROSPECTUS. IN MAKING A DECISION IN CONNECTION WITH THE CRESCENT OPERATING BANKRUPTCY PLAN, STOCKHOLDERS MUST RELY ON THEIR OWN EXAMINATION OF CRESCENT OPERATING AND CRESCENT REAL ESTATE AND THE TERMS OF THE CRESCENT OPERATING BANKRUPTCY PLAN, INCLUDING THE MERITS AND RISKS INVOLVED. STOCKHOLDERS SHOULD NOT CONSTRUE THE CONTENTS OF THIS PROXY STATEMENT/PROSPECTUS AS PROVIDING ANY LEGAL, BUSINESS, FINANCIAL OR TAX ADVICE. EACH STOCKHOLDER SHOULD CONSULT WITH ITS OWN LEGAL, BUSINESS, FINANCIAL AND TAX ADVISORS WITH RESPECT TO ANY SUCH MATTERS CONCERNING THIS PROXY STATEMENT/PROSPECTUS, THE CRESCENT OPERATING BANKRUPTCY PLAN OR THE TRANSACTIONS CONTEMPLATED THEREBY. ix QUESTIONS AND ANSWERS ABOUT THE CRESCENT OPERATING BANKRUPTCY PLAN AND THE SPECIAL MEETING Unless the context otherwise requires, the terms Crescent Operating and Crescent Real Estate include the subsidiaries of each and, in the case of Crescent Real Estate, includes Crescent Real Estate Equities Limited Partnership, or Crescent Partnership. Unless the context otherwise requires, "bankruptcy plan" and "Plan of Reorganization" both refer to the Crescent Operating bankruptcy plan that is described in this proxy statement/prospectus. The Plan of Reorganization is attached to this proxy statement/prospectus as Annex A and is incorporated by reference to this proxy statement/prospectus. Unless the context otherwise requires, "Settlement Agreement" refers to the Settlement Agreement executed on February 14, 2002, as amended by the First Amendment to Settlement Agreement executed effective October 1, 2002. The Settlement Agreement and the First Amendment to Settlement Agreement are attached to this proxy statement/prospectus as Annex B and are incorporated by reference to this proxy statement/prospectus. The Crescent Operating Bankruptcy Plan Q. WHAT AM I VOTING ON? A. You are voting on a proposal to accept a bankruptcy plan that will result in the orderly termination of Crescent Operating's business and could result in your receiving Crescent Real Estate common shares. Q. WHY IS CRESCENT OPERATING PROPOSING THE BANKRUPTCY PLAN? A. Crescent Operating is proposing the bankruptcy plan to effect an orderly termination of its business. Substantially all of Crescent Operating's assets are or were encumbered by liens in favor of Crescent Real Estate. Crescent Operating is in default in its obligations to Crescent Real Estate. The value of Crescent Operating's assets was, and continues to be, insufficient to satisfy the secured claims of Crescent Real Estate. On February 14, 2002, Crescent Operating entered into the original Settlement Agreement with Crescent Real Estate and transferred many of the encumbered assets to Crescent Real Estate in partial satisfaction of its claims. The Settlement Agreement requires the filing of a prepackaged bankruptcy plan for Crescent Operating. If the bankruptcy plan is confirmed, the Settlement Agreement obligates Crescent Real Estate to provide Crescent Operating with funds to cover budgeted expenses and pay in full or otherwise resolve the claims of those creditors of Crescent Operating identified in the original Settlement Agreement and gives Crescent Operating stockholders the opportunity to receive Crescent Real Estate common shares. Q. WHY IS THE SOLE DIRECTOR OF CRESCENT OPERATING RECOMMENDING THAT I VOTE FOR THE CRESCENT OPERATING BANKRUPTCY PLAN? A. Crescent Operating's sole director is recommending that you vote for the Crescent Operating bankruptcy plan because he concluded that the bankruptcy plan, which provides for payments to Crescent Operating's creditors as well as the opportunity for Crescent Operating stockholders to receive Crescent Real Estate common shares with a value that is expected to be between $0.20 to $0.50 per share, but will not be less than $0.20 per share, of Crescent Operating common stock, 1 was the best available alternative for Crescent Operating, its creditors and stockholders. After Crescent Real Estate terminated the asset purchase agreement and the securities purchase agreement described below under "The Reorganization Transactions - Events Leading to the Reorganization Transactions," the sole director, working with Crescent Operating's counsel, analyzed Crescent Operating's alternatives. These alternatives included the following: - exploring the possibility of obtaining additional funds sufficient to satisfy its obligations and continue its ongoing operations; - liquidating Crescent Operating under Chapter 7 of the Bankruptcy Code; - instigating litigation requesting that a court set aside Crescent Real Estate's liens or recharacterize the Crescent Real Estate agreements as equity infusions rather than loans; and - not settling its claims with Crescent Real Estate and filing for bankruptcy to avoid a foreclosure by Crescent Real Estate. After analyzing these alternatives, the sole director concluded that the bankruptcy plan provided the best alternative with regard to the amount and the likelihood of recovery for the creditors and stockholders of Crescent Operating. Before finalizing his evaluation, however, Crescent Operating's sole director consulted with legal and financial advisors and also obtained an opinion stating that the aggregate consideration to be received by Crescent Operating and its stockholders, taken as a whole, in connection with the transactions contemplated by the bankruptcy plan and the Settlement Agreement is fair to the public stockholders of Crescent Operating from a financial point of view, assuming a distribution of Crescent Real Estate common shares with a value of $0.32 to $0.50. However, this opinion maintains that it would not necessarily change if Crescent Real Estate were to advance additional funds, as Crescent Real Estate agreed to do in the October 2002 amendment to the Settlement Agreement and as described below in "The Reorganization Transactions - Summary of the Reorganization Transactions - Payment by Crescent Real Estate of Crescent Operating Claims and Expenses," that reduce the value of Crescent Real Estate common shares to below $0.32. See "The Reorganization Transactions - Analysis of Alternatives" for a more detailed description of the analyses performed on behalf of Crescent Operating by the sole director and third-party consultants. Crescent Operating's sole director performed these analyses and negotiated the bankruptcy plan and Settlement Agreement independently from the other four members of the Crescent Operating Board of Directors, each of whom also serves as a trust manager of Crescent Real Estate. In order to avoid conflicts of interest, none of these four directors participated in the negotiations on behalf of Crescent Operating, and all four resigned as directors of Crescent Operating on February 13, 2002. One of these directors, John C. Goff, participated in the initial structuring of the proposed transactions, but did not participate in any negotiations due to potential conflicts of interest arising primarily from his position as Chief Executive Officer and a trust manager of Crescent Real Estate, as more fully described in "The Reorganization Transactions - Interests of Certain Persons in the Reorganization Transactions." As a result of these analyses, the sole director concluded that the Settlement Agreement and the pre-packaged bankruptcy were the best available alternatives for the Crescent Operating creditors and stockholders and the alternatives most likely to maximize stockholder value. Q. WHAT IS THE VOTE REQUIRED TO ACCEPT THE CRESCENT OPERATING BANKRUPTCY PLAN? A. The affirmative vote of two-thirds of the votes cast in person or by proxy is required to accept the Crescent Operating bankruptcy plan. In addition, at least a majority of the outstanding Crescent Operating common stock must be represented at the special meeting to constitute a quorum. Holders of Crescent Operating common stock are entitled to one vote for each share of Crescent Operating common stock they hold. 2 Q. WHAT HAPPENS IF THE CRESCENT OPERATING STOCKHOLDERS VOTE FOR ACCEPTANCE OF THE CRESCENT OPERATING BANKRUPTCY PLAN? A. If the Crescent Operating stockholders cast enough votes to accept the Crescent Operating bankruptcy plan, Crescent Operating will file a bankruptcy petition under the Bankruptcy Code and will submit the bankruptcy plan to the bankruptcy court for confirmation. If the bankruptcy court confirms the bankruptcy plan, you will cease to be a stockholder of Crescent Operating on the date the bankruptcy plan becomes effective. You will receive common shares of Crescent Real Estate subject to the conditions discussed below in the answer to the question "Are there conditions to my receipt of Crescent Real Estate common shares?" If the holders of Crescent Operating common stock, voting as a class, vote for acceptance of the bankruptcy plan, each stockholder will be deemed to unconditionally release Crescent Operating and Crescent Real Estate and all current and former officers and directors or trust managers of Crescent Operating and Crescent Real Estate from all claims and liabilities, except for performance or nonperformance under the Settlement Agreement and the bankruptcy plan and except for any action or omission that constitutes actual fraud or criminal behavior. The Settlement Agreement and the mutual releases executed in connection with the Settlement Agreement, including Crescent Operating's release of all claims it may have against Crescent Real Estate, are enforceable whether or not the bankruptcy plan is approved by Crescent Operating's stockholders and whether or not the bankruptcy plan is confirmed by the bankruptcy court. If the Crescent Operating stockholders vote to accept the bankruptcy plan, but an individual stockholder votes against the bankruptcy plan, abstains or does not vote, and either does not receive or refuses to accept any distribution under the bankruptcy plan, then that stockholder will not be deemed to have released any claims against Crescent Real Estate or its current or former officers and trust managers or Crescent Operating's current or former officers and directors. The release of Crescent Operating stockholder claims will apply to Crescent Operating stockholders only in their capacity as Crescent Operating stockholders and will not affect their rights as holders of Crescent Real Estate common shares. In substance, section 524(e) of the Bankruptcy Code provides that the release of third party claims against a debtor such as Crescent Operating does not release any other person. In addition to the release of Crescent Operating, the bankruptcy plan includes releases of Crescent Real Estate and all current and former officers and directors or trust managers of Crescent Operating or Crescent Real Estate. It is the position of the Securities and Exchange Commission that these additional releases violate section 524(e) unless separate consideration is provided by the specific parties being released or the releases are voluntary. Crescent Operating believes the releases contemplated by the bankruptcy plan comply with section 524(e) of the Bankruptcy Code and applicable law, both because Crescent Real Estate is paying substantial consideration to Crescent Operating and its stockholders to obtain the releases provided under the bankruptcy plan and because the releases are voluntary. In addition, as discussed in this proxy statement, Crescent Real Estate is providing sufficient funds both to pay in full or otherwise resolve the claims of those creditors of Crescent Operating identified in the original Settlement Agreement and to cover budgeted expenses of Crescent Operating. In addition, Crescent Real Estate is providing a distribution to Crescent Operating stockholders of Crescent Real Estate common shares if the stockholders vote to accept the bankruptcy plan and the bankruptcy court confirms the plan. Accordingly, the consideration is being provided either directly by the persons who receive the benefit of the releases provided in the bankruptcy plan or on their behalf. Whether this consideration for the releases is sufficient is an issue of fact that the bankruptcy court has authority to determine. If the bankruptcy court 3 concludes that the releases in the bankruptcy plan violate section 524(e) of the Bankruptcy Code, the bankruptcy court may refuse to confirm the bankruptcy plan as written. In that event, Crescent Real Estate does not have an obligation to fund payments to Crescent Operating's creditors or to make a distribution to stockholders of Crescent Operating even though the stockholders cast enough votes to accept the Crescent Operating bankruptcy plan proposed to them. Crescent Operating also believes that the release by any stockholder who accepts the bankruptcy plan is voluntary. Any Crescent Operating stockholder who does not wish to provide the release may retain full rights to pursue claims against Crescent Real Estate, Crescent Operating and their current and former officers and directors or trust managers by voting against the bankruptcy plan, abstaining or not voting, and either not receiving or refusing to accept any distribution under the bankruptcy plan. Q. IS THE TOTAL VALUE OF THE CRESCENT REAL ESTATE COMMON SHARES BEING OFFERED TO CRESCENT OPERATING STOCKHOLDERS IN THE CRESCENT OPERATING BANKRUPTCY PLAN SUBJECT TO ADJUSTMENT? A. Yes. The total value of the Crescent Real Estate common shares offered to Crescent Operating stockholders will depend on the dollar amount of claims and expenses paid by Crescent Real Estate in connection with the Crescent Operating bankruptcy and the reorganization transactions, but will not be less than approximately $2.16 million, or $0.20 per share of Crescent Operating common stock. Q. HOW WILL CRESCENT REAL ESTATE AND CRESCENT OPERATING DETERMINE THE TOTAL VALUE OF THE CRESCENT REAL ESTATE COMMON SHARES BEING OFFERED TO CRESCENT OPERATING STOCKHOLDERS PURSUANT TO THE CRESCENT OPERATING BANKRUPTCY PLAN? A. The total value of the Crescent Real Estate common shares offered to Crescent Operating stockholders will equal the greater of: - approximately $2.16 million; or - $16.0 million minus the total amount of payments made by Crescent Real Estate for claims and expenses relating to the Crescent Operating bankruptcy and the reorganization transactions, including expenses of Crescent Real Estate but excluding payments in satisfaction of the Bank of America claim. As of December 31, 2002, Crescent Real Estate had incurred approximately $8.5 million in claims and expenses in connection with the Crescent Operating bankruptcy and the reorganization transactions and expects to incur an aggregate of $10.6 million to $13.8 million in total claims and expenses. Q. HOW MUCH DO CRESCENT OPERATING AND CRESCENT REAL ESTATE EXPECT CRESCENT REAL ESTATE TO PAY FOR CLAIMS AND EXPENSES, AND WHAT IS THE TOTAL VALUE OF THE CRESCENT REAL ESTATE COMMON SHARES THAT CRESCENT OPERATING AND CRESCENT REAL ESTATE BELIEVE WILL BE ISSUED TO CRESCENT OPERATING STOCKHOLDERS? A. Crescent Operating and Crescent Real Estate currently estimate that Crescent Real Estate will advance funds to pay in full or otherwise resolve total claims and expenses of between $10.6 million and $13.8 million. Accordingly, the total value of the Crescent Real Estate common shares issued to the Crescent Operating stockholders is expected to be between $5.4 million and 4 $2.16 million, or $0.50 to $0.20 per share of Crescent Operating common stock. If a material variance in this estimated range of aggregate claims and expenses occurs after the date that Crescent Operating mails this proxy statement/prospectus to its stockholders, then Crescent Operating will issue a press release and file a Current Report on Form 8-K with the Securities and Exchange Commission disclosing the material variance. Regardless of the actual amount of claims and expenses, in no event will the stockholders of Crescent Operating have the opportunity to reconsider approval of the bankruptcy plan. As of December 31, 2002, Crescent Real Estate had incurred approximately $8.5 million in claims and expenses. Q. CAN THE TOTAL CLAIMS AND EXPENSES THAT CRESCENT REAL ESTATE PAYS IN CONNECTION WITH THE CRESCENT OPERATING BANKRUPTCY AND THE REORGANIZATION TRANSACTIONS REDUCE THE VALUE OF THE DISTRIBUTION OF CRESCENT REAL ESTATE COMMON SHARES TO THE CRESCENT OPERATING STOCKHOLDERS TO LESS THAN $0.20 PER SHARE? A. No. Regardless of the total amount of claims and expenses that are paid by Crescent Real Estate in connection with the bankruptcy plan and the reorganization transactions, if the bankruptcy plan is accepted by the requisite vote of the Crescent Operating stockholders and is confirmed by the bankruptcy court, then Crescent Operating stockholders will receive common shares of Crescent Real Estate with a value of at least $2.16 million, or $0.20 per share of Crescent Operating common stock. Q. HOW IS THE VALUE OF THE CRESCENT REAL ESTATE COMMON SHARES CALCULATED? A. The value of the Crescent Real Estate common shares to be issued pursuant to the bankruptcy plan is computed based on the average of the closing prices of the Crescent Real Estate common shares on the New York Stock Exchange, or the NYSE, for the ten trading days immediately preceding the date of confirmation of the Crescent Operating bankruptcy plan. Q. ARE THERE CONDITIONS TO MY RECEIPT OF CRESCENT REAL ESTATE COMMON SHARES? A. Yes. There are three principal conditions: - Crescent Operating stockholders must accept the Crescent Operating bankruptcy plan by the requisite vote (2/3 or more of the number of votes cast at the meeting in person or by proxy); - the bankruptcy court must confirm the Crescent Operating bankruptcy plan, including the releases incorporated in the bankruptcy plan; and - you must be a Crescent Operating stockholder on the confirmation date. Q. WHAT SHOULD I KNOW ABOUT CRESCENT REAL ESTATE AND THE CRESCENT REAL ESTATE COMMON SHARES? A. Crescent Real Estate is a real estate investment trust. This proxy statement/prospectus contains a description of Crescent Real Estate and its business, as well as its financial statements. You should carefully review this proxy statement/prospectus, including the annexes hereto, before casting your vote. An investment in Crescent Real Estate common shares involves risks, as described in "Risk Factors - Risks Associated with an Investment in Crescent Real Estate Common Shares". The common shares of Crescent Real Estate trade publicly on the NYSE under the symbol "CEI." 5 Q. WHAT HAPPENS IF THE CRESCENT OPERATING STOCKHOLDERS VOTE AGAINST ACCEPTANCE OF THE CRESCENT OPERATING BANKRUPTCY PLAN? A. If a sufficient number of Crescent Operating stockholders vote against the Crescent Operating bankruptcy plan, such that not enough votes are cast to accept the bankruptcy plan, the bankruptcy plan provides that none of the stockholders of Crescent Operating will receive Crescent Real Estate common shares under the plan. Crescent Operating will still file a bankruptcy petition under the Bankruptcy Code and seek to have the bankruptcy plan, as currently proposed to the stockholders of Crescent Operating, confirmed by the bankruptcy court pursuant to the "cramdown" provision of the Bankruptcy Code. If the bankruptcy court confirms the plan pursuant to the "cramdown" provision, Crescent Operating stockholders will not receive common shares of Crescent Real Estate but will still cease to be stockholders of Crescent Operating on the date the bankruptcy plan becomes effective. In this circumstance, the stockholder releases described in the answer to the question "What happens if the Crescent Operating stockholders vote FOR acceptance of the Crescent Operating bankruptcy plan?" will not take effect, and the Crescent Operating stockholders will not be deemed to have released any of their direct claims against Crescent Operating or Crescent Real Estate or against the current and former officers and the directors or trust managers of either Crescent Operating or Crescent Real Estate. In addition, each Crescent Operating stockholder would retain the right to seek to enforce a Crescent Operating cause of action against parties other than Crescent Real Estate and the other parties released under the Settlement Agreement. Crescent Operating's pre-bankruptcy release of its claims against Crescent Real Estate, including claims by stockholders seeking to enforce, on behalf of Crescent Operating, a claim of Crescent Operating against Crescent Real Estate, however, will remain in effect. The bankruptcy court has authority to determine whether Crescent Operating's release of its claims, or the other transactions under the Settlement Agreement, could be avoided or set aside as a fraudulent transfer under either Texas law or section 548 of the Bankruptcy Code. The primary consideration in a fraudulent transfer action is whether the transferor received reasonably equivalent value in exchange for the transfer. In this case, Crescent Operating believes that the payments and other consideration that Crescent Real Estate is providing pursuant to the Settlement Agreement in connection with the bankruptcy plan constitute reasonably equivalent value for the consideration Crescent Operating gave Crescent Real Estate in the Settlement Agreement. Fraudulent transfer claims are typically brought for the benefit of creditors. In this case, Crescent Real Estate agreed, if the bankruptcy plan is confirmed, to pay in full or otherwise resolve the claims of the Crescent Operating creditors that Crescent Operating identified at the time of the execution of the original Settlement Agreement. As a result, these creditors, rather than being harmed by the Settlement Agreement, will benefit from the Settlement Agreement. If the bankruptcy court refuses to confirm the bankruptcy plan described in this proxy statement, Crescent Operating may seek to have an alternative plan confirmed by the court. In that event, Crescent Operating creditors and stockholders will receive further notice regarding the alternative plan. Q. WHAT RIGHTS DO I HAVE IF I OPPOSE THE CRESCENT OPERATING BANKRUPTCY PLAN? A. If you oppose the bankruptcy plan, you may vote against it. There are no dissenters' appraisal rights available under applicable state corporate law with respect to the Crescent Operating bankruptcy plan. After the bankruptcy plan is filed with the bankruptcy court, you may hire an attorney to argue your position to the court and you may file pleadings with the bankruptcy court 6 explaining why you believe the bankruptcy plan should not be confirmed, whether or not the Crescent Operating stockholders approved the bankruptcy plan. As described previously in "What happens if the Crescent Operating stockholders vote AGAINST acceptance of the Crescent Operating bankruptcy plan?", Crescent Operating will file its bankruptcy petition and seek to have the bankruptcy plan confirmed even if the requisite numbers of Crescent Operating stockholders do not vote to accept the bankruptcy plan. Crescent Operating believes it will be successful in obtaining confirmation of the bankruptcy plan, even over the stockholders' failure to approve the bankruptcy plan or a stockholder's objection, but it is not a certainty that the court will confirm the bankruptcy plan. If the Crescent Operating bankruptcy plan is confirmed by the bankruptcy court, all of the stockholders of Crescent Operating will be bound by all of the terms and conditions of the bankruptcy plan. However, Crescent Operating stockholders who sell their shares of Crescent Operating common stock before the voting record date, as well as Crescent Operating stockholders who vote against the bankruptcy plan, abstain from voting or do not vote on the bankruptcy plan, and who do not receive or refuse to accept a distribution under the bankruptcy plan, will not be bound by the releases in the bankruptcy plan. If the class of Crescent Operating stockholders votes against the bankruptcy plan, the Crescent Operating stockholders will not release any direct, or non-derivative, claims against third parties. Each Crescent Operating stockholder would retain the right to assert any direct claims that the stockholder may have against Crescent Operating or Crescent Real Estate, or the officers and directors or trust managers of either entity, including claims alleging violations of applicable state or federal securities laws. In addition, each Crescent Operating stockholder would retain the right to seek to enforce a Crescent Operating cause of action against parties other than Crescent Real Estate and the other parties released under the Settlement Agreement. The Settlement Agreement and the mutual releases executed in connection with the Settlement Agreement, including Crescent Operating's release of all claims it may have against Crescent Real Estate and affiliates arising prior to the execution of the original Settlement Agreement, are enforceable whether or not the bankruptcy plan is approved by Crescent Operating's stockholders and whether or not the bankruptcy plan is confirmed by the bankruptcy court. The bankruptcy court has the authority to determine whether Crescent Operating's release of its claims, or the other transactions under the Settlement Agreement, could be avoided or set aside as a fraudulent transfer under either state law or section 548 of the Bankruptcy Code. The primary consideration in a fraudulent transfer action is whether the transferor received reasonably equivalent value for the transfer. In this case, Crescent Operating believes that the payments and other consideration that Crescent Real Estate is providing pursuant to the Settlement Agreement and in connection with the bankruptcy plan constitute reasonably equivalent value for the consideration Crescent Operating gave Crescent Real Estate in the Settlement Agreement. Fraudulent transfer claims are typically brought for the benefit of creditors. In this case, Crescent Real Estate agreed, if the bankruptcy plan is confirmed, to pay all the claims of the Crescent Operating creditors that Crescent Operating identified at the time of the Settlement Agreement. As a result, these creditors, rather than being harmed by the Settlement Agreement, in fact will benefit from the Settlement Agreement. Q. WAS A FAIRNESS OPINION RENDERED IN CONNECTION WITH THE CRESCENT OPERATING BANKRUPTCY PLAN? A. Yes. The sole director of Crescent Operating has received and relied upon an opinion from Houlihan Lokey Howard & Zukin Financial Advisors, Inc., an investment-banking firm, dated February 14, 2002, that, subject to and based on the considerations in its opinion, the aggregate consideration to be received by Crescent Operating and its stockholders, taken as a whole, in connection with the transactions 7 contemplated by the bankruptcy plan and the Settlement Agreement is fair to the public stockholders of Crescent Operating from a financial point of view, assuming a distribution of Crescent Real Estate common shares with a value of $0.32 to $0.50. However, Houlihan Lokey's opinion specifically stated that its opinion would not necessarily change if Crescent Real Estate were to advance additional funds, as Crescent Real Estate agreed to do in the October 2002 amendment to the Settlement Agreement and as described below in "The Reorganization Transactions - Summary of the Reorganization Transactions - Payment by Crescent Real Estate of Crescent Operating Claims and Expenses," that reduce the value of Crescent Real Estate common shares to below $0.32. The full text of Houlihan Lokey's opinion, which sets forth, among other things, the assumptions made, procedures followed, matters considered and limitations on the review undertaken by Houlihan Lokey, is attached as Annex C to this proxy statement/prospectus. Crescent Operating urges you to read the Houlihan Lokey opinion in its entirety. See "The Crescent Operating Bankruptcy Plan - Opinion of Crescent Operating's Financial Advisor" for a more detailed description of the opinion and the background of the opinion. In addition, you should read "Risk Factors - Limitations on the scope of Houlihan Lokey's fairness opinion could lead to Crescent Operating stockholders to assign too much importance to the fairness opinion in making their decision on whether to vote to approve the bankruptcy plan" for a discussion of issues and concerns related to the date and the limited scope of Houlihan Lokey's opinion. Q. WHAT ARE THE FEDERAL INCOME TAX CONSEQUENCES OF THE CRESCENT OPERATING BANKRUPTCY PLAN? A. The distribution to you of Crescent Real Estate common shares will be treated as a distribution in liquidation of Crescent Operating. You will realize gain or loss based on the difference between your basis in your shares of Crescent Operating common stock and the fair market value of the Crescent Real Estate common shares you receive. In general, if you are not a dealer in securities, you must treat this gain or loss as a long term capital gain or loss if you held your shares of Crescent Operating common stock for more than one year or, otherwise, as a short term capital gain or loss. If you acquired shares of Crescent Operating common stock at different times, the determination of gain or loss and the holding period is made on the facts specific to each share. Your basis in the Crescent Real Estate common shares you will receive will be the fair market value of the Crescent Real Estate common shares at the time of distribution. Q. ARE THERE ANY RISKS IN THE CRESCENT OPERATING BANKRUPTCY PLAN? A. Yes. If there are enough votes to accept the Crescent Operating bankruptcy plan, you are expected to receive Crescent Real Estate common shares only if the bankruptcy plan is confirmed and you own shares of Crescent Operating common stock on the date that the Crescent Operating bankruptcy plan is confirmed. The number of Crescent Real Estate common shares that you will receive is subject to reduction depending on the amount of expenses and claims relating to the Crescent Operating bankruptcy plan and reorganization transactions that Crescent Real Estate pays, however, in no event will the Crescent Operating stockholders receive Crescent Real Estate common shares with a value of less than approximately $2.16 million or $0.20 per share of Crescent Operating common stock if the bankruptcy plan is accepted by the Crescent Operating stockholders and confirmed by the bankruptcy court. If there are not enough votes of the Crescent Operating stockholders to accept the Crescent Operating bankruptcy plan, Crescent Operating will still seek confirmation of the bankruptcy plan, but the Crescent Operating stockholders will receive no Crescent Real Estate common shares. Other risks relating to the bankruptcy plan, including, but not limited to, the bankruptcy court denying confirmation of the bankruptcy plan and Crescent Real Estate electing not to assume any unidentified liabilities of 8 Crescent Operating are described in "Risk Factors - Risks Associated with the Crescent Operating Bankruptcy Plan." Q. ARE THERE ANY CONDITIONS TO CONFIRMATION AND IMPLEMENTATION OF THE CRESCENT OPERATING BANKRUPTCY PLAN? A. Yes. The Crescent Operating bankruptcy plan provides that, except as expressly waived by Crescent Operating with the consent of Crescent Real Estate, the following are conditions to confirmation and implementation of the Crescent Operating bankruptcy plan: - the bankruptcy court has signed a confirmation order confirming the Crescent Operating bankruptcy plan, and the clerk of the bankruptcy court has duly entered the confirmation order on the docket for the bankruptcy case in a form and substance that is acceptable to Crescent Operating; - the confirmation order has become effective and has not been stayed, modified, reversed or amended; and - Crescent Real Estate has received all regulatory approvals and authorizations necessary to create the subsidiary of Crescent Real Estate that will acquire Crescent Operating's entire membership interest in COPI Cold Storage, LLC, and that will distribute its shares to the holders of Crescent Real Estate common shares, other than the holders of Crescent Real Estate common shares distributed to the Crescent Operating stockholders as a result of the Crescent Operating bankruptcy plan. Q. WHEN DO YOU EXPECT THE CRESCENT OPERATING BANKRUPTCY PLAN TO BE CONFIRMED BY THE BANKRUPTCY COURT? A. Crescent Operating's goal is to have the Crescent Operating bankruptcy plan confirmed as quickly as possible. Crescent Operating currently believes that the Crescent Operating bankruptcy plan will be confirmed in the first quarter of 2003. The Special Meeting Q. HOW DO I VOTE? A. After you carefully read this document, you may vote by proxy using any of the following means: - by indicating on the enclosed proxy card how you want to vote, signing it, dating it and mailing it in the enclosed prepaid return envelope; - by touchtone telephone from the U.S. and Canada, using the toll-free telephone number on the proxy card; or - in person at the special meeting, unless you are a "street name" holder without a proxy signed by your broker. You should indicate your vote now by proxy even if you expect to attend the special meeting and vote in person. Indicating your vote now will not prevent you from later canceling or revoking your vote at any time prior to the vote at the special meeting and will ensure that your shares are voted if you later find you cannot attend the special meeting. 9 Q. CAN I CHANGE MY VOTE AFTER I HAVE VOTED BY PROXY? A. Yes. Unless you hold your shares in "street name" through your broker, you can change your vote prior to the taking of the vote at the special meeting: - by giving written notice of revocation to the secretary of Crescent Operating; - only if the prior vote was by written proxy, by properly submitting a duly executed proxy bearing a later date; - only if the prior vote was by telephone, by casting a subsequent vote by telephone prior to the special meeting; or - by voting in person at the special meeting. Only the last vote of a stockholder will be counted. For a more complete description of voting procedures, see "The Special Meeting of Crescent Operating Stockholders - Proxies." Q. IF MY BROKER HOLDS MY SHARES IN "STREET NAME," WILL MY BROKER VOTE MY SHARES FOR ME? A. No. Unless you provide instructions to your broker on how to vote your "street name" shares, your broker will be unable to vote them for you. You should follow the directions provided by your broker regarding how to instruct your broker to vote your shares. If you wish to change your vote, you must contact your broker. Q. WHAT IS THE EFFECT OF MY FAILURE TO VOTE? A. If you sign and send in your proxy card and do not indicate how you want to vote, your shares will be voted in favor of acceptance of the Crescent Operating bankruptcy plan. If you do not return your proxy card, do not vote by telephone, or do not vote in person at the special meeting, your shares will not be voted. IF NOT ENOUGH STOCKHOLDERS OF CRESCENT OPERATING VOTE TO ACCEPT THE CRESCENT OPERATING BANKRUPTCY PLAN, THE BANKRUPTCY PLAN PROVIDES THAT NONE OF THE STOCKHOLDERS OF CRESCENT OPERATING WILL RECEIVE CRESCENT REAL ESTATE COMMON SHARES. See "The Special Meeting of Crescent Operating Stockholders - Effect of Abstentions and Broker Non-Votes" for more information regarding the effect of your failure to vote. Q. DO I NEED TO SEND ANYTHING IN ADDITION TO MY PROXY AT THIS TIME? A. No. If Crescent Real Estate issues common shares to Crescent Operating stockholders, then after you receive written notice that the Crescent Operating bankruptcy plan has become effective, the disbursement agent will send you a letter and written instructions relating to any information that is required from you to ensure that the stock certificates representing your Crescent Real Estate common shares are issued and delivered to you. You will receive your Crescent Real Estate common shares promptly after the disbursement agent receives the requested information from you. Q. WHO CAN HELP ANSWER MY QUESTIONS? A. If you would like additional copies of this document, or have any questions about the Crescent Operating bankruptcy plan, you should contact: 10 Crescent Operating, Inc. Attention: Jeffrey L. Stevens or Kiersten Thompson 777 Main Street, Suite 1240 Fort Worth, Texas 76102 Phone Number: (817) 321-1602 11 SUMMARY This summary highlights selected information presented in this proxy statement/prospectus and may not contain all of the information that is important to you. To understand the Crescent Operating bankruptcy plan to be voted on at the special meeting more fully, you should carefully read this entire proxy statement/prospectus and the documents to which this proxy statement/prospectus refers. See "Where You Can Find More Information." In particular, you should read the documents attached to this proxy statement/prospectus, including the Plan of Reorganization attached as Annex A and the Settlement Agreement attached as Annex B, both of which are incorporated by reference into this proxy statement/prospectus. THE COMPANIES CRESCENT OPERATING, INC. 777 Main Street, Suite 1240 Fort Worth Texas 76102 (817) 321-1602 Overview Crescent Operating, Inc., a Delaware corporation, was formed on April 1, 1997, by Crescent Real Estate. Effective June 12, 1997, Crescent Real Estate distributed shares of Crescent Operating common stock to shareholders of Crescent Real Estate and limited partners of Crescent Partnership, and, on that date, Crescent Operating became a public company. Crescent Operating was formed to be the lessee and operator of certain assets owned or to be acquired by Crescent Real Estate. As of December 31, 2001, Crescent Operating, through various subsidiaries and affiliates, had assets and operations consisting of four business segments: - equipment sales and leasing segment; - hospitality segment; - temperature-controlled logistics segment; and - land development segment. In February and March 2002, pursuant to the terms of the Settlement Agreement, Crescent Operating transferred to Crescent Real Estate, in lieu of foreclosure, the assets of its hospitality segment, and, pursuant to a strict foreclosure, the interests in its land development segment. As a result, Crescent Operating no longer has operations in these two segments. In addition, on February 6, 2002, Crescent Machinery Company, through which Crescent Operating operates its equipment sales and leasing segment, filed for protection under the federal bankruptcy laws. Crescent Machinery has filed schedules of assets and liabilities in its bankruptcy case. Those schedules indicate that virtually all of Crescent Machinery's assets are subject to lien claims of certain secured lenders. Moreover, the schedules indicate that the collateral securing the claims of these creditors has a value at or below the amount owed to the lenders. In fact, the only unencumbered assets owned by Crescent Machinery are several parcels of real estate that Crescent Machinery estimates to have a fair market value of approximately $3.0 million and miscellaneous inventory and accounts receivable of undetermined value. The value of the real estate will need to be first used to pay administrative expense claims in the bankruptcy case, after which it might be 12 available for distribution to unsecured creditors. There are approximately $17.0 million of unsecured claims in the Crescent Machinery bankruptcy case. Crescent Operating expects the Crescent Machinery creditors to object to Crescent Operating receiving any distribution unless those creditors are paid in full. Although there can be no assurance as to the outcome of the Crescent Machinery bankruptcy case, Crescent Operating believes the prudent course is to estimate that it would not receive a material distribution in respect of either its unsecured claim in the Crescent Machinery case or in respect of its ownership of 100% of the Crescent Machinery common stock. As of the date of this proxy statement/prospectus, the only remaining operating assets of Crescent Operating are its 40% interest in AmeriCold Logistics, LLC and its 100% equity interest in Crescent Machinery. Historical Operations As of December 31, 2001, Crescent Operating owned the following: - The equipment sales and leasing segment, consisting of a 100% interest in Crescent Machinery and its subsidiary, a construction equipment sales, leasing and service company which had as many as 18 locations in seven states. As of September 30, 2002, Crescent Machinery operated nine locations in three states. - The hospitality segment, consisting of the following assets: - Crescent Operating's lessee interests in three upscale business class hotels owned by Crescent Real Estate. The hotels are the Denver Marriott City Center, the Hyatt Regency Albuquerque, and the Renaissance Hotel in Houston, Texas. - Lessee interests in three destination resort properties owned by Crescent Real Estate. The properties are the Hyatt Regency Beaver Creek, the Ventana Inn and Spa and the Sonoma Mission Inn and Spa (including the Sonoma Mission Inn Golf and Country Club). - Lessee interests in two destination fitness resort and spa properties owned by Crescent Real Estate. The properties are Canyon Ranch-Tucson and Canyon Ranch-Lenox. - A 5% economic interest in CRL Investments, Inc., or CRL, which has an investment in the Canyon Ranch Day Spa in the Venetian Hotel in Las Vegas, Nevada and participates in the future use of the "Canyon Ranch" name. Crescent Real Estate owned the remaining 95% economic interest. Crescent Operating's lessee interests in these eight properties and its interest in CRL are referred to as the hotel operations. - The temperature-controlled logistics segment, consisting of a 40% interest in the operations of AmeriCold Logistics, LLC, which operates 100 refrigerated storage properties with an aggregate storage capacity of approximately 525 million cubic feet. Crescent Real Estate has a 40% interest in AmeriCold Corporation, which owned 89 of the 100 properties. - The land development segment, consisting of the following assets: 13 - A 4.65% economic interest in Desert Mountain, a master planned, luxury residential and recreational community in northern Scottsdale, Arizona. Crescent Real Estate owned an 88.35% economic interest in Desert Mountain. - A 52.5% general partner interest in The Woodlands Operating Company, L.P. - A 2.625% economic interest in The Woodlands Land Development Company L.P. Crescent Real Estate owned a 49.875% economic interest in this entity. - A 60% general partner interest in COPI Colorado, LP, a company that has a 10% economic interest in Crescent Resort Development, Inc., or CRDI, formerly Crescent Development Management Corp. Crescent Real Estate owned the remaining 90% economic interest in CRDI. These interests are referred to as the land development interests. Structure The following chart depicts the structure of Crescent Operating's ownership of assets as of September 30, 2002. As a result of the transactions described in this section, the entities in Crescent Operating's hospitality and land development segments no longer hold any assets and, therefore, do not appear on this chart. Subsequent to the consummation of the bankruptcy plan and the reorganization transactions, Crescent Operating and its subsidiaries will be dissolved. [ORGANIZATIONAL CHART] 14 CRESCENT REAL ESTATE EQUITIES COMPANY 777 Main Street, Suite 2100 Fort Worth, Texas 76102 (817) 321-2100 Overview Crescent Real Estate Equities Company was organized in 1994 and operates as a real estate investment trust, or REIT, for federal income tax purposes. Together with its subsidiaries, Crescent Real Estate provides management, leasing and development services for some of its properties. Crescent Real Estate conducts all of its business through Crescent Partnership and its other subsidiaries. Crescent Real Estate is structured to facilitate and maintain the qualification of Crescent Real Estate as a REIT. This structure permits persons contributing properties, or interests in properties, to Crescent Real Estate to defer some or all of the tax liability that they otherwise might have incurred in connection with the sale of assets to Crescent Real Estate. In February 2002, pursuant to the terms of the Settlement Agreement, Crescent Real Estate acquired from Crescent Operating, through transfers in lieu of foreclosure, the interests in Crescent Operating's hospitality segment and, pursuant to a strict foreclosure, the assets of Crescent Operating's land development segment. Crescent Real Estate holds these assets and interests through two newly organized corporations and one newly organized limited liability company that are wholly owned subsidiaries of Crescent Real Estate, or taxable REIT subsidiaries. Crescent Real Estate included these assets in its resort/hotel and residential development segments beginning on the dates of the transfers. Historical Operations As of September 30, 2002, Crescent Real Estate's assets and operations were composed of four major investment segments: - office segment; - resort/hotel segment; - residential development segment; and - temperature-controlled logistics segment. Within these segments, Crescent Real Estate owned, directly or indirectly, the following real estate, referred to as the Crescent Real Estate properties, as of September 30, 2002. - Office segment consisted of 73 office properties located in 25 metropolitan submarkets in six states with an aggregate of approximately 28.5 million net rentable square feet. - Resort/hotel segment consisted of five destination resort properties with a total of 1,036 rooms/guest nights and four upscale business-class hotels with a total of 1,771 rooms, or the Crescent Real Estate hotel properties. 15 - Residential development segment consisted of Crescent Real Estate's ownership of real estate mortgages and voting and non-voting common stock representing interests ranging from 94% to 100% in five unconsolidated residential development corporations, which in turn, through joint venture or partnership arrangements, owned 21 upscale residential development properties. These are referred to as the Crescent Real Estate residential development properties. - Temperature-controlled logistics segment consisted of Crescent Real Estate's 40% interest in a general partnership referred to as the temperature-controlled logistics partnership, which owns all of the common stock, representing substantially all of the economic interest, of AmeriCold Corporation, a REIT, which directly or indirectly owned 88 temperature-controlled logistics properties, or the Crescent Real Estate temperature-controlled logistics properties, with an aggregate of approximately 441.5 million cubic feet, or 17.5 million square feet, of warehouse space. - Other Crescent Real Estate properties consisted of 9 behavioral healthcare properties. AGREEMENT FOR TRANSFER OF CRESCENT OPERATING ASSETS TO CRESCENT REAL ESTATE On June 28, 2001, Crescent Operating and Crescent Real Estate entered into an asset and stock purchase agreement in which Crescent Real Estate agreed to acquire the hotel operations, the land development interests and other assets in exchange for $78.4 million. Crescent Real Estate also entered into an agreement to make a $10.0 million investment in Crescent Machinery, which, along with capital from a third-party investment firm, was expected to put Crescent Machinery on solid financial footing. Following the date of the agreements, the results of operations for the hotel operations and the land development interests declined, due in part to the slowdown in the economy after September 11. In addition, Crescent Machinery's results of operations suffered because of the economic environment and the overall reduction in national construction levels that has affected the equipment rental and sale business, particularly post September 11. As a result, Crescent Real Estate believes that a significant additional investment would have been necessary to adequately capitalize Crescent Machinery and satisfy concerns of Crescent Machinery's lenders. On January 23, 2002, Crescent Real Estate terminated the purchase agreement pursuant to which Crescent Real Estate would have acquired the Crescent Operating hotel operations, the Crescent Operating land development interests and other assets. On February 4, 2002, Crescent Real Estate terminated the agreement relating to its planned investment in Crescent Machinery. On February 6, 2002, Crescent Machinery filed for protection under the federal bankruptcy laws. On February 12 and February 13, 2002, Crescent Real Estate delivered default notices to Crescent Operating relating to approximately $49.0 million of unpaid rent and approximately $76.2 million of principal and accrued interest due to Crescent Real Estate under certain secured loans. SETTLEMENT AGREEMENT On February 14, 2002, Crescent Operating and Crescent Real Estate entered into the Settlement Agreement, which was amended effective October 1, 2002. The amendment provides for, among other things, a minimum value of Crescent Real Estate common shares to be issued in connection with the bankruptcy plan if the bankruptcy plan is accepted by the requisite vote of Crescent Operating stockholders and confirmed by the bankruptcy court. The Settlement Agreement provided the basis for Crescent Operating 16 to file a prepackaged bankruptcy plan that Crescent Operating believes will provide for a limited recovery to its stockholders. The principal terms of the Settlement Agreement are set forth below. - Pursuant to the Settlement Agreement, Crescent Operating transferred the following assets, and related indebtedness, to Crescent Real Estate: - all of its hotel operations, in lieu of foreclosure, on February 14, 2002, in exchange for a $23.6 million reduction in its rent obligations to Crescent Real Estate; and - all of its land development interests pursuant to a strict foreclosure on February 14, 2002 and March 22, 2002, in exchange for a $40.1 million reduction of its debt obligations to Crescent Real Estate. - If the bankruptcy court confirms the bankruptcy plan, Crescent Real Estate will make sufficient funds available to Crescent Operating to pay in full or otherwise resolve the claims of the creditors that Crescent Operating identified in the original Settlement Agreement and to cover the budgeted expenses of implementing the Settlement Agreement and seeking to confirm the bankruptcy plan. To facilitate Crescent Operating's repayment of $15.0 million, plus interest, that it owes to Bank of America, Crescent Real Estate has allowed Crescent Operating to secure the Bank of America debt with a pledge of Crescent Operating's interest in AmeriCold Logistics, LLC. The Settlement Agreement and the bankruptcy plan contemplate that a Crescent Real Estate affiliate will purchase Crescent Operating's interest in AmeriCold Logistics for between $15.0 to $15.5 million. - If Crescent Operating's stockholders accept the bankruptcy plan by the requisite vote and the bankruptcy court confirms the bankruptcy plan, then Crescent Real Estate will issue common shares of Crescent Real Estate to the Crescent Operating stockholders pursuant to the formula contained in the bankruptcy plan and described in "Summary - Summary of the Plan of Reorganization" below. If the stockholders of Crescent Operating do NOT accept the bankruptcy plan, they will NOT receive a distribution of common shares of Crescent Real Estate. - Crescent Operating stockholders receiving Crescent Real Estate shares, regardless of the value of the shares they receive, will be deemed to have released all claims they may have against Crescent Operating and Crescent Real Estate and those acting on their behalf that arose before the effective date of the bankruptcy plan. The release of Crescent Operating stockholder claims will apply to Crescent Operating stockholders only in their capacity as Crescent Operating stockholders, and will not affect their rights as shareholders of Crescent Real Estate. IF THE CRESCENT OPERATING STOCKHOLDERS DO NOT CAST ENOUGH VOTES TO ACCEPT THE CRESCENT OPERATING BANKRUPTCY PLAN, CRESCENT OPERATING WILL STILL SEEK TO HAVE ITS BANKRUPTCY PLAN CONFIRMED BY THE BANKRUPTCY COURT PURSUANT TO THE "CRAMDOWN" PROVISION OF THE BANKRUPTCY CODE. IF THE BANKRUPTCY COURT CONFIRMS THE BANKRUPTCY PLAN, CRESCENT OPERATING STOCKHOLDERS WILL NOT RECEIVE COMMON SHARES OF CRESCENT REAL ESTATE BUT WILL STILL CEASE TO BE STOCKHOLDERS OF CRESCENT OPERATING ON THE DATE THE BANKRUPTCY PLAN BECOMES EFFECTIVE. - Crescent Operating will cancel all outstanding shares of its common stock. 17 - Crescent Operating and Crescent Real Estate exchanged mutual releases. Pursuant to the Settlement Agreement, Crescent Operating and Crescent Real Estate and the directors, officers, agents and employees of each will be released from all liabilities and claims arising prior to the effective date of the bankruptcy plan. - Pursuant to both the Settlement Agreement and the bankruptcy plan, Crescent Operating will transfer the remaining assets of Crescent Operating at the direction of Crescent Real Estate. - If Crescent Real Estate, in its sole discretion, offers to settle or assume unsecured claims that were not identified by Crescent Operating in the original Settlement Agreement and that are asserted by third parties, and Crescent Operating accepts the offer, then the total value of the Crescent Real Estate common shares paid to Crescent Operating stockholders will be reduced (but not below a total value of approximately $2.16 million, or $0.20 per share of Crescent Operating common stock) by the amount agreed to by Crescent Real Estate and Crescent Operating, and approved by the bankruptcy court, as compensation to Crescent Real Estate for assuming the claims. If Crescent Real Estate and Crescent Operating are not able to agree to Crescent Real Estate's assumption of any such unresolved third party claims that were not identified by Crescent Operating in the original Settlement Agreement and that are an obstacle to confirmation of the Crescent Operating bankruptcy plan, then it is possible that the bankruptcy plan will not be confirmed. A copy of the Settlement Agreement, including the amendment to the Settlement Agreement, is attached as Annex B to this proxy statement/prospectus. Regardless of whether the bankruptcy plan is approved by Crescent Operating's stockholders and/or confirmed by the bankruptcy court, (i) the Settlement Agreement is effective, (ii) the mutual releases executed in connection with the Settlement Agreement, including Crescent Operating's release of all claims it may have against Crescent Real Estate, are enforceable, and (iii) Crescent Real Estate is obligated to assist Crescent Operating in resolving creditor claims identified by Crescent Operating in the original Settlement Agreement. Crescent Operating does not believe that the Settlement Agreement or the releases incorporated therein would be avoidable in bankruptcy if Crescent Operating elected to file a bankruptcy case independent of the pre-packaged plan. OTHER CRESCENT OPERATING RECENT DEVELOPMENTS Effective December 31, 2001, Crescent Operating, in connection with extending the maturity of its $15.0 million loan from Bank of America from December 31, 2001 to August 15, 2002, agreed to modify the loan from an unsecured to a secured credit facility. Crescent Operating, with the consent of Crescent Partnership which agreed to subordinate its security interest in Crescent Operating's 40% interest in AmeriCold Logistics, pledged all of its interest in AmeriCold Logistics to Bank of America to secure the loan. On August 14, 2002, Bank of America further extended the maturity of this loan to January 15, 2003 and Crescent Operating prepaid interest for that time period in the amount of $0.3 million. In January 2003, Bank of America further extended the maturity of this loan to March 15, 2003 and Crescent Operating agreed to prepay an additional two months of interest at the loan's current rate. These modifications delay, but do not reduce, any liability that Mr. Rainwater and Mr. Goff may have under the support agreement in which they personally agree to make additional equity investments in Crescent Operating if and to the extent Crescent Operating defaults on payment obligations on its line of credit with Bank of America. Any further defaults by Crescent Operating under the line of credit will revive the default that was waived under the August 2002 amendment to the line of credit. Effective February 13, 2002, all of the directors of Crescent Operating, other than Jeffrey L. Stevens, who became the sole director of Crescent Operating, resigned. The four directors who resigned continue to serve as trust managers of Crescent Real Estate. In addition, two of these directors, Richard E. Rainwater and John C. Goff, also served as officers of both Crescent Operating and Crescent Real 18 Estate. Mr. Rainwater continues to serve as Chairman of the Board of Crescent Real Estate and Mr. Goff continues to serve as Vice Chairman of the Board and Chief Executive Officer of Crescent Real Estate. Both resigned from their executive officer positions with Crescent Operating effective February 14, 2002. The directors and officers who resigned determined that resignation was advisable and in the interest of the Crescent Operating stockholders in order to avoid potential conflicts of interest and the appearance of impropriety. On December 19, 2002, the Official Unsecured Creditors Committee of Crescent Machinery Company, referred to in this proxy statement/prospectus as the Crescent Machinery Committee, commenced a lawsuit in the District Court of Tarrant County, Texas, styled "The Estates of Crescent Machinery and E.L. Lester, Inc. v. Mark Roberson, Jeffrey Stevens, Gerald Haddock, Rick Knight and Crescent Operating, Inc." The lawsuit seeks an unspecified amount of direct, consequential and punitive damages, as well as related attorneys' fees, for alleged breaches of fiduciary duty, aiding and abetting breaches of fiduciary duty, negligent misrepresentation, and gross negligence. The Crescent Machinery Committee has alleged that the creditors of Crescent Machinery have been damage as a result of the following: - lack of experienced management; - failure to have a written acquisition plan; - withdrawal of acquisition funding by Crescent Operating; - accounting misstatements; and - failure to restructure Crescent Machinery. Each of the named individual defendants was either an officer or director, or both, of Crescent Machinery at the time the alleged breaches occurred. Pursuant to the certificate of incorporation and bylaws of Crescent Operating, each of the individual defendants may be entitled to indemnification by Crescent Operating against some or all of the claims alleged in the lawsuit, including reimbursement of reasonable attorney's fees incurred in defending the lawsuit. Crescent Operating has director's and officer's liability insurance in the face amount of $3.0 million that may afford coverage for these indemnity claims. Nonetheless, if any of the Crescent Machinery Committee's claims against these officers and directors are allowed in an amount in excess of any available insurance, then that claim will have to be satisfied before any distribution could be made to Crescent Operating's stockholders. Crescent Operating intends to vigorously defend against the allegations and claims in the lawsuit. There is a risk that substantial delays could result from the process in which the Crescent Machinery Committee's lawsuit is adjudicated. In addition, there is a risk that if the Crescent Machinery Committee were ultimately successful in the prosecution of its lawsuit, or if Crescent Real Estate, pursuant to the Settlement Agreement, offers to assume or settle any obligations under the Crescent Machinery Committee's lawsuit and Crescent Operating accepts the offer, the total value of the Crescent Real Estate common shares that the Crescent Operating stockholders will receive will be reduced and the Crescent Operating stockholders will receive fewer Crescent Real Estate common shares. There is also a risk that the total obligations of Crescent Operating to the unsecured creditors of Crescent Operating identified in the original Settlement Agreement, plus newly asserted claims such as those in the lawsuit, will exceed the amount of funds that Crescent Real Estate will make available to Crescent Operating for the payment of such claims and that, as a result, the bankruptcy court will not confirm the bankruptcy plan. However, even if Crescent Real Estate does offer to assume or settle obligations under the Crescent Machinery Committee's lawsuit and Crescent Operating accepts the offer, the total value of Crescent Real Estate common shares that the Crescent Operating stockholders will be entitled to receive will be at least $2.16 million, or $0.20 per share of Crescent Operating common stock, if the bankruptcy plan is accepted by the Crescent Operating stockholders and confirmed by the bankruptcy court. For more information regarding this dispute, please see "Description of Crescent Operating's Business - Legal Proceedings." SUMMARY OF THE PLAN OF REORGANIZATION Crescent Operating's Plan of Reorganization, attached as Annex A to this proxy statement/prospectus, is a bankruptcy plan that will be filed with the Bankruptcy Court that is supported by the Settlement Agreement between Crescent Operating and certain of its affiliates on the one hand and Crescent Real Estate on the other hand. In the Settlement Agreement, Crescent Real Estate has agreed to make funds available to Crescent Operating that Crescent Operating will use to satisfy the claims of those creditors that Crescent Operating identified in the original Settlement Agreement. Following the satisfaction of all conditions to the bankruptcy plan, on the effective date of the bankruptcy plan or the date upon which the bankruptcy plan becomes final, at Crescent Real Estate's election, or as soon thereafter as practicable, a plan administrator will make distributions to the holders of allowed claims against Crescent Operating and prepare Crescent Operating for dissolution. The Plan of Reorganization provides that, upon its acceptance by the Crescent Operating stockholders and its confirmation by the bankruptcy court, Crescent Real Estate will pay on the effective date of the bankruptcy plan or the date upon which the bankruptcy plan becomes final, at Crescent Real 19 Estate's election, or as soon thereafter as practicable, to each holder of Crescent Operating common stock the product of: - the number of shares of Crescent Operating common stock owned by such holder on the confirmation date, divided by the number of shares of Crescent Operating common stock outstanding on the confirmation date, and - the consideration amount, as described below, divided by the average of the daily closing prices per Crescent Real Estate common share as reported on the New York Stock Exchange Composite Transaction reporting system for the 10 consecutive NYSE trading days immediately preceding confirmation of the Crescent Operating bankruptcy plan by the bankruptcy court. The consideration amount will equal the greater of: - approximately $2.16 million; or - $16.0 million minus the total amount of payments made by Crescent Real Estate for claims and expenses relating to the Crescent Operating bankruptcy and the reorganization transactions, including expenses of Crescent Real Estate but excluding payments in satisfaction of the Bank of America claim. As of December 31, 2002, Crescent Real Estate had incurred approximately $8.5 million in claims and expenses and expects to incur an aggregate of $10.6 million to $13.8 million in total claims and expenses. Based on these estimates, the consideration amount would be between $5.4 million and $2.16 million. If there occurs a material variance in this estimated range of aggregate claims and expenses after the date that Crescent Operating mails this proxy statement/prospectus to its stockholders, then Crescent Operating will issue a press release and file a Current Report on Form 8-K with the Securities and Exchange Commission disclosing the material variance. Regardless of the total amount of claims and expenses paid by Crescent Real Estate in connection with the Crescent Operating bankruptcy and reorganization transactions, if the bankruptcy plan is accepted by the Crescent Operating stockholders and confirmed by the bankruptcy court, the stockholders of Crescent Operating will receive common shares of Crescent Real Estate with a value of at least $2.16 million, or $0.20 per share of Crescent Operating common stock. No certificate or scrip representing fractional Crescent Real Estate common shares shall be issued, no cash share be paid in lieu of fractional shares, and all fractional shares shall be rounded up or down to the nearest whole Crescent Real Estate common share. If the Crescent Operating stockholders accept the bankruptcy plan and the bankruptcy court confirms the bankruptcy plan, the stockholders will be deemed to have released all claims they may have against Crescent Operating and Crescent Real Estate, as well as their respective officers, directors, stockholders, employees, consultants, attorneys, accountants and other representatives, that arose prior to the effective date of the bankruptcy plan. The release of Crescent Operating stockholder claims will not apply to the claims, if any, of a person who sold its shares of Crescent Operating common stock before the record date for voting on the bankruptcy plan or who voted against the bankruptcy plan, abstained or did not vote on the bankruptcy plan, and thereafter either did not receive or refused to accept a distribution of Crescent Real Estate common shares. The releases of Crescent Operating stockholder claims will apply to Crescent Operating stockholders only in their capacity as Crescent Operating stockholders, and will not affect their rights as holders of Crescent Real Estate common shares. The Crescent Operating common stock will be cancelled upon confirmation of the bankruptcy plan. If the Crescent Operating stockholders reject the bankruptcy plan, the Crescent Operating stockholders will receive no distribution under the bankruptcy plan and will not be deemed to have released any claims. Crescent Operating will seek to 20 have the bankruptcy plan confirmed over the objection of its stockholders if they do not vote to accept the bankruptcy plan. The bankruptcy plan must be approved by certain of Crescent Operating's creditors and the bankruptcy court before it can become effective. Please see "The Plan of Reorganization - Confirmation of the Plan of Reorganization" for a discussion of the requirements for confirmation. RELEASE AND WAIVER OF CLAIMS BY CRESCENT OPERATING AND STOCKHOLDERS OF CRESCENT OPERATING The bankruptcy plan provides that on its effective date, Crescent Operating, on its own behalf and as representative of its bankruptcy estate, will release unconditionally, and will be deemed to release unconditionally, from any and all claims, obligations, suits, judgments, damages, rights, causes of action and liabilities whatsoever, whether known or unknown, foreseen or unforeseen, existing or hereafter arising, in law, equity or otherwise, based in whole or in part upon any act or omission, transaction, event or other occurrence taking place on or prior to the effective date of the bankruptcy plan in any way relating to the releasees, Crescent Operating, the Chapter 11 case or the bankruptcy plan: - each of Crescent Operating's officers, directors, shareholders, employees, consultants, attorneys, accountants and other representatives; - Crescent Partnership and each of Crescent Partnership's officers, directors, partners, employees, consultants, attorneys, accountants, affiliates and other representatives; - Crescent Real Estate and each of Crescent Real Estate's officers, trust managers, shareholders, employees, consultants, attorneys, accountants, affiliates and other representatives; - the creditors' committee appointed in the Chapter 11 proceedings, if any; and - solely in their capacity as members and representatives of the creditors' committee, each member, consultant, attorney, accountant or other representative of the creditors' committee. The bankruptcy plan further provides that each holder of a claim or interest: - who has accepted the bankruptcy plan; - whose claim or interest is in a class that has accepted or is deemed to have accepted the bankruptcy plan pursuant to section 1126 of the Bankruptcy Code; or - who may be entitled to receive a distribution of property pursuant to the bankruptcy plan, shall be deemed to have unconditionally released the above releasees, from any and all rights, claims, causes of action, obligations, suits, judgments, damages and liabilities whatsoever which any such holder may be entitled to assert, whether known or unknown, foreseen or unforeseen, existing or hereafter arising, in law, equity or otherwise, based in whole or in part upon any act or omission, transaction, event or other occurrence taking place on or before the effective date of the bankruptcy plan in any way relating to Crescent Operating, the Chapter 11 case or the bankruptcy plan, provided however, that the foregoing shall not apply to all rights, claims and obligations created by or arising under the bankruptcy plan. The release of Crescent Operating stockholder claims will not apply to the claims, if any, of a person who sold its shares of Crescent Operating common stock before the record date for voting on the bankruptcy plan or who voted against the bankruptcy plan, abstained or did not vote, and thereafter either 21 did not receive or refused to accept a distribution of Crescent Real Estate common shares. The release of Crescent Operating stockholder claims also will not apply if the holders of Crescent Operating common stock, voting as a class, vote against the bankruptcy plan. The release of Crescent Operating stockholder claims will apply to Crescent Operating stockholders only in their capacity as Crescent Operating stockholders, and will not affect their rights as holders of Crescent Real Estate common shares. In the event that the bankruptcy court concludes that the bankruptcy plan cannot be confirmed without excising any portion of the release of claims held by creditors and stockholders, then, with the consent of Crescent Real Estate in its sole discretion, the bankruptcy plan may be confirmed with the portion of the releases that the bankruptcy court finds is a bar to confirmation excised so as to give effect as much as possible to the foregoing releases without precluding confirmation of the bankruptcy plan. If Crescent Real Estate does not consent to modification of the release, the bankruptcy plan will not be confirmed and Crescent Real Estate will not be obligated to pay in full or otherwise resolve the claims of the creditors that Crescent Operating identified in the original Settlement Agreement or to make a distribution to Crescent Operating stockholders. In substance, section 524(e) of the Bankruptcy Code provides that the release of third party claims against a debtor such as Crescent Operating does not release any other person. In addition to the release of Crescent Operating, the bankruptcy plan includes releases of Crescent Real Estate and all current and former officers and directors or trust managers of Crescent Operating or Crescent Real Estate. It is the position of the Securities and Exchange Commission that these additional releases violate section 524(e) unless separate consideration is provided by the specific parties being released or the releases are voluntary. Crescent Operating believes the releases contemplated by the bankruptcy plan comply with section 524(e) of the Bankruptcy Code and applicable law, both because Crescent Real Estate is paying substantial consideration to Crescent Operating and its stockholders to obtain the releases provided under the bankruptcy plan and because the releases are voluntary. As discussed in this proxy statement, Crescent Real Estate is providing sufficient funds both to pay in full or otherwise resolve the claims of those creditors of Crescent Operating identified in the original Settlement Agreement and to cover budgeted expenses of Crescent Operating. In addition, Crescent Real Estate is providing a distribution to Crescent Operating stockholders of Crescent Real Estate common shares if the stockholders vote to accept the bankruptcy plan and the bankruptcy court confirms the plan. Accordingly, the consideration is being provided, either directly by the persons who receive the benefit of the releases provided in the bankruptcy plan or on their behalf. Whether this consideration for the releases is sufficient is an issue of fact that the bankruptcy court has authority to determine. Crescent Operating also believes that the release by any stockholder who accepts the bankruptcy plan is voluntary. Any Crescent Operating stockholder who does not wish to provide the release may retain full rights to pursue claims against Crescent Real Estate, Crescent Operating and their current and former officers and directors or trust managers by voting against the bankruptcy plan, abstaining or not voting, and either not receiving or refusing to accept any distribution under the bankruptcy plan. The releases given by Crescent Operating to Crescent Real Estate in the Settlement Agreement survive and are effective regardless of whether the bankruptcy plan is confirmed or the releases described above are included in or excised from the bankruptcy plan. The Crescent Operating release in the Settlement Agreement includes a release of all derivative claims, which are claims brought by a stockholder of a corporation to enforce, on behalf of the corporation, a cause of action that belongs to the corporation. 22 SPECIAL MEETING AND VOTING Crescent Operating will hold its special meeting of stockholders at The Fort Worth Club, located at 306 West 7th Street, Fort Worth, Texas, on Thursday, March 6, 2003, at 10:00 a.m. Central Time. At the special meeting, Crescent Operating stockholders will be asked to consider and vote upon the acceptance of the Crescent Operating bankruptcy plan. A majority of the outstanding shares of common stock of Crescent Operating entitled to vote is necessary to constitute a quorum for the transaction of business at the special meeting. The affirmative vote of two-thirds or more of the votes cast in person or by proxy at the special meeting is required for acceptance of the Crescent Operating bankruptcy plan. The Bankruptcy Code deems a class of stockholders to have accepted a bankruptcy plan if it is accepted by two-thirds of the votes cast at the special meeting, rather than two-thirds of the outstanding shares. As a result, a failure to vote, unlike a vote against the bankruptcy plan, has no effect on the outcome of the vote on the bankruptcy plan, but will affect whether or not a quorum has been reached at the special meeting. Only Crescent Operating stockholders of record as of the close of business on the record date, January 8, 2003, are entitled to notice of, and to vote at, the special meeting. At the close of business on the record date, 10,828,497 shares of Crescent Operating common stock were issued, outstanding and entitled to vote at the special meeting. The trust managers and executive officers of Crescent Real Estate own shares of Crescent Operating common stock representing approximately 14.0% of the Crescent Operating common stock outstanding on the record date and have advised the sole director of Crescent Operating that they intend to vote their shares in favor of acceptance of the Crescent Operating bankruptcy plan. Each outstanding share is entitled to one vote. Shares cannot be voted at the special meeting unless the record holder thereof is present or represented by proxy. RECOMMENDATION OF SOLE DIRECTOR OF CRESCENT OPERATING Crescent Operating's sole director performed a comprehensive analysis of Crescent Operating's strategic alternatives for maximizing creditor and stockholder value. These alternatives, in the judgment of the sole director, are unlikely to result in any significant recovery for the creditors, other than Crescent Real Estate. Based upon the liquidation analysis of Crescent Operating, the director determined that neither creditors, other than Crescent Real Estate, nor Crescent Operating stockholders would receive anything in a liquidation of Crescent Operating. Crescent Operating's sole director also consulted with financial and legal advisors and obtained an opinion stating that the aggregate consideration to be received by Crescent Operating and its stockholders, taken as a whole, in connection with the transactions contemplated by the bankruptcy plan and the Settlement Agreement is fair to the public stockholders from a financial point of view, assuming a distribution of Crescent Real Estate common shares with a value of $0.32 to $0.50. However, this opinion maintains that it would not necessarily change if Crescent Real Estate were to advance additional funds that reduce the value of Crescent Real Estate common shares to below $0.32. Based on this information and analysis for Crescent Operating creditors and stockholders, Crescent Operating's sole director determined that the Crescent Operating bankruptcy plan was the best available alternative and the alternative most likely to maximize stockholder value. Crescent Operating's sole director performed these analyses and negotiated the bankruptcy plan and Settlement Agreement independently from the persons then serving as the other four members of the Crescent Operating Board of Directors, each of whom also serves as a trust manager of Crescent Real Estate. In order to avoid any conflicts of interest, none of these four directors participated in the negotiations on behalf of Crescent Operating, and all of them resigned as directors of Crescent Operating on February 13, 2002. One such director, John C. Goff, participated in initial structuring of the proposed transactions, but did not participate in any negotiations due to potential conflicts of interest. 23 The sole director is recommending that Crescent Operating stockholders vote for acceptance of the Crescent Operating bankruptcy plan. NO DISSENTERS' APPRAISAL RIGHTS There are no dissenters' appraisal rights available under applicable state corporate law with respect to the reorganization transactions. If the Crescent Operating bankruptcy plan is confirmed by the bankruptcy court, all Crescent Operating stockholders will be bound by all of the terms and conditions of the Crescent Operating bankruptcy plan, except that those stockholders who vote against the bankruptcy plan, abstain or do not vote, and who thereafter either do not receive or refuse to accept any distribution under the bankruptcy plan, will not be deemed to have released the claims discussed in the bankruptcy plan. TAX CONSIDERATIONS The distribution of Crescent Real Estate common shares to Crescent Operating stockholders will be treated as a distribution in liquidation of Crescent Operating. Stockholders of Crescent Operating will realize gain or loss based on the difference between their basis in their shares of Crescent Operating common stock and the fair market value of the Crescent Real Estate common shares they receive. In general, a Crescent Operating stockholder who is not a dealer in securities must treat this gain or loss as a long term capital gain or loss if the stockholder held the shares of Crescent Operating common stock for more than one year or, otherwise, as a short term capital gain or loss. If a stockholder acquired shares of Crescent Operating common stock at different times, the determination of gain or loss and the holding period is made on the facts specific to each share. The stockholders' basis in the Crescent Real Estate common shares they will receive will be the fair market value of the Crescent Real Estate common shares at the time of distribution. INTERESTS OF CERTAIN PERSONS IN THE REORGANIZATION TRANSACTIONS Richard E. Rainwater, who serves as the Chairman of the Board of Crescent Real Estate and served as the Chairman of the Board of Crescent Operating until February 2002, and John C. Goff, who serves as Vice Chairman and Chief Executive Officer of Crescent Real Estate and served as Vice Chairman, President and Chief Executive Officer of Crescent Operating until February 2002, have financial interests in the Crescent Operating bankruptcy plan. As of the record date, Mr. Rainwater was the beneficial owner of approximately 11.5% of the outstanding shares of Crescent Operating common stock and approximately 14.6% of the outstanding Crescent Real Estate common shares, including in each case shares underlying vested options. As of the same date, Mr. Goff was the beneficial owner of approximately 6.6% of the outstanding shares of Crescent Operating common stock and approximately 4.1% of the outstanding Crescent Real Estate common shares, including in each case shares underlying vested options. As beneficial owners of Crescent Real Estate common shares, Messrs. Rainwater and Goff may have interests in the Crescent Operating bankruptcy plan that differ from those of beneficial owners of Crescent Operating common stock who are also not owners of Crescent Real Estate common shares. As beneficial owners of Crescent Operating common stock, Messrs. Rainwater and Goff will receive Crescent Real Estate common shares if the Crescent Operating bankruptcy plan is approved by the required vote of the shares of Crescent Operating common stock and confirmed by the bankruptcy court. Messrs. Rainwater and Goff have stated an intention to vote in favor of the bankruptcy plan. Messrs. Goff and Rainwater are also parties to a support agreement with Crescent Operating and Bank of America whereby they have personally agreed to make additional equity investments in Crescent Operating if and to the extent Crescent Operating defaults on payment obligations on its line of credit with Bank of America. 24 Effective December 31, 2001, Crescent Operating, in connection with extending the maturity of its $15.0 million loan from Bank of America from December 31, 2001 to August 15, 2002, agreed to modify the loan from an unsecured to a secured credit facility. The amendment to the line of credit also waived Crescent Operating's default under the line of credit, as a result of Crescent Operating's failure to pay the principal balance in full on December 31, 2001. During August 2002, Bank of America further extended the maturity of this loan to January 15, 2003 and Crescent Operating prepaid interest for that time period in the amount of $0.3 million. In January 2003, Bank of America further extended the maturity of this loan to March 15, 2003 and Crescent Operating agreed to prepay an additional two months of interest at the loan's current rate. These modifications delay, but do not reduce, any liability that Mr. Rainwater and Mr. Goff may have under the support agreement. Any future defaults by Crescent Operating under the line of credit will revive the default that was waived under the August 2002 amendment to the line of credit. In connection with the Crescent Operating bankruptcy plan, it is expected that Crescent Operating's line of credit with Bank of America will be fully repaid, and Messrs. Goff and Rainwater will be relieved of their potential personal liability under the support agreement. As of September 30, 2002, the aggregate amount outstanding under the loan was $15.0 million. Mr. Goff was subject to conflicts of interest as a result of his participation in the initial proposal of the Crescent Operating bankruptcy plan and related agreements while serving simultaneously as an executive officer and trust manager of Crescent Real Estate and as an executive officer of Crescent Operating, but he did not participate in negotiations of the terms of the Settlement Agreement or the bankruptcy plan. Additionally, Jeffrey L. Stevens, Crescent Operating's current chief executive officer and sole director, will serve as plan administrator of Crescent Operating's contemplated Chapter 11 bankruptcy. For more information regarding the plan administrator, see "The Plan of Reorganization - Implementation of the Plan of Reorganization - The Plan Administrator." In addition, pursuant to the Settlement Agreement and the Crescent Operating bankruptcy plan, the current and former directors and officers of Crescent Operating and the current and former trust managers and officers of Crescent Real Estate will receive certain liability releases as described below in "The Reorganization Transactions - Interests of Certain Persons in the Reorganization Transactions" and "The Plan of Reorganization - Effects of the Confirmation of the Plan of Reorganization - Releases." In February and March 2002, pursuant to the terms of the Settlement Agreement, Crescent Operating transferred to Crescent Real Estate, in lieu of foreclosure, the interests in its hospitality segment and, pursuant to a strict foreclosure, the assets of its land development segment. Crescent Real Estate holds these assets and interests through two newly organized corporations and one newly organized limited liability company that are wholly owned subsidiaries of Crescent Real Estate, or taxable REIT subsidiaries. In addition, in connection with the execution of the Settlement Agreement, Crescent Real Estate and Crescent Operating exchanged mutual releases. In pertinent part, Crescent Operating released any and all claims that it might have against Crescent Real Estate and its current and former trust managers and officers, and Crescent Real Estate released any and all claims that it might have against Crescent Operating and its current and former directors and officers arising at any time prior to the original execution of the Settlement Agreement. This release remains effective regardless of whether the bankruptcy plan is accepted by Crescent Operating's stockholders and/or confirmed by the bankruptcy court. In addition, pursuant to the Crescent Operating bankruptcy plan, Crescent Real Estate will receive certain liability releases from the Crescent Operating stockholders as described in "The Plan of Reorganization - Effects of Confirmation of the Plan of Reorganization - Releases" if the bankruptcy 25 plan is accepted by the requisite vote of the Crescent Operating stockholders and confirmed by the bankruptcy court. 26 RISK FACTORS Before voting in favor of the Crescent Operating bankruptcy plan, you should be aware that there are risks associated with the Crescent Operating bankruptcy plan and in receiving Crescent Real Estate common shares. You should carefully consider these risk factors together with all of the information included or incorporated by reference in this proxy statement/prospectus before you decide to vote in favor of the Crescent Operating bankruptcy plan and possibly receive Crescent Real Estate common shares. This section includes certain forward-looking statements. Please refer to the explanation of the qualifications and limitations on such forward-looking statements beginning on Page 275. RISKS ASSOCIATED WITH THE CRESCENT OPERATING BANKRUPTCY PLAN THE CRESCENT OPERATING BANKRUPTCY PLAN MAY NOT BE CONFIRMED BY THE BANKRUPTCY COURT, AND CONFIRMATION IS A CONDITION TO THE DISTRIBUTION OF CRESCENT REAL ESTATE COMMON SHARES TO CRESCENT OPERATING STOCKHOLDERS. There are many reasons why the Crescent Operating bankruptcy plan may not be confirmed by the bankruptcy court. These reasons include the following: - Crescent Operating may not receive the votes necessary to accept the Crescent Operating bankruptcy plan. - Even if Crescent Operating receives the votes necessary to accept the Crescent Operating bankruptcy plan, the bankruptcy court may decide not to confirm the Crescent Operating bankruptcy plan because the Crescent Operating bankruptcy plan provides that Crescent Operating and each holder of Crescent Operating common stock on the confirmation date of the Crescent Operating bankruptcy plan will be deemed to release certain parties from specified liabilities. Crescent Operating may not modify the bankruptcy plan to remove or alter the releases without the consent of Crescent Real Estate. If Crescent Real Estate does not consent to modification of the release, the bankruptcy plan will not be confirmed and Crescent Real Estate will not be obligated to pay in full or otherwise resolve the claims of the creditors that Crescent Operating identified in the original Settlement Agreement or to make a distribution to Crescent Operating stockholders. - Even if Crescent Operating receives the votes necessary to accept the Crescent Operating bankruptcy plan, the bankruptcy court may determine not to consider these votes if it determines that (a) the Crescent Operating bankruptcy plan was not transmitted to substantially all of Crescent Operating's stockholders, (b) an unreasonably short time was prescribed for Crescent Operating's stockholders to accept or reject the Crescent Operating bankruptcy plan, (c) the solicitation was not made in accordance with applicable nonbankruptcy law or, if there is no such law, that this proxy statement/prospectus does not contain adequate information for purposes of section 1125(a) of the Bankruptcy Code; or (d) the voting was not limited to persons or entities that were stockholders of record as of the record date. - Even if Crescent Operating receives the votes necessary to accept the Crescent Operating bankruptcy plan, the bankruptcy court may still deny confirmation of the Crescent Operating bankruptcy plan if it determines that the Crescent Operating bankruptcy plan does not meet the requirements of applicable law, including the applicable requirements of section 1129 of the Bankruptcy Code, which requires the Crescent Operating bankruptcy plan be in the "best 27 interests" of dissenting members of impaired classes and be "feasible." The requirement that a bankruptcy plan be in the best interests of dissenting members of impaired classes generally means that the value of the consideration to be distributed under the Crescent Operating bankruptcy plan to Crescent Operating's stockholders is not less than those parties would receive if Crescent Operating were liquidated in a hypothetical liquidation under Chapter 7 of the Bankruptcy Code. Under the feasibility requirement, the bankruptcy court must find that confirmation of the Crescent Operating bankruptcy plan is not likely to be followed by the need for further financial reorganization. Thus, Crescent Operating cannot assure you that the bankruptcy court will determine that the Crescent Operating bankruptcy plan is in the "best interests" of dissenting members of impaired classes and is "feasible." - Even if Crescent Operating receives the votes necessary to accept the Crescent Operating bankruptcy plan, Crescent Operating is not permitted by the current bankruptcy plan to seek confirmation of the plan if Crescent Operating cannot pay all unsecured claims in full. Crescent Real Estate has agreed to pay the unsecured claims against Crescent Operating that were identified in the original Settlement Agreement. These claims do not include the claims contained in the lawsuit filed by the Crescent Machinery Committee. If Crescent Real Estate does not offer to assume or settle these claims, or if Crescent Real Estate offers to assume or settle these claims and Crescent Operating does not accept the offer, Crescent Operating will not have sufficient funds to pay its unsecured creditors in full. Because the bankruptcy plan provides that the unsecured creditors will be paid in full, the Bankruptcy Code does not require Crescent Operating to solicit their votes on the bankruptcy plan, and Crescent Operating has not solicited their votes. As a result, Crescent Operating may not seek confirmation of the bankruptcy plan unless the unsecured creditors will be paid in full. The Bankruptcy Code also prohibits Crescent Operating from making any distribution to its stockholders if unsecured claims are not paid in full unless the holders of the unsecured claims agree to such a distribution. For these reasons, Crescent Operating does not expect the bankruptcy court to confirm the current bankruptcy plan if the total unsecured claims against Crescent Operating exceed the amount that Crescent Real Estate will agree to make available to pay unsecured claims. Further, Crescent Operating does not expect Crescent Real Estate to pay unsecured claims in addition to those identified in the original Settlement Agreement without a reduction in the amount of the distribution otherwise available to Crescent Operating stockholders, although the distribution will not be reduced below approximately $2.16 million, or $0.20 per share of the Crescent Operating common stock. Crescent Operating no longer has assets that generate revenue. Crescent Operating is currently operating based upon limited financial support from Crescent Real Estate. If the Crescent Operating bankruptcy plan is not confirmed and the reorganization transactions are not otherwise consummated, Crescent Operating will be unable to continue to operate as a going concern and it is likely that Crescent Operating would have to liquidate its assets. The auditor's report filed in connection with Crescent Operating's annual report on Form 10-K for the year ended December 31, 2001 is qualified by a reference to Crescent Operating's recurring net losses, net capital deficiency, debts in default and other liabilities which it is unable to liquidate in the normal course of business. In addition, the auditor's report mentions the transfer the assets and operations of Crescent Operating's hospitality and land development segments to Crescent Real Estate, Crescent Operating's intent to file a pre-packaged bankruptcy plan, and Crescent Machinery filing for bankruptcy. The auditor's report states that "these conditions raise substantial doubt about the company's ability to continue as a going concern." 28 THE RELEASE OF CRESCENT REAL ESTATE BY CRESCENT OPERATING AND THE STOCKHOLDERS OF CRESCENT OPERATING AND THE RELEASE OF CRESCENT OPERATING AND ITS OFFICERS AND DIRECTORS BY THE STOCKHOLDERS OF CRESCENT OPERATING MAY RESULT IN THE RELEASE OF VIABLE CLAIMS. In connection with execution of the Settlement Agreement, Crescent Operating released all claims that it had or might have had against Crescent Real Estate and affiliates arising prior to the execution of the original Settlement Agreement. To the extent that a stockholder has claims which are derivative of, or derived from, those of Crescent Operating, those derivative claims, which are claims that may be made by a stockholder of a corporation to enforce, on behalf of the corporation a claim that belongs to the corporation, were released in the Settlement Agreement, and are or will be effective whether or not the Crescent Operating stockholders receive any common shares of Crescent Real Estate. In addition, the bankruptcy plan provides that Crescent Operating will release all claims that it has or might have against Crescent Real Estate and affiliates, whether or not those claims arose prior to execution of the Settlement Agreement. As a result, if the bankruptcy plan is confirmed, the Crescent Operating stockholders will not, after confirmation, be able to pursue any derivative claims against Crescent Real Estate and the other parties released by Crescent Operating under the Settlement Agreement. Also, if the Crescent Operating stockholders accept the bankruptcy plan and the bankruptcy court confirms the bankruptcy plan, each Crescent Operating stockholder that is a member of the class that accepted the bankruptcy plan and that was a holder on the confirmation date will be deemed on the effective date of the bankruptcy plan to unconditionally release certain parties, including, without limitation, each of Crescent Operating's current and former officers and directors, employees, agents, attorneys, financial advisors and other representatives, Crescent Real Estate and each of Crescent Real Estate's current and former officers and directors, employees, agents, attorneys, financial advisors, affiliates and other representatives from all claims and liabilities relating to the reorganization transactions, except for performance or nonperformance under the Crescent Operating bankruptcy plan or any action or omission that constitutes actual fraud or criminal behavior. The potential claims covered by the Crescent Operating stockholders' release include direct claims against Crescent Operating and its officers and directors and direct claims against Crescent Real Estate and the other parties released by Crescent Operating under the Settlement Agreement. However, if a stockholder of Crescent Operating sells its stock before the voting record date for the bankruptcy plan or if a stockholder votes against the bankruptcy plan, abstains from voting or does not vote on the bankruptcy plan, and either does not receive or refuses to accept any distribution of Crescent Real Estate common shares, that stockholder will not release its direct claims. The releases of Crescent Operating stockholder claims will apply to Crescent Operating stockholders only in their capacity as Crescent Operating stockholders, and will not affect their rights as holders of Crescent Real Estate common shares. As a result of the releases provided for in the bankruptcy plan, confirmation of the bankruptcy plan may result in the release of claims that a Crescent Operating stockholder could otherwise raise if the bankruptcy court confirms the bankruptcy plan. IF THE CRESCENT OPERATING BANKRUPTCY PLAN IS NOT ACCEPTED BY THE CRESCENT OPERATING STOCKHOLDERS, THE BANKRUPTCY PLAN MAY STILL BE CONFIRMED BY THE BANKRUPTCY COURT, AND, IN THAT CASE, THE CRESCENT OPERATING STOCKHOLDERS WOULD RECEIVE NOTHING. Section 1129(b) of the Bankruptcy Code contains provisions for the confirmation of a bankruptcy plan even if the bankruptcy plan is not accepted by the stockholders of Crescent Operating as long as the bankruptcy plan "does not discriminate unfairly" and is "fair and equitable" with respect to such class. This provision is commonly referred to as the "cramdown provision." Crescent Operating anticipates that it would seek to utilize the "cramdown provision" of section 1129(b) of the Bankruptcy Code if necessary to confirm the bankruptcy plan. The bankruptcy plan provides that the stockholders of Crescent Operating are entitled to receive common shares of Crescent Real Estate only if the bankruptcy plan is accepted by the required vote of the Crescent Operating stockholders. Accordingly, if the holders of Crescent Operating common stock, voting as a class, vote against the bankruptcy plan and if the bankruptcy plan is instead confirmed pursuant to the "cramdown provision" of section 1129(b) of the 29 Bankruptcy Code, the stockholders of Crescent Operating will receive nothing under the bankruptcy plan, their shares of Crescent Operating common stock will be canceled and the release of stockholder claims will not apply. However, the Settlement Agreement and the mutual releases executed in connection with the Settlement Agreement, including Crescent Operating's release of all claims it may have against Crescent Real Estate, are enforceable whether or not the bankruptcy plan is approved by Crescent Operating's stockholders or confirmed by the bankruptcy court. CRESCENT OPERATING STOCKHOLDERS MAY RECEIVE FEWER CRESCENT REAL ESTATE COMMON SHARES AS A RESULT OF INCREASED CLAIMS AND EXPENSES AGAINST CRESCENT OPERATING. As payments by Crescent Real Estate for claims and expenses relating to the Crescent Operating bankruptcy and the reorganization transactions, including the expenses of Crescent Real Estate but excluding payments in satisfaction of the Bank of America claim, increase, the total value of the Crescent Real Estate common shares that the Crescent Operating stockholders will receive will be reduced and the Crescent Operating stockholders will receive fewer Crescent Real Estate common shares. The total value of the Crescent Real Estate common shares that the Crescent Operating stockholders will receive is equal to the greater of (a) approximately $2.16 million and (b) $16.0 million minus the total amount of any payments by Crescent Real Estate for claims and expenses relating to the Crescent Operating bankruptcy and the reorganization transactions, including the expenses of Crescent Real Estate but excluding payments in satisfaction of the Bank of America claim. As of December 31, 2002, Crescent Real Estate had incurred approximately $8.5 million in claims and expenses in connection with the Crescent Operating bankruptcy and the reorganization transactions. Currently, Crescent Real Estate and Crescent Operating estimate that Crescent Real Estate will advance the funds to pay in full or otherwise resolve total claims and expenses of between $10.6 million and $13.8 million. Accordingly, the total value of the Crescent Real Estate common shares issued to the Crescent Operating stockholders is expected to be between $5.4 million and $2.16 million, or $0.50 to $0.20 per share of Crescent Operating common stock. In addition, if Crescent Real Estate, pursuant to the Settlement Agreement, offers to assume or settle any obligations arising from the lawsuit brought by the Crescent Machinery Committee or another unsecured claim not identified in the original Settlement Agreement and Crescent Operating accepts the offer, the total value of the Crescent Real Estate common shares that the Crescent Operating stockholders will receive will be reduced and the Crescent Operating stockholders will receive fewer Crescent Real Estate common shares. However, even if Crescent Real Estate does offer to assume or settle obligations under the Crescent Machinery Committee's lawsuit and Crescent Operating accepts the offer, then the total value of the Crescent Real Estate common shares that the Crescent Operating stockholders will be entitled to receive if the bankruptcy plan is accepted by the Crescent Operating stockholders and confirmed by the bankruptcy court will be at least $2.16 million, or $0.20 per share of Crescent Operating common stock. More information regarding the Crescent Machinery Committee's claim, is set forth in "Description of Crescent Operating's Business - Legal Proceedings." LIMITATIONS ON THE SCOPE OF HOULIHAN LOKEY'S FAIRNESS OPINION COULD LEAD CRESCENT OPERATING STOCKHOLDERS TO ASSIGN TOO MUCH IMPORTANCE TO THE FAIRNESS OPINION IN MAKING THEIR DECISION ON WHETHER TO VOTE TO APPROVE THE BANKRUPTCY PLAN. Houlihan Lokey's fairness opinion is limited in scope and is subject to various qualifications and assumptions. These limitations, qualifications and assumptions include the following: - the opinion covers only the fairness to the public stockholders of Crescent Operating of the aggregate consideration to be received by Crescent Operating and its stockholders, taken as a whole, in connection with the transactions contemplated by the bankruptcy plan from a financial point of view and does not opine as to the overall fairness of the bankruptcy plan and the Settlement Agreement to the stockholders; 30 - the opinion assumes that the stockholders will receive common shares of Crescent Real Estate with a value of between $0.32 and $0.50 per share of Crescent Operating, but it maintains that it would not necessarily change if Crescent Real Estate were to advance additional funds, as Crescent Real Estate agreed to do in the October 2002 amendment to the Settlement Agreement and as described below in "The Reorganization Transaction - Summary of the Reorganization Transactions - Payment by Crescent Real Estate of Crescent Operating Claims and Expenses," that reduced the value of Crescent Real Estate common shares to below $0.32; and - the opinion does not attribute any value to the potential claims against Crescent Real Estate that are being released by Crescent Operating and its stockholders in connection with the bankruptcy plan. In addition, the opinion predates the First Amendment to the Settlement Agreement pursuant to which Crescent Real Estate agreed to issue a minimum number of its common shares to Crescent Operating stockholders if the bankruptcy plan is accepted by the Crescent Operating stockholders and approved by the bankruptcy court. Further, since the date of the opinion, the estimated claims and expenses to be paid by Crescent Real Estate in connection with the reorganization transactions have increased as a result of delays in the commencement of Crescent Operating's solicitation of the vote of its stockholders that have resulted in, among other things, higher legal and accounting expenses of Crescent Real Estate and Crescent Operating and ongoing interest charges and other expenses incurred by Crescent Operating. Accordingly, the total value of Crescent Real Estate and Crescent Operating common stock issuable to Crescent Operating stockholders is currently expected to be between $0.20 and $0.50 per share of the Crescent Operating common stock, rather than the $0.32 to $0.50 that Houlihan Lokey determined was fair to the Crescent Operating stockholders from a financial point of view. Accordingly, you should consider the following factors that are not covered by the fairness opinion: - whether the value of the Crescent Real Estate common shares will be within the range assumed in the fairness opinion, particularly since the current estimated value is between $0.20 (which is less than the low end of the range that Houlihan Lokey concluded was fair to the Crescent Operating stockholders from a financial point of view) and $0.50 and since the claims and allegations in the lawsuit filed by the Crescent Machinery Committee were made after the issuance of the fairness opinion; - the value and likelihood of recovery of the potential claims against Crescent Real Estate that are being released as a part of the overall transaction; and - the alternatives to the bankruptcy plan that are or may be available to the Crescent Operating stockholders and the likelihood of their success. For information related to Crescent Operating's analysis of these factors, please see "The Reorganization Transactions - Analysis of Alternatives." THE SOLE DIRECTOR AND FORMER OFFICERS AND DIRECTORS OF CRESCENT OPERATING HAVE INTERESTS IN THE ACCEPTANCE OF THE CRESCENT OPERATING BANKRUPTCY PLAN THAT MAY CONFLICT WITH THE INTERESTS OF CRESCENT OPERATING'S STOCKHOLDERS. The sole director and the former directors and officers of Crescent Operating received liability releases for events prior to execution of the Settlement Agreement. If the Crescent Operating bankruptcy plan 31 becomes effective, these persons also will receive liability releases through the effective date of the bankruptcy plan. Richard E. Rainwater and John C. Goff, who are officers and trust managers of Crescent Real Estate and who were officers and directors of Crescent Operating, also have a financial interest in the reorganization transactions. See "The Reorganization Transactions - Interests of Certain Persons in the Reorganization Transactions" for a more detailed description of these and other benefits to current and former officers and directors of Crescent Operating resulting from the reorganization transactions. LIABILITY RELEASES. Upon approval of the Crescent Operating bankruptcy plan, in addition to the releases that Crescent Operating granted in connection with the Settlement Agreement, which are already effective, each of the present and former officers and directors of Crescent Operating will be released from substantially all claims and liabilities related to Crescent Operating's business, the bankruptcy case, the reorganization transactions, and the Crescent Operating bankruptcy plan and will be entitled to indemnification to the fullest extent permitted under applicable law if the Crescent Operating bankruptcy plan is confirmed. OTHER INTERESTS. As of January 8, 2003, Richard E. Rainwater, the Chairman of the Board of Crescent Real Estate, and John C. Goff, the Chief Executive Officer, President and Vice Chairman of the Board of Crescent Real Estate, together with the other trust managers and executive officers of Crescent Real Estate, beneficially owned an approximately 18.5% equity interest in Crescent Real Estate in the aggregate. In addition, as of January 8, 2003, Messrs. Rainwater and Goff beneficially owned an aggregate of approximately 17.4% of the outstanding common stock of Crescent Operating through their aggregate ownership of Crescent Operating common stock, including shares underlying vested options. As equity owners of both Crescent Real Estate and Crescent Operating, and as persons who, until February 2002, also served as directors and executive officers of Crescent Operating, Messrs. Goff and Rainwater have a potential conflict of interest in voting on the acceptance of the Crescent Operating bankruptcy plan and reorganization transactions. Additionally, Mr. Goff was subject to conflicts of interests as a result of his participation in the initial proposal of the Crescent Operating bankruptcy plan and related agreements while serving simultaneously as an executive officer and trust manager of Crescent Real Estate and as an executive officer of Crescent Operating. Neither Mr. Rainwater nor, once the original structure of the bankruptcy plan and reorganization transactions was proposed, Mr. Goff participated in the negotiation of the Crescent Operating bankruptcy plan and reorganization transactions, in order to avoid potential conflicts of interest and the appearance of impropriety. THE SETTLEMENT AGREEMENT MAY BE TERMINATED AND CRESCENT OPERATING WOULD BE UNABLE TO CONFIRM THE CRESCENT OPERATING BANKRUPTCY PLAN. If the Settlement Agreement were terminated, Crescent Operating would be unable to confirm the Crescent Operating bankruptcy plan as currently proposed, and no alternative to the Crescent Operating bankruptcy plan may be available or, if available, such alternatives may not be as favorable to the Crescent Operating stockholders as the Crescent Operating bankruptcy plan. The Settlement Agreement may be terminated at any time prior to the effective date of the bankruptcy plan by mutual agreement of Crescent Operating and Crescent Real Estate, or by either Crescent Operating or Crescent Real Estate if the other is in material breach after notice and a 10-business-day opportunity to cure. See "The Reorganization Transactions - Summary of the Reorganization Transactions - Other Material Terms of the Settlement Agreement" for a discussion of the events that could lead to the termination of the Settlement Agreement. 32 THE SETTLEMENT AGREEMENT LIMITS CRESCENT OPERATING'S ABILITY TO UNDERTAKE ALTERNATIVE TRANSACTIONS WITH ANYONE OTHER THAN CRESCENT REAL ESTATE, AND THIS LIMITATION COULD DISCOURAGE THIRD PARTIES FROM MAKING PROPOSALS THAT WOULD BE MORE FAVORABLE TO CRESCENT OPERATING STOCKHOLDERS THAN THE CRESCENT OPERATING BANKRUPTCY PLAN. The Settlement Agreement places substantial restrictions on Crescent Operating's ability to contact, solicit, encourage or pursue possible alternative transactions with any person other than Crescent Real Estate. These provisions could have the effect of discouraging third parties that might otherwise have an interest in making a proposal with respect to a transaction that could result in distributions to Crescent Operating's stockholders that exceed those provided under the Settlement Agreement and the Crescent Operating bankruptcy plan. See "The Reorganization Transactions - Summary of the Reorganization Transactions - Other Material Terms of the Settlement Agreement - Covenants of Crescent Operating" for a discussion of these provisions. RISKS ASSOCIATED WITH AN INVESTMENT IN CRESCENT REAL ESTATE COMMON SHARES The risk factors enumerated below assume the confirmation and consummation of the Crescent Operating bankruptcy plan and all transactions contemplated by the bankruptcy plan, and do not include matters that could prevent or delay confirmation of the Crescent Operating bankruptcy plan. CRESCENT REAL ESTATE MAY BE UNABLE TO INTEGRATE CRESCENT OPERATING'S RESORT/HOTEL AND RESIDENTIAL DEVELOPMENT SEGMENTS INTO ITS OPERATIONS SUCCESSFULLY. In the first quarter of 2002, in satisfaction of a portion of its outstanding debt and rental obligations to Crescent Real Estate, Crescent Operating transferred to subsidiaries of Crescent Real Estate, in lieu of foreclosure, its lessee interests in eight resort/hotel properties that it leased from Crescent Real Estate and, pursuant to a strict foreclosure, its voting interests in three of Crescent Real Estate's residential development corporations, in which Crescent Real Estate already owned the nonvoting stock, and other assets. Crescent Real Estate will face significant challenges in integrating Crescent Operating's hotel and residential development segments into Crescent Real Estate's resort/hotel and residential development segments in a timely and efficient manner. The integration will be complex and time-consuming. The consolidation of operations will require substantial attention from management. The diversion of management attention and any difficulties encountered in the transition and integration process, as well as any unanticipated or undisclosed liabilities, could adversely affect Crescent Real Estate's results of operations and its ability to make distributions to its shareholders and decrease its cash flow. In addition, if the transfers are challenged by Crescent Operating's stockholders or creditors or other claims are made, Crescent Real Estate could incur additional costs in defending its position. These risks would increase if the Crescent Operating bankruptcy plan were not consummated. CRESCENT REAL ESTATE'S PERFORMANCE AND VALUE ARE SUBJECT TO GENERAL RISKS ASSOCIATED WITH THE REAL ESTATE INDUSTRY. Crescent Real Estate's economic performance and the value of its real estate assets, and consequently the value of its investments, are subject to the risk that if its office, resort/hotel, residential development and temperature-controlled logistics properties do not generate revenues sufficient to meet its operating expenses, including debt service and capital expenditures, its cash flow and ability to pay distributions to its shareholders will be adversely affected. As a real estate company, Crescent Real Estate is susceptible to the following real estate industry risks: - downturns in the national, regional and local economic conditions where its properties are located; 33 - competition from other office, resort/hotel, residential development and temperature-controlled logistics properties; - adverse changes in local real estate market conditions, such as oversupply or reduction in demand for office space, resort/hotel space, luxury residences or temperature-controlled logistics storage space; - changes in tenant preferences that reduce the attractiveness of its properties to tenants; - tenant defaults; - zoning or regulatory restrictions; - decreases in market rental rates; - costs associated with the need to periodically repair, renovate and relet space; - increases in the cost of adequate maintenance, insurance and other operating costs, including real estate taxes, associated with one or more properties, which may occur even when circumstances such as market factors and competition cause a reduction in revenues from one or more properties; and - illiquidity of real estate investments, which may limit its ability to vary its portfolio promptly in response to changes in economic or other conditions. CRESCENT REAL ESTATE MAY EXPERIENCE DIFFICULTY OR DELAY IN RENEWING LEASES OR RE-LEASING SPACE. Crescent Real Estate derives most of its revenue directly or indirectly from rent received from its tenants. Crescent Real Estate is subject to the risks that, upon expiration, leases for space in its office properties may not be renewed, the space may not be re-leased, or the terms of renewal or re-lease, including the cost of required renovations or concessions to tenants, may be less favorable than current lease terms. As a result, Crescent Real Estate's cash flow could decrease and its ability to make distributions to its shareholders could be adversely affected. As of September 30, 2002, office properties with leases with respect to approximately 1.7 million, 3.6 million and 4.4 million square feet, representing approximately 7%, 14%, and 17% of net rentable area, expire in 2002, 2003 and 2004, respectively. During these same three years, leases of approximately 34% of the net rentable area of Crescent Real Estate's office properties in Dallas and approximately 42% of the net rentable area of its office properties in Houston expire. MANY REAL ESTATE COSTS ARE FIXED, EVEN IF INCOME FROM CRESCENT REAL ESTATE'S PROPERTIES DECREASES. Crescent Real Estate's financial results depend primarily on leasing space in its office properties to tenants, renting rooms at its resorts and hotels and successfully developing and selling lots, single family homes, condominiums, town homes and time share units at Crescent Real Estate's residential development properties, in each case on terms favorable to Crescent Real Estate. Costs associated with real estate investment, such as real estate taxes and maintenance costs, generally are not reduced even when a property is not fully occupied, the rate of sales at a project decreases, or other circumstances cause a reduction in income from the investment. 34 As a result, cash flow from the operations of Crescent Real Estate's office properties may be reduced if a tenant does not pay its rent. Under those circumstances, Crescent Real Estate might not be able to enforce its rights as landlord without delays, and may incur substantial legal costs. The income from Crescent Real Estate's office properties also may be reduced if tenants are unable to pay rent or Crescent Real Estate is unable to rent properties on favorable terms. Crescent Real Estate's income from its resorts and hotels may be reduced if it is unable to rent a sufficient number of rooms on favorable terms, and Crescent Real Estate's income from its residential development properties may decrease if it is unable to sell the lots or other components of a particular residential development project at the rates or on the terms it anticipated. Additionally, new properties that Crescent Real Estate may acquire or develop may not produce any significant revenue immediately, and the cash flow from existing operations may be insufficient to pay the operating expenses and debt service associated with that property until the property is fully leased. CRESCENT REAL ESTATE DERIVES THE SUBSTANTIAL MAJORITY OF ITS OFFICE RENTAL REVENUES FROM ITS GEOGRAPHICALLY CONCENTRATED MARKETS. As of September 30, 2002, approximately 73% of Crescent Real Estate's office portfolio, based on total net rentable square feet, representing 63% of its total revenues for the year ended December 31, 2001, was located in the metropolitan areas of Dallas/Fort Worth and Houston, Texas. Due to this geographic concentration, any deterioration in economic conditions in the Dallas/Fort Worth or Houston metropolitan areas, or in other geographic markets in which Crescent Real Estate in the future may acquire substantial assets, could adversely affect Crescent Real Estate's results of operations and its ability to make distributions to its shareholders and decrease its cash flow. In addition, Crescent Real Estate competes for tenants based on rental rates, attractiveness and location of a property and quality of maintenance and management services. An increase in the supply of properties competitive with Crescent Real Estate's properties in these markets could have a material adverse effect on Crescent Real Estate's ability to attract and retain tenants in these markets. CRESCENT REAL ESTATE MAY HAVE LIMITED FLEXIBILITY IN DEALING WITH ITS JOINTLY OWNED INVESTMENTS. Crescent Real Estate's organizational documents do not limit the amount of funds that it may invest in properties and assets jointly with other persons or entities. Approximately 12% of the net rentable area of Crescent Real Estate's office properties is held jointly with other persons or entities. In addition, as of September 30, 2002, all of Crescent Real Estate's residential development and temperature-controlled logistics properties were owned jointly. Joint ownership of properties may involve special risks, including the possibility that Crescent Real Estate's partners or co-investors might become bankrupt, that those partners or co-investors might have economic or other business interests or goals which are unlike or incompatible with Crescent Real Estate's business interests or goals, and that those partners or co-investors might be in a position to take action contrary to Crescent Real Estate's suggestions or instructions, or in opposition to Crescent Real Estate's policies or objectives. Joint ownership gives a third party the opportunity to influence the return Crescent Real Estate can achieve on some of its investments and may adversely affect Crescent Real Estate's ability to make distributions to its shareholders. In addition, in many cases Crescent Real Estate does not control the timing or amount of distributions that it receives from the joint investment, and amounts otherwise available for distribution to Crescent Real Estate may be reinvested in the property or used for other costs and expenses of the joint operation. ACQUISITIONS AND NEW DEVELOPMENTS MAY FAIL TO PERFORM AS EXPECTED. 35 Crescent Real Estate intends to focus its investment strategy primarily on investment opportunities and markets considered "demand-driven" within its office property segment, with a long-term strategy of acquiring properties at a cost significantly below that which would be required to develop a comparable property. Acquisition or development of properties entails risks that include the following, any of which could adversely affect Crescent Real Estate's results of operations and its ability to meet its obligations: - Crescent Real Estate may not be able to identify suitable properties to acquire or may be unable to complete the acquisition of the properties it selects for acquisition; - Crescent Real Estate may not be able to integrate new acquisitions into its existing operations successfully; - Crescent Real Estate's estimate of the costs of improving, repositioning or redeveloping an acquired property may prove to be too low, and, as a result, the property may fail to meet Crescent Real Estate's estimates of the profitability of the property, either temporarily or for a longer time; - Office properties, resorts or hotels Crescent Real Estate acquires may fail to achieve the occupancy and rental or room rates Crescent Real Estate anticipates at the time it makes the decision to invest in the properties, resulting in lower profitability than expected in analyzing the properties; - Crescent Real Estate's pre-acquisition evaluation of the physical condition of each new investment may not detect certain defects or necessary repairs until after the property is acquired, which could significantly increase Crescent Real Estate's total acquisition costs; and - Crescent Real Estate's investigation of a property or building prior to its acquisition, and any representations it may receive from the seller, may fail to reveal various liabilities, which could effectively reduce the cash flow from the property or building, or increase Crescent Real Estate's acquisition cost. CRESCENT REAL ESTATE MAY BE UNABLE TO SELL PROPERTIES WHEN APPROPRIATE BECAUSE REAL ESTATE INVESTMENTS ARE ILLIQUID. Real estate investments generally cannot be sold quickly. In addition, there are some limitations under federal income tax laws applicable to REITs that may limit Crescent Real Estate's ability to sell its assets. Crescent Real Estate may not be able to alter its portfolio promptly in response to changes in economic or other conditions. Crescent Real Estate's inability to respond quickly to adverse changes in the performance of its investments could have an adverse effect on Crescent Real Estate's ability to meet its obligations and make distributions to its shareholders. THE REVENUES FROM CRESCENT REAL ESTATE'S NINE HOTEL PROPERTIES, EVEN AFTER ACQUISITIONS OF THE CRESCENT OPERATING HOTEL OPERATIONS, DEPEND ON THIRD-PARTY OPERATORS THAT CRESCENT REAL ESTATE DOES NOT CONTROL. Crescent Real Estate owns nine hotel properties, eight of which are leased to Crescent Real Estate's subsidiaries. Crescent Real Estate currently leases the remaining hotel property, the Omni Austin Hotel, to a third party entity, HCD Austin Corporation. To maintain Crescent Real Estate's status as a REIT, third-party property managers manage each of the nine hotel properties. As a result, Crescent Real 36 Estate is unable to directly implement strategic business decisions with respect to the operation and marketing of its hotel properties, such as decisions with respect to the quality of accommodations, room rate structure, the quality and scope of amenities such as food and beverage facilities and similar matters. The amount of revenue that Crescent Real Estate receives from the hotel properties is dependent on the ability of the property managers to maintain and increase the gross receipts from these properties. Although Crescent Real Estate consults with the managers with respect to strategic business plans, the managers are under no obligation to implement any of Crescent Real Estate's recommendations with respect to these matters. If the gross receipts of the resort/hotels decline, Crescent Real Estate's revenues would decrease as well, which could reduce the amount of cash available to meet its obligations and for distribution to its shareholders. THE REVENUES FROM CRESCENT REAL ESTATE'S NINE HOTEL PROPERTIES ARE SUBJECT TO RISKS ASSOCIATED WITH THE HOSPITALITY INDUSTRY. The following factors, among others, are common to the resort/hotel industry, and may reduce the receipts generated by Crescent Real Estate's hotel properties: - based on such features as access, location, quality of accommodations, room rate structure and, to a lesser extent, the quality and scope of other amenities such as food and beverage facilities, Crescent Real Estate's hotel properties compete for guests with other resorts and hotels, a number of which have greater marketing and financial resources than the lessees or the hotel property managers; - if there is an increase in operating costs resulting from inflation or other factors, Crescent Real Estate or the property managers may not be able to offset such increase by increasing room rates; - Crescent Real Estate's hotel properties are subject to fluctuating and seasonal demands for business travelers and tourism; and - Crescent Real Estate's hotel properties are subject to general and local economic conditions that may affect the demand for travel in general and other factors that are beyond Crescent Real Estate's control, such as acts of terrorism. In addition, Crescent Real Estate's hotel properties have experienced a decrease in occupancy rates, revenue per available room and total revenue since September 11, 2001. For the year ended December 31, 2001, compared to the year ended December 31, 2000, the weighted average occupancy of Crescent Real Estate's hotel properties decreased approximately 6%, the average daily rate decreased approximately 3%, revenue per available room decreased approximately 6% and same store net operating income decreased by an average of 16%. For the nine months ended September 30, 2002, compared to the nine months ended September 30, 2001, the weighted average occupancy of Crescent Real Estate's hotel properties decreased approximately 1%, the average daily rate decreased approximately 2.0%, the revenue per available room decreased approximately 3.3% and the same store net operating income decreased by an average of 6.8%. Military actions against terrorists, new terrorist attacks, actual or threatened, and other political events could cause a lengthy period of uncertainty that might increase customer reluctance to travel and therefore adversely affect Crescent Real Estate's results of operations and its ability to meet its obligations. THE PERFORMANCE OF CRESCENT REAL ESTATE'S RESIDENTIAL DEVELOPMENT PROPERTIES IS AFFECTED BY NATIONAL, REGIONAL AND LOCAL ECONOMIC CONDITIONS. 37 Crescent Real Estate's residential development properties, which include The Woodlands and Desert Mountain, are generally targeted toward purchasers of high-end primary residences or seasonal secondary residences. As a result, the economic performance and value of these properties is particularly sensitive to changes in national, regional and local economic and market conditions. Economic downturns may discourage potential customers from purchasing new, larger primary residences or vacation or seasonal homes. In addition, other factors may affect the performance and value of a property adversely, including changes in laws and governmental regulations (including those governing usage, zoning and taxes), changes in interest rates (including the risk that increased interest rates may result in decreased sales of lots in any residential development property) and the availability to potential customers of financing. Adverse changes in any of these factors, each of which is beyond Crescent Real Estate's control, could reduce the income that it receives from the properties, and adversely affect Crescent Real Estate's ability to meet its obligations. CRESCENT REAL ESTATE DOES NOT CONTROL REVENUES FROM ITS TEMPERATURE-CONTROLLED LOGISTICS PROPERTIES, AND THE LESSEE MAY BE UNABLE TO MEET ALL OF ITS RENT OBLIGATIONS. Crescent Real Estate owns a 40% interest in the temperature-controlled logistics partnership that owns AmeriCold Corporation, which in turn directly or indirectly owns the Crescent Real Estate temperature-controlled logistics properties. The temperature-controlled logistics properties are operated by, and leased to, AmeriCold Logistics, L.L.C., owned 60% by Vornado Operating and 40% by COPI Cold Storage. Crescent Real Estate has no ownership interest in AmeriCold Logistics and, thus, does not have the authority to control the management or operation of the Crescent Real Estate temperature-controlled logistics properties. Pursuant to the leases, AmeriCold Logistics may elect to defer a portion of the rent for the Crescent Real Estate temperature-controlled logistics properties for up to three years beginning on March 12, 1999, to the extent that available cash, as defined in the leases, is insufficient to pay such rent. The leases were amended in February 22, 2001 to extend the rent deferral period to December 31, 2003. Through September 30, 2002, AmeriCold Logistics has deferred approximately $70.5 million of rent, of which Crescent Real Estate's portion is approximately $28.2 million. In December 2001, the temperature-controlled logistics partnership, as lessor, waived its rights to collect $39.8 million of the $49.9 million of deferred rent, of which Crescent Real Estate's share was $15.9 million. The remaining deferred rent, or rent payable in the future, may not be paid in full on a timely basis. Crescent Real Estate cannot assure its shareholders that AmeriCold Logistics will operate the Crescent Real Estate temperature-controlled logistics properties in a manner which will enable it to meet its ongoing rental obligations to Crescent Real Estate. In the event that AmeriCold Logistics is unable to make its rental payments, Crescent Real Estate's cash flow would be adversely affected, which could affect Crescent Real Estate's results of operations, ability to meet its obligations and the amount of distributions made to Crescent Real Estate's shareholders. THE AMOUNT OF DEBT CRESCENT REAL ESTATE HAS AND THE RESTRICTIONS IMPOSED BY THAT DEBT COULD ADVERSELY AFFECT CRESCENT REAL ESTATE'S FINANCIAL CONDITION. Crescent Real Estate has a substantial amount of debt. As of September 30, 2002, Crescent Real Estate had approximately $2.4 billion of consolidated debt outstanding, of which approximately $1.6 billion was secured by approximately 31% of Crescent Real Estate's gross total assets. In addition, as a result of the acquisition by subsidiaries of Crescent Real Estate of Crescent Operating's lessee interests in eight hotel properties then leased to subsidiaries of Crescent Operating, the voting interests in three of Crescent Real Estate's residential development corporations and other assets, Crescent Real Estate is now required to consolidate an additional approximately $99.0 million of debt as of September 30, 2002. 38 Crescent Real Estate's organizational documents do not limit the level or amount of debt that Crescent Real Estate may incur. Crescent Real Estate does not have a policy limiting the ratio of its debt to total capitalization or assets. The amount of debt Crescent Real Estate has and may have outstanding could have important consequences to Crescent Real Estate's shareholders. For example, it could: - make it difficult to satisfy Crescent Real Estate's debt service requirements; - prevent Crescent Real Estate from making distributions on its outstanding common shares and preferred shares; - require Crescent Real Estate to dedicate a substantial portion of its cash flow from operations to payments on its debt, thereby reducing funds available for operations, property acquisitions and other appropriate business opportunities that may arise in the future; - require Crescent Real Estate to dedicate increased amounts of its cash flow from operations to payments on its variable rate, unhedged debt if interest rates rise; - limit Crescent Real Estate's flexibility in planning for, or reacting to, changes in its business and the factors that affect the profitability of Crescent Real Estate's business; - limit Crescent Real Estate's ability to obtain additional financing, if Crescent Real Estate needs it in the future for working capital, debt refinancing, capital expenditures, acquisitions, development or other general corporate purposes; - increase the adverse effect on Crescent Real Estate's available cash flow from operations that may result from changes in conditions in the economy in general and in the areas in which Crescent Real Estate's properties are located; and - limit Crescent Real Estate's flexibility in conducting its business, which may place Crescent Real Estate at a disadvantage compared to competitors with less debt. Crescent Real Estate's ability to make scheduled payments of the principal of, to pay interest on, or to refinance, its indebtedness will depend on Crescent Real Estate's future performance, which to a certain extent is subject to economic, financial, competitive and other factors beyond Crescent Real Estate's control. There can be no assurance that Crescent Real Estate's business will continue to generate sufficient cash flow from operations in the future to service its debt or meet its other cash needs. If Crescent Real Estate is unable to do so, it may be required to refinance all or a portion of its existing debt, or to sell assets or obtain additional financing. Crescent Real Estate cannot assure its shareholders that any such refinancing, sale of assets or additional financing would be possible on terms that Crescent Real Estate would find acceptable. If Crescent Real Estate were to breach certain of its debt covenants, Crescent Real Estate's lenders could require it to repay the debt immediately, and, if the debt is secured, could immediately take possession of the property securing the loan. In addition, if any other lender declared its loan due and payable as a result of a default, the holders of Crescent Real Estate's public and private notes, along with the lenders under Crescent Real Estate's credit facility, might be able to require that those debts be paid immediately. As a results, any default under Crescent Real Estate's debt covenants could have an adverse effect on its financial condition, its results of operations, its ability to meet its obligations and the market value of its shares. 39 CRESCENT REAL ESTATE IS OBLIGATED TO COMPLY WITH FINANCIAL AND OTHER COVENANTS IN ITS DEBT THAT COULD RESTRICT ITS OPERATING ACTIVITIES, AND THE FAILURE TO COMPLY COULD RESULT IN DEFAULTS THAT ACCELERATE THE PAYMENT UNDER ITS DEBT. Crescent Real Estate's secured debt generally contains customary covenants, including, among others, provisions: - relating to the maintenance of the property securing the debt; - restricting Crescent Real Estate's ability to pledge assets or create other liens; - restricting Crescent Real Estate's ability to incur additional debt; - restricting Crescent Real Estate's ability to amend or modify existing leases; and - restricting Crescent Real Estate's ability to enter into transactions with affiliates. Crescent Real Estate's unsecured debt generally contains various restrictive covenants. The covenants in Crescent Real Estate's unsecured debt include, among others, provisions restricting its ability to: - incur additional debt; - incur additional debt and subsidiary debt; - make certain distributions, investments and other restricted payments, including distribution payments on Crescent Real Estate's or Crescent Real Estate's subsidiaries' outstanding common and preferred equity; - limit the ability of restricted subsidiaries to make payments to Crescent Real Estate; - enter into transactions with affiliates; - create certain liens; - sell assets; - enter into certain sale-leaseback transactions; and - consolidate, merge or sell all or substantially all of Crescent Real Estate's assets. In addition, certain covenants in Crescent Real Estate's bank facilities require Crescent Real Estate and its subsidiaries to maintain certain financial ratios. Any of the covenants described in this risk factor may restrict Crescent Real Estate's operations and its ability to pursue potentially advantageous business opportunities. Crescent Real Estate's failure to comply with these covenants could also result in an event of default that, if not cured or waived, could result in the acceleration of all or a substantial portion of Crescent Real Estate's debt. 40 RISING INTEREST RATES COULD ADVERSELY AFFECT CRESCENT REAL ESTATE'S CASH FLOW. Of Crescent Real Estate's approximately $2.4 billion of debt outstanding as of September 30, 2002, approximately $228 million was unhedged variable rate debt. Crescent Real Estate also may borrow additional funds at variable interest rates in the future, and Crescent Real Estate has entered, and in the future may enter, into other transactions to limit its exposure to rising interest rates. Increases in interest rates, or the loss of the benefits of any interest rate hedging arrangements, would increase Crescent Real Estate's interest expense on its variable rate debt, which would adversely affect cash flow and its ability to service its debt, meet its obligations and make distributions to its shareholders. THE NUMBER OF SHARES AVAILABLE FOR FUTURE SALE COULD ADVERSELY AFFECT THE MARKET PRICE OF CRESCENT REAL ESTATE'S PUBLICLY TRADED SECURITIES. Crescent Real Estate has entered into various private placement transactions whereby units and limited partnership interests in Crescent Partnership were issued in exchange for properties or interests in properties. These units and interests are currently exchangeable for Crescent Real Estate common shares on the basis of two shares for each one unit or, at Crescent Real Estate's option, an equivalent amount of cash. Upon exchange for Crescent Real Estate's common shares, those common shares may be sold in the public market pursuant to registration rights. As of September 30, 2002, approximately 6,541,234 units were outstanding, which were exchangeable for 13,082,468 Crescent Real Estate common shares or, at Crescent Real Estate's option, an equivalent amount of cash. In addition, as of December 31, 2001, Crescent Partnership had outstanding options to acquire approximately 1,197,143 units, of which 882,857 options were exercisable at a weighted average price of $18.00 with a weighted average remaining contractual life of 4.8 years. Crescent Real Estate has also reserved a number of common shares for issuance pursuant to its employee benefit plans, and such common shares will be available for sale from time to time. As of December 31, 2001, Crescent Real Estate had issued options to acquire approximately 6,975,334 common shares outstanding, of which approximately 3,126,684 options were exercisable at a weighted average exercise price of $24.00, with a weighted average remaining contractual life of seven years. Crescent Real Estate's employees may also participate in an employee stock purchase plan that allows them to purchase up to 1,000,000 newly issued common shares. Crescent Real Estate cannot predict the effect that future sales of common shares, or the perception that such sales could occur, will have on the market prices of its equity securities. ENVIRONMENTAL PROBLEMS ARE POSSIBLE AND MAY BE COSTLY. Under various federal, state and local laws, ordinances and regulations, Crescent Real Estate may be required to investigate and clean up certain hazardous or toxic substances released on or in properties Crescent Real Estate owns or operates, and also may be required to pay other costs relating to hazardous or toxic substances. This liability may be imposed without regard to whether Crescent Real Estate knew about the release of these types of substances or was responsible for their release. The presence of contamination or the failure to remediate properly contaminations at any of Crescent Real Estate's properties may adversely affect its ability to sell or lease the properties or to borrow using the properties as collateral. The costs or liabilities could exceed the value of the affected real estate. Crescent Real Estate has not been notified by any governmental authority, however, of any non-compliance, liability or other claim in connection with any of its properties, and Crescent Real Estate is not aware of any other environmental condition with respect to any of its properties that management believes would have a material adverse effect on its business, assets or results of operations taken as a whole. The uses of any of Crescent Real Estate's properties prior to Crescent Real Estate's acquisition of the property and the building materials used at the property are among the property-specific factors that will affect how the environmental laws are applied to Crescent Real Estate's properties. In general, before Crescent Real Estate purchased each of its properties, independent environmental consultants conducted or updated Phase I environmental assessments, which generally do not involve invasive 41 techniques such as soil or ground water sampling, and where indicated, based on the Phase I results, conducted Phase II environmental assessments which do involve this type of sampling. None of these assessments revealed any materially adverse environmental condition relating to any particular property not previously known to Crescent Real Estate. Crescent Real Estate believes that all of these previously known conditions either have been remediated or are in the process of being remediated at this time. There can be no assurance, however, that environmental liabilities have not developed since these environmental assessments were prepared, or that future uses or conditions, including changes in applicable environmental laws and regulations, will not result in imposition of environmental liabilities. If Crescent Real Estate is subject to environmental liabilities, the liabilities could adversely affect Crescent Real Estate's results of operations and its ability to meet its obligations, which could in turn affect the market value of its common shares. COMPLIANCE WITH THE AMERICANS WITH DISABILITIES ACT COULD BE COSTLY. Under the Americans with Disabilities Act of 1990, all public accommodations and commercial facilities must meet certain federal requirements related to access and use by disabled persons. Compliance with the ADA requirements could involve removal of structural barriers from certain disabled persons' entrances. Other federal, state and local laws may require modifications to or restrict further renovations of Crescent Real Estate's properties with respect to such accesses. Although Crescent Real Estate believes that its properties are substantially in compliance with present requirements, noncompliance with the ADA or related laws or regulations could result in the United States government imposing fines or private litigants being awarded damages against Crescent Real Estate. Costs such as these, as well as the general costs of compliance with these laws or regulations, may adversely affect Crescent Real Estate's ability to make payments under its debt and adversely affect the price of its common shares. DEVELOPMENT AND CONSTRUCTION RISKS COULD ADVERSELY AFFECT CRESCENT REAL ESTATE'S PROFITABILITY. Crescent Real Estate is currently developing, expanding or renovating some of its office or hotel properties and may in the future engage in these activities for other properties it owns. In addition, Crescent Real Estate's residential development properties engage in the development of raw land and construction of single-family homes, condominiums, town homes and timeshare units. These activities may be exposed to the following risks, each of which could adversely affect Crescent Real Estate's results of operations and its ability to meet its obligations. - Crescent Real Estate may be unable to obtain, or suffer delays in obtaining, necessary zoning, land-use, building, occupancy and other required governmental permits and authorizations, which could result in increased costs or abandonment of these activities. - Crescent Real Estate may incur costs for development, expansion or renovation of a property which exceed its original estimates due to increased costs for materials or labor or other costs that were unexpected. - Crescent Real Estate may not be able to obtain financing with favorable terms, which may make Crescent Real Estate unable to proceed with development and other related activities on the schedule originally planned or at all. 42 - Crescent Real Estate may be unable to complete construction and sale or lease-up of a lot, office property or residential development unit on schedule, which could result in increased debt service expense or construction costs. Additionally, the time frame required for development, construction and lease-up of these properties means that Crescent Real Estate may have to wait a few years for a significant cash return. As a REIT, Crescent Real Estate is required to make cash distributions to its shareholders. If Crescent Real Estate's cash flow from operations is not sufficient, Crescent Real Estate may be forced to borrow to fund these distributions, which could affect its ability to meet its other obligations. COMPETITION FOR ACQUISITIONS MAY RESULT IN INCREASED ACQUISITION COSTS. Crescent Real Estate plans to make select additional investments from time to time in the future and may compete for available investment opportunities with entities that have greater liquidity or financial resources. Several real estate companies may compete with Crescent Real Estate in seeking properties for acquisition or land for development and prospective tenants, guests or purchasers. This competition may increase the costs of any acquisitions that Crescent Real Estate makes and adversely affect its ability to meet its obligations by: - reducing the number of suitable investment opportunities offered to Crescent Real Estate; and - increasing the bargaining power of property owners. In addition, if a competitor succeeds in making an acquisition in a market in which Crescent Real Estate's properties compete, ownership of that investment by a competitor may adversely affect Crescent Real Estate's results of operations and its ability to meet its obligations by: - interfering with Crescent Real Estate's ability to attract and retain tenants, guests or purchasers; and - adversely affecting Crescent Real Estate's ability to minimize expenses of operation. FAILURE TO QUALIFY AS A REIT WOULD CAUSE CRESCENT REAL ESTATE TO BE TAXED AS A CORPORATION, WHICH WOULD SUBSTANTIALLY REDUCE FUNDS AVAILABLE FOR PAYMENT OF DISTRIBUTIONS. Crescent Real Estate intends to continue to operate in a manner that allows it to meet the requirements for qualification as a REIT under the Internal Revenue Code of 1986, as amended. A REIT generally is not taxed at the corporate level on income it distributes to its shareholders, as long as it distributes at least 90 percent of its income to its shareholders annually and satisfies certain other highly technical and complex requirements. Unlike many REITs, which tend to make only one or two types of real estate investments, Crescent Real Estate invests in a broad range of real estate products. Several of its investments also are more complicated than those of other REITs. As a result, Crescent Real Estate is likely to encounter a greater number of interpretative issues under the REIT qualification rules, and more issues which lack clear guidance, than are other REITs. Crescent Real Estate, as a matter of policy, consults with outside tax counsel in structuring its new investments in an effort to satisfy the REIT qualification rules. Shaw Pittman LLP, tax counsel to Crescent Real Estate, has given Crescent Real Estate an opinion stating that Crescent Real Estate qualified as a REIT under the Internal Revenue Code for its taxable years ending on or before December 31, 2001, that Crescent Real Estate is organized in conformity with the requirements for qualification as a REIT under the Internal Revenue Code and that its proposed method of operation will permit Crescent Real Estate to continue to meet the requirements for 43 qualification and taxation as a REIT. This opinion is based on representations made by Crescent Real Estate as to factual matters, opinions of other law firms and on existing law, which is subject to change, both retroactively and prospectively, and to possibly different interpretations. Shaw Pittman LLP's opinion also is not binding on either the Internal Revenue Service or the courts. Crescent Real Estate must meet the requirements of the Internal Revenue Code in order to qualify as a REIT now and in the future. The laws and regulations governing federal income taxation are the subject of frequent review and amendment, and proposed or contemplated changes in the laws or regulations may affect Crescent Real Estate's ability to qualify as a REIT and the manner in which Crescent Real Estate conducts its business. If Crescent Real Estate fails to qualify as a REIT for federal income tax purposes, Crescent Real Estate would not be allowed a deduction for distributions to shareholders in computing taxable income and would be subject to federal income tax at regular corporate rates. In addition to these taxes, Crescent Real Estate may be subject to the federal alternative minimum tax. Unless Crescent Real Estate is entitled to relief under certain statutory provisions, Crescent Real Estate could not elect to be taxed as a REIT for four taxable years following any year during which Crescent Real Estate was first disqualified. Therefore, if Crescent Real Estate loses its REIT status, Crescent Real Estate could be required to pay significant income taxes, which would reduce its funds available for investments or for distributions to its shareholders. This would likely adversely affect the value of an investment in Crescent Real Estate. In addition, Crescent Real Estate would no longer be required by law or its operating agreements to make any distributions to its shareholders. PROVISIONS OF CRESCENT REAL ESTATE'S DECLARATION OF TRUST AND BYLAWS COULD INHIBIT CHANGES IN CONTROL OR DISCOURAGE TAKEOVER ATTEMPTS BENEFICIAL TO SHAREHOLDERS. Certain provisions of Crescent Real Estate's declaration of trust and bylaws may delay or prevent either a change in control of Crescent Real Estate or another transaction that could provide its shareholders with a premium over the then-prevailing market price of Crescent Real Estate's common shares or which might otherwise be in the best interest of its security holders. These include a staggered Board of Trust Managers, which makes it more difficult for a third party to gain control of Crescent Real Estate's Board, and the ownership limit described below. In addition, any future series of preferred shares may have certain voting provisions that could delay or prevent a change of control or other transaction that might involve a premium price or otherwise be beneficial to its security holders. The declaration of trust also establishes special requirements with respect to "business combinations," including certain issuances of equity securities, between Crescent Real Estate and an "interested shareholder," and mandates procedures for obtaining voting rights with respect to "control shares" acquired in a control share acquisition. OWNERSHIP OF CRESCENT REAL ESTATE'S SHARES IS SUBJECT TO LIMITATION FOR REIT TAX PURPOSES. To remain qualified as a REIT for federal income tax purposes, not more than 50% in value of Crescent Real Estate's outstanding shares may be owned, directly or indirectly, by five or fewer individuals (as defined in the federal income tax laws applicable to REITs) at any time during the last half of any taxable year, and Crescent Real Estate's outstanding shares must be beneficially owned by 100 or more persons at least 335 days of a taxable year. To facilitate maintenance of its REIT qualification, Crescent Real Estate's declaration of trust, subject to certain exceptions, prohibits ownership by any single shareholder of more than 8.0% of its issued and outstanding common shares, or such greater percentage as established by the Board of Trust Managers, but in no event greater than 9.9% of its issued and outstanding preferred shares. In addition, the declaration of trust prohibits ownership by Richard E. Rainwater, the Chairman of the Board of Trust Managers, together with certain of his affiliates or relatives, initially of more than 8.0% and subsequently of more than 9.5% of the issued and outstanding Crescent Real Estate common shares. Crescent Real Estate refers to these limits collectively as the 44 "ownership limit." Any transfer of shares may be null and void if it causes a person to violate the ownership limit, and the intended transferee or holder will acquire no rights in the shares. Those shares will automatically convert into excess shares, and the shareholder's rights to distributions and to vote will terminate. The shareholder would have the right to receive payment of the purchase price for the shares and certain distributions upon Crescent Real Estate's liquidation. Excess shares will be subject to repurchase by Crescent Real Estate at its election. While the ownership limit helps preserve Crescent Real Estate's status as a REIT, it could also delay or prevent any person or small group of persons from acquiring, or attempting to acquire, control of Crescent Real Estate and, therefore, could adversely affect Crescent Real Estate's shareholders' ability to realize a premium over the then-prevailing market price for their shares. CRESCENT REAL ESTATE'S INSURANCE COVERAGE ON ITS PROPERTIES MAY BE INADEQUATE. Crescent Real Estate currently carries comprehensive insurance on all of its properties, including insurance for liability, fire and flood. Crescent Real Estate believes this coverage is of the type and amount customarily obtained for or by an owner of real property assets. Crescent Real Estate intends to obtain similar insurance coverage on subsequently acquired properties. Crescent Real Estate's existing insurance policies expire in October 2003. As a consequence of the September 11, 2001 terrorist attacks, Crescent Real Estate may be unable to renew or duplicate its current insurance coverage in adequate amounts or at reasonable prices. In addition, insurance companies may no longer offer coverage against certain types of losses, such as losses due to terrorist acts and toxic mold, or, if offered, the expense of obtaining these types of insurance may not be justified. Crescent Real Estate therefore may cease to have insurance coverage against certain types of losses and/or there may be decreases in the limits of insurance available. If an uninsured loss or a loss in excess of its insured limits occurs, Crescent Real Estate could lose all or a portion of the capital it has invested in a property, as well as the anticipated future revenue from the property, but still remain obligated for any mortgage debt or other financial obligations related to the property. Crescent Real Estate cannot guarantee that material losses in excess of insurance proceeds will not occur in the future. If any of Crescent Real Estate's properties were to experience a catastrophic loss, it could seriously disrupt Crescent Real Estate's operations, delay revenue and result in large expenses to repair or rebuild the property. Also, due to inflation, changes in codes and ordinances, environmental considerations and other factors, it may not be feasible to use insurance proceeds to replace a building after it has been damaged or destroyed. Events such as these could adversely affect Crescent Real Estate's results of operations and its ability to meet its obligations, including distributions to its shareholders. CRESCENT REAL ESTATE IS DEPENDENT ON ITS KEY PERSONNEL WHOSE CONTINUED SERVICE IS NOT GUARANTEED. To a large extent Crescent Real Estate is dependent on its executive officers, particularly John C. Goff, Vice Chairman of the Board of Trust Managers and Chief Executive Officer and Richard E. Rainwater, Chairman of the Board of Trust Managers, for strategic business direction and real estate experience. While Crescent Real Estate believes that it could find replacements for its key personnel, loss of their services could adversely affect Crescent Real Estate's operations. Crescent Real Estate does not have key man life insurance for its executive officers. 45 COMPARATIVE PER SHARE MARKET PRICE INFORMATION Crescent Real Estate's common shares are traded on the NYSE under the symbol "CEI," and Crescent Operating's common stock is traded on the OTC Bulletin Board under the symbol "COPI.OB." On February 13, 2002, the last full trading day prior the date of the execution of the original Settlement Agreement, the closing sale price per Crescent Real Estate common share on the NYSE, the closing sale price per share of Crescent Operating common stock on the OTC Bulletin Board and the equivalent per share price were as set forth in the table below. The equivalent per share price is the value of the Crescent Real Estate common shares that Crescent Operating stockholders will receive for each share of Crescent Operating stock they own if the Crescent Operating stockholders approve the Crescent Operating bankruptcy plan, assuming that the total claims and expenses paid by Crescent Real Estate in connection with the Crescent Operating bankruptcy agreement and the reorganization transactions is $10.6 million to $13.8 million. The actual number of the Crescent Real Estate common shares that Crescent Operating stockholders will receive will be based on the average of the closing prices of the Crescent Real Estate common shares on the ten trading days prior to the date of confirmation of the Crescent Operating bankruptcy plan. In addition, the value of the Crescent Real Estate common shares that Crescent Operating stockholders will receive may be decreased or increased, but will not be less than $0.20 per share of Crescent Operating common stock if the bankruptcy plan is accepted by the Crescent Operating stockholders and confirmed by the bankruptcy court. See "The Reorganization Transactions -- Summary of the Reorganization Transactions -- Issuance of Crescent Real Estate Common Shares to Crescent Operating Stockholders" for a description of the circumstances under which the value of the Crescent Real Estate common shares that Crescent Operating stockholders will receive may be decreased or increased. EQUIVALENT PER SHARE PRICE -------------------------------------------------- CRESCENT REAL CRESCENT ASSUMING $10.6 MILLION ASSUMING $13.8 ESTATE OPERATING IN CRESCENT REAL MILLION IN CRESCENT COMMON SHARES COMMON STOCK ESTATE EXPENSES REAL ESTATE EXPENSES ------------- ------------ --------------- -------------------- February 13, 2002 $17.25 $0.01 $0.50 $0.20 SELECTED HISTORICAL FINANCIAL INFORMATION OF CRESCENT REAL ESTATE The following table sets forth selected historical financial and operating information for Crescent Real Estate on a consolidated basis. All information relating to Crescent Real Estate common shares has been adjusted to reflect the two-for-one stock split effected in the form of a 100% share dividend paid on March 26, 1997 to shareholders of record on March 20, 1997. The selected balance sheet information and operating data for the nine months ended September 30, 2002 and 2001 is based on the unaudited financial statements of Crescent Real Estate included in this proxy statement/prospectus. The selected balance sheet information for each of the two years ended December 31, 2000 and 2001, and the operating data for the three years ended December 31, 1999, 2000 and 2001 is based on the audited financial statements of Crescent Real Estate included in this proxy statement/prospectus, and the information for the preceding years is based on the audited financial statements of Crescent Real Estate 46 previously filed with the Securities and Exchange Commission. The following information should be read in conjunction with "Crescent Real Estate Management's Discussion and Analysis of Financial Condition and Results of Operations" and the historical financial statements of Crescent Real Estate and notes to the financial statements included in this proxy statement/prospectus. YEAR ENDED NINE MONTHS ENDED SEPTEMBER 30, DECEMBER 31, --------------------------------- ------------- 2002 2001 2001 ------------- ------------- ------------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) OPERATING DATA: Total revenue $ 760,191 $ 537,181 $ 686,194 Operating (loss) income 28,650 66,235 (29,923) Income before minority interests, income taxes, discontinued operations, extraordinary item and cumulative effect of a change in accounting principle 68,277 103,687 25,733 Basic earnings per common share: (Loss) income before extraordinary item, discontinued operations and cumulative effect of a change in accounting principle $ 0.41 $ 0.63 $ (0.08) Net (Loss) income 0.37 0.54 (0.17) Diluted earnings per common share: (Loss) income before discontinued operations, extraordinary item and cumulative effect of a change in accounting principle $ 0.41 $ 0.62 $ (0.08) Net (Loss) income 0.37 0.53 (0.17) BALANCE SHEET DATA (AT PERIOD END): Total assets $ 4,341,111 $ 4,139,905 $ 4,142,149 Total debt 2,412,544 2,083,930 2,214,094 Total shareholders' equity 1,431,939 1,594,912 1,405,940 OTHER DATA: Funds from operations - new definition(1) $ 167,344 $ 216,585 $ 177,117 Cash distribution declared per common share $ 1.125 $ 1.475 $ 1.85 Weighted average common shares and units outstanding - basic 104,526,572 108,170,259 121,017,605 Weighted average common shares and units outstanding - diluted 105,041,173 110,011,558 122,544,421 Cash flow provided by (used in): Operating activities $ 152,706 $ 253,817 $ 212,813 Investing activities 106,012 166,593 209,994 Financing activities (212,361) (426,213) (425,488) YEAR ENDED DECEMBER 31, ---------------------------------------------------------------------------- 2000 1999 1998 1997 ------------- ------------- ------------- ------------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) OPERATING DATA: Total revenue $ 707,480 $ 734,448 $ 698,343 $ 447,373 Operating (loss) income 86,524 (59,063) 143,893 111,281 Income before minority interests, income taxes, discontinued operations, extraordinary item and cumulative effect of a change in accounting principle 299,692 9,234 183,210 135,024 Basic earnings per common share: (Loss) income before extraordinary item, discontinued operations and cumulative effect of a change in accounting principle $ 2.05 $ (0.09) $ 1.26 $ 1.25 Net (Loss) income 2.05 (0.06) 1.26 1.25 Diluted earnings per common share: (Loss) income before discontinued operations, extraordinary item and cumulative effect of a change in accounting principle $ 2.02 $ (0.09) $ 1.21 $ 1.20 Net (Loss) income 2.02 (0.06) 1.21 1.20 BALANCE SHEET DATA (AT PERIOD END): Total assets $ 4,543,318 $ 4,950,561 $ 5,043,447 $ 4,179,980 Total debt 2,271,895 2,598,929 2,318,156 1,710,125 Total shareholders' equity 1,731,327 2,056,774 2,422,545 2,197,317 OTHER DATA: Funds from operations - new definition(1) $ 326,897 $ 340,777 $ 341,713 $ 214,396 Cash distribution declared per common share $ 2.20 $ 2.20 $ 1.86 $ 1.37 Weighted average common shares and units outstanding - basic 127,535,069 135,954,043 132,429,405 106,835,579 Weighted average common shares and units outstanding - diluted 128,731,883 137,891,561 140,388,063 110,973,459 Cash flow provided by (used in): Operating activities $ 275,715 $ 336,060 $ 299,497 $ 211,714 Investing activities 428,306 (205,811) (820,507) (2,294,428) Financing activities (737,981) (167,615) 564,680 2,123,744 ____________________________________ (1) Funds from operations, or FFO, based on the revised definition adopted by the Board of Governors of the National Association of Real Estate Investment Trusts, or NAREIT, effective January 1, 2000, and as used herein, means net income (loss), determined in accordance with GAAP, excluding gains (losses) from sales of depreciable operating property, excluding extraordinary items, as defined by GAAP, plus depreciation and amortization of real estate assets, and after adjustments for unconsolidated partnerships and joint ventures. FFO is a non-GAAP measure and should not be considered an alternative to GAAP measures, including net income and cash generated from operating activities. For a more detailed definition and description of FFO and comparisons to GAAP measures, see "Crescent Real Estate Management's Discussion and Analysis of Financial Condition and Results of Operations." 47 SELECTED HISTORICAL FINANCIAL INFORMATION OF CRESCENT OPERATING The following table sets forth certain selected historical financial information for Crescent Operating and for its predecessors, taken as a group. For purposes of this table, the predecessors consist of Moody-Day, Inc. and Hicks Muse Tate & First Equity Fund II, L.P., which are collectively referred to as the Carter-Crowley Asset Group. The selected balance sheet information and operating data for the nine months ended September 30, 2002 and 2001 is based on the unaudited financial statements included in this proxy statement/prospectus. The selected balance sheet information for each of the two years ended December 31, 2000 and 2001, and the operating data for the three years ended December 31, 1999, 2000 and 2001 is based on the audited financial statements of Crescent Operating included in this proxy statement/prospectus, and the information for the preceding years is based on the audited financial statements of Crescent Operating previously filed with the Securities and Exchange Commission. The following information should be read in conjunction with "Crescent Operating Management's Discussion and Analysis of Financial Condition and Results of Operations" and the historical financial statements of Crescent Operating and notes to the financial statements included in this proxy statement/prospectus. CARTER-CROWLEY ASSET GROUP (PREDECESSORS) -------------- FOR THE FOR THE PERIOD PERIOD FROM FROM FOR THE NINE MONTHS FOR THE YEAR ENDED MAY 9, 1997 JANUARY 1, ENDED SEPTEMBER 30, DECEMBER 31, TO 1997 TO ----------------------- ------------------------------------------------ DECEMBER 31, MAY 8 2002 2001 2001 2000 1999 1998 1997 1997 -------- --------- --------- --------- --------- --------- --------- ------ (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) OPERATING DATA: Revenues $ 25,992 $ 50,884 $ 67,521 $ 102,591 $ 97,615 $ 80,754 $ 19,600 $4,657 (Loss) income from operations (6,059) (19,937) (22,893) 1,027 2,440 2,734 (556) 158 Net income (loss) 10,208 (43,439) (78,133) (3,690) (2,695) 1,141 (22,165) 25 Income (Loss) per share - basic and diluted 0.95 (4.20) (7.55) (0.36) (0.26) 0.10 (2.00) -- BALANCE SHEET DATA: Total assets $ 61,548 $ 988,544 $ 945,404 $ 910,528 $ 795,653 $ 937,333 $ 602,083 -- Total debt 93,440 592,462 587,110 473,517 421,874 371,139 258,129 -- Total shareholders' (80,022) (57,286) (93,388) (23,533) (20,522) (16,068) (8,060) -- deficit SELECTED PRO FORMA FINANCIAL AND OPERATING INFORMATION OF CRESCENT REAL ESTATE The following table sets forth selected pro forma financial and operating information for Crescent Real Estate for the nine months ended September 30, 2002 and for the year ended December 31, 2001. The pro forma financial and operating information gives effect to: 48 - the transfer to some of Crescent Real Estate's subsidiaries of Crescent Operating's lessee interests in Crescent Real Estate's eight resort/hotel properties, Crescent Operating's voting interests in three of Crescent Real Estate's residential development corporations and other assets owned by Crescent Operating; - the capitalization of Crescent Spinco, a newly formed company that will commit to purchase Crescent Operating's interest in COPI Cold Storage, L.L.C., which owns a 40% partnership interest in the owner of AmeriCold Logistics, and the distribution of the common stock of Crescent Spinco to Crescent Real Estate shareholders and the unitholders of Crescent Real Estate's operating partnership; - the issuance of Crescent Real Estate's common shares to the stockholders of Crescent Operating in connection with a prepackaged bankruptcy plan of Crescent Operating; - Crescent Real Estate's April 2002 notes offering and the application of net proceeds thereof; - Crescent Real Estate's April 2002 Series A Preferred share offering and the application of proceeds thereto; and - Crescent Real Estate's May 2002 offering of its Series B Cumulative Redeemable Preferred Shares and the application of $81.9 million in net proceeds thereof. The pro forma financial and operating information set forth below should be read in conjunction with, and is qualified in its entirety by, the historical and pro forma financial statements and notes to the financial statements of Crescent Real Estate included in this proxy statement/prospectus. NINE MONTHS ENDED YEAR ENDED SEPTEMBER 30, DECEMBER 31, 2002 2001 ------------ ---------- OPERATING DATA Total revenue $ 853,714 $1,138,968 Operating income (loss) 24,746 (36,715) Income before minority interests 62,403 16,446 Basic earnings per common share: Income (loss) before extraordinary item, discontinued operations and cumulative effect of change in accounting principle $ 0.34 $ (0.30) Diluted earnings per common share: Income (loss) before extraordinary item and cumulative effect of change in accounting principle $ 0.34 $ (0.30) BALANCE SHEET DATA (AT PERIOD END): Total assets $ 4,341,111 N/A Total debt 2,428,044 N/A Total shareholders' equity 1,418,595 N/A Weighted average common shares outstanding - basic 104,670,322 N/A Weighted average common shares outstanding - diluted 105,184,923 N/A 49 COMPARATIVE PER SHARE DATA Set forth below are historical and pro forma earnings per share, cash dividends per share and book value per share data for Crescent Real Estate's common shares and Crescent Operating's common stock. The data set forth below should be read in conjunction with Crescent Real Estate's and Crescent Operating's audited financial statements, including the notes to the financial statements, which are included in this proxy statement/prospectus. The data should also be read in conjunction with the unaudited pro forma financial statements, including the notes to the pro forma financial statements, included in this proxy statement/prospectus. The pro forma data gives effect to: - the transfer to some of Crescent Real Estate's subsidiaries of Crescent Operating's lessee interests in Crescent Real Estate's eight resort/hotel properties, Crescent Operating's voting interests in three of Crescent Real Estate's residential development corporations and other assets owned by Crescent Operating; - the capitalization of Crescent Spinco, which will commit to purchase Crescent Operating's interest in COPI Cold Storage, L.L.C., which owns a 40% partnership interest in the owner of AmeriCold Logistics and the distribution of the common stock of Crescent Spinco to Crescent Real Estate shareholders and the unitholders of Crescent Real Estate's operating partnership; - the issuance of Crescent Real Estate's common shares to the stockholders of Crescent Operating in connection with a prepackaged bankruptcy plan of Crescent Operating; - Crescent Real Estate's April 2002 notes offering and the application of net proceeds thereof; - Crescent Real Estate's April 2002 Series A Preferred share offering and the application of proceeds thereto; and - Crescent Real Estate's May 2002 offering of its Series B Cumulative Redeemable Preferred Shares and the application of $81.9 million in net proceeds thereof. The pro forma data are not necessarily indicative of the actual financial position that would have occurred, or future operating results that will occur, upon consummation of the Crescent Operating bankruptcy plan. NINE MONTHS ENDED YEAR ENDED SEPTEMBER 30, DECEMBER 31, 2002 2001 HISTORICAL -- CRESCENT REAL ESTATE Basic earnings per share $ 0.34 $ (0.17) Diluted earnings per share 0.34 (0.17) Cash dividends per share(1) 1.125 1.85 HISTORICAL -- CRESCENT OPERATING Basic earnings per share $ 0.95 $ (7.55) Diluted earnings per share 0.95 (7.55) Cash dividends per share -- -- PRO FORMA COMBINED(2) Basic earnings per share $ 0.09 $ (0.37) Diluted earnings per share 0.09 (0.37) Cash dividends paid per share 1.125 1.85 Equivalent per Crescent Operating share .015 .025 STOCKHOLDERS' EQUITY (BOOK VALUE) PER SHARE (END OF PERIOD) Historical Crescent Real Estate $ 15.42 $ 16.34 Historical Crescent Operating (7.39) (8.99) Pro forma combined per Crescent Real Estate share (2) 15.40 N/A Equivalent pro forma combined per Crescent Operating share 0.20 N/A ------------------ (1) On October 17, 2001, Crescent Real Estate announced that its quarterly distribution was reduced from $0.55 per common share to $0.375 per common share. See "Price Range of Crescent Real Estate Common Shares, Dividends and Related Shareholder Matters" for more information regarding Crescent Real Estate's distributions. (2) The pro forma combined per share data for Crescent Real Estate has been prepared as if the Crescent Operating bankruptcy plan and other transactions had been consummated as of January 1, 2001, and resulted in an increase in weighted average Crescent Real Estate common shares outstanding of 143,750 shares for the nine months ended September 30, 2002 and year ended December 31, 2001. 50 THE SPECIAL MEETING OF CRESCENT OPERATING STOCKHOLDERS PROXY STATEMENT/PROSPECTUS This proxy statement/prospectus is being furnished to you in connection with the solicitation of proxies by Crescent Operating's sole director in connection with the Crescent Operating bankruptcy plan. This proxy statement/prospectus is first being furnished to Crescent Operating stockholders on or about January __, 2003. Before voting to accept or reject the Crescent Operating bankruptcy plan, each Crescent Operating stockholder should carefully review the Plan of Reorganization attached as Annex A and described below under "The Plan of Reorganization." All descriptions of the Crescent Operating bankruptcy plan that are contained in this proxy statement/prospectus are subject to the terms and conditions of the Plan of Reorganization attached as Annex A. Instructions for voting on the Crescent Operating bankruptcy plan are set forth in the instructions contained in the enclosed proxy. DATE, TIME, AND PLACE OF SPECIAL MEETING Crescent Operating will hold its special meeting of stockholders at The Fort Worth Club, located at 306 West 7th Street, Fort Worth, Texas, on Thursday, March 6, 2003, at 10:00 a.m. Central Time. PURPOSE OF THE SPECIAL MEETING The special meeting is being held so that Crescent Operating stockholders may consider and vote upon the proposal to accept the Crescent Operating bankruptcy plan. The bankruptcy plan provides as follows: - Crescent Real Estate Equities Company will make sufficient funds available to Crescent Operating to pay in full or otherwise resolve those creditor claims of Crescent Operating that Crescent Operating identified in the original Settlement Agreement, other than the Crescent Real Estate claims, and to cover the budgeted expenses of implementing the Settlement Agreement and 51 seeking to confirm the bankruptcy plan. To facilitate Crescent Operating's repayment of $15.0 million, plus interest, that it owes to Bank of America, Crescent Real Estate has allowed Crescent Operating to secure the Bank of America debt with a pledge of Crescent Operating's interest in AmeriCold Logistics, LLC. The Settlement Agreement and the bankruptcy plan contemplate that Crescent Spinco, an affiliate of Crescent Real Estate, will purchase Crescent Operating's interest in AmeriCold Logistics for between $15.0 to $15.5 million. - If Crescent Operating's stockholders accept the bankruptcy plan and the bankruptcy court confirms the bankruptcy plan, Crescent Real Estate will issue common shares of Crescent Real Estate to the Crescent Operating stockholders. In no event will the Crescent Operating stockholders be entitled to reconsider their approval of the bankruptcy plan. - The total value of the Crescent Real Estate common shares that the Crescent Operating stockholders would receive would be the greater of: - Approximately $2.16 million; or - $16.0 million minus the total amount of payments made by Crescent Real Estate for claims and expenses relating to the Crescent Operating bankruptcy and the reorganization transactions, including the expenses of Crescent Real Estate but excluding payments in satisfaction of the Bank of America claim. - As of December 31, 2002, Crescent Real Estate had incurred approximately $8.5 million in claims and expenses and expects to incur an aggregate of $10.6 million to $13.8 million in total claims and expenses. If there occurs a material variance in this estimated range of aggregate claims and expenses after the date that Crescent Operating mails this proxy statement/prospectus to its stockholders, then Crescent Operating will issue a press release disclosing the material variance and will file a Current Report on Form 8-K with the Securities and Exchange Commission disclosing the same information. - If the Crescent Operating stockholders accept the bankruptcy plan and the bankruptcy court confirms the bankruptcy plan, the stockholders will be deemed to have released all claims they may have against Crescent Operating and Crescent Real Estate, as well as their respective officers, directors, stockholders, employees, consultants, attorneys, accountants and other representatives, that arose prior to the effective date of the bankruptcy plan. The release of Crescent Operating stockholder claims will not apply to the claims, if any, of a person who sold its shares of Crescent Operating common stock before the record date for voting on the bankruptcy plan or who either voted against the bankruptcy plan, abstained or did not vote on the bankruptcy plan, and thereafter either did not receive or refused to accept a distribution of Crescent Real Estate common shares. In addition, the release of Crescent Operating stockholder claims will apply to Crescent Operating stockholders only in their capacity as Crescent Operating stockholders, and will not affect their rights as holders of Crescent Real Estate common shares. The Crescent Operating common stock will be cancelled. If the Crescent Operating stockholders reject the bankruptcy plan, the Crescent Operating stockholders will receive no distribution under the bankruptcy plan and will not be deemed to have released any claims. The Settlement Agreement and the mutual releases executed in connection with the Settlement Agreement, including Crescent Operating's release of all claims that it may have against Crescent Real Estate, are enforceable whether or not the bankruptcy plan is approved by Crescent Operating's stockholders and whether or not the bankruptcy plan is confirmed by the bankruptcy court. 52 - Pursuant to both the Settlement Agreement and the bankruptcy plan, Crescent Operating will transfer the remaining assets of Crescent Operating at the direction of Crescent Real Estate. STOCKHOLDER RECORD DATE FOR THE SPECIAL MEETING Only stockholders of record as the close of business on the record date, January 8, 2003, are entitled to notice of, and to vote at, the special meeting. At the record date, 10,828,497 shares of Crescent Operating common stock were issued, outstanding and entitled to vote at the special meeting. Each outstanding share is entitled to one vote. The enclosed proxy card shows the number of shares of Crescent Operating common stock that the recipient of the proxy card is entitled to vote. Shares cannot be voted at the special meeting unless the holder thereof is present or represented by proxy. VOTE OF CRESCENT OPERATING STOCKHOLDERS REQUIRED FOR ACCEPTANCE OF THE CRESCENT OPERATING BANKRUPTCY PLAN A majority of the outstanding shares of Crescent Operating common stock entitled to vote is necessary to constitute a quorum for the transaction of business at the special meeting. The affirmative vote of two-thirds of the votes cast in person or by proxy is required to accept the Crescent Operating bankruptcy plan. Each holder of common stock is entitled to one vote at the special meeting for each share of Crescent Operating common stock held by such stockholder. PROXIES A proxy for use at the special meeting and a return envelope are enclosed. Shares of Crescent Operating's common stock represented by a properly executed written proxy and delivered pursuant to this solicitation, and not later revoked, will be voted at the special meeting in accordance with the instructions indicated in such proxy. If no instructions are given, the properly executed proxy will be voted "FOR" acceptance of the Crescent Operating bankruptcy plan. In addition, you may vote your proxy by touchtone telephone from the U.S. and Canada, using the toll-free telephone number on the proxy card and other enclosures. "Street name" holders may vote by telephone if their bank or broker makes those methods available, in which case the bank or broker will enclose the instructions with the proxy statement. The telephone voting procedures, including the use of control numbers, are designed to authenticate share owners' identities, to allow share owners to vote their shares, and to confirm that their instructions have been properly recorded. All stockholders whose shares are not held in "street name" may vote in person at the special meeting. If your broker holds your shares in "street name," your broker will not be able to vote your shares for you unless you provide instructions to your broker on how to vote your "street name" shares. You should follow the directions provided by your broker regarding how to instruct your broker to vote your shares. If you do not instruct your broker to vote in favor of or against the Crescent Operating bankruptcy plan, your broker will not be able to vote for you, and your shares will not be voted. Once you have instructed your broker on how to vote your shares, you may revoke your proxy or change your vote only by following the instructions provided by your broker. A stockholder who has voted and who does not hold his shares in "street name" may change his vote at any time prior to the taking of the vote at the special meeting: - by giving written notice of revocation to the secretary of the special meeting; 53 - only if the prior vote was by written proxy, by properly submitting a duly executed proxy bearing a later date; - only if the prior vote was by telephone, by casting a subsequent vote by telephone prior to the special meeting; or - by voting in person at the special meeting. Only the last vote of a stockholder will be counted. All written notices of revocation should be addressed as follows: Crescent Operating, Inc., 777 Main Street, Suite 1240, Fort Worth, Texas 76102, Attention: Jeffrey L. Stevens. PROXY SOLICITATION Crescent Real Estate has agreed to pay all reasonable documented out-of-pocket expenses incurred by Crescent Operating or its subsidiaries through the date on which the Crescent Operating bankruptcy plan is confirmed, subject to certain limitations described in "The Reorganization Transactions." As a result, all costs of preparing, assembling and mailing proxy solicitation materials as well as the costs of the proxy solicitation will be borne by Crescent Real Estate. These costs will be included with other reorganization costs in the formula used to determine the number of Crescent Real Estate common shares to be distributed to the stockholders of Crescent Operating under the Crescent Operating bankruptcy plan. See "Summary - Summary of the Reorganization Transactions" above. Crescent Operating has engaged an independent proxy solicitor, D.F. King & Co., Inc., to assist in solicitation of proxies. Under its engagement agreement, D.F. King will receive approximately $10,000 in fees, plus $5.00 per soliciting phone call to stockholders, plus expense reimbursements, all of which will ultimately be borne by Crescent Real Estate. Crescent Operating has also made arrangements with brokerage firms, banks, nominees and other fiduciaries to forward proxy solicitation materials for shares held of record by them to the beneficial owners of such shares and to obtain the proxies of such beneficial holders. Crescent Real Estate will reimburse such persons for postage and reasonable clerical expenses incurred in connection with forwarding such materials and obtaining proxies. EFFECT OF ABSTENTIONS AND BROKER NON-VOTES Under Delaware law and Crescent Operating's bylaws, a majority of the outstanding shares of Crescent Operating common stock entitled to vote is necessary to constitute a quorum for the transaction of business at the special meeting. The affirmative vote of two-thirds of the votes cast in person or by proxy is required to accept the Crescent Operating bankruptcy plan. As a result, abstentions and broker non-votes will have no effect on the outcome of the vote on such proposal. THE REORGANIZATION TRANSACTIONS REASONS FOR THE REORGANIZATION TRANSACTIONS Crescent Operating and its operating units have defaulted in the payments of debts to Crescent Real Estate. As of February 12, 2002, these debts were approximately $125.2 million and are secured by substantially all of Crescent Operating's assets. These debts arose from loans made by Crescent Real Estate to Crescent Operating and from deferrals by Crescent Real Estate of Crescent Operating's obligations to pay rent. 54 On February 12, 2002 and February 13, 2002, Crescent Real Estate notified Crescent Operating that each of Crescent Operating's obligations to Crescent Real Estate was in default. Moreover, Crescent Real Estate announced that it would seek to enforce collection by foreclosure or otherwise of its claims against Crescent Operating and its operating units as quickly as possible. Crescent Operating lacked sufficient liquidity or capital resources to address the issues arising from the defaults that Crescent Real Estate had declared. Crescent Operating's operating income had been at or less than the amount necessary to pay direct operating expenses. Based upon then current and reasonably forecasted operating results, Crescent Operating did not believe that it would, in the reasonably foreseeable future, be able to pay all of its obligations as they accrued. Likewise, it would not be able to repay the obligations to Crescent Real Estate as to which a default had been declared. Crescent Operating analyzed various alternatives for resolution of the Crescent Real Estate obligations, including a foreclosure or bankruptcy proceeding. For a description of the various alternatives examined by Crescent Operating, please see "-- Analysis of Alternatives." Neither of these options would have likely resulted in any recovery for Crescent Operating's unsecured creditors and stockholders. In addition, these proceedings would have been costly and time consuming. Moreover, Crescent Real Estate would likely have opposed any attempt by Crescent Operating to use its cash collateral to pay the costs of a bankruptcy proceeding other than to maintain Crescent Real Estate's collateral. Accordingly, Crescent Operating and Crescent Real Estate determined it would be in each of its respective best interests to negotiate an alternative settlement. An alternative that became available to the parties only after the effectiveness of the REIT Modernization Act on January 1, 2001 was Crescent Real Estate's acquisition of the Crescent Operating hotel operations and land development interests. Crescent Real Estate previously was unable to lease or own these interests without jeopardizing its status as a REIT for federal income tax purposes. After extensive negotiations and discussions, Crescent Operating and Crescent Real Estate agreed to the Settlement Agreement and Crescent Operating bankruptcy plan. The bankruptcy plan is attractive to Crescent Operating as it provides that consideration will be delivered to all of Crescent Operating's unsecured creditors identified by Crescent Operating in the original Settlement Agreement, as well as to the Crescent Operating stockholders. For Crescent Real Estate, the Settlement Agreement and bankruptcy plan enabled Crescent Real Estate to obtain the assets of Crescent Operating securing the Crescent Operating obligations in a quick and efficient manner, without litigation. As essential consideration for its agreement to enter into the Settlement Agreement, Crescent Real Estate required the execution of a mutual release between Crescent Real Estate and Crescent Operating. Pursuant to this release, Crescent Operating released Crescent Real Estate and its affiliates from any and all claims that Crescent Operating might have that arose at any time prior to the execution of the Settlement Agreement. This release also provides that Crescent Real Estate has released Crescent Operating and its affiliates from any and all claims that it may have that arose at any time prior to the execution of the Settlement Agreement. Furthermore, as essential consideration for its agreement to enter into the Settlement Agreement, Crescent Real Estate required that the bankruptcy plan include a provision that Crescent Operating stockholders who vote to accept the bankruptcy plan or who accept the distribution of Crescent Real Estate common shares under the bankruptcy plan, will be deemed to have released Crescent Real Estate and its affiliates from any and all claims that may have arisen on or before the effective date of the bankruptcy plan, except for performance or non-performance under the Settlement Agreement or the bankruptcy plan and except for any act or omission that constitutes actual fraud or criminal behavior. Prior to entering into the Settlement Agreement, Crescent Operating analyzed whether it had claims against Crescent Real Estate that should be pursued as an alternative to the proposed Settlement Agreement. Crescent Operating consulted its counsel who reviewed, among other matters, the origin of 55 the indebtedness to Crescent Real Estate and the business relationship between Crescent Operating and Crescent Real Estate that began in 1997 when the shares of Crescent Operating common stock were distributed to Crescent Real Estate shareholders. Crescent Operating independently evaluated whether the benefit to Crescent Operating stockholders in consummating the Settlement Agreement outweighed the benefit that might be derived from declining the proposed Settlement Agreement and instead pursuing claims against Crescent Real Estate. In making this evaluation, Crescent Operating took into consideration the relative certainty of its creditors and stockholders realizing the benefits provided for in the Settlement Agreement and the relative uncertainty of recovery in, as well as the costs and delay associated with, prosecuting any claims, and particularly claims of uncertain merit. Based upon the totality of all the circumstances, Crescent Operating made the independent judgment that the best interests of its creditors and stockholders would be served by entering into the Settlement Agreement. Crescent Operating concluded that the benefits to its creditors and stockholders that would be realized through the Settlement Agreement outweighed the cost to Crescent Operating of granting the releases to Crescent Real Estate. After giving effect to the transfer of Crescent Operating's hospitality and land development assets and the reduction in Crescent Operating's debt under the terms of the Settlement Agreement, the outstanding amounts that Crescent Operating owed to Crescent Real Estate as of September 30, 2002, totaled $68.5 million. This amount consists of $23.7 million of deferred rent obligations and $44.8 million of principal and accrued interest. SUMMARY OF THE REORGANIZATION TRANSACTIONS The Settlement Agreement, dated as of February 14, 2002 and amended as of October 1, 2002, between Crescent Partnership, Crescent Real Estate, Crescent Operating and certain subsidiaries of Crescent Operating, contains the basic structure of the reorganization transactions. The Settlement Agreement provides for a "pre-packaged" bankruptcy of Crescent Operating on the terms set forth in the Settlement Agreement and the Plan of Reorganization. The Settlement Agreement and the mutual releases executed in connection with the Settlement Agreement, including Crescent Operating's release of all claims it may have against Crescent Real Estate, are effective and enforceable, and Crescent Real Estate is obligated to assist Crescent Operating in resolving creditor claims identified by Crescent Operating in the original Settlement Agreement, only if the bankruptcy plan is confirmed by the bankruptcy court. Similarly, the Settlement Agreement provides that distributions to Crescent Operating stockholders will be made only if Crescent Operating stockholders accept the bankruptcy plan and the bankruptcy plan is confirmed. Effective October 1, 2002, Crescent Operating and Crescent Real Estate amended the Settlement Agreement. The amendment provides for, among other things, a minimum value of Crescent Real Estate common shares to be issued in connection with the bankruptcy plan if the bankruptcy plan is accepted by the requisite vote of Crescent Operating stockholders and the bankruptcy court confirms the bankruptcy plan. The following summarizes the principal reorganization transactions provided for in the Crescent Operating bankruptcy plan and the Settlement Agreement and is not intended to be complete. You should refer to the Plan of Reorganization attached as Annex A and the Settlement Agreement attached as Annex B for a complete description of the provisions of the Crescent Operating bankruptcy plan. Transfer of Assets Under the Crescent Operating loans, Crescent Real Estate had a security interest in substantially all of Crescent Operating's assets and was entitled to exercise its rights under the loans and related pledge agreements upon a default by Crescent Operating under the loans. The assets pledged to Crescent Real Estate included the Crescent Operating hotel operations and the Crescent Operating land development 56 interests. Crescent Real Estate was entitled to terminate the leases of the hotel properties upon a default under the leases. Crescent Real Estate notified Crescent Operating that it was in default under the loans and the leases. Hospitality Assets. Pursuant to the Settlement Agreement, in lieu of a foreclosure by Crescent Real Estate on these equity interests, the lessees of the hotel properties, all of which are wholly owned subsidiaries of Crescent Operating, agreed to transfer the Crescent Operating hotel operations to Crescent Real Estate in exchange for cancellation of an aggregate amount of rental payments due to Crescent Real Estate equal to the agreed upon value of the transferred assets, or $23.6 million. The Crescent Operating hotel operations include all of the hotel property leases and all business contracts, licenses, furniture, fixtures and equipment, cash and intellectual property relating to the hospitality business. Crescent Operating also agreed to cooperate with Crescent Real Estate to assure the transfer of all of the assets relating to the hospitality business to Crescent Real Estate. Crescent Real Estate has not agreed to assume obligations or liabilities of the lessees that arose prior to the date of the transfer, and has not waived its rights to seek collection in bankruptcy of the remaining $25.4 million in unpaid rent due to Crescent Real Estate. As of the date hereof, all of the assets associated with the businesses of the following hotel properties, constituting all of Crescent Operating's hospitality assets, have been transferred to Crescent Real Estate in lieu of foreclosure: (i) the Denver Marriott, (ii) the Hyatt Regency Beaver Creek, (iii) the Hyatt Regency Albuquerque, (iv) Sonoma Mission Inn & Spa, (v) Ventana Inn & Spa, (vi) Houston Renaissance, (vii) Canyon Ranch - Lenox, and (viii) Canyon Ranch - Tucson. Equity Interests in Residential Land Development and Other Companies. Beginning in 1997 and ending in 2000, pursuant to various credit and security agreements, and a pledge agreement, as amended, Crescent Real Estate made several loans to Crescent Operating which were secured by assets of Crescent Operating. Crescent Operating agreed, under the Settlement Agreement, to consent to Crescent Real Estate's acquisition through strict foreclosure of some of these pledged assets, which included stock, membership interests and partnership interests, in satisfaction of $40.1 million of Crescent Operating debt, as follows: - 500 shares of voting common stock, $.01 par value, of CRL, representing 100% of the issued and outstanding voting capital stock and 5% of the issued and outstanding capital stock of CRL; - a 1.5% membership interest in CR License LLC, an Arizona limited liability company; - 100 shares of common stock, $.01 par value, of WOCOI Investment Company, a Texas corporation, representing 100% of the issued and outstanding capital stock of WOCOI Investment Company; - 500 shares of voting common stock, $.01 par value, of The Woodlands Land Company, Inc., a Texas corporation, representing 100% of the issued and outstanding voting capital stock and 5% of the issued and outstanding capital stock of The Woodlands Land Company; - 50 shares of voting common stock, $.01 par value, of Desert Mountain Development Corporation, a Delaware corporation, representing 100% of the issued and outstanding voting capital stock and 5% of the issued and outstanding capital stock of Desert Mountain Development Corporation; 57 - 10 shares of voting common stock, $.01 par value, of CRE Diversified Holdings, Inc., a Delaware corporation, representing 100% of the issued and outstanding voting capital stock and 1% of the issued and outstanding capital stock of CRE Diversified Holdings; and - Crescent Operating's general partner interest in COPI Colorado, representing a 60% general partner interest in COPI Colorado. Crescent Operating also agreed to cause all of the officers and directors of the corporate entities that are also officers, directors or employees of Crescent Operating to resign or to remove them. As of the date of this proxy statement/prospectus, Crescent Real Estate has acquired the equity interests of all of the entities listed above. As a result, Crescent Real Estate now controls all of those entities. Crescent Real Estate has not agreed to assume obligations or liabilities of those entities that arose prior to the date of the transfer, and has not waived its rights to collection in the bankruptcy of the remaining $36.6 million in unpaid indebtedness at September 30, 2002. The Settlement Agreement provides that Crescent Operating will transfer its remaining assets at the direction of Crescent Real Estate. The bankruptcy plan similarly provides that, in partial satisfaction of Crescent Real Estate's claim, Crescent Operating will transfer its remaining assets at the direction of Crescent Real Estate. Those transfers may be made before or after the bankruptcy plan is filed or confirmed. Crescent Operating and Crescent Real Estate contemplate that all transfers will be complete on or about the effective date of the bankruptcy plan. The transfers will be made to Crescent Real Estate or its affiliates in partial satisfaction of Crescent Operating's debts to Crescent Real Estate. In the event that Crescent Operating receives a distribution in the Crescent Machinery bankruptcy or retains its interest in Crescent Machinery prior to the effective date of the bankruptcy plan, Crescent Real Estate is likely to elect to have Crescent Operating transfer the distribution or interest to Crescent Real Estate. Bankruptcy Plan Pursuant to the Settlement Agreement, Crescent Operating has agreed to file a petition under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware, or such other jurisdiction as Crescent Real Estate and Crescent Operating shall agree, as soon as practicable after the date of the special meeting. On the same date, Crescent Operating will file with the bankruptcy court the Plan of Reorganization in such form attached as Annex A, this proxy statement/prospectus and all other related disclosure and solicitation materials delivered to the Crescent Operating stockholders and impaired creditors in connection with this solicitation. Crescent Operating has agreed to seek approval of this proxy statement/prospectus and other disclosure and solicitation materials, and confirmation of the Crescent Operating bankruptcy plan, within 45 days after filing the petition with the bankruptcy court. Payment by Crescent Real Estate of Crescent Operating Claims and Expenses Pursuant to the Settlement Agreement, Crescent Real Estate has agreed to advance funds to Crescent Operating sufficient for Crescent Operating to pay its reasonable and necessary documented out-of-pocket expenses to the extent Crescent Operating is unable to pay them, in accordance with the monthly budget prepared by Crescent Operating. Advances in excess of the budget are at Crescent Real Estate's discretion. A revolving demand note entered into on February 14, 2002, and amended and restated effective as of October 1, 2002, evidences Crescent Real Estate's obligation to advance up to $3.2 million to cover these expenses through September 2002. In addition, Crescent Real Estate has 58 agreed to advance funds to Crescent Operating, under the amended and restated note, in an aggregate amount of up to $2.7 million, to cover specified known contingent obligations. Under the amended and restated note, these contingent obligations are identified as follows: - up to $1,500,000 for federal, state and local taxes and fees that may be required to be paid by Crescent Operating; - up to $700,000 for payments owed by Crescent Operating in connection with its investment in AmeriCold Logistics; and - up to $500,000 for amounts that may become due to Crescent Machinery if a payment by Crescent Machinery to Crescent Operating is determined, in connection with the bankruptcy proceedings of Crescent Machinery, to be a preference payment that Crescent Operating must return to Crescent Machinery; and As of the effective date of the amended and restated note, Crescent Real Estate had advanced the $3.2 million provided for budgeted operating expenses of Crescent Operating, plus an additional $431,000. The additional $431,000 consists of: - $381,000 to cover out-of-pocket expenses that Crescent Operating incurred, as specified in its monthly budget, but requiring an advance from Crescent Real Estate because Crescent Operating has not yet received the return of its $900,000 overpayment to a health insurer that Crescent Operating expected to receive and budgeted for receipt in September 2002; and - $50,000 to cover amounts paid by Crescent Operating to Delaware counsel for its prior services to Crescent Operating. In addition, although the original note provided that Crescent Real Estate would advance up to $1,725,000 to Crescent Operating for its obligations under notes payable to E.L. Lester and Company, Harvey Equipment Center, Inc. and L and H Leasing Company, as payees under the notes, Crescent Real Estate purchased these notes directly from the payees for $1,321,258. This purchase satisfied Crescent Operating's contingent obligation relating to these notes and, accordingly, the up to $1,725,000 Crescent Real Estate had agreed to advance to Crescent Operating to permit it to satisfy the obligation has been eliminated in the amended and restated note. Similarly, the up to $900,000 that Crescent Real Estate had agreed to advance to Crescent Operating if Crescent Operating's overpayment to a health insurer was not returned by September 2002 has been reduced to the $381,000 already advanced. As a result of the advances and changes in circumstances detailed in the two preceding paragraphs, the amended and restated note provides for an aggregate loan in the principal amount of $6,331,000, $3,631,000 of which had been advanced under the note as of December 31, 2002. Crescent Operating's management believes that the aggregate amount specified in the amended and restated note is a "worst case" estimates and expects that the actual payments will be less in the aggregate. Crescent Operating has agreed to seek approval of the bankruptcy court to provide Crescent Real Estate with a priority claim and lien for the funds Crescent Real Estate advances under the amended and restated note. Under the Settlement Agreement, Crescent Real Estate also has agreed, under a separate, secured promissory note entered into effective October 1, 2002, to advance up to $2,900,000 in additional funds to Crescent Operating. Under this secured note, which is a revolving demand note, Crescent Real Estate has 59 agreed to advance funds sufficient for Crescent Operating to pay its reasonable and necessary documented out-of-pocket expenses to the extent Crescent Operating is unable to pay them, in accordance with the monthly budget prepared by Crescent Operating for expenses through March 2003. Other than as described below, advances in excess of $2,000,000 are at Crescent Real Estate's discretion. The secured note is secured by an interest in the $900,000 insurance overpayment expected to be returned to Crescent Operating by a health insurer by March 2003. In addition, Crescent Real Estate has agreed to advance up to an additional $900,000 to Crescent Operating to cover Crescent Operating's budgeted out-of-pocket expenses in the event that the overpayment is not returned to Crescent Operating, or in the event that Crescent Operating, in accordance with the security agreement relating to the return of the overpayment, pays the amount returned to Crescent Real Estate. As Crescent Real Estate advances funds to Crescent Operating to pay for or otherwise resolve claims and expenses in connection with the Crescent Operating bankruptcy and the reorganization transactions, including expenses of Crescent Real Estate, the total value of the Crescent Real Estate common shares to be offered to the Crescent Operating stockholders (assuming that the stockholders accept, and the bankruptcy court confirms, the bankruptcy plan) will decrease, but not below a total value of approximately $2.16 million, or $0.20 per share of Crescent Operating common stock. Crescent Operating believes that, other than claims of trade creditors and other claims associated with the ordinary, day-to-day business operations of Crescent Operating, the only other claims against Crescent Operating are possible liabilities relating to the bankruptcy of Crescent Machinery and the Bank of America claim. The Settlement Agreement provides that, if Crescent Real Estate, in its sole discretion, offers to settle or assume unsecured claims asserted by third parties and not identified by Crescent Operating in the original Settlement Agreement, and Crescent Operating accepts the offer, then the total value of the Crescent Real Estate common shares paid to Crescent Operating stockholders will be reduced (but not below a total value of approximately $2.16 million, or $0.20 per share of Crescent Operating common stock) by the amount agreed to by Crescent Real Estate and Crescent Operating, and approved by the bankruptcy court, as compensation to Crescent Real Estate for assuming the claims. If Crescent Real Estate and Crescent Operating are not able to agree to Crescent Real Estate's assumption of any such unresolved third party claims that were not identified by Crescent Operating in the original Settlement Agreement and that are an obstacle to confirmation of the Crescent Operating bankruptcy plan, then it is possible that the bankruptcy plan will not be confirmed. Payment of Bank of America Claim Crescent Operating is the obligor under a loan from Bank of America in the principal amount of $15.0 million and does not have sufficient funds to repay the obligation. Crescent Real Estate holds a first lien security interest in Crescent Operating's entire membership interest in COPI Cold Storage. Pursuant to the Settlement Agreement, Crescent Real Estate has agreed to allow Crescent Operating to grant Bank of America a first priority security interest in Crescent Operating's entire membership interest in COPI Cold Storage and to subordinate Crescent Real Estate's security interest in COPI Cold Storage to Bank of America. Crescent Real Estate has also agreed to use commercially reasonable efforts to assist Crescent Operating in arranging Crescent Operating's repayment of its $15.0 million obligation to Bank of America, together with up to $0.5 million of accrued interest. Crescent Real Estate will undertake the transactions described below under "-- Spin Off of AmeriCold Logistics Interest to Crescent Real Estate Shareholders," including the formation of a new entity referred to as Crescent Spinco, to be owned by the shareholders of Crescent Real Estate. Crescent Spinco would purchase the AmeriCold Logistics interest. Crescent Operating has agreed that it will use the proceeds of the sale of the AmeriCold Logistics interest to repay Bank of America in full. 60 Spin Off of AmeriCold Logistics Interest to Crescent Real Estate Shareholders and Crescent Partnership Unitholders Pursuant to the Settlement Agreement, Crescent Real Estate will form and capitalize Crescent Spinco, which will file a Form S-1 registration statement with the Securities and Exchange Commission. Crescent Real Estate has committed to cause Crescent Spinco to commit to acquire Crescent Operating's entire membership interest in COPI Cold Storage for between $15.0 to $15.5 million. COPI Cold Storage owns a 40% general partner interest in the owner of AmeriCold Logistics. Upon effectiveness of the Form S-1 registration statement, Crescent Spinco will distribute its shares to the holders of Crescent Real Estate common shares and the unitholders of Crescent Partnership and will purchase Crescent Operating's membership interest in COPI Cold Storage. The distribution of the Crescent Spinco shares will be made to the holders of Crescent Real Estate common shares prior to the issuance of Crescent Real Estate common shares to the Crescent Operating stockholders. As a result, the holders of Crescent Operating common stock will not receive any interest in Crescent Spinco. Issuance of Crescent Real Estate Common Shares to Crescent Operating Stockholders If the Crescent Operating stockholders accept Crescent Operating's bankruptcy plan and the bankruptcy court confirms the bankruptcy plan, Crescent Real Estate will distribute to each holder of Crescent Operating common stock, common shares of Crescent Real Estate equal to the product of: - the number of shares of Crescent Operating common stock owned by the holder on the confirmation date, divided by the number of shares of Crescent Operating common stock outstanding on the confirmation date, and - the consideration amount, as described below, divided by the average of the daily closing prices per Crescent Real Estate common share as reported on the NYSE Composite Transaction reporting system for the 10 consecutive NYSE trading days immediately preceding confirmation of the Crescent Operating bankruptcy plan by the bankruptcy court, but in no event will the value of the distributed common shares of Crescent Real Estate be less than approximately $0.20 per share of Crescent Operating common stock outstanding. Crescent Real Estate will make this distribution to the Crescent Operating stockholders promptly following the effective date of the Crescent Operating bankruptcy plan or the date upon which the bankruptcy plan becomes final, at Crescent Real Estate's election, or as soon thereafter as practicable. The consideration amount will equal the greater of: - approximately $2.16 million; or - $16.0 million minus the total amount of payments made by Crescent Real Estate or claims and expenses relating to the Crescent Operating bankruptcy and the reorganization transactions, including expenses of Crescent Real Estate but excluding payments in satisfaction of the Bank of America claim. Crescent Operating and Crescent Real Estate estimate that Crescent Real Estate will advance the funds to Crescent Operating or pay in full or otherwise resolve claims and expenses related to the Crescent Operating bankruptcy and the reorganization transactions, including Crescent Real Estate expenses but excluding payments in satisfaction of the Bank of America claim, of $10.6 million to $13.8 61 million. These expenses include the payments referred to above in "-- Payment by Crescent Real Estate of Crescent Operating Claims and Expenses." Crescent Operating does not believe that there are any significant claims against Crescent Operating that Crescent Real Estate has not agreed to use commercially reasonable efforts to satisfy, with the exception of the disputed claims of the Crescent Machinery Committee. In addition, Crescent Operating has determined its ongoing cash flow requirements, which are set forth in a budget approved by Crescent Real Estate and attached to the up to approximately $2.9 million secured note payable to Crescent Real Estate by Crescent Operating. As a result, Crescent Operating and Crescent Real Estate believe that the $10.6 million to $13.8 million claims and expenses estimate is based upon reasonable assumptions. However, Crescent Real Estate's actual expenses will depend on a number of factors that may differ, some materially, from these assumptions. As a result, Crescent Operating and Crescent Real Estate cannot assure you that the consideration amount will not be significantly less than the high estimate of $5.4 million. In no event, however, will the Crescent Operating stockholders receive Crescent Real Estate common shares with a total value of less than approximately $2.16 million, or $0.20 per share of Crescent Operating common stock if the bankruptcy plan is accepted by the Crescent Operating stockholders and confirmed by the bankruptcy court. For purposes of the following example, assume that - Crescent Real Estate pays $10.6 million in expenses relating to the Crescent Operating bankruptcy, - the total number of shares of Crescent Operating common stock outstanding is 10,828,497 (the total number of shares of Crescent Operating common stock outstanding at January 8, 2003), and - the average of the daily closing prices per Crescent Real Estate common share as reported on the NYSE Composite Transaction reporting system for the 10 consecutive NYSE trading days immediately preceding confirmation of the Crescent Operating bankruptcy plan by the bankruptcy court is $20.00. Based on the preceding assumptions, Crescent Real Estate will distribute a total of approximately 0.0249 Crescent Real Estate common shares per share of Crescent Operating common stock to Crescent Operating stockholders. Making the same assumptions described in the second and third bullet points above, but assuming that Crescent Real Estate instead pays $13.8 million in expenses relating to the Crescent Operating bankruptcy, Crescent Real Estate will distribute a total of approximately 0.0102 Crescent Real Estate common shares per share of Crescent Operating common stock to Crescent Operating stockholders. As soon as practicable after the effective date, Crescent Real Estate will deposit with the disbursement agent for the Crescent Operating bankruptcy plan, in trust for the holders of shares of Crescent Operating common stock on such date, certificates representing the Crescent Real Estate common shares issuable to the Crescent Operating stockholders. As soon as practicable after the effective date, the disbursement agent shall mail to each record holder of a certificate or certificates that immediately prior to the effective date represented outstanding shares of Crescent Operating common stock, or the Certificates, a letter of transmittal in form reasonably acceptable to Crescent Operating, which shall specify that delivery shall be effected, and risk of loss and title to the Certificates shall pass, only upon actual delivery of the Certificates to the disbursement agent, and shall contain instructions for use in effecting the surrender of the Certificates. Upon surrender for cancellation to the disbursement 62 agent of a Certificate, together with such letter of transmittal, duly executed, the holder of such Certificate shall be entitled to receive a certificate representing that number of Crescent Real Estate common shares, rounded up or down to the nearest whole number, provided for in the Crescent Operating bankruptcy plan, and any Certificate so surrendered shall be canceled. After the confirmation date, there will be no further transfers of Crescent Operating common stock on the stock transfer books of Crescent Operating. Shares of Crescent Operating common stock will be deemed for all corporate purposes to evidence only the right to receive the number of Crescent Real Estate common shares to which the holder is entitled under the Crescent Operating bankruptcy plan. If a certificate representing Crescent Operating common stock is presented for transfer on or after the confirmation date, a certificate representing the appropriate number of whole Crescent Real Estate common shares will be issued in exchange therefor. Cancellation of Crescent Operating Common Stock At the confirmation date of the Crescent Operating bankruptcy, Crescent Operating will close its stock transfer books, and no further transfers of Crescent Operating common stock will be possible. On the date on which the Crescent Operating bankruptcy plan becomes effective, all shares of Crescent Operating common stock shall automatically be canceled and retired and shall cease to exist. Each holder of a stock certificate shall cease to have any rights with respect thereto, except the right to receive certificates representing the Crescent Real Estate common shares to which such holder is entitled based on the number of shares held by the holder on the confirmation date. No fractional Crescent Real Estate common shares will be issued, no cash shall be paid in lieu of fractional shares, and any fractional share amounts shall be rounded up or down to the closest number of whole Crescent Real Estate common shares. Accordingly, assuming a share price of $20.00 per Crescent Real Estate common share, a payment by Crescent Real Estate of $13.8 million in expenses relating to the Crescent Operating bankruptcy and a distribution of $0.20 per share of Crescent Operating common stock, each Crescent Operating stockholder must hold at least 50 shares of Crescent Operating common stock in order to receive any Crescent Real Estate common shares. Mutual Release Pursuant to the Settlement Agreement, on February 14, 2002, Crescent Operating and the lessees of the hotel properties, on the one hand, and Crescent Real Estate, on the other hand, have executed and delivered to each other a general release of each other, their respective officers, directors, trust managers, agents and employees from all liabilities and claims of any nature arising from events, matters or transactions occurring prior to the date of the release, except for liabilities or claims arising under the Settlement Agreement. This release remains effective regardless of whether the bankruptcy plan is accepted by Crescent Operating's stockholders and/or confirmed by the bankruptcy court. Crescent Operating does not believe the release can be avoided both because Crescent Real Estate is paying substantial consideration to Crescent Operating and its stockholders to obtain the releases provided under the bankruptcy plan and because the releases are voluntary. Termination Agreement Pursuant to the Settlement Agreement, on February 14, 2002, Crescent Operating executed an agreement terminating the Intercompany Agreement between Crescent Operating and Crescent Real Estate. Under the Intercompany Agreement, Crescent Operating and Crescent Real Estate granted each other rights to participate in certain transactions involving the other party. In order to participate in those transactions, each party was required to contribute financially to the transactions. Crescent Operating currently neither has funds available nor a means of obtaining funds to be used for additional investments. 63 As a result, the termination of the Intercompany Agreement is not expected to affect Crescent Operating's operations. Other Material Terms of the Settlement Agreement Representations and Warranties of Crescent Operating. The Settlement Agreement contains representations and warranties made by Crescent Operating and the Crescent Operating subsidiaries that are parties to the Settlement Agreement. Crescent Operating and these Crescent Operating subsidiaries represent and warrant: - that they are duly organized, existing and in good standing; - that they have the requisite power and authority to enter into the Settlement Agreement, to undertake the obligations contained therein and to consummate the transactions contemplated thereby; - that to Crescent Operating's knowledge, there are no obligations or claims existing or assertable against Crescent Operating, other than the claims referred to in the Settlement Agreement; and - as to their ownership interests in the entities to be retained by Crescent Real Estate pursuant to the Plan of Reorganization. Representations and Warranties of Crescent Real Estate and Crescent Partnership. The Settlement Agreement also contains certain representations and warranties made by Crescent Real Estate and Crescent Partnership to Crescent Operating and the Crescent Operating subsidiaries. Crescent Real Estate and Crescent Partnership represent and warrant: - that they are duly organized, existing and in good standing; - that they have the requisite power and authority to enter into the Settlement Agreement, to undertake the obligations contained therein, and to consummate the transactions contemplated thereby; and - that the Crescent Real Estate common shares to be issued to the Crescent Operating stockholders pursuant to the Settlement Agreement have been duly authorized for issuance and will be validly issued, fully paid, nonassessable, and free of any liens upon issuance. Each representation, warranty, covenant and agreement contained in the Settlement Agreement survives indefinitely. Covenants of Crescent Operating. Pursuant to the Settlement Agreement, Crescent Operating and its subsidiaries signatory thereto agree: - to obtain and cooperate in obtaining consents, to make filings with and to give notices to governmental or regulatory authorities or any other person required to consummate the purchase of the assets; - to provide Crescent Partnership and its representatives access to its books and records; - not to pursue any agreement or arrangement for the transfer of the assets that Crescent Partnership will obtain pursuant to the Settlement Agreement; - to conduct business only in the ordinary course, consistent with past practices; and 64 - to take all commercially reasonable steps to satisfy obligations of Crescent Partnership and not to take or fail to take any action that could be expected to result in the nonfulfillment of any such condition. Further, each of Crescent Operating, its subsidiaries signatory to the Settlement Agreement and the transferred businesses whose stock Crescent Operating is transferring to Crescent Partnership and their subsidiaries, agrees to refrain from, without the prior written consent of Crescent Partnership: - acquiring or disposing of any assets and properties used to conduct the businesses of the subsidiary signatories or the transferred businesses, other than in the ordinary course of business; - creating or incurring a lien on any assets and properties used to conduct the businesses of the subsidiary signatories or the transferred businesses, other than in the ordinary course of business or in favor of Crescent Partnership or its affiliates; - entering into, amending, modifying, terminating, granting any waiver under or giving consent to any material contract, other than in the ordinary course of business; - violating, breaching or defaulting under, or taking or failing to take any action that would constitute a violation, breach of or default under, any term of a material contract; - engaging in a business combination; - engaging in transactions with their affiliates, other than in the ordinary course of business or on an arm's-length basis; - amending their formation documents; - selling, transferring or otherwise encumbering their stock, or agreeing to any restrictions on their stock; - incurring or increasing any indebtedness, other than in the ordinary course of business; - giving third-party guarantees; - making capital expenditures or commitments for additions to property, plant or equipment constituting capital assets on behalf of the businesses of the subsidiary signatories in excess of $75,000 in the aggregate; - making any significant payments outside a delineated budget. The preceding list of restrictions will remain in effect even if the bankruptcy plan is not confirmed. These restrictions are contained in the Settlement Agreement, a binding agreement between the parties that will remain in effect, and with which Crescent Operating intends to comply, even if the bankruptcy plan is not confirmed. Crescent Operating and its subsidiaries are required to comply with the preceding list of restrictions on their business activities from the original execution date of the Settlement Agreement until: - the last date on which the remaining consents, approvals, notices or waiting periods necessary for any transferred business to transfer, and Crescent Partnership to receive, the assets owned by such transferred business, or such other date as Crescent Partnership determines, provided that Crescent Partnership gives the transferred businesses the required notice and allows the transferred business time to obtain the necessary consents, approvals, notices or waiting periods; - the last date on which Crescent Partnership retains some or all of the Crescent Operating equity interests in residential land development and other companies in satisfaction of $40.1 million of Crescent Operating debt, or such other date as Crescent Partnership determines; - any other date to which Crescent Operating consents in writing; or 65 - termination of the Settlement Agreement in accordance with its terms, except that each transferred business will remain liable to Crescent Real Estate and Crescent Operating for any willful breach of the Settlement Agreement by the transferred business existing at the time of such termination, and Crescent Real Estate or Crescent Operating will remain liable to each transferred business for any willful breach of the Settlement Agreement by Crescent Real Estate or Crescent Operating, respectively, existing at the time of such termination. Crescent Operating also covenants to cause Jeffrey L. Stevens and any other Crescent Operating officer, director or employee, other than John C. Goff, to resign from specified Crescent Operating subsidiaries on the date any stock of such subsidiaries is transferred to Crescent Partnership. Covenants of Crescent Real Estate and Crescent Partnership. Pursuant to the Settlement Agreement, Crescent Partnership and Crescent Real Estate covenant to obtain consents from, to make filings with and to give notices to governmental or regulatory authorities or any other person required to consummate the purchase of the assets. Crescent Partnership also agrees to take all commercially reasonable steps to satisfy identified obligations of the Crescent Operating and will not take or fail to take any action that could be expected to result in the nonfulfillment of any condition. Indemnification. The Settlement Agreement provides for indemnification with respect to Crescent Operating, Crescent Partnership and Crescent Real Estate as follows: - Crescent Operating shall indemnify Crescent Partnership and Crescent Real Estate and their respective officers, directors, trust managers, employees and agents against any and all losses suffered by any of them relating to any misrepresentation and any nonfulfillment of or failure to perform any covenant or agreement; - Crescent Partnership shall indemnify Crescent Operating and its officers, directors, employees and agents against any and all losses suffered by any of them relating to any misrepresentation and any nonfulfillment of or failure to perform any covenant or agreement; - Crescent Real Estate shall indemnify Crescent Operating and its officers, directors, employees and agents against any and all losses suffered by any of them relating to any misrepresentation and any nonfulfillment of or failure to perform any covenant or agreement; and - The indemnification obligations are subject to limitations for actual damages incurred and reductions for amounts actually received by an indemnified party. Termination. Subject to various limitations, the Settlement Agreement may be terminated: - by mutual consent of Crescent Operating, each Crescent Operating subsidiary that is a party to the Settlement Agreement, Crescent Real Estate, and Crescent Partnership; - by Crescent Operating and the Crescent Operating subsidiaries in the event of a material breach by Crescent Real Estate or Crescent Partnership that is not cured within 10 business days following notification of the material breach; - by Crescent Real Estate or Crescent Partnership in the event of a material breach by Crescent Operating and the Crescent Operating subsidiaries that is not cured within 10 business days following notification of the material breach; and 66 - by any party, if such party's obligations under the Settlement Agreement become impossible or impractical within the use of commercially reasonable means, unless such impossibility or impracticality is caused by a material breach of such party. If the Settlement Agreement is terminated pursuant to the provisions set forth in the preceding paragraph, the Settlement Agreement shall be null and void and all liability and obligations of each party shall cease, except that: - the confidentiality provisions of the Settlement Agreement will continue to apply; - Crescent Operating or any Crescent Operating subsidiary, where applicable, will remain liable to Crescent Real Estate or Crescent Partnership for any willful breach of the Settlement Agreement existing at the time of termination of the Settlement Agreement; and - Crescent Real Estate or Crescent Partnership will remain liable to Crescent Operating or any Crescent Operating subsidiary, where applicable, for any willful breach of the Settlement Agreement existing at the time of termination of the Settlement Agreement. ANALYSIS OF ALTERNATIVES Crescent Operating, in conjunction with its legal counsel, undertook an analysis of its claims and defenses to Crescent Real Estate's claims against it and investigated whether proceedings under the bankruptcy laws might provide solutions to Crescent Operating's obligations to Crescent Real Estate. Upon reviewing the agreements creating Crescent Real Estate's claims against Crescent Operating and security interests in Crescent Operating's assets, Crescent Operating's counsel advised that the agreements appeared valid and enforceable. Crescent Operating's counsel advised management that, because Crescent Operating's existing obligations to Crescent Real Estate were in default, Crescent Operating would have to obtain Crescent Real Estate's agreement before incurring additional or replacement debt sufficient to satisfy Crescent Operating's obligations and continue its ongoing operations. In addition, Crescent Operating anticipated that it would be unlikely to locate a lender that would be willing to provide the necessary loans under such circumstances. Crescent Operating also believed that obtaining additional funds through the sale of equity would not be a feasible alternative, because the demand for Crescent Operating's equity was not adequate to meet Crescent Operating's capital requirements. Crescent Operating engaged counsel to examine the facts and circumstances of Crescent Real Estate's business relationships and connections to Crescent Operating to determine whether there was any basis to achieve a better result for Crescent Operating creditors and stockholders than is provided pursuant to the Settlement Agreement and the bankruptcy plan. Crescent Operating's counsel advised management that the most likely way to prevent Crescent Real Estate from enforcing its agreements would be to instigate litigation requesting that a court set aside Crescent Real Estate's liens or recharacterize the Crescent Real Estate loans as equity infusions. This type of litigation is very expensive and difficult to win, and Crescent Operating did not have sufficient funds to pursue litigation that is generally pursued for the benefit of creditors, not equity holders. Because each loan from Crescent Real Estate to Crescent Operating would be analyzed separately, it is unlikely that all of the loans would be recharacterized. Any loans not recharacterized as equity would have to be repaid before there could be any distribution to the stockholders of Crescent Operating. In addition, it is very difficult to predict the effect that recharacterizing the loans would have on distributions to Crescent Real Estate and to Crescent Operating's stockholders. Crescent Operating's counsel is not aware of any case law precedent determining how Crescent Real Estate and Crescent Operating stockholders would share in any value that would be available to Crescent Operating if Crescent Real Estate's transactions were altered by a court. As noted above, these types of claims are usually asserted for the benefit of creditors, not equity holders, and the only parties that receive any value are creditors. Since the Settlement Agreement provides for 67 payment in full of Crescent Operating's creditors and is not contingent on the outcome of risky and expensive litigation, the sole director concluded that the Settlement Agreement and the bankruptcy plan provide a better outcome to creditors and stockholders. Prior to entering into the Settlement Agreement, Crescent Operating analyzed whether it had claims against Crescent Real Estate that should be pursued as an alternative to the proposed Settlement Agreement. Crescent Operating consulted its counsel who reviewed, among other matters, the origin of the indebtedness to Crescent Real Estate and the business relationship between Crescent Operating and Crescent Real Estate that began in 1997 when the shares of Crescent Operating common stock were distributed to Crescent Real Estate shareholders. Crescent Operating then independently evaluated whether the benefit to Crescent Operating creditors and stockholders in consummating the Settlement Agreement outweighed the benefit that might be derived from declining the proposed Settlement Agreement and instead pursuing claims against Crescent Real Estate. In making this evaluation, Crescent Operating took into consideration the relative certainty of its creditors and stockholders realizing the benefits provided for in the Settlement Agreement and the relative uncertainty of recovery in, as well as the costs and delay associated with, prosecuting any claims, and particularly claims of uncertain merit. Based upon the totality of the circumstances, Crescent Operating made the independent judgment that the best interests of its creditors and stockholders would be served by entering into the Settlement Agreement. Crescent Operating concluded that the benefits to its creditors and stockholders that would be realized through the Settlement Agreement outweighed the cost to Crescent Operating of granting the releases to Crescent Real Estate. Without the alternatives provided by the Settlement Agreement and the bankruptcy plan, Crescent Operating could have been liquidated under Chapter 7 of the Bankruptcy Code by Crescent Real Estate's foreclosure of its liens. In response, Crescent Operating could have either allowed Crescent Real Estate to exercise its remedies or Crescent Operating could have not settled its claims with Crescent Real Estate and filed bankruptcy to avoid the foreclosure. If Crescent Operating had filed a bankruptcy in response to a foreclosure, unless Crescent Operating successfully challenged the Crescent Real Estate liens, Crescent Operating would not have been able to propose and fund a plan that paid its unsecured creditors or that made any distribution to stockholders because Crescent Operating has no equity in the assets pledged to Crescent Real Estate. Crescent Operating did not consider proposing a pre-packaged bankruptcy plan that does not pay Bank of America because Crescent Operating wanted to confirm a bankruptcy plan that made a distribution to its stockholders. Under the absolute priority rule, Crescent Operating would be prohibited from making a distribution to its stockholders if it failed to pay its unsecured creditors, such as Bank of America, in full. Absent the Settlement Agreement, which provides for and requires a bankruptcy plan that pays Bank of America in full, it is likely that all of Crescent Operating's assets would be exhausted in satisfying the secured claims of Crescent Real Estate and there would be no distribution to holders of unsecured claims or stockholders. Crescent Operating did not seek any alternative offers for the purchase of its hospitality and land development segments. The large amount of debt owed to Crescent Real Estate carried by Crescent Operating made acquisition of Crescent Operating unattractive to other third-party buyers. Furthermore, most of Crescent Operating's debt was secured by liens in favor of Crescent Real Estate and these liens would have prevented Crescent Operating from transferring its hospitality and land development assets without the approval of Crescent Real Estate. Finally, Crescent Operating's management believed that the price offered by Crescent Real Estate exceeded what could reasonably be expected of a competing third-party offer. 68 In either a litigation or a bankruptcy proceeding, the claims of Bank of America, other than to the extent of its first priority lien on Crescent Operating's interest in AmeriCold Logistics, and other creditors' claims are contractually subordinate to the claims and liens held by Crescent Real Estate. Rights of Crescent Operating stockholders are in turn legally subordinated to the rights of Bank of America and the rights of other Crescent Operating creditors. Management concluded that, in the event of a litigation or a non-negotiated bankruptcy proceeding, there would be few or no assets available for satisfaction of claims of any creditor other than the senior and secured claims of Crescent Real Estate. After taking steps to convert all its assets to cash in an orderly fashion, there would still not be sufficient funds to pay the outstanding indebtedness to Crescent Real Estate. Management believed that Crescent Operating may not even have sufficient liquidity to pay its liabilities on a current basis. Additional costs associated with litigation or a non-negotiated bankruptcy would diminish further the funds available for payments to creditors or stockholders. In fact, virtually all of Crescent Operating's current cash flow is encumbered by liens in favor of Crescent Real Estate. There is a material risk in a litigation or a non-negotiated bankruptcy that Crescent Real Estate could successfully object to Crescent Operating's use of this cash flow for any purpose other than for payment of obligations directly related to the preservation of Crescent Real Estate's collateral. If Crescent Operating is not able to consummate the Crescent Operating bankruptcy plan, no Crescent Real Estate stock would be issued to Crescent Operating's stockholders. If the plan is not consummated, Crescent Operating anticipates that Crescent Real Estate and Bank of America would enforce their liens. In that event, Crescent Operating would have few, if any, funds available to pay its administrative or priority tax claims or its other unsecured creditors. In all likelihood, Bank of America would foreclose its liens in the AmeriCold Interests in satisfaction of its claims. Any remaining asset value would continue to be subject to the liens and claims of Crescent Real Estate. As a result of any failure to consummate the bankruptcy plan, the unsecured creditors identified by Crescent Operating in the original Settlement Agreement would probably not be paid and stockholders would receive nothing. Crescent Operating could file a Chapter 7 bankruptcy liquidation case. Pursuant to Chapter 7, a third party would be appointed and would liquidate Crescent Operating's assets for distribution to creditors in accordance with the priorities established by the Bankruptcy Code. Crescent Operating believes that in a Chapter 7 proceeding, the trustee would consent to Crescent Real Estate and Bank of America foreclosing on their respective collateral. Crescent Operating believes it is also likely that the trustee would not have sufficient funds to pay administrative, priority tax and unsecured claims in full. Crescent Operating believes there would not be a distribution to stockholders in a Chapter 7 liquidation. The liquidation analysis that assumes that the transactions contemplated by the Settlement Agreement have been consummated is presented in "--Liquidation Analyses - Table 2 - Liquidation After Giving Effect to Settlement Agreement." In deciding whether to enter into the Settlement Agreement and whether the Crescent Operating bankruptcy plan is in the best interests of Crescent Operating's creditors and stockholders, Crescent Operating also prepared an analysis of the estimated value that might be obtained by holders of general unsecured claims and Crescent Operating's stockholders if Crescent Operating had not entered into the Settlement Agreement and Crescent Operating were liquidated in a hypothetical Chapter 7 case. Based on this analysis, Crescent Operating believes that liquidation under Chapter 7 would result in no distribution being made to Crescent Operating's stockholders and creditors, other than Crescent Real Estate. Crescent Operating then compared the results of this liquidation analysis to the distributions to be made to creditors and stockholders pursuant to the Settlement Agreement and the bankruptcy plan and concluded that the results for these persons under the Settlement Agreement and bankruptcy plan were superior to the results that would occur if the Settlement Agreement and bankruptcy plan were not consummated and Crescent Operating's assets were liquidated under Chapter 7 of the Bankruptcy Code. The liquidation analysis based on the assumption that the Settlement Agreement and bankruptcy plan 69 were not consummated is presented in "--Liquidation Analyses - Table 1 - Liquidation Before Giving Effect to Settlement Agreement." Crescent Operating believes that, if the Crescent Operating bankruptcy plan is not consummated, it will be unable to meet its financial obligations and continue as a going concern. See "-- Liquidation Analyses." Given the extent of Crescent Real Estate's liens and the benefits provided to both Crescent Operating's creditors and stockholders by the Settlement Agreement, Crescent Operating's sole director determined that the Crescent Operating bankruptcy plan was the best available alternative and the alternative most likely to maximize stockholder value. LIQUIDATION ANALYSES If Crescent Operating is not able to consummate the Crescent Operating bankruptcy plan, no Crescent Real Estate stock could be issued to Crescent Operating's stockholders. In all likelihood, Bank of America would foreclose its liens in the AmeriCold Interest in satisfaction of its claims. Any remaining asset value would continue to be subject to the liens and claims of Crescent Real Estate. Thus, if the plan were not consummated, the unsecured creditors identified by Crescent Operating in the original Settlement Agreement would probably not be paid in full and Crescent Operating stockholders would receive nothing. Crescent Operating could simply allow Crescent Real Estate and Bank of America to enforce their liens in the remaining assets. Alternatively, Crescent Operating could file a Chapter 7 bankruptcy liquidation case. Pursuant to Chapter 7, a third party would be appointed and would liquidate Crescent Operating's assets for distribution to creditors in accordance with the priorities established by the Bankruptcy Code. Crescent Operating believes that in a Chapter 7 proceeding, the trustee would consent to Crescent Real Estate and Bank of America foreclosing on their respective collateral. As in the other alternatives, Crescent Operating believes that, in a Chapter 7 liquidation, there would not be a distribution to stockholders. In deciding to enter into the Settlement Agreement, and to assist in the determination of whether the Settlement Agreement and the Crescent Operating bankruptcy plan would be in the best interests of Crescent Operating's creditors and stockholders, Crescent Operating prepared two liquidation analyses. The first analysis, which is presented in Tables 1A and 1B, illustrates the estimated value that might have been distributed to holders of general unsecured claims and to Crescent Operating's stockholders if Crescent Operating had not entered into the Settlement Agreement and Crescent Operating was liquidated in a hypothetical Chapter 7 case as of November 30, 2001. Based on this analysis, Crescent Operating believes that if it had not entered into the Settlement Agreement, liquidation under Chapter 7 would have resulted in no distribution being made to Crescent Operating's stockholders and creditors, other than Crescent Real Estate. The second analysis, which is presented in Tables 2A and 2B, illustrates the outcome for creditors and stockholders in a Chapter 7 liquidation after giving effect to the transfers and credits provided for in the Settlement Agreement as of March 31, 2002. Under this analysis stockholders would receive nothing. These analyses are based upon a number of estimates and assumptions, including those described after the table, that are inherently subject to significant uncertainties and contingencies, many of which would be beyond the control of Crescent Operating. Accordingly, while the analyses that follow are necessarily presented with numerical specificity, there can be no assurance that the values assumed would be realized if Crescent Operating were in fact liquidated, nor can there be any assurance that a bankruptcy court would accept these analyses or concur with such assumptions in making its determinations under the Bankruptcy Code. Actual liquidation proceeds could be materially lower or higher than the amounts set forth below, and no representation or warranty can or is being made with respect to the actual 70 proceeds that could be received in a Chapter 7 liquidation of Crescent Operating. The liquidation valuations have been prepared solely for the purposes of estimating proceeds available in a Chapter 7 liquidation of Crescent Operating and do not represent values that may be appropriate for any other purpose. Nothing contained in these valuations is intended or may constitute a concession or admission of Crescent Operating for any other purpose. These liquidation analyses have not been independently audited or verified. 71 TABLE 1A - LIQUIDATION BEFORE GIVING EFFECT TO SETTLEMENT AGREEMENT SUMMARY OF LIQUIDATION VALUE OF ASSETS (1) (2) (unaudited, dollars in thousands) Estimated Estimated Estimated Recovery Range(3) Recovery Range (3) Value ---------------------- ---------------------- as of 11/30/01 Low (%) High (%) Low ($) High ($) --------------- ------- -------- -------- ------- Cash and cash equivalents $ 627 100% 100% $ 627 $ 627 Accounts receivable 1,489 75% 85% 1,117 1,266 Notes receivable 10,165 0% 0% - - Prepaid expenses 3,637 0% 0% - - Other current assets 13,599 0% 0% - - --------- -------- -------- TOTAL CURRENT ASSETS 29,517 1,744 1,893 Partnership and member interests (4) 11,874 80% 100% 9,499 11,874 Property and equipment 57 25% 50% 14 29 Investment in Crescent Machinery 29,147 0% 0% - - Intangibles and other assets 42 0% 0% - - Deferred tax asset 10,377 0% 0% - - --------- -------- -------- TOTAL FIXED ASSETS 51,497 9,513 11,903 TOTAL LIQUIDATION VALUE OF ASSETS (5) $ 81,014 $ 11,257 $ 13,796 -------------------------- (1) All recoveries shown before any possible applicable present value discount. (2) All recoveries are shown before the addition of certain ongoing operating expenses that may be required throughout the Chapter 7 case. (3) Recovery ranges estimated by Crescent Operating's management. (4) Excludes negative book value investments. (5) In preparing these estimates, Crescent Operating management did not assign any value to litigation claims against Crescent Real Estate. Crescent Operating analyzed the documentation and the surrounding facts and circumstances in respect of its relationship with, and its obligations to, Crescent Real Estate to determine whether there might be value for creditors and stockholders that would support a decision to forgo the Settlement Agreement in favor of pursuing litigation. As discussed in "-- Analysis of Alternatives," Crescent Operating independently concluded that it should enter into the Settlement Agreement based on the totality of the circumstances, which included as factors the benefits that the Settlement Agreement conferred upon creditors and stockholders, the relative certainty of the creditors and stockholders of Crescent Operating realizing those benefits, and the relative uncertainty of recovery in, as well as the costs and delay associated with the prosecution of any claims, and particularly claims of uncertain merit. As described in the answer to the question "What happens if the Crescent Operating stockholders vote AGAINST acceptance of the Crescent Operating bankruptcy plan?", Crescent Operating also did not assign any value to potential preference or fraudulent transfer claims, primarily because (i) Crescent Real Estate is paying substantial consideration to Crescent Operating and its creditors and stockholders and (ii) the claims of Crescent Real Estate were fully secured. 72 TABLE 1B - LIQUIDATION BEFORE GIVING EFFECT TO SETTLEMENT AGREEMENT SUMMARY CLAIMS RECOVERIES (1) (unaudited, dollars in thousands) ---------------------------------------------------------------------------------------------------------------------------------- Estimated Estimated Value Recovery Range Recovery Range as of -------------------------- --------------------- 11/30/01 Low (%) High (%) Low ($) High ($) -------- ------- -------- ------- -------- ASSETS AVAILABLE FOR SECURED, ADMINISTRATIVE, PRIORITY $11,257 $13,796 TAX AND UNSECURED CLAIMS SECURED CLAIMS: Crescent Real Estate Equities, Ltd. (debt and accrued interest) $70,258 16%(2) 20% $11,257 $13,796 ------- ------- ------- SECURED CLAIMS RECOVERY 70,258 11,257 13,796 ASSETS AVAILABLE FOR ADMINISTRATIVE, PRIORITY TAX AND UNSECURED CLAIMS -- -- ADMINISTRATIVE CLAIMS: Trustee expenses (including legal and accounting) 250 0% 0% -- -- ------- ------- ------- TOTAL ADMINISTRATIVE CLAIMS 250 0% 0% -- -- PRIORITY TAX CLAIMS: 1,500 0% 0% -- -- -- -- NET ASSETS AVAILABLE FOR UNSECURED CLAIMS -- UNSECURED CLAIMS:(3) Bank of America 15,000 0% 0% -- -- Trade Debt 507 0% 0% -- -- Seller Notes (debt and accrued interest) 3,660 0% 0% -- -- Other Accrueds 1,164 0% 0% -- -- ------- ------- ------- TOTAL UNSECURED CLAIMS(3) 20,331 -- -- ------- ------- ------- NET ASSETS AVAILABLE FOR EQUITY HOLDERS $ -- $ -- $ -- -------------------------- (1) Classification of claims for purposes of analysis presented after consultation with Crescent Operating's counsel. (2) Assumes 100% of liquidation value of assets would be distributed to Crescent Real Estate on account of its secured claims. (3) The table does not assign any value to the lawsuit filed by the Crescent Machinery Committee because Crescent Operating intends to vigorously defend against the allegations and claims in the lawsuit. If the claims in the lawsuit are successfully pursued, however, they could negatively impact Crescent Operating's ability to confirm the bankruptcy plan. 73 TABLE 2A - LIQUIDATION AFTER GIVING EFFECT TO SETTLEMENT AGREEMENT SUMMARY CLAIMS RECOVERIES (1) (unaudited, dollars in thousands) Estimated Estimated Estimated Recovery Range (3) Recovery Range (3) Value ------------------------ ------------------------- as of 3/31/02 Low (%) High (%) Low ($) High ($) ------------- ------- -------- ------- -------- Cash and cash equivalents $ 1,105 100% 100% $ 1,105 $ 1,105 Accounts receivable 978 75% 85% 734 831 Notes receivable -- 0% 0% -- -- Prepaid expenses 10 0% 0% -- -- Other current assets 12,483 0% 0% -- -- ---------- -------- --------- TOTAL CURRENT ASSETS 14,576 1,839 1,936 Partnership and member interests (4) 15,000 70% 100% 10,500 15,000 Property and equipment 50 25% 50% 13 25 Intangibles and other assets -- 0% 0% -- -- Deferred tax asset 6,678 0% 0% -- -- ---------- -------- --------- TOTAL FIXED ASSETS 21,728 10,513 15,025 TOTAL LIQUIDATION VALUE OF ASSETS (5) $ 36,304 $ 12,352 $ 16,961 ___________________________ (1) All recoveries shown before any possible applicable present value discount. (2) All recoveries are shown before the addition of certain ongoing operating expenses that may be required throughout a Chapter 7 case. (3) Recovery ranges estimated by Crescent Operating's management. (4) Excludes negative book investments. Includes AmeriCold Logistics interest pledged to Bank of America at an agreed upon value. (5) In preparing these estimates, Crescent Operating management did not assign any value to litigation claims against Crescent Real Estate. Crescent Operating analyzed the documentation and the surrounding facts and circumstances in respect of its relationship with, and its obligations to, Crescent Real Estate to determine whether there might be value for creditors and stockholders that would support a decision to forgo the Settlement Agreement in favor of pursuing litigation. As discussed in "-- Analysis of Alternatives," Crescent Operating independently concluded that it should enter into the Settlement Agreement based on the totality of the circumstances, which included as factors the benefits that the Settlement Agreement conferred upon creditors and stockholders, the relative certainty of the creditors and stockholders of Crescent Operating realizing those benefits, and the relative uncertainty or recovery in, as well as the costs and delay associated with the prosecution of any claims, and particularly claims of uncertain merit. As described in the answer to the Question "What happens if the Crescent Operating stockholders vote AGAINST acceptance of the Crescent Operating bankruptcy plan?", Crescent Operating also did not assign any value to potential preference or fraudulent transfer claims, primarily because (i) Crescent Real Estate is paying substantial consideration to Crescent Operating and its creditors and stockholders and (ii) the claims of Crescent Real Estate were fully secured. 74 TABLE 2B -- LIQUIDATION AFTER GIVING EFFECT TO SETTLEMENT AGREEMENT SUMMARY CLAIMS RECOVERIES(1) (unaudited, dollars in thousands) -------------------------------------------------------------------------------------------------------------------------------- Estimated Estimated Estimated Recovery Range Recovery Range Claims ---------------------- ----------------------- as of 3/31/02 Low (%) High (%) Low ($) High ($) --------------- ------- --------- ---------- ---------- ASSETS AVAILABLE FOR SECURED, ADMINISTRATIVE AND $ 12,352 $ 16,961 UNSECURED CLAIMS SECURED CLAIMS: Bank of America (secured by AmeriCold Logistics Interest) $ 15,000 70% 100% 10,500 15,000 Crescent Real Estate Equities, Ltd. (debt and accrued interest) (secured by blanket lien on all assets; subordinate to Bank of America in AmeriCold) 38,688 4.8%(2) 5.1% 1,852 1,961 -------- -------- -------- ASSETS AVAILABLE FOR ADMINISTRATIVE, PRIORITY TAX AND UNSECURED CLAIMS AFTER SATISFACTION OF SECURED CLAIMS -- -- ADMINISTRATIVE CLAIMS: Trustee expenses (including legal and accounting) 250 0% 0% -- -- -------- -------- -------- TOTAL ADMINISTRATIVE CLAIMS 250 -- -- PRIORITY TAX CLAIMS: 1,500 0% 0% -- -- NET ASSETS AVAILABLE FOR UNSECURED CLAIMS -- -- -- UNSECURED CLAIMS(3) Trade Debt -- 100% 100% -- -- Other Accrueds -- 100% 100% -- -- -------- -------- -------- TOTAL UNSECURED CLAIMS () -- -- -- NET ASSETS AVAILABLE FOR EQUITY HOLDERS $ -- $ -- $ -- ___________________________ (1) Classification of claims for purposes of analysis presented after consultation with Crescent Operating's counsel. (2) Assumes 100% of liquidation value of assets would be distributed to Crescent Real Estate on account of its secured claims. (3) The table does not assign any value to the lawsuit filed by the Crescent Machinery Committee because Crescent Operating intends to vigorously defend against the allegations and claims in the lawsuit. If the claims in the lawsuit are successfully pursued, however, they could negatively impact Crescent Operating's ability to confirm the bankruptcy plan. 75 General Assumptions Liquidation Before Giving Effect To Settlement Agreement Estimated Liquidation Proceeds. Estimates were made of the cash proceeds that might be available for distribution and the allocation of such proceeds among various claimants based on their relative priority under the assumption that Crescent Operating had not entered into and made the transfers and received the credits on its debt to Crescent Real Estate as provided for in the Settlement Agreement. It is probable in a Chapter 7 liquidation that the trustee would conclude that the Chapter 7 estate had no beneficial interest in the collateral securing the Crescent Real Estate claims. Under such circumstances, it is reasonable to assume that the Crescent Operating Bankruptcy trustee would either abandon the estate's interest in the assets or agree to a court order that Crescent Real Estate could foreclose on its collateral. Crescent Operating considered a number of factors and data in estimating the liquidation proceeds, including the following, in no particular order: - Crescent Operating's operating and projected financial performance; - The attractiveness of each of the operating segments to potential buyers; - The potential universe of possible buyers; - The potential impact of a Chapter 7 case upon the operating segments as well as possible buyers' pricing strategies; - The relative timing of the potential sale of Crescent Operating's operating segments; and - Analysis of the liabilities and obligations of Crescent Operating's operating segments. In estimating the liquidation proceeds and applying the foregoing factors and considerations to make such estimate, both the general economic environment as well as the current condition of Crescent Operating's business were considered. See "Crescent Operating Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Description of Crescent Operating's Business" for information regarding the current condition of Crescent Operating's business. Investment in Crescent Machinery. On February 6, 2002, Crescent Machinery filed for protection under Chapter 11 in the Bankruptcy Court in Fort Worth, Texas and filed its Schedules and Statement of Financial Affairs on March 22, 2002. Crescent Operating has reviewed this financial information. Crescent Operating has discussed with Crescent Machinery management and counsel the likelihood that Crescent Machinery will emerge from Chapter 11 as an operating company and the probable impact of such an outcome on Crescent Operating's equity interest in Crescent Machinery. Based upon its independent review of the financial information contained in the Crescent Machinery bankruptcy file and the statements of Crescent Machinery management and counsel regarding Crescent Machinery's reorganization prospects, Crescent Operating has concluded that it is highly unlikely that any value will be realized by Crescent Operating in respect of its stock ownership in Crescent Machinery. Crescent Operating has claims against Crescent Machinery based upon intercompany advances it made prior to Crescent Machinery's Chapter 11 filing. It is not possible to predict whether any monies will be distributed to Crescent Operating in respect of these claims. For purpose of the liquidation analyses, Crescent Operating has assumed that it will not receive anything of value for its claims against Crescent Machinery. Trustee in Bankruptcy. In a Chapter 7 case, Crescent Operating's management would be replaced by a Chapter 7 trustee. Under ordinary circumstances, a Chapter 7 trustee is not authorized to continue operating a debtor's business. Crescent Operating assumes that any Chapter 7 trustee appointed would not continue Crescent Operating's business operations. This liquidation analysis also assumes the Chapter 7 trustee would elect to liquidate Crescent 76 Operating's assets, as opposed to paying another liquidating agent to conduct liquidation sales. Crescent Operating cannot assure you that these assumptions would be made or accepted by a bankruptcy court. Nature and Timing of the Liquidation Process. Pursuant to the Bankruptcy Code, a Chapter 7 trustee must, among other duties, collect and convert the property of the debtor's estate to cash and close the estate as expeditiously as is compatible with the best interests of the parties in interest. Solely for purposes of preparing this liquidation analysis, Crescent Operating assumed that it would have filed the Chapter 7 liquidation on November 30, 2001. Additional Liabilities and Reserves. Crescent Operating believes that there would be certain actual and contingent liabilities and expenses for which provision would be required in a Chapter 7 liquidation before distributions could be made to creditors, including the following: - additional administrative expenses involved in the appointment of a trustee and attorneys and other professionals to assist such trustee; - additional expenses and claims, some of which would be entitled to priority over Crescent Operating's creditors and stockholders, which would be generated during the liquidation and from the rejection of leases and other executory contracts in connection with a cessation of Crescent Operating's operations; and - a failure to realize any going concern value from Crescent Operating's assets since Crescent Operating has pledged substantially all of its assets, other than a small amount of cash, to Crescent Real Estate to secure repayment of $76.2 million in debt. Crescent Operating believes that there is significant uncertainty as to the reliability of Crescent Operating's estimates of the amounts related to the foregoing that have been assumed in the liquidation analysis. Liquidation After Giving Effect To Settlement Agreement Between February 14 and March 22, 2002, Crescent Operating and Crescent Real Estate consummated a number of transactions provided for in the Settlement Agreement. These included, among other things, the transfers by Crescent Operating and its affiliated entities of certain partnership and limited liability company member interests and rights under various management contracts to Crescent Real Estate or its designees. In exchange for these transfers, Crescent Operating received, among other things, a credit on its indebtedness to Crescent Real Estate in the sum of $40.1 million. In addition, Crescent Real Estate agreed, on condition the plan were consummated, to fund an amount to Crescent Operating sufficient to pay its unsecured creditors identified in the original Settlement Agreement in full, and, under certain circumstances, Crescent Real Estate common shares would be distributed to Crescent Operating's stockholders. Table 2 illustrates Crescent Operating's estimate of the results of a liquidation after giving effect to the transfers and credits on Crescent Real Estate's claims as provided for in the Settlement Agreement. Under these circumstances Crescent Operating believes shareholders would receive nothing since Crescent Real Estate's obligation to issue its common shares to Crescent Operating's stockholders is conditioned, among other things, upon consummation of the plan. Distributions; Absolute Priority. Under a Chapter 7 liquidation, all secured claims are required to be satisfied from the proceeds of the collateral securing such claims before any such proceeds would be distributed to any other claim holders. This liquidation analysis assumes the application of the rule of absolute priority of distributions with respect to the remaining proceeds of Crescent Operating. Under that rule, no junior creditor receives any distribution until all senior creditors are paid in full. To the extent that proceeds remain after satisfaction of all secured claims, Crescent Operating believes the unsecured claimants would receive substantially less than pursuant to the Crescent Operating bankruptcy plan. 77 Conclusion Crescent Operating believes that liquidation under Chapter 7 would result in no distribution being made to Crescent Operating stockholders and that general unsecured creditors would receive substantially less recovery on their claims than under the Crescent Operating bankruptcy plan. Crescent Operating estimates that the amount of its indebtedness to Crescent Real Estate substantially exceeds the value of the assets securing repayment of that debt. Accordingly, in a Chapter 7 liquidation, it is likely that the trustee will abandon Crescent Operating's interest in the pledged assets or agree that the automatic stay be lifted so that Crescent Real Estate could proceed with foreclosure. In such a foreclosure, Crescent Real Estate is not likely to receive the amount of its claims. As a result, Crescent Real Estate could in fact have a substantial unsecured claim against Crescent Operating. Likewise, the collateral securing the Bank of America claim may have a value less than the balance of the Bank of America debt plus the secured claim of Crescent Real Estate. In a Chapter 7 liquidation, the trustee would probably abandon the estate's interest in the collateral securing repayment of Crescent Operating's debt to Bank of America. EVENTS LEADING TO THE REORGANIZATION TRANSACTIONS General Crescent Operating was formed in 1997 to, among other things, participate under the Intercompany Agreement with Crescent Real Estate in certain investments. As a result, over a period of several years, Crescent Operating became an investor in various entities in diverse business segments. This rapid growth into diverse fields made it difficult for the general public to understand and value Crescent Operating's structure. Thus, during 1999, management of Crescent Operating and its Intercompany Evaluation Committee commenced negotiations with Crescent Real Estate to sell the entities within Crescent Operating's hospitality and land development segments to Crescent Real Estate or one of its affiliates in order to focus upon a core business. Please see "--Description of Meeting of Intercompany Evaluation Committee and Board of Directors" for more information regarding the Intercompany Evaluation Committee and the deliberations of the Committee and the Board of Directors. As part of these negotiations, the Intercompany Evaluation Committee considered available options, including a restructuring of Crescent Operating under bankruptcy reorganization and liquidation under Chapter 7 of the Bankruptcy Code, and determined that a successful asset sale transaction with Crescent Real Estate or Crescent Partnership would be in the best interest of the stockholders of Crescent Operating because it would provide adequate liquidity and allow Crescent Operating to focus on its equipment sales and leasing business. Based on that decision, negotiations continued. Crescent Operating's management and the Intercompany Evaluation Committee established certain criteria that they believed necessary for any transaction to be successful for Crescent Operating. These criteria developed into the goals of Crescent Operating for the transaction, the most significant of which were to (i) decrease Crescent Operating's debt level to the lowest amount possible, (ii) simplify Crescent Operating's structure so that it could be understood within the marketplace and (iii) provide stability and potential growth opportunities to Crescent Machinery following the transactions. To accomplish this, the Intercompany Evaluation Committee determined that Crescent Machinery would need a significant amount of additional funds in connection with any transaction to achieve the established goals. During the period of negotiations, Crescent Operating did not seek any alternative offers for the purchase of its hospitality and land development segments. The large amount of debt owed to Crescent Real Estate carried by Crescent Operating made acquisition of Crescent Operating unattractive to other third-party buyers. Furthermore, most of Crescent Operating's debt was secured by liens in favor of Crescent Real Estate and these liens would have prevented Crescent Operating from transferring its hospitality and land development assets without the approval of Crescent Real Estate. Finally, Crescent Operating's management believed that the price offered by Crescent Real Estate exceeded what could reasonably be expected of a competing third-party offer. Crescent Operating's management faced a number of issues that made the transaction difficult to structure and delayed the finalization of a complete plan. These issues included the evaluation of tax planning objectives of the various parties to the restructuring transactions, the need for Crescent Real Estate to maintain its status as a REIT for 78 federal income tax purposes and consideration of outstanding litigation related to Charter Behavioral Health Systems, LLC and its bankruptcy. See "-- Legal Proceedings" below for information on the CBHS bankruptcy. While Crescent Operating's management was able to continue negotiations while seeking structures to resolve these issues, complications such as these significantly delayed the negotiation process. Certain tax and other specific structuring issues were not resolved until 2002 and the provisions of the REIT Modernization Act were not final until late 2000, both of which made it impossible for Crescent Real Estate to consummate the transactions without jeopardizing its REIT status. Due to the length of time the negotiations spanned, values of Crescent Operating's investments had to be updated on several occasions to encompass significant changes to certain of the Crescent Operating's assets and business enterprises. In December 2000, Crescent Operating identified SunTx Fulcrum Fund, L.P. and its affiliates, a Dallas-based private equity fund focused on making strategic investments in middle-market companies based primarily in, or with significant corporations in the southern United States, as an investment group interested in a potential investment opportunity in Crescent Machinery. Mr. Goff and Mr. Stevens, on behalf of Crescent Operating's management, immediately began discussions with SunTx representatives Ned N. Fleming, III and Mark R. Matteson about making an investment related to Crescent Machinery. Based upon the opportunities identified through these discussions, SunTx moved forward with its due diligence process and the negotiation of a securities purchase agreement, ultimately agreeing to invest $19.0 million of capital into Crescent Machinery. In addition to the funds to be provided by SunTx, Crescent Operating's management, along with the Intercompany Evaluation Committee, agreed that additional equity would be required to achieve the goals which had been set for Crescent Operating. At that point in time, Crescent Operating approached Crescent Real Estate about making a similar equity contribution as part of the overall transaction. After further negotiations between David M. Dean, on behalf of Crescent Real Estate, and Crescent Operating, Crescent Real Estate agreed to invest $10.0 million of capital into Crescent Machinery through an affiliate, CRE Equipment Holdings, LLC. On January 1, 2001, the REIT Modernization Act became effective. This legislation allows Crescent Real Estate, through its subsidiaries, to operate or lease certain of its investments that had been previously operated or leased by Crescent Operating. On June 28, 2001, Crescent Operating entered into an asset purchase agreement with Crescent Real Estate as well as a securities purchase agreement with SunTx and CRE Equipment Holdings, whereby SunTx and CRE Equipment Holdings would invest capital in the amount of $19.0 million and $10.0 million, respectively, into Crescent Machinery. Under the terms of the asset purchase agreement, Crescent Partnership would pay to Crescent Operating approximately $78.4 million, payable in cancellation of certain debt and rent obligation and cash, in exchange for (i) all of the assets related to Crescent Operating's hospitality business, (ii) all shares of voting common stock owned by Crescent Operating and its subsidiaries and (iii) all of the membership interests of CR License LLC owned by Crescent Operating. Also, Crescent Operating agreed not to encourage or solicit any acquisition proposals by a third party, although Crescent Operating's Board of Directors could entertain unsolicited offers if it was concluded in good faith that consideration of such proposals were necessary to comply with their fiduciary duties. In connection with the securities purchase agreement, Crescent Machinery would have been merged into Crescent Machinery, L.P., or CMC LP. In exchange for CRE Equipment Holdings and SunTx's investment in CMC LP, CRE Equipment Holdings would have received 10,000 Series A preferred partnership interests in CMC LP and SunTx would have received 19,000 Series B preferred partnership interests. In connection with the purchase of Series B preferred partnership interests, SunTx would have received a warrant to purchase 2,800,000 shares of Crescent Operating common stock for $.01 per share. Subject to certain restrictions, both series of preferred partnership interests would have been exchangeable for Crescent Operating common stock. 79 In October 2001, management of Crescent Operating, CRE Equipment Holdings and SunTx amended the terms of the original securities purchase agreement. Since the time the asset and securities purchase agreements had been entered into, there had been a general deterioration of the United States economy and stock markets, and a significant decline in the price of Crescent Operating's common stock. As a result, the economic terms of the original securities purchase agreement and the anticipated terms for the required Crescent Operating rights offering were no longer acceptable to CRE Equipment Holdings and SunTx. CRE Equipment Holdings and SunTx indicated that they would be unable to proceed to consummate the purchase of the preferred partnership interests under the economic terms of the original securities purchase agreement. Because each transaction was dependent upon the completion of all other transactions, the failure to complete the sale of the preferred partnership interests would have also resulted in the failure to conclude all other transactions, including the asset sale. As a result, in October 2001, management of Crescent Operating, CRE Equipment Holdings and SunTx amended the securities purchase agreement, primarily to revise the rate of exchange for the preferred partnership interests into shares of Crescent Operating common stock, and in some cases the rate of conversion for preferred partnership interests into common limited partnership interests of CMC LP, so that such conversion rates would reflect changes in the market price of Crescent Operating common stock. Similarly, it was also agreed that the price to purchase shares of Crescent Operating common stock should be changed to reflect the market price for Crescent Operating common stock at the time of the rights offering. Crescent Operating filed its definitive proxy statement for the annual meeting on November 1, 2001, and sent its proxy statement for the annual meeting to the stockholders on or about November 1, 2001. On December 6, 2001, the stockholders of Crescent Operating approved the reorganization transactions, which noted that Crescent Machinery did not make a principal payment for October 2001 to four of its primary lenders holding approximately 85% of its outstanding debt. Further, the closing of the reorganization transactions required, among other things, for Crescent Machinery to obtain consents from its lenders to the restructure transaction. At that time, it was believed that an agreement could be reached with the lenders to accommodate Crescent Machinery's needs and obtain the necessary consents. Unfortunately, the overall equipment rental and sales industry was struggling because of an economic downturn and the September 11 terrorist attacks. Crescent Machinery was faced with excess inventory at a point when there was a significant oversupply in the industry and a severe reduction in construction activity. Crescent Machinery was unable to reach satisfactory agreements with its lenders regarding restructuring of the loans. As a result, Crescent Real Estate advised Crescent Operating that it believed that substantial additional capital, beyond the investment called for in the securities purchase agreement, would have to be made to Crescent Machinery to adequately capitalize Crescent Machinery and satisfy concerns of Crescent Machinery's lenders. Crescent Real Estate announced that it was "unwilling to make this non-core investment." Because all of the reorganization agreements were dependent upon each other, Crescent Real Estate gave notice that it was terminating the asset purchase agreement on January 23, 2002, and gave notice that it was terminating the securities purchase agreement on February 4, 2002. In November 2001, Mr. Stevens solely on behalf of Crescent Operating and Mr. Goff and Mr. Dean, solely on behalf of Crescent Real Estate, entered into discussions of an alternative plan to allow Crescent Real Estate to acquire Crescent Operating's land development and hospitality assets. In January 2002, Mr. Goff suggested an arrangement that would allow Crescent Real Estate to obtain by agreement Crescent Operating's land development and hospitality assets in an agreed foreclosure action and in lieu of foreclosure and Mr. Dean devised a structure that would allow Crescent Real Estate shareholders to acquire the temperature-control business from Crescent Operating. Once this structure was proposed, Mr. Goff refrained from participating in any negotiations regarding prices and consideration in order to avoid any potential conflicts of interest. After Mr. Stevens examined numerous possible solutions that are more fully described in "Analysis of Alternatives," he agreed to move forward with the bankruptcy plan, subject to obtaining a fairness opinion from Houlihan Lokey. Mr. Stevens, as the sole director independent from Crescent Real Estate, consulted with independent financial and legal advisors during these negotiations and believed that the proposed plan would satisfy all of Crescent Operating's indebtedness to its creditors and leave value to the Crescent 80 Operating stockholders that he felt they would not receive in a bankruptcy action that was not pre-negotiated. After the 2001 Annual Meeting of shareholders, no director of Crescent Operating, other than Mr. Stevens acting as an independent director, negotiated on behalf of Crescent Operating. In this time period, Crescent Operating also began negotiations with Bank of America in connection with Bank of America's approximately $15.5 million potential claim against Crescent Operating for debt obligations, arising from an unsecured loan originally funded in 1997. The indebtedness matured on December 31, 2001, but Crescent Operating was unable to pay at that time. Accordingly, negotiations commenced shortly thereafter in which Crescent Operating, with the consent of Crescent Real Estate, offered to grant to Bank of America a first priority security interest in COPI Cold Storage in exchange for the Bank's agreement to extend the maturity date of the loan to August 15, 2002. Pursuant to the Settlement Agreement, Crescent Real Estate agreed to permit Crescent Operating to grant this first priority security interest to Bank of America. Bank of America agreed to Crescent Operating's proposal, and loan documents reflecting the arrangement were executed on March 12, 2002, effective as of December 31, 2001. During August 2002, Bank of America further extended the maturity of this loan to January 15, 2003 and Crescent Operating prepaid interest for that time period in the amount of $0.3 million. In January 2003, Bank of America further extended the maturity of this loan to March 15, 2003 and Crescent Operating agreed to prepay an additional two months of interest at the loan's current rate. Houlihan Lokey issued its fairness opinion regarding the proposed transactions on February 14, 2002, and on February 14, 2002, Crescent Operating, some of its operating subsidiaries, Crescent Real Estate and Crescent Partnership entered into the original Settlement Agreement memorializing the negotiations between Mr. Stevens and Mr. Dean. Effective October 1, 2002, Crescent Operating and Crescent Real Estate amended the Settlement Agreement. The amendment provides for, among other things, a minimum value of Crescent Real Estate common shares to be issued in connection with the bankruptcy plan if the bankruptcy plan is accepted by the requisite vote of Crescent Operating stockholders and confirmed by the bankruptcy court. For more information on the Settlement Agreement and the Crescent Operating bankruptcy plan, see "The Plan of Reorganization." Description of Meetings of Intercompany Evaluation Committee and Board of Directors. The Intercompany Evaluation Committee is a standing committee of the Board of Directors of Crescent Operating established at the first meeting of the Board of Directors held subsequent to Crescent Operating's becoming a public company in June 1997. The Committee was formed originally for the purposes of reviewing, evaluating, analyzing, negotiating the terms of, and making recommendations to the Board of Directors regarding, business and investment opportunities presented to Crescent Operating by Crescent Partnership under the Intercompany Agreement. This review specifically included evaluating whether a transaction opportunity was consistent with Crescent Operating's purpose and fair to Crescent Operating. The Committee's scope expanded to include all proposed transactions with or involving Crescent Partnership or Crescent Real Estate. Because of its responsibility, the Committee was at all times composed entirely of directors who were not officers or directors of Crescent Real Estate or Crescent Partnership. Until March 1999, the sole members of the Committee were Carl F. Thorne and Jeffrey L. Stevens; in March 1999, William A. Abney, became the third member of the Committee. Messrs. Thorne and Abney served on the Committee until the 2001 Annual Meeting of Shareholders held December 6, 2001, when their terms as directors expired. During 1999, 2000 and 2001, the Committee held ten separate meetings: - On March 10 and 11, 1999, the Committee met to consider a proposal for the restructuring of its temperature controlled logistics investment. This proposal involved a complicated transaction that would result in Crescent Operating's effectively surrendering an investment in the real estate side of the temperature controlled logistics business in exchange for a much larger investment in the operational side of the business. The Committee negotiated with Crescent Partnership the sale price for Crescent Operating's interest in the controlled subsidiary and also negotiated a loan from Crescent 81 Partnership to fund Crescent Operating's investment in the new operational entity. When the Committee had obtained satisfactory agreements on those two matters, it recommended to the Board of Directors that Crescent Operating proceed with the transaction. - On March 27, 1999, the Committee met to consider a request from management of the operational entity for the temperature controlled logistics business concerning expansion of two existing storage facilities. The lessor of the facilities - an entity owned jointly by Vornado Trust Realty and Crescent Partnership - had agreed to fund the costs of expansion in return for increases in the rental rates in the leases for those properties. The Committee recommended to the Board of Directors that Crescent Operating proceed with the transaction, which required no outlay of cash by Crescent Operating. - On April 22, 1999, the Committee met to evaluate an opportunity offered by Crescent Partnership for Crescent Operating to become the new lessee of the Renaissance Hotel in Houston, Texas, pursuant to the Intercompany Agreement. The Committee recommended to the Board of Directors that Crescent Operating accept this opportunity. - On November 8, 1999, the Committee met to consider engaging Sonoma Management Corp. I, a company affiliated with Sonoma Management Company, to provide asset management services for the hospitality properties which Crescent Operating leased from Crescent Partnership. At the time of the meeting, Crescent Operating was receiving asset management services for certain of its hospitality properties under contracts with The Varma Group, the principals of which were Sanjay and Johanna Varma, but those contracts would expire in 2000, leaving Crescent Operating unable to fulfill its obligations as the lessee of those properties. The Varmas had formed Sonoma Management Company, with the help of equity investment from Crescent Partnership, to acquire hotel and resort properties, and had also created Sonoma Management Corp. I to provide property management and asset management services. The Varmas were interested in providing Crescent Operating asset management services for its hospitality properties through Sonoma Management Corp. I when the existing asset management agreements expired. After examining the proposed terms of the engagement, the Committee directed management to renegotiate certain financial terms relating to the engagement. - On July 26, 2000, the Committee met to consider a proposal for the restructuring of its interest in the Transportal Network Venture, a business venture within its temperature controlled logistics segment. The restructuring proposal would relieve Crescent Operating of its obligation for certain startup costs, while leaving it with a reduced equity interest in the restructured Transportal by transferring most of Crescent Operating's interest in Transportal to a newly-formed company jointly owned by Crescent Operating and Crescent Partnership. The Committee recommended to the Board of Directors that Crescent Operating offer Crescent Partnership the opportunity to acquire a portion of Crescent Operating's interest in Transportal substantially on the terms presented to the Committee for its consideration. - On March 29, 2001, the Committee met to consider, with the assistance of bankruptcy counsel from Thompson & Knight and a bankruptcy analyses presentation prepared by Thompson & Knight, whether the interests of Crescent Operating's creditor and stockholder constituencies would be better served by reorganization through Chapter 11 bankruptcy than by the proposed negotiated restructuring with Crescent Partnership and SunTx. The Committee concluded that it would not recommend to the Board of Directors the course of bankruptcy. - In May 2001, the Committee met to consider proposals made by Mr. Goff for resolving two aspects of the proposed negotiated restructuring with Crescent Partnership and SunTx in which Mr. Goff was 82 personally interested: modifying Crescent Operating's $15.0 million term loan from Bank of America, which was supported by credit enhancement provided by Mr. Goff and Richard E. Rainwater, to provide debt service relief to Crescent Operating; and liquidating COPI Colorado, L.P., a limited partnership which held Crescent Operating's investment in Crescent Development Management Corp., which later became Crescent Resort Development, Inc. and in which Mr. Goff was a limited partner, to effect the transfer to Crescent Partnership of that interest in Crescent Development Management Corp. The Committee concluded that both proposals were fair and in the best interest of Crescent Operating and recommended to the Board of Directors that Crescent Operating undertake to implement both proposals. - On June 19, 2001, the Committee met to consider whether the terms of the proposed negotiated restructuring with Crescent Partnership and SunTx, as set forth in the current drafts of the transaction agreements submitted to the Committee, was fair to and in the best interests of Crescent Operating. The Committee concluded that transaction agreements and the transactions contemplated thereby were fair to and in the best interests of Crescent Operating and recommended to the Board of Directors that those agreements and transactions be approved and undertaken by Crescent Operating. Subsequent to entering into the securities purchase agreement, effective June 28, 2001, with SunTx, the Committee met twice to discuss repricing of the securities to be issued pursuant to that agreement, as continued declines in the market price of Crescent Operating's common stock caused SunTx to renegotiate the pricing of the securities. Agreement on repricing was reached in October 2001, when the parties entered into an amended and restated securities purchase agreement, effective October 31, 2001. From 1999 through January 5, 2003, the Board of Directors of Crescent Operating held eleven meetings and, in addition, acted by unanimous written consent three times. At the following meetings and in the following consents, the Board considered proposed transactions with Crescent Partnership, Crescent Real Estate or their affiliates: - At a meeting held March 1, 1999, the Board accepted the report and recommendation of the Intercompany Evaluation Committee for a $17.5 million expansion and renovation program at Sonoma Mission Inn & Spa to be funded entirely by Crescent Partnership, the owner of that resort, in return for amendment of the rental rate paid by Wine Country Hotel, LLC, the subsidiary of Crescent Operating that was the lessee of Sonoma Mission Inn & Spa, and approved all actions taken to effect that transaction. The Board also approved increases in the base rentals for all of the hotels and resorts within the hospitality segment and the giving by Crescent Operating of its limited guaranty of its subsidiaries' obligations under the leases in that segment in consideration of capital improvements funded by Crescent Partnership, the elimination of certain capital maintenance contractual restrictions on certain hospitality segment subsidiaries, and the fixing of future monetary obligations of Crescent Operating's hospitality subsidiaries upon the termination of their respective leases and adopted the recommendations of the Compensation Committee of the Board on compensation for the officers of Crescent Operating, including Gerald W. Haddock as President and Chief Executive Officer, who, at the time, held the same offices at Crescent Real Estate. - At a meeting held June 10, 1999, the Board considered the terms of an agreement with Mr. Haddock relating to his resignation as an officer and director of Crescent Operating. At the same time, Mr. Haddock was also resigning as an officer and director of Crescent Real Estate . The final agreement with Mr. Haddock was ratified at a meeting of the Board held on June 17, 1999. - At a meeting held August 27, 1999, the Board discussed and approved the terms of an agreement with Magellan Health Services and Crescent Partnership for the restructuring of Charter Behavioral Health Systems, LLC or, CBHS, which was consummated in September 1999. At the same meeting, the Board received the recommendation of the Intercompany Evaluation Committee regarding lease of the 83 Renaissance Hotel in Houston and approved the lease of that hotel by a subsidiary and guaranty of that lease by Crescent Operating. The Board also ratified the March 1999 restructuring of its temperature controlled logistics investment. - At a meeting held February 11, 2000, the Board discussed the imminent bankruptcy of CBHS, which did file a voluntary petition in bankruptcy on February 16, 2000, and approved a proposal for a newly formed subsidiary of Crescent Operating to offer to purchase the core assets of CBHS out of bankruptcy using bank financing guaranteed by Mr. Rainwater, Chairman of the Board of Directors and Crescent Operating's largest stockholder. Crescent Operating's chief financial officer, Richard P. Knight, and its President and Chief Executive Officer, Mr. Goff, were appointed a special committee to negotiate and approve the terms of an asset purchase agreement for CBHS's core assets, to obtain from PricewaterhouseCoopers its professional advice about a fair, arm's length fee to be paid to Mr. Rainwater for guaranteeing the acquisition debt and to submit that advice to the full Board for its approval, and to negotiate and approve the other terms of an agreement with Mr. Rainwater to procure his guaranty. - At a meeting held March 6, 2000, the Board discussed various restructuring alternatives with Crescent Partnership regarding different assets of Crescent Operating made possible by the REIT Modernization Act. The Board also approved the asset purchase agreement for CBHS's core assets, a fee, within the range recommended by PricewaterhouseCoopers, to be paid to Mr. Rainwater for his guaranty of acquisition indebtedness, and the terms of an agreement with Mr. Rainwater for his guaranty; and the engagement of Sonoma Management to provide asset management and administrative services to the subsidiaries in the hospitality segment, with a guaranty by Crescent Operating of the obligations of its subsidiaries, on the terms set forth in a global agreement presented to the Board. - At a meeting held November 6, 2000, management gave the Board a detailed presentation on the current plan for restructuring Crescent Operating through a transaction with Crescent Partnership and SunTx , for the stated purpose of discerning whether the Board approved of the restructuring strategy before management proceeded with negotiating transaction agreements. In addition, the Board accepted the recommendation of the Intercompany Evaluation Committee to approve the restructuring of the Transportal Network Venture. - At a meeting held March 8, 2001, the Board received a report on the progress of the restructuring, received the report of Houlihan Lokey concerning its fairness opinion on the restructuring transaction and met with SunTx representatives. At this meeting, the Board determined to investigate the probable consequences to Crescent Operating and its constituencies, including its stockholders, of pursuing reorganization through bankruptcy, as an alternative to the restructuring transaction with Crescent Partnership and SunTx, and decided to request from Crescent Operating's legal counsel, Thompson & Knight, an analysis of the bankruptcy alternative. The Board also considered whether, outside of bankruptcy, the proposed restructuring represented the best of Crescent Operating's alternatives. - At a meeting held May 7, 2001, the Board listened to bankruptcy counsel from Thompson & Knight repeat to the full Board the bankruptcy analysis presentation which the counsel had given to the Intercompany Evaluation Committee. The Board also approved the retention of SunTx under a management agreement for Crescent Machinery, and accepted and approved a proposal for Crescent Partnership to be substituted for SunTx in the restructuring transactions if SunTx failed to close its portion of the transactions. In addition, the Board discussed the proposals, described above, made by Mr. Goff regarding the modification of Crescent Operating's $15.0 million term loan from Bank of America to provide debt service relief to Crescent Operating and liquidating COPI Colorado, L.P. to 84 effect the transfer to Crescent Partnership of that interest in Crescent Development Management Corp., but made no decisions regarding those proposals. - At a meeting held June 22, 2001, the Board found it to be in the best interests of Crescent Operating and its stockholders for Crescent Operating to enter into and perform the transactions contemplated by those agreements with Crescent Partnership and SunTx for the restructuring of Crescent Operating, and approved Crescent Operating's execution and delivery of those agreements and the submission of those agreements and the restructuring transactions contemplated thereby to the stockholders of Crescent Operating for their consideration and approval at the 2001 annual meeting of stockholders. - Following the resignations on February 13, 2002, of all directors other than Mr. Stevens, the Board, by written consent, found it to be in the best interests of Crescent Operating, its stockholders and other constituencies for Crescent Operating and certain subsidiaries to enter into and perform the transactions contemplated by the Settlement Agreement with Crescent Real Estate. - At a meeting held on October 1, 2002, Mr. Stevens, as sole director of Crescent Operating, approved and executed the amendment to the Settlement Agreement. - By written consent dated January 5, 2003, Mr. Stevens, as sole director of Crescent Operating, called the special meeting of the stockholders to be held on March 6, 2003, set a record date of January 8, 2003 for the special meeting, and approved various other matters related to the special meeting. RECOMMENDATION OF THE SOLE DIRECTOR OF CRESCENT OPERATING The sole director of Crescent Operating recommends that you vote in favor of the Crescent Operating bankruptcy plan. OPINION OF CRESCENT OPERATING'S FINANCIAL ADVISOR The Crescent Operating Board of Directors retained Houlihan Lokey as its financial advisor in connection with its evaluation of certain matters related to the bankruptcy plan and the transactions contemplated by the Settlement Agreement. On February 14, 2002, using publicly available information and information provided by Crescent Operating or its entities, Houlihan Lokey delivered to the Board of Directors its opinion that, as of such date and based upon and subject to the various limitations, qualifications and assumptions stated in its opinion, the aggregate consideration to be received by Crescent Operating and its stockholders, taken as a whole, in connection with the transactions contemplated by the bankruptcy plan and the Settlement Agreement is fair to the public stockholders of Crescent Operating from a financial point of view. Houlihan Lokey was retained as an independent financial advisor to assist the Board of Directors and the Intercompany Evaluation Committee of Crescent Operating in evaluating, from a financial point of view, only those aspects of the bankruptcy plan and the transactions contemplated by the Settlement Agreement that involved related party considerations. Houlihan Lokey was not requested to make evaluations regarding aspects of the contemplated transactions that the Board of Directors of Crescent Operating believed it could capably consider and evaluate and where such related party considerations were absent. As a result, the opinion of Houlihan Lokey does not address Crescent Operating's underlying business decision either to effect the transactions contemplated by the bankruptcy plan and the Settlement Agreement or the bankruptcy plan itself. Houlihan Lokey was not requested to, and did not, solicit third party indications of interest in selling all or any part of Crescent Operating. In addition, Houlihan Lokey did not evaluate, or include in its analysis any value attributable to, the claims being waived and releases being granted by Crescent Operating and the Crescent Operating stockholders, although Houlihan Lokey made an assessment of the value of the assets transferred to Crescent Real Estate under the bankruptcy plan. At the request of the Board of Directors of Crescent Operating, Houlihan Lokey did not negotiate or advise the Board of Directors of alternatives to the bankruptcy plan, the Settlement Agreement or the transactions contemplated thereby. Houlihan Lokey did not make, and was not requested by Crescent Operating to make, any recommendations as to the form or amount of consideration to be paid to Crescent Operating in connection with the bankruptcy plan and Settlement Agreement. Houlihan Lokey was not requested to, and did not, opine as to the overall fairness of the bankruptcy plan and 85 Settlement Agreement to the public stockholders of Crescent Operating. Similarly, Houlihan Lokey was not requested to, and did not, evaluate the fairness of the individual transactions contemplated by the bankruptcy plan and Settlement Agreement. Instead, the Intercompany Evaluation Committee of the Crescent Operating Board assessed the individual transactions contemplated by the bankruptcy plan and the Settlement Agreement, and determined that, taken as a whole, they were fair to the creditors and stockholders of Crescent Operating. Issues and concerns related to the limited scope of Houlihan Lokey's opinion are described in detail under the heading "Risk Factors - Risks Associated with the Crescent Operating Bankruptcy Plan - Limitations on the scope of Houlihan Lokey's fairness opinion could lead Crescent Operating's stockholders to assign too much importance to the fairness opinion in making their decision on whether to vote to approve the bankruptcy plan." A copy of Houlihan Lokey's written opinion, which sets forth the assumptions made, matters considered and limitations on the review undertaken in connection with the opinion, is included as Annex B to this proxy statement/prospectus. Among other things, the Houlihan Lokey fairness opinion assumes that Crescent Operating's stockholders will receive shares of Crescent Real Estate with a value of between $0.32 and $0.50 per share, but specifically states that it would not necessarily change if Crescent Real Estate makes available to Crescent Operating additional funds, as Crescent Real Estate agreed to do in the October 2002 amendment to the Settlement Agreement and as described in "The Reorganization Transactions - Summary of the Reorganization Transactions - Payment by Crescent Real Estate of Crescent Operating Claims and Expenses," that reduce the value of Crescent Real Estate common shares to below $0.32. YOU SHOULD READ HOULIHAN LOKEY'S OPINION CAREFULLY AND IN ITS ENTIRETY. Houlihan Lokey is a nationally recognized investment-banking firm. The board of directors of Crescent Operating selected Houlihan Lokey based on Houlihan Lokey's reputation and experience in investment banking generally and its recognized expertise in the valuation of assets and businesses related to the real estate industry. In connection with the prior proposed sale of assets and stock to Crescent Partnership and sale of preferred partnership interests to CRE Equipment Holdings, LLC and SunTx, Houlihan Lokey performed various analyses, including the issuance of a fairness opinion on October 1, 2000. Houlihan Lokey received $380,000 for the fairness opinion. Other than the fairness opinions delivered in connection with the previous reorganization proposals, Houlihan Lokey has no material prior relations with Crescent Operating or Crescent Operating's affiliates. Houlihan Lokey based its opinion of the financial fairness to the public stockholders of the transactions contemplated by the bankruptcy plan and the Settlement Agreement on the analyses described below. No restrictions or limitations were imposed on Houlihan Lokey with respect to its investigation of Crescent Operating or the procedures followed by Houlihan Lokey in rendering its opinion. In connection with its opinion, Houlihan Lokey made such reviews, analyses and inquiries as it deemed necessary and appropriate under the circumstances. Among other things, Houlihan Lokey: 1. held discussions with management of Crescent Operating, Crescent Real Estate and East West Partners; 2. reviewed historical operating statements for the hotel properties; 3. reviewed the hotel lease agreements between the affiliates of Crescent Operating (as the lessees) and Crescent Real Estate (as the lessors); 4. reviewed the balance sheet of RoseStar Management, LLC dated as of November 30, 2001; 5. reviewed projections for the hotel properties, provided by Crescent Operating, for the period of operation corresponding with the remaining term of the lease; 6. reviewed a legal entity ownership chart provided by Crescent Operating; 86 7. reviewed projections for the life of the CRDI land development projects prepared by East West Partners; 8. reviewed the internally prepared consolidating balance sheets and income statements for East West Resort Transportation LLC and East West Resort Transportation II LLC for the period ended December 31, 2001; 9. reviewed historical operating statements and 2002 budgets for CDMC Palm Beach; 10. reviewed projections for The Woodlands Land Development Company provided by Crescent Operating for the periods ending December 31, 2002 through December 31, 2011; 11. reviewed projections for The Woodlands Operating Company provided by Crescent Operating for the periods ending December 31, 2002 through December 31, 2006; 12. reviewed projections for Desert Mountain provided by Crescent Operating for the periods ending December 31, 2002 through December 31, 2010; 13. reviewed the publicly available Securities and Exchange Commission filings of Crescent Operating, including the Form 10-K for the fiscal year ended December 31, 2000 and the Form 10-Q for the period ended September 30, 2001; 14. reviewed the internally prepared consolidating balance sheet for CRDI for the period ended December 31, 2001; 15. reviewed the internally prepared consolidating balance sheet of Crescent Operating for the periods ended November 30, 2000; December 31, 2000; and November 30, 2001; 16. reviewed the internally prepared liquidation analysis of Crescent Operating, which is set forth in "The Reorganization Transactions - Liquidation Analyses - Table 1 - Liquidation Before Giving Effect to Settlement Agreement;" 17. reviewed the AmeriCold management package, including income statement and balance sheet, for the fiscal year ended December 31, 2001; 18. reviewed the AmeriCold budget for the fiscal year ended December 31, 2002; 19. reviewed a draft Settlement Agreement dated February 14, 2002; and 20. conducted such other studies, analyses and inquiries as Houlihan Lokey deemed appropriate. The following chart indicates the relationship to Crescent Operating of each of the entities listed above. As of February 13, 2002, Crescent Operating had a direct or indirect interest in each of these entities: RELATIONSHIP TO CRESCENT OPERATING AS REPRESENTED ENTITY TO HOULIHAN LOKEY BY CRESCENT OPERATING MANAGEMENT RoseStar Management, LLC Crescent Operating has an ownership interest Crescent Resort Crescent Operating has an indirect ownership Development, Inc. interest CDMC Palm Beach Crescent Operating has an indirect ownership interest 87 EastWest Resort Crescent Operating has an indirect ownership Transportation LLC interest EastWest Resort Crescent Operating has an indirect ownership Transportation II LLC interest CDMC Palm Beach Crescent Operating has an indirect ownership interest Woodlands Land Crescent Operating has an indirect ownership Development Co., LP interest The Woodlands Operating Crescent Operating has an indirect ownership Company, LP interest Desert Mountain Crescent Operating has an indirect ownership Properties, LP interest AmeriCold Crescent Operating has an indirect ownership interest Houlihan Lokey did not independently verify the accuracy and completeness of, or assume any responsibility for, the information supplied to it with respect to Crescent Operating and Crescent Operating's affiliates. Houlihan Lokey did not make any physical inspection or independent appraisal of any of the properties or assets of Crescent Operating and Crescent Operating's affiliates. The opinion is based on business, economic, market and other conditions that existed and could be evaluated by Houlihan Lokey at the date of the opinion. Houlihan Lokey prepared the opinion in order to provide information to the Board of Directors in connection with its evaluation of the transactions contemplated by the bankruptcy plan and Settlement Agreement. The opinion is not a recommendation to Crescent Operating or any of its stockholders as to whether to approve or take action in connection with the bankruptcy plan. A copy of the opinion was delivered to the Board of Directors of Crescent Operating in accordance with the requirements of Houlihan Lokey's engagement letter with Crescent Operating. The opinion speaks only as of its date, and Houlihan Lokey is under no obligation to update the opinion at any time after the date thereof. Crescent Operating engaged Houlihan Lokey for total fees of approximately $225,000 for its services in connection with the opinion, plus reasonable out-of-pocket expenses incurred by Houlihan Lokey in connection therewith, including reasonable fees and expenses of its legal counsel. Crescent Operating paid Houlihan Lokey $225,000 upon execution of the engagement letter, and made subsequent payments totaling $14,270 for expenses upon receipt of periodic billings. No portion of the fees is or was contingent upon the consummation of the bankruptcy plan, Settlement Agreement or the conclusions reached in the opinion. Crescent Operating has not agreed to make any additional payments to Houlihan Lokey, other than payments required to be made to cover any additional expenses incurred by Houlihan Lokey in connection with the preparation of this proxy statement/prospectus. Valuation Methodology Hotel/Resort Leases. In assessing the range of value of the hotel and resort leases, which include leases for the Denver Marriott, the Hyatt Beaver Creek, the Allegria Spa at the Hyatt Beaver Creek, the Hyatt Albuquerque, the Sonoma Mission Inn and Spa, the Ventana Inn and Spa, the Houston Renaissance, the Canyon Ranch Lenox, the Canyon Ranch Tucson, and the WECCR GP, Houlihan Lokey utilized the Discounted Cash Flow approach. In order to account for the risk of cash flows and the time value of money, Houlihan Lokey discounted the projected cash flows of each lease, as prepared by Crescent Partnership, at rates ranging from 13% to 18.5%, depending on specific qualitative and quantitative factors. 88 These factors included the location of the property, the historical performance of the property, the implicit risk of the projected cash flows, the market in which the property was located, the condition of the property, the competitive position of the property, and the economic outlook in general. Houlihan Lokey assessed a range of value of approximately $14.4 million to $15.4 million for the hotel and resort leases, not including the WECCR GP, as discussed below. Land Development Projects. In assessing the range of value of the land development projects, which include Desert Mountain, The Woodlands Land Development Company, and certain projects of CRDI, Houlihan Lokey also utilized the Discounted Cash Flow approach. In order to account for the risk of cash flows and the time value of money, Houlihan Lokey discounted estimated cash flows expected to be received by CRDI or Crescent Operating from the individual real estate project's projected cash flows, as prepared by Crescent Partnership or East West Partners, at rates ranging from 10% to 25%, depending on specific qualitative and quantitative factors. These factors included the location of the property, the historical performance of the property, the implicit risk of the projected cash flows, the market in which the property was located, the phase of the project, the applicable entitlement risk, construction risk, home building risk, financing risk, or market risk, the competitive position of the property, and the economic outlook in general. For those projects in which Crescent Operating or CRDI had an ownership of less than 100%, including Desert Mountain, The Woodlands Land Development Company, The Woodlands Country Club and Convention Center, and the projects of CRDI, Houlihan Lokey applied the respective ownership percentage to the discounted cash flow value to assess the ultimate range of value to Crescent Operating. Houlihan Lokey assessed Crescent Operating's assessed range of value at approximately $4.3 million to $4.6 million for Desert Mountain and approximately $9.7 million to $10.8 million for The Woodlands Land Development Company. The value of COPI Colorado and its interest in CRDI is summarized below. Crescent Resort Development, Inc. (formerly Crescent Development Management Corporation)/COPI Colorado. In assessing the range of value of CRDI, as represented by Crescent Operating's ownership of COPI Colorado, Houlihan Lokey summed the assessed value of CRDI's interests in its land development projects, described above, and going-concern businesses, described below. The assessed value of CRDI's interests in its land development projects and going concern businesses was between $122.591 and $151.123 million, including cash, and deducting the $180.4 million of debt owed to Crescent Partnership. Applying COPI Colorado's 10% ownership percentage and then adding cash at the COPI Colorado level, Crescent Operating common stock of 1.1 million shares, and a receivable from CRDI to COPI Colorado resulted in the total value of COPI Colorado. Houlihan Lokey assessed the range of value of COPI Colorado, which includes the 10% ownership in CRDI, from approximately $12.3 million to $15.1 million. Houlihan Lokey assessed that Crescent Operating's 60% ownership interest in COPI Colorado ranged in value from approximately $8.0 to $9.8 million. The valuation of CRDI included, without limitation, a valuation of the following going-concern businesses in which CRDI has an interest: East West Resort Transportation LLC and East West Resort Transportation II LLC. In assessing the range of value of East West Resort Transportation LLC and East West Resort Transportation II LLC, or collectively "East West Resort Transportation," Houlihan Lokey utilized a variety of valuation methodologies, including the Market Multiple Approach and the Gordon Growth Approach. With respect to the Market Multiple Approach, Houlihan Lokey applied market-based multiples of comparable public companies to representative historical levels of East West Resort Transportation. Houlihan Lokey adjusted that 89 value for debt to arrive at a minority equity value. A 25% control premium was then applied to arrive at a control equity range of value, and debt was added back for control enterprise range of value. With respect to the Gordon Growth Approach, Houlihan Lokey capitalized a projected level of earnings of East West Resort Transportation, as provided by East West Transportation, utilizing discount rates ranging from 14% to 16%, to consider the risk of the cash flows and the time value of money, and growth rates ranging from 2% to 4%. Utilizing the two approaches, based on a reasonable range of Control Enterprise Value, adjusted for debt and cash, Houlihan Lokey arrived at a control equity range of value of East West Resort Transportation. CRDI's 50% ownership was applied to the control equity value to assess the ultimate range of equity value to CRDI in East West Resort Transportation. Houlihan Lokey assessed that CRDI's value in East West Resort Transportation ranged from approximately $8.8 million to $9.8 million. CRDI Palm Beach, Inc. In assessing the range of value of CRDI Palm Beach, Houlihan Lokey utilized a Direct Capitalization Approach whereby Houlihan Lokey applied market-based debt free capitalization rates to representative historical and projected earnings levels of Manalapan Hotel Partners to arrive at a minority enterprise range of value. Capitalization rates applied to earnings levels of Manalapan Hotel Partners ranged from 8 to 10% for December 31, 2001 Earnings (loss) before interest expense, income taxes, depreciation and amortization or EBITDA; 8 to 10% for 2002 expected EBITDA; and 10 to 13% for "Normalized" EBITDA which was an average EBITDA of fiscal years ended December 31, 1998 through December 31, 2000. Utilizing this approach, based on a reasonable range of Minority Enterprise Value, adjusted for debt and cash, Houlihan Lokey arrived at a minority equity range of value of Manalapan Hotel Partners. CRDI Palm Beach's 25% ownership was applied to the minority equity range of value to assess the ultimate range of equity value to CRDI Palm Beach in Manalapan Hotel Partners. Houlihan Lokey assessed that CRDI Palm Beach's value in Manalapan Hotel Partners ranged from approximately $0.1 million to $4.0 million. The Woodlands Operating Company, L.P. In assessing the range of value of The Woodlands Operating Company, Houlihan Lokey utilized a variety of valuation methodologies, including the Market Multiple Approach, and the Enterprise Discounted Cash Flow approach. With respect to the Market Multiple Approach, Houlihan Lokey applied market-based multiples of comparable public companies, including Grubb & Ellis, Co., Insignia Financial Group, Inc., Jones Lang LaSalle, Inc. and Trammell Crow Company, to representative historical and projected earnings levels of The Woodlands Operating Company and applied a 20% control premium to arrive at a control equity range of value. The market-based multiples applied to the Woodlands Operating Company earnings levels ranged from between 5.0x to 5.5x December 31, 2001 EBITDA and from between 8.0x to 8.5x December 31, 2001 Earnings (loss) before interest expense and income taxes or EBIT. As there is no debt or preferred stock, the control equity value equals the control enterprise range of value. With respect to the Enterprise Discounted Cash Flow Approach, Houlihan Lokey discounted the projected cash flows of The Woodlands Operating Company, as provided by Crescent Operating, at rates ranging from 12% to 16% to consider the risk of the cash flows and the time value of money. A terminal multiple was then applied to the terminal year earnings. The sum of the discounted interim cash flows and the discounted terminal year cash flow represents the control enterprise range of value. Utilizing the two approaches, based on a reasonable range of Control Enterprise Value, adjusted for debt and cash, Houlihan Lokey arrived at a control equity range of value of The Woodlands Operating Company. Crescent Operating's ownership percentage was applied to the control equity range of value to assess the ultimate range of equity value of Crescent Operating's interest in The Woodlands Operating Company. Crescent Operating's pro rata assessed value in the WECCR GP was added to arrive at Crescent Operating's total value in The Woodlands Operating 90 Company. Houlihan Lokey assessed that Crescent Operating's value in The Woodlands Operating Company, including the WECCR GP, ranged from approximately $9.9 million to $11.0 million. CRL Investments, Inc. Houlihan Lokey applied an estimate of approximately $1.2 million, as provided by the management of Crescent Operating, to assess the range of value of Crescent Operating's investment in CRL. Canyon Ranch Tucson - FF&E. Houlihan Lokey applied the book value of approximately $6.9 million, as provided by the management of Crescent Operating, to assess the range of value of the fixed assets of the Canyon Ranch - Tucson. Valuation Summary The following table summarizes the assessed range of value of Crescent Operating's holdings in its hospitality and land development segments: DERIVED VALUES (ROUNDED) Low High ------- ------- (dollars in millions) Hotel/Resort Leases $14.430 -- $15.439 Desert Mountain 4.299 -- 4.608 The Woodlands Land Co. 9.719 -- 10.820 COPI Colorado 8.040 -- 9.780 The Woodlands Operating Co. (includes WECCR GP) 9.900 -- 11.000 CRL Investments 1.200 -- 1.200 Canyon Ranch Tucson FF&E - Book Value 6.874 -- 6.874 Total Value of the Hospitality and Land Development Assets $54.462 -- $59.721 COPI Cold Storage LLC Houlihan Lokey has been asked to rely upon the transaction value implied by Crescent Spinco's acquisition of Crescent Operating's equity interest in AmeriCold Logistics. This value was agreed upon based on negotiations between Crescent Real Estate and Crescent Operating. Crescent Operating determined that the price was fair in all respects based on its independent analysis of historic operating results and future estimates of operating income and determined that the price was sufficient and that it would be considered preemptive and in excess of a price it could reasonably expect from any third party. Therefore Crescent Operating did not deem it necessary to incur the expense of hiring Houlihan Lokey to render a separate fairness opinion with regard to the value of AmeriCold. No further conclusions have been reached by Houlihan Lokey. The aforementioned analyses required studies of the overall market, economic and industry conditions under which Crescent Operating and its entities operate, and Crescent Operating's and its entities' operating results. Research into, and consideration of, these conditions were incorporated into the analyses. In assessing the fairness of the aggregate consideration to be received by Crescent Operating in connection with the transactions contemplated by the bankruptcy plan and the Settlement Agreement, Houlihan Lokey analyzed the reasonableness of the consideration offered by Crescent Real Estate, including the debt and rent forgiveness, advances up to $10.5 million, between approximately $0.32 and $0.50 per share of Crescent Real Estate stock and repayment of the $15 million Bank of America obligation, in exchange for transfer of Crescent Operating's hospitality and land development assets and COPI Cold Storage. Based on its analysis, Houlihan Lokey is of the opinion that the aggregate consideration to be received by Crescent Operating in connection with the transactions contemplated by the bankruptcy plan and the Settlement Agreement is fair, from a financial point of view, to the public stockholders of 91 Crescent Operating. Houlihan Lokey did not evaluate, and does not offer any opinion relating to the other elements of the bankruptcy plan or Settlement Agreement, individually or in the aggregate. The opinion is based on the business, economic, market and other conditions as they existed as of the date of the opinion. Houlihan Lokey relied upon and assumed, without independent verification, the accuracy, completeness and fairness of all of the financial and other information reviewed by it in connection with rendering the opinion. Houlihan Lokey also assumed that the financial results and projections provided by Crescent Operating and its entities have been reasonably prepared and reflect the best current available estimates of the financial results, condition, and prospects of Crescent Operating. Houlihan Lokey did not independently verify the accuracy or completeness of the information supplied to it with respect to Crescent Operating and its affiliates and does not assume responsibility for such information. Except as described above, Houlihan Lokey did not make any physical inspection or independent appraisal of the specific properties, assets or liabilities of Crescent Operating or its entities. The preparation of a fairness opinion is a complex analytical process involving various determinations as to the most appropriate and relevant methods of financial analysis and application of those methods to the particular circumstances and is therefore not readily susceptible to summary description. In arriving at the opinion, Houlihan Lokey did not attribute any particular weight to any one analysis or factor, but rather made qualitative judgments as to the significance and relevance of each analysis and factor. Houlihan Lokey believes its analyses and the summary set forth herein must be considered as a whole and that selecting portions of its analyses or this summary, without considering all factors and analyses, could create an incomplete view of the processes underlying the analyses set forth in the opinion. Houlihan Lokey made numerous assumptions with respect to Crescent Operating and its affiliates, industry performance, general business, economic, market and financial conditions and other matters, many of which are beyond the control of Crescent Operating and its affiliates. The estimates contained in such analyses are not necessarily indicative of an actual range of values or predictive of future results or values, which may be more or less favorable than suggested by such analyses. Additionally, analyses relating to the range of value of businesses or securities do not purport to be appraisals or to reflect the prices at which businesses or securities actually may be sold. Accordingly, such analyses and estimates are inherently subject to substantial uncertainty. INTERESTS OF CERTAIN PERSONS IN THE REORGANIZATION TRANSACTIONS Richard E. Rainwater, who serves as the Chairman of the Board of Crescent Real Estate and served as the Chairman of the Board of Crescent Operating until February 2002, and John C. Goff, who serves as Vice Chairman and Chief Executive Officer of Crescent Real Estate and served as Vice Chairman, President and Chief Executive Officer of Crescent Operating until February 2002, have financial interests in the Crescent Operating bankruptcy plan. As of the record date, Mr. Rainwater was the beneficial owner of approximately 11.5% of the outstanding shares of Crescent Operating common stock and approximately 14.6% of the outstanding Crescent Real Estate common shares, including in each case shares underlying vested options. As of the same date, Mr. Goff was the beneficial owner of approximately 6.6% of the outstanding shares of Crescent Operating common stock and approximately 4.1% of the outstanding Crescent Real Estate common shares, including in each case shares underlying vested options. As beneficial owners of Crescent Real Estate common shares, Messrs. Rainwater and Goff may have interests in the Crescent Operating bankruptcy plan that differ from those of beneficial owners of Crescent Operating common stock who are not also owners of Crescent Real Estate common shares. As beneficial owners of Crescent Operating common stock, Mr. Rainwater and Mr. Goff will receive Crescent Real Estate common shares if the Crescent Operating bankruptcy plan is approved by the required vote of the shares of Crescent Operating common stock and confirmed by the bankruptcy court. Mr. Goff and Mr. Rainwater are also parties to a support agreement with Crescent Operating and Bank of America relating to Crescent Operating's $15.0 million obligation, plus accrued interest, to Bank of America. At the time Crescent Operating obtained the loan, Bank of America required, as a condition to making the loan, that Mr. Rainwater, the Chairman of the Board of Trust Managers of Crescent Real Estate and member of the strategic planning committee of Crescent Real Estate Equities, Ltd., and John C. Goff, Vice Chairman of the Board of Trust Managers and Chief Executive Officer of Crescent Real Estate and sole director, Chief Executive Officer and President of 92 Crescent Real Estate Equities, Ltd., enter into a support agreement with Crescent Operating and Bank of America, pursuant to which they agreed to make additional equity investments in Crescent Operating if Crescent Operating defaulted on payment obligations under its line of credit with Bank of America and the net proceeds of an offering of Crescent Operating securities were insufficient to allow Crescent Operating to pay Bank of America in full. Effective December 31, 2001, Crescent Operating, in connection with extending the maturity of its $15.0 million loan from Bank of America from December 31, 2001 to August 15, 2002, agreed to modify the loan from an unsecured to a secured credit facility. Crescent Operating, with the consent of Crescent Partnership which agreed to subordinate its security interest in Crescent Operating's 40% interest in AmeriCold Logistics in the Settlement Agreement, pledged all of its interest in AmeriCold Logistics to Bank of America to secure the loan. The amendment to the line of credit also waived Crescent Operating's default under the line of credit, as a result of Crescent Operating's failure to pay the principal balance in full on December 31, 2001. During August 2002, Bank of America further extended the maturity of this loan to January 15, 2003 and Crescent Operating prepaid interest for that time period in the amount of $0.3 million. In January 2003, Bank of America further extended the maturity of this loan to March 15, 2003 and Crescent Operating agreed to prepay an additional two months of interest at the loan's current rate. These modifications delay, but do not reduce, any liability that Mr. Rainwater and Mr. Goff may have under the support agreement. Any future defaults by Crescent Operating under the line of credit will revive the default that was waived under the August 2002 amendment to the line of credit. In connection with the Crescent Operating bankruptcy plan, it is expected that Crescent Operating's line of credit with Bank of America will be fully repaid, and Messrs. Goff and Rainwater will be relieved of their potential personal liability under the support agreement. As of September 30, 2002, the aggregate amount outstanding under the loan was $15.0 million, plus accrued interest. In addition, Mr. Goff was subject to conflicts of interest as a result of his participation in the initial proposal of the Crescent Operating bankruptcy plan and related agreements while serving simultaneously as an executive officer and trust manager of Crescent Real Estate and as an executive officer of Crescent Operating, but he did not participate in negotiations of the terms of the Settlement Agreement or bankruptcy plan. Jeffrey L. Stevens, Crescent Operating's current Chief Executive Officer and sole director, will serve as plan administrator of Crescent Operating's contemplated Chapter 11 bankruptcy. For more information regarding the plan administrator, see "The Plan of Reorganization - Implementation of the Plan of Reorganization - The Plan Administrator." Pursuant to the Crescent Operating bankruptcy plan, the current and former directors and officers of Crescent Operating and the current and former trust managers and officers of Crescent Real Estate will also receive certain liability releases from the Crescent Operating stockholders as described in "The Plan of Reorganization - Effects of the Confirmation of the Plan of Reorganization - Releases." In February and March 2002, pursuant to the terms of the Settlement Agreement, Crescent Operating transferred to Crescent Real Estate, in lieu of foreclosure, the interests in its hospitality segment and, pursuant to a strict foreclosure, the assets of its land development segment. Crescent Real Estate holds these assets and interests through two newly organized corporations and one newly organized limited liability company that are wholly owned subsidiaries of Crescent Real Estate, or taxable REIT subsidiaries. In addition, in connection with the execution of the Settlement Agreement, Crescent Real Estate and Crescent Operating exchanged mutual releases. In pertinent part, Crescent Operating released any and all claims that it might have against Crescent Real Estate and its current and former trust managers and officers and Crescent Real Estate released any and all claims that it might have against Crescent Operating and its current and former directors and officers arising at any time prior to execution of the original Settlement Agreement. This release remains effective regardless of whether the bankruptcy plan is accepted by Crescent Operating's stockholders and/or confirmed by the bankruptcy court. 93 In addition, pursuant to the Crescent Operating bankruptcy plan, Crescent Real Estate will receive certain liability releases from the Crescent Operating stockholders as described in "The Plan of Reorganization - Effects of Confirmation of the Plan of Reorganization - Releases." RESTRICTIONS ON SALES OF CRESCENT REAL ESTATE COMMON SHARES BY AFFILIATES OF CRESCENT OPERATING All Crescent Real Estate common shares received by Crescent Operating stockholders under the Crescent Operating bankruptcy plan will be freely transferable, except that Crescent Real Estate common shares received by persons who are deemed to be "affiliates" of Crescent Operating under the Securities Act at the time of the special meeting may be resold by them only in transactions permitted by Rule 145 or as otherwise permitted under the Securities Act. Persons who may be deemed to be affiliates of Crescent Operating under the Securities Act for such purposes generally include individuals or entities that control, are controlled by, or are under common control with, Crescent Operating and may include certain officers, former directors and the sole director and principal stockholders of Crescent Operating. The Crescent Operating bankruptcy plan requires Crescent Operating to use all reasonable efforts to cause each person, who in Crescent Operating's reasonable judgment (subject to Crescent Real Estate's counsel's reasonable satisfaction) may be deemed to be an affiliate, to execute a written agreement to the effect that such person will not offer or sell or otherwise dispose of any of the Crescent Real Estate common shares issued to such person pursuant to the Crescent Operating bankruptcy plan in violation of the Securities Act or the rules and regulations promulgated by the Securities and Exchange Commission thereunder. LISTING ON THE NEW YORK STOCK EXCHANGE OF CRESCENT REAL ESTATE COMMON SHARES TO BE ISSUED IN THE REORGANIZATION TRANSACTIONS Crescent Real Estate has agreed to cause the Crescent Real Estate common shares to be issued under the Crescent Operating bankruptcy plan and to use its reasonable best efforts to cause the Crescent Real Estate common shares to be listed on the NYSE on or prior to the to the confirmation of the Crescent Operating bankruptcy plan. NO DISSENTERS' APPRAISAL RIGHTS There are no dissenters' appraisal rights available under applicable state corporate law with respect to the reorganization transactions. However, if a stockholder opposes the bankruptcy plan, the stockholder may vote against it. After the bankruptcy plan is filed with the bankruptcy court, a stockholder may file pleadings with the bankruptcy court explaining why it believes the bankruptcy plan should not be confirmed. The stockholder may hire an attorney to argue its position to the court. If the Crescent Operating bankruptcy plan is confirmed by the bankruptcy court, the Crescent Operating stockholders, including the stockholders who do not vote to accept the Crescent Operating bankruptcy plan, will be bound by all of the terms and conditions of the Crescent Operating bankruptcy plan. However, stockholders who vote against the bankruptcy plan, abstain or do not vote, and who do not receive or refuse to accept any consideration under the bankruptcy plan, will not be bound by the releases in the bankruptcy plan. Additionally, stockholders who sell their stock before the voting record date will not be bound by the release. THE PLAN OF REORGANIZATION OVERVIEW AND INCORPORATION BY REFERENCE CRESCENT OPERATING HAS NOT COMMENCED THE REORGANIZATION CASE UNDER THE BANKRUPTCY CODE. HOWEVER, IF CRESCENT OPERATING OBTAINS THE REQUISITE VOTES ACCEPTING THE BANKRUPTCY PLAN AS A RESULT OF THE SOLICITATION, CRESCENT OPERATING WILL FILE A VOLUNTARY PETITION UNDER CHAPTER 11 OF THE BANKRUPTCY CODE TO COMMENCE THE REORGANIZATION CASE. 94 IF THE BANKRUPTCY PLAN IS NOT ACCEPTED BY THE REQUIRED VOTE, CRESCENT OPERATING WILL LIKELY STILL FILE THE CHAPTER 11 CASE AND REQUEST THAT THE BANKRUPTCY COURT CONFIRM THE BANKRUPTCY PLAN UNDER THE "CRAMDOWN PROVISION" OF THE BANKRUPTCY CODE. THIS PROVISION WOULD PERMIT CONFIRMATION OF THE BANKRUPTCY PLAN IF THE COURT FINDS THAT THE BANKRUPTCY PLAN DOES NOT DISCRIMINATE UNFAIRLY AND IS FAIR AND EQUITABLE TO CRESCENT OPERATING'S STOCKHOLDERS. THE BANKRUPTCY PLAN PROVIDES THAT, IF THE BANKRUPTCY PLAN IS NOT ACCEPTED BY THE REQUIRED VOTE OF THE CRESCENT OPERATING STOCKHOLDERS, AND THE BANKRUPTCY PLAN IS CONFIRMED BY THE BANKRUPTCY COURT PURSUANT TO THE "CRAMDOWN PROVISION," THE CRESCENT OPERATING STOCKHOLDERS WILL NOT RECEIVE THE CRESCENT REAL ESTATE COMMON SHARES ISSUABLE TO THEM IF THE BANKRUPTCY PLAN IS ACCEPTED BY THE REQUIRED VOTE. The following is a brief summary of the material provisions of the Bankruptcy Code and material provisions of the Plan of Reorganization. The following discussion of the material provisions of the Plan of Reorganization is only a summary. For a complete and more detailed discussion of these provisions, please read the Plan of Reorganization, a copy of which is attached as Annex A to this proxy statement/prospectus and is incorporated herein by reference. The term "Debtor," as used in this section, refers to Crescent Operating, Inc. BRIEF EXPLANATION OF CHAPTER 11 Chapter 11 is the principal business reorganization chapter of the Bankruptcy Code. Under Chapter 11, a debtor is authorized to operate its business in the ordinary course while attempting to reorganize its business for the benefit of its creditors and equity security holders. In addition to facilitating the rehabilitation of the debtor, reorganization under Chapter 11 is intended to promote equality of treatment of creditors and equity security holders of equal rank with respect to the distribution of the debtor's assets. In furtherance of these goals, upon filing of a petition for reorganization under Chapter 11, section 362 of the Bankruptcy Code generally provides for an automatic stay of substantially all actions and proceedings against the debtor and its properties, including attempts to collect debts or enforce liens that arose prior to the commencement of the debtor's case under Chapter 11. Consummation of a plan of reorganization is the principal objective of a Chapter 11 reorganization case. In general, a Chapter 11 plan of reorganization: - divides most claims and interests into classes; - specifies the property, distribution or other treatment that each member of a class is to receive under the bankruptcy plan on account of its claim or interest, if any; and - contains other provisions necessary or appropriate to the reorganization of the debtor. Confirmation of a plan of reorganization by a bankruptcy court makes the bankruptcy plan binding upon the debtor, any issuer of securities under the bankruptcy plan, any person acquiring property under the bankruptcy plan and any creditor or interest holder of the debtor. Except as specifically provided in the plan of reorganization or the order confirming the bankruptcy plan, the order confirming the bankruptcy plan discharges the debtor from any debt that arose prior to the date that the bankruptcy plan becomes effective to the fullest extent authorized or provided for by the Bankruptcy Code or other applicable law, and substitutes for such indebtedness the obligations specified in the bankruptcy plan of reorganization. CLASSIFICATION AND TREATMENT OF CLAIMS AND INTERESTS The bankruptcy plan classifies claims against and interests in the Debtor into eight (8) classes. Administrative claims, which are claims for costs and expenses of administration of the bankruptcy case including (i) the costs of preserving the Debtor's assets and operating its business after the filing date and (ii) professional fees incurred in connection with the reorganization, are not classified. These claims will be paid in full on the effective date (the date on which all conditions to the effectiveness of the bankruptcy plan are satisfied) of the bankruptcy plan or as soon 95 thereafter as practicable or when due in the ordinary course of the Debtor's business. Certain priority tax claims are also not classified. These claims will also be paid in full on or soon after the effective date. Section 1122 of the Bankruptcy Code requires that a claim or interest may be placed in a particular class only if it is substantially similar to all other claims in that class. Creditors and interest holders may object to the classification of claims or interests. The bankruptcy plan includes two classes of secured claims; the Crescent Real Estate secured claims and the Bank of America secured claims. The holders of claims in these classes are impaired and are entitled to vote on the bankruptcy plan. Class 1 is the allowed Crescent Real Estate secured claims. Crescent Real Estate will retain its pre-petition liens and upon Crescent Real Estate's request, reorganized Crescent Operating shall deliver and transfer to Crescent Real Estate any and all Crescent Operating property pledged to Crescent Real Estate. The parties anticipate that any and all remaining assets of Crescent Operating, other than the 40% partnership interest of COPI Cold Storage in AmeriCold Logistics, will be transferred to Crescent Real Estate prior to or on the bankruptcy plan effective date on account of Crescent Real Estate's Class 1 secured claims. Class 2 is the Bank of America secured claims. Bank of America's claim will either (i) be paid in full as soon after the effective date as is practicable, or (ii) the Debtor will deliver the 40% partnership interest of COPI Cold Storage in AmeriCold Logistics, Bank of America's collateral, to Bank of America in full satisfaction of it's allowed secured claim. Class 3 includes claims entitled to priority treatment under 11 U.S.C. Section 507(a) other than administrative claims and pre-petition priority tax claims. Class 3 is not impaired and is not entitled to vote on the bankruptcy plan. These claims will be paid in full. Class 3 claims will consist primarily of unpaid pre-petition salaries and benefits. Crescent Operating estimates that Class 3 claims will be approximately $1.1 million. Class 4 includes the claims of general unsecured creditors. Class 4 is not impaired and is not entitled to vote on the bankruptcy plan. Because the Debtor is essentially a holding company, it does not have significant general unsecured claims. The holders of Class 4 unsecured claims will be paid in full as soon as practicable after the later of (i) the effective date, (ii) the date on which the claim is no longer disputed, or (iii) the date such payment becomes due in the ordinary course of business. Crescent Operating estimates that the total Class 4 claims will be approximately $0.5 million. This estimate does not include the claims that the Crescent Machinery Committee has alleged in its lawsuit against Crescent Operating. If the total obligations of Crescent Operating to the unsecured creditors of Crescent Operating identified in the original Settlement Agreement, plus newly asserted claims such as those of the Crescent Machinery Committee, exceed the amount of funds that Crescent Real Estate will make available to Crescent Operating for the payment of these claims, there is a risk that the bankruptcy court will not confirm the bankruptcy plan. Class 5 includes the holders of certain promissory notes secured by assets of Crescent Machinery, a Crescent Operating subsidiary that commenced a Chapter 11 bankruptcy case on February 6, 2001. Class 5 is impaired and the holders of the allowed claims in Class 5 are entitled to vote on the bankruptcy plan. Crescent Real Estate purchased the promissory notes from their original holders in February 2002 for $1.7 million. This amount will be included as an expense for purposes of determining the number of Crescent Real Estate common shares to be distributed to the stockholders of Crescent Operating pursuant to the bankruptcy plan. The amount of principal and interest outstanding on the Class 5 claims as of September 30, 2002 was $2.8 million. If the bankruptcy plan is confirmed, Crescent Real Estate will not receive a distribution on account of its Class 5 claim from Crescent Operating but will retain its liens on certain assets of Crescent Machinery. Class 6 includes Crescent Real Estate's unsecured claims. Class 6 is impaired and Crescent Real Estate is entitled to vote on the bankruptcy plan. Upon Crescent Real Estate's request, Crescent Operating shall deliver and transfer to Crescent Real Estate any and all Crescent Operating property not otherwise distributed under the bankruptcy plan; provided, however, that if the bankruptcy plan is confirmed, whether consensually or over the objection of other holders of allowed claims or interests, Crescent Real Estate agrees not to object to confirmation on 96 the grounds that it may not receive a distribution under the bankruptcy plan on account of its unsecured claim and that its unsecured claim is treated less favorably than other unsecured claims. The treatment of Crescent Real Estate's secured Class 1 and unsecured Class 6 claims leaves open the possibility that Crescent Operating assets may be transferred to Crescent Real Estate after the effective date of the bankruptcy plan. The vast majority of Crescent Operating's assets have already been transferred to Crescent Real Estate and it is contemplated that all assets of value, other than the interest in COPI Cold Storage, will be transferred to Crescent Real Estate before the effective date. Class 7 consists of the interests of holders of Crescent Operating common stock. Class 7 is impaired and is entitled to vote on the bankruptcy plan. Class 7 is treated differently depending on whether or not Class 7 accepts the bankruptcy plan. If Class 7 accepts the bankruptcy plan, Crescent Real Estate will pay on the effective date of the bankruptcy plan or the date upon which the bankruptcy plan becomes final, at Crescent Real Estate's election, or as soon thereafter as practicable to each holder of Crescent Operating common stock, the product of (i) (A) the number of shares of Crescent Operating common stock owned by such holder on the confirmation date, divided by (B) the total number of shares of Crescent Operating common stock outstanding on the confirmation date, and (ii) the quotient of (A) the consideration amount, as described below, and (B) the average of the daily closing prices per Crescent Real Estate common share as reported on the New York Stock Exchange Composite Transaction reporting system for the 10 consecutive NYSE trading days immediately preceding the date a confirmation order is entered on the docket in the bankruptcy case. The consideration amount will equal the greater of: - approximately $2.16 million; or - $16.0 million minus the total amount of payments made by Crescent Real Estate or claims and expenses relating to the Crescent Operating bankruptcy and the reorganization transactions including expenses of Crescent Real Estate but excluding payments in satisfaction of the Bank of America claim. No certificate or scrip representing fractional Crescent Real Estate common shares shall be issued, no cash shall be paid in lieu of fractional shares, and all fractional shares shall be rounded up or down to the nearest whole Crescent Real Estate common share. The Crescent Operating common stock shall be cancelled. If Class 7 rejects the bankruptcy plan, and the bankruptcy plan is still confirmed by the bankruptcy court, Class 7 will receive no distribution under the bankruptcy plan, and the Crescent Operating stock shall still be cancelled. Class 8 consists of the holders of all warrants and stock options that are still exercisable but that have not been exercised. Class 8 is impaired but it is not entitled to vote on the bankruptcy plan because it is deemed to have rejected the bankruptcy plan. Class 8 will receive no distribution under the bankruptcy plan and the warrants and stock options shall be cancelled on the effective date. The creditors in Class 1 and Class 2 are Crescent Real Estate and Bank of America. Each of these impaired creditors will be provided with this proxy statement/prospectus in connection with solicitation of its pre-petition approval of the bankruptcy plan. Crescent Operating anticipates that all voting on the bankruptcy plan will be completed in the pre-petition period. CONDITIONS TO OCCURRENCE OF THE EFFECTIVE DATE The bankruptcy plan provides that, except as expressly waived by Debtor with the consent of Crescent Real Estate, it is a condition to the effectiveness of the bankruptcy plan that: - the bankruptcy court has signed the confirmation order, and the clerk of the bankruptcy court has duly entered the confirmation order on the docket for the reorganization case in a form and substance that is acceptable to Debtor; - the confirmation order has become effective and has not been stayed, modified, reversed or amended; and 97 - Crescent Real Estate has received all regulatory approvals and authorizations necessary to create Crescent Spinco and effect the related transaction. EXECUTORY CONTRACTS AND UNEXPIRED LEASES An executory contract generally is described as a contract on which performance remains due from both parties to the contract. The bankruptcy plan provides for the rejection of all executory contracts and unexpired leases to which Debtor is a party as of the date of the confirmation of the bankruptcy plan, except for any executory contract or unexpired lease that (i) has been assumed or rejected pursuant to a final order or (ii) is the subject of a pending motion for authority to assume the contract or lease filed by Debtor prior to the date of the confirmation of the bankruptcy plan. Because Crescent Operating is essentially a holding company, it is not a party to material executory contracts, other than the Settlement Agreement, or unexpired leases. Crescent Operating does not intend to reject the Settlement Agreement. If Crescent Operating were to reject the Settlement Agreement, it would constitute a breach of the Settlement Agreement. Crescent Real Estate would be relieved of its obligation to pay Crescent Operating's creditors and to distribute Crescent Real Estate common shares to Crescent Operating stockholders under the terms of the bankruptcy plan. As a result, the bankruptcy plan would not be feasible. Additionally, Crescent Operating would be liable for the damages, if any, that its breach caused Crescent Real Estate. Rejection of the Settlement Agreement would not affect or undo Crescent Operating's transfers of Crescent Real Estate's collateral to it. Crescent Operating, however, would lose all of the benefits it otherwise would have received under the Settlement Agreement following any rejection of the Settlement Agreement. The bankruptcy plan establishes a bar date for the filing of claims arising out of the rejection of executory contracts and unexpired leases. MODIFICATIONS OF PLAN OF REORGANIZATION; SEVERABILITY OF PROVISIONS Crescent Operating reserves the right, in accordance with the Bankruptcy Code, to amend or modify the bankruptcy plan prior to the entry of the confirmation order. After the entry of the confirmation order, Crescent Operating, as it is reorganized pursuant to the bankruptcy plan, may, upon order of the bankruptcy court, amend or modify the bankruptcy plan in accordance with section 1127(b) of the Bankruptcy Code, or remedy any defect or omission or reconcile any inconsistency in the bankruptcy plan in such manner as may be necessary to carry out the purpose and intent of the bankruptcy plan. Any modifications of the bankruptcy plan, whether before or after confirmation, requires the consent of Crescent Real Estate in its sole discretion. If, prior to the confirmation of the bankruptcy plan, any term or provision of the bankruptcy plan that does not govern the treatment of claims, interests or the conditions of the effective date of the bankruptcy plan, is held by the bankruptcy court to be invalid, void or unenforceable, the bankruptcy court will have the power to alter and interpret such term or provision to make it valid or enforceable to the maximum extent practicable, consistent with the original purpose of the term or provision held to be invalid, void or unenforceable, and such term or provision will then be applicable as altered or interpreted. Notwithstanding any such holding, alteration or interpretation, the remainder of the terms and provisions of the bankruptcy plan will remain in full force and effect and will in no way be affected, impaired or invalidated by such holding, alteration or interpretation. The confirmation order shall constitute a judicial determination and will provide that each term and provision of the bankruptcy plan, as it may have been altered or interpreted in accordance with the foregoing, is valid and enforceable pursuant to its terms. CONFIRMATION OF THE PLAN OF REORGANIZATION The Confirmation Hearing Section 1128(a) of the Bankruptcy Code requires the bankruptcy court, after notice, to hold a confirmation hearing at which Crescent Operating will seek confirmation of the bankruptcy plan. Section 1128(b) of the Bankruptcy 98 Code provides that any party in interest may object to confirmation of a bankruptcy plan. Even if the bankruptcy plan is accepted by the class of Crescent Operating stockholders, an individual stockholder may object to confirmation of the bankruptcy plan. Notice of the confirmation hearing will be provided to all holders of claims and interests, and to other parties in interest, in a notice to be approved by the bankruptcy court at Crescent Operating's request. Crescent Operating will seek approval of a confirmation notice providing that (1) the confirmation hearing may be adjourned from time to time by the bankruptcy court without further notice except for an announcement of the adjourned date made at the confirmation hearing or any adjournment thereof, (2) objections to confirmation must be made in writing, specifying in detail the name and address of the person or entity objecting, the grounds for the objection, and the nature and amount of the claim or interest held by the objector, if applicable, and (3) objections must be filed with the bankruptcy court, together with proof of service, and served upon the parties designated in the confirmation notice, on or before the time and date designated in the confirmation notice as being the last day for serving and filing objections to confirmation of the bankruptcy plan. Objections to confirmation of the bankruptcy plan are governed by bankruptcy rule 9014 and the local rules of the bankruptcy court. UNLESS AN OBJECTION TO CONFIRMATION IS TIMELY SERVED AND FILED IT MAY NOT BE CONSIDERED BY THE BANKRUPTCY COURT. Requirements For Confirmation Under Section 1129(A) Of The Bankruptcy Code In order for the bankruptcy plan to be confirmed, and regardless of whether all impaired classes of claims and interests vote to accept the bankruptcy plan, the Bankruptcy Code requires the bankruptcy court to determine independently that the bankruptcy plan complies with the requirements of section 1129(a) of the Bankruptcy Code. The requirements of section 1129(a) include, among others: - that the bankruptcy plan complies, and Crescent Operating in proposing the bankruptcy plan has complied, with the applicable provisions of Chapter 11; - that the bankruptcy plan is proposed in good faith and not by any means forbidden by law; - that any payment made or to be made by Crescent Operating or by a person issuing securities or acquiring property under the bankruptcy plan for services, costs or expenses in connection with the reorganization case, or in connection with the bankruptcy plan and incident to the reorganization case, has been approved by or is subject to approval by the bankruptcy court as reasonable; - as discussed more fully below, that, to the extent any holder of a claim or interest in an impaired class under the bankruptcy plan has not accepted the bankruptcy plan, the bankruptcy plan is in the "best interests" of such holder; and - as discussed more fully below, that the bankruptcy plan is "feasible." Crescent Operating believes that all applicable requirements of section 1129(a) of the Bankruptcy Code will be satisfied at the confirmation hearing. Best Interests Test. Under the "best interests" test, a plan is confirmable if, with respect to each impaired class of claims or interests, each holder thereof either (1) accepts the bankruptcy plan or (2) will receive or retain under the bankruptcy plan, on account of its claim or interest, property of a value, as of the effective date of the bankruptcy plan that is not less than the value such holder would receive or retain if the debtor were liquidated under Chapter 7 of the Bankruptcy Code on the same date. 99 To determine what amount the holders in each impaired class of claims or interests would receive if the debtor were liquidated on the effective date of the bankruptcy plan , the bankruptcy court must determine the dollar amount that would be generated from a liquidation of the assets and properties of the debtor in the context of a hypothetical Chapter 7 liquidation case. The cash amount that would be available for non-administrative priority and unsecured claims against, and interests in, the debtor would consist of the proceeds from disposition of the assets of the debtor, augmented by the cash held by the debtor at the time of the commencement of the hypothetical Chapter 7 case. This amount would be reduced by the amount of any secured claims, the costs and expenses of the hypothetical Chapter 7 liquidation, unpaid administrative expenses of the Chapter 11 case and additional administrative expense claims resulting from the termination of the debtor's business in Chapter 7. Liquidation costs under Chapter 7 would include fees payable to the Chapter 7 trustee, fees payable to attorneys and other professionals that the trustee might engage, asset disposition expenses, litigation costs and claims arising from the operations of Crescent Operating's business during the Chapter 7 case. Administrative claims in the liquidation would also include unpaid expenses incurred by the debtor during the Chapter 11 case, such as compensation for attorneys, financial advisors and accountants, as well as costs and expenses of members of any committee appointed in the Chapter 11 case. In addition, administrative claims may arise by reason of the breach or rejection in the hypothetical Chapter 7 case of executory contracts or unexpired leases entered into or assumed by Crescent Operating during the pendency of the Chapter 11 case. To determine if the bankruptcy plan is in the best interests of Crescent Operating's stockholders, the value of the distributions to Crescent Operating's stockholders from proceeds of a hypothetical Chapter 7 liquidation, less the estimated costs and expenses attributable thereto, is compared to the value offered under the bankruptcy plan to such stockholders. For a summary of the liquidation analysis, and the material assumptions Crescent Operating relied upon, see "The Reorganization Transactions - Liquidation Analyses." Crescent Operating is not aware of any events subsequent to the liquidation analyses dates that would materially impact the liquidation analyses. There can be no assurance that the assumptions underlying the liquidation analyses would be made or accepted by the bankruptcy court. However, as set forth below, Crescent Operating believes that hypothetical liquidation under Chapter 7 would result in no distributions being made to general unsecured creditors or Crescent Operating's stockholders, compared to full payment of claims of general unsecured creditors, and distributions of Crescent Real Estate common shares to Crescent Operating's stockholders whose stock is being cancelled. Based upon the liquidation analysis, Crescent Operating believes that the bankruptcy plan is in the best interests of Crescent Operating's stockholders because such holders will receive distributions under the bankruptcy plan of a value, as of the effective date greater than the amount such holders would receive if the debtor were liquidated under Chapter 7 of the Bankruptcy Code as of the same date. Feasibility of the Plan of Reorganization. The court may confirm the bankruptcy plan only if it finds that the bankruptcy plan is feasible and is not likely to be followed by the liquidation or further need for reorganization of the debtor. In this case, Crescent Operating is liquidating and thus the bankruptcy plan is feasible if reorganized Crescent Operating can make the distributions required by the bankruptcy plan. The bankruptcy plan's feasibility is primarily dependent on Crescent Real Estate's performance of its obligations under the Settlement Agreement. Pursuant to the Settlement Agreement, Crescent Real Estate will make sufficient funds available to Crescent Operating to pay in full or otherwise resolve those creditor claims of Crescent Operating that Crescent Operating identified in the original Settlement Agreement, other than the Crescent Real Estate claims, and to cover budgeted expenses of implementing the Settlement Agreement and seeking to confirm the bankruptcy plan. Specifically, Crescent Real Estate has committed to pay up to $5.0 million of Crescent Operating's cash flow shortage from the original execution of the Settlement Agreement through the entry of a final decree in the bankruptcy case. These operating expenses include the anticipated unsecured claims of parties with whom Crescent Operating does business on an ordinary course basis as well as all the expense of consummating the Settlement Agreement, including the transactions between Crescent Real Estate and Crescent Operating affiliates, and the 100 expenses of the bankruptcy case. Crescent Operating believes that this amount is sufficient to pay the designated expenses. However, if it is insufficient, the bankruptcy plan may not be feasible unless Crescent Real Estate agrees to fund any excess. In connection with the Settlement Agreement and with the purpose of facilitating confirmation of the bankruptcy plan, Crescent Real Estate has agreed to subordinate its lien in the COPI Cold Storage equity interests to allow Crescent Operating to pledge this asset to Bank of America. Crescent Real Estate also will create a new subsidiary, Crescent Spinco, to purchase the COPI Cold Storage equity interests and to thereby provide Crescent Operating with funds to satisfy the Bank of America claim. If Crescent Real Estate is unsuccessful in obtaining the requisite regulatory and other approvals for the creation of Crescent Spinco, the bankruptcy plan will still be feasible as to Bank of America since it will hold a first lien security interest on the COPI Cold Storage equity interests, which have a value sufficient to satisfy Bank of America's claim. Finally, Crescent Real Estate has advanced or agreed to advance additional amounts of up to $8.772 million to satisfy all other claims against Crescent Operating. These amounts, and other amounts that Crescent Real Estate funds to Crescent Operating, or to creditors on Crescent Operating's behalf, to make the bankruptcy plan feasible, will reduce the value of the distribution to Crescent Operating stockholders. However, if the bankruptcy plan is accepted by the Crescent Operating stockholders and approved by the bankruptcy court, the distribution to Crescent Operating will not be less than approximately $2.16 million, or $0.20 per share of Crescent Operating common stock, regardless of the other amounts that Crescent Real Estate funds. Crescent Operating currently estimates that Crescent Real Estate will need to advance funds sufficient to pay in full or otherwise resolve total claims and expenses of between $10.6 million to $13.8 million. The most significant element of the bankruptcy plan's feasibility is Crescent Real Estate's ability to perform its obligations under the Settlement Agreement. Crescent Operating believes that Crescent Real Estate has the ability to perform its obligations and will perform. There are no material uncertainties regarding Crescent Real Estate's ability to perform. Crescent Real Estate will use funds obtained primarily from cash flow provided by operating activities to meet its obligations. Crescent Real Estate has not agreed to pay all claims against Crescent Operating, but has agreed to pay all claims that were identified by Crescent Operating in the original Settlement Agreement. On December 19, 2002, the Crescent Machinery Committee filed a lawsuit against Crescent Operating and certain of its current and former officers and directors seeking an unspecified amount of direct, consequential and punitive damages, as well as related attorneys' fees, for alleged breaches of fiduciary duty, aiding and abetting breaches of fiduciary duty, negligent misrepresentation, and gross negligence. If a court determines that Crescent Operating has liability to Crescent Machinery, the amount of Crescent Operating's liability to its unsecured creditors may exceed the amounts that Crescent Real Estate will agree to make available to Crescent Operating for payments on account of creditors' claims. Because Crescent Operating has no other sources of funds to pay its creditors' claims, the bankruptcy plan may not be feasible if Crescent Operating is found liable to Crescent Machinery and the amount owed to all unsecured creditors exceeds the amount that Crescent Real Estate will agree to pay under the Settlement Agreement. Crescent Real Estate has agreed that if the bankruptcy plan is confirmed, Crescent Real Estate's administrative expense claim arising out of its funding of Crescent Operating's post-petition operations and professional fees will be satisfied in the same manner as its Class 1 claims and Crescent Real Estate will not object to the bankruptcy plan on the grounds that its administrative expense claim is not getting paid in full in cash on the effective date of the bankruptcy plan. 101 IMPLEMENTATION OF THE PLAN OF REORGANIZATION Funding of Obligations by Crescent Partnership and Crescent Real Estate under Settlement Agreement. On the effective date, to the extent that Crescent Operating has insufficient funds to make the payments to holders of allowed administrative and priority claims and Class 3, 4 and 5 Claims, Crescent Partnership shall provide Crescent Operating with sufficient funds to pay such allowed claims in accordance with, and as limited by, the terms of the Settlement Agreement. Transfer of Crescent Real Estate Common Shares to Plan Administrator. If Class 7 (the holders of Crescent Operating common stock) accepts the bankruptcy plan, Crescent Real Estate shall deposit with the plan administrator, in trust for the holders of Crescent Operating common stock whose shares are being canceled under the bankruptcy plan, certificates representing the Crescent Real Estate common shares issuable to the Crescent Operating common stockholders. Registration of Crescent Real Estate Common Shares Prior to the effective date, Crescent Real Estate will have registered under the Securities Act of 1933 all of the Crescent Real Estate common shares issuable under the bankruptcy plan. Purchase of COPI Cold Storage Interests by Crescent Spinco Prior to the effective date, Crescent Real Estate shall spin-off to Crescent Real Estate's shareholders Crescent Spinco, which will be capitalized with at least $15.0 million. Crescent Spinco shall acquire all of Crescent Operating's interest in COPI Cold Storage. The purchase price for the equity interests in COPI Cold Storage shall be an amount to be agreed upon between Crescent Partnership and Crescent Operating, which shall be not less than $15.0 million and not more than $15.5 million. Crescent Operating shall use all of the proceeds as are necessary to repay the full principal balance (including accrued and unpaid interest) of the Bank of America secured claims. Issuance of New Crescent Operating Common Stock On the effective date, pursuant to the confirmation order and without any further action by the stockholders or directors of the Debtor or the reorganized Crescent Operating, the reorganized Crescent Operating shall issue a single share of Crescent Operating common stock which shall be held by the plan administrator as nominee for the holders of allowed claims against Debtor. Cancellation of Old Crescent Operating Common Stock On the effective date, the Crescent Operating common stock shall be canceled, and the statements of resolution governing such Crescent Operating common stock shall be rendered void. Thereafter, the only outstanding share of common stock of the reorganized Crescent Operating will be held by the plan administrator, as nominee. If the bankruptcy plan is accepted by the stockholders of Crescent Operating and confirmed by the bankruptcy court, the holders of Crescent Operating common stock on the date of entry of the confirmation order shall be entitled to receive common shares of Crescent Real Estate as set forth elsewhere in this proxy statement. Corporate Action Upon entry of the confirmation order, the following shall be and be deemed authorized and approved in all respects: (i) the filing by reorganized Crescent Operating of the Amended Certificate of Incorporation, and (ii) the Amended Bylaws. On the effective date, or as soon thereafter as is practicable, the reorganized Crescent Operating 102 shall file with the Secretary of State of the State of Delaware, in accordance with applicable state law, the Amended Certificate of Incorporation which shall conform to the provisions of the bankruptcy plan and prohibit the issuance of non-voting equity securities. On the effective date, the matters provided under the bankruptcy plan involving the capital and corporate structures and governance of the reorganized Crescent Operating shall be deemed to have occurred and shall be in effect from and after the effective date pursuant to applicable state laws without any requirement of further action by the stockholders or directors of the Debtor or the reorganized Crescent Operating. On the effective date, the reorganized Debtor shall be authorized and directed to take all necessary and appropriate actions to effectuate the transactions contemplated by the bankruptcy plan and this proxy statement/prospectus. The Plan Administrator On the effective date, the officers and board of directors of the Debtor shall be deemed removed from office pursuant to the confirmation order and the operation of the reorganized Debtor in accordance with the provisions of the bankruptcy plan shall become the general responsibility of the plan administrator pursuant to and in accordance with the provisions of the bankruptcy plan and Plan Administration Agreement. Mr. Jeffrey L. Stevens, Crescent Operating's current chief executive officer and sole director, will serve as plan administrator. The primary responsibility of the plan administrator is to make the distributions provided in the bankruptcy plan, to wind up Crescent Operating's affairs and to prepare it for dissolution. Responsibilities. The responsibilities of the plan administrator shall include prosecuting objections to and estimations of claims; calculating and making all distributions in accordance with the bankruptcy plan; filing all required tax returns and paying taxes and all other obligations on behalf of the reorganized Debtor; providing to Crescent Partnership on a monthly basis an accounting of claims paid; an estimation of claims remaining to be paid; funds held by reorganized Crescent Operating; and additional funds required from Crescent Partnership to pay allowed claims and the expenses of reorganized Crescent Operating, including the expenses of the plan administrator; and such other responsibilities as may be vested in the plan administrator pursuant to the bankruptcy plan, the bankruptcy plan Administration Agreement or bankruptcy court order or as may be necessary and proper to carry out the provisions of the bankruptcy plan. Powers. The powers of the plan administrator shall, without bankruptcy court approval in each of the following cases, include the power to invest funds in, and withdraw, make distributions and pay taxes and other obligations owed by the reorganized Debtor from the Debtor's bank accounts in accordance with the plan; the power to engage employees and professional persons to assist the plan administrator with respect to its responsibilities; the power to compromise and settle claims and causes of action on behalf of or against the reorganized Debtor; and such other powers as may be vested in or assumed by the plan administrator pursuant to the plan, the Plan Administration Agreement, the Amended Certificate of Incorporation, the Amended By-Laws or bankruptcy court order or as may be necessary and proper to carry out the provisions of the plan. Compensation. In addition to reimbursement for the actual out-of-pocket expenses incurred, the plan administrator shall be entitled to reasonable compensation for services rendered on behalf of the reorganized Debtor in an amount and on such terms as may be agreed to by the Debtor as reflected in the Plan Administration Agreement. Any dispute with respect to such compensation shall be resolved by agreement among the parties or, if the parties are unable to agree, determined by the bankruptcy court. Information and Reporting. The plan administrator shall file reports with the bankruptcy court no less often than as soon as practicable after the end of every calendar quarter with respect to the status of the execution and implementation of the bankruptcy plan, including amounts expended for administrative expenses, amounts distributed to creditors and the amount of unpaid or disputed claims. 103 Termination. The duties, responsibilities and powers of the plan administrator shall terminate on the date following the entry of the final decree in the bankruptcy case on which the reorganized Debtor is dissolved under applicable state law in accordance with the bankruptcy plan. MANNER OF DISTRIBUTION OF PROPERTY UNDER THE PLAN OF REORGANIZATION Distribution Procedures Except as otherwise provided in the bankruptcy plan, all distributions of cash and other property shall be made by the reorganized Debtor or the plan administrator on the latest of the effective date, the date a claim or interest becomes an allowed claim or interest, or the date upon which the bankruptcy plan becomes final, at Crescent Real Estate's election, or as soon thereafter as practicable. Distributions required to be made on a particular date shall be deemed to have been made on such date if actually made on such date or as soon thereafter as practicable. No payments or other distributions of property shall be made on account of any claim or portion thereof unless and until such claim or portion thereof is allowed. For purposes of applying this section, the holders of allowed interests under or evidenced by Crescent Operating common stock shall, in the case of Crescent Operating common stock held in "street name," mean the beneficial holders thereof as of the confirmation date. The total number of Crescent Real Estate shares to be distributed under the bankruptcy plan may not be determined as of the date of the initial distribution. If a subsequent distribution is required due to unresolved claims as of the effective date, it may be made, at Crescent Real Estate's election, in cash or in additional shares of Crescent Real Estate common shares. If the distribution is in additional Crescent Real Estate shares, the number of shares shall be determined using the same Crescent Real Estate stock price as is used to determine the number of shares in the initial distribution. Distribution of Crescent Real Estate Common Shares The plan administrator shall distribute all of the Crescent Real Estate common shares to be distributed under the bankruptcy plan. If Class 7 accepts the bankruptcy plan and the bankruptcy plan is confirmed by the bankruptcy court, the initial distribution of Crescent Real Estate common shares on account of allowed interests shall be either on the effective date or, at Crescent Real Estate's election, on the date upon which the order confirming the bankruptcy plan became final, or as soon thereafter as practicable. The plan administrator may employ or contract with other entities to assist in or perform the distribution of Crescent Real Estate common shares. Surrender and Cancellation of Old Securities As a condition to receiving the Crescent Real Estate common shares, the record holders of Crescent Operating common stock as of the confirmation date shall surrender their Crescent Operating common stock, if held in certificate form, to the plan administrator or its agent. As soon as practicable following the effective date, the plan administrator shall mail to each record holder of Crescent Operating common stock as of the confirmation date, a letter of transmittal which shall specify that delivery shall be effected, and risk of loss and title to the stock certificates shall pass only upon actual delivery of the Crescent Operating common stock certificates to the plan administrator, and shall contain instructions for surrendering such certificates. When a holder surrenders its Crescent Operating common stock to Crescent Operating, Crescent Operating shall hold the instrument in "book entry only" until such instruments are canceled. Any holder of Crescent Operating common stock whose instrument has been lost, stolen, mutilated or destroyed shall, in lieu of surrendering such instrument, deliver to Crescent Operating: (a) evidence satisfactory to Crescent Operating of the loss, theft, mutilation or destruction of such instrument, and (b) such security or indemnity that may be reasonably required by Crescent Operating to hold the Crescent Operating and Crescent Partnership harmless with respect to any such representation of the holder. Upon compliance with the preceding sentence, such holder shall, for all purposes under the bankruptcy plan, be deemed to have surrendered such instrument. Any holder 104 of Crescent Operating common stock which has not surrendered or been deemed to have surrendered its Crescent Operating common stock within two years after the effective date shall have its interest as a holder of Crescent Operating common stock disallowed, shall receive no distribution on account of its interest as a holder of Crescent Operating common stock, and shall be forever barred from asserting any interest on account of its Crescent Operating common stock. As of the confirmation date, Crescent Operating shall close its stock books and transfer ledgers. All Crescent Operating common stock shall represent only the right to participate in the distributions provided in the bankruptcy plan on account of such Crescent Operating common stock. If a certificate representing Crescent Operating common stock is presented for transfer on or after the confirmation date, a certificate representing the appropriate number of whole Crescent Real Estate common shares will be issued in exchange therefor. Disputed Claims Notwithstanding any other provisions of the bankruptcy plan, no payments or distributions shall be made on account of any disputed claim or interest until such claim or interest becomes an allowed claim or interest, and then only to the extent that it becomes an allowed claim or interest. Manner of Payment Under the Plan Cash payments made pursuant to the bankruptcy plan shall be in U.S. dollars by checks drawn on a domestic bank selected by the reorganized Debtor, or by wire transfer from a domestic bank, at the reorganized Debtor's option, except that payments made to foreign trade creditors holding allowed claims may be paid, at the option of reorganized Debtor in such funds and by such means as are necessary or customary in a particular foreign jurisdiction. Delivery of Distributions and Undeliverable or Unclaimed Distributions Delivery of Distributions in General. Except as provided below for holders of undeliverable distributions, distributions to holders of allowed claims shall be distributed by mail as follows: (a) except in the case of the holders of Crescent Operating common stock, (1) at the addresses set forth on the respective proofs of claim filed by such holders; (2) at the addresses set forth in any written notices of address changes delivered to the reorganized Debtor after the date of any related proof of claim; or (3) at the address reflected on the schedule of assets and liabilities filed by the Debtor if no proof of claim or proof of interest is filed and the reorganized Debtor has not received a written notice of a change of address; and (b) in the case of the holders of Crescent Operating common stock, as provided in sections 6.3 and 6.4 of the bankruptcy plan. Undeliverable Distributions Holding and Investment of Undeliverable Property. If the distribution to the holder of any claim is returned to the reorganized Debtor as undeliverable, no further distribution shall be made to such holder unless and until the reorganized Debtor are notified in writing of such holder's then current address. Subject to section 7.8(b)(ii) of the bankruptcy plan, undeliverable distributions shall remain in the possession of the reorganized Debtor pursuant to this section until such times as a distribution becomes deliverable. Unclaimed cash (including interest) shall be held in trust in a segregated bank account in the name of the reorganized Debtor, for the benefit of the potential claimants of such funds, and shall be accounted for separately. For a period of two years after the effective date, undeliverable Crescent Real Estate common shares shall be held in trust for the benefit of the potential claimants of such securities by the plan administrator in a number of shares sufficient to provide for the unclaimed amounts of such securities, and shall be accounted for separately. 105 Distribution of Undeliverable Property After it Becomes Deliverable and Failure to Claim Undeliverable Property. Any holder of an allowed claim who does not assert a claim for an undeliverable distribution held by the reorganized Debtor within one (1) year after the effective date shall no longer have any claim to or interest in such undeliverable distribution, and shall be forever barred from receiving any distributions under the bankruptcy plan. In such cases, any funds held in reserve for such claim shall become unrestricted cash of the reorganized Debtor and, upon entry of the final decree and dissolution of Crescent Operating, shall be delivered to Crescent Partnership. De Minimis Distributions. No cash payment of less than twenty-five dollars ($25.00) shall be made to any holder on account of an allowed claim unless a request therefor is made in writing to the reorganized Debtor. Failure to Negotiate Checks. Checks issued in respect of distributions under the bankruptcy plan shall be null and void if not negotiated within 60 days after the date of issuance. Any amounts returned to the reorganized Debtor in respect of such checks shall be held in reserve by the reorganized Debtor. Requests for reissuance of any such check may be made directly to the reorganized Debtor by the holder of the allowed claim with respect to which such check originally was issued. Any claim in respect of such voided check is required to be made before the second anniversary of the effective date. All claims in respect of void checks and the underlying distributions shall be discharged and forever barred from assertion against the reorganized Debtor and their property. Compliance with Tax Requirements. In connection with the bankruptcy plan, to the extent applicable, the reorganized Debtor shall comply with all withholding and reporting requirements imposed on it by any governmental unit, and all distributions pursuant to the bankruptcy plan shall be subject to such withholding and reporting requirements. Setoffs. Unless otherwise provided in a final order or in the bankruptcy plan, the Debtor may, but shall not be required to, set off against any claim and the payments to be made pursuant to the bankruptcy plan in respect of such claim, any claims of any nature whatsoever the Debtor may have against the holder thereof or its predecessor, but neither the failure to do so nor the allowance of any claim hereunder shall constitute a waiver or release by the Debtor of any such claims the Debtor may have against such holder or its predecessor. Fractional Interests. The calculation of the percentage distribution of Crescent Real Estate common shares to be made to holders of Crescent Operating common stock as provided elsewhere in the bankruptcy plan may mathematically entitle a holder of Crescent Operating common stock to a fractional interest in Crescent Real Estate common shares. The number of Crescent Real Estate common shares to be received by a holder of Crescent Operating common stock shall be rounded to the next higher or lower whole number of shares. No consideration shall be provided in lieu of the fractional shares that are rounded down and not issued. Accordingly, assuming a share price of $20.00 per Crescent Real Estate common share, a payment by Crescent Real Estate of $13.8 million in expenses relating to the Crescent Operating bankruptcy and a distribution of $0.20 per share of Crescent Operating common stock, each Crescent Operating stockholder must hold at least 50 shares of Crescent Operating common stock in order to receive any Crescent Real Estate common shares. EFFECTS OF CONFIRMATION OF THE PLAN OF REORGANIZATION Discharge and Injunction The bankruptcy plan will be binding upon all present and former holders of claims and equity interests, and their respective successors and assigns, including the reorganized Debtor. Except as otherwise provided in the bankruptcy plan or by subsequent order of the bankruptcy court, the confirmation order will provide, among other things, that from and after the confirmation of the bankruptcy plan, all persons or entities who have held, hold, or may hold claims against or equity interests in Debtor are permanently enjoined from taking any of the following actions against the estate, the reorganized Crescent Operating, the Creditors' Committee appointed in the Chapter 11 case, if any, Crescent Partnership, Crescent Real Estate or any of their respective property on account of any such claims or 106 equity interests: (i) commencing or continuing, in any manner or in any place, any action or other proceeding; (ii) enforcing, attaching, collecting or recovering in any manner any judgment, award, decree or order; (iii) creating, perfecting or enforcing any lien or encumbrance; (iv) asserting a setoff, right of subrogation or recoupment of any kind against any debt, liability or obligation due to Debtor other than through a proof of claim or adversary proceeding; and (v) commencing or continuing, in any manner or in any place, any action that does not comply with or is inconsistent with the provisions of the bankruptcy plan; provided, however, that nothing will preclude such persons from exercising their rights pursuant to and consistent with the terms of the bankruptcy plan. Liquidation and Dissolution of Crescent Operating The bankruptcy plan is a liquidating plan. Any assets that Crescent Operating owns on the effective date of the bankruptcy plan will either be used to satisfy creditor claims or will be transferred to Crescent Real Estate in accordance with the treatment of the Class 1 and Class 6 claims. Upon consummation of the bankruptcy plan, the plan administrator will wind up Crescent Operating's affairs and Crescent Operating will be dissolved. Releases In addition to the releases granted by Crescent Operating to Crescent Real Estate in connection with the Settlement Agreement, on the effective date of the bankruptcy plan, the reorganized Debtor, on its own behalf and as representative of Debtor's estate, will release unconditionally, and is deemed to release unconditionally (i) each of Debtor's officers, directors, partners, employees, consultants, attorneys, accountants and other representatives, (ii) Crescent Partnership and each of Crescent Partnership's officers, directors, shareholders, employees, consultants, attorneys, accountants, affiliates and other representatives, (iii) Crescent Real Estate and each of Crescent Real Estate's officers, directors, shareholders, employees, consultants, attorneys, accountants, affiliates and other representatives, (iv) the creditors' committee, if any, and, solely in their capacity as members and representatives of the creditors' committee, each member, consultant, attorney, accountant or other representative of the creditors' committee (the entities identified in (i), (ii), (iii) and (iv) are referred to collectively as, the "releasees"), from any and all claims, obligations, suits, judgments, damages, rights, causes of action and liabilities whatsoever, whether known or unknown, foreseen or unforeseen, existing or hereafter arising, in law, equity or otherwise, based in whole or in part upon any act or omission, transaction, event or other occurrence taking place on or prior to the effective date in any way relating to the releasees, Debtor, the Chapter 11 case or the bankruptcy plan. A party who believes it may have a claim should contact a lawyer to discuss the potential value of its claim as compared to the value likely to be distributed to stockholders under the bankruptcy plan. On the effective date of the bankruptcy plan, each holder of a claim or interest (i) who has accepted the bankruptcy plan, (ii) whose claim or interest is in a class that has accepted or is deemed to have accepted the bankruptcy plan pursuant to section 1126 of the Bankruptcy Code, or (iii) who may be entitled to receive a distribution of property pursuant to the bankruptcy plan, shall be deemed to have unconditionally released the releasees, from any and all rights, claims, causes of action, obligations, suits, judgments, damages and liabilities whatsoever which any such holder may be entitled to assert, whether known or unknown, foreseen or unforeseen, existing or hereafter arising, in law, equity or otherwise, based in whole or in part upon any act or omission, transaction, event or other occurrence taking place on or before the effective date of the bankruptcy plan in any way relating to Debtor, the Chapter 11 case or the bankruptcy plan, provided however, that the foregoing shall not apply to all rights, claims and obligations created by or arising under the bankruptcy plan. The release of Crescent Operating stockholder claims will not apply to the claims, if any, of a person who sold its shares of Crescent Operating common stock before the record date for voting on the bankruptcy plan or who voted against the bankruptcy plan, abstained from voting or did not vote and thereafter either did not receive or refused to accept a distribution of Crescent Real Estate common shares. The release of Crescent Operating stockholder claims also will not apply if the holders of Crescent Operating common stock, voting as a class, vote against the bankruptcy plan. The release of 107 Crescent Operating stockholder claims will apply to Crescent Operating stockholders only in their capacity as Crescent Operating stockholders, and will not affect their rights as holders of Crescent Real Estate common shares. In the event that the bankruptcy court concludes that the bankruptcy plan cannot be confirmed without excising any portion of the release of claims held by creditors and stockholders, then, with the consent of Crescent Real Estate in its sole discretion, the bankruptcy plan may be confirmed with the portion of the releases that the bankruptcy court finds is a bar to confirmation excised so as to give effect as much as possible to the foregoing releases without precluding confirmation of the bankruptcy plan. If Crescent Real Estate does not consent to modification of the release, the bankruptcy plan will not be confirmed and Crescent Real Estate will not be obligated to pay in full or otherwise resolve the claims of the creditors that Crescent Operating identified in the original Settlement Agreement or to make a distribution to Crescent Operating stockholders. In substance, section 524(e) of the Bankruptcy Code provides that the release of third party claims against a debtor such as Crescent Operating does not release any other person. In addition to the release of Crescent Operating, the bankruptcy plan includes releases of Crescent Real Estate and all current and former officers and directors or trust managers of Crescent Operating or Crescent Real Estate. It is the position of the Securities and Exchange Commission that these additional releases violate section 524(e) unless separate consideration is provided by the specific parties being released or the releases are voluntary. Crescent Operating believes the releases contemplated by the bankruptcy plan comply with section 524(e) of the Bankruptcy Code and applicable law, both because Crescent Real Estate is paying substantial consideration to Crescent Operating and its stockholders to obtain the releases provided under the bankruptcy plan and because the releases are voluntary. As discussed in this proxy statement, Crescent Real Estate is providing sufficient funds both to pay in full or otherwise resolve the claims of those creditors of Crescent Operating that Crescent Operating identified in the original Settlement Agreement and to cover budgeted expenses of Crescent Operating. In addition, Crescent Real Estate is providing a distribution to Crescent Operating stockholders of Crescent Real Estate common shares if the stockholders vote to accept the bankruptcy plan and the bankruptcy court confirms the plan. Accordingly, the consideration is being provided, either directly by the persons who receive the benefit of the releases provided in the bankruptcy plan or on their behalf. Whether this consideration for the releases is sufficient is an issue of fact that the bankruptcy court has authority to determine. Moreover, if the Crescent Operating stockholders vote for the bankruptcy plan, the releases are voluntary. The release of Crescent Operating stockholder claims will not apply to the claims, if any, of a person who sold their shares of Crescent Operating common stock before the record date for voting on the bankruptcy plan or who either voted against the bankruptcy plan, abstained from voting on the bankruptcy plan or who did not vote on the bankruptcy plan and thereafter either did not receive or refused to accept a distribution of Crescent Real Estate common shares. The release of Crescent Operating stockholder claims will also not apply if the holders of Crescent Operating common stock, voting as a class, vote against the bankruptcy plan. Limitation of Liability Notwithstanding any other provision of the bankruptcy plan, Crescent Operating, Crescent Real Estate, and the disbursing agent as well as each of their respective stockholders, directors, officers, agents, employees, members, accountants, attorneys, financial advisors and representatives, and affiliates of Crescent Real Estate, or any one or more of the foregoing, will not be liable, other than for willful misconduct, to any holder of a claim or interest or any person or governmental authority, with respect to any action, omission, forbearance from action, decision, or exercise of discretion taken at any time prior to the effective date of the bankruptcy plan in connection with, but not limited to: - Crescent Operating's management or operation, or the discharge of Crescent Operating's duties under the Bankruptcy Code or applicable nonbankruptcy law; - the filing of the petition for relief; 108 - the implementation of any of the transactions provided for, or contemplated in, the bankruptcy plan or the collateral documents; - any action taken in connection with either the enforcement of Crescent Operating's rights against any person or the defense of claims asserted against Crescent Operating with regard to the reorganization case; - any action taken in the negotiation, formulation, development, proposal, disclosure, confirmation or implementation of the bankruptcy plan, including, but not limited to, the Settlement Agreement, any competing acquisition proposal or new agreement; or - the administration of the bankruptcy plan or the assets and property to be distributed pursuant to the bankruptcy plan. Nothing in the limitation of liability will excuse performance or nonperformance under the Settlement Agreement or any of the documents, instruments, securities or agreements issued or executed to effectuate the transactions contemplated by the bankruptcy plan or the Settlement Agreement; and provided, further, that the liability of any person that solicits acceptance or rejection of the bankruptcy plan, or that participates in the offer, issuance, sale or purchase of a security offered or sold under the bankruptcy plan, on account of such solicitation or participation, or violation of any applicable law, rule, or regulation governing solicitation of acceptance or rejection of the bankruptcy plan or the offer, issuance, sale or purchase of securities, will be limited as set forth in section 1125(e) of the Bankruptcy Code. Crescent Operating, Crescent Real Estate, and the disbursing agent, as well as each of their respective shareholders, directors, officers, agents, employees, members, accountants, attorneys, financial advisors and representatives, or any one or more of the foregoing, may rely reasonably upon the opinions of their respective counsel, accountants, and other experts or professionals and such reliance, if reasonable, will conclusively establish good faith and the absence of willful misconduct; provided, however, that a determination that such reliance is unreasonable will not, by itself, constitute a determination of willful misconduct. In any action, suit or proceeding by any holder of a claim or interest or any other entity contesting any action by, or non-action of Crescent Operating, Crescent Real Estate and the disbursing agent or of their respective shareholders, directors, officers, agents, employees, members, attorneys, accountants, financial advisors, and representatives, the reasonable attorneys' fees and costs of the prevailing party will be paid by the losing party, and as a condition to going forward with such action, suit, or proceeding at the outset thereof, all parties thereto will be required to provide appropriate proof and assurances of their capacity to make such payments of reasonable attorneys' fees and costs in the event they fail to prevail. The provisions of the limitation of liability are not intended to limit, and will not limit, any defenses to liability otherwise available to any party in interest in this reorganization case. Notwithstanding the foregoing, in the event that the bankruptcy court concludes that the bankruptcy plan cannot be confirmed without excising with any portion of the foregoing limitation of liability provisions, then, with the consent of Crescent Real Estate in its sole discretion, the bankruptcy plan may be confirmed with that portion excised or modified, so as to give effect as much as possible to the foregoing limitation of liability provisions without precluding confirmation of the bankruptcy plan. The limitation of liability will not apply to the claims, if any, of a person who sold their Crescent Operating stock before the record date for voting on the bankruptcy plan or who voted against the bankruptcy plan, abstained or did not vote, and thereafter either did not receive or refused to accept a distribution of Crescent Real Estate common shares. The limitation of liability will also not apply if less than two-thirds of the shares of Crescent Operating common stock represented at the special meeting are voted in favor of the bankruptcy plan. Retention and Enforcement of Causes of Action Except as provided in the bankruptcy plan or the confirmation order, any and all claims, rights, or causes of action that constitute property of the estate or of Crescent Operating, whether arising under the Bankruptcy Code or under nonbankruptcy law, including all avoiding power actions under sections 544, 545, 547, 548, 549, and 550 of the Bankruptcy Code or under applicable nonbankruptcy law as applied through section 544(b) of the Bankruptcy Code, (1) are expressly retained and may be enforced by Crescent Operating and any successors in interest, and (2) may be pursued, as appropriate, in accordance with Crescent Operating's, or its successors', best interests. 109 To Crescent Operating's best knowledge, no preferential or fraudulent transfers exist. Other than to the extent discussed in the answer to the question "What happens if the Crescent stockholders vote AGAINST acceptance of the Crescent Operating bankruptcy plan?", Crescent Operating has not investigated whether any transfers of property that could constitute preferential transfers or fraudulent transfers might have occurred, and expressly reserves the right to make such an investigation and to pursue preference and fraudulent transfer claims, if any, that Crescent Operating may have to the extent permitted by applicable law. Any recoveries from preference or fraudulent transfer claims would be distributed to Crescent Real Estate under the bankruptcy plan. Unclaimed Distributions The bankruptcy plan provides that in the event that any distribution of property remains unclaimed for a period of one year after it has been delivered, or delivery has been attempted, or has otherwise been made available, such unclaimed property will be forfeited by such holder, and the unclaimed property will be distributed pro rata to the other holders of common stock, as applicable, to whom distributions were made under the bankruptcy plan. Further Assurances and Authorizations Crescent Operating, Crescent Real Estate and all holders of claims or interests receiving distributions under the bankruptcy plan and all other parties in interest will, from time to time, if and to the extent necessary, execute and deliver any agreements or documents and take any other actions as may be necessary or advisable to effectuate the provisions and intent of the bankruptcy plan, the Settlement Agreement and any collateral documents. THE SOLICITATION; VOTING Crescent Operating is soliciting votes on the bankruptcy plan only from creditors with claims in classes 1, 2, 5 and 6 and holders of interests in Class 7 (holder of Crescent Operating common stock). Under the Bankruptcy Code, holders of claims or interests in an unimpaired class are conclusively presumed to have accepted the bankruptcy plan and are not entitled to vote on the bankruptcy plan. Under the bankruptcy plan, Classes 1, 2, 5, 6 and 7 are impaired. In addition, if holders of claims or interests do not receive or retain any property under a Chapter 11 plan, the affected class is deemed not to have accepted the bankruptcy plan. Class 8 which includes holder of Crescent Operating warrants and stock options will be deemed not to have accepted the bankruptcy plan on this basis. Under the Bankruptcy Code, a class of claims or interests is considered to be "unimpaired" if a Chapter 11 plan (1) does not alter the legal, equitable and contractual rights of the holders of such claims or interests or (2) notwithstanding any contractual or legal entitlement to accelerated payment of a claim or interest upon default, cures any such default, reinstates the maturity of such claim or interest, compensates the holder of such claim or interest for any damages sustained by such holder's reasonable reliance on such contract or law and does not otherwise alter the legal, equitable or contractual rights of such holder. As indicated below, classes 3 and 4 are unimpaired under the bankruptcy plan, and such classes are, therefore, conclusively presumed to have accepted the bankruptcy plan and are not entitled to vote. Holders of claims and interests in classes 1, 2, 5, 6 and 7 are impaired and will receive or retain property under the bankruptcy plan and, therefore, are entitled to vote on the bankruptcy plan. An impaired class of interests will be determined to have accepted the bankruptcy plan if votes to accept the bankruptcy plan are cast by the holders of at least two-thirds in amount of allowed interests in such class that actually voted on the bankruptcy plan. As of the voting record date, 10,828,497 shares of common stock were outstanding and entitled to vote on the bankruptcy plan. Pursuant to bankruptcy rule 3018(b), the bankruptcy court must determine that the solicitation period prescribed to accept or reject the bankruptcy plan is not unreasonably short. The bankruptcy court must also determine this disclosure and proxy statement meets the requirements of the Bankruptcy Code. Crescent Operating believes the 110 prescribed solicitation period is reasonable and that the court will determine this disclosure and proxy statement meets applicable requirements. However, there can be no assurance that the bankruptcy court will agree and, if the bankruptcy court finds the solicitation to be unreasonably short or that the disclosure is unsatisfactory, the votes cast will not be counted for purposes of confirmation of the bankruptcy plan, and Crescent Operating will have to re-solicit such votes. BY VOTING TO ACCEPT THE BANKRUPTCY PLAN, YOU WILL EXPRESSLY WAIVE ANY RIGHT YOU OR YOUR SUCCESSORS OR ASSIGNS MAY HAVE TO CHANGE OR WITHDRAW YOUR ACCEPTANCE AFTER THE EXPIRATION DATE UNLESS THE BANKRUPTCY COURT DETERMINES THAT (1) THE DISCLOSURE YOU RECEIVED WAS NOT ADEQUATE AS REQUIRED BY SECTION 1126(b) OF THE BANKRUPTCY CODE OR (2) THE BANKRUPTCY PLAN OF REORGANIZATION HAS BEEN MODIFIED IN A MANNER THAT MATERIALLY AND ADVERSELY CHANGES THE TREATMENT OF YOUR INTEREST. If you execute and deliver a proxy card without checking either of the boxes entitled "FOR" or "AGAINST", or if you check both of such boxes, the proxy will be deemed to constitute acceptance of the bankruptcy plan. If you fail to execute and deliver your proxy card, you will not be counted for purposes of determining either acceptance or rejection of the bankruptcy plan by an impaired class of claims or interests. Under section 1126(b) of the Bankruptcy Code, if you accept or reject the bankruptcy plan before the Chapter 11 case commences, you will be deemed to have accepted or rejected the bankruptcy plan for purposes of confirmation of the bankruptcy plan under Chapter 11 if the solicitation complied with any applicable nonbankruptcy law, rule or regulation governing adequacy of disclosure in connection with the solicitation, or, if no such law, rule or regulation applies, the solicitation was made following disclosure of adequate information as defined in the Bankruptcy Code. In addition, bankruptcy rule 3018(b) requires, in the case of a prepackaged plan of reorganization, that (1) such plan be disseminated to substantially all holders in any impaired class that is solicited, (2) with respect to securities held of record, votes be solicited from the holders of record of such securities on the date specified in the solicitation and (3) the time prescribed for voting on the bankruptcy plan not be unreasonably short. Crescent Operating believes this proxy statement/prospectus and the solicitation comply with the requirements of the Bankruptcy Code and the bankruptcy rules, as well as the requirements of any applicable nonbankruptcy laws. If Crescent Operating receives the requisite acceptances of the bankruptcy plan by the expiration date, Crescent Operating will commence the reorganization case by filing a voluntary petition under Chapter 11 and will thereafter continue to operate its business as a debtor in possession. You should be aware Crescent Operating can extend the expiration date in its sole discretion. Crescent Operating will then use the proxies received pursuant to the solicitation to seek confirmation of the bankruptcy plan as promptly as practicable. ACCEPTANCE OR CRAMDOWN Section 1129(b) of the Bankruptcy Code contains provisions for the confirmation of a plan of reorganization even if the bankruptcy plan is not accepted by the stockholders in Class 7 as long as the bankruptcy plan "does not discriminate unfairly" and is "fair and equitable" with respect to such class. This provision is commonly referred to as the "cramdown provision." Crescent Operating anticipates that it would seek to utilize the "cramdown provision" of section 1129(b) of the Bankruptcy Code if necessary to confirm the bankruptcy plan. The bankruptcy plan provides that the stockholders of Crescent Operating are entitled to receive common shares of Crescent Real Estate only if the bankruptcy plan is accepted by the required vote of the Crescent Operating stockholders. Accordingly, if the bankruptcy plan is confirmed pursuant to the "cramdown provision" of section 1129(b) of the Bankruptcy Code, the stockholders of Crescent Operating will receive nothing under the bankruptcy plan, and their shares of Crescent Operating common stock will be cancelled. A plan does not discriminate unfairly if no class receives more than it is legally entitled to receive for its claims or equity interests. "Fair and equitable," as defined in section 1129(b)(2) of the Bankruptcy Code, has different meanings for secured claims, unsecured claims and interests. With respect to a secured claim, "fair and equitable" 111 means either (i) the impaired secured creditor retains its liens to the extent of its allowed claim and receives deferred cash payments at least equal to the allowed amount of its claims with a present value as of the effective date of the bankruptcy plan at least equal to the value of such creditor's interest in the property securing its liens, (ii) property subject to the lien of the impaired secured creditor is sold free and clear of that lien, with that lien attaching to the proceeds of sale, and such lien proceeds must be treated in accordance with clauses (i) and (iii) hereof, or (iii) the impaired secured creditor realizes the "indubitable equivalent" of its claim under the bankruptcy plan. With respect to an unsecured claim, "fair and equitable" means either (i) each impaired creditor receives or retains property of a value equal to the amount of its allowed claim or (ii) the holders of claims and equity interests that are junior to the claims of the dissenting class will not receive any property under the bankruptcy plan. With respect to interests, such as the holders of the common stock interests in class 7, the condition that a reorganization plan be "fair and equitable" includes the requirement that each class 7 interest holder receive or retain property of a value equal to the greater of the allowed amount of any fixed liquidation preference to which such holder is entitled, any fixed redemption price to which such holder is entitled or the value of such interest. Crescent Operating believes that the bankruptcy plan does not discriminate unfairly against, and is fair and equitable with respect to, class 7, inasmuch as holders of interests in class 7 would receive nothing in a liquidation of Crescent Operating. FEDERAL INCOME TAX CONSIDERATIONS In the opinion of Crescent Real Estate's tax counsel, Shaw Pittman, LLP, the discussion in " - Tax Consequences of the Crescent Operating Bankruptcy Plan," which follows, summarizes the material federal income tax consequences to Crescent Operating stockholders of the Crescent Operating bankruptcy plan. The sections " - Taxation of Taxable U.S. Shareholders," " - Taxation of Tax-Exempt U.S. Shareholders" and " - Taxation of Non-U.S. Shareholders" briefly describe the opinion of Shaw Pittman, LLP, as to the material federal income tax consequences to an investor of an investment in Crescent Real Estate. Because this "Federal Income Tax Considerations" section is a summary, it does not address all of the tax issues that may be important to you. In addition, this section does not address the tax issues that may be important to certain types of shareholders that are subject to special treatment under the federal income tax laws, such as insurance companies, tax-exempt organizations (except to the extent discussed in " - Taxation of Tax-Exempt U.S. Shareholders" below), financial institutions and broker-dealers, and non-U.S. individuals and foreign corporations (except to the extent discussed in " - Taxation of Non-U.S. Shareholders" below). The statements in this section are based on the current federal income tax laws governing Crescent Real Estate's qualification as a REIT. Crescent Real Estate cannot assure you that new laws, interpretations of laws or court decisions, any of which may take effect retroactively, will not cause any statement in this section to be inaccurate. Crescent Real Estate urges you to consult your own tax advisor regarding the specific federal, state, local, foreign and other tax consequences to you of purchasing, owning and disposing of Crescent Real Estate's securities, Crescent Real Estate's election to be taxed as a REIT and the effect of potential changes in applicable tax laws. TAX CONSEQUENCES OF THE CRESCENT OPERATING BANKRUPTCY PLAN The distribution of Crescent Real Estate common shares to Crescent Operating stockholders will be treated as a distribution in liquidation of Crescent Operating. Stockholders of Crescent Operating will realize gain or loss based on the difference between their basis in their shares of Crescent Operating common stock and the fair market value of the Crescent Real Estate common shares they receive. In general, a Crescent Operating stockholder who is not a dealer in securities must treat this gain or loss as a long term capital gain or loss if the stockholder held the shares of Crescent Operating common stock for more than one year or, otherwise, as a short term capital gain or loss. If a stockholder acquired shares of Crescent Operating common stock at different times, the determination of gain or loss and the holding period is made on the facts specific to each share. The stockholders' 112 basis in the Crescent Real Estate common shares they will receive will be the fair market value of the Crescent Real Estate common shares at the time of distribution. TAXATION OF CRESCENT REAL ESTATE Crescent Real Estate elected to be taxed as a REIT under the federal income tax laws when it filed its 1994 tax return. Crescent Real Estate has operated in a manner intended to qualify as a REIT and intends to continue to operate in that manner. This section discusses the laws governing the federal income tax treatment of a REIT and its shareholders. These laws are highly technical and complex. In the opinion of Crescent Real Estate's tax counsel, Shaw Pittman LLP, (i) Crescent Real Estate qualified as a REIT under sections 856 through 859 of the Internal Revenue Code for each of its taxable years beginning with its taxable year ended on December 31, 1994, through its taxable year ended on December 31, 2001; and (ii) it is organized in conformity with the requirements for qualification as a REIT under the Internal Revenue Code, and its current method of operation will enable it to meet the requirements for qualification as a REIT for the current taxable year and for future taxable years, provided that it has operated and continues to operate in accordance with various assumptions and factual representations made by Crescent Real Estate concerning its business, properties and operations. Crescent Real Estate may not, however, have met or continue to meet such requirements. You should be aware that opinions of counsel are not binding on the Internal Revenue Service or any court. Crescent Real Estate's qualification as a REIT depends on its ability to meet, on a continuing basis, certain qualification tests set forth in the federal tax laws. Those qualification tests involve the percentage of income that Crescent Real Estate earns from specified sources, the percentage of its assets that fall within certain categories, the diversity of the ownership of its shares, and the percentage of its earnings that it distributes. Accordingly, for the current taxable year and for future taxable years, no assurance can be given that Crescent Real Estate's actual operating results will satisfy the qualification tests. For a discussion of the tax treatment of Crescent Real Estate and its shareholders if it fails to qualify as a REIT, see " - Requirements for REIT Qualification - Failure to Qualify." If Crescent Real Estate qualifies as a REIT, it generally will not be subject to federal income tax on the taxable income that it distributes to its shareholders. The benefit of that tax treatment is that it avoids the "double taxation" (i.e., at both the corporate and stockholder levels) that generally results from owning stock in a corporation. However, Crescent Real Estate will be subject to federal tax in the following circumstances: - Crescent Real Estate will pay federal income tax on taxable income (including net capital gain) that it does not distribute to its shareholders during, or within a specified time period after, the calendar year in which the income is earned; - Crescent Real Estate may be subject to the "alternative minimum tax" on any items of tax preference that it does not distribute or allocate to its shareholders; - Crescent Real Estate will pay income tax at the highest corporate rate on (i) net income from the sale or other disposition of property acquired through foreclosure that it holds primarily for sale to customers in the ordinary course of business and (ii) other non-qualifying income from foreclosure property; - Crescent Real Estate will pay a 100% tax on net income from certain sales or other dispositions of property (other than foreclosure property) that it holds primarily for sale to customers in the ordinary course of business ("prohibited transactions"); - if Crescent Real Estate fails to satisfy the 75% gross income test or the 95% gross income test (as described below under " - Requirements for REIT Qualification - Income Tests"), and nonetheless continues to qualify as a REIT because it meets certain other requirements, Crescent Real Estate will pay a 113 100% tax on (i) the gross income attributable to the greater of the amount by which it fails the 75% or 95% gross income test, multiplied by (ii) a fraction intended to reflect its profitability; - if Crescent Real Estate fails to distribute during a calendar year at least the sum of (i) 85% of its REIT ordinary income for such year, (ii) 95% of its REIT capital gain net income for such year, and (iii) any undistributed taxable income from prior periods, it will pay a 4% excise tax on the excess of such required distribution over the amount it actually distributed; - if Crescent Real Estate acquires any asset from a C corporation (i.e., a corporation generally subject to full corporate-level tax) in a merger or other transaction in which Crescent Real Estate acquires a "carryover" basis in the asset (i.e., basis determined by reference to the C corporation's basis in the asset (or another asset)), Crescent Real Estate will pay tax at the highest regular corporate rate applicable if it recognizes gain on the sale or disposition of such asset during the 10-year period after it acquires such asset. The amount of gain on which Crescent Real Estate will pay tax is the lesser of (i) the amount of gain that it recognizes at the time of the sale or disposition and (ii) the amount of gain that it would have recognized if it had sold the asset at the time it acquired the asset. The rule described in this paragraph will apply assuming that Crescent Real Estate makes an election under section 1.337(d)-5T(b) of the Treasury Regulations upon its acquisition of an asset from a C corporation; and - Crescent Real Estate will incur a 100% excise tax on transactions with a "taxable REIT subsidiary" to the extent that they are not conducted on an arm's-length basis. Requirements for REIT Qualification. In order to qualify as a REIT, Crescent Real Estate must be a corporation, trust or association and meet the following requirements: - it is managed by one or more trustees or directors; - its beneficial ownership is evidenced by transferable shares, or by transferable certificates of beneficial interest; - it would be taxable as a domestic corporation, but for sections 856 through 860 of the Internal Revenue Code; - it is neither a financial institution nor an insurance company subject to certain provisions of the Internal Revenue Code; - at least 100 persons are beneficial owners of its shares or ownership certificates; - not more than 50% in value of its outstanding shares or ownership certificates is owned, directly or indirectly, by five or fewer individuals (as defined in the Internal Revenue Code to include certain entities) during the last half of any taxable year (the "5/50 Rule"); - it elects to be a REIT (or has made such election for a previous taxable year) and satisfies all relevant filing and other administrative requirements established by the Internal Revenue Service that must be met to elect and maintain REIT status; - it uses a calendar year for federal income tax purposes and complies with the record keeping requirements of the Internal Revenue Code and the related Treasury Regulations; and 114 - it meets certain other qualification tests, described below, regarding the nature of its income and assets. Crescent Real Estate must meet requirements 1 through 4 during its entire taxable year and must meet requirement 5 during at least 335 days of a taxable year of 12 months, or during a proportionate part of a taxable year of less than 12 months. Crescent Real Estate was not required to meet requirements 5 and 6 during 1994. If Crescent Real Estate complies with all the requirements for ascertaining the ownership of its outstanding shares in a taxable year and has no reason to know that it violated the 5/50 Rule, it will be deemed to have satisfied the 5/50 Rule for such taxable year. For purposes of determining share ownership under the 5/50 Rule, an "individual" generally includes a supplemental unemployment compensation benefits plan, a private foundation, or a portion of a trust permanently set aside or used exclusively for charitable purposes. An "individual," however, generally does not include a trust that is a qualified employee pension or profit sharing trust under Internal Revenue Code section 401(a), and beneficiaries of such a trust will be treated as holding its shares in proportion to their actuarial interests in the trust for purposes of the 5/50 Rule. Crescent Real Estate believes it has issued sufficient common shares with sufficient diversity of ownership to satisfy requirements 5 and 6 set forth above. In addition, its declaration of trust restricts the ownership and transfer of the common shares so that Crescent Real Estate should continue to satisfy requirements 5 and 6. The provisions of its declaration of trust restricting the ownership and transfer of the common shares are described in "Description of Shares of Beneficial Ownership - Restrictions on Ownership and Transfer." Crescent Real Estate currently has several wholly owned corporate subsidiaries and may have additional corporate subsidiaries in the future. A corporation that is a "qualified REIT subsidiary" is not treated as a corporation separate from its parent REIT. All assets, liabilities, and items of income, deduction, and credit of a qualified REIT subsidiary are treated as assets, liabilities, and items of income, deduction, and credit of the REIT. A qualified REIT subsidiary is a corporation, all of the capital stock of which is owned by the parent REIT, which has not elected to be treated as a taxable REIT subsidiary. Thus, in applying the requirements described herein, any qualified REIT subsidiary of Crescent Real Estate's will be ignored, and all assets, liabilities, and items of income, deduction, and credit of such subsidiary will be treated as Crescent Real Estate's assets, liabilities, and items of income, deduction, and credit. Crescent Real Estate believes its wholly owned corporate subsidiaries that are not taxable REIT subsidiaries are qualified REIT subsidiaries. Accordingly, they are not subject to federal corporate income taxation, though they may be subject to state and local taxation. A REIT is treated as owning its proportionate share of the assets of any partnership in which it is a partner and as earning its allocable share of the gross income of the partnership for purposes of the applicable REIT qualification tests. Thus, Crescent Real Estate's proportionate share of the assets, liabilities and items of income of Crescent Partnership and of any other partnership (or limited liability company treated as a partnership) in which Crescent Real Estate has acquired or will acquire an interest, directly or indirectly (a "subsidiary partnership"), are treated as Crescent Real Estate's assets and gross income for purposes of applying the various REIT qualification requirements. Tax legislation effective in 2001 allows a REIT to own up to 100% of the outstanding capital stock of one or more taxable REIT subsidiaries, also referred to as TRSs. A TRS is a fully taxable corporation that pays income tax at regular corporate rates on its taxable income. A TRS may earn income that would not be qualifying income if earned directly by the parent REIT. Both the TRS and the REIT must jointly elect to treat the subsidiary as a TRS. Overall, no more than 20% of the value of a REIT's assets may consist of securities of one or more TRSs. In addition, the TRS rules may limit the deductibility of interest paid or accrued by a TRS to its parent REIT to assure that the TRS is subject to the appropriate level of corporate taxation. The rules also impose a 100% excise tax on transactions between a TRS and its parent REIT or the REIT's tenants to the extent that they are not conducted on an arm's-length basis. Crescent Real Estate currently owns interests in several TRSs, but the collective value of Crescent Real Estate's 115 interests in the TRSs does not exceed 20% of the value of its assets. In addition, Crescent Real Estate believes that all transactions between it and its TRSs have been, and continue to be, conducted on an arm's-length basis. Income Tests Crescent Real Estate must satisfy two gross income tests annually to maintain its qualification as a REIT: - At least 75% of its gross income (excluding gross income from prohibited transactions) for each taxable year must consist of defined types of income that it derives, directly or indirectly, from investments relating to real property or mortgages on real property or temporary investment income (the "75% gross income test"). Qualifying income for purposes of the 75% gross income test includes "rents from real property," interest on debt secured by mortgages on real property or on interests in real property, and dividends or other distributions on and gain from the sale of shares in other REITs; and - At least 95% of its gross income (excluding gross income from prohibited transactions) for each taxable year must consist of income that is qualifying income for purposes of the 75% gross income test, dividends, other types of interest, gain from the sale or disposition of stock or securities, or any combination of the foregoing (the "95% gross income test"). Application of Income Tests to Crescent Real Estate Crescent Partnership's primary source of income is primarily derived from leasing the office properties and the Crescent Real Estate hotel properties. Rents under these leases will constitute "rents from real property," which is qualifying income for purposes of the 75% and 95% gross income tests, only if the following requirements are met: - The rent is not based, in whole or in part, on the income or profits of any person, although, generally, rent may be based on a fixed percentage or percentages of receipts or sales. - Neither Crescent Real Estate nor someone who owns 10% or more of Crescent Real Estate's shares owns 10% or more of a tenant (other than a TRS that is a tenant of one or more of the Crescent Real Estate hotel properties) from which Crescent Partnership or one of the subsidiary partnerships receives rent (a "related party tenant"). Crescent Real Estate's ownership and the ownership of a tenant is determined based on direct, indirect, and constructive ownership. - The rent attributable to any personal property leased in connection with a lease of property is no more than 15% of the total rent received under the lease. - Neither Crescent Partnership nor any of the subsidiary partnerships operates or manages its property or furnishes or renders services to its tenants, other than through a TRS or through an "independent contractor" that is adequately compensated and from which Crescent Partnership and the subsidiary partnerships do not derive revenue. Crescent Partnership and the subsidiary partnerships may provide services directly if the services are "usually or customarily rendered" in connection with the rental of space for occupancy only and are not otherwise considered rendered to the occupant. In addition, Crescent Partnership and the subsidiary partnerships may render directly a de minimis amount of "non-customary" services to the tenants of a property without disqualifying the income as "rents from real property," as long as its income from the services does not exceed 1% of its income from the property. - The Crescent Real Estate hotel properties are either (a) leased to unrelated tenants, or (b) leased to TRSs and are managed by "eligible independent contractors," which are independent contractors that, at the time they entered into management agreements with the TRSs, were actively engaged in the business of operating lodging facilities for people or entities not related to Crescent Real Estate or the TRSs. 116 Crescent Real Estate, based in part upon opinions of its tax counsel or other lawyers as to whether various tenants constitute related party tenants and as to whether certain hotel managers constitute eligible independent contractors, believes that the income it has received since 1994 and will receive in subsequent taxable years from rent that does not satisfy the five requirements set forth above will not cause it to fail to meet the gross income tests. Crescent Partnership will also receive fixed and contingent interest on the mortgages on the Crescent Real Estate residential development properties. Interest on mortgages secured by real property satisfies the 75% and 95% gross income tests only if it does not include any amount that is based in whole or in part upon the income of any person, except that (1) an amount is not excluded from qualifying interest solely by reason of being based on a fixed percentage or percentages of receipts or sales and (2) income derived from a shared appreciation provision in a mortgage is treated as gain recognized from the sale of the mortgaged property. Some of the residential development property mortgages contain provisions for contingent interest based upon property sales. Crescent Real Estate's tax counsel has opined that each of the residential development property mortgages constitutes debt for federal income tax purposes, any contingent interest derived therefrom will be treated as being based on a fixed percentage of sales, and therefore all interest derived therefrom will constitute interest received from mortgages for purposes of the 75% and 95% gross income tests. If, however, the contingent interest provisions were instead characterized as shared appreciation provisions, any resulting income would be treated as income from prohibited transactions, because the underlying properties are primarily held for sale to customers in the ordinary course. Such income would not satisfy the 75% and 95% gross income tests and would be subject to a 100% tax. In applying the 95% and 75% gross income tests, Crescent Real Estate must consider the form in which its assets are held, whether that form will be respected for federal income tax purposes, and whether, in the future, such form may change into a new form with different tax attributes. For example, the Crescent Real Estate residential development properties are primarily held for sale to customers in the ordinary course of business, and the income resulting from such sales, if directly attributed to Crescent Real Estate, would not qualify under the 75% and 95% gross income tests. In addition, such income would be considered "net income from prohibited transactions" and thus would be subject to a 100% tax. The income from such sales, however, will be earned by the residential development corporations rather than by Crescent Partnership and will be paid to Crescent Partnership in the form of interest and principal payments on the residential development property mortgages or distributions with respect to the stock in the residential development corporations held by Crescent Partnership. In similar fashion, the income earned by the Crescent Real Estate hotel properties, if directly attributed to Crescent Real Estate, would not qualify under the 75% and 95% gross income tests because it would not constitute "rents from real property." Such income is, however, earned by the lessees of these Crescent Real Estate hotel properties and what Crescent Partnership and the subsidiary partnerships receive from the lessees of these Crescent Real Estate hotel properties is rent with respect to the leases. Crescent Partnership may also receive distributions on its stock in the TRS lessees. Crescent Real Estate's tax counsel has opined that: - the Crescent Real Estate residential development properties or any interest therein will be treated as owned by the residential development corporations; - amounts derived by Crescent Partnership from the residential development corporations under the terms of the residential development property mortgages will qualify as interest or principal, as the case may be, paid on mortgages on real property for purposes of the 75% and 95% gross income tests; - amounts derived by Crescent Partnership with respect to the stock of the residential development corporations will be treated as distributions on stock for purposes of the 75% and 95% gross income tests; and - the leases of the Crescent Real Estate hotel properties will be treated as leases for federal income tax purposes, and the rent payable under the leases of the Crescent Real Estate hotel properties will qualify as "rents from real property." 117 Investors should be aware that there are no controlling Treasury Regulations, published rulings, or judicial decisions involving transactions with terms substantially the same as those with respect to the residential development corporations and the leases of the Crescent Real Estate hotel properties. Therefore, the opinions of Crescent Real Estate's tax counsel with respect to these matters are based upon all of the facts and circumstances and upon rulings and judicial decisions involving situations that are considered to be analogous. Opinions of counsel are not binding upon the Internal Revenue Service or any court, and there can be no complete assurance that the Internal Revenue Service will not assert successfully a contrary position. If one or more of the leases of the Crescent Real Estate hotel properties is not a true lease, part or all of the payments that Crescent Partnership or one of the subsidiary partnerships receives from the respective lessee may not satisfy the various requirements for qualification as "rents from real property," or Crescent Partnership might be considered to operate the Crescent Real Estate hotel properties directly. In that case, Crescent Real Estate likely would not be able to satisfy either the 75% or 95% gross income tests and, as a result, likely would lose its REIT status. Similarly, if the Internal Revenue Service were to challenge successfully the arrangements with the residential development corporations, Crescent Real Estate's qualification as a REIT could be jeopardized. If any of the Crescent Real Estate residential development properties were to be acquired by Crescent Partnership as a result of foreclosure on any of the residential development property mortgages, or if any of the Crescent Real Estate hotel properties were to be operated directly by the Partnership or a subsidiary partnership as a result of a default by the lessee under the lease, such property would constitute foreclosure property for three years following its acquisition (or for up to an additional three years if an extension is granted by the Internal Revenue Service), provided that (i) Crescent Partnership or its subsidiary partnership conducts sales or operations through an independent contractor; (ii) Crescent Partnership or its subsidiary partnership does not undertake any construction on the foreclosed property other than completion of improvements which were more than 10% complete before default became imminent; and (iii) foreclosure was not regarded as foreseeable at the time Crescent Real Estate acquired the residential development property mortgages or leased the Crescent Real Estate hotel properties. For so long as any of these properties constitutes foreclosure property, the income from such sales would be subject to tax at the maximum corporate rates and would qualify under the 75% and 95% gross income tests. However, if any of these properties does not constitute foreclosure property at any time in the future, income earned from the disposition or operation of such property will not qualify under the 75% and 95% gross income tests and, in the case of the Crescent Real Estate residential development properties, will be subject to the 100% tax. Crescent Real Estate anticipates that it will have certain income that will not satisfy the 75% or the 95% gross income test. For example, income from dividends on the stock of the residential development corporations or other TRSs will not satisfy the 75% gross income test. It is also possible that certain income resulting from the use of creative financing or acquisition techniques would not satisfy the 75% or 95% gross income tests. Crescent Real Estate believes, however, that the aggregate amount of nonqualifying income will not cause it to exceed the limits on nonqualifying income under the 75% or 95% gross income tests. Relief from Consequences of Failing to Meet Income Tests If Crescent Real Estate fails to satisfy one or both of the 75% and 95% gross income tests for any taxable year, it nevertheless may qualify as a REIT for such year if it qualifies for relief under certain provisions of the Internal Revenue Code. Those relief provisions generally will be available if Crescent Real Estate's failure to meet such tests is due to reasonable cause and not due to willful neglect, Crescent Real Estate attaches a schedule of the sources of its income to its tax return, and any incorrect information on the schedule was not due to fraud with intent to evade tax. Crescent Real Estate may not qualify for the relief provisions in all circumstances. In addition, as discussed above in " - Taxation of Crescent Real Estate," even if the relief provisions apply, Crescent Real Estate would incur a 100% tax on gross income to the extent it fails the 75% or 95% gross income test (whichever amount is greater), multiplied by a fraction intended to reflect its profitability. 118 Asset Tests To maintain its qualification as a REIT, Crescent Real Estate also must satisfy two asset tests at the close of each quarter of each taxable year: - At least 75% of the value of its total assets must consist of cash or cash items (including certain receivables), government securities, "real estate assets," or qualifying temporary investments (the "75% asset test"). - "Real estate assets" include interests in real property, interests in mortgages on real property and stock in other REITs. "Interests in real property" include an interest in mortgage loans or land and improvements thereon, such as buildings or other inherently permanent structures (including items that are structural components of such buildings or structures), a leasehold of real property, and an option to acquire real property (or a leasehold of real property). - Qualifying temporary investments are investments in stock or debt instruments during the one-year period following Crescent Real Estate's receipt of new capital that Crescent Real Estate raises through equity or long-term (at least five-year) debt offerings. - For investments not included in the 75% asset test, (A) the value of Crescent Real Estate's interest in any one issuer's securities may not exceed 5% of the value of its total assets (the "5% asset test") and (B) Crescent Real Estate may not own more than 10% of the voting power or value of any one issuer's outstanding securities (the "10% asset test"). - As mentioned above, the collective value of Crescent Real Estate's interests in TRSs cannot exceed 20% of the value of its assets. For purposes of the second asset test, the term "securities" does not include Crescent Real Estate's equity ownership in another REIT, its equity or debt securities of a qualified REIT subsidiary or a TRS, or its equity interest in any partnership. The term "securities," however, generally includes Crescent Real Estate's debt securities issued by a partnership, except that non-participating debt securities of a partnership are not treated as "securities" for purposes of the value portion of the 10% asset test if Crescent Real Estate owns at least a 20% profits interest in the partnership. Crescent Real Estate intends to select future investments so as to comply with the asset tests. If Crescent Real Estate failed to satisfy the asset tests at the end of a calendar quarter, it would not lose its REIT status if (i) it satisfied the asset tests at the close of the preceding calendar quarter and (ii) the discrepancy between the value of its assets and the asset test requirements arose from changes in the market values of its assets and was not wholly or partly caused by the acquisition of one or more nonqualifying assets. If Crescent Real Estate did not satisfy the condition described in clause (ii) of the preceding sentence, it still could avoid disqualification as a REIT by eliminating any discrepancy within 30 days after the close of the calendar quarter in which the discrepancy arose. Crescent Partnership owns 100% of the outstanding stock of each residential development corporation. In order to avoid violating the 10% asset test, Crescent Real Estate has made a joint election with each residential development corporation for it to be treated as a TRS. In addition, Crescent Partnership owns the residential development property mortgages. As stated above, Crescent Real Estate's tax counsel has opined that each of these mortgages will constitute debt for federal income tax purposes and therefore will be treated as a real estate asset; however, the Internal Revenue Service could assert that such mortgages should be treated as equity interests in their respective issuers, which would not qualify as real estate assets. By virtue of Crescent Real Estate's ownership of partnership interests in Crescent Partnership, Crescent Real Estate will be considered to own its pro rata share of these assets. Crescent Real Estate also believes that the collective value of its pro rata shares of the value of the securities of the residential development corporations and its other TRSs does not exceed 20% of the value of its assets. These beliefs are based in part upon Crescent Real Estate's analysis of the estimated values of the various securities owned 119 by Crescent Partnership relative to the estimated value of the total assets owned by Crescent Partnership. No independent appraisals will be obtained to support this conclusion, and Crescent Real Estate's tax counsel, in rendering its opinion as to Crescent Real Estate's qualification as a REIT, is relying on Crescent Real Estate's conclusions as to the value of the various securities and other assets. There can be no assurance, however, that the Internal Revenue Service might not contend that the values of the various securities of the TRSs held by Crescent Real Estate through Crescent Partnership in the aggregate exceed the 20% value limitation. Finally, if Crescent Partnership were treated for tax purposes as a corporation rather than as a partnership, Crescent Real Estate would violate the 10% asset test and 5% of value limitation, and the treatment of any of Crescent Partnership's subsidiary partnerships as a corporation rather than as a partnership could also violate one or the other, or both, of these limitations. In the opinion of Crescent Real Estate's tax counsel, for federal income tax purposes Crescent Partnership and all the subsidiary partnerships will be treated as partnerships and not as either associations taxable as corporations or publicly traded partnerships. See " -- Tax Aspects of Crescent Real Estate's Investments in Crescent Partnership and Subsidiary Partnerships" below. The various percentage value requirements must be satisfied not only on the date Crescent Real Estate first acquires corporate securities, but also each time it increases its ownership of securities (including as a result of increasing its interest in Crescent Partnership either with the proceeds of an offering or by acquiring units of limited partnership interest from limited partners upon the exercise of their rights to exchange units of limited partnership interest for Crescent Real Estate common shares). Although Crescent Real Estate plans to take steps to ensure that it satisfies the 5% and 25% value tests for any quarter with respect to which retesting is to occur, there can be no assurance that such steps (i) will always be successful; (ii) will not require a reduction in Crescent Real Estate's overall interest in the various corporations; or (iii) will not restrict the ability of the residential development corporations to increase the sizes of their respective businesses, unless the value of Crescent Real Estate's assets is increasing at a commensurate rate. Distribution Requirements Each taxable year, Crescent Real Estate must distribute dividends (other than capital gain dividends and deemed distributions of retained capital gain) to its shareholders in an aggregate amount at least equal to (1) the sum of 90% of (A) its "REIT taxable income" (computed without regard to the dividends paid deduction and its net capital gain or loss) and (B) its net income (after tax), if any, from foreclosure property, minus (2) certain items of non-cash income. Crescent Real Estate must pay such distributions in the taxable year to which they relate, or in the following taxable year if Crescent Real Estate declares the distribution before it timely files its federal income tax return for such year and pays the distribution on or before the first regular dividend payment date after such declaration. Crescent Real Estate will pay federal income tax on taxable income (including net capital gain) that it does not distribute to shareholders. Furthermore, Crescent Real Estate will incur a 4% nondeductible excise tax if it fails to distribute during a calendar year (or, in the case of distributions with declaration and record dates falling in the last three months of the calendar year, by the end of January following such calendar year) at least the sum of (1) 85% of its REIT ordinary income for such year, (2) 95% of its REIT capital gain income for such year, and (3) any undistributed taxable income from prior periods. The excise tax is on the excess of such required distribution over the amounts Crescent Real Estate actually distributed. Crescent Real Estate may elect to retain and pay income tax on the net long-term capital gain it receives in a taxable year. See " - Taxation of Taxable U.S. Shareholders." For purposes of the 4% excise tax, Crescent Real Estate will be treated as having distributed any such retained amount. Crescent Real Estate believes that it has made, and it intends to continue to make, timely distributions sufficient to satisfy the annual distribution requirements. In this regard, the Agreement of Limited Partnership of Crescent Partnership (the "Partnership Agreement") authorizes the General Partner to take such steps as may be necessary to cause Crescent Partnership to distribute to its partners an amount sufficient to permit Crescent Real Estate to meet these distribution requirements. It is possible, however, that, from time to time, Crescent Real Estate may 120 experience timing differences between (i) the actual receipt of income and actual payment of deductible expenses and (ii) the inclusion of such income and deduction of such expenses in arriving at its "real estate investment trust taxable income." Issues may also arise as to whether certain items should be included in income. In addition, it is possible that certain creative financing or creative acquisition techniques used by Crescent Partnership may result in income (such as income from cancellation of indebtedness or gain upon the receipt of assets in foreclosure the fair market value of which exceeds Crescent Partnership's basis in the debt that was foreclosed upon) that is not accompanied by cash proceeds. In this regard, the modification of a debt can result in taxable gain equal to the difference between the holder's basis in the debt and the principal amount of the modified debt. Based on the foregoing, Crescent Real Estate may have less cash available for distribution in a particular year than is necessary to meet its annual distribution requirement or to avoid tax with respect to capital gain or the excise tax imposed on certain undistributed income for such year. To meet the distribution requirement necessary to qualify as a REIT or to avoid tax with respect to capital gain or the excise tax imposed on certain undistributed income, Crescent Real Estate may find it appropriate to arrange for borrowings through Crescent Partnership or to pay distributions in the form of taxable share dividends. Under certain circumstances, Crescent Real Estate may be able to correct a failure to meet the distribution requirement for a year by paying deficiency dividends to its shareholders in a later year. Crescent Real Estate may include such deficiency dividends in its deduction for dividends paid for the earlier year. Although Crescent Real Estate may be able to avoid income tax on amounts distributed as deficiency dividends, it will be required to pay interest to the Internal Revenue Service based upon the amount of any deduction it takes for deficiency dividends. Record Keeping Requirements Crescent Real Estate must maintain certain records in order to qualify as a REIT. In addition, to avoid a monetary penalty, Crescent Real Estate must request on an annual basis certain information from its shareholders designed to disclose the actual ownership of its outstanding stock. It has complied, and it intends to continue to comply, with such requirements. Failure to Qualify If Crescent Real Estate failed to qualify as a REIT in any taxable year, and no relief provision applied, it would be subject to federal income tax (including any applicable alternative minimum tax) on its taxable income at regular corporate rates. In calculating its taxable income in a year in which it failed to qualify as a REIT, Crescent Real Estate would not be able to deduct amounts paid out to shareholders. In fact, Crescent Real Estate would not be required to distribute any amounts to shareholders in such year. In such event, to the extent of Crescent Real Estate's current and accumulated earnings and profits, all distributions to shareholders would be taxable as ordinary income. Subject to certain limitations of the Internal Revenue Code, corporate shareholders might be eligible for the dividends received deduction. Unless Crescent Real Estate qualified for relief under specific statutory provisions, it also would be disqualified from electing taxation as a REIT for the four taxable years following the year during which it ceased to qualify as a REIT. Crescent Real Estate cannot predict whether in all circumstances it would qualify for such statutory relief. TAXATION OF TAXABLE U.S. SHAREHOLDERS As long as Crescent Real Estate qualifies as a REIT, a taxable "U.S. shareholder" must take into account, as ordinary income, distributions out of Crescent Real Estate's current or accumulated earnings and profits that Crescent Real Estate does not designate as capital gain dividends or retained long-term capital gain. A U.S. shareholder will not qualify for the dividends received deduction generally available to corporations. As used herein, a U.S. shareholder is a holder of common shares that for U.S. federal income tax purposes is: - a citizen or resident of the United States; 121 - a corporation, partnership, or other entity created or organized in or under the laws of the United States or of a political subdivision thereof; - an estate whose income is subject to U.S. federal income taxation regardless of its source; or - any trust with respect to which (A) a U.S. court is able to exercise primary supervision over the administration of such trust and (B) one or more U.S. persons have the authority to control all substantial decisions of the trust. A U.S. shareholder will recognize distributions that Crescent Real Estate designates as capital gain dividends as long-term capital gain, to the extent they do not exceed its actual net capital gain for the taxable year, without regard to the period for which the U.S. shareholder has held its common shares. Subject to certain limitations, Crescent Real Estate will designate its capital gain dividends as either 20% or 25% rate distributions. A corporate U.S. shareholder, however, may be required to treat up to 20% of certain capital gain dividends as ordinary income. Crescent Real Estate may elect to retain and pay income tax on the net long-term capital gain that it receives in a taxable year. In that case, a U.S. shareholder would be taxed on its proportionate share of Crescent Real Estate's undistributed long-term capital gain. The U.S. shareholder would receive a credit or refund for its proportionate share of the tax Crescent Real Estate paid. The U.S. shareholder would increase the basis in its stock by the amount of its proportionate share of Crescent Real Estate's undistributed long-term capital gain, minus its share of the tax Crescent Real Estate paid. A U.S. shareholder will not incur tax on a distribution in excess of Crescent Real Estate's current and accumulated earnings and profits if such distribution does not exceed the adjusted basis of the U.S. shareholder's common shares. Instead, such distribution will reduce the adjusted basis of such common shares. A U.S. shareholder will recognize a distribution in excess of both Crescent Real Estate's current and accumulated earnings and profits and the U.S. shareholder's adjusted basis in its common shares as long-term capital gain, or short-term capital gain if the common shares have been held for one year or less, assuming the common shares are a capital asset in the hands of the U.S. shareholder. In addition, if Crescent Real Estate declares a distribution in October, November, or December of any year that is payable to a U.S. shareholder of record on a specified date in any such month, such distribution shall be treated as both paid by Crescent Real Estate and received by the U.S. shareholder on December 31 of such year, provided that Crescent Real Estate actually pays the distribution during January of the following calendar year. Crescent Real Estate will notify U.S. shareholders after the close of its taxable year as to the portions of the distributions attributable to that year that constitute ordinary income or capital gain dividends. Taxation of U.S. Shareholders on the Disposition of the Common Shares In general, a U.S. shareholder who is not a dealer in securities must treat any gain or loss realized upon a taxable disposition of the common shares as long-term capital gain or loss if the U.S. shareholder has held the common stock for more than one year and otherwise as short-term capital gain or loss. However, a U.S. shareholder must treat any loss upon a sale or exchange of common shares held by such shareholder for six months or less, after applying certain holding period rules, as a long-term capital loss to the extent of capital gain dividends and other distributions from Crescent Real Estate that such U.S. shareholder treats as long-term capital gain. All or a portion of any loss a U.S. shareholder realizes upon a taxable disposition of the common shares may be disallowed if the U.S. shareholder purchases additional common shares within 30 days before or after the disposition. Capital Gains and Losses A taxpayer generally must hold a capital asset for more than one year for gain or loss derived from its sale or exchange to be treated as long-term capital gain or loss. The highest marginal individual income tax rate is 38.6%. On June 7, 2001, President Bush signed into law the Economic Growth and Tax Relief Reconciliation Act of 2001. That 122 legislation reduces the highest marginal individual income tax rate of 38.6% to 37.6% for the period from January 1, 2004 to December 31, 2005, and to 35% for the period from January 1, 2006 to December 31, 2010. The maximum tax rate on long-term capital gain applicable to non-corporate taxpayers is 20% for sales and exchanges of assets held for more than one year. The maximum tax rate on long-term capital gain from the sale or exchange of "Section 1250 property" (i.e., depreciable real property) is 25% to the extent that such gain would have been treated as ordinary income if the property were "Section 1245 property." With respect to distributions that Crescent Real Estate designates as capital gain dividends and any retained capital gain that it is deemed to distribute, Crescent Real Estate may designate, subject to certain limits, whether such a distribution is taxable to its non-corporate shareholders at a 20% or 25% rate. Thus, the tax rate differential between capital gain and ordinary income for non-corporate taxpayers may be significant. A U.S. shareholder required to include retained long-term capital gains in income will be deemed to have paid, in the taxable year of the inclusion, its proportionate share of the tax paid by Crescent Real Estate in respect of such undistributed net capital gains. U.S. shareholders subject to these rules will be allowed a credit or a refund, as the case may be, for the tax deemed to have been paid by such shareholders. U.S. shareholders will increase their basis in their common shares by the difference between the amount of such includible gains and the tax deemed paid by the U.S. shareholder in respect of such gains. In addition, the characterization of income as capital gain or ordinary income may affect the deductibility of capital losses. A non-corporate taxpayer may deduct capital losses not offset by capital gains against its ordinary income only up to a maximum annual amount of $3,000. A non-corporate taxpayer may carry forward unused capital losses indefinitely. A corporate taxpayer must pay tax on its net capital gain at ordinary corporate rates. A corporate taxpayer can deduct capital losses only to the extent of capital gains, with unused losses being carried back three years and forward five years. Information Reporting Requirements and Backup Withholding Crescent Real Estate will report to its shareholders and to the Internal Revenue Service the amount of distributions it pays during each calendar year, and the amount of tax it withholds, if any. Under the backup withholding rules, a shareholder may be subject to backup withholding at the rate of 30%, gradually decreasing to 28% in 2006, with respect to distributions unless such holder (1) is a corporation or comes within certain other exempt categories and, when required, demonstrates this fact or (2) provides a taxpayer identification number, certifies as to no loss of exemption from backup withholding, and otherwise complies with the applicable requirements of the backup withholding rules. A shareholder who does not provide Crescent Real Estate with its correct taxpayer identification number also may be subject to penalties imposed by the IRS. Any amount paid as backup withholding will be creditable against the shareholder's income tax liability. In addition, it may be required to withhold a portion of capital gain distributions to any shareholders who fail to certify their non-foreign status to it. TAXATION OF TAX-EXEMPT U.S. SHAREHOLDERS Most tax-exempt employees' pension trusts are not subject to federal income tax except to the extent of their receipt of "unrelated business taxable income," or "UBTI." Distributions by Crescent Real Estate to a shareholder that is a tax-exempt entity should not constitute UBTI, provided that the tax-exempt entity has not financed the acquisition of Crescent Real Estate's shares with "acquisition indebtedness" and the shares are not otherwise used in an unrelated trade or business of the tax-exempt entity. In addition, certain pension trusts that own more than 10% of a "pension-held REIT" must report a portion of the dividends that they receive from such a REIT as UBTI. Crescent Real Estate has not been and does not expect to be treated as a pension-held REIT for purposes of this rule. TAXATION OF NON-U.S. SHAREHOLDERS The rules governing U.S. federal income taxation of nonresident alien individuals, foreign corporations, foreign partnerships, and other foreign shareholders (collectively, "non-U.S. shareholders") are complex. This section is only a summary of such rules. Crescent Operating urges non-U.S. shareholders to consult their own tax advisors to determine the impact of federal, state, and local income tax laws on ownership of common shares, including any reporting requirements. 123 Ordinary Dividends A non-U.S. shareholder that receives a distribution that is not attributable to gain from Crescent Real Estate's sale or exchange of U.S. real property interests (as defined below) and that Crescent Real Estate does not designate as a capital gain dividend or retained capital gain will recognize ordinary income to the extent that Crescent Real Estate pays such distribution out of its current or accumulated earnings and profits. A withholding tax equal to 30% of the gross amount of the distribution ordinarily will apply to such distribution unless an applicable tax treaty reduces or eliminates the tax. However, if a distribution is treated as effectively connected with the non-U.S. shareholder's conduct of a U.S. trade or business, the non-U.S. shareholder generally will be subject to federal income tax on the distribution at graduated rates, in the same manner as U.S. shareholders are taxed with respect to such distributions (and also may be subject to the 30% branch profits tax in the case of a non-U.S. shareholder that is a non-U.S. corporation). Crescent Real Estate plans to withhold U.S. income tax at the rate of 30% on the gross amount of any such distribution paid to a non-U.S. shareholder unless (i) a lower treaty rate applies and the non-U.S. shareholder files IRS Form W-8BEN with Crescent Real Estate evidencing eligibility for that reduced rate or (ii) the non-U.S. shareholder files an IRS Form W-8ECI with Crescent Real Estate claiming that the distribution is effectively connected income. Return of Capital A non-U.S. shareholder will not incur tax on a distribution in excess of Crescent Real Estate's current and accumulated earnings and profits if such distribution does not exceed the adjusted basis of its common shares. Instead, such a distribution will reduce the adjusted basis of such common shares. A non-U.S. shareholder will be subject to tax on a distribution that exceeds both Crescent Real Estate's current and accumulated earnings and profits and the adjusted basis of its common shares, if the non-U.S. shareholder otherwise would be subject to tax on gain from the sale or disposition of its common shares, as described below. Because Crescent Real Estate generally cannot determine at the time it makes a distribution whether or not the distribution will exceed its current and accumulated earnings and profits, Crescent Real Estate normally will withhold tax on the entire amount of any distribution at the same rate as it would withhold on a dividend. However, a non-U.S. shareholder may obtain a refund of amounts that Crescent Real Estate withholds if Crescent Real Estate later determines that a distribution in fact exceeded Crescent Real Estate's current and accumulated earnings and profits. Capital Gain Dividends For any year in which Crescent Real Estate qualifies as a REIT, a non-U.S. shareholder will incur tax on distributions that are attributable to gain from Crescent Real Estate's sale or exchange of "U.S. real property interests" under the provisions of the Foreign Investment in Real Property Tax Act of 1980 ("FIRPTA"). The term "U.S. real property interests" includes certain interests in real property and stock in corporations at least 50% of whose assets consists of interests in real property, but excludes mortgage loans and mortgage-backed securities. Under FIRPTA, a non-U.S. shareholder is taxed on distributions attributable to gain from sales of U.S. real property interests as if such gain were effectively connected with a U.S. business of the non-U.S. shareholder. A non-U.S. shareholder thus would be taxed on such a distribution at the normal capital gain rates applicable to U.S. shareholders (subject to applicable alternative minimum tax and a special alternative minimum tax in the case of a nonresident alien individual). A non- U.S. corporate shareholder not entitled to treaty relief or exemption also may be subject to the 30% branch profits tax on distributions subject to FIRPTA. Crescent Real Estate must withhold 35% of any distribution that it could designate as a capital gain dividend. However, if Crescent Real Estate makes a distribution and later designates it as a capital gain dividend, then (although such distribution may be taxable to a non-U.S. shareholder) it is not subject to withholding under FIRPTA. Instead, Crescent Real Estate must make-up the 35% FIRPTA withholding from distributions made after the designation, until the amount of distributions withheld at 35% equals the amount of the distribution designated as a capital gain dividend. A non-U.S. shareholder may receive a credit against its FIRPTA tax liability for the amount Crescent Real Estate withholds. 124 Distributions to a non-U.S. shareholder that Crescent Real Estate designates at the time of distribution as capital gain dividends which are not attributable to or treated as attributable to Crescent Real Estate's disposition of a U.S. real property interest generally will not be subject to U.S. federal income taxation, except as described below under " - Sale of Shares." Sale of Shares A non-U.S. shareholder generally will not incur tax under FIRPTA on gain from the sale of its common shares as long as Crescent Real Estate is a "domestically controlled REIT." A "domestically controlled REIT" is a REIT in which at all times during a specified testing period non-U.S. persons held, directly or indirectly, less than 50% in value of the stock. Crescent Real Estate anticipates that it will continue to be a "domestically controlled REIT." In addition, a non-U.S. shareholder that owns, actually or constructively, 5% or less of outstanding common shares at all times during a specified testing period will not incur tax under FIRPTA if the common shares are "regularly traded" on an established securities market. If neither of these exceptions were to apply, the gain on the sale of the common shares would be taxed under FIRPTA, in which case a non-U.S. shareholder would be taxed in the same manner as U.S. shareholders with respect to such gain (subject to applicable alternative minimum tax, a special alternative minimum tax in the case of nonresident alien individuals, and the possible application of the 30% branch profits tax in the case of non-U.S. corporations). A non-U.S. shareholder will incur tax on gain not subject to FIRPTA if (1) the gain is effectively connected with the non-U.S. shareholder's U.S. trade or business, in which case the non-U.S. shareholder will be subject to the same treatment as U.S. shareholders with respect to such gain, or (2) the non-U.S. shareholder is a nonresident alien individual who was present in the U.S. for 183 days or more during the taxable year, in which case the non-U.S. shareholder will incur a 30% tax on its capital gains. Capital gains dividends not subject to FIRPTA will be subject to similar rules. Backup Withholding Backup withholding tax (which generally is withholding tax imposed at the rate of 30%, gradually decreasing to 28% in 2006, on certain payments to persons that fail to furnish certain information under the United States information reporting requirements) and information reporting will generally not apply to distributions to a non-U.S. shareholder provided that the non-U.S. shareholder certifies under penalty of perjury that the shareholder is a non-U.S. shareholder, or otherwise establishes an exemption. As a general matter, backup withholding and information reporting will not apply to a payment of the proceeds of a sale of common shares effected at a foreign office of a foreign broker. Information reporting (but not backup withholding) will apply, however, to a payment of the proceeds of a sale of common shares by a foreign office of a broker that: - is a U.S. person; - derives 50% or more of its gross income for a specified three year period from the conduct of a trade or business in the U.S.; - is a "controlled foreign corporation" (generally, a foreign corporation controlled by U.S. shareholders) for U.S. tax purposes; or - that is a foreign partnership, if at any time during its tax year 50% or more of its income or capital interest are held by U.S. persons or if it is engaged in the conduct of a trade or business in the U.S., unless the broker has documentary evidence in its records that the holder or beneficial owner is a non-U.S. shareholder and certain other conditions are met, or the shareholder otherwise establishes an exemption. Payment of the proceeds of a sale of common shares effected at a U.S. office of a broker is subject to both backup withholding and information 125 reporting unless the shareholder certifies under penalty of perjury that the shareholder is a non-U.S. shareholder, or otherwise establishes an exemption. Backup withholding is not an additional tax. A non-U.S. shareholder may obtain a refund of excess amounts withheld under the backup withholding rules by filing the appropriate claim for refund with the IRS. STATE AND LOCAL TAX CONSEQUENCES Crescent Real Estate and/or you may be subject to state and local tax in various states and localities, including those states and localities in which Crescent Real Estate or you transact business, own property or reside. The state and local tax treatment in such jurisdictions may differ from the federal income tax treatment described above. Consequently, you should consult your own tax advisor regarding the effect of state and local tax laws upon an investment in Crescent Real Estate's securities. TAX ASPECTS OF CRESCENT REAL ESTATE'S INVESTMENT IN CRESCENT PARTNERSHIP AND SUBSIDIARY PARTNERSHIPS The following discussion summarizes certain federal income tax considerations applicable to Crescent Real Estate's direct or indirect investments in Crescent Partnership and its subsidiaries. The discussion does not cover state or local tax laws or any federal tax laws other than income tax laws. Classification as Partnerships Crescent Real Estate's tax counsel has opined, based on the provisions of Crescent Partnership Agreement and the partnership agreements and operating agreements of the various subsidiary partnerships, and certain factual assumptions and certain representations described in the opinion, that Crescent Partnership and the subsidiary partnerships will each be treated as a partnership and not an association taxable as a corporation for federal income tax purposes, and that Crescent Partnership will not be treated as a "publicly traded partnership" taxable as a corporation. Unlike a ruling from the Internal Revenue Service, however, an opinion of counsel is not binding on the Internal Revenue Service or the courts, and no assurance can be given that the Internal Revenue Service will not challenge the status of Crescent Partnership and its subsidiary partnerships as partnerships for federal income tax purposes. If for any reason Crescent Partnership were taxable as a corporation rather than as a partnership for federal income tax purposes, Crescent Real Estate would fail to qualify as a REIT because it would not be able to satisfy the income and asset requirements. See " -- Taxation of Crescent Real Estate," above. In addition, any change in Crescent Partnership's status for tax purposes might be treated as a taxable event, in which case Crescent Real Estate might incur a tax liability without any related cash distributions. See " -- Taxation of Crescent Real Estate," above. Further, items of income and deduction for Crescent Partnership would not pass through to the respective partners, and the partners would be treated as shareholders for tax purposes. Crescent Partnership would be required to pay income tax at regular corporate tax rates on its net income, and distributions to partners would constitute dividends that would not be deductible in computing Crescent Partnership's taxable income. Similarly, if any of the subsidiary partnerships were taxable as a corporation rather than as a partnership for federal income tax purposes, such treatment might cause Crescent Real Estate to fail to qualify as a REIT, and in any event such partnership's items of income and deduction would not pass through to its partners, and its net income would be subject to income tax at regular corporate rates. Income Taxation of Crescent Partnership and its Partners The partners of Crescent Partnership are subject to taxation. Crescent Partnership itself is not a taxable entity for federal income tax purposes. Rather, as a partner in Crescent Partnership, Crescent Real Estate is required to take into account its allocable share of Crescent Partnership's income, gains, losses, deductions and credits for any taxable year of Crescent Partnership ending during Crescent Real Estate's taxable year, without regard to whether Crescent Real Estate has received or will receive any distribution from Crescent Partnership. Crescent Partnership's income, gains, losses, deductions and credits for any taxable year will include its allocable share of such items from its subsidiary partnerships. 126 Partnership Allocations Although a partnership agreement generally will determine the allocation of income and losses among partners, such allocations will be disregarded for tax purposes if they do not comply with the provisions of section 704(b) of the Internal Revenue Code and the Treasury regulations promulgated thereunder. If an allocation is not recognized for federal income tax purposes, the item subject to the allocation will be reallocated in accordance with the partners' interests in the partnership, which will be determined by taking into account all of the facts and circumstances relating to the economic arrangement of the partners with respect to such item. Crescent Partnership's allocations of taxable income, gain and loss are intended to comply with the requirements of section 704(b) of the Internal Revenue Code and the Treasury regulations promulgated thereunder. Tax Allocations With Respect to Contributed Properties Pursuant to section 704(c) of the Internal Revenue Code, income, gain, loss and deduction attributable to appreciated or depreciated property that is contributed to a partnership in exchange for an interest in the partnership must be allocated in a manner such that the contributing partner is charged with, or benefits from, respectively, the unrealized gain or unrealized loss associated with the property at the time of the contribution. The amount of such unrealized gain or unrealized loss is generally equal to the difference between the fair market value of contributed property at the time of contribution and the adjusted tax basis of such property at the time of contribution (a "Book-Tax Difference"). Such allocations are solely for federal income tax purposes and do not affect the book capital accounts or other economic or legal arrangements among the partners. Crescent Partnership was formed by way of contributions of appreciated property and has received contributions of appreciated property since its formation. In general, the fair market value of the properties initially contributed to Crescent Partnership were substantially in excess of their adjusted tax bases. The Partnership Agreement requires that allocations attributable to each item of initially contributed property be made so as to allocate the tax depreciation available with respect to such property first to the partners other than the partner that contributed the property, to the extent of, and in proportion to, such partners' share of book depreciation, and then, if any tax depreciation remains, to the partner that contributed the property. Accordingly, the depreciation deductions allocable will not correspond exactly to the percentage interests of the partners. Upon the disposition of any item of initially contributed property, any gain attributable to an excess at such time of basis for book purposes over basis for tax purposes will be allocated for tax purposes to the contributing partner and, in addition, the Partnership Agreement provides that any remaining gain will be allocated for tax purposes to the contributing partners to the extent that tax depreciation previously allocated to the noncontributing partners was less than the book depreciation allocated to them. These allocations are intended to be consistent with section 704(c) of the Internal Revenue Code and with Treasury regulations thereunder. The tax treatment of properties contributed to Crescent Partnership subsequent to its formation is expected generally to be consistent with the foregoing. In general, the partners who contribute property to Crescent Partnership will be allocated depreciation deductions for tax purposes which are lower than such deductions would be if determined on a pro rata basis. In addition, in the event of the disposition of any of the contributed assets (including Crescent Real Estate's properties) which have a Book-Tax Difference, all income attributable to such Book-Tax Difference will generally be allocated to the contributing partners, including Crescent Real Estate, and each partner will generally be allocated only its share of capital gains attributable to appreciation, if any, occurring after the closing of any offering of securities hereunder. This will tend to eliminate the Book-Tax Difference over the life of Crescent Partnership. However, the special allocation rules of section 704(c) do not always entirely eliminate the Book-Tax Difference on an annual basis or with respect to a specific taxable transaction such as a sale. Thus, the carryover basis of the contributed assets in the hands Crescent Partnership will cause Crescent Real Estate to be allocated lower depreciation and other deductions, and possibly an amount of taxable income in the event of a sale of such contributed assets in excess of the economic or book income allocated to it as a result of such sale. This may cause Crescent Real Estate to recognize taxable income in excess of cash proceeds, which might adversely affect its ability to comply with the REIT distribution requirements. See " - Requirements for REIT Qualification - Distribution Requirements." The foregoing principles also apply in determining Crescent Real Estate's earnings and profits for purposes of determining the portion of distributions taxable 127 as dividend income. The application of these rules over time may result in a higher portion of distributions being taxed as dividends than would have occurred had Crescent Real Estate purchased the contributed assets at their agreed values. Sale of Crescent Partnership's Property Generally, any gain realized by Crescent Partnership on the sale of property held by it for more than one year will be long-term capital gain, except for any portion of such gain that is treated as depreciation or cost recovery recapture. Any gain recognized by Crescent Partnership on the disposition of contributed properties will be allocated first to its partners under section 704(c) of the Internal Revenue Code to the extent of their "built-in gain" on those properties for federal income tax purposes. The partners' "built-in gain" on the contributed properties sold will equal the excess of the partners' proportionate share of the book value of those properties over the partners' tax basis allocable to those properties at the time of the sale. Any remaining gain recognized by Crescent Partnership on the disposition of the contributed properties, and any gain recognized by Crescent Partnership on the disposition of the other properties, will be allocated among the partners in accordance with their respective percentage interests in Crescent Partnership. Crescent Real Estate's share of any gain realized by Crescent Partnership on the sale of any property held by Crescent Partnership as inventory or other property held primarily for sale to customers in the ordinary course of Crescent Partnership's trade or business will be treated as income from a prohibited transaction that is subject to a 100% penalty tax. Such prohibited transaction income also may have an adverse effect upon Crescent Real Estate's ability to satisfy the income tests for REIT status. See " - Requirements for REIT Qualification - Income Tests." Under existing law, whether property is held as inventory or primarily for sale to customers in the ordinary course of Crescent Partnership's business is a question of fact that depends on all the facts and circumstances with respect to the particular transaction. Crescent Partnership intends to hold its properties for investment with a view to long-term appreciation, to engage in the business of acquiring, developing, owning and operating the properties, and to make such occasional sales of properties as are consistent with these investment objectives. Taxation of the Residential Development Corporations and Other TRSs A portion of the amounts to be used to fund distributions to shareholders is expected to come from the residential development corporations and other TRSs through dividends on non-voting stock thereof held by Crescent Partnership and interest on the residential development property mortgages held by Crescent Partnership. The residential development corporations and other TRSs will pay federal, state and local income taxes on their taxable incomes at normal corporate rates, which taxes will reduce the cash available for distribution by Crescent Real Estate to its shareholders. Any federal, state or local income taxes that the residential development corporations and other TRSs are required to pay will reduce the cash available for distribution by Crescent Real Estate to its shareholders. DESCRIPTION OF CRESCENT OPERATING'S BUSINESS In February and March of 2002, Crescent Operating transferred to Crescent Real Estate, in lieu of foreclosure, the assets of its hospitality segment and, pursuant to a strict foreclosure, the interests in its land development segment pursuant to the terms of the Settlement Agreement described under "The Reorganization Transactions - Summary of the Reorganization Transactions." As a result, Crescent Operating no longer has operations in these two segments. In addition, on February 6, 2002, Crescent Machinery, through which Crescent Operating operates its equipment sales and leasing segment, filed for protection under the federal bankruptcy laws. OVERVIEW OF CRESCENT OPERATING Crescent Operating, Inc., a Delaware corporation, was formed on April 1, 1997, by Crescent Real Estate and its subsidiary Crescent Partnership. Effective June 12, 1997 Crescent Real Estate distributed shares of Crescent 128 Operating common stock to shareholders of Crescent Real Estate and unit holders of Crescent Partnership, and, on that date, Crescent Operating became a public company. Crescent Operating was formed to be the lessee and operator of certain assets owned or to be acquired by Crescent Real Estate that could not be operated directly or indirectly by Crescent Real Estate without jeopardizing its status as a REIT. On January 1, 2001, however, the REIT Modernization Act became effective. This legislation allows Crescent Real Estate, through its subsidiaries, to operate or lease certain of its investments that had been previously operated or leased by Crescent Operating. Crescent Operating's charter provides that one of its purposes is to perform the Intercompany Agreement between Crescent Operating and Crescent Partnership. Under the terms of the Intercompany Agreement, both parties agree to provide each other with rights to participate in certain transactions. In addition, Crescent Operating's charter prohibits Crescent Operating from engaging in activities or making investments that a REIT could make unless, in accordance with the terms of the Intercompany Agreement, Crescent Partnership was first given the opportunity but elected not to pursue such activities or investments. To facilitate the review, evaluation and negotiation of the terms of and making recommendations with respect to investment opportunities presented to Crescent Operating by Crescent Partnership, Crescent Operating established the Intercompany Evaluation Committee, which was composed entirely of directors of Crescent Operating who were not also officers or directors of Crescent Real Estate and Crescent Partnership. The scope of the committee eventually expanded to include analysis of all proposed transaction involving Crescent Real Estate or Crescent Partnership. Effective February 14, 2002, Crescent Operating entered into the Settlement Agreement with Crescent Real Estate. The Settlement Agreement provided for the cancellation of the Intercompany Agreement. Crescent Operating was intended to function principally as an operating company, in contrast to Crescent Real Estate's principal focus on investment in real estate assets. The operating activities and operating assets made available to Crescent Operating by Crescent Real Estate were designed to provide Crescent Real Estate's existing shareholders with the long-term benefits of ownership in an entity devoted to the conduct of operating business activities in addition to their investment interest in Crescent Real Estate. BUSINESS SEGMENTS Immediately prior to the asset transfers made pursuant to the Settlement Agreement on February 14, 2002, Crescent Operating, through various subsidiaries and affiliates, had assets and operations comprising four business segments: (i) equipment sales and leasing, (ii) hospitality, (iii) temperature-controlled logistics and (iv) land development. Within these segments Crescent Operating owned the following: - The equipment sales and leasing segment consisted of a 100% interest in Crescent Machinery and its subsidiary, a construction equipment sales, leasing and service company with 14 locations in four states. As of September 30, 2002, Crescent Machinery operated nine locations in three states. - The hospitality segment consisted of the following assets: - Crescent Operating's lessee interests in three upscale business class hotels owned by Crescent Real Estate. The hotels are the Denver Marriott City Center, the Hyatt Regency Albuquerque and the Renaissance Hotel in Houston, Texas; - Lessee interests in three destination resort properties owned by Crescent Real Estate. The properties are the Hyatt Regency Beaver Creek, the Ventana Inn and Spa, Sonoma Mission Inn and Spa (including the Sonoma Mission Inn golf and Country Club); - Lessee interests in two destination fitness resort and spa properties owned by Crescent Real Estate. The properties are Canyon Ranch-Tucson and Canyon Ranch-Lenox and; 129 - A 5% economic interest in CRL, which has an investment in the Canyon Ranch Day Spa in the Venetian Hotel in Las Vegas, Nevada and participates in the future use of the "Canyon Ranch" name. Crescent Real Estate owned the remaining 95% economic interest. - The temperature-controlled logistics segment consisted of a 40% interest in the operations of AmeriCold Logistics, which operates 100 refrigerated storage properties with an aggregate storage capacity of approximately 525 million cubic feet. Crescent Real Estate has a 40% interest in AmeriCold Corporation, which owned 89 of the 100 properties. - The land development segment consisted of the following assets: - A 4.65% economic interest in Desert Mountain, a master planned, luxury residential and recreational community in northern Scottsdale, Arizona. Crescent Real Estate owned an 88.35% economic interest in Desert Mountain; - A 52.5% general partner interest in The Woodlands Operating Company; - A 2.625% economic interest in The Woodlands Land Development Company L.P. Crescent Real Estate owned a 49.875% economic interest in this entity; and - A 60% general partner interest in COPI Colorado, a company that has a 10% economic interest in CRDI, formerly Crescent Development Management Corp. Crescent Real Estate owned the remaining 90% economic interest in CRDI. Equipment Sales and Leasing Crescent Machinery is engaged in the sale, leasing and service of construction equipment and accessories to the construction industry located primarily in three states as of September 30, 2002. Historically, construction equipment businesses have been owned and operated primarily by individuals in a localized area. Crescent Machinery has consolidated some of these businesses in order to gain improvements in purchasing and operating efficiencies. All of the Crescent Machinery locations represent major lines of equipment. This differentiates Crescent Machinery from some of its pure rent-to-rent competition. Crescent Machinery's locations offer new and used equipment for sale and rent, have factory trained service personnel, and provide parts and warranty service. Effective February 6, 2001, Crescent Operating, Crescent Machinery and SunTx entered into a Management Rights Agreement. Under the Management Agreement, Crescent Operating and Crescent Machinery engaged SunTx to provide general administrative and financial advice regarding all matters not otherwise reserved for the board of directors for Crescent Machinery for a fee of $1.0 million. This Management Agreement terminated December 31, 2001. Like many companies serving the construction industries, Crescent Machinery was affected in 2001 by multiple factors negatively impacting the industry. These factors include excess inventories of machines available for sale or rental, severe price competition, a slowdown in many construction markets, the reduction in the number of new projects, the general recessionary economy, and the continued negative effects following the terrorist attacks of September 11, 2001. Beginning in the second quarter of 2001, Crescent Machinery's business plan focused on right-sizing the business and creating liquidity. This plan included the reduction of operating costs and excess or underutilized assets. As of September 30, 2002, Crescent Machinery's net book value of its inventory and rental fleet was reduced by approximately $48.1 million and operating expenses have been reduced by $16.4 million since December 31, 2001. Crescent Machinery also closed its branches in Beaumont, Texas; Van Wert, Ohio; Franklin, Indiana; 130 Honolulu, Hawaii; Santa Rosa, California; Sacramento, California; Sparks, Nevada; Fresno, California; Tracy, California and Union City, California in 2002. Subsequent to September 30, 2002, Crescent Machinery closed its final West Coast location leaving it with eight branches in two states. As part of that business plan, Crescent Machinery continued reviewing key factors to its business, including the business mix between the sale of equipment and various rental and service programs; evaluating the suppliers Crescent Machinery used or may add in the future to maximize the equipment solutions Crescent Machinery offered its customers; standardizing best practices across all branch locations; and implementing new compensation programs that directly linked pay to performance. An essential part of Crescent Machinery's plan involved restructuring its existing lines of credit to provide debt service relief. Crescent Machinery defaulted on certain major loans from commercial institutions due to Crescent Machinery's decision not to pay the principal portion of payment installments due from September through December 2001 in the total amount of approximately $6.4 million. Outstanding principal amounts under default by Crescent Machinery totaled $42.9 million at September 30, 2002. Crescent Machinery's lenders did not exercise remedies available for Crescent Machinery's payment default. Crescent Machinery was unable to reach satisfactory agreements with other lenders, however, and on February 6, 2002, Crescent Machinery filed a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code with the U.S. Bankruptcy Court for the Northern District of Texas in Fort Worth, Texas. Crescent Machinery intends to continue its normal operations in the sale, rental and servicing of construction equipment, while attempting to reorganize and restructure its debt to emerge a financially stronger and more competitive business. Crescent Machinery plans to continue with business as usual during this process, but certain locations will be evaluated and may be sold or closed to improve efficiency. Crescent Machinery did reach an agreement with one of its lenders to take back the equipment it had financed and limit Crescent Machinery's exposure to shortfall on the sale of the equipment to $500,000. The lender further agreed to finance the $500,000 over three years at 1% over prime interest rate. Completion of the return of equipment under this agreement would eliminate approximately $11.5 million of indebtedness of Crescent Machinery. To that effect, Crescent Machinery has closed all of its locations outside of Texas and Oklahoma in 2002. In addition to its equity claim as the sole shareholder of Crescent Machinery, Crescent Operating is a creditor of Crescent Machinery, holding an unsecured $10.0 million principal amount note receivable from Crescent Machinery. Crescent Operating does not anticipate receiving a significant repayment, if any, of this note receivable in the Crescent Machinery bankruptcy case. Crescent Operating is unable to predict as of the date of the filing of this proxy statement/prospectus whether Crescent Machinery will be able to successfully reorganize its debt and operations, or what the treatment of creditors of Crescent Machinery and Crescent Operating, as the sole shareholder of Crescent Machinery and as a creditor, will be under any proposed plan of reorganization of Crescent Machinery. The payment rights and other entitlements of pre-petition creditors of Crescent Machinery, including Crescent Operating, and Crescent Operating, as Crescent Machinery's sole shareholder, may be substantially altered by any plan of reorganization confirmed by the bankruptcy court. Under a plan, pre-petition creditors may receive less than 100% of the face value of their claims, and the ownership interest of Crescent Operating in Crescent Machinery may be substantially diluted or cancelled in whole or in part. Crescent Machinery has filed schedules of assets and liabilities in its bankruptcy case. Those schedules indicate that virtually all of Crescent Machinery's assets are subject to lien claims of certain secured lenders. Moreover, the schedules indicate that the collateral securing the claims of these creditors has a value at or below the amount owed to the lenders. In fact, the only unencumbered assets owned by Crescent Machinery are several parcels of real estate that Crescent Machinery estimates to have a fair market value of approximately $3.0 million and miscellaneous inventory and accounts receivable of undetermined value. The value of the real estate will need to be first used to pay administrative expense claims in the bankruptcy case, after which it might be available for distribution to unsecured creditors. There are approximately $17.0 million of unsecured claims in the Crescent Machinery bankruptcy case. Crescent Operating expects the Crescent Machinery creditors to object to Crescent Operating receiving any distribution unless those creditors are paid in full. Although there can be no assurance as to the outcome of the Crescent Machinery bankruptcy case, Crescent Operating believes the prudent course is to estimate that it would not receive a material distribution in respect of either its unsecured note claim in the Crescent Machinery case or in 131 respect of its ownership of 100% of the Crescent Machinery common stock. There can be no assurance given that a plan of reorganization of Crescent Machinery will be approved by the creditors, or that the bankruptcy court will confirm any such plan. If a plan of reorganization is not confirmed by the bankruptcy court, there can be no assurance that Crescent Machinery will have sufficient funds to continue as a going concern, to restructure its debt on acceptable terms or continue its operations. If such a plan is not confirmed by the bankruptcy court, Crescent Machinery may be forced to liquidate its assets under Chapter 7 of the U.S. Bankruptcy Code and to cease operations, in which case it is unlikely that Crescent Operating would realize any significant value for its ownership interest in Crescent Machinery. Operational Information. The following tables set forth operational statistics for the eight remaining branch locations with continued operations on a same store basis for the three and nine months ended September 30, 2002 and for the years ended December 31, 1999 through December 31, 2001. THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ------------------- ------------------- 2002 2001 2002 2001 Revenue: New and used equipment ..... 30% 51% 37% 43% Rental equipment ........... 43% 32% 40% 37% Parts, service and supplies 27% 17% 23% 20% ---- ---- ---- ---- Total revenue ................ 100% 100% 100% 100% Expenses: Cost of sales: New and used equipment .... 91% 96% 89% 92% Rental equipment .......... 59% 67% 68% 67% Parts, service and supplies 60% 64% 61% 65% ---- ---- ---- ---- Total cost of sales .......... 69% 81% 74% 78% Gross profit ................. 31% 19% 26% 22% Operating expenses ........... 53% 26% 47% 26% ---- ---- ---- ---- Loss from operations ......... (22%) (7%) (21%) (3%) ==== ==== ==== ==== For The Year Ended December 31, -------------------------------- 2001 2000 1999 ---- ---- ---- Revenue: New and used equipment ..... 47% 47% 59% Rental equipment ........... 35% 34% 27% Parts, service and supplies 18% 19% 14% ---- ---- ---- Total revenue ................ 100% 100% 100% Expenses: Cost of sales: New and used equipment .... 93% 88% 83% Rental equipment .......... 69% 61% 47% Parts, service and supplies 64% 66% 85% ---- ---- ---- Total cost of sales .......... 80% 75% 73% Gross profit ................. 20% 25% 27% Operating expenses ........... 26% 23% 21% ---- ---- ---- Income (loss) from operations (5%) 2% 6% ==== ==== ==== 132 Net operating loss for continuing operations for the year ended December 31, 2001 was $15.9 million as compared with net operating income of $1.3 million for the year ended December 31, 2000. Equipment sales and leasing revenue decreased $24.9 million, or 48.9%, to $26.0 million for the nine months ended September 30, 2002, compared with $50.9 million for the nine months ended September 30, 2001. Net operating loss for the nine months ended September 30, 2002 was $3.3 million as compared with net operating loss of $1.6 million for the nine months ended September 30, 2001. Crescent Operating believes that the results for the nine months ended September 30, 2002 are not necessarily indicative of the operating results expected for the full year, due to the closing of its West Coast branches in 2002 and to the seasonality of the business. Under the agreement relating to Crescent Real Estate's planned investment in Crescent Machinery, which was terminated on February 4, 2002, Crescent Operating agreed upon a value for its investment in Crescent Machinery. Such agreed upon value served as an indicator to Crescent Operating that the potential existed for the impairment of certain assets as it relates to its current investment in Crescent Machinery. As required under Statement of Financial Accounting Standards No. 121, using all information available, Crescent Operating determined that certain assets within Crescent Machinery have carrying values which exceed the estimated undiscounted cash flows of those assets. As a result, Crescent Operating recorded an adjustment of $12.3 million and $26.9 million as "impairment loss on assets" in Crescent Operating's results from continuing operations and discontinued operations of closed branches, respectively, for the year ended December 31, 2001 related to Crescent Machinery. Crescent Operating will continue to evaluate the assets within Crescent Machinery for impairment and adjust such carrying values as necessary. Hospitality Effect of the Reorganization Transactions. In February 2002, in lieu of a foreclosure by Crescent Real Estate on the Crescent Operating hotel operations, Crescent Operating caused the lessees of these properties to transfer all of the leases, business contracts and licenses, furniture, fixtures and equipment, cash and intellectual property to Crescent Real Estate in exchange for cancellation of rental payments due to Crescent Real Estate with an aggregate value equal to the agreed upon value of the transferred assets, or $23.6 million. See "The Reorganization Transactions -- Summary of the Reorganization Transactions" for a description of these transfers. Overview. Prior to the February 2002 transfer of Crescent Operating's hotel operations to Crescent Partnership, the hospitality segment generally consisted of the hotel operations. Each of such properties were owned by Crescent Partnership or its affiliates and all were leased to subsidiaries of Crescent Operating under long term leases. In addition to these properties, Crescent Operating also had other investments in CRL. The hotel operations were comprised of unique luxury resorts, business and convention hotels and destination health and fitness resorts and made up a small portion of the hospitality industry. Because Crescent Operating, for the most part, relied on third-party operators such as Marriott and Hyatt, Crescent Operating enjoyed the advantage of the third-party operators' nationwide advertising, reservation services and strong management. 133 Each of the hotel operations was under lease with Crescent Real Estate, with terms expiring from December 2004 to June 2009 and generally providing for (i) base rent, with periodic rent increases, (ii) percentage rent based on a percentage of gross hotel revenues less food and beverage revenues above a specified amount and (iii) a percentage of gross food and beverage revenues above a specified amount. Under the leases, Crescent Operating's subsidiaries had assumed the rights and obligations of the property owner under the respective management agreement with the hotel operators, including the property management agreements with Sonoma Management Company for Sonoma Mission Inn and Spa, Sonoma Mission Inn Golf and Country Club and Ventana Inn and Spa, as well as the obligation to pay all property taxes and other charges against the property. As part of each of the lease agreements for eight of the hotel operations, Crescent Real Estate had agreed to fund all capital expenditures relating to furniture, fixtures and equipment reserves required under the applicable management agreements. The only exception was Canyon Ranch-Tucson, in which instance Crescent Operating owned all furniture, fixtures and equipment associated with the property and funded all related capital expenditures. With the permission of Crescent Real Estate, Crescent Operating had deferred payment of rent on the hotel operations. Rent expense accrued but deferred as of December 31, 2001 was $41.2 million. All of Crescent Operating's hotel operations, except for the Sonoma Mission Inn and Spa, Sonoma Mission Inn Golf and Country Club and the Ventana Inn and Spa, were managed by third party operators. Crescent Operating and its hospitality subsidiaries had a Master Asset Management and Administrative Services Agreement with Sonoma Management to manage the Hyatt Albuquerque, the Renaissance Hotel Houston and the Denver City Center Marriott. In addition, Crescent Operating's hospitality subsidiaries had accepted assignment from the owners of the Sonoma Mission Inn and Spa, the Sonoma Mission Inn Golf and Country Club and the Ventana Inn and Spa of its property management agreements with Sonoma Management. The principals of Sonoma Management are Sanjay and Johanna Varma and Crescent Real Estate is an equity owner in Sonoma Management. Payment of obligations under the Master Asset Management and Administrative Services Agreement was guaranteed by Crescent Operating. For each property for which it provided asset management services, Sonoma Management was receive a base fee equal to 0.85% of gross revenues of the property managed plus an incentive fee of 50% of actual net income in excess of budgeted net income. For each property for which it provided property management services, Sonoma Management was entitled to receive a base fee equal to 2.0% of gross revenues of the property plus an incentive fee of 20% of net operating income in excess of a 12% annual return on investment to owner. As consideration for its services under the Master Asset Management and Administrative Services Agreement, Sonoma Management received an annual base fee (and no incentive fee) for 2001 of approximately $0.6 million, for its asset management services related to the Hyatt Albuquerque, the Renaissance Houston Hotel and the Denver City Center Marriott. Crescent Operating had limited the potential impact of downturns in the hospitality industry on Crescent Operating by limiting its guarantee of the rent payment obligations of its hospitality segment subsidiaries. Crescent Operating's guarantee related to rent payments was limited to cash generated by the hospitality segment, i.e. cash flows from segments other than hospitality would not be used to fund rent payments in the event cash flows of the hotel operations were less than scheduled rent payments. The individual hotel operations were affected by seasonality; however, the seasonal fluctuations are varied and are determined by both location and the nature of the business conducted on the property. The effects of seasonality of the hotel operations are generally offsetting; however, March and October have the greatest positive impact and November through January have the greatest negative impact on Crescent Operating's consolidated results. The hotel operations in Denver and Albuquerque are business and convention center hotels that compete against other similar hotels in their markets. Crescent Operating believes, however, that its destination health and fitness resorts are unique properties that have very limited competition. In addition, Crescent Operating believes that the other hotel operations experience limited or no direct competition due to their high replacement costs and unique 134 concepts or locations. The hotel operations do compete, to a limited extent, against business class hotels or middle-market resorts in their geographic areas, as well as against luxury resorts nationwide and around the world. Crescent Operating had a 5% economic interest, representing all of the voting stock, in CRL. CRL has a 30% interest in CR License. CR License is the entity which owns the rights to the future use of the "Canyon Ranch" name. CRL also has an approximate 65% economic interest in the Canyon Ranch Spa Club located in the Venetian Hotel in Las Vegas. Operational Information. The following table sets forth certain information about the hotel operations, excluding the Sonoma Mission Inn Golf and Country Club, Houston Center Athletic Club, or HCAC, CRL and the Four Seasons in Houston for the years ended December 31, 2001 and 2000. As Crescent Operating only operated this segment for one and one-half months in 2002, there is no information for the three and nine months ended September 30, 2002. The information below is based on available rooms, except for Canyon Ranch-Tucson and Canyon Ranch-Lenox, which are destination health and fitness resorts that measure performance based on available guest nights. For the Year Ended December 31, ----------------------------------------------------- Average Average Revenue Occupancy Daily Per Rate Rate Available Room Lease ------------- -------------- -------------- Location Expiration Rooms 2001 2000 2001 2000 2001 2000 -------- ---------- ----- ---- ---- ---- ---- ---- ---- Upscale Business Class Hotels: Denver Marriott City Center.. Denver, CO June 2005 613 77% 84% $123 $120 $ 95 $101 Hyatt Regency Albuquerque.... Albuquerque, NM December 2005 395 69 69 108 106 74 73 Renaissance Houston.......... Houston, TX June 2009 389 64 59 113 95 73 56 ------ --- --- ---- ---- ---- ---- Total/Weighted Average 1,397 71% 73% $116 $111 $ 83 $ 80 ====== === === ==== ==== ==== ==== Luxury Resorts and Spas: Hyatt Regency Beaver Avon, CO December 2004 276 57% 69% $278 $254 $159 $176 Creek(1)..................... Sonoma Mission Inn & Spa..... Sonoma, CA October 2006 228(2) 59 75 299 302 176 226 Ventana Inn & Spa............ Big Sur, CA December 2007 62 73 78 420 458 304 358 ------ --- --- ---- ---- ---- ---- Total/Weighted Average 566 60% 72% $305 $298 $182 $216 ====== === === ==== ==== ==== ==== Guest Nights ------ Destination Fitness Resorts and Spas: Canyon Ranch-Tucson.......... Tucson, AZ July 2006 250(3) Canyon Ranch-Lenox........... Lenox, MA December 2006 212(3) ------ --- --- ---- ---- ---- ---- Total/Weighted Average 462 81%(4) 86%(4) $469(5) $442(5) $318(6) $340(6) ====== === === ==== ==== ==== ==== Grand Total/Weighted Average 71% 75% $263 $256 $183 $191 ====== === === ==== ==== ==== ==== (1) The hotel is undergoing $6.9 million renovation of all guest rooms. The project is scheduled to be completed by the second quarter of 2002. (2) In January 2000, 20 rooms, which were previously taken out of commission for construction of a 30,000 square foot full-service spa in connection with an approximately $21.0 million expansion of the hotel, were returned to service. The expansion was completed in the second quarter of 2000. The expansion also included 30 additional guest rooms. Rates were discounted during the construction period, which resulted in a lower average daily rate and revenue per available room for the year ended December 31, 1999, as compared to December 31, 2000. (3) Represents available guest nights, which is the maximum number of guests that the resort can accommodate per night. (4) Represents the number of paying and complimentary guests for the period, divided by the maximum number of available guest nights for the period. (5) Represents the average daily "all-inclusive" guest package charges for the period, divided by the average daily number of paying guests for the period. (6) Represents the total "all-inclusive" guest package charges for the period, divided by the maximum number of available guest nights for the period. 135 Temperature-Controlled Logistics Effect of the Reorganization Transactions On February 14, 2002, Crescent Operating agreed in the Settlement Agreement that a Crescent Real Estate subsidiary, Crescent Spinco, upon the effectiveness of its registration statement, will distribute its shares to the holders of Crescent Real Estate common shares and the unitholders of Crescent Partnership and will purchase Crescent Operating's entire membership interest in COPI Cold Storage for between $15.0 million to $15.5 million. It is anticipated that the interest in AmeriCold Logistics will be transferred in 2003. The proceeds are intended to payoff the Bank of America loan for which Crescent Operating's 40% interest in AmeriCold Logistics serves as collateral. The distribution of the Crescent Spinco shares will be made to the holders of Crescent Real Estate common shares prior to the issuance of Crescent Real Estate common shares to the Crescent Operating stockholders. As a result, the holders of Crescent Operating common stock will not receive any interest in Crescent Spinco. Overview In October 1997, the Crescent/Vornado REIT partnership, in which Vornado Realty Trust has a 60% interest and Crescent Real Estate has a 40% interest, acquired each of AmeriCold Corporation and URS Logistics, Inc. The Crescent/Vornado REIT partnership acquired the assets of Freezer Services, Inc. in June 1998 and acquired the Carmar Group in July 1998. In March 1999, a new partnership doing business under the name AmeriCold Logistics was formed. Crescent Operating, through its wholly owned subsidiary COPI Cold Storage, has a 40% general partnership interest in AmeriCold Logistics and Vornado Operating has the remaining 60% general partnership interest. Immediately following its formation, AmeriCold Logistics purchased all of the non-real estate assets of the Crescent/Vornado REIT partnership for $48.7 million. AmeriCold Logistics then leased the real estate assets of the Crescent/Vornado REIT partnership from that entity and continued to operate the temperature-controlled warehouse business that was created by consolidating the businesses of AmeriCold Corporation, URS Logistics, Freezer Services and the Carmar Group. AmeriCold Logistics currently leases 89 temperature controlled warehouses from the Crescent/Vornado REIT partnership, which continues to own the real estate, and manages 11 additional warehouses. AmeriCold Logistics provides the frozen food industry with refrigerated warehousing and transportation management services. As of the date of this proxy statement/prospectus, Crescent Operating continues to own and conduct its temperature-controlled logistics operations through its wholly owned subsidiary, COPI Cold Storage. The temperature-controlled logistics segment consists of a 40% interest in the operations of AmeriCold Logistics. AmeriCold Logistics, headquartered in Atlanta, Georgia, has 5,900 employees and operates 101 temperature controlled storage facilities nationwide with an aggregate of approximately 538 million cubic feet of refrigerated, frozen and dry storage space. Of the 101 warehouses, AmeriCold Logistics leases 88 temperature controlled facilities with an aggregate of approximately 442 million cubic feet from the temperature-controlled logistics partnerships, and manages 13 additional facilities containing approximately 96 million cubic feet of space. AmeriCold Logistics provides the frozen food industry with refrigerated storage and transportation management services. AmeriCold Logistics leases 88 refrigerated storage facilities used in its business. The leases, as amended, which commenced in March 1999, generally have a 15-year term with two five-year renewal options and provide for the payment of fixed base rent and percentage rent based on revenues AmeriCold Logistics receives from its customers. Fixed base rent was approximately $136.0 million in 2000 and was and will be approximately $137.0 million per annum from 2001 through 2003, $139.0 million per annum from 2004 through 2008 and $141.0 million per annum from 2009 through February 28, 2014. Percentage rent for each lease is based on a specified percentage of revenues in excess of a specified base amount. The aggregate base revenue amount under five of the six leases is approximately $350.0 million and the weighted average percentage rate is approximately 36% through 2003, approximately 38% for the period from 2004 through 2008 and approximately 40% for the period from 2009 through February 28, 2014. The aggregate base revenue amount under the sixth lease is approximately $32.0 million through 2001, and approximately $26.0 million for the period from 2002 through February 28, 2014, and the percentage rate is 24% through 2001, 37.5% for the period from 2002 through 2006, 40% from 2007 through 2011 and 41% from 2012 through February 28, 2014. AmeriCold Logistics recognized $156.3 million and $170.6 million of rent expense for the year ended December 31, 2001 and December 31, 2000, respectively, which includes, effects of straight-lining, rent to 136 parties other than the landlord and is before the waiver of rent discussed below. AmeriCold Logistics is required to pay for all costs arising from the operation, maintenance and repair of the properties, including all real estate taxes and assessments, utility charges, permit fees and insurance premiums, as well as property capital expenditures in excess of $9.5 million annually. AmeriCold Logistics has the right to defer the payment of 15% of the fixed base rent and all percentage rent for up to three years beginning on March 11, 1999 to the extent that available cash, as defined in the leases, is insufficient to pay such rent. AmeriCold Logistics deferred $25.5 million of rent payments for the period ending December 31, 2001 and $19.0 million for the period ending December 31, 2000. On February 22, 2001, the AmeriCold Logistics leases were restructured to, among other things, (i) reduce 2001's contractual rent to $146.0 million ($14.5 million less than 2000's contractual rent), (ii) reduce 2002's contractual rent to $150.0 million, plus contingent rent in certain circumstances, (iii) increase the Landlord's share of annual maintenance capital expenditures by $4.5 million to $9.5 million effective January 1, 2000 and (iv) extend the deferred rent period to December 31, 2003 from March 11, 2002. In the fourth quarter ended December 31, 2001, AmeriCold Logistics reversed $25.5 million of the rent expense recorded for 2001 resulting from temperature-controlled logistics partnerships waiving of its rights to collect this portion of the rent. Further, temperature-controlled logistics partnerships waived $14.3 million of the rent expense recorded by AmeriCold Logistics for 2000 which AmeriCold Logistics recorded as income in the fourth quarter ended December 31, 2001. The aggregate amount waived by the landlord of $39.8 million represents a portion of the rent due under the leases which AmeriCold Logistics deferred in such years. Under the terms of the partnership agreement for AmeriCold Logistics, Vornado Operating has the right to make all decisions relating to the management and operations of AmeriCold Logistics other than certain major decisions that require the approval of both Crescent Operating and Vornado Operating. Vornado Operating must obtain Crescent Operating's approval for specified matters involving AmeriCold Logistics, including approval of the annual budget, requiring specified capital contributions, entering into specified new leases or amending existing leases, selling or acquiring specified assets and any sale, liquidation or merger of AmeriCold Logistics. If the partners fail to reach an agreement on such matters during the period from November 1, 2000 through October 30, 2007, Vornado Operating may set a price at which it commits to either buy Crescent Operating's investment, or sell its own, and Crescent Operating will decide whether to buy or sell at that price. If the partners fail to reach agreement on such matters after October 30, 2007, either party may set a price at which it commits to either buy the other party's investment, or sell its own, and the other party will decide whether to buy or sell at that price. Neither partner may transfer its rights or interest in the partnership without the consent of the other partner. Vornado Operating has consented to Crescent Operating's transfer of its membership interest in COPI Cold Storage, and thus Crescent Operating's general partnership interest in AmeriCold Logistics, to a subsidiary of Crescent Real Estate. The partnership will continue for a term through October 30, 2027, except as the partners may otherwise agree. As of December 31, 2001, Crescent Operating had not contributed its 40% portion of a total $10.0 million expected contribution to AmeriCold Logistics. Accordingly, AmeriCold Logistics cancelled its $4.0 million contribution receivable in partners capital on December 31, 2001. In the first quarter of 2002, Vornado Operating's previous contribution of $6.0 million, representing its 60% match of the $10.0 million total expected contribution, was reclassified as a special equity contribution that: (i) has priority over the original equity amounts, with voting rights of the partner not effected, (ii) is redeemable only at AmeriCold Logistics' option, and (iii) accrues interest at 12% compounded annually from March 7, 2000. The partner's ownership remains at 60%. In addition, during 2001, AmeriCold Logistics recorded a charge of $8.9 million comprised of (i) severance and relocation costs associated with a management restructuring and (ii) expenses arising from the consolidation of a portion of the corporate office in Portland, Oregon into AmeriCold Logistics Atlanta headquarters. On May 1, 2001, Alec C. Covington became the President and Chief Executive Officer of AmeriCold Logistics. Mr. Covington succeeded Daniel F. McNamara who continues as Vice Chairman until May, 2002. Mr. 137 Covington, age 45, was formerly an Executive Vice President of SUPERVALU Inc. (NYSE:SVU) and President and Chief Operating Officer of the SUPERVALU food distribution companies division, which is the nation's largest distributor to grocery retailers having $17.0 billion of revenue and 34 distribution centers. Previously, Mr. Covington was the President and Chief Operating Officer of the wholesale division of Richfood Holdings, Inc. when it was acquired by SUPERVALU in the fall of 1999. He has more than 25 years of wholesale, retail and supply-chain management experience in the food industry. On October 22, 2001, Jonathan C. Daiker joined AmeriCold Logistics as Chief Financial Officer. Most recently, Mr. Daiker served for five years as Executive Vice President and Chief Financial Officer of the Simmons Company, a manufacturer and distributor of mattresses. Prior thereto, from 1981-1995, he held subsidiary and unit Chief Financial Officer positions with Phillips Electronics N.V., a multibillion dollar consumer electronics company. Mr. Daiker, a CPA, began his career with Price Waterhouse & Company. AmeriCold Logistics is experiencing cash flow deficits which its management is currently addressing through sales of non-core assets. Recent Developments On December 31, 2002, AmeriCold Logistics sold its interests in its Carthage, Missouri and Kansas City, Kansas quarries to a joint venture owned 56% by Crescent Real Estate Equities Company and 44% by Vornado Realty Trust for approximately $20 million. AmeriCold Logistics will continue to manage these assets on behalf of the new owners. On November 5, 2002, AmeriCold Logistics issued a $6.0 million note to Vornado Operating, effective March 11, 2002, in exchange for Vornado Operating's $6.0 million special equity contribution. Certain of AmeriCold Logistics' trade receivables collateralize the loan. The loan bears interest of 12% and requires monthly interest payments until maturity on December 31, 2004. On January 23, 2002, the leases with the temperature-controlled logistics partnerships were restructured to consolidate four of the non-encumbered leases into one non-encumbered lease. The restructuring did not affect total contractual rent due under the combined leases. During the first and second quarters of 2002, AmeriCold Logistics exercised its right, pursuant to the terms of its leases, to defer payment of rent. As of September 30, 2002, AmeriCold Logistics had deferred $20.6 million of rent for 2002, bringing the total deferred rent to $30.7 million. For the years ended December 31, 2001 and December 31, 2000, AmeriCold Logistics had exercised its right, pursuant to the terms of its leases with the landlord, to defer payment of $25.5 million and $19.0 million of rent, respectively, of which Crescent Operating's share was $10.2 million and $7.6 million, respectively. Effective December 31, 2001, Crescent Operating, in connection with extending the maturity of its $15.0 million loan from Bank of America from December 31, 2001 to August 15, 2002, agreed to modify the loan from an unsecured to a secured credit facility. On August 14, 2002, Bank of America further extended the maturity of this loan to January 15, 2003 and Crescent Operating prepaid the interest for that time period in the amount of $0.3 million. Crescent Operating, with the consent of Crescent Partnership which agreed to subordinate its security interest in Crescent Operating's 40% interest in AmeriCold Logistics, pledged all of its interest in AmeriCold Logistics to Bank of America to secure the loan. In January 2003, Bank of America further extended the maturity of this loan to March 15, 2003 and Crescent Operating agreed to prepay an additional two months of interest at the loan's current rate. Operational Information As of the date of this proxy statement/prospectus, Crescent Operating continues to hold a 40% economic interest in AmeriCold Logistics. Crescent Operating's share of pretax loss from AmeriCold Logistics for the year ended December 31, 2001 was $2.3 million. AmeriCold Logistics is experiencing cash flow deficits which management of AmeriCold Logistics is currently addressing through sales of non-core assets. Crescent Operating has written off its entire investment in AmeriCold Logistics and does not anticipate recognizing any additional AmeriCold Logistics losses for accounting purposes. 138 The following table shows the location and size of facility for each of the properties operated by AmeriCold Logistics as of September 30, 2002: Total Cubic Total Cubic Number of Footage Number of Footage State Properties (in millions) State Properties (in millions) ----- ---------- ------------- ----- ---------- ------------- Alabama 5 10.8 Missouri(1) 2 46.8 Arizona 1 2.9 Nebraska 2 4.4 Arkansas 6 33.1 New York 1 11.8 California 11 47.1 North Carolina 3 10.0 Colorado 1 2.8 Ohio 1 5.5 Florida 5 6.5 Oklahoma 2 2.1 Georgia 8 49.5 Oregon 6 40.4 Idaho 2 18.7 Pennsylvania 4 50.8 Illinois 2 11.6 South Carolina 1 1.6 Indiana 1 9.1 South Dakota 2 6.3 Iowa 2 12.5 Tennessee 3 10.6 Kansas 2 5.0 Texas 5 39.1 Kentucky 1 2.7 Utah 1 8.6 Maine 1 1.8 Virginia 3 13.8 Massachusetts 5 10.5 Washington 6 28.7 Minnesota 1 5.9 Wisconsin 3 17.4 Mississippi 1 4.7 Canada 1 4.8 --- ----- Total 101 537.9 === ===== (1) Includes one underground facility of approximately 33.1 million cubic feet. Market Information. AmeriCold Logistics provides frozen food manufacturers with refrigerated warehousing and transportation management services. The temperature-controlled logistics properties consist of production and distribution facilities. Production facilities differ from distribution facilities in that they typically serve one or a small number of customers located nearby. These customers store large quantities of processed or partially processed products in the facility until they are further processed or shipped to the next stage of production or distribution. Distribution facilities primarily serve customers who store a wide variety of finished products to support shipment to end-users, such as food retailers and food service companies, in a specific geographic market. Transportation management services include freight routing, dispatching, freight rate negotiation, backhaul coordination, freight bill auditing, network flow management, order consolidation and distribution channel assessment. AmeriCold Logistics' temperature-controlled logistics expertise and access to both the frozen food warehouses and distribution channels enable the customers of AmeriCold Logistics to respond quickly and efficiently to time-sensitive orders from distributors and retailers. Customers consist primarily of national, regional and local frozen food manufacturers, distributors, retailers and food service organizations, including H.J. Heinz & Co., ConAgra, Inc., Sara Lee Corp., Tyson Foods, Inc. and McCain Foods, Inc. Consolidation among retail and food service channels has limited the ability of manufacturers to pass along cost increases by raising prices. Because of this, manufacturers have been forced in the recent past to focus more intensely on supply chain cost, such as inventory management, transportation and distribution, reduction initiatives in an effort to improve operating performance. AmeriCold Logistics is the largest operator of public refrigerated warehouse space in the country. AmeriCold Logistics operated an aggregate of approximately 18% of total public refrigerated warehouse space as of December 31, 2001. No other person or entity operated more than 8% of total public refrigerated warehouse space as of December 31, 2001. As a result, AmeriCold Logistics does not have any competitors of comparable size. AmeriCold Logistics operates in an environment in which competition is national, regional and local in nature and in which the range of service, temperature-controlled logistics facilities, customer mix, service performance and price are the principal competitive factors. 139 Land Development Effect of the Reorganization Transactions. In February 2002, a subsidiary of Crescent Real Estate acquired, through a strict foreclosure under the terms of the Settlement Agreement, Crescent Operating's land development entities other than The Woodlands Operating Company. Crescent Operating's interest in The Woodlands Operating Company was subsequently acquired, through a strict foreclosure under the terms of the Settlement Agreement, by a subsidiary of Crescent Real Estate in March 2002. See "The Reorganization Transactions - Summary of the Reorganization Transactions" for a description of this acquisition by strict foreclosure. Overview. Prior to the transfer of Crescent Operating's land development interests to Crescent Partnership in February and March 2002 pursuant to the Settlement Agreement, the land development segment consisted primarily of: - a 4.65% economic interest in Desert Mountain, a master planned, luxury residential and recreational community in northern Scottsdale, Arizona; - a 52.5% general partner interest in The Woodlands Operating Company, which provided management, advisory, landscaping and maintenance services to The Woodlands, Texas, an approximately 27,000 acre master-planned residential and commercial community, and was the lessee of The Woodlands Resort and Conference Center; - a 2.625% economic interest in The Woodlands Land Development Company, which owned approximately 6,600 acres for commercial and residential development as well as a realty office, an athletic center, and interests in both a title company and a mortgage company; and - a 60% economic interest in COPI Colorado, an entity that had a 10% economic interest in CRDI, formerly CDMC, which invests in entities that develop or manage residential and resort properties (primarily in Colorado) and provides support services to such properties. The land development segment competed against a variety of other housing alternatives including other planned developments, pre-existing single-family homes, condominiums, townhouses and non-owner occupied housing, such as luxury apartments. Desert Mountain. Desert Mountain is a master planned, mixed use residential and recreational community located in northern Scottsdale, Arizona. The property consists of 8,000 acres of land located in the high Sonoran Desert that is zoned for the development of approximately 4,500 lots. Desert Mountain includes The Desert Mountain Club, a private golf, tennis and fitness club which serves over 2,300 members and offers five Jack Nicklaus signature 18-hole golf courses and four clubhouses. One of these courses is Cochise, the site of the Senior PGA Tour's The Tradition golf tournament. Lyle Anderson, the original developer of Desert Mountain, provides advisory services in connection with the operation and development of Desert Mountain. Pursuant to the terms of a limited partnership agreement, Desert Mountain Development is entitled to receive 93% of the net cash flow of Desert Mountain after certain payments to the sole limited partner, Sonora Partners Mountain Partnership which owns the remaining 7% interest, have been made. 140 The Woodlands Operating Company. The Woodlands, is an approximately 27,000-acre master-planned residential and commercial community located approximately 27 miles north of Houston, Texas, unique among developments in the Houston area because it functions as a self-contained community. Amenities contained in the development, which are not contained within other local developments, include a shopping mall, retail centers, office buildings, a hospital, a community college, places of worship, a conference center, 60 parks, 81 holes of golf, two man made lakes, a riverwalk and a performing arts pavilion. The Woodlands Operating Company was formed to provide management, advisory, landscaping and maintenance services to entities affiliated with Crescent Operating and Crescent Real Estate as well as to third parties. Pursuant to the terms of service agreements, The Woodlands Operating Company performed general management, landscaping and maintenance, construction, design, sales, promotional and other marketing services for certain properties in which Crescent Real Estate owns a direct or indirect interest. In addition, The Woodlands Operating Company monitored certain of the real estate investments of, and provides advice regarding real estate and development issues to, such entities. As compensation for its management and advisory services, The Woodlands Operating Company was paid a monthly advisory fee on a cost-plus basis. As compensation for its landscaping and maintenance services, The Woodlands Operating Company received a monthly fee on a cost-plus basis related to performing the required landscaping and maintenance services. The Woodlands Operating Company also leased The Woodlands Conference Center and Country Club, an executive conference center with a private golf and tennis club and certain related assets from The Woodlands Commercial Properties Company, L.P., a partnership, the interests of which are owned by Crescent Real Estate and certain Morgan Stanley Group funds. The Woodlands Operating Company leased The Woodlands Conference Center and Country Club on a triple net basis, with base rent in the amount of $0.75 million per month during the eight-year term of the lease. The lease also provides for the payment of percentage rent for each calendar year in which gross receipts from the operation of The Woodlands Conference Center and Country Club exceed certain amounts. The Woodlands Operating Company partnership agreement provided that distributions be made to partners in accordance with specified payout percentages subject to change based upon whether certain established cumulative preferred returns were earned. As cumulative preferred returns reach certain thresholds, distributions to Crescent Operating from The Woodlands Operating Company increased from 42.5% to 49.5% and then from 49.5% to 52.5%. Beginning in 2000, both the 42.5% and the 49.5% thresholds were met by The Woodlands Operating Company; therefore, the payout percentage to Crescent Operating increased to 52.5%. On March 22, 2002, a subsidiary of Crescent Real Estate acquired, through a strict foreclosure which was agreed upon under the terms of the Settlement Agreement, Crescent Operating's interest in The Woodlands Operating Company, giving Crescent Real Estate an indirect 52.5% general partnership interest in The Woodlands Operating Company. Prior to this transfer, neither Crescent Real Estate or its affiliates owned any interest in The Woodlands Operating Company. The Woodlands Land Company, Inc. Crescent Operating owned all of the voting stock, representing a 5% economic interest, of The Woodlands Land Company, a residential and commercial development corporation which was formerly wholly owned by Crescent Partnership, prior to the original Settlement Agreement on February 14, 2002. The Woodland's Land Company holds a 52.5% general partner interest in, and is the managing general partner of, The Woodlands Land Development Company, a Texas limited partnership in which certain Morgan Stanley funds hold a 47.5% limited partner interest. The Woodlands Land Development Company primarily owns (i) approximately 4,900 acres of land capable of supporting the development of more than 13,100 lots for single-family homes, (ii) approximately 1,700 acres capable of supporting more than 13.3 million net rentable square feet of commercial development, (iii) a realty office, (iv) contract rights relating to the operation of its property, (v) an athletic center and (vi) a 50% interest in a title company. 141 The Woodlands Land Development Company partnership agreement provided that distributions be made to partners in accordance with specified payout percentages subject to change based upon whether certain established cumulative preferred returns were earned. As cumulative preferred returns reach certain thresholds, distributions to The Woodlands Land Company from The Woodlands Land Development Company increase from 42.5% to 49.5% and then from 49.5% to 52.5%. In 2001, the 42.5% and 49.5% thresholds were met; therefore, the payout percentage to Crescent Operating increased to 2.625%. Crescent Resort Development, Inc. (formerly Crescent Development Management Corp.). CRDI's investments included direct and indirect economic interests that vary from 25% to 64% consisting primarily of the following: (i) six residential and commercial developments and eleven residential developments in Colorado, South Carolina and California; (ii) a timeshare development in Colorado; (iii) two transportation companies providing approximately 80% of the airport shuttle service to Colorado resort areas; (iv) two private clubs consisting of various recreational and social amenities in Colorado and California; and (v) an interest in a partnership owning an interest in the Ritz Carlton Hotel in Palm Beach, Florida. Until December 2000, CRDI had an indirect economic interest in a real estate company specializing in the management of resort properties in Colorado, Utah, South Carolina and Montana. That investment was transferred to CDMC II, a newly formed entity having the same owners, board of directors and officers as CRDI. In connection with that transfer, CDMC II assumed the indebtedness of CRDI incurred in connection with that investment, all of which is owed to Crescent Partnership. Effective March 30, 2001, CDMC II sold that investment - a membership interest in East West Resorts, LLC - to a company affiliated with the other owner of East-West Resorts, for cash and a secured promissory note. CDMC II immediately transferred the cash and note to Transportal Investment Corp. in exchange for its assumption of all of its indebtedness and dissolved. Crescent Operating owned 1%, and Crescent Partnership owned 99%, of Transportal Investment Corp., which owns an interest in Transportal Network, LLC. Transportal Network is an abandoned venture that had been planned to provide routing and load management services and facilitate related purchases over the internet to independent truckers, shippers and receivers. Transportal Network ceased operations in October 2000. Effective September 11, 1998, Crescent Operating and Gerald W. Haddock, John C. Goff and Harry H. Frampton, III entered into a partnership agreement to form COPI Colorado. COPI Colorado was formed for the purpose of holding and managing the voting stock of CRDI (and, consequently, to manage CRDI) and investing in shares of Crescent Operating common stock. In September, 1998, Crescent Operating contributed to COPI Colorado $9.0 million in cash in exchange for a 50% general partner interest in COPI Colorado, and each of Mr. Haddock, Mr. Goff and Mr. Frampton contributed to COPI Colorado approximately 667 shares of CRDI voting stock, which each of Mr. Haddock, Mr. Goff and Mr. Frampton owned individually, in exchange for an approximately 16.67% limited partner interest in COPI Colorado; as a result and until January 2000, Crescent Operating owned a 50% managing interest in COPI Colorado and Mr. Haddock, Mr. Goff and Mr. Frampton collectively owned a 50% investment interest in COPI Colorado. Mr. Haddock assigned his 16.67% limited partner interest to COPI Colorado effective January 2000, causing the Crescent Operating's general partner interest to increase from 50% to 60%. In forming COPI Colorado, Crescent Operating was able to obtain ownership of CRDI while investing a portion of the cash otherwise payable to the former owners of CRDI, two of whom were executive officers of Crescent Operating at the time, in COPI Colorado, which used the cash to acquire shares of Crescent Operating common stock. COPI Colorado has purchased approximately 1.1 million shares of Crescent Operating common stock at a total purchase price of $4.3 million. The average price paid for such shares, excluding brokers' commissions, was $3.88 per share. COPI Colorado has not purchased shares of Crescent Operating since August 1999. Recent Developments. On February 13, 2002, in anticipation of Crescent Operating's entering into the Settlement Agreement, pursuant to which Crescent Operating transferred its 60% general partnership interest in COPI Colorado to Crescent 142 Partnership, the partners of COPI Colorado caused it to distribute among its partners, in accordance with their respective ownership percentage, all of the shares of Crescent Operating's stock it held. Messrs. Goff and Frampton each received 220,506 shares, while Crescent Operating received 661,518 shares. Effective February 14, 2002, Crescent Operating transferred its equity interests in the land development assets and related liabilities, other than Crescent Operating's interest in The Woodlands Operating Company, as provided for in the Settlement Agreement. Crescent Operating transferred its interest in The Woodlands Operating Company to Crescent Real Estate on March 22, 2002. Operational Information. Net income for the land development segment was $2.7 million for the year ended December 31, 2001. Crescent Operating's share of Desert Mountain Development's net loss for the year ended December 31, 2001 was $0.3 million. Crescent Operating's share of net income from both The Woodlands Land Company and WOCOI Investment Company for the year ended December 31, 2001 was $2.6 million. Crescent Operating's share of COPI Colorado's net income for the year ended December 31, 2001 was $0.2 million. The following table sets forth certain information as of December 31, 2001 relating to the residential development properties. As Crescent Operating only operated the land development segment for one and one-half months in 2002, there is no information for the three and nine months ended September 30, 2002. Total Total Average Total Lots/Units Lots/Units Closed Lots/ Developed Closed Sale Price Units Since Since Per Lot/ Range of Proposed Land Development Planned Inception Inception Unit(1) Sale Prices Per Lot(2) ---------------- ------- --------- --------- ------- ---------------------- Desert Mountain............ 2,665 2,338 2,195 $ 515,000 $400,000-$3,050,000(3) The Woodlands.............. 37,554 26,027 24,472 $ 57,000 $16,000-$1,035,000 CRDI....................... 2,679 1,274 869 N/A $25,000-$4,600,000 ------ ------ ------ Total Land Development..... 42,898 29,639 27,536 ====== ====== ====== ______________________ (1) Based on lots/units closed during Crescent Operating's ownership period. (2) Based on existing inventory of developed lots and lots to be developed. (3) Includes golf membership, which as of December 31, 2001, was $225,000. Other Investments Charter Behavioral Health Systems, LLC. CBHS was the largest provider of behavioral health care treatment in the United States. From September 9, 1999 to December 29, 2000, Crescent Operating (which prior thereto had owned 50% of CBHS) owned a 25% common membership interest and 100% of the preferred membership interests in CBHS, and a limited partnership interest in COPI CBHS Holdings (controlled by individual officers of Crescent Operating), in which Crescent Operating owned 100% of the economic interests, and which owned 65% of the common interests of CBHS. In the fourth quarter of 1999, CBHS began significant downsizing, including the closing of 18 facilities in December 1999 and 33 facilities in January 2000. Closure of those facilities resulted in the filing by terminated employees of several lawsuits against CBHS and others, including Crescent Operating, for alleged violation of the WARN Act (see "- Legal Proceedings"). On February 16, 2000, CBHS petitioned for relief under Chapter 11 of the United States Bankruptcy Code. Under the protection of the bankruptcy court, CBHS has engaged in efforts to sell and liquidate, in a controlled fashion, all of its ongoing business. On April 16, 2000, the asset purchase agreement to which a newly formed, wholly 143 owned subsidiary of Crescent Operating had agreed to acquire, for $24.5 million, CBHS's core business assets used in the operation of 37 behavioral healthcare facilities, subject to certain conditions, terminated by its own terms because not all of the conditions precedent to closing had been met by that date. Subsequent to the termination of the asset purchase agreement, CBHS sold or closed all of its remaining facilities and is in the process of final liquidation of any remaining assets. As a result of the liquidation of CBHS through bankruptcy, the equity investment in CBHS became worthless. On December 29, 2000 Crescent Operating sold its 25% common interest and its 100% preferred membership interest in CBHS, and COPI CBHS Holdings sold its 65% common interest in CBHS, to The Rockwood Financial Group, Inc. for a nominal sum. The Rockwood Financial Group, Inc. is wholly owned by Jeffrey L. Stevens, Crescent Operating's Chief Executive Officer and sole director. The sale of CBHS to the Rockwood Financial Group, Inc. was effected as part of Crescent Operating's tax planning strategy. For the year 2000, Crescent Operating was faced with a potentially large minimum tax liability. Crescent Operating sold its interest in CBHS in order to trigger a loss that would significantly reduce, if not eliminate this alternative minimum tax liability. Magellan Warrants. In connection with the transaction in which Crescent Operating acquired its interest in CBHS in 1997, Crescent Operating purchased, for $12.5 million, warrants to acquire 1,283,311 shares of common stock of Magellan Health Services, Inc. for an exercise price of $30.00 per share. The Magellan warrants are exercisable in varying increments beginning on May 31, 1998 and ending on May 31, 2009. As of December 31, 2001, the aggregate value of the Magellan warrants was $4.1 million, calculated using the Black-Scholes method. As of January 1, 2001, Crescent Operating was required to adopt SFAS No. 133, as amended by SFAS No. 138. SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, provides that all derivative instruments be recognized as either assets or liabilities depending on the rights or obligations under the contract and that all derivative instruments be measured at fair value. Upon adoption, Crescent Operating was required to record the net comprehensive loss related to its investment in Magellan warrants as a charge in the statement of operations. Based on the value of the warrants on December 31, 2000, Crescent Operating expensed $9.5 million on January 1, 2001 as a cumulative effect of change in accounting principle. From January 1, 2001 forward, Crescent Operating records changes in the fair value of these warrants in the statement of operations as investment income (loss). Crescent Operating transferred the Magellan warrants to Crescent Machinery in 1999 as a contribution to capital. On February 6, 2002, Crescent Machinery filed for protection under the federal bankruptcy laws. With the commencement of Crescent Machinery's bankruptcy proceedings, the Magellan warrants became part of Crescent Machinery's estate, subject to the claims of creditors. The Magellan warrants are not proposed to be treated in any manner in connection with the Crescent Operating bankruptcy plan, and, instead, will be part of the resolution of the Crescent Machinery bankruptcy. Crescent Operating had previously written down its investment in the warrants based on the estimated fair value of the warrants to $3.0 million at December 31, 2000, using the Black-Scholes pricing model. For the year ended December 31, 2001, Crescent Operating recorded changes in the fair value of these warrants as investment income of $1.1 million in Crescent Operating's statement of operations. For the six months ended June 30, 2002, Crescent Operating recorded changes in the fair market value of the warrants as an investment loss of $4.1 million in Crescent Operating's statement of operations. As of June 30, 2002, the value of the warrants was zero. Crescent Operating does not anticipate any future recognition of value relating to the warrants. For additional financial information related to Crescent Operating's business segments, see Crescent Operating's notes to the consolidated financial statements. 144 EMPLOYEES As of December 31, 2001, Crescent Operating and its consolidated subsidiaries had the number of employees indicated below: Crescent Operating-corporate................. 5 Equipment sales and leasing segment.......... 337 Hospitality segment.......................... 635 Land development segment..................... 691 ----- 1,668 ===== On May 1, 2001, Richard P. Knight resigned his position as Vice President and Chief Financial Officer to pursue other interests. Crescent Operating has excluded employees of The Woodlands Operating Company, The Woodlands Land Development Company and AmeriCold Logistics, as these subsidiaries represent equity investments for financial reporting purposes. PROPERTIES Immediately prior to Crescent Operating's transfer to Crescent Partnership on February 14, 2002, Crescent Operating, through its subsidiary, Crescent Machinery, owned fee simple interests in four properties located in Dallas and Austin, Texas, Tulsa, Oklahoma and Van Wert, Ohio. Crescent Operating, directly or indirectly, also held leasehold interests in certain facilities, including the hotel operations and other leased Crescent Machinery locations, collectively, the leased properties. Crescent Operating transferred all of the leasehold interests in the hotel operations to Crescent Partnership in February 2002. Crescent Machinery filed a voluntary petition in bankruptcy on February 6, 2002, and its properties and assets, including but not limited to these fee simple interests and leaseholds, are subject to the claims of creditors. Crescent Operating believes it will not likely receive any distribution in respect of the bankruptcy proceeding. Management believes that, for so long as it directly or indirectly owned or controlled fee simple interests and leaseholds, each of such owned and leased properties was adequately maintained and suitable for use in its respective capacity. Crescent Operating or certain of its subsidiaries entered into lease agreements in respect of the leased properties, pursuant to which each respective lessee was responsible for routine maintenance of the subject property. For further description as to the general character of Crescent Operating's properties by segment, see "Description of Crescent Operating's Business - Business Segments" above. LEGAL PROCEEDINGS CBHS became the subject of Chapter 11 bankruptcy proceedings by filing a voluntary petition on February 16, 2000, in United States Bankruptcy Court for the District of Delaware. Although CBHS is not a subsidiary of Crescent Operating, Crescent Operating did own a majority (90%) economic interest in CBHS until December 29, 2000. As stated above under "Description of Crescent Operating Business - Business Segments - Other Investments - Charter Behavioral Health Systems, LLC," as a result of the liquidation of CBHS through bankruptcy, the equity investment in CBHS became worthless. On December 29, 2000, as part of Crescent Operating's tax planning, Crescent Operating sold its 25% common interest and its 100% preferred membership interest in CBHS, and COPI CBHS Holdings sold its 65% common interest in CBHS to The Rockwood Financial Group, Inc. for a nominal sum. 145 Crescent Operating held no funded or liquidated claims against the estate of CBHS. Crescent Operating filed proofs of claim against CBHS as a protective matter for potential indemnification or contribution for third party lawsuits and claims where Crescent Operating is a named defendant with CBHS, such as lawsuits based upon alleged WARN Act violations purported to have been committed by CBHS and/or its subsidiaries in closing behavioral health care facilities in 1999 and 2000. The only such lawsuits that have been brought against Crescent Operating arise from WARN Act claims. In connection with a settlement entered into among Crescent Operating, CBHS, the WARN Act plaintiffs, and others, Crescent Operating's indemnification and contribution claims against CBHS based on such lawsuits have been resolved. No other claims or lawsuits have been asserted against Crescent Operating that would give rise to indemnification or contribution claims by Crescent Operating against CBHS. In the event that, prior to the bar date for asserting claims against Crescent Operating in its bankruptcy case, no other claims or lawsuits are asserted against Crescent Operating that would give rise to indemnification or contribution claims by Crescent Operating against CBHS, Crescent Operating's claims for indemnification or contribution in the CBHS case will be disallowed. If any such lawsuits or claims are brought, Crescent Operating will pursue its indemnification and contribution claims in the CBHS case as appropriate. To date, several lawsuits, all of which seek class action certification, have been filed against CBHS alleging violations of the WARN Act in the closing of certain healthcare facilities in 1999 and 2000. Of those lawsuits, three also named Crescent Operating as a defendant, but all three of those suits have since been dismissed. An additional suit seeking similar relief was also filed against Crescent Operating and Crescent Partnership, as well as CBHS. A global Stipulation of Settlement of all WARN matters was reached and filed with the United States District Court and Bankruptcy Court for the District of Delaware by the WARN Act claimants, CBHS, Crescent Operating, Crescent Partnership and the Creditors Committee in the CBHS case. The settlement was approved by the District Court by order dated March 18, 2002. As it applies to Crescent Operating, the settlement provides that either Crescent Operating or Crescent Partnership was required to deposit into escrow $500,000 for the benefit of the WARN Act claimants and, upon the settlement becoming final, Crescent Operating received a complete release for all WARN Act claims and any other claims in the CBHS case other than potential claims from those CBHS employees who have opted out of the settlement. It appears that a maximum of three such employees have opted out and none have made claims against Crescent Operating to date. Crescent Partnership has paid the $500,000 into escrow. This payment will not be included as an expense for the purposes of calculating the aggregate value of the Crescent Real Estate shares to be distributed to the Crescent Operating stockholders. In accordance with an agreement between Gerald Haddock and Crescent Operating, COPI Colorado redeemed the limited partnership interest of Mr. Haddock, Crescent Operating's former Chief Executive Officer and President, in January 2000. COPI Colorado paid Mr. Haddock approximately $2.6 million for his approximate 16.67% limited partner interest (determined from an independent appraisal of the value of COPI Colorado). Mr. Haddock challenged the valuation performed by the independent appraiser and the procedures followed by Crescent Operating with respect to the redemption and valuation process. On February 7, 2001, Crescent Operating filed a lawsuit in the 141st Judicial Court of Tarrant County, Texas seeking a declaratory judgment to assist in resolution of Crescent Operating's dispute with Mr. Haddock. The parties settled their dispute, and the lawsuit was dismissed effective as of January 2, 2002. Crescent Machinery Company is a wholly owned subsidiary of Crescent Operating. Crescent Machinery is a debtor in possession in a Chapter 11 reorganization case pending in the United States Bankruptcy Court for the Northern District of Texas. On December 19, 2002, the Crescent Machinery Committee commenced a lawsuit in the District Court of Tarrant County, Texas, styled "The Estates of Crescent Machinery and E.L. Lester, Inc. v. Mark Roberson, Jeffrey Stevens, Gerald Haddock, Rick Knight and Crescent Operating, Inc." The lawsuit seeks an unspecified amount of direct, consequential and punitive damages, as well as related attorneys fees, for alleged breaches of fiduciary duty, aiding and abetting breaches of fiduciary duty, negligent misrepresentation, and gross negligence. The creditors committee has alleged that the creditors of Crescent Machinery have been damaged as a result of the following: - lack of experienced management; - failure to have a written acquisition plan; - withdrawal of acquisition funding by Crescent Operating; - accounting misstatements; and - failure to restructure Crescent Machinery. Each of the named individual defendants was either an officer or director, or both, of Crescent Machinery at the time the alleged breaches occurred. Pursuant to the certificate of incorporation and bylaws of Crescent Operating, each of the individual defendants may be entitled to indemnification by Crescent Operating against some or all of the claims alleged in the lawsuit, including reimbursement of reasonable attorney's fees incurred in defending the lawsuit. Even if Crescent Operating were successful in defending against the claims in the lawsuit, there is the possibility that the plaintiffs may be successful against one or more of the individual defendants and that such defendant may have a claim for indemnity against Crescent Operating. Crescent Operating has director's and officer's liability insurance in the face amount of $3.0 million that may afford coverage for these indemnity claims. Nonetheless, if any of the Crescent Machinery Committee's claims against these officers and directors are allowed in an amount in excess of any available insurance, then that claim will have to be satisfied before any distribution could be made to Crescent Operating's stockholders. Crescent Operating intends to vigorously defend against the allegations and claims in the lawsuit. 146 Crescent Operating will ask the Bankruptcy Court to estimate any claims by the Crescent Machinery Committee at zero for purposes of distribution under Crescent Operating's plan of reorganization. Crescent Operating believes that there is a strong likelihood that the bankruptcy court having jurisdiction over its Chapter 11 case will estimate the claim at zero, and, therefore, the distributions that would otherwise be made to Crescent Operating stockholders will not be diminished by the assertion of such claim. There can be no assurance, however, that the Crescent Machinery Committee's claim will be estimated at zero, or even that the bankruptcy court would conduct an estimation hearing in lieu of the normal trial procedures in bankruptcy court. Therefore, there is a risk that substantial delays could result from the process in which the Crescent Machinery Committee's claim is adjudicated. In addition, there is a risk that if the Crescent Machinery Committee were ultimately successful in the prosecution of its claim, or if Crescent Real Estate, pursuant to the Settlement Agreement, offers to assume or settle any obligations under the Crescent Machinery Committee's claim and Crescent Operating accepts the offer, the total value of the Crescent Real Estate common shares that the Crescent Operating stockholders will receive will be reduced and the Crescent Operating stockholders will receive fewer Crescent Real Estate common shares. However, even if Crescent Real Estate does offer to assume or settle obligations under the Crescent Machinery Committee's claim and Crescent Operating accepts the offer, the total value of the minimum number of Crescent Real Estate common shares that the Crescent Operating stockholders will be entitled to receive if the bankruptcy plan is accepted by the Crescent Operating stockholders and confirmed by the bankruptcy court will be at least $2.16 million, or $0.20 per share of Crescent Operating common stock. DESCRIPTION OF CRESCENT REAL ESTATE'S BUSINESS OVERVIEW OF CRESCENT REAL ESTATE Crescent Real Estate operates as a REIT for federal income tax purposes, and, together with its subsidiaries, provides management, leasing and development services for some of its properties. The direct and indirect subsidiaries of Crescent Real Estate at September 30, 2002 included: - Crescent Real Estate Equities Limited Partnership, or Crescent Partnership; - Crescent Real Estate Equities Ltd., or the General Partner of Crescent Partnership; and - Subsidiaries of Crescent Partnership and the General Partner of Crescent Partnership. Crescent Real Estate conducts all of its business through Crescent Partnership and its other subsidiaries. Crescent Real Estate is structured to facilitate and maintain the qualification of Crescent Real Estate as a REIT. INDUSTRY SEGMENTS As of September 30, 2002, Crescent Real Estate's assets and operations were composed of four investment segments: - office segment; - resort/hotel segment; - residential development segment; and 147 - temperature-controlled logistics segment. Within these segments, Crescent Real Estate owned or had an interest in the following real estate assets as of September 30, 2002: - Office segment consisted of 73 office properties located in 25 metropolitan submarkets in six states, with an aggregate of approximately 28.5 million net rentable square feet (64 of the office properties, including three retail properties, are wholly owned and 10 are owned through joint ventures, seven of which are consolidated and three of which are unconsolidated); - Resort/hotel segment consisted of five luxury and destination fitness resorts and spas with a total of 1,036 rooms/guest nights and four upscale business-class hotel properties with a total of 1,771 rooms; - Residential development segment consisted of Crescent Real Estate's ownership of real estate mortgages and voting and non-voting common stock representing interests ranging from 94% to 100% in five residential development corporations, which in turn, through joint venture or partnership arrangements, owned 21 upscale residential development properties; and - Temperature-controlled logistics segment consisted of the Crescent Real Estate's 40% interest in a general partnership, which owns all of the common stock, representing substantially all of the economic interest, of AmeriCold Corporation, a REIT, which, as of September 30, 2002, directly or indirectly owned 88 temperature-controlled logistics properties with an aggregate of approximately 441.5 million cubic feet (17.5 million square feet) of warehouse space. See "Note 1. Organization and Basis of Presentation" included in Financial Statements of Crescent Real Estate for the six months ended September 30, 2002 (unaudited) for a table that lists the principal subsidiaries of Crescent Real Estate and the properties owned by such subsidiaries. See "Note 7. Investments in Real Estate Mortgages and Equity of Unconsolidated Companies" included in Financial Statements of Crescent Real Estate for the nine months ended September 30, 2002 (unaudited) for a table that lists Crescent Real Estate's ownership in significant unconsolidated companies and equity investments as of September 30, 2002, including the three office properties in which Crescent Real Estate owned an interest through unconsolidated companies and equity investments and Crescent Real Estate's ownership interests in the residential development segment and the temperature-controlled logistics segment. On February 14, 2002, Crescent Real Estate executed an agreement with Crescent Operating pursuant to which Crescent Operating transferred to subsidiaries of Crescent Real Estate Crescent Operating's lessee interests in the eight Crescent Real Estate hotel properties leased to subsidiaries of Crescent Operating in lieu of foreclosure and the voting common stock in three of Crescent Real Estate's residential development corporations pursuant to a strict foreclosure. Crescent Real Estate fully consolidated the operations of the eight Crescent Real Estate hotel properties and the three residential development corporations, beginning on the dates of the transfers of these assets. See "Note 22. Subsequent Events" included in Financial Statements of Crescent Real Estate for the year ended December 31, 2001 (audited) and "Note 16. COPI" included in the Financial Statement of Crescent Real Estate for the nine months ended September 30, 2002, (unaudited) for additional information regarding Crescent Real Estate's agreement with Crescent Operating. See "Note 3. Segment Reporting" included in Financial Statements of Crescent Real Estate for the year ended December 31, 2001 (audited) and "Note 6. Segment Reporting" included in the Financial Statements of Crescent Real Estate for the nine months ended September 30, 2002 (unaudited) for a table showing total revenues, funds from operations, and equity in net income of unconsolidated companies for each of these investment segments for the years ended December 31, 2001, 2000 and 1999 and the three and nine months ended September 30, 2002 and 2001 and identifiable assets for each of these investment segments at December 31, 2001 and 2000 and at September 30, 2002. 148 Office Segment Ownership Structure. As of September 30, 2002, Crescent Real Estate owned or had an interest in 73 office properties located in 25 metropolitan submarkets in six states, with an aggregate of approximately 28.5 million net rentable square feet. Sixty-four of the office properties, including three retail properties, are wholly owned and 10 are owned through joint ventures, seven of which are consolidated and three of which are unconsolidated. Crescent Real Estate, as lessor, has retained substantially all of the risks and benefits of ownership of the office properties and accounts for its leases as operating leases. Additionally, Crescent Real Estate provides management and leasing services for some of its office properties. See "Properties" below for more information about Crescent Real Estate's office properties. In addition, see "Note 1. Organization and Basis of Presentation" included in Financial Statements of Crescent Real Estate for the nine months ended September 30, 2002 (unaudited) for a table that lists the principal subsidiaries of Crescent Real Estate and the properties owned by such subsidiaries and "Note 7. Investments in Real Estate Mortgages and Equity of Unconsolidated Companies" included in Financial Statements of Crescent Real Estate for the nine months ended September 30, 2002 (unaudited) for a table that lists Crescent Real Estate's ownership in significant unconsolidated companies or equity investments and the three office properties in which Crescent Real Estate owned an interest through these unconsolidated companies or equity investments. Joint Venture Arrangements. 5 Houston Center On June 4, 2001, Crescent Real Estate entered into a joint venture arrangement with a pension fund advised by JP Morgan Investment Management, Inc., or JPM, to construct the 5 Houston Center office property within Crescent Real Estate's Houston Center mixed-use office property complex in Houston, Texas. The Class A office property will consist of 577,000 net rentable square feet. The joint venture is structured such that the fund holds a 75% equity interest, and Crescent Real Estate holds a 25% equity interest in the property. In addition, Crescent Real Estate is developing, and will manage and lease, the property on a fee basis. Four Westlake Park and Bank One Tower On July 30, 2001, Crescent Real Estate entered into joint venture arrangements with an affiliate of General Electric Pension Fund, or GE, for two office properties, Four Westlake Park in Houston, Texas, and Bank One Tower in Austin, Texas. The joint ventures are structured such that GE holds an 80% equity interest in each of the office properties, Four Westlake Park, a 560,000 square foot Class A office property located in the Katy Freeway submarket of Houston, and Bank One Tower, a 390,000 square foot Class A office property located in downtown Austin. Crescent Real Estate continues to hold the remaining 20% equity interests in each office property. In addition, Crescent Real Estate manages and leases the office properties on a fee basis. Three Westlake Park On August 21, 2002, Crescent Real Estate entered into a joint venture arrangement with an affiliate of GE. In connection with the formation of the venture, Crescent Real Estate contributed an office property, Three Westlake Park in Houston, Texas, and GE made a cash contribution. GE holds an 80% equity interest in Three Westlake Park, a 415,000 square foot Class A office property located in the Katy Freeway submarket of Houston, and Crescent Real Estate continues to hold the remaining 20% equity interest in the office property, with Crescent Real Estate's interest accounted for under the equity method. Crescent Real Estate will continue to manage and lease Three Westlake Park on a fee basis. 149 Market Information. The office properties reflect Crescent Real Estate's strategy of investing in premier assets within markets that have significant potential for rental growth. Within its selected submarkets, Crescent Real Estate has focused on premier locations that management believes are able to attract and retain the highest quality tenants and command premium rents. Consistent with its long-term investment strategies, Crescent Real Estate has sought transactions where it was able to acquire properties that have strong economic returns based on in-place tenancy and also have a dominant position within the submarket due to quality and/or location. Accordingly, management's long-term investment strategy not only demands acceptable current cash flow return on invested capital, but also considers long-term cash flow growth prospects. In selecting the office properties, Crescent Real Estate analyzed demographic and economic data to focus on markets expected to benefit from significant long-term employment growth as well as corporate relocations. Crescent Real Estate's office properties are located primarily in the Dallas/Fort Worth and Houston, Texas, metropolitan areas, both of which are projected to benefit from strong population and employment growth over the next 10 years. As indicated in the table below entitled "Projected Population Growth and Employment Growth for all Company Markets," these core markets are projected to outperform the 10-year averages for the United States. In addition, Crescent Real Estate considers these markets "demand-driven" markets due to high levels of in-migration by corporations, affordable housing costs, moderate cost of living, and the presence of centrally located travel hubs, making all areas of the country easily accessible. Texas As of December 2001, the Texas unemployment rate was 5.7%, slightly better than the national unemployment rate of 5.8%. According to the Texas Economic Update, Texas weathered the 2001 economic slowdown better than the nation as a whole. Dallas/Fort Worth According to the Bureau of Labor Statistics, 2001 job growth slowed considerably in the Dallas/Fort Worth area. As of December 2001, the Dallas/Fort Worth unemployment rate was 5.6%, compared with the Texas unemployment rate of 5.7% and the national unemployment rate of 5.8%. As for Dallas/Fort Worth's 2001 commercial office market, according to CoStar data, citywide net economic absorption, excluding space available for sublease, was approximately 1.0 million square feet, primarily represented by a positive 1.0 million square feet of absorption in Class A space. The city's total net absorption, including space available for sublease, was approximately negative 3.0 million square feet for 2001; however, Class A space represented only approximately negative 700,000 square feet of the negative 3.0 million total square feet. Houston Houston's employment data held steady through much of 2001, despite the slowdown in the economy. Approximately 23,000 jobs were created in 2001, an increase of approximately 1.1% over 2000. As of December 2001, the Houston unemployment rate was 4.4%, compared with the Texas unemployment rate of 5.7% and the national unemployment rate of 5.8%. As for Houston's 2001 commercial office market, according to CoStar data, citywide net economic absorption, excluding space available for sublease, was 2.0 million square feet, with 2.75 million square feet in Class A space. The city's total net absorption, including space available for sublease, was negative 200,000 square feet for 2001; however, Class A space had a positive total net absorption of 1.4 million square feet. 150 The demographic conditions, economic conditions and trends, population growth and employment growth, favoring the markets in which Crescent Real Estate has invested are projected to continue to exceed the national averages, as illustrated in the following table. Projected Population Growth and Employment Growth for all Crescent Real Estate Markets. Population Employment Growth Growth Metropolitan Statistical Area 2002-2011 2002-2011 ----------------------------- --------- --------- Albuquerque, NM 22.05% 14.15% Austin, TX 26.02 36.61 Colorado Springs, CO 27.48 15.83 Dallas, TX 15.89 20.92 Denver, CO 11.34 19.76 Fort Worth, TX 19.03 22.31 Houston, TX 15.61 22.43 Miami, FL 9.03 15.90 Phoenix, AZ 27.24 33.41 San Diego, CA 17.35 17.29 UNITED STATES 8.49 12.01 ---------- SOURCE: COMPILED FROM INFORMATION PUBLISHED BY ECONOMY.COM, INC. Crescent Real Estate does not depend on a single customer or a few major customers within the office segment, the loss of which would have a material adverse effect on Crescent Real Estate's financial condition or results of operations. Based on rental revenues from office leases in effect as of December 31, 2001 and September 30, 2002, no single tenant accounted for more than 5% of Crescent Real Estate's total office segment rental revenues for 2001 or the nine months ended September 30, 2002. Crescent Real Estate applies a well-defined leasing strategy in order to capture the potential rental growth in Crescent Real Estate's portfolio of office properties as occupancy and rental rates increase within the markets and the submarkets in which Crescent Real Estate has invested. Crescent Real Estate's strategy is based, in part, on identifying and focusing on investments in submarkets in which weighted average full-service rental rates (representing base rent after giving effect to free rent and scheduled rent increases that would be taken into account under generally accepted accounting principles, or GAAP, and including adjustments for expenses payable by or reimbursed from tenants) are significantly less than weighted average full-service replacement cost rental rates (the rate management estimates to be necessary to provide a return to a developer of a comparable, multi-tenant building sufficient to justify construction of new buildings) in that submarket. In calculating replacement cost rental rates, management relies on available third-party data and its own estimates of construction costs (including materials and labor in a particular market) and assumes replacement cost rental rates are achieved at a 95% occupancy level. Crescent Real Estate believes that the difference between the two rates is a useful measure of the additional revenue that Crescent Real Estate may be able to obtain from a property, because the difference should represent the amount by which rental rates would be required to increase in order to justify construction of new properties. For Crescent Real Estate's office properties, the weighted average full-service rental rate as of December 31, 2001 was $22.42 per square foot, compared to an estimated weighted average full-service replacement cost rental rate of $30.23 per square foot. Competition. Crescent Real Estate's office properties, primarily Class A properties located within the southwest, individually compete against a wide range of property owners and developers, including property management companies and other REITs, that offer space in similar classes of office properties - for example, Class A and Class B 151 properties. A number of these owners and developers may own more than one property. The number and type of competing properties in a particular market or submarket could have a material effect on Crescent Real Estate's ability to lease space and maintain or increase occupancy or rents in its existing office properties. Crescent Real Estate's management believes, however, that the quality services and individualized attention that Crescent Real Estate offers its customers, together with its active preventive maintenance program and superior building locations within markets, enhance Crescent Real Estate's ability to attract and retain customers for its office properties. In addition, as of December 31, 2001, on a weighted average basis, Crescent Real Estate owned 16% of the Class A office space in the 26 submarkets in which Crescent Real Estate owned Class A office properties, and 24% of the Class B office space in the two submarkets in which Crescent Real Estate owned Class B office properties. Crescent Real Estate's management believes that ownership of a significant percentage of office space in a particular market reduces property operating expenses, enhances Crescent Real Estate's ability to attract and retain customers and potentially results in increases in Crescent Real Estate's net operating income. Dispositions. During the nine months ended September 30, 2002, Crescent Real Estate disposed of five fully consolidated office properties. On January 18, 2002, Crescent Real Estate completed the sale of Cedar Springs Plaza, a wholly owned office property in Dallas, Texas. On May 29, 2002, Woodlands office Equities - '95 Limited, or Woodlands Office Equities, owned by Crescent Real Estate and the Woodlands Commercial Properties Company, L.P., sold two consolidated office properties located within the Woodlands, Texas. On August 1, 2002, Crescent Real Estate completed the sale of the 6225 North 24th Street office property in Phoenix, Arizona. On September 20, 2002, Crescent Real Estate completed the sale of the Reverchon Plaza office property in Dallas, Texas. During the year ended December 31, 2001, five of Crescent Real Estate's fully consolidated office properties were disposed of. On September 18, 2001, Crescent Real Estate completed the sale of the two Washington Harbour office properties. The Washington Harbour office properties were Crescent Real Estate's only office properties in Washington, D.C. On September 28, 2001, the Woodlands Office Equities sold two office properties located within The Woodlands, Texas. On December 20, 2001, Woodlands Office Equities sold another office property located within The Woodlands, Texas. During the nine months ended September 30, 2002, The Woodlands Commercial Properties Company, L.P., sold two unconsolidated office properties located within The Woodlands, Texas. During the year ended December 31, 2001, two of the unconsolidated companies in which Crescent Real Estate has an equity interest, sold three office properties and one retail property. On September 27, 2001, the Woodlands Commercial Properties Company, owned by The Woodlands Lands Company, Inc. and an affiliate of Morgan Stanley, sold one office/venture tech property and located within The Woodlands, Texas. On November 9, 2001, The Woodlands Land Development Company, L.P., owned by Crescent Real Estate and an affiliate of Morgan Stanley, sold two office properties and one retail property located within The Woodlands, Texas. Acquisition. ------------ On August 29, 2002, Crescent Real Estate acquired John Manville Plaza, a 29-story, 675,000 square foot Class A office building located in Denver, Colorado. Crescent Real Estate acquired the property for approximately $91,200. The property is wholly owned by Crescent Real Estate and included in the office segment. 152 Development. Avallon IV Office Property In May 2001, Crescent Real Estate completed the construction of the Avallon IV office property in Austin, Texas. The property is a Class A office property with 86,315 net rentable square feet. Construction of this property commenced in September 2000. 5 Houston Center Office Property Crescent Real Estate is currently developing the 5 Houston Center office property in Houston, Texas. Construction of the planned 27-story, Class A office property consisting of 577,000 net rentable square feet commenced in November 2000, and is expected to be completed in the fourth quarter of 2002. In June 2001, Crescent Real Estate entered into a joint venture arrangement with a pension fund advised by JPM to construct this office property. The joint venture is structured such that the fund holds a 75% equity interest, and Crescent Real Estate holds a 25% equity interest in the property. Joint Venture Arrangements. Four Westlake Park and Bank One Tower One July 30, 2001, Crescent Real Estate entered into joint venture arrangements with an affiliate GE, in which Crescent Real Estate contributed two office properties, Four Westlake Park in Houston, Texas, and Bank One Tower in Austin, Texas into the joint ventures and GE made a cash contribution. The joint ventures are structured such that GE holds an 80% equity interest in each of Four Westlake Park. Crescent Real Estate continues to hold the remaining 20% equity interests in each property. In addition, Crescent Real Estate manages and leases the office properties on a fee basis. Three Westlake Park On August 21, 2002, Crescent Real Estate entered into a joint venture arrangement with an affiliate of GE. In connection with the formation of the venture, Crescent Real Estate contributed an office property, Three Westlake Park in Houston, Texas, and GE made a cash contribution. GE holds an 80% equity interest in the Three Westlake Park and Crescent Real Estate continues to hold the remaining 20% equity interest in the office property. Crescent Real Estate will continue to manage and lease Three Westlake Park on a fee basis. Miami Center On September 25, 2002, Crescent Real Estate entered into a joint venture arrangement with an affiliate of a fund managed by JP Morgan Investment Management, Inc., or JPM, in connection with which JPM purchased a 60% interest in Crescent Miami Center, L.L.C. with a cash contribution. Crescent Miami Center, L.L.C. owns an Office Property, Miami Center in Miami, Florida. The joint venture is structured such that JPM holds a 60% equity interest in Miami Center, and Crescent Real Estate holds the remaining 40% equity interest in the office property. Resort/Hotel Segment Ownership Structure. Prior to enactment of the REIT Modernization Act, Crescent Real Estate's status as a REIT for federal income tax purposes prohibited it from operating the Crescent Real Estate hotel properties. As of December 31, 2001, Crescent Real Estate owned nine hotel properties, all of which, other than the Omni Austin Hotel, were leased to subsidiaries of Crescent Operating pursuant to eight separate leases. The Omni Austin Hotel was leased, under a separate lease, to HCD Austin Corporation, an unrelated third party. Under the leases, each having a term of 10 years, Crescent Real Estate hotel property lessees assumed the rights and obligations of the property owner under the respective management agreements with the hotel operators, as well as the obligation to pay all property taxes and other costs related to the properties. The leases provided for the payment by Crescent Real Estate hotel property lessees of all or a combination of the following: - base rent, with periodic rent increases if applicable; - percentage rent based on a percentage of gross hotel receipts or gross room revenues, as applicable, above a specified amount; and - a percentage of gross food and beverage revenues above a specified amount. On February 14, 2002, Crescent Real Estate executed an agreement with Crescent Operating, pursuant to which Crescent Operating transferred to subsidiaries of Crescent Real Estate, in lieu of foreclosure, Crescent Operating's lessee interests in the eight Crescent Real Estate hotel properties leased to subsidiaries of Crescent Operating. As a result, these subsidiaries of Crescent Real Estate became the lessees of the eight Crescent Real Estate hotel properties. See "Note 22. Subsequent Events" included in Financial Statements of Crescent Real Estate for the year ended December 31, 2001 (audited) for additional information regarding Crescent Real Estate's agreement with Crescent Operating. Joint Venture Arrangement Sonoma Mission Inn & Spa 153 On September 1, 2002, Crescent Real Estate entered into a joint venture arrangement with a subsidiary of Fairmont Hotels & Resorts Inc., or FHR, pursuant to which Crescent Real Estate contributed a resort/hotel property and FHR purchased a 19.9% equity interest in the limited liability company that owns Crescent Real Estate's Sonoma Mission Inn & Spa Resort/Hotel Property in Sonoma County, California. Crescent Real Estate continues to own the remaining 80.1% interest. Under Crescent Real Estate's agreement with FHR, Crescent Real Estate will manage the limited liability company that owns the Sonoma Mission Inn & Spa, and FHR will operate and manage the property under the Fairmont brand. CR License, LLC and CRL Investments, Inc. As of December 31, 2001, Crescent Real Estate had a 28.5% interest in CR License, LLC, the entity which owns the right to the future use of the "Canyon Ranch" name. Crescent Real Estate also had a 95% economic interest, representing all of the non-voting common stock, in CRL Investments, Inc., which has an approximately 65% economic interest in the Canyon Ranch Spa Club in the Venetian Hotel in Las Vegas, Nevada. On February 14, 2002, Crescent Real Estate executed an agreement with Crescent Operating, pursuant to which Crescent Real Estate acquired, pursuant to a strict foreclosure, Crescent Operating's 1.5% interest in CR License and 5.0% interest, representing all of the voting stock, in CRL Investments. Market Information. Lodging demand is highly dependent upon the global economy and volume of business travel. Prior to 2001, the hospitality industry enjoyed record profits. However, the uncertainty surrounding the weak global economy and the costs and fear resulting from the events of September 11, 2001 are expected to result in weak performance for much of 2002. This is evidenced by declines in both business and leisure travel in the United States. Competition. Most of Crescent Real Estate's upscale business class hotel properties in Denver, Albuquerque, Austin and Houston are business and convention center hotels that compete against other business and convention center hotels. Crescent Real Estate believes, however, that its luxury and destination fitness resorts and spas are unique properties that have no significant direct competitors due either to their high replacement cost or unique concept and location. However, the luxury and destination fitness resorts and spas do compete against business-class hotels or middle-market resorts in their geographic areas, as well as against luxury resorts nationwide and around the world. Residential Development Segment Ownership Structure. As of December 31, 2001, Crescent Real Estate owned economic interests in five residential development corporations through the residential development property mortgages and the non-voting common stock of these residential development corporations. The residential development corporations in turn, through joint ventures or partnership arrangements, own interests in 21 residential development properties. The residential development corporations are responsible for the continued development and the day-to-day operations of the Crescent Real Estate residential development properties. On February 14, 2002, Crescent Real Estate executed an agreement with Crescent Operating, pursuant to which Crescent Operating transferred to subsidiaries of Crescent Real Estate, pursuant to a strict foreclosure, Crescent Operating's voting interests in three of the residential development corporations. These three residential development corporations, Desert Mountain Development, The Woodlands Land Company and CRDI, own interests in 16 Crescent Real Estate residential development properties. 154 See "Note 22. Subsequent Events" included in Financial Statements of Crescent Real Estate for the year ended December 31, 2001 (audited) for additional information regarding Crescent Real Estate's agreement with Crescent Operating. Market Information. A slowing economy, combined with the events of September 11, 2001 contributed to the reduction in lot absorption, primarily at Desert Mountain. CRDI, formerly Crescent Development Management Corp., was not significantly impacted because most of its products were pre-sold. However, CRDI did change its strategy by delaying the commencement of certain projects, which will impact its performance in 2002. In addition, The Woodlands experienced a reduction in lot absorption of its higher priced lots, including Carlton Woods, The Woodlands' new upscale gated residential development. However, The Woodlands was not significantly impacted due to the higher prices of the lots sold offsetting lower lot sales. Competition. Crescent Real Estate's residential development properties compete against a variety of other housing alternatives in each of their respective areas. These alternatives include other planned developments, pre-existing single-family homes, condominiums, townhouses and non-owner occupied housing, such as luxury apartments. Crescent Real Estate's management believes that the Crescent Real Estate properties owned by The Woodlands Land Company, CRDI and Desert Mountain, representing Crescent Real Estate's most significant investments in residential development properties, contain certain features that provide competitive advantages to these developments. The Woodlands, which is an approximately 27,000-acre, master-planned residential and commercial community north of Houston, Texas, is unique among developments in the Houston area, because it functions as a self-contained community. Amenities contained in the development, which are not contained within most other local developments, include a shopping mall, retail centers, office buildings, a hospital, a community college, places of worship, a conference center, 85 parks, 117 holes of golf, including a Tournament Players Course and signature courses by Jack Nicklaus, Arnold Palmer, and Gary Player, two man-made lakes and a performing arts pavilion. The Woodlands competes with other master planned communities in the surrounding Houston market. Desert Mountain, a luxury residential and recreational community in Scottsdale, Arizona, which also offers five 18-hole Jack Nicklaus signature golf courses and tennis courts, has few direct competitors due in part to the superior environmental attributes and the types of amenities that it offers. CRDI invests primarily in mountain resort residential real estate in Colorado and California, and residential real estate in downtown Denver, Colorado. Crescent Real Estate's management believes CRDI does not have any direct competitors because the projects and project locations are unique and the land is limited in most of these locations. Temperature-Controlled Logistics Segment Ownership Structure. Effective March 12, 1999, Crescent Real Estate, Vornado Realty Trust, Crescent Operating, the temperature-controlled logistics partnership and AmeriCold Corporation (including all affiliated entities that owned any portion of the business operations of the Crescent Real Estate temperature-controlled logistics properties at that time) sold all of the non-real estate assets, encompassing the business operations, for approximately $48.7 million to a subsidiary of a newly formed partnership called AmeriCold Logistics, which is owned 60% by Vornado Operating L.P. and 40% by a subsidiary of Crescent Operating. Crescent Real Estate has no interest in AmeriCold Logistics. 155 As of September 30, 2002, Crescent Real Estate held a 40% interest in the temperature-controlled logistics partnership, which owns the AmeriCold Corporation, which directly or indirectly owns the 88 Crescent Real Estate temperature-controlled logistics properties, with an aggregate of approximately 441.5 million cubic feet (17.5 million square feet) of warehouse space. AmeriCold Logistics, as sole lessee of the Crescent Real Estate temperature-controlled logistics properties, leases the Crescent Real Estate temperature-controlled logistics properties from AmeriCold Corporation under three triple-net master leases, as amended on January 23, 2002. On February 22, 2001, AmeriCold Corporation and AmeriCold Logistics agreed to restructure certain financial terms of the leases, including the adjustment of the rental obligation for 2001 to $146.0 million, the adjustment of the rental obligation for 2002 to $150.0 million (plus contingent rent in certain circumstances), the increase of the AmeriCold Corporation's share of capital expenditures for the maintenance of the properties from $5.0 million to $9.5 million (effective January 1, 2000) and the extension of the date on which deferred rent was required to be paid to December 31, 2003. AmeriCold Logistics deferred $20.6 million of the total $102.4 million of rent payable for the nine months ended September 30, 2002. Crescent Real Estate's share of the deferred rent was $8.2 million. Crescent Real Estate recognizes rental income when earned and collected and has not recognized the $8.2 million of deferred rent in equity in net income of the temperature controlled logistics properties for the nine months ended September 30, 2002. In addition, AmeriCold Logistics deferred $25.5 million of rent for the year ended December 31, 2001, of which Crescent Real Estate's share was $10.2 million. AmeriCold Logistics also deferred $19.0 million and $5.4 million of rent for the years ended December 31, 2000 and 1999, respectively, of which Crescent Real Estate's share was $7.5 million and $2.1 million, respectively. In December 2001, AmeriCold Corporation waived its rights to collect deferred rent of $39.8 million of the total $49.9 million of deferred rent, of which Crescent Real Estate's share was $15.9 million. AmeriCold Corporation had recorded adequate valuation allowances related to the waived deferred rental revenue during the years ended December 31, 2000, and 2001; therefore, there was no financial statement impact to AmeriCold Corporation or to Crescent Real Estate related to AmeriCold Corporation's decision to waive collection of the deferred rent. Business and Industry Information. AmeriCold Logistics provides frozen food manufacturers with refrigerated warehousing and transportation management services. The Crescent Real Estate temperature-controlled logistics properties consist of production and distribution facilities. Production facilities differ from distribution facilities in that they typically serve one or a small number of customers located nearby. These customers store large quantities of processed or partially processed products in the facility until they are further processed or shipped to the next stage of production or distribution. Distribution facilities primarily serve customers who store a wide variety of finished products to support shipment to end-users, such as food retailers and food service companies, in a specific geographic market. AmeriCold Logistics' transportation management services include freight routing, dispatching, freight rate negotiation, backhaul coordination, freight bill auditing, network flow management, order consolidation and distribution channel assessment. AmeriCold Logistics' temperature-controlled logistics expertise and access to both the frozen food warehouses and distribution channels enable the customers of AmeriCold Logistics to respond quickly and efficiently to time-sensitive orders from distributors and retailers. 156 AmeriCold Logistics' customers consist primarily of national, regional and local frozen food manufacturers, distributors, retailers and food service organizations. A breakdown of AmeriCold Logistics' largest customers include: PERCENTAGE OF 2001 REVENUE ------------ H.J. Heinz & Co......................... 16% Con-Agra, Inc........................... 8 Sara Lee Corp........................... 5 McCain Foods, Inc....................... 5 Tyson Foods, Inc........................ 4 General Mills........................... 4 J.R. Simplot............................ 3 Flowers Food, Inc....................... 3 Pro-Fac Cooperative, Inc................ 2 Farmland Industries, Inc................ 2 Other................................... 48 --- TOTAL 100% === Consolidation among retail and food service channels has limited the ability of manufacturers to pass along cost increases by raising prices. Because of this, manufacturers have been forced in the recent past to focus more intensely on supply chain cost, such as inventory management, transportation and distribution, reduction initiatives in an effort to improve operating performance. Competition. AmeriCold Logistics is the largest operator of public refrigerated warehouse space in North America and has more than twice the cubic feet of the second largest operator. AmeriCold Logistics operated an aggregate of approximately 18% of total cubic feet of public refrigerated warehouse space as of December 31, 2001. No other person or entity operated more than 8% of total public refrigerated warehouse space as of December 31, 2001. As a result, AmeriCold Logistics does not have any competitors of comparable size. AmeriCold Logistics operates in an environment in which competition is national, regional and local in nature and in which the range of service, temperature-controlled logistics facilities, customer mix, service performance and price are the principal competitive factors. Development. AmeriCold Corporation completed the acquisition of one facility in the first quarter of 2001 for $10.0 million and completed the construction of one facility in the third quarter of 2001 for $15.8 million, representing in aggregate approximately 8.5 million cubic feet (0.2 million square feet) of additional warehouse space. EMPLOYEES As of September 30, 2002, Crescent Real Estate had 650 employees. None of these employees are covered by collective bargaining agreements. Crescent Real Estate considers its employee relations to be good. PROPERTIES Crescent Real Estate considers all of its properties to be in good condition, well-maintained and suitable and adequate to carry on Crescent Real Estate's business. Office Properties As of September 30, 2002, Crescent Real Estate owned or had an interest in 73 office properties located in 25 metropolitan submarkets in six states with an aggregate of approximately 28.5 million net rentable square feet. The office properties were, on a weighted average basis, 89% occupied at September 30, 2002, and are located approximately 43% in central business districts and approximately 57% in urban markets. Crescent Real Estate's office properties are located primarily in the Dallas and Houston, Texas, metropolitan areas. As of September 30, 2002, Crescent Real 157 Estate's office properties in Dallas and Houston represented an aggregate of approximately 73% of its office portfolio based on total net rentable square feet (36% for Dallas and 37% for Houston). In addition, Crescent Real Estate owns a 25% interest in the 5 Houston Center office property which was completed in September 2002. In pursuit of management's objective to dispose of non-strategic and non-core assets, five of Crescent Real Estate's fully consolidated office properties were disposed of during the nine months ended September 30, 2002. 158 Office Properties Tables. The following table shows, as of September 30, 2002, certain information about Crescent Real Estate's office properties. In the table below "CBD" means central business district. WEIGHTED AVERAGE FULL-SERVICE NET RENTABLE RENTAL RATE NO. OF YEAR AREA PERCENT PER LEASED STATE, CITY, PROPERTY PROPERTIES SUBMARKET COMPLETED (SQ. FT.) LEASED SQ. FT.(1) --------------------- ---------- --------- --------- --------- ------ ---------- TEXAS DALLAS Bank One Center(2) 1 CBD 1987 1,530,957 82% $23.03 Fountain Place 1 CBD 1986 1,200,266 99 20.90 The Crescent Office Towers 1 Uptown/Turtle Creek 1985 1,134,826 98 33.23 Trammell Crow Center(3) 1 CBD 1984 1,128,331 87 24.95 Stemmons Place 1 Stemmons Freeway 1983 634,381 85 17.71 Spectrum Center(4) 1 Far North Dallas 1983 598,250 82 23.72 Waterside Commons 1 Las Colinas 1986 458,906 85 18.43 125 E. John Carpenter Freeway 1 Las Colinas 1982 446,031 88 26.88 The Aberdeen 1 Far North Dallas 1986 320,629 100 19.50 MacArthur Center I & II 1 Las Colinas 1982/1986 298,161 94 23.41 Stanford Corporate Centre 1 Far North Dallas 1985 275,372 67 23.26 12404 Park Central 1 LBJ Freeway 1987 239,103 100 19.83 Palisades Central II 1 Richardson/Plano 1985 237,731 87 18.98 3333 Lee Parkway 1 Uptown/Turtle Creek 1983 233,543 49 22.39 Liberty Plaza I & II 1 Far North Dallas 1981/1986 218,813 99 16.15 The Addison 1 Far North Dallas 1981 215,016 99 20.14 Palisades Central I 1 Richardson/Plano 1980 180,503 95 21.73 The Crescent Atrium 1 Uptown/Turtle Creek 1985 164,696 99 30.77 Greenway II 1 Richardson/Plano 1985 154,329 100 22.56 Greenway I & IA 2 Richardson/Plano 1983 146,704 100 20.62 Addison Tower 1 Far North Dallas 1987 145,886 76 21.68 Las Colinas Plaza 1 Las Colinas 1987 134,953 96 21.23 5050 Quorum 1 Far North Dallas 1981 133,799 76 18.47 - ---------------- ---- ---------- --- ----- Subtotal/Weighted Average 24 10,231,186 89% $23.34 -- ---------- --- ------ FORT WORTH Carter Burgess Plaza 1 CBD 1982 954,895 93%(5) $17.25 - --- ---- ---------- ------ ------ HOUSTON Richmond-Buffalo Greenway Plaza Office Portfolio 10 Speedway 1969-1982 4,348,052 92% $21.05 Houston Center 3 CBD 1974-1983 2,764,417 90 22.27 Post Oak Central 3 West Loop/Galleria 1974-1981 1,279,759 85 19.91 Four Westlake Park(6) 1 Katy Freeway 1992 561,065 100 22.07 The Woodlands Office Properties(7) 6 The Woodlands 1980-1996 462,775 93 18.48 Three Westlake Park(6) 1 Katy Freeway 1983 414,792 95(5) 23.74 1800 West Loop South 1 West Loop/Galleria 1982 399,777 62(5) 19.87 The Park Shops 1 CBD 1983 190,729 76 23.27 - --- ---- ---------- --- ----- Subtotal/Weighted Average(8) 26 10,421,366 90% $21.30 -- ---------- --- ------ AUSTIN Frost Bank Plaza 1 CBD 1984 433,024 96% $25.26 301 Congress Avenue(9) 1 CBD 1986 418,338 83 26.44 Bank One Tower(6) 1 CBD 1974 389,503 93 25.15 Austin Centre 1 CBD 1986 343,664 83 29.19 The Avallon 3 Northwest 1993/1997 318,217 93(5) 24.87 Barton Oaks Plaza One 1 Southwest 1986 98,955 100 27.68 - --------- ---- ---------- --- ----- Subtotal/Weighted Average 8 2,001,701 90% $26.09 - ---------- --- ------ COLORADO DENVER Johns Manville Plaza(10) 1 CBD 1978 675,400 100% $20.21 MCI Tower 1 CBD 1982 550,805 47(5) 22.41 Ptarmigan Place 1 Cherry Creek 1984 418,630 96 20.14 Denver Technology Regency Plaza One 1 Center 1985 309,862 84 24.48 55 Madison 1 Cherry Creek 1982 137,176 99 21.10 159 The Citadel 1 Cherry Creek 1987 130,652 99 25.11 44 Cook 1 Cherry Creek 1984 124,174 95 21.02 - ------------ ---- ---------- --- ----- Subtotal/Weighted Average 7 2,346,699 84% $21.47 - ---------- --- ------ COLORADO SPRINGS Briargate Office and Research Center 1 Colorado Springs 1988 258,766 74% $20.05 - ---------------- ---- ---------- --- ------ FLORIDA MIAMI Miami Center(11) 1 CBD 1983 782,211 92% $28.17 Datran Center 2 South Dade/Kendall 1986/1988 476,412 93 24.53 - ------------------ --------- ---------- --- ----- Subtotal/Weighted Average 3 1,258,623 92% $26.79 - --------- --- ------ ARIZONA PHOENIX Two Renaissance Square 1 Downtown/CBD 1990 476,373 98% $26.26 - ------------ ---- ---------- --- ------ NEW MEXICO ALBUQUERQUE Albuquerque Plaza 1 CBD 1990 366,236 87% $19.03 - --- ---- ---------- --- ------ CALIFORNIA SAN DIEGO Chancellor Park(12) 1 University Town Center 1988 195,733 81% $28.17 - ---------------------- ---- ---------- --- ------ TOTAL/WEIGHTED AVERAGE 73 28,511,578 89%(5) $22.58(13) == ========== ====== ========= (1) Calculated based on base rent payable as of September 30, 2002, without giving effect to free rent or scheduled rent increases that would be taken into account under GAAP and including adjustments for expenses payable by or reimbursable from customers. (2) Crescent Real Estate has a 49.5% limited partner interest and a 0.5% general partner interest in the partnership that owns Bank One Center. (3) Crescent Real Estate owns the principal economic interest in Trammell Crow Center through its ownership of fee simple title to the property (subject to a ground lease and a leasehold estate regarding the building) and two mortgage notes encumbering the leasehold interests in the land and building. (4) Crescent Real Estate owns the principal economic interest in Spectrum Center through an interest in Crescent Spectrum Center, L.P. which owns both the mortgage notes secured by Spectrum Center and the ground lessor's interest in the land underlying the office building. (5) Leases have been executed at certain office properties but had not commenced as of September 30, 2002. If such leases had commenced as of September 30, 2002, the percent leased for all office properties would have been 91%. The total percent leased for these properties would have been as follows: Carter Burgess Plaza - 98%, Three Westlake - 100%, 1800 West Loop - 73%, The Avallon - 100%, and MCI Tower - 60%. (6) Crescent Real Estate has a 0.1% general partner interest and a 19.9% limited partner interest in the partnerships that own Four Westlake Park, Three Westlake Park and Bank One Tower. (7) Crescent Real Estate has a 75% limited partner interest and an approximate 10% indirect general partner interest in the partnership that owns the six office properties that comprise The Woodlands Office Properties. (8) Excludes the 5 Houston Center office property, which was placed in service on September 16, 2002. This office property will be included when it becomes stabilized. At September 30, 2002, it was 34% leased. If executed leases at September 30, 2002 had commenced, it would have been 88% leased. (9) Crescent Real Estate has a 1% general partner interest and a 49% limited partner interest in the partnership that owns 301 Congress Avenue. (10) Johns Manville Plaza was acquired by Crescent Real Estate on August 29, 2002. (11) Crescent Real Estate has a 40% member interest in the limited liability company that owns Miami Center. (12) Crescent Real Estate owns Chancellor Park through its ownership of a mortgage note secured by the building and through its direct and indirect interests in the partnership, which owns the building. (13) The weighted average full-service rental rate per square foot calculated based on base rent payable for Crescent Real Estate office properties as of September 30, 2002, giving effect to free rent and scheduled rent increases that are taken into consideration under GAAP and also including adjustments for expenses payable by or reimbursed from customers is $22.71. 160 The following table shows, as of September 30, 2002, the principal business conducted by the customers at Crescent Real Estate's office properties, based on information supplied to Crescent Real Estate from the customers. Percent of Industry Sector Leased Sq. Ft. --------------- -------------- Professional Services(1) 28% Energy(2) 20 Financial Services(3) 19 Telecommunications 7 Technology 7 Other(4) 5 Manufacturing 4 Food Service 3 Government 3 Retail 2 Medical 2 ------ TOTAL LEASED 100% ====== Average Square Footage Per Customer 14,767 ====== ---------- (1) Includes legal, accounting, engineering, architectural and advertising services. (2) Includes oil and gas and utility companies. (3) Includes banking, title and insurance and investment services. (4) Includes construction, real estate, transportation and other industries. 161 Aggregate Lease Expirations of Office Properties. The following tables show schedules of lease expirations for leases in place as of September 30, 2002, for Crescent Real Estate's total office properties and for Dallas, Houston and Austin, Texas, and Denver, Colorado, individually, for each of the 10 years beginning with 2002, assuming that none of the tenants exercises or has exercised renewal options. Total Office Properties. TOTAL OFFICE PROPERTIES PERCENTAGE NET RENTABLE PERCENTAGE OF TOTAL OF ANNUAL FULL- AREA LEASED NET ANNUAL ANNUAL FULL- SERVICE RENT NUMBER OF REPRESENTED RENTABLE AREA FULL-SERVICE SERVICE RENT PER SQUARE TENANTS WITH BY EXPIRING REPRESENTED RENT UNDER REPRESENTED FOOT OF NET YEAR OF LEASE EXPIRING LEASES BY EXPIRING EXPIRING BY EXPIRING RENTABLE AREA EXPIRATION LEASES (SQUARE FEET) LEASES LEASES(1) LEASES EXPIRING(1) ------ ------------- ------ --------- ------ ----------- 2002 233 1,667,335(2)(3) 6.7% $ 38,019,466 6.4% $22.80 2003 361 3,579,920(4)(5) 14.3 78,035,044 13.1 21.80 2004 298 4,374,255 17.4 101,227,128 17.0 23.14 2005 282 3,585,999 14.3 83,173,181 14.0 23.19 2006 180 2,611,299 10.4 63,952,207 10.7 24.49 2007 173 2,797,085 11.2 65,761,851 11.0 23.51 2008 54 1,071,904 4.3 25,569,531 4.3 23.85 2009 37 943,491 3.8 24,404,507 4.1 25.87 2010 32 1,535,400 6.1 42,578,335 7.1 27.73 2011 27 900,065 3.6 23,973,071 4.0 26.63 2012 and thereafter 32 2,006,355 7.9 49,397,995 8.3 24.62 ----- ---------- ----- ------------ ----- ------ 1,709 25,073,108(6) 100.0% $596,092,316 100.0% $23.77 ===== ========== ===== ============ ===== ====== (1) Calculated based on base rent payable under the lease for net rentable square feet expiring, without giving effect to free rent or scheduled rent increases that would be taken into account under GAAP and including adjustments for expenses payable by or reimbursable from tenants based on current expense levels. (2) Expirations by quarter are as follows: Q4: 1,667,335 sf. (3) As of September 30, 2002 leases have been signed for 746,219 net rentable square feet (representing approximately 45% of expiring square footage and including renewed leases and leasing of previously vacant space) commencing in 2002. (4) Expirations by quarter are as follows: Q1: 1,124,696 sf Q2: 986,832 sf Q3: 701,764 sf Q4: 766,628 sf. (5) As of September 30, 2002 leases have been signed for 1,388,127 net rentable square feet (representing approximately 39% of expiring square footage and rent leases and leasing of previously vacant space) commencing in 2003. (6) Reconciliation of Occupied Square Footage to Total Office NRA: SQUARE FEET ---- Occupied square footage 25,073,108 Non-revenue generating space 359,687 ---------- Total occupied office square footage 25,432,795 Total vacant square footage 3,078,783 ---------- Total office NRA 28,511,578 ========== 162 Dallas Office Properties. PERCENTAGE NET RENTABLE PERCENTAGE OF TOTAL OF ANNUAL FULL- AREA LEASED NET ANNUAL ANNUAL FULL- SERVICE RENT NUMBER OF REPRESENTED RENTABLE AREA FULL-SERVICE SERVICE RENT PER SQUARE TENANTS WITH BY EXPIRING REPRESENTED RENT UNDER REPRESENTED FOOT OF NET YEAR OF LEASE EXPIRING LEASES BY EXPIRING EXPIRING BY EXPIRING RENTABLE AREA EXPIRATION LEASES (SQUARE FEET) LEASES LEASES(1) LEASES EXPIRING(1) ---------- ------ ------------- ------ --------- ------ ----------- 2002 59 508,984(2)(3) 5.6% $ 13,873,448 6.3% $27.26 2003 95 1,344,481(4)(5) 14.9 29,662,076 13.5 22.06 2004 87 1,235,599 13.7 32,070,950 14.6 25.96 2005 107 1,847,576 20.5 41,195,819 18.7 22.30 2006 43 680,220 7.5 17,394,448 7.9 25.57 2007 51 1,123,308 12.4 27,575,931 12.5 24.55 2008 15 516,780 5.7 12,796,529 5.8 24.76 2009 9 409,489 4.5 10,730,350 4.9 26.20 2010 12 670,634 7.4 19,877,588 9.0 29.64 2011 7 251,030 2.8 6,947,876 3.2 27.68 2012 and thereafter 12 440,292 5.0 7,869,961 3.6 17.87 --- --------- ----- ------------ ----- ------ 497 9,028,393 100.0% $219,994,976 100.0% $24.37 === ========= ===== ============ ===== ====== (1) Calculated based on base rent payable under the lease for net rentable square feet expiring, without giving effect to free rent or scheduled rent increases that would be taken into account under GAAP and including adjustments for expenses payable by or reimbursable from tenants based on current expense levels. (2) Expirations by quarter are as follows: Q4 508,984 sf. (3) As of September 30, 2002 leases have been signed for 189,931 net rentable square feet (representing approximately 37% of expiring square footage and including renewed leases and leasing of previously vacant space) commencing in 2002. (4) Expirations by quarter are as follows: Q1: 592,840 sf Q2: 405,184 sf Q3: 136,951 sf Q4: 209,506 sf. (5) As of September 30, 2002 leases have been signed for 492,560 net rentable square feet (representing approximately 37% of expiring square footage and including renewed leases and leasing of previously vacant space) commencing in 2003. 163 Houston Office Properties. PERCENTAGE NET RENTABLE PERCENTAGE OF TOTAL OF ANNUAL FULL- AREA LEASED NET ANNUAL ANNUAL FULL- SERVICE RENT NUMBER OF REPRESENTED RENTABLE AREA FULL-SERVICE SERVICE RENT PER SQUARE TENANTS WITH BY EXPIRING REPRESENTED RENT UNDER REPRESENTED FOOT OF NET YEAR OF LEASE EXPIRING LEASES BY EXPIRING EXPIRING BY EXPIRING RENTABLE AREA EXPIRATION LEASES (SQUARE FEET) LEASES LEASES(1) LEASES EXPIRING(1) ---------- ------ ------------- ------ --------- ------ ----------- 2002 104 829,555(2)(3) 9.0% $ 17,040,934 8.1% $20.54 2003 136 1,166,459(4)(5) 12.6 24,374,256 11.7 20.90 2004 117 1,898,176 20.6 39,572,871 18.9 20.85 2005 88 650,680 7.1 14,777,526 7.1 22.71 2006 64 1,124,218 12.2 25,394,927 12.1 22.59 2007 65 1,203,580 13.0 26,247,046 12.5 21.81 2008 16 350,636 3.8 7,469,410 3.6 21.30 2009 8 87,434 1.0 2,147,400 1.0 24.56 2010 11 591,928 6.4 14,602,679 7.0 24.67 2011 13 534,394 5.8 12,848,920 6.1 24.04 2012 and thereafter 6 796,770 8.5 24,763,651 11.9 31.08 --- --------- ----- ------------ ----- ------ 628 9,233,830 100.0% $209,239,620 100.0% $22.66 === ========= ===== ============ ===== ====== (1) Calculated based on base rent payable under the lease for net rentable square feet expiring, without giving effect to free rent or scheduled rent increases that would be taken into account under GAAP and including adjustments for expenses payable by or reimbursable from tenants based on current expense levels. (2) Expirations by quarter are as follows: Q4: 829,555 sf. (3) As of September 30, 2002 leases have been signed for 360,784 net rentable square feet (representing approximately 43% of expiring square footage and including renewed leases and leasing of previously vacant space) commencing in 2002. (4) Expirations by quarter are as follows: Q1: 178,720 sf Q2: 443,970 sf Q3: 372,719 sf Q4: 171,050 sf. (5) As of September 30, 2002 leases have been signed for 766,894 net rentable square feet (representing approximately 66% of expiring square footage and including renewed leases and leasing of previously vacant space) commencing in 2003. Austin Office Properties. PERCENTAGE NET RENTABLE PERCENTAGE OF TOTAL OF ANNUAL FULL- AREA LEASED NET ANNUAL ANNUAL FULL- SERVICE RENT NUMBER OF REPRESENTED RENTABLE AREA FULL-SERVICE SERVICE RENT PER SQUARE TENANTS WITH BY EXPIRING REPRESENTED RENT UNDER REPRESENTED FOOT OF NET YEAR OF LEASE EXPIRING LEASES BY EXPIRING EXPIRING BY EXPIRING RENTABLE AREA EXPIRATION LEASES (SQUARE FEET) LEASES LEASES(1) LEASES EXPIRING(1) ---------- ------ ------------- ------ --------- ------ ----------- 2002 17 53,797(2)(3) 3.1% $1,664,541 3.6% $30.94 2003 33 249,460(4)(5) 14.4 6,226,323 13.6 24.96 2004 19 349,919 20.2 8,518,887 18.6 24.35 2005 25 529,901 30.6 13,812,528 30.1 26.07 2006 16 320,394 18.5 9,233,495 20.1 28.82 2007 10 84,278 4.9 2,432,875 5.3 28.87 2008 7 78,902 4.6 2,321,594 5.1 29.42 2009 2 29,935 1.7 833,259 1.8 27.84 2010 1 1,387 0.1 31,665 0.1 22.83 2011 -- -- 0.0 -- 0.0 -- 2012 and thereafter 1 33,315 1.9 834,248 1.7 25.04 --- --------- ----- ----------- ----- ------ 131 1,731,288 100.0% $45,909,415 100.0% $26.52 === ========= ===== =========== ===== ====== (1) Calculated based on base rent payable under the lease for net rentable square feet expiring, without giving effect to free rent or scheduled rent increases that would be taken into account under GAAP and including adjustments for expenses payable by or reimbursable from tenants based on current expense levels. (2) Expirations by quarter are as follows: Q4: 53,797 sf. (3) As of September 30, 2002 leases have been signed for 5,057 net rentable square feet (representing approximately 9% of expiring square footage and including renewed leases and leasing of previously vacant space) commencing in 2002. (4) Expirations by quarter are as follows: Q1: 93,914 sf Q2: 59,276 sf Q3: 76,759 sf Q4: 19,511 sf. (5) As of September 30, 2002 leases have been signed for 31,762 net rentable square feet (representing approximately 13% of expiring square footage and including renewed leases and leasing of previously vacant space) commencing in 2003. 164 Denver Office Properties. PERCENTAGE NET RENTABLE PERCENTAGE OF TOTAL OF ANNUAL FULL- AREA LEASED NET ANNUAL ANNUAL FULL- SERVICE RENT NUMBER OF REPRESENTED RENTABLE AREA FULL-SERVICE SERVICE RENT PER SQUARE TENANTS WITH BY EXPIRING REPRESENTED RENT UNDER REPRESENTED FOOT OF NET YEAR OF LEASE EXPIRING LEASES BY EXPIRING EXPIRING BY EXPIRING RENTABLE AREA EXPIRATION LEASES (SQUARE FEET) LEASES LEASES(1) LEASES EXPIRING(1) ---------- ------ ------------- ------ --------- ------ ----------- 2002 18 98,070(2)(3) 5.0% $ 1,835,797 4.2% $18.72 2003 38 443,555(4)(5) 22.7 9,430,578 21.4 21.26 2004 25 397,378 20.3 8,138,678 18.5 20.48 2005 19 305,935 15.7 6,804,690 15.4 22.24 2006 11 152,776 7.8 3,804,720 8.6 24.90 2007 16 144,301 7.4 3,407,362 7.7 23.61 2008 6 53,787 2.8 1,180,878 2.7 21.95 2009 11 203,472 10.4 5,211,558 11.8 25.61 2010 3 91,074 4.7 2,631,070 6.0 28.89 2011 1 2,478 0.1 52,038 0.1 21.00 2012 and thereafter 1 61,080 3.1 1,599,197 3.6 26.18 --- --------- ----- ----------- ----- ------ 149 1,953,906 100.0% $44,096,566 100.0% $22.57 === ========= ===== =========== ===== ====== (1) Calculated based on base rent payable under the lease for net rentable square feet expiring, without giving effect to free rent or scheduled rent increases that would be taken into account under GAAP and including adjustments for expenses payable by or reimbursable from tenants based on current expense levels. (2) Expirations by quarter are as follows: Q4: 98,070 sf. (3) As of September 30, 2002 leases have been signed for 93,768 net rentable square feet (representing approximately 96% of expiring square footage and including renewed leases and leasing of previously vacant space) commencing in 2002. (4) Expirations by quarter are as follows: Q1: 76,494 sf Q2: 25,845 sf Q3: 57,113 Q4: 284,103 sf. (5) As of September 30, 2002 leases have been signed for 37,031 net rentable square feet (representing approximately 8% of expiring square footage and including renewed leases and leasing of previously vacant space) commencing in 2003. 165 Other Office Properties. PERCENTAGE NET RENTABLE PERCENTAGE OF TOTAL OF ANNUAL FULL- AREA LEASED NET ANNUAL ANNUAL FULL- SERVICE RENT NUMBER OF REPRESENTED RENTABLE AREA FULL-SERVICE SERVICE RENT PER SQUARE TENANTS WITH BY EXPIRING REPRESENTED RENT UNDER REPRESENTED FOOT OF NET YEAR OF LEASE EXPIRING LEASES BY EXPIRING EXPIRING BY EXPIRING RENTABLE AREA EXPIRATION LEASES (SQUARE FEET) LEASES LEASES(1) LEASES EXPIRING(1) ---------- ------ ------------- ------ --------- ------ ----------- 2002 35 176,929(2)(3) 5.7% $ 3,604,746 4.7% $20.37 2003 59 375,965(4)(5) 12.0 8,341,811 10.9 22.19 2004 50 493,183 15.8 12,925,742 16.8 26.21 2005 43 251,907 8.1 6,582,618 8.6 26.13 2006 46 333,691 10.7 8,124,617 10.6 24.35 2007 31 241,618 7.7 6,098,637 7.9 25.24 2008 10 71,799 2.3 1,801,120 2.3 25.09 2009 7 213,161 6.8 5,481,940 7.1 25.72 2010 5 180,377 5.8 5,435,333 7.1 30.13 2011 6 112,163 3.6 4,124,237 5.4 36.77 2012 and thereafter 12 674,898 21.5 14,330,938 18.6 21.23 --- --------- ----- ----------- ----- ------ 304 3,125,691 100.0% $76,851,739 100.0% $24.59 === ========= ===== =========== ===== ====== (1) Calculated based on base rent payable under the lease for net rentable square feet expiring, without giving effect to free rent or scheduled rent increases that would be taken into account under GAAP and including adjustments for expenses payable by or reimbursable from tenants based on current expense levels. (2) Expirations by quarter are as follows: Q4: 176,929 sf. (3) As of September 30, 2002 leases have been signed for 96,679 net rentable square feet (representing approximately 55% of expiring square footage and including renewed leases and leasing of previously vacant space) commencing in 2002. (4) Expirations by quarter are as follows: Q1: 182,728 sf Q2: 52,557 sf Q3: 58,222 sf Q4: 82,458 sf. (5) As of September 30, 2002 leases have been signed for 59,880 net rentable square feet (representing approximately 16% of expiring square footage and including renewed leases and leasing of previously vacant space) commencing in 2003. 166 Crescent Real Estate Hotel Properties The following tables show certain information for the years ended December 31, 2001, and 2000, and the nine months ended September 30, 2002, and 2001, respectively, with respect to Crescent Real Estate's hotel properties. The information for the hotel properties is based on available rooms, except for Canyon Ranch-Tucson and Canyon Ranch-Lenox, which measure their performance based on available guest nights. FOR THE YEAR ENDED DECEMBER 31, ---------------------------------------------- REVENUE AVERAGE AVERAGE PER OCCUPANCY DAILY AVAILABLE YEAR RATE RATE ROOM/GUEST NIGHT COMPLETED/ ROOMS/ ------------- ----------- ---------------- RESORT/HOTEL PROPERTY(1) LOCATION RENOVATED GUEST NIGHTS 2001 2000 2001 2000 2001 2000 ----------------------------------- --------------- --------------- ------------ ----- ----- ---- ---- ---- ---- UPSCALE BUSINESS-CLASS HOTELS: Denver Marriott City Center Denver, CO 1982/1994 613 77% 84% $123 $120 $ 95 $101 Hyatt Regency Albuquerque Albuquerque, NM 1990 395 69 69 108 106 74 73 Omni Austin Hotel Austin, TX 1986 372 68 81 124 133 84 108 Renaissance Houston Hotel Houston, TX 1975/2000 389 64 59 113 95 73 56 ------------ ----- ----- ---- ---- ---- ---- TOTAL/WEIGHTED AVERAGE 1,769 71% 75% $118 $116 $ 83 $ 86 ============ ===== ===== ==== ==== ==== ==== LUXURY RESORTS AND SPAS: Park Hyatt Beaver Creek Resort Avon, CO 1989 276 57% 69% $278 $254 $159 $176 and Spa(2) Sonoma Mission Inn & Spa Sonoma, CA 1927/1987/1997 228 59 75 299 302 176 226 Ventana Inn & Spa Big Sur, CA 1975/1982/1988 62 73 78 420 458 304 358 ------------ ----- ----- ---- ---- ---- ---- TOTAL/WEIGHTED AVERAGE 566 60% 72% $305 $298 $182 $216 ============ ===== ===== ==== ==== ==== ==== GUEST DESTINATION FITNESS RESORTS & SPAS: NIGHTS ----------------------------------- ------ Canyon Ranch-Tucson Tucson, AZ 1980 250(3) Canyon Ranch-Lenox Lenox, MA 1989 212(3) ------------ ----- ----- ---- ---- ---- ---- TOTAL/WEIGHTED AVERAGE 462 81% 86% $622 $593 $482 $487 ============ ===== ===== ==== ==== ==== ==== GRAND TOTAL/WEIGHTED AVERAGE FOR RESORT/HOTEL PROPERTIES 70% 76% $245 $238 $170 $180 ===== ===== ==== ==== ==== ==== (1) As of December 31, 2001, Crescent Real Estate had leased all of the Crescent Real Estate hotel properties, except the Omni Austin Hotel, to subsidiaries of Crescent Operating. As of December 31, 2001, the Omni Austin Hotel was leased pursuant to a separate lease to HCD Austin Corporation. On February 14, 2002, Crescent Real Estate executed the Settlement Agreement with Crescent Operating, pursuant to which Crescent Operating transferred to subsidiaries of Crescent Real Estate, in lieu of foreclosure, Crescent Operating's lessee interests in the eight Crescent Real Estate hotel properties. (2) The hotel is undergoing a $6.9 million renovation of all guestrooms. (3) Represents available guest nights, which is the maximum number of guests that the resort can accommodate per night. 167 YEAR COMPLETED/ ROOMS/ RESORT/HOTEL PROPERTY(1) LOCATION RENOVATED GUEST NIGHTS ------------------------ -------- --------- ------------ UPSCALE BUSINESS-CLASS HOTELS: Denver Marriott City Center Denver, CO 1982/1994 613 Hyatt Regency Albuquerque Albuquerque, NM 1990 395 Omni Austin Hotel Austin, TX 1986 375 Renaissance Houston Hotel Houston, TX 1975/2000 388 ----------- TOTAL/WEIGHTED AVERAGE 1,771 =========== LUXURY RESORTS AND SPAS: Park Hyatt Beaver Creek Resort and Spa Avon Co Avon, CO 1989 275 Sonoma Mission Inn & Spa Sonoma, CA 1927/1987/1997 228 Ventana Inn & Spa Big Sur, CA 1975/1982/1988 62 ----------- TOTAL/WEIGHTED AVERAGE 565 =========== GUEST DESTINATION FITNESS RESORTS & SPAS: NIGHTS Canyon Ranch-Tucson Tucson, AZ 1980 259(2) Canyon Ranch-Lenox Lenox, MA 1989 212(2) ----------- TOTAL/WEIGHTED AVERAGE 471 =========== Luxury and Destination Fitness Resorts combined GRAND TOTAL/WEIGHTED AVERAGE FOR RESORT/HOTEL PROPERTIES FOR THE NINE MONTHS ENDED SEPTEMBER 30, ------------------------------------------------------------------ REVENUE AVERAGE AVERAGE PER OCCUPANCY DAILY AVAILABLE RATE RATE ROOM/GUEST NIGHT ----------------- ---------------- ---------------- RESORT/HOTEL PROPERTY(1) 2002 2001 2002 2001 2002 2002 ---- ---- ---- ---- ---- ---- UPSCALE BUSINESS-CLASS HOTELS: Denver Marriott City Center 77% 81% $119 $124 $ 92 $100 Hyatt Regency Albuquerque 73 70 106 106 77 74 Omni Austin Hotel 70 69 117 126 82 87 Renaissance Houston Hotel 62 65 111 113 69 74 ---- ---- ---- ---- ---- ---- TOTAL/WEIGHTED AVERAGE 71% 72% $114 $118 $ 81 $ 85 ==== ==== ==== ==== ==== ==== LUXURY RESORTS AND SPAS: Park Hyatt Beaver Creek Resort and Spa Avon Co 61% 62% $294 $290 $180 $178 Sonoma Mission Inn & Spa 63 63 268 299 169 188 Ventana Inn & Spa 73 75 394 423 286 316 ---- ---- ---- ---- ---- ---- TOTAL/WEIGHTED AVERAGE 63% 64% $296 $311 $187 $198 ==== ==== ==== ==== ==== ==== DESTINATION FITNESS RESORTS & SPAS: Canyon Ranch-Tucson Canyon Ranch-Lenox ---- ---- ---- ---- ---- ---- TOTAL/WEIGHTED AVERAGE 80% 83% $628 $621 $478 $490 ==== ==== ==== ==== ==== ==== Luxury and Destination Fitness Resorts combined 71% 72% $463 $469 $319 $331 ---- GRAND TOTAL/WEIGHTED AVERAGE FOR RESORT/HOTEL PROPERTIES 71% 72% $244 $249 $172 $178 ==== ==== ==== ==== ==== ==== (1) As of December 31, 2001, Crescent Real Estate had leased all of the Crescent Real Estate hotel properties, except the Omni Austin Hotel, to subsidiaries of Crescent Operating. As of December 31, 2001, the Omni Austin Hotel was leased pursuant to a separate lease to HCD Austin Corporation. On February 14, 2002, Crescent Real Estate executed the Settlement Agreement with Crescent Operating, pursuant to which Crescent Operating transferred to subsidiaries of Crescent Real Estate, in lieu of foreclosure, Crescent Operating's lessee interests in the eight Crescent Real Estate hotel properties previously leased to Crescent Operating. (2) Represents available guest nights, which is the maximum number of guests that the resort can accommodate per night. 168 Crescent Real Estate Residential Development Properties The following table shows certain information as of September 30, 2002, relating to the Crescent Real Estate residential development properties. TOTAL TOTAL RESIDENTIAL RESIDENTIAL TOTAL LOTS/UNITS LOTS/UNITS RESIDENTIAL DEVELOPMENT DEVELOPMENT LOTS/ DEVELOPED CLOSED DEVELOPMENT PROPERTIES TYPE OF CORPORATION'S UNITS SINCE SINCE CORPORATION(1) (RDP) RDP(2) LOCATION OWNERSHIP% PLANNED INCEPTION INCEPTION -------------- ----- ------ -------- ---------- ------- --------- --------- Desert Mountain Desert Mountain SF Scottsdale, AZ 93.0% 2,665 2,354 2,234 Development ------- -------- --------- Corporation The Woodlands The Woodlands SF The Woodlands, TX 42.5%(6) 37,554 26,772 25,290 ------------- -- ----------------- ------------ ------- -------- --------- Land Company, Inc. Crescent Bear Paw Lodge CO Avon, CO 60.0% 53 53 53 Resort Eagle Ranch SF Eagle, CO 60.0% 1,100(6) 535 484 Development, Main Street Inc. Junction CO Breckenridge, CO 30.0% 36 36 30 Main Street Station CO Breckenridge, CO 30.0% 82 82 77 Main Street Station Vacation Club TS Breckenridge, CO 30.0% 42 42 21 Riverbend SF Charlotte, NC 60.0% 650 205 205 Three Peaks (Eagle's Nest) SF Silverthorne, CO 30.0% 391(6) 253 184 Park Place at Riverfront CO Denver, CO 64.0% 70(6) 70 64 Park Tower at Riverfront CO Denver, CO 64.0% 61(6) 61 49 Promenade Lofts at Riverfront CO Denver, CO 64.0% 66(6) 66 60 Cresta TH/SFH Edwards, CO 60.0% 25(6) 20 18 Snow Cloud CO Avon, CO 64.0% 54 54 48 One Vendue Range CO Charleston, SC 62.0% 50(6) -- -- Tahoe Mountain Resorts SF/CO/TH/TS Tahoe, CA 57.0% - 71.2% (7) (7) (7) ------- ----------- --------- ------------ ------- -------- --------- TOTAL CRESCENT RESORT DEVELOPMENT, INC. 2,680 1,477 1,293 --------------------------------------- ------- -------- --------- Mira Vista Mira Vista SF Fort Worth, TX 100.0% 740 740 707 Development The Highlands SF Breckenridge, CO 12.3% 750 503 456 Corp. ------- -------- --------- TOTAL MIRA VISTA DEVELOPMENT CORP. 1,490 1,243 1,163 ---------------------------------- ------- -------- --------- Houston Area Falcon Point SF Houston, TX 100.0% 510 364 326 Development Falcon Landing SF Houston, TX 100.0% 623 566 539 Corp. Spring Lakes SF Houston, TX 100.0% 520 338 303 ------------ -- ----------- ------------ ------- -------- --------- TOTAL HOUSTON AREA DEVELOPMENT CORP. 1,653 1,268 1,168 ------------------------------------ ------- -------- --------- TOTAL 46,042 33,114 31,148 ===== ======= ======== ========= 169 AVERAGE RESIDENTIAL CLOSED RANGE OF RESIDENTIAL DEVELOPMENT SALE PRICE PROPOSED DEVELOPMENT PROPERTIES TYPE OF PER LOT/ SALE PRICES CORPORATION(1) (RDP) RDP(2) LOCATION UNIT($)(3) PER LOT/UNIT($)(4) ----- ------ -------- ---------- ------------------ Desert Mountain Desert Mountain SF Scottsdale, AZ 522,000 400,000 - 4,000,000(5) Development Corporation The Woodlands The Woodlands SF The Woodlands, TX 58,000 16,000 - 2,160,000 Land Company, Inc. Crescent Bear Paw Lodge CO Avon, CO 1,450,000 665,000 - 2,025,000 Resort Eagle Ranch SF Eagle, CO 80,000 50,000 - 150,000 Development, Main Street Inc. Junction CO Breckenridge, CO 460,000 300,000 - 580,000 Main Street Station CO Breckenridge, CO 490,000 215,000 - 1,065,000 Main Street Station Vacation Club TS Breckenridge, CO 1,129,000 380,000 - 4,600,000 Riverbend SF Charlotte, NC 30,000 25,000 - 38,000 Three Peaks (Eagle's Nest) SF Silverthorne, CO 257,000 135,000 - 425,000 Park Place at Riverfront CO Denver, CO 415,000 195,000 - 1,445,000 Park Tower at Riverfront CO Denver, CO 640,000 180,000 - 2,100,000 Promenade Lofts at Riverfront CO Denver, CO 426,000 180,000 - 2,100,000 Cresta TH/SFH Edwards, CO 1,874,000 1,230,000 - 3,434,000 Snow Cloud CO Avon, CO 1,714,000 840,000 - 4,545,000 One Vendue Range CO Charleston, SC N/A 450,000 - 3,100,000 Tahoe Mountain Resorts SF/CO/TH/TS Tahoe, CA N/A N/A N/A TOTAL CRESCENT RESORT DEVELOPMENT , INC. Mira Vista Mira Vista SF Fort Worth, TX 99,000 50,000 - 265,000 Development The Highlands SF Breckenridge, CO 193,000 55,000 - 625,000 Corp. TOTAL MIRA VISTA DEVELOPMENT CORP. Houston Area Falcon Point SF Houston, TX 42,000 28,000 - 52,000 Development Falcon Landing SF Houston, TX 21,000 20,000 - 26,000 Corp. Spring Lakes SF Houston, TX 31,000 35,000 - 50,000 TOTAL HOUSTON AREA DEVELOPMENT CORP. TOTAL (1) As of December 31, 2001, Crescent Real Estate had an approximately 95%, 95%, 90%, 94%, and 94% ownership interest in Desert Mountain Development Corporation, The Woodlands Land Company, Inc., Crescent Resort Development, Inc., Mira Vista Development Corp. and Houston Area Development Corp., respectively, through ownership of non-voting common stock in each of these Residential Development Corporations. On February 14, 2002, Crescent Real Estate executed an agreement with COPI, pursuant to which COPI transferred to subsidiaries of Crescent Real Estate, in lieu of foreclosure, COPI's ownership interests, representing substantially all of the voting stock, in Desert Mountain Development Corporation, The Woodlands Land Company, Inc. and Crescent Resort Development, Inc. (2) SF (Single-Family Lots); CO (Condominium); TH (Townhome); SFH (Single-Family Homes) and TS (Timeshare Equivalent Units). (3) Based on lots/units close during Crescent Real Estate's ownership period. (4) Based on existing inventory of developed lots and lots to be developed. (5) Includes golf membership, which as of September 30, 2002, is $0.2 million. (6) As of September 30, 2002, 65 golf course lots were under contract at Eagle Ranch representing $4.6 million in sales; one unit was under contract at Park Place at Riverfront representing $0.2 million in sales; three units were under contract at Park Tower at Riverfront representing $2.4 million in sales; two units were under contract at Promenade Lofts representing $0.8 million in sales; one unit was under contract at Cresta representing $2.6 million in sales; four lots were under contract at Three Peaks representing $1.2 million in sales and 45 units were under contract at One Vendue Range representing $53.9 million in sales. (7) This project is in the early stages of development, and this information is not available as of September 30, 2002. 170 Crescent Real Estate Temperature-Controlled Logistics Properties The following table shows the number and aggregate size of the Crescent Real Estate temperature-controlled logistics properties by state as of September 30, 2002: TOTAL CUBIC TOTAL NUMBER OF FOOTAGE SQUARE FEET STATE PROPERTIES(1) (IN MILLIONS) (IN MILLIONS) ----------------- ------------- ------------- ------------- Alabama 4 10.7 0.3 Arizona 1 2.9 0.1 Arkansas 6 33.1 1.0 California 8 24.9 0.9 Colorado 1 2.8 0.1 Florida 5 7.5 0.3 Georgia 8 49.5 1.7 Idaho 2 18.7 0.8 Illinois 2 11.6 0.4 Indiana 1 9.1 0.3 Iowa 2 12.5 0.5 Kansas 2 5.0 0.2 Kentucky 1 2.7 0.1 Maine 1 1.8 0.2 Massachusetts 5 10.5 0.5 Mississippi 1 4.7 0.2 Missouri(2) 2 46.8 2.8 Nebraska 2 4.4 0.2 New York 1 11.8 0.4 North Carolina 3 10.0 0.4 Ohio 1 5.5 0.2 Oklahoma 2 2.1 0.1 Oregon 6 40.4 1.7 Pennsylvania 2 27.4 0.9 South Carolina 1 1.6 0.1 South Dakota 1 2.9 0.1 Tennessee 3 10.6 0.4 Texas 2 6.6 0.2 Utah 1 8.6 0.4 Virginia 2 8.7 0.3 Washington 6 28.7 1.1 Wisconsin 3 17.4 0.6 ------------- ------------- ------------- TOTAL 88(3) 441.5(3) 17.5(3) ============= ============= ============= (1) As of September 30, 2002, Crescent Real Estate held a 40% interest in the temperature-controlled logistics partnership, which owns AmeriCold Corporation, which directly or indirectly owns the 88 temperature-controlled logistics properties. The business operations associated with the temperature-controlled logistics properties are owned by AmeriCold Logistics, in which Crescent Real Estate has no interest. AmeriCold Corporation is entitled to receive lease payments from AmeriCold Logistics. (2) Includes an underground storage facility, with approximately 33.1 million cubic feet. (3) As of September 30, 2002, AmeriCold Logistics operated 101 temperature-controlled logistics properties with an aggregate of approximately 537.9 million cubic feet (20.6 million square feet). LEGAL PROCEEDINGS Currently, there are no material pending legal proceedings, other than ordinary routine litigation incidental to Crescent Real Estate's business, to which Crescent Real Estate is a party or to which any of its property is the subject. CRESCENT OPERATING MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Settlement Agreement discussed above provides for a bankruptcy plan of Crescent Operating to be implemented under Chapter 11 of the Bankruptcy Code. In addition, all of Crescent Operating's assets in its hospitality and land development segments were transferred to Crescent Real Estate pursuant to the Settlement Agreement. See "The Reorganization Transactions - Summary of the Reorganization Transactions" for more information about the Settlement Agreement. 171 Crescent Operating is a diversified management company that, through various subsidiaries and affiliates, operated, prior to the February 14 and March 22, 2002 asset transfers, primarily in four business segments: - equipment sales and leasing; - hospitality; - temperature-controlled logistics; and - land development. See "Description of Crescent Operating's Business" above for more information about Crescent Operating's business segments. As of September 30, 2002, the only remaining operating assets of Crescent Operating were its 40% interest in AmeriCold Logistics, LLC and its 100% equity interest in Crescent Machinery. The following discussion should be read in conjunction with the "Selected Historical Financial Information of Crescent Operating" and the financial statements and notes thereto, appearing elsewhere in this proxy statement/prospectus. Historical results and percentage relationships set forth below and in "Selected Historical Financial Information of Crescent Operating" should not be taken as indicative of future operations of Crescent Operating. The following table sets forth financial data for Crescent Operating for the three and nine months ended September 30, 2002 and for the years ended December 31, 2001, 2000 and 1999. For the For the For the Three Months Ended Nine Months Ended Year Ended September 30, 2002 September 30, 2002 December 31, 2001 ------------------ ------------------ ----------------- (dollars in thousands) REVENUES Equipment sales & leasing $ 7,757 $ 25,992 $ 67,521 Hospitality -- -- -- ---------- ---------- ---------- Total Revenues 7,757 25,992 67,521 OPERATING EXPENSES Equipment sales & leasing 8,624 29,340 71,113 Hospitality Hospitality properties rent-CEI -- -- -- Land development -- -- -- Corporate general and administrative 451 2,677 6,969 Impairment of assets -- 34 12,332 ---------- ---------- ---------- Total operating expenses 9,075 32,051 90,414 ---------- ---------- ---------- (LOSS) INCOME FROM OPERATIONS (1,318) (6,059) (22,893) ---------- ---------- ---------- INVESTMENT (LOSS) INCOME -- (4,127) 1,135 EQUITY IN LOSS OF UNCONSOLIDATED SUBSIDIARIES -- (2,142) (2,275) OTHER EXPENSE (INCOME) Interest expense 1,487 5,037 13,241 Interest income (5) (12) -- Gain on lease termination of hotel and sale of club -- -- -- Other 47 221 1,417 ---------- ---------- ---------- Total other expense (income) 1,529 5,246 14,658 ---------- ---------- ---------- LOSS FROM CONTINUING OPERATIONS BEFORE REORGANIZATION COSTS (2,847) (17,574) (38,691) For the For the Year Ended Year Ended December 31, 2000 December 31, 1999 ----------------- ----------------- (dollars in thousands) REVENUES Equipment sales & leasing $ 69,976 $ 62,311 Hospitality 32,615 35,304 ---------- ---------- Total Revenues 102,591 97,615 OPERATING EXPENSES Equipment sales & leasing 68,710 58,799 Hospitality 22,582 24,649 Hospitality properties rent-CEI 8,102 9,105 Land development -- 18 Corporate general and administrative 4,224 2,604 Impairment of assets -- -- ---------- ---------- Total operating expenses 103,618 95,175 ---------- ---------- (LOSS) INCOME FROM OPERATIONS (1,027) 2,440 ---------- ---------- INVESTMENT (LOSS) INCOME 772 1,890 EQUITY IN LOSS OF UNCONSOLIDATED SUBSIDIARIES (6,952) (3,472) OTHER EXPENSE (INCOME) Interest expense 14,123 11,993 Interest income (439) (458) Gain on lease termination of hotel and sale of club -- -- Other 762 19 ---------- ---------- Total other expense (income) (5,406) 11,554 ---------- ---------- LOSS FROM CONTINUING OPERATIONS BEFORE REORGANIZATION COSTS (1,851) (10,696) 172 REORGANIZATION ITEMS REORGANIZATION FEES 871 2,015 -- ---------- ---------- ---------- LOSS FROM OPERATIONS AFTER REORGANIZATION COSTS, BEFORE TAXES (3,718) (19,589) (38,691) INCOME TAX BENEFIT (707) (2,710) (8,591) ---------- ---------- ---------- LOSS FROM CONTINUING OPERATIONS (3,011) (16,879) (30,100) DISCONTINUED OPERATIONS (LOSS) INCOME FROM OPERATIONS OF DISCONTINUED HOSPITALITY AND LAND DEVELOPMENT SEGMENTS (LESS APPLICABLE INCOME TAX EXPENSE OF $0, $2,502, $7,966, $14,664, AND $6,505, AND MINORITY INTERESTS OF $0, $1,897, $(13,588), $(26,018) AND $(14,112) -- 3,272 (5,817) LOSS FROM OPERATIONS OF DISCONTINUED EQUIPMENT SALES AND LEASING BRANCHES (LESS APPLICABLE INCOME TAX BENEFIT OF $0, $0, $(1,968), $(1,988) AND $(874) (553) (2,998) (32,707) GAIN ON DISPOSAL OF HOSPITALITY AND LAND DEVELOPMENT SEGMENTS (LESS APPLICABLE INCOME TAX EXPENSE OF $0, $17,876, $0, $0, AND $0) -- 26,813 -- ---------- ---------- ---------- (LOSS) INCOME FROM DISCONTINUED OPERATIONS (553) 27,087 (38,524) INCOME (LOSS) BEFORE ACCOUNTING CHANGE (3,564) 10,208 (68,624) CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE -- -- (9,509) ---------- ---------- ---------- NET INCOME (LOSS) $ (3,564) $ 10,208 $ (78,133) ========== ========== ========== REORGANIZATION ITEMS REORGANIZATION FEES -- -- ---------- ---------- LOSS FROM OPERATIONS AFTER REORGANIZATION COSTS, BEFORE TAXES (1,851) (10,696) INCOME TAX BENEFIT (929) (9,102) ---------- ---------- LOSS FROM CONTINUING OPERATIONS (922) (1,594) DISCONTINUED OPERATIONS (LOSS) INCOME FROM OPERATIONS OF DISCONTINUED HOSPITALITY AND LAND DEVELOPMENT SEGMENTS (LESS APPLICABLE INCOME TAX EXPENSE OF $0, $2,502, $7,966, $14,664 AND $6,505 AND MINORITY INTERESTS OF $0, $1,897, $(13,588), $(26,018) AND $(14,112) 106 319 LOSS FROM OPERATIONS OF DISCONTINUED EQUIPMENT SALES AND LEASING BRANCHES (LESS APPLICABLE INCOME TAX BENEFIT OF $0, $0, $(1,968), $(1,988) AND $(874) (2,874) (1,420) GAIN ON DISPOSAL OF HOSPITALITY AND LAND DEVELOPMENT SEGMENTS (LESS APPLICABLE INCOME TAX EXPENSE OF $0, $17,876, $0, $0, AND $0) -- -- ---------- ---------- (LOSS) INCOME FROM DISCONTINUED OPERATIONS (2,768) (1,101) INCOME (LOSS) BEFORE ACCOUNTING CHANGE (3,690) (2,695) CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE -- -- ---------- ---------- NET INCOME (LOSS) $ (3,690) $ (2,695) ========== ========== 173 The following is a summary of Crescent Operating's estimated financial information reported by segment for the three and nine months ended September 30, 2002, respectively. As Crescent Operating only operated its hospitality and land development segments for one and one-half months in 2002, there is no information available for these segments. SEGMENT FINANCIAL INFORMATION FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2002 (DOLLARS IN THOUSANDS) EQUIPMENT TEMPERATURE SALES CONTROLLED AND LEASING LOGISTICS OTHER TOTAL ----------- --------- ----- ----- Revenues ...................... $ 7,757 $ -- $ -- $ 7,757 Operating expenses ............ 8,624 -- 451 9,075 ----------- ----------- ----------- ----------- Loss from operations .......... (867) -- (451) (1,318) Investment loss ............... -- -- -- -- Equity in Earnings of unconsolidated Subsidiaries .................. -- -- -- -- Other (income) expense Interest expense ........ 166 -- 1,321 1,487 Interest income ......... (2) -- (3) (5) Other ................... 48 -- (1) 47 ----------- ----------- ----------- ----------- Total other expense ........... 212 -- 1,317 1,529 ----------- ----------- ----------- ----------- Loss from operations before reorganization costs .......... (1,079) -- (1,768) (2,847) Reorganization Costs Professional fees ...... 871 -- -- 871 ----------- ----------- ----------- ----------- Loss from operations before income taxes .................. (1,950) -- (1,768) (3,718) Income tax benefit ............ -- -- (707) (707) ----------- ----------- ----------- ----------- Loss from continuing operations $ (1,950) $ -- $ (1,061) $ (3,011) =========== =========== =========== =========== SEGMENT FINANCIAL INFORMATION FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 (DOLLARS IN THOUSANDS) EQUIPMENT TEMPERATURE SALES CONTROLLED AND LEASING LOGISTICS OTHER TOTAL ----------- --------- ----- ----- Revenues ...................... $ 25,992 $ -- $ -- $ 25,992 Operating expenses ............ 29,340 -- 2,711 32,051 ----------- ----------- ----------- ----------- Loss from operations .......... (3,348) -- (2,711) (6,059) Investment loss ............... -- -- (4,127) (4,127) Equity in Earnings of unconsolidated Subsidiaries .................. -- (2,142) -- (2,142) Other (income) expense Interest expense ........ 1,074 -- 3,963 5,037 Interest income ......... (3) -- (9) (12) Other ................... 217 -- 4 221 ----------- ----------- ----------- ----------- Total other expense ........... 1,288 -- 3,958 5,246 ----------- ----------- ----------- ----------- Loss from operations before reorganization costs .......... (4,636) (2,142) (10,796) (17,574) Reorganization Costs Professional fees ...... 2,015 -- -- 2,015 ----------- ----------- ----------- ----------- Loss from operations before income taxes .................. (6,651) (2,142) (10,796) (19,589) Income tax benefit ............ -- (283) (2,427) (2,710) ----------- ----------- ----------- ----------- Loss from continuing operations $ (6,651) $ (1,859) $ (8,369) $ (16,879) =========== =========== =========== =========== 174 The following is a summary of Crescent Operating's estimated financial information reported by segment for the year ended December 31, 2001: SEGMENT FINANCIAL INFORMATION (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) EQUIPMENT TEMPERATURE- SALES CONTROLLED LAND AND LEASING HOSPITALITY LOGISTICS DEVELOPMENT OTHER TOTAL ----------- ----------- --------- ----------- ----- ----- Revenues ..................................... $ 67,521 $ -- $ -- $ -- $ -- $ 67,521 Operating expenses ........................... 83,445 -- 21 -- 6,948 90,414 --------- --------- --------- --------- --------- --------- Loss from operations ......................... 15,924 -- (21) -- (6,948) (22,893) Investment loss .............................. -- -- -- -- 1,135 1,135 Equity in Losses of unconsolidated subsidiaries .............................. -- -- (2,275) -- -- (2,275) Other (income) expense Interest expense ....................... 4,133 -- -- -- 9,070 13,203 Interest income ........................ (8) -- -- -- 46 38 Other .................................. 1,419 -- -- -- (2) 1,417 --------- --------- --------- --------- --------- --------- Total other expense .......................... 5,544 -- -- -- 9,114 14,658 --------- --------- --------- --------- --------- --------- Loss income before income taxes .............. (21,468) -- (2,296) -- (14,927) (38,691) Income tax provision (benefit)................ 1,816 -- (919) -- (5,856) (8,591) --------- --------- --------- --------- --------- --------- Loss from continuing operations............... (19,652) -- (1,377) -- (9,071) (30,100) Discounted operations (note 4 of Financial Statements of Crescent Operating) (Loss) income from operations of discontinued Hospitality and Land Development segments (less applicable income tax expense of $7,966 and minority interests of $(13,588)........ -- (8,536) -- 2,719 -- (5,817) Loss from operations of discontinued equipment and sales and leasing branches less applicable income tax benefit of $(1,968)................ (32,707) -- -- -- -- (32,707) --------- --------- --------- --------- --------- --------- (Loss) income from discontinued operations.... (32,707) (8,536) -- 2,719 -- (38,524) --------- --------- --------- --------- --------- --------- (Loss) income before accounting change ....... (52,359) (8,536) (1,377) 2,719 (9,071) (68,624) Cumulative effect of change in accounting principle ...................... -- -- -- -- (9,509) (9,509) --------- --------- --------- --------- --------- --------- Net (loss) income ........................... $ (52,359) $ (8,536) $ (1,377) $ 2,719 $ (18,580) $ (78,133) ========= ========= ========= ========= ========= ========= 175 RECENT DEVELOPMENTS For a description of events that have occurred subsequent to September 30, 2001, see "Summary - Other Crescent Operating Recent Developments" above. RESULTS OF OPERATIONS Three and Nine Months ended September 30, 2002, as Compared to Three and Nine Months Ended September 30, 2001 Revenues. Total revenue, which consists of equipment sales and leasing revenue, decreased $11.2 million, or 58.9%, to $7.8 million for the three months ended September 30, 2002, compared with $19.0 million for the three months ended September 30, 2001. Total revenue decreased $24.9 million, or 48.9%, to $26.0 million for the nine months ended September 30, 2002, compared with $50.9 million for the nine months ended September 30, 2001. Significant components of the decreases were: - a net decrease of $7.3 million and $13.2 million in new and used equipment sales for the three and nine months ended September 30, 2002 as compared to the corresponding periods in 2001 primarily due to the slowing economy and the impact of the Chapter 11 bankruptcy process on Crescent Machinery's business; - a decrease of $0.9 million and $3.3 million in parts, service and supplies revenue for the three and nine months ended September 30, 2002 as compared to the corresponding periods in 2001 primarily due to decreased demand for maintenance and repair work and the impact of the Chapter 11 bankruptcy process on Crescent Machinery's business; and - a decrease of $3.0 million and $8.4 million in rental revenue for the three and nine months ended September 30, 2002 as compared to the corresponding period in 2001 primarily due to the slowing economy and the impact of the Chapter 11 bankruptcy process on Crescent Machinery's business. Operating Expenses. Total operating expenses decreased $16.8 million, or 64.9%, to $9.1 million for the three months ended September 30, 2002, compared with $25.9 million for the three months ended September 30, 2001. Total operating expenses decreased $38.7 million, or 54.7%, to $32.1 for the nine months ended September 30, 2002, compared with $70.8 million for the nine months ended September 30, 2001. The decreases in total operating expenses are attributable to the factors discussed in the following paragraphs. Equipment Sales and Leasing Segment Equipment sales and leasing expenses decreased $11.7 million, or 57.6%, to $8.6 million for the three months ended September 30, 2002, compared with $20.3 million for the three months ended September 30, 2001. Equipment sales and leasing expenses decreased $23.1 million, or 44.1%, to $29.3 million for the nine months ended September 30, 2002, compared with $52.4 million for the nine months ended September 30, 2001. Significant components of the decreases were: 176 - a decrease of $7.2 million and $12.3 million in new and used equipment expenses for the three and nine months ended September 30, 2002 as compared to the corresponding periods in 2001 directly related to the decrease in new and used equipment revenue; - a decrease of $0.6 million and $2.5 million in parts, service and supplies expenses for the three and nine months ended September 30, 2002 as compared to the corresponding periods in 2001 primarily as a result of the decrease in parts, service and supplies revenues for the same periods; - a $2.3 million and a $5.5 million decrease in rental expenses for the three and nine months ended September 30, 2002 as compared to the corresponding periods in 2001 primarily due to the decrease in rental revenue for the three and nine months ended September 30, 2002; and - a decrease of $1.6 million and $2.8 million in general and administrative expenses for the three and nine months ended September 30, 2002 as compared to the corresponding periods in 2001 primarily due to cost reduction measures put into place. Corporate General and Administrative Expenses Corporate general and administrative expenses totaled $0.5 million and $2.7 million for the three and nine months ended September 30, 2002, respectively, as compared to $0.5 million and $1.5 million for the three and nine months ended September 30, 2001. The increases are primarily related to increases in general corporate overhead costs, such as legal and accounting costs, related to the Settlement Agreement and the proposed prepackaged bankruptcy. Investment Income (Loss). There was no investment income (loss) for the three months ended September 30, 2002. Investment income (loss) decreased $10.1 million or 168%, to a $4.1 million loss for the nine months ended September 30, 2002, compared with income of $6.0 million for the nine months ended September 30, 2001. The decreases are attributable to the decreases in the fair value of Crescent Operating's Magellan warrants resulting in investment losses as compared with income for the corresponding period in 2001. Equity in Earnings (Loss) of Unconsolidated Subsidiaries. There was no equity in earnings (loss) of unconsolidated subsidiaries for the three months ended September 30, 2002 due to Crescent Operating not recording any additional losses related to its investment in AmeriCold Logistics for the three months ended September 30, 2002 due to Crescent Operating's share of historical losses being in excess of its investment balance. Equity in earnings (loss) of unconsolidated subsidiaries decreased $2.3 million or 52.3%, to a loss of ($2.1) million for the nine months ended September 30, 2002, compared with a loss of $4.4 million for the nine months ended September 30, 2001. The nine month decrease was primarily due to equity in loss of AmeriCold Logistics in the amount of ($0.7) million and to the realization of other comprehensive income (loss) of ($1.4) million. Other (Income) Expense. Other (income) expense decreased $0.4 million, or 21.1%, to $1.5 million for the three months ended September 30, 2002, compared with $1.9 million for the three months ended September 30, 2001. 177 For the nine months ended September 30, 2002, other (income) expenses decreased $2.5 million, or 32.5%, to $5.2 million, compared with $7.7 million for the nine months ended September 30, 2001. Significant components of the decreases were primarily attributable to net decreases in interest expense of $1.7 million for the nine months ended September 30, 2002. Reorganization Items Crescent Operating incurred $0.9 million and $2.0 million in professional fees for the three and nine months ended September 30, 2002 due to Crescent Machinery Company's reorganization through bankruptcy that were not incurred during the corresponding periods in 2001. Income Tax Provision (Benefit). Income tax benefit of $0.7 million for the three months ended September 30, 2002 represents a decrease of $0.5 million from the $1.2 million benefit provided for the three months ended September 30, 2001. Income tax benefit of $2.7 million for the nine months ended September 30, 2002 represents a decrease of $1.7 million from the $4.4 million benefit provided for the nine months ended September 30, 2001. Income tax provision attributable to discontinued operations for the nine months ended September 30, 2002 was comprised of a $2.2 million expense for the hospitality segment and a $0.3 million expense for the land development segment. Income tax provision for the nine months ended September 30, 2002 of $17.9 was attributable to the gain from the disposal of discontinued operations resulting primarily from the cancellation of corporate level indebtedness pursuant to the Settlement Agreement. Crescent Operating generally provides for taxes using a 40% effective rate on Crescent Operating's share of income or loss. Management continues to evaluate its ability to realize the deferred tax assets quarterly by assessing the need for a valuation allowance. An inability of Crescent Operating to execute business plans for certain of its segments could affect the ultimate realization of the deferred tax assets. Minority Interests. Minority interests were eliminated as a result of the assignment of the land development and hospitality segments to Crescent Real Estate pursuant to the Settlement Agreement. Discontinued Operations. Pursuant to the Settlement Agreement, Crescent Operating transferred its interests in the hospitality and land development segments as of February 14, 2002 and March 22, 2002. Crescent Operating had a deminimus loss from discontinued operations related to the hospitality and land development segments for the three months ending September 30, 2002. Crescent Operating realized income from discontinued operations of $3.3 million, after minority interest of $1.9 million and a $2.5 million income tax expense, related to the hospitality and land development segments for the nine months ended September 30, 2002. The gain on disposal of discontinued operations was zero for the three months ended September 30, 2002 and $26.8 million, net of a $17.9 million income tax expense, for the nine months ended September 30, 2002. In December 2001, Crescent Operating adopted Statements of Financial Accounting Standards SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 broadens the definition of what constitutes a discontinued operation and how the results of a discontinued operation are to be measured and presented. During the second and third quarters of 2002, Crescent Machinery closed down six branch locations and is currently in the process of closing one 178 additional branch location. Crescent Operating realized a $2.5 million decrease in loss from discontinued operations related to the equipment sales and leasing segment for the three months ended September 30, 2002 as compared to the corresponding period in 2001. Crescent Operating realized a $2.4 million decrease in loss from discontinued operations related to the equipment sales and leasing segment for the nine months ended September 30, 2002 as compared to the corresponding period in 2001. The decreases for the three and nine months ended September 30, 2002 as compared to the three and nine months ended September 30, 2001 are primarily attributable to the timing of the closings of the discontinued branch locations. Cumulative Effect of Change in Accounting Principal. Cumulative effect of change in accounting principle decreased $9.5 million, or 100%, for the nine months ended September 30, 2002 as compared to the corresponding period in 2001. The change from the prior period was due to the prior year's adoption of SFAS No. 133 on January 1, 2001, whereby Crescent Operating realized a $9.5 million loss related to its investment in Magellan warrants, calculated as the difference between the original cost of the Magellan warrants of $12.5 million and their estimated fair value at December 31, 2001, $3.0 million, as calculated using the Black-Scholes pricing model. Year Ended December 31, 2001, as Compared to 2000 Revenues. Total revenue decreased $35.1 million, or 34.2%, to $67.5 million for the year ended December 31, 2001, compared with $102.6 million for the year ended December 31, 2000. The decrease in total revenue is attributable to the following: Equipment Sales and Leasing Segment Equipment sales and leasing revenue decreased $2.5 million, or 3.6%, to $67.5 million for the year ended December 31, 2001, compared with $70.0 million for the year ended December 31, 2000. The decrease in revenue is discussed below. In addition, Crescent Operating believes that revenue was impacted significantly and negatively by the general recession and additionally as a consequence of the September 11, 2001 terrorist attacks against the United States and the continuing threat of terrorism as certain industries reduce their construction expenditures. - a decrease of $1.3 million in new and used equipment sales due to weaker market conditions and increased demand from customers for rentals as compared to purchases; and - a decrease in parts, service and supplies revenue of $1.6 million for the current year primarily due to decreased demand for maintenance and repair work; partially offset by - an increase in rental revenue of $0.4 million during the year ended December 31, 2001 primarily due to same store rental growth. Hospitality Segment Hospitality revenue from continuing operations decreased $32.6 million, or 100%, for the year ended December 31, 2001 as compared to hospitality revenue from continuing operations of $32.6 million for the year ended December 31, 2000. The decrease in revenue was due to the sale of the Four Seasons Hotel in Houston on November 3, 2000. 179 Operating Expenses. Total operating expenses decreased $13.2 million, or 12.7%, to $90.4 million for the year ended December 31, 2001, compared with $103.6 million for the year ended December 31, 2000. The increase in operating expenses is attributable to the following: Equipment Sales and Leasing Segment Equipment sales and leasing expenses increased $14.7 million, or 21.4%, to $83.4 million for the year ended December 31, 2001, compared with $68.7 million for the year ended December 31, 2000. Significant components of the overall increase were: - an adjustment of $12.3 million related to impairment of property, equipment and goodwill at Crescent Machinery; - a $2.1 million increase in rental expenses due mainly to an increase in rental inventory resulting in increased depreciation expense and maintenance costs for the year ended December 31, 2001; partially offset by - an increase of $1.0 million in general and administrative expenses due primarily to increases in corporate payroll, insurance expenses and professional fees; and - a $0.5 million increase expenses in new and used equipment expenses; partially offset by - a $1.2 million decrease in parts, service and supplies expenses due primarily to reductions in sales of new and used equipment. Hospitality Segment Hospitality expenses from continuing operations decreased $30.7 million, or 100%, for the year ended December 31, 2001 as compared to hospitality expenses from continuing operations of $30.7 million for the year ended December 31, 2000. The decrease was due to the sale of the Four Seasons Hotel in Houston on November 3, 2000. 180 Corporate General and Administrative Expenses. Corporate general and administrative expenses increased $2.8 million, or 66.7%, to $7.0 million for the year ended December 31, 2001, compared with $4.2 million for the year ended December 31, 2000. These expenses consisted of general corporate overhead costs, such as legal and accounting costs, insurance costs and corporate salaries. The increase over prior year is primarily attributable to (i) a reserve recorded by Crescent Operating for amounts due from Crescent Operating, Inc. Voluntary Employees' Beneficiary Association Health Care Plan, (ii) management fees payable to SunTx under the Management Agreement and (iii) professional fees incurred in connection with the proposed restructuring of Crescent Operating. Investment Income. 181 Investment income increased $0.4 million or 57.1%, to $1.1 million for the year ended December 31, 2001, compared with $0.7 million for the year ended December 31, 2000. Significant components of the overall increase were: o an increase in investment income of Magellan warrants in the amount of $1.1 million; partially offset by o no gains on sales of investments in 2001 compared to gains on sale of CS I and CS II in the amount of $0.7 million which occurred in 2000. Equity in Losses of Unconsolidated Subsidiaries Equity in losses of unconsolidated subsidiaries decreased $4.7 million or 67.1% to $(2.3) million for the year ended December 31, 2001, compared with loss of $(7.0) million for the year ended December 31, 2000. Significant components of the overall decrease were: o no equity in income of Transportal Network as compared to income of $0.4 million in 2000, partially offset by o a decrease in equity in loss of AmeriCold Logistics in the amount of $5.1 million. Other Expense (Income) Other expense (income) decreased $20.1 million to $14.7 million for the year ended December 31, 2001, compared with income of $(5.4) million for the year ended December 31, 2000. Significant components of the decrease were: o no gain on sale of the Four Seasons Hotel in Houston of $18.3 million; o no gain on sale of the Houston Center Athletic Club of $1.6 million; o a decrease in interest expense of $0.9 million for the year ended December 31, 2001 primarily due to lower debt balances as compared to the year ended December 31, 2000; and o a decrease in interest income in the amount of $0.4 million due to a put option to sell Crescent Operating's remaining 20% of its 5% interest in the temperature controlled logistics partnerships in 2000; partially offset by o an increase in other expense in the amount of $0.7 million due to increases in bad debt expense within the equipment sales and leasing segment. Income Tax (Benefit) Provision. Income tax benefit of $8.6 million for the year ended December 31, 2001 represents an increase of $7.7 million from the year ended December 31, 2000. Income tax benefit consisted of a $5.9 million benefit at the corporate level, a $1.8 million benefit for the Equipment Sales and Leasing segment, and a $0.9 million benefit for the Temperature Controlled Logistics segment. Management continues to evaluate its ability to realize the deferred tax assets quarterly by assessing the need for a valuation allowance. An inability of Crescent Operating to execute business plans for certain of Crescent Operating's segments could affect the ultimate realization of the deferred tax assets. Minority Interests Minority interest s were eliminated as a result of the assignment of the land development and hospitality segments to Crescent Real Estate pursuant to the Settlement Agreement. Discontinued Operations On January 1, 2002, Crescent Operating adopted Statements of Financial Accounting Standards SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No.144 broadens the definition of what constitutes a discontinued operation and how the results of a discontinued operation are to be measured and presented. Pursuant to the Settlement Agreement, Crescent Operating transferred its interests in the hospitality and land development segments as of February 14, 2002 and March 22, 2002. Crescent Operating has reclassed results from operations for the hospitality and land development segments as discontinued operations for the years ended December 31, 2001, 2000 and 1999. Crescent Operating realized losses from discontinued operations of $5.8 million after minority interest of $13.6 million and a $8.0 million income tax expense, related to the hospitality and land development segments for the year ended December 31, 2001, as compared to income from discontinued operations of $0.1 million after minority interest of $26.0 million and income tax expense of $14.7 million, for the year ended December 31, 2000. Significant components of the $5.9 million decrease in discontinued operations related to the hospitality and land development segments were: o decrease in income from the hospitality segment due to decreases in occupancy from weaker market conditions; and o fewer home sales and member ships within the land development segment due to weaker market conditions. In addition, during 2002, Crescent Machinery closed down ten branch locations. Crescent Operating realized a loss $32.7 million, net of income tax benefit of $2.0 million, from discontinued operations related to the equipment sales and leasing segment for the year ended December 31, 2001 as compared to a loss of $2.9 million, net of income tax benefit of $2.0 million for the year ended December 31, 2000. Significant components of the $29.8 million decrease were: o an adjustment of $26.9 million related to impairment of property; equipment and goodwill at the closed branches; and o decreases in new and used equipment income and parts, supplies and service income due to weaker market conditions and increased demand for rentals as compared to purchases. Year Ended December 31, 2000, as Compared to 1999 Revenues. 182 Total revenue increased $5.0 million, or 5.1%, to $102.6 million for the year ended December 31, 2000, compared with $97.6 million for the year ended December 31, 1999. The increase in total revenue is attributable to the following: Equipment Sales and Leasing Segment Equipment sales and leasing revenue increased $7.7 million, or 12.4%, to $70.0 million for the year ended December 31, 2000, compared with $62.3 million for the year ended December 31, 1999. Significant components of the increase were: o an increase in rental revenue of $6.4 million during the year ended December 31, 2000 primarily due to acquisitions since January 1, 1999 and same store rental growth; and o an increase in parts, service and supplies revenue of $4.7 million for the current year primarily due to increased demand for maintenance and repair work; partially offset by o a decrease of $3.4 million in new and used equipment sales due to increased demand from customers for rentals as compared to purchases. Hospitality Segment Hospitality revenue from continuing operations decreased $2.7 million, or 7.6%, to $32.6 million for the year ended December 31, 2000 as compared to hospitality revenue from continuing operations of $35.3 million for the year ended December 31, 1999. The $2.7 million decrease in revenue was due to the sale of the Four Seasons Hotel in Houston on November 3, 2000. 183 Operating Expenses. Total operating expenses increased $8.4 million, or 8.8%, to $103.6 million for the year ended December 31, 2000, compared with $95.2 million for the year ended December 31, 1999. The increase in operating expenses is attributable to the following: Equipment Sales and Leasing Segment Equipment sales and leasing expenses increased $9.9 million, or 16.8%, to $68.7 million for the year ended December 31, 2000, compared with $58.8 million for the year ended December 31, 1999. Significant components of the overall increase were: - a $6.4 million increase in rental expenses due mainly to an increase in rental inventory resulting in increased depreciation expense for the year ended December 31, 2000; - a $3.2 million increase in operating expenses due primarily to acquisitions since January 1, 1999 and to the startup of the Fort Worth location in late 1999; and - a $1.4 million increase in parts, service and supplies expenses as a result of an increase in parts, service and supplies revenue; partially offset by - a $1.1 million decrease in new and used equipment expenses as a result of a decrease in new and used equipment sales. 184 Hospitality Segment Hospitality expenses from continuing operations decreased $3.1 million, or 9.2%, to $30.7 million for the year ended December 31, 2000 as compared to hospitality expenses from continuing operations of $33.8 million for the year ended December 31, 1999. The decrease of $3.1 million was due to the sale of the Four Seasons Hotel in Houston on November 3, 2000. Corporate General and Administrative Expenses. Corporate general and administrative expenses increased $1.6 million, or 61.5%, to $4.2 million for the year ended December 31, 2000, compared with $2.6 million for the year ended December 31, 1999. These expenses consisted of general corporate overhead costs, such as legal and accounting costs, insurance costs and corporate salaries. The increase over prior year is primarily attributable to (i) costs of approximately $0.5 million incurred in connection with proceedings in bankruptcy court and litigation outside of bankruptcy court arising from Crescent Operating's ownership interest in CBHS, (ii) professional fees of approximately $0.6 million incurred in connection with the proposed restructuring of Crescent Operating and (iii) transaction costs of approximately $0.5 million incurred by Crescent Operating in conjunction with the negotiation, execution and termination of the asset purchase agreement with CBHS. Investment Income. Investment income decreased $1.2 million or 63.2%, to $0.7 million for the year ended December 31, 2000, compared with $1.9 million for the year ended December 31, 1999. Significant components of the overall decrease were: - a decrease in gain on sale of CS I and CS II of $0.8 million to $0.7 million for the year ended December 31, 2000 as compared to a gain of $1.5 million for the year ended December 31, 1999; - no recognition of income of $0.2 million from the investment in Hicks Muse as it was sold in 1999; and - no gain on sale from the Corporate Arena of $0.2 million recognized for the year ended December 31, 1999. 185 Equity in Income (Loss) of Unconsolidated Subsidiaries Equity in income (loss) of unconsolidated subsidiaries increased $3.5 million or 100%, to $(7.0) million for the year ended December 31, 2000, compared with losses of $3.5 million for the year ended December 31, 1999. Significant components of the overall increase were: - an increase in equity in loss of AmeriCold Logistics in the amount of $3.7 million partially due to holding the investment for a full year as compared to ten months in the prior year as well as increased labor costs; - a decrease in equity in income of HCAC in the amount of $0.3 million; and - a decrease in equity in income of CS I and CS II in the amount of $0.3 million; partially offset by - a decrease in equity in loss of Transportal Network in the amount of $0.8 million. Other Expense (Income) Other expense (income) decreased $17.0 million, or 147%, to $(5.4) million for the year ended December 31, 2000, compared with $11.6 million for the year ended December 31, 1999. Significant components of the decrease were: - gain on lease termination resulting from sale of the Four Seasons Hotel in Houston of $18.3 million; and - gain on sale of the Houston Center Athletic Club of $1.6 million; partially offset by - an increase in interest expense in the amount of $2.1 million for the year ended December 31, 2000, resulting from an increase in outstanding indebtedness in connection with acquisitions; and - to an increase in other expense in the amount of $0.8 million due to increases in bad debt expense within the equipment sales and leasing segment. Income Tax Benefit Income tax benefit of $0.9 million for the year ended December 31, 2000 represents a decrease of $8.2 million from the year ended December 31, 1999. Income tax benefit consisted of a $4.4 million benefit at the corporate level, a $1.8 million benefit for the equipment sales and leasing segment and a $3.0 million benefit for the temperature controlled logistics segment partially offset by income tax expense for the hospitality segment of $8.2 million. Management continues to evaluate its ability to realize the deferred tax assets quarterly by assessing the need for a valuation allowance. An inability of Crescent Operating to execute business plans for certain of the company's segments could affect the ultimate realization of the deferred tax assets. Minority Interests Minority interest were eliminated as a result of the assignment of the land development and hospitality segments to Crescent Equities pursuant to the Settlement Agreement. Discontinued Operations On January 1, 2002, Crescent Operating adopted Statements of Financial Accounting Standards SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No.144 broadens the definition of what constitutes a discontinued operation and how the results of a discontinued operation are to be measured and presented. Pursuant to the Settlement Agreement, Crescent Operating transferred its interests in the hospitality and land development segments as of February 14, 2002 and March 22, 2002. Crescent Operating has reclassed results from operations for the hospitality and land development segments remaining at December 31, 2001 as discontinued operations for the year ended December 31, 2001, 2000, and 1999. Crescent Operating realized income from discontinued operations of $0.1 million after minority interest of $14.7 million and a $22.9 million income tax expense, related to the hospitality and land development segments for the year ended December 31, 2000, as compared to income from discontinued operations of $0.3 million after minority interest of $14.1 million and income tax expense of $6.5 million, for the year ended December 31, 1999. Significant components of the $0.2 million decrease were: - decreased income from the land development segment due to fewer home and lot sales as compared to the prior year; partially offset by - increase income at Sonoma Mission Inn and Spa which can be attributed to the 30 additional guest rooms completed in April 2000, the return of 20 rooms in January 2000 which were taken out of commission in February 1999 to house a temporary spa during the construction of the 30,000 square foot full-service spa, as well as increased rates in the current year as compared to discounted rates used in the prior year during the construction period; and - income from the Renaissance Hotel, which was first leased by the Crescent Operating in June 1999; - increased income from the hospitality segment due to increased rates and occupancy as compared to 1999. During 2002, Crescent Machinery closed down ten branch locations. Crescent Operating realized a loss $2.9 million, net of income tax benefit of $2.0 million, from discontinued operations related to the equipment sales and leasing segment for the year ended December 31, 2000 as compared to a loss of $1.4 million, net of income tax benefit of $0.9 million for the year ended December 31, 1999. Significant components of the $1.5 million increase were: o an increase in loss during the year ended December 31, 2000 as compared to the year ended December 31, 1999 primarily due to a full year recognition of operations from acquisitions throughout 1999; and o a decrease in demand of new and used equipment due to increased demand from customers for rentals as compared to purchases. LIQUIDITY AND CAPITAL RESOURCES Recognizing that cash flow from its assets would not provide Crescent Operating with adequate capital to meet its requirements during 2000 and 2001, Crescent Operating, during the first quarter of 2000, extended certain payment obligations by reaching agreements with Crescent Real Estate to defer 186 until February 2001 payments on certain of Crescent Operating's obligations to Crescent Real Estate otherwise scheduled to be made in 2000. During 2001, Crescent Operating and Crescent Partnership agreed to modify certain debt agreements, subject to the consummation of the proposed restructuring transactions, to (i) defer principal and interest payments until the earlier of December 31, 2001 or the close of the transaction contemplated by the Purchase Agreement and (ii) cease the accrual of interest on certain debt instruments as of May 1, 2001. Because the transactions contemplated by the Purchase Agreement were not consummated, the condition was not met, and the modifications became ineffective. In addition, in August 2001, November 2001 and again in March 2002, with an effective date of December 2001, Crescent Operating modified the due date of its line of credit with Bank of America to be August 15, 2002. On August 14, 2002, the maturity date of Crescent Operating's line of credit with Bank of America was further extended to January 15, 2003, and Crescent Operating prepaid interest for that time period in the amount of $0.3 million. Crescent Operating, with the consent of Crescent Partnership which agreed to subordinate its security interest in Crescent Operating's 40% interest in AmeriCold Logistics, pledged all of its interest in AmeriCold Logistics to Bank of America to secure the loan. In January 2003, Bank of America further extended the maturity of this loan to March 15, 2003 and Crescent Operating agreed to prepay an additional two months of interest at the loan's current rate. In addition, the recession, magnified by the September 11, 2001 terrorist attacks, has placed significant pressure on Crescent Operating's ability to meet its obligations as they come due. Consequently, Crescent Operating and its operating units have defaulted in the payment of their obligations owed to Crescent Real Estate and Crescent Partnership. Based upon current and reasonably forecasted operating results, Crescent Operating will not be able to pay all of its obligations as they come due. In addition, Crescent Operating's auditors report included on the consolidated financial statements included in its 2001 Annual Report on Form 10-K expressed substantial doubt about Crescent Operating's ability to continue to operate as a going concern. In February 2002, Crescent Operating was notified by Crescent Real Estate that Crescent Operating's obligations to Crescent Real Estate were in default. Moreover, Crescent Real Estate announced that it would seek to enforce collection by foreclosure or otherwise of its claims against Crescent Operating and its operating units as quickly as possible. Crescent Operating was unable to repay the debts to Crescent Real Estate as to which a default had been declared. Crescent Operating did not have sufficient liquidity to pay its liabilities on a current basis. In light of these factors, Crescent Operating entered into the Settlement Agreement with Crescent Real Estate. The Settlement Agreement significantly restricts Crescent Operating's ability to access capital resources. Among other things, the Settlement Agreement limits Crescent Operating's ability to incur additional indebtedness, incur liens, pay dividends or make certain other restrictive payments. Based on these restrictions in the Settlement Agreement and Crescent Operating's current financial condition, it is unlikely that Crescent Operating would have access to any third-party financing. In connection with the Settlement Agreement, Crescent Real Estate did provide Crescent Operating with a $8.6 million facility to provide liquidity and payment of specific expenditures during the pendency of the bankruptcy case. This facility was amended effective October 2002 to decrease the availability of funds to $6.3 million. A second facility was entered into effective October 2002 to provide $2.9 million of additional funds to Crescent Operating through the pendency of the bankruptcy case which is expected to occur in the first quarter of 2003. Pursuant to this facility, Crescent Real Estate will fund only Crescent Operating's out-of-pocket operating expenses through the bankruptcy. Even with this financing, it is unlikely that Crescent Operating will be able to fund its working capital requirements. Interest payments and rent payments due to Crescent Real Estate, accrued but deferred as of September 30, 2002, totaled approximately $9.2 million and $23.7 million, respectively, and as of December 31, 2001 totaled approximately $6.4 million and $41.2 million, respectively. Nine Months ended September 30, 2002 Cash Flows. 187 Cash and cash equivalents include amounts from all consolidated subsidiaries, including subsidiaries not wholly owned. Changes, therefore, do not necessarily represent increases or decreases in cash directly available to Crescent Operating. Cash and cash equivalents were $4.8 million and $13.9 million at September 30, 2002 and December 31, 2001, respectively. See "Note 1. Organization and Basis of Presentation," included in the Financial Statements of Crescent Operating for the nine months ended September 30, 2002. The 65% decrease is attributable to $11.1 million and $3.5 million of cash used in investing and financing activities, respectively, partially offset by $5.6 million of cash provided by operating activities. Operating Activities Net cash flows provided by operating activities for the nine months ended September 30, 2002 were $5.6 million compared with net cash used in operating activities of $166.2 million for the nine months ended September 30, 2001. Crescent Operating's inflow of cash provided by operating activities of $5.6 million was primarily attributable to inflows from: - net income of $10.2 million; - a decrease in accounts receivable of $6.1 million; - a decrease in inventories of $4.0 million; and - an increase in accounts payable and accrued expenses - Crescent Real Estate of $3.2 million. The inflow of cash provided by operating activities was partially offset by outflows from: - an increase in prepaid expenses and current assets of $0.8 million; and - a decrease in accounts payable of $1.5 million. Investing Activities Net cash flows used in investing activities for the nine months ended September 30, 2002 were $11.1 million compared with net cash provided by investing activities of $6.3 million for the nine months ended September 30, 2001. Crescent Operating's outflow of cash used in investing activities of $11.1 million was primarily attributable to outflows from disposition of business interests, net of cash transferred of $15.8 million. The outflow of cash used in investing activities was partially offset by inflows from net proceeds from the sale of property and equipment of $4.8 million. Financing Activities Net cash flows used in financing activities for the nine months ended September 30, 2002 were $3.5 million compared with net cash provided by financing activities of $133.3 million for the nine 188 months ended September 30, 2001. Crescent Operating's outflow of cash used in financing activities of $3.5 million was primarily attributable to outflow from payments of all long-term debt of $7.1 million. The outflow of cash provided by financing activities was partially offset by inflows from: - proceeds of all long-term debt of $3.6 million. Year ended December 31, 2001 Cash Flows Cash and cash equivalents include amounts from all consolidated subsidiaries, including subsidiaries not wholly owned. Changes, therefore, do not necessarily represent increases or decreases in cash directly available to Crescent Operating. Cash and cash equivalents were $0.5 million and $1.0 million at December 31, 2001 and December 31, 2000, respectively. See "Note 1. Organization and Basis of Presentation," included in the Financial Statements of Crescent Operating for the year ended December 31, 2001. The 50.0% decrease is attributable to $14.2 million and $118.7 million of cash provided by investing and financing activities, respectively, partially offset by $133.4 million of cash used in operating activities. Operating Activities Net cash flows used in operating activities for the year ended December 31, 2001 were $133.4 million compared with the net cash used in operating activities of $46.4 million and $9.1 million for the years ended December 31, 2000 and 1999, respectively. Crescent Operating's outflow of cash used in operating activities of $133.4 million was primarily attributable to outflows from: - net operating activities of discontinued operations of $136.7 million; - net loss of $78.1 million; and - a decrease in other assets of $0.5 million. The outflow of cash used in operating activities was partially offset by: - decrease in inventories of $15.8 million; - decrease in accounts receivable of $11.2 million; and - decrease in prepaid expenses and current assets of $0.6 million. Investing Activities Net cash flows provided by investing activities for the year ended December 31, 2001 were $14.2 million compared with the net cash provided by investing activities of $20.4 million and the net cash used in investing activities of $34.5 million for the years ended December 31, 2000 and 1999, respectively. Crescent Operating's inflow of cash provided by investing activities of $14.2 million was primarily attributable to inflows from proceeds from the sale of property and equipment of $22.4 million, and net investing activities of discontinued operations of $13.0 million. 189 The inflow of cash provided by investing activities was partially offset by purchases of property and equipment of $21.1 million. Financing Activities. Net cash flows provided by financing activities for the year ended December 31, 2001 were $118.7 million compared with the net cash provided by financing activities of $27.0 million and $40.1 million for the years ended December 31, 2000 and 1999, respectively. Crescent Operating's inflow of cash provided by financing activities of $118.7 million was primarily attributable to inflows from net financing activities of discontinued operations of $156.2 million and proceeds of all long-term debt of $39.8 million. The inflow of cash provided by financing activities was partially offset by payments of all long-term debt of $77.4 million. Financing Attributable to Corporate and Wholly Owned Subsidiaries. As of December 31, 2001, financing instruments attributable to corporate and wholly owned subsidiaries were as follows: - During 2001, Bank of America extended the maturity date of Crescent Operating's $15.0 million unsecured bank line of credit from Bank of America, first from August 2001 to November 2001, then from November 2001 to the earlier of December 31, 2001 or the close of the Purchase Agreement, then in March 2002, with an effective date of December 31, 2001, from December 2001 to August 2002 and finally in August 2002, from August 2002 to January 2003. Crescent Operating, with the consent of Crescent Partnership which agreed to subordinate its security interest in Crescent Operating's 40% interest in AmeriCold Logistics, pledged all of its interest in AmeriCold Logistics to Bank of America to secure the loan. The line of credit bears interest at the bank's prime rate and all principal and unpaid interest on the line of credit is payable January 15, 2003. In January 2003, Bank of America further extended the maturity of this loan to March 15, 2003 and Crescent Operating agreed to prepay an additional two months of interest at the loan's current rate. The $15.0 million available under the line of credit from Bank of America is fully drawn. - In connection with the formation and capitalization of Crescent Operating in the second quarter of 1997, Crescent Operating received approximately $14.1 million in cash from Crescent Partnership and Crescent Partnership loaned Crescent Operating approximately $35.9 million pursuant to a five-year term loan, maturing on May 8, 2002, of which approximately $16.2 million was outstanding as of December 31, 2001. The loan is a recourse loan that is collateralized, to the extent not prohibited by pre-existing arrangements, by a first lien on the assets which Crescent Operating now owns or may acquire in the future. The loan bears interest at the rate of 12% per annum, compounded quarterly, with required quarterly principal and interest payments limited by quarterly cash flow of Crescent Operating as defined in the applicable credit agreement. - Effective March 12, 1999, Crescent Operating agreed to make a permanent reduction in its $30.4 million 12% line of credit with Crescent Partnership commensurate with the proceeds from the sale of 80% of Crescent Operating's 2% interest in the temperature-controlled logistics partnerships. On March 12, 1999, Crescent Operating received $13.2 million of proceeds and correspondingly permanently reduced the availability under the line of credit from $30.4 million 190 to $17.2 million. The line of credit bears interest at the rate of 12% per annum, compounded quarterly, payable on an interest-only basis during its term, which expires on the later of (i) May 21, 2002 or (ii) five years after the last draw under the line of credit (in no event shall the maturity date be later than June 2007). Draws may be made under the line of credit until June 22, 2002. The line of credit is a recourse obligation and amounts outstanding thereunder are collateralized, to the extent not prohibited by pre-existing arrangements, by a first lien on the assets which Crescent Operating now owns or may acquire in the future. The line of credit is cross-collateralized and cross-defaulted with Crescent Operating's other borrowings from Crescent Partnership. As of December 31, 2001, $20.2 million was outstanding under the line of credit. - Also effective March 12, 1999, Crescent Operating obtained from Crescent Partnership a $19.5 million line of credit bearing interest at a rate of 9% per annum. The line of credit is payable on an interest-only basis during its term, which expires in May 2002. The note is cross-collateralized and cross-defaulted with Crescent Operating's other borrowings from Crescent Partnership. Upon inception of this line of credit, Crescent Operating immediately borrowed the full $19.5 million with which it contributed approximately $15.5 million in connection with the formation of AmeriCold Logistics and used the remaining $4.0 million of proceeds to reduce the amount outstanding under the 12% line of credit with Crescent Partnership. As of December 31, 2001, $22.0 million was outstanding under the line of credit. - Crescent Operating funded its contribution to COPI Colorado using the proceeds from a $9.0 million term loan from Crescent Partnership. The loan bears interest at 12% per annum, with interest payable quarterly and the full original principal amount of $9.0 million, together with any accrued but unpaid interest, payable in May 2002. Crescent Operating's interest in COPI Colorado secures the loan, which is cross-collateralized and cross-defaulted with Crescent Operating's other borrowings from Crescent Partnership. As of December 31, 2001, $10.6 million was outstanding under the line of credit. - As a part of the acquisitions of E.L. Lester and Company and Harvey Equipment Center, Inc., Crescent Operating issued notes payable in the amount of $6.0 million and $1.2 million, respectively. The Lester and Harvey notes are payable in semi-annual principal and interest payments and bear interest at 7.5% and 8.0%, respectively. All principal and unpaid interest on the Harvey and Lester notes are due July 2002 and July 2003, respectively. The Lester note is collateralized by stock of E.L. Lester and Company. As of December 31, 2001, the outstanding balances on the Lester and Harvey notes were $2.5 million and $0.3 million, respectively. - Crescent Machinery has various equipment notes payable and floor plan notes under credit facilities which are collateralized by the equipment financed. The equipment notes are payable in monthly principal and interest payments and bear interest at 4.5% to 9.5% per annum and mature in 2002 due to defaults in payments. The floor plan notes do not bear interest, do not require monthly principal or interest payments and generally have terms ranging from three to twelve months. As of December 31, 2001, the outstanding balance on the equipment notes was $80.7 million and on the floor plan notes was $4.2 million. At December 31, 2001, Crescent Machinery was in default on its loans from commercial institutions because of its nonpayment of required principal payments with outstanding principal amounts under default by Crescent Machinery of $84.9 million at December 31, 2001. Subsequent to December 31, 2001, the following events occurred involving such financing instruments: - On February 15, 2002, Crescent Partnership purchased the Lester and Harvey notes from the note holders. 191 - Due to its bankruptcy filing and to non-payment of required principal payments, Crescent Machinery is currently in default on its equipment financing notes. Outstanding principal amounts under default by Crescent Machinery totaled $84.9 million at December 31, 2001. On February 6, 2002, Crescent Machinery Company filed a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code with the U.S. Bankruptcy Court in Fort Worth, Texas. - On February 13, 2002, Crescent Operating received notice from Crescent Partnership that it was in default on the 1997 term loan, the 1997 revolving loan, the AmeriCold loan and the COPI Colorado loan. On February 14, 2002, pursuant to the Settlement Agreement, Crescent Partnership foreclosed on certain collateral securing such loans, which had the effect of reducing the aggregate indebtedness from $76.2 million to $36.1 million. Financing Attributable to Non Wholly Owned Subsidiaries. As of December 31, 2001, financing instruments attributable to non wholly owned subsidiaries were as follows: - Desert Mountain Properties has a credit agreement with Crescent Partnership pursuant to which Crescent Partnership has advanced funds to Desert Mountain Properties through a "Junior Note". The Junior Note evidences a $60.0 million advance from Crescent Partnership to Desert Mountain Properties and accrues interest at 14% per annum. The principal and interest on the Junior Note is payable in quarterly installments, based on proceeds from the operations of Desert Mountain Properties. As of December 31, 2001, the outstanding balance of the Junior Note was $59.0 million. - Desert Mountain Properties entered into a $50.0 million credit facility with National Bank of Arizona in May 1998. The facility was amended in December 2001. The facility is comprised of (i) a $40.0 million line of credit available for vertical financing related to new home construction and bears an annual interest at the prime rate and (ii) a $10.0 million line of credit available for borrowings against certain notes receivable issued by Desert Mountain Properties and bears an annual interest rate of prime plus 1%. The credit facility expires November 2003 with interest payable monthly, collateralized by land owned by Desert Mountain Properties, deeds of trust on lots sold and home construction. As of December 31, 2001, the outstanding balance on the line of credit with National Bank of Arizona was $29.9 million. - Desert Mountain Properties has an unsecured promissory note payable to Crescent Partnership for $1.0 million. The note bears interest at 10%, with payments of interest due in quarterly installments. Payment of principal is due at the note's expiration of December 31, 2002. - CRDI has four lines of credit with Crescent Partnership. The first line of credit of $56.2 million bears interest at 11.5% per annum, compounded annually. Principal and interest payments are due as distributions from projects are received, as defined by the applicable agreement. The line of credit is due August 2004. As of December 31, 2001, $48.4 million was outstanding on the $56.2 million line of credit. The second line of credit of $100.0 million bears interest at 11.5% per annum, compounded annually. Principal and interest payments are due as distributions from projects are received, as defined by the applicable agreement. The line of credit is due September 2008. As of December 31, 2001, $72.3 million was outstanding on the $100.00 million line of credit. The third line of credit with Crescent Partnership for $40.0 million bears interest at 11.5% per annum. Principal and interest payments are due as distributions are received, as defined by the applicable credit agreement. The line of credit is due December 2006. As of December 31, 2001, $23.4 million was outstanding on the $40.0 million line of credit. The fourth line of credit with Crescent Partnership for $70.0 million bears interest at 11.5% per annum. Principal and interest payments are due as distributions are received, as defined by the applicable credit 192 agreement. The line of credit is due December 2006. As of December 31, 2001, $36.6 million was outstanding on the $70.0 million line of credit. The lines of credit are collateralized by CRDI's interests in East West Resort Development partnerships, East West Resorts, LLC and other CRDI property. Generally, CRDI's loans with Crescent Partnership are cross-collateralized and cross-defaulted. - The operating entities in which CRDI invests have various construction loans for East West projects which are collateralized by deeds of trust, security agreements and a first lien on the assets conveyed. The notes are payable in monthly principal and interest payments and bear interest at 4.4% to 11.3% per annum. The notes mature between 2002 and 2003. As of December 31, 2001, the outstanding balance on these construction notes was $136.6 million in the aggregate. - CRL has a line of credit with Crescent Partnership in the amount of $7.0 million bearing interest at a rate of 12% per annum. The line of credit is due August 2003. The principal and interest are payable as CRL receives distributions pursuant to the CR License Operating Agreement and the CR Las Vegas Operating Agreement. The $7.0 million available under the line of credit was fully drawn as of December 31, 2001. - In July 2000, CRL obtained from Crescent Partnership a $0.2 million term note bearing interest at a rate of 12% per annum. The full original principal amount of $0.2 million, together with any accrued but unpaid interest is due August 2003. As of December 31, 2001, $0.2 million was outstanding on the note. In February and March 2002, in accordance with the Settlement Agreement, Crescent Operating transferred its equity interest in each of the debtors to Crescent Partnership. On a consolidated basis, this had an impact of transferring debt of $414.3 million at December 31, 2001 back to Crescent Partnership. CRITICAL ACCOUNTING POLICIES Crescent Operating's discussion and analysis of financial condition and results of operations is based on its consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires Crescent Operating to make estimates and judgments that affect the reported amounts of assets, liabilities, and contingencies as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Crescent Operating evaluates its assumptions and estimates on an on-going basis. Crescent Operating bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Crescent Operating believes the following critical accounting policies affect the more significant judgments and estimates used in the preparation of its consolidated financial statements. Inventories Inventories consist of new and used equipment held for sale and equipment parts, all of which are stated at the lower of cost or market using the first-in, first-out or specific identification methods. Property and Equipment Property and equipment is recorded at cost. Crescent Operating uses the straight-line method of depreciation for financial statement purposes. The estimated useful lives used in computing depreciation are as follows: Rental Equipment................................... 2-10 years Transportation equipment........................... 3-5 years Furniture, fixtures, and other equipment.......... 5-10 years From time-to-time, Crescent Machinery offers its rental customers the opportunity to purchase rented equipment for a stated value at a future point in time. In such instances, Crescent Machinery depreciates the specific rental item in accordance with the contract. Expenditures for maintenance and repairs are charged to expense as incurred. Expenditures for renewals or betterments are capitalized. The cost of property replaced, retired, or otherwise disposed of is removed from the asset account along with the related accumulated depreciation. Long-lived assets are evaluated when indications of impairment are present, and provisions from possible losses are recorded when undiscounted cash flows estimated to be generated by those assets are less than the asset's carrying value. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK At December 31, 2001, Crescent Operating had fixed and variable rate notes payable and lines of credit subject to market risk related to changes in interest rates, none of which were entered into for trading purposes. Crescent Operating endeavored to manage its market risk by attempting to match anticipated inflow of cash from its operating, investing and financing activities with anticipated outflow of cash to fund debt payments, investments and other cash requirements. Crescent Operating has not used derivative financial instruments to manage interest rate risk. As of December 31, 2001, Crescent Operating's subsidiaries had amounts outstanding under variable rate notes payable and lines of credit totaling $242.1 million, with a weighted average interest rate of 10.5% per annum. A hypothetical 10% increase in the weighted average interest rate on Crescent Operating's variable rate notes and lines of credit would cause a $2.5 million increase in interest expense and a decrease in Crescent Operating's earnings and cash flows of $0.7 million, based on the amount of variable rate debt outstanding as of December 31, 2001. Crescent Operating ceased either to own or to control such subsidiaries in February 2002 and thus ceased to have market interest rate exposure with respect to those instruments. As of December 31, 2001, Crescent Operating had amounts outstanding under fixed rate notes payable and lines of credit totaling $345.0 million, with a weighted average interest rate of 11.4% per annum. Hypothetically, if market interest rates were substantially lower than the rates on Crescent Operating's fixed rate notes and credit lines, Crescent Operating would be able to reduce interest expense 193 if it were able to prepay and/or refinance those instruments. However, as explained elsewhere in this proxy statement/prospectus, Crescent Operating is unable to prepay or refinance any of those instruments, either because Crescent Operating in February 2002 ceased either to own or to control subsidiaries holding such instruments or because such instruments have matured due to Crescent Operating's payment default. Since December 31, 2001, there have been no material changes to the information regarding market risk. CRESCENT REAL ESTATE MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS You should read this section in conjunction with the selected financial data and the consolidated financial statements and the accompanying notes in the Financial Statements of Crescent Real Estate, respectively, of this proxy statement/prospectus. Historical results and percentage relationships set forth in these Items and this section should not be taken as indicative of future operations of Crescent Real Estate. SEGMENT INFORMATION The economic slowdown in the third quarter of 2001, combined with the events of the September 11, 2001 have had an adverse impact on resort/hotel operations and lot sales primarily at the Desert Mountain residential development property. However, the office property portfolio, which represents approximately 59% of total assets, continues to be stable with same-store weighted average occupancy in excess of 90% and average remaining lease term of approximately five years at September 30, 2002. Although management does not expect full recovery of these investment segments in the near-term, Crescent Real Estate remains committed to its fundamental investment segments. The following sections include information for each of Crescent Real Estate's investment segments for the three and nine months ended September 30, 2002 and the year ended December 31, 2001. Office Segment Crescent Real Estate owned or had an interest in 74 office properties as of December 31, 2001 and 73 office properties (including three retail properties) as of September 30, 2002. The following tables show the same-store net operating income growth for the approximately 25.4 million square feet of office property space owned as of December 31, 2001 and the approximately 24.1 million square feet of office property space owned as of September 30, 2002. These amounts exclude approximately 1.5 million square feet of office property space at Bank One Center, in which Crescent Real Estate owns a 50% equity interest, approximately 1.5 million square feet of office property space at Four Westlake Park, Bank One Tower and Three Westlake Park, in each of which Crescent Real Estate has a 20% equity interest, approximately 0.1 million square feet of office property space at Avallon IV, which was completed during the year ended December 31, 2001, approximately 0.8 million square 194 feet of office property space at Miami Center, in which Crescent Real Estate owns a 40% equity interest, approximately 0.6 million square feet of office property space at 5 Houston Center, which was completed on September 16, 2002 and in which Crescent Real Estate owns a 25% equity interest, and approximately 0.7 million square feet of office property space at Johns Manville Plaza, which Crescent Real Estate acquired on August 29, 2002. FOR THE THREE MONTHS ENDED SEPTEMBER 30, FOR THE NINE MONTHS ENDED SEPTEMBER 30, ---------------------------------------- --------------------------------------- PERCENTAGE/ PERCENTAGE/ POINT INCREASE POINT INCREASE 2002 2001 (DECREASE) 2002 2002 (DECREASE) ---- ---- ---------- ---- ---- ---------- (IN MILLIONS) Same-store Revenues(1) $129.0 $132.5 (2.6)% $392.3 $395.0 (0.7)% Same-store Expenses (58.9) (60.5) (2.6)% (181.5) (180.0) 0.8% ------ ------ ---- ------ ------ ---- Net Operating Income $ 70.1 $ 72.0 (2.6)% $210.8 $215.0 (2.0)% ====== ====== ==== ====== ====== ==== Weighted Average Occupancy 89.7% 93.0% (3.3) pts 90.1% 93.2% (3.1) pts ------ ------ ---- ------ ------ ---- FOR THE YEAR ENDED DECEMBER 31, ------------------------------- PERCENTAGE/ POINT INCREASE 2001 2000 (DECREASE) ---- ---- ---------- (IN MILLIONS) Same-store Revenues $552.5 $519.9 6.3% Same-store Expenses (250.1) (229.3) 9.1% ------ ------ ------ Net Operating Income $302.4 $290.6 4.1% ====== ====== ====== Weighted Average Occupancy 92.3% 91.8% 0.5 pt ------ ------ ------ The following tables show renewed or re-leased leasing activity and the percentage increase of leasing rates for signed leases compared to expiring leases at Crescent Real Estate's office properties owned as of the three and nine months ended September 30, 2002 and the year ended December 31, 2001. FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2002, ---------------------------------------------- EXPIRING PERCENTAGE SIGNED LEASES LEASES INCREASES ------------- ------ --------- Renewed or re-leased(1) 1,108,000 sq ft 1,108,000 sq ft N/A Weighted average full-service rental rate(2) $22.24 per sq ft $23.70 per sq ft (6)% FFO annual net effective rental rate(3) (4) $12.26 per sq ft $14.04 per sq ft (13)% ---------- (1) Excludes termination fees. FOR THE SIX MONTHS ENDED SEPTEMBER 30, 2002, -------------------------------------------- EXPIRING PERCENTAGE SIGNED LEASES LEASES INCREASES ------------- ------ --------- Renewed or re-leased(1) 2,165,000 sq ft 2,165,000 sq ft. N/A Weighted average full-service rental rate(2) $22.02 per sq ft $22.27 per sq ft (1)% FFO annual net effective rental rate(3) (4) $12.13 per sq ft $12.56 per sq ft (3)% FOR THE YEAR ENDED DECEMBER 31, 2001 ------------------------------------ EXPIRING PERCENTAGE SIGNED LEASES LEASES INCREASES ------------- ------ --------- Renewed or re-leased(1) 1,890,000 sq ft N/A N/A Weighted average full-service rental rate(2) $23.67 per sq ft $20.21 per sq ft 17% FFO annual net effective rental rate(3) (4) $14.70 per sq ft $11.21 per sq ft 31% ---------- (1) All of which have commenced or will commence during the next 12 months. 195 (2) Including free rent, scheduled rent increases taken into account under GAAP and including adjustments for expenses payable by or reimbursable from customers based on current expense levels. Crescent Real Estate discloses 100% of the rental rate related to each tenant regardless of Crescent Real Estate's ownership in the building. (3) Calculated as weighted average full-service rental rate minus operating expenses. (4) Funds from operations, or FFO, based on the revised definition adopted by the Board of Governors of the National Association of Real Estate Investment Trusts, or NAREIT, effective January 1, 2000, and as used herein, means net income (loss), determined in accordance with GAAP, excluding gains (losses) from sales of depreciable operating property, excluding extraordinary items, as defined by GAAP, plus depreciation and amortization of real estate assets, and after adjustments for unconsolidated partnerships and joint ventures. FFO is a non-GAAP measure and should not be considered an alternative to GAAP measures, including net income and cash generated from operating activities. For a more detailed definition and description of FFO and comparisons to GAAP measures, see " - Liquidity and Capital Resources - Funds from Operations" below. Resort/Hotel Segment Crescent Real Estate owned nine hotel properties as of September 30, 2002 and December 31, 2001. The following table shows same-store net operating income, weighted average occupancy, average daily rate and revenue per available room/guest for the Crescent Real Estate hotel properties for the three and nine months ended September 30, 2002 and the years ended December 31, 2001 and 2000. FOR THE THREE MONTHS ENDED SEPTEMBER 30, FOR THE NINE MONTHS ENDED SEPTEMBER 30, ---------------------------------------- --------------------------------------- PERCENTAGE/ PERCENTAGE/ POINT POINT UPSCALE BUSINESS-CLASS HOTELS 2002 2001 DECREASE 2002 2001 CHANGE ----------------------------- ---- ---- -------- ---- ---- ------ Same-Store NOI (in thousands) ........ $ 3,714 $ 3,672 1% $13,676 $14,111 (3)% Weighted average occupancy ........... 73% 72% 1 pts 71% 72% (1) pts Average daily rate ................... $ 109 $ 111 (2)% $ 114 $ 118 (3)% Revenue per available room/guest night $ 79 $ 80 (1)% $ 81 $ 859 (5)% FOR THE THREE MONTHS ENDED SEPTEMBER 30, FOR THE NINE MONTHS ENDED SEPTEMBER 30, ---------------------------------------- --------------------------------------- PERCENTAGE/ PERCENTAGE/ POINT POINT LUXURY AND DESTINATION FITNESS 2002 2001 DECREASE 2001 2000 CHANGE RESORTS AND SPAS ---- ---- -------- ---- ---- ------ Same-Store NOI (in thousands) ........ $ 6,185 $ 7,085 (13)% $22,707 $24,938 (9)% Weighted average occupancy ........... 74% 72% 2 pts 71% 72% (1)pts Average daily rate ................... $ 117 $ 418 --% $ 463 $ 469 (1)% Revenue per available room/guest ..... $ 301 $ 294 2% $ 319 $ 331 (4)% FOR THE YEAR ENDED DECEMBER 31, ------------------------------- PERCENTAGE/ POINT UPSCALE BUSINESS-CLASS HOTELS 2001 2000 CHANGE ----------------------------- ---- ---- ------ Same-Store NOI (in thousands)(1) ..... $20,165 $22,157 (9)% Weighted average occupancy ........... 71% 75% (4) pts Average daily rate ................... $ 118 $ 116 2% Revenue per available room/guest night $ 83 $ 86 (3)% ---------- (1) Excludes the Four Seasons Hotel -- Houston, which was sold on November 3, 2000. FOR THE YEAR ENDED DECEMBER 31, ------------------------------- PERCENTAGE/ LUXURY AND DESTINATION FITNESS POINT RESORTS AND SPAS 2001 2000 DECREASE ---------------- ---- ---- -------- Same-Store NOI (in thousands) ........ $29,451 $36,837 (20)% Weighted average occupancy ........... 69% 79% (10)pts Average daily rate ................... $ 470 $ 442 6% Revenue per available room/guest ..... $ 318 $ 340 (6)% 196 On February 14, 2002, Crescent Real Estate executed an agreement with Crescent Operating, pursuant to which Crescent Operating transferred to subsidiaries of Crescent Real Estate, in lieu of foreclosure, Crescent Operating's lessee interests in the eight Crescent Real Estate hotel properties leased to subsidiaries of Crescent Operating. As a result, the subsidiaries of Crescent Real Estate became the lessees of these Crescent Real Estate hotel properties. Crescent Real Estate fully consolidated the operations of the eight hotel properties beginning on the date of the transfers. CR License, LLC and CRL Investments, Inc. As of December 31, 2001, Crescent Real Estate had a 28.5% interest in CR License, LLC, the entity which owns the right to the future use of the "Canyon Ranch" name. Crescent Real Estate also had a 95% economic interest, representing all of the non-voting common stock, in CRL Investments, Inc., which has an approximately 65% economic interest in the Canyon Ranch Spa Club in the Venetian Hotel in Las Vegas, Nevada. On February 14, 2002, Crescent Real Estate executed an agreement with Crescent Operating, pursuant to which Crescent Operating transferred to subsidiaries of Crescent Real Estate, pursuant to a strict foreclosure, Crescent Operating's 1.5% interest in CR License and 5.0% interest, representing all of the voting stock, in CRL Investments. As a result, as of September 30, 2002, Crescent Real Estate had a 30.0% interest in CR License, the entity which owns the right to the future use of the "Canyon Ranch" name. Crescent Real Estate also had a 100% economic interest, representing all of the common stock in CRL Investments, which has a approximately 65% economic interest in the Canyon Ranch Spa Club in the Venetian Hotel in Las Vegas, Nevada. Residential Development Segment As of September 30, 2002, Crescent Real Estate owned or had economic interests in five residential development corporations. The residential development corporations in turn, through joint ventures or partnership arrangements, own interests in 21 residential development properties. The residential development corporations are responsible for the continued development and the day to day operations of the residential development properties. On February 14, 2002, Crescent Real Estate executed an agreement with Crescent Operating, pursuant to which Crescent Operating transferred to subsidiaries of Crescent Real Estate, pursuant to a strict foreclosure, Crescent Operating's voting interests in three of the residential development corporations, specifically The Woodlands Land Company, Desert Mountain Development Corporation and CRDI. Crescent Real Estate fully consolidated the operations of the three residential development corporations beginning on the dates of the asset transfers. The Woodlands Land Development Company, L.P. and The Woodlands Commercial Properties Company, The Woodlands, Texas The following tables show residential lot sales at an average price per lot and commercial land sales at an average price per acre for the three and nine months ended September 30, 2002 and 2001 and the year ended December 31, 2001 and 2000. 197 FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, --------------------------- ------------------------- 2002 2001 2002 2001 -------- -------- -------- -------- Residential lot sales 306 432 818 1,296 Average sales price per lot $ 78,000 $ 75,000 $ 69,000 $ 77,000 Commercial land sales 8 acres 6 acres 60 acres 83 acres Average sales price per acre $384,000 $381,000 $346,000 $331,000 FOR THE YEAR ENDED DECEMBER 31, --------------------------- 2001 2000 -------- -------- Residential lot sales 1,718 2,033 Average sales price per lot $ 72,000 $ 62,000 Commercial land sales 94 acres 124 acres Average sales price per acre $337,000 $308,000 - Average sales price per lot decreased by $8,000, or 10% due to fewer higher priced lots sold primarily from the Carlton Woods development in the nine months ended September 30, 2002, compared to the same period 2001. Average sales price per lot increased by $10,000, or 16%, due to a product mix of higher priced lots from the Carlton Woods development in the year ended December 31, 2001, compared to the same period in 2000. - Carlton Woods is The Woodlands' new upscale residential development. It is a gated community consisting of 491 lots located around a Jack Nicklaus signature golf course. As of December 31, 2001, 213 lots had sold at prices ranging from $0.1 million to $1.0 million per lot, or an average price of $343,000 per lot. As of September 30, 2002, 233 lots had been sold at prices ranging from $0.1 million to $2.2 million per lot, or an average price of $348,000 per lot. Additional phases within Carlton Woods are expected to be marketed to the public over the next two years. - Future buildout of The Woodlands is estimated at approximately 12,264 residential lots and approximately 1,599 acres of commercial land, of which approximately 1,671 residential lots and 972 acres are currently in inventory. Desert Mountain Properties Limited Partnership, Scottsdale, Arizona The following tables show residential lot sales at an average price per lot for the three and nine months ended September 30, 2002 and 2001 and the years ended December 31, 2001 and 2000. FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, --------------------------- --------------------------- 2002 2001 2002 2001 -------- -------- -------- -------- Residential lot sales 6 17 54 59 Average sales price per lot(1) $831,000 $470,000 $746,000 $734,000 FOR THE YEAR ENDED DECEMBER 31, -------------------------- 2001 2000 -------- -------- Residential lot sales 86 178 Average sales price per lot (1) $688,000 $619,000 -------------------- (1) Including equity golf memberships. - With the higher priced residential lots being completed during the latter phases of development at Desert Mountain, the average sales price per lot increased by $69,000, or 11%, for the year ended 198 December 31, 2001, as compared to the same period in 2000. As a result of product mix and a decline in the economy combined with the events of September 11, 2001, the number of lot sales decreased to 86 lots for the year ended December 31, 2001, as compared to 178 lots for the same period in 2000. - Approved future buildout is estimated to be approximately 205 residential lots, of which approximately 120 are currently in inventory. Crescent Resort Development, Inc., formerly Crescent Development Management Corp., Beaver Creek, Colorado The following tables show total active projects, residential lot and residential unit sales, commercial land sales and average sales price per lot and unit. FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, -------------------------- -------------------------- 2002 2001 2002 2001 -------- -------- -------- -------- Active projects 14 13 14 13 Residential lot sales 30 34 189 108 Residential unit sales: Townhome sales 1 1 3 9 Single-family home sales -- -- -- -- Residential equivalent timeshare unit sales 2 -- 10 -- Condominium sales 26 10 222 22 Commercial land sales -- -- -- -- Average sales price per residential lot $ 108,000 $ 86,000 $ 68,000 $ 64,000 Average sales price per residential unit $ 1.0 million $ 1.7 million $ 669,000 $1.6 million Average sales price per residential equivalent time share unit $ 1.1 million -- $ 1.2 million -- FOR THE YEAR ENDED DECEMBER 31, ------------------------------- 2001 2000 ----------- -------- Active projects 14 12 Residential lot sales 181 343 Residential unit sales: Townhome sales 11 19 Single-family home sales -- 5 Equivalent timeshare unit sales 11 -- Condominium sales 109 26 Commercial land sales -- acres 9 acres Average sale price per residential lot $ 73,000 $ 136,000 Average sale price per residential unit $ 1.0 million $ 1.6 million Average sales price per time share unit N/A N/A - Average sales price per lot decreased by $63,000, or 46%, and average sales price per unit decreased $0.6 million, or 38%, due to lower priced product mix sold in the year ended December 31, 2001, as compared to the same period in 2000. Average sales price per unit decreased $0.9 million, or 56%, due to lower priced product mix sold in the nine months ended September 30, 2002, as compared to the same period in 2001. 199 Temperature-Controlled Logistics Segment As of September 30, 2002 Crescent Real Estate held a 40% interest in the temperature-controlled logistics partnership, which owns AmeriCold Corporation, which directly or indirectly owns the 88 Crescent Real Estate temperature-controlled logistics properties, with an aggregate of approximately 441.5 million cubic feet, or 17.5 million square feet, of warehouse space. The business operations associated with the Crescent Real Estate temperature-controlled logistics properties are owned by AmeriCold Logistics, which is owned 60% by Vornado Operating, L.P. and 40% by a subsidiary of Crescent Operating. Crescent Real Estate has no interest in AmeriCold Logistics. AmeriCold Logistics, as sole lessee of the Crescent Real Estate temperature-controlled logistics properties, leases the temperature-controlled logistics properties from AmeriCold Corporation under three triple-net master leases, as amended. On February 22, 2001, AmeriCold Corporation and AmeriCold Logistics agreed to restructure certain financial terms of the leases, including the adjustment of the rental obligation for 2001 to $146.0 million, the adjustment of the rental obligation for 2002 to $150.0 million (plus contingent rent in certain circumstances), the increase of AmeriCold Corporation's share of capital expenditures for the maintenance of the properties from $5.0 million to $9.5 million (effective January 1, 2000) and the extension of the date on which deferred rent was required to be paid to December 31, 2003. In the first quarter of 2000, AmeriCold Logistics started to experience a slowing in revenue growth from the previous year. This was primarily due to customers focusing more interest on inventory management in an effort to improve operating performance. Starting in 2000 and continuing into 2001, AmeriCold Logistics has seen consolidation among retail and food service channels begin to significantly limit the ability of manufacturers to pass along cost increases by raising prices. Because of this, manufacturers are focused on supply chain cost reduction initiatives (such as inventory management, transportation and distribution) in an effort to improve operating performance. In the second and third quarters of 2000, AmeriCold Logistics deferred a portion of its rent payments in accordance with the terms of the leases of the temperature-controlled logistics properties. For the three months ended June 30, 2000, AmeriCold Corporation recorded a valuation allowance for a portion of the rent that had been deferred during that period, and for the three months ended September 30, 2000 recorded a valuation allowance for 100% of the rent that had been deferred during the three months ended September 30, 2000 and has continued to record a valuation allowance for 100% of the deferred rent prospectively. These valuation allowances resulted in a decrease in the equity in net income of Crescent Real Estate in AmeriCold Corporation. AmeriCold Corporation had not recorded a valuation allowance with respect to rent deferred by AmeriCold Logistics prior to the quarter ended June 30, 2000, because the financial condition of AmeriCold Logistics prior to that time did not indicate the inability of AmeriCold Logistics ultimately to make the full rent payments. As a result of continuing net losses and the increased amount of deferred rent, AmeriCold Corporation determined that the collection of additional deferred rent was doubtful. AmeriCold Logistics deferred $25.5 million of rent for the year ended December 31, 2001, of which Crescent Real Estate's share was $10.2 million. AmeriCold Logistics also deferred $19.0 million and $5.4 million of rent for the years ended December 31, 2000 and 1999, respectively, of which Crescent Real Estate's share was $7.5 million and $2.1 million, respectively. In December 2001, AmeriCold Corporation waived its rights to collect $39.8 million of the total $49.9 million of deferred rent, of which Crescent Real Estate's share was $15.9 million. AmeriCold Corporation and Crescent Real Estate began to recognize rental income when earned and collected during the year ended December 31, 2000 and continued this accounting treatment for the year ended December 31, 2001; therefore, there was no financial statement impact to AmeriCold Corporation or to Crescent Real Estate related to the AmeriCold Corporation's decision in December 2001 to waive collection of deferred rent. 200 AmeriCold Logistics deferred $20.6 million of the total $102.4 million of rent payable for the nine months ended September 30, 2002. Crescent Real Estate's share of the deferred rent was $8.2 million. Crescent Real Estate recognizes rental income when earned and collected and has not recognized the $8.2 million of deferred rent in equity in net income of AmeriCold Corporation for the nine months ended September 30, 2002. The following table shows the total, and Crescent Real Estate's portion of, deferred rent and valuation allowance rent at December 31, 2001, 2000 and 1999 and for the nine months ended September 30, 2002. DEFERRED RENT VALUATION ALLOWANCE ---------------------------- --------------------------- TOTAL COMPANY'S COMPANY'S (in millions) PORTION PORTION TOTAL PORTION ------------- ------- ------- ----- ------- FOR THE YEAR ENDED DECEMBER 31, 1999 $ 5.4 $ 2.1 $ -- $ -- 2000 19.0 7.5 16.3 6.5 2001 25.5 10.2 25.5 10.2 ------- --------- ------ -------- BALANCE AT DECEMBER 31, 2001 $ 10.1 $ 3.9 $ -- $ -- ------- --------- ------ -------- FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 $ 20.6 $ 8.2 $ 20.6 $ 8.2 ------- --------- ------ -------- $ 30.7 $ 12.1 $ 20.6 $ 8.2 ======= ========= ====== ======== (1) Represents the rental obligation (excluding the effect of straight-lining rents and deferred rent) of AmeriCold Logistics. AmeriCold Corporation completed the acquisition of one facility in the first quarter of 2001 for $10.0 million and completed the construction of one facility in the third quarter of 2001 for $15.8 million, representing a total of approximately 8.5 million cubic feet (0.2 million square feet). Behavioral Healthcare Segment During 1999, Crescent Real Estate's investment segments included a behavioral healthcare segment. As of December 31, 1999, the behavioral healthcare segment consisted of 88 behavioral healthcare properties in 24 states, all of which were leased to Charter Behavioral Health Systems, or CBHS, and its subsidiaries under a triple-net master lease. During the year ended December 31, 1999, Crescent Real Estate received cash rental payments of approximately $35.3 million from CBHS. However, during 1999, CBHS's business was negatively affected by many factors, including adverse industry conditions, and CBHS failed to perform in accordance with its operating budget. In the third quarter of 1999 CBHS was unable to meet its rental obligation to Crescent Real Estate. In the third quarter of 1999, Crescent Real Estate, Crescent Operating, Magellan and CBHS commenced a recapitalization of CBHS. As part of this recapitalization, Crescent Real Estate commissioned an independent public accounting firm to assist in the evaluation of alternatives related to CBHS, which included an appraisal of the behavioral healthcare properties. 201 The following financial statement charges were made with respect to Crescent Real Estate's investment in the behavioral healthcare properties in the third quarter of 1999: - CBHS rent was reflected on a cash basis beginning in the third quarter of 1999 due to the uncertainty that CBHS would be able to fulfill its rental obligations under the lease; - Crescent Real Estate wrote-off the rent that was deferred according to the CBHS lease agreement from the commencement of the lease in June of 1997 through June 30, 1999. The balance written-off totaled $25.6 million; - Crescent Real Estate wrote-down its behavioral healthcare real estate assets by approximately $103.8 million to a book value of $245.0 million; - Crescent Real Estate wrote-off the book value of warrants to purchase common shares of Magellan of $12.5 million; - Crescent Real Estate recorded approximately $15.0 million of additional expense to be used by CBHS as working capital; and - Crescent Real Estate ceased recording depreciation expense in the beginning of November of 1999 on the behavioral healthcare properties that were classified as held for disposition. On February 16, 2000, CBHS and all of its subsidiaries that were subject to the master lease with Crescent Real Estate filed voluntary Chapter 11 bankruptcy petitions in the United States Bankruptcy Court for the District of Delaware. During the year ended December 31, 2000, payment and treatment of rent for the behavioral healthcare properties was subject to a rent stipulation agreed to by certain of the parties involved in the CBHS bankruptcy proceeding. Crescent Real Estate received approximately $15.4 million in rent and interest from CBHS during the year ended December 31, 2000. Crescent Real Estate also completed the sale of 60 behavioral healthcare properties previously classified as held for disposition during the year ended December 31, 2000 (contained in Net Investment in Real Estate). The sales generated approximately $233.7 million in net proceeds and a net gain of approximately $58.6 million for the year ended December 31, 2000. During the year ended December 31, 2000, Crescent Real Estate recognized an impairment loss of approximately $9.3 million on the behavioral healthcare properties held for disposition. This amount represents the difference between the carrying values and the estimated sales prices less the costs of the sales. At December 31, 2000, the carrying value of the 28 behavioral healthcare properties classified as held for disposition was approximately $68.5 million (contained in Net Investment in Real Estate). Depreciation has not been recognized since the dates the behavioral healthcare properties were classified as held for sale. Crescent Real Estate received approximately $6.0 million in repayment of a working capital loan from CBHS during the year ended December 31, 2001. Crescent Real Estate also completed the sale of 18 behavioral healthcare properties previously classified as held for disposition during the year ended December 31, 2001. The sales generated approximately $34.7 million in net proceeds and a net gain of approximately $1.6 million for the year ended December 31, 2001. During the year ended December 31, 2001, Crescent Real Estate recognized an impairment loss of approximately $8.5 million on the behavioral healthcare properties held for disposition. This amount represents the difference between the carrying values and the estimated sales prices less the costs of the sales. 202 As of September 30, 2002, Crescent Real Estate owned 7 behavioral healthcare properties, all of which were classified as held for sale. The carrying value of the behavioral healthcare properties at September 30, 2002 was approximately $21.0 million. During the nine months ended September 30, 2002, Crescent Real Estate recognized an impairment charge of approximately $0.6 million on one of the behavioral healthcare properties held for sale. This amount represents the difference between the carrying value and the estimated sales price less costs of the sale for this property. Depreciation expense has not been recognized since the dates the behavioral healthcare properties were classified as held for sale. Crescent Real Estate has entered into contracts or letters of intent to sell three behavioral healthcare properties and is actively marketing for sale the remaining seven behavioral healthcare properties. The sales of these behavioral healthcare properties are expected to close within the year. RESULTS OF OPERATIONS The following tables show Crescent Real Estate's financial data as a percentage of total revenues for the three and nine months ended September 30, 2002 and 2001 and the three years ended December 31, 2001, 2000 and 1999 and the variance in dollars between the three and nine months ended September 30, 2002 and 2001 and between the years ended December 31, 2001 and 2000 and the years ended December 31, 2000 and 1999. See "Note 9. Segment Reporting" included in the Financial Statements of Crescent Real Estate for the nine months ended September 30, 2002 (unaudited) and "Note 3. Segment Reporting" included in the Financial Statements of Crescent Real Estate for the year ended December 31, 2001 (audited) for financial information about investment segments. 203 FINANCIAL DATA AS A PERCENTAGE OF TOTAL FINANCIAL DATA AS A PERCENTAGE OF TOTAL REVENUES FOR THE THREE MONTHS ENDED REVENUES FOR THE NINE MONTHS ENDED ----------------------------------- ---------------------------------- SEPTEMBER 30, SEPTEMBER 30, 2002 2001 2002 2001 ---- ---- ---- ---- REVENUES Office properties 59.1% 87.2% 56.5% 84.9% Resort/Hotel properties 22.6 7.2 19.5 8.3 Residential Development Property 17.6 -- 23.3 -- Interest and other income 0.7 5.6 0.7 6.8 ----- ----- ----- ----- TOTAL REVENUES 100.0% 100.0% 100.0% 100.0% ----- ----- ----- ----- EXPENSES Office Property operating expenses 25.0% 37.5% 24.9% 36.5% Resort/Hotel Property expense 17.9 -- 14.6 -- Residential Development Property expense 16.9 -- 21.2 -- Corporate general and administrative 3.3 3.6 2.6 3.4 Interest expense 18.9 25.9 17.9 25.9 Amortization of deferred financing costs 1.1 1.4 1.0 1.3 Depreciation and amortization 15.4 17.9 14.1 16.9 Impairment and other charges related to real estate assets -- 2.1 -- 3.5 ----- ----- ----- ----- TOTAL EXPENSES 98.5% 88.4% 96.3% 87.5% ----- ----- ----- ----- OPERATING INCOME 1.5% 11.6% 3.7% 12.5% ----- ----- ----- ----- OTHER INCOME AND EXPENSES Equity in net income of unconsolidated companies: Office properties 0.4% 0.9% 0.5% 0.7% Resort/Hotel properties -- -- -- -- Residential development properties 1.7 4.2 3.0 5.2 Temperature-controlled logistics properties (1.2) (1.2) (0.5) 0.4 Other (0.3) 1.0 (0.7) 0.5 ----- ----- ----- ----- TOTAL EQUITY IN NET INCOME FROM UNCONSOLIDATED COMPANIES 0.6% 4.9% 2.3% 6.8% Gain on property sales, net 9.3 0.6 2.9 0.1 ----- ----- ----- ----- TOTAL OTHER INCOME AND EXPENSE 9.9% 5.5% 5.2% 6.9% ----- ----- ----- ----- INCOME BEFORE MINORITY INTERESTS, INCOME TAXES, DISCONTINUED OPERATIONS AND CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE 11.4% 17.1% 8.9% 19.4% Minority interests (1.6) (4.6) (2.3) (4.8) Income tax benefit 1.0 -- 0.9 -- ----- ----- ----- ----- INCOME BEFORE DISCONTINUED OPERATIONS AND CUMULATIVE EFFECT OF A CHANGE IN AN ACCOUNTING PRINCIPAL 10.8% 12.5% 7.5% 14.6% Discontinued operations - income and gain on assets sold and held for sale 0.6 0.3 0.8 0.3 Cumulative effect of a change in accounting principal -- -- (1.4) -- Extraordinary item - extinguishment of debt -- (5.7) -- (2.0) ----- ----- ----- ----- NET INCOME 11.4% 7.1% 6.9% 12.9% 6 3/4% Series A Preferred Share distributions (1.9) (2.0) (1.6) (1.9) 9 -1/2% Series B Share distributions (0.7) -- (0.4) -- ----- ----- ----- ----- NET INCOME AVAILABLE TO COMMON SHAREHOLDERS 8.8% 5.1% 4.9% 11.0% ===== ===== ===== ===== 204 TOTAL VARIANCE IN DOLLARS BETWEEN ------------------------------------------- THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, 2001 SEPTEMBER 30, AND 2002 2001 AND 2002 -------- ------------- REVENUES Office properties $ (4.5) $(27.0) Resort/Hotel properties 43.7 103.7 Residential Development Property 43.8 176.9 Interest and other income (7.9) (30.6) ------ ------ TOTAL REVENUES $ 75.1 $223.0 ------ ------ EXPENSES Office Property operating expenses $ (2.8) $ (7.2) Resort/Hotel Property expense 44.6 110.7 Residential Development Property expense 42.1 161.3 Corporate general and administrative 1.9 1.5 Interest expense 2.2 (3.3) Amortization of deferred financing costs 0.3 0.5 Depreciation and amortization 7.3 16.0 Impairment and other charges related to real estate assets (3.6) (18.9) ------ ------ TOTAL EXPENSES $ 92.0 $260.6 ------ ------ OPERATING INCOME $(16.9) $(37.6) ------ ------ OTHER INCOME Equity in net income of unconsolidated companies: Office properties $ (0.6) $ (0.1) Resort/Hotel properties (0.1) (0.1) Residential development properties (3.0) (4.8) Temperature-controlled logistics properties (1.0) (6.1) Other (2.5) (8.2) ------ ------ TOTAL EQUITY IN NET INCOME FROM UNCONSOLIDATED COMPANIES $ (7.2) $(19.3) Gain on property sales, net 22.1 21.5 ------ ------ TOTAL OTHER INCOME AND EXPENSE $ 14.9 $ 2.2 ------ ------ INCOME BEFORE MINORITY INTERESTS, INCOME TAXES, DISCONTINUED OPERATIONS AND CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE $ (2.0) $(35.4) Minority interests 3.9 8.7 Income tax benefit 2.7 6.6 ------ ------ INCOME BEFORE DISCONTINUED OPERATIONS AND CUMULATIVE EFFECT OF A CHANGE IN AN ACCOUNTING PRINCIPAL $ 4.6 $(20.1) Discontinued operations - income and gain on assets sold and held for sale 0.9 4.7 Cumulative effect of a change in accounting principal -- (10.5) Extraordinary item - extinguishment of debt -- 10.8 ------ ------ NET INCOME $ 5.5 $(15.1) 6 3/4% Series A Preferred Share distributions (1.2) (2.0) 9 -1/2% Series B Preferred Share distributions (2.0) (3.0) NET INCOME AVAILABLE TO COMMON SHAREHOLDERS $ 2.3 $(20.1) ====== ====== 205 FINANCIAL DATA AS A PERCENTAGE OF TOTAL REVENUES FOR THE YEAR ENDED TOTAL VARIANCE IN DOLLARS BETWEEN DECEMBER 31, THE YEARS ENDED DECEMBER 31, ---------------------------------- --------------------------------- (IN MILLIONS) 2001 2000 1999 2001 AND 2000 2000 AND 1999 ---- ---- ---- ------------- ------------- REVENUES Office properties 87.5% 84.1% 82.0% $ 5.2 $ (7.6) Resort/Hotel properties 6.7 10.2 9.0 (26.4) 6.9 Interest and other income 5.8 5.7 9.0 (0.1) (26.3) ------ ------ ------ ------ ------ TOTAL REVENUES 100.0% 100.0% 100.0% $(21.3) $(27.0) ------ ------ ------ ------ ------ EXPENSES Operating expenses 37.8% 34.6% 34.2% $ 13.6 $ (6.9) Corporate general and administrative 3.5 3.4 2.2 0.1 7.8 Interest expense 26.4 28.7 26.1 (20.8) 11.2 Amortization of deferred financing costs 1.4 1.1 1.4 (0.2) (0.9) Depreciation and amortization 18.0 17.2 17.6 2.1 (7.8) Settlement of merger dispute -- -- 2.0 -- (15.0) Impairment and other charges related to real estate assets 3.7 2.5 24.3 7.5 (160.9) Impairment and other charges related to Crescent Operating 13.5 -- -- 92.8 -- ------ ------ ------ ------ ------ TOTAL EXPENSES 104.5% 87.5% 107.8% 95.1 (172.5) ------ ------ ------ ------ ------ OPERATING (LOSS) INCOME (4.5)% 12.5% (7.9)% $(116.4) $145.5 OTHER INCOME Equity in net income of unconsolidated companies: Office properties 0.9 0.5 0.7 2.9 (2.1) Residential development properties 6.0 7.6 5.8 (12.5) 10.6 Temperature-controlled logistics properties 0.2 1.0 2.0 (6.3) (7.6) Other 0.4 1.6 0.7 (8.6) 6.5 ------ ------ ------ ------ ------ TOTAL EQUITY IN NET INCOME FROM UNCONSOLIDATED COMPANIES 7.5% 10.7% 9.2% $(24.5) $ 7.4 Gain on property sales, net 0.6 19.4 -- (133.1) 137.5 ------ ------ ------ ------ ------ TOTAL OTHER INCOME AND EXPENSE 8.1% 30.1% 9.2% $(157.6) $144.9 ------ ------ ------ ------ ------ (LOSS) INCOME BEFORE MINORITY INTERESTS, EXTRAORDINARY ITEM AND DISCONTINUED OPERATIONS 3.6% 42.6% 1.4% $(274.0) $290.4 Minority interests (3.1) (7.2) (0.3) 29.4 (48.7) ------ ------ ------ ------ ------ NET (LOSS) INCOME BEFORE EXTRAORDINARY ITEM AND DISCONTINUED OPERATIONS 0.5% 35.4% 1.1% $(244.6) $241.7 Extraordinary item - extinguishment of debt (1.6) (0.6) -- (6.9) (3.9) Discontinued Operations 0.2 0.4 0.5 (1.4) (0.7) ------ ------ ------ ------ ------ NET (LOSS) INCOME (0.9)% 35.2% 1.6% $(252.9) $237.1 6 3/4% Series A Preferred Share distributions (2.0) (1.9) (1.8) -- -- Share repurchase agreement return -- (0.4) (0.1) 2.9 (2.3) Forward share purchase agreement return -- -- (0.6) -- 4.3 ------ ------ ------ ------ ------ NET (LOSS) INCOME AVAILABLE TO COMMON SHAREHOLDERS (2.9)% 32.9% (0.9)% $(250.0) $239.1 ====== ====== ====== ====== ====== Three Months Ended September 30, 2002 as Compared to Three Months Ended September 30, 2001 Revenues. 206 Total revenues increased $75.1 million, or 43.3%, to $248.5 million for the quarter ended September 30, 2002, as compared to $173.4 million for the quarter ended September 30, 2001. The components of the increase are: - an increase in residential development property revenue of $43.8 million due to the consolidation of three residential development corporations beginning on February 14, 2002, as a result of the Crescent Operating transaction (previously Crescent Real Estate recorded its share of earnings under the equity method); and - an increase in hotel property revenue of $43.7 million due to the consolidation of the operations of eight of the resort/hotel properties beginning on February 14, 2002, as a result of the Crescent Operating transaction (previously Crescent Real Estate recognized lease payments related to these properties); partially offset by - a decrease in interest and other income of $7.9 million primarily attributable to the $5.1 million of income and gain recognized on the sale of marketable securities and other income recognized in the third quarter of 2001; and - a decrease in Crescent Real Estate office property revenue of $4.5 million primarily due to: - a decrease of $7.9 million from the disposition of five office properties in 2001; - the contribution of two office properties to joint ventures in 2001; - the contribution of two office properties to joint ventures in 2002; - decreased expense recovery revenue of $1.6 million and decreased rental revenues of $0.8 million, partially offset by - net insurance proceeds of approximately $5.0 million received in September 2002 as a result of an insurance claim on one of Crescent Real Estate's office properties that had been damaged as a result of a tornado and - $1.3 million of rental revenue from the office property acquired in the third quarter of 2002. Expenses. Total expense increased $92.0 million, or 60.1%, to $245.0 million for the three months ended September 30, 2002, as compared to $153.0 million for the three months ended September 30, 2001. The primary components of this increase are: - an increase in resort/hotel property expense of $44.6 million due to the consolidation of the operations of eight of the resort/hotel properties beginning February 14, 2002, as a result of the Crescent Operating transaction (previously Crescent Real Estate recognized lease payments related to these properties); - an increase in residential development property expense of $42.1 million due to the consolidation of three residential development corporations beginning February 14, 2002, as a result of the 207 Crescent Operating transaction (previously Crescent Real Estate recorded its share of earnings under the equity method); and - an increase in depreciation and amortization expense of $7.3 million primarily due to the consolidation of the operations of three residential development corporations beginning February 14, 2002, as a result of the Crescent Operating transaction partially offset by - a decrease due to the recognition in the second quarter of 2001 of $3.6 million due to the impairment charges relating to the behavioral healthcare properties; and - a decrease in office property operating expense of $2.8 million primarily due to the disposition of five office properties in 2001, the contribution of two office properties to joint ventures in 2001 and the contribution of two office properties to joint ventures in 2002. Other Income and Expense. Other income increased $14.9 million, or 156.8%, to $24.4 million for the three months ended September 30, 2002, as compared to $9.5 million for the three months ended September 30, 2001, as a result of: - an increase due to the recognition in the third quarter of 2002 of a $23.2 million gain on two properties that were contributed to joint ventures and the sale of Canyon Ranch - Tucson Land compared with the recognition of a $1.1 million gain on property sales in the third quarter of 2001; partially offset by - a decrease in equity in net income of unconsolidated companies of $7.2 million, primarily due to the consolidation of three residential development corporations beginning February 14, 2002, as a result of the Crescent Operating transaction (previously Crescent Real Estate recorded its interests in the residential development corporations under the equity method). Income Tax Benefit. Crescent Real Estate recognized consolidated income tax benefit of $2.7 million for the three months ended September 30, 2002, primarily related to hotel and residential development operations. Because these operations were not consolidated for the three months ended September 30, 2001, no consolidated income tax expense was recognized for that period. Discontinued Operations. The income from discontinued operations from assets sold and held for sale increased $0.9 million, or 180%, to $1.4 million for the three months ended September 30, 2002, compared to $0.5 million for the three months ended September 30, 2001. This increase is primarily due to the gains on disposals, net of minority interest, of two office properties sold during the three months ended September 30, 2002. 208 SEGMENT ANALYSIS Office Segment FOR THE THREE MONTHS ENDED SEPTEMBER 30, VARIANCE -------------------------- ---------------------- 2002 2001 $ % -------- -------- ---- ---- (IN MILLIONS) Office Property Revenue $ 146.8 $ 151.3 (4.5) (3.0) Office Property Operating Expense 62.2 64.9 (2.7) (4.2) Equity in Earnings of Unconsolidated office properties 0.9 1.5 (0.6) (40.0) The primary components of the decrease in office property revenues are as follows: - decreased revenue of $7.9 million due to the disposition of five office properties in 2001, the contribution of two office properties to joint ventures in 2001 and the contribution of two office properties to joint ventures in 2002; - decreased recovery revenue of $1.6 million primarily due to lease turnover; and - decreased rental revenues of $0.8 million; partially offset by - net insurance proceeds of $5.0 million received in September 2002 as a result of an insurance claim on one of Crescent Real Estate's office properties that had been damaged as a result of a tornado; and - $1.3 million of rental revenue from the office property acquired in the third quarter in 2002. The components of the decrease in office property operating expense are as follows: - decreased expenses of $3.1 million due to the disposition of five office properties in 2001, the contribution of two office Properties to joint ventures in 2001 and the contribution of two office properties to joint ventures in 2002; - decreased office property utility expense of $2.4 million due to lower rates as a result of a one-year energy contract effective beginning in first quarter of 2002 for certain Texas properties; and - decreased real estate taxes of $1.6 million; partially offset by 209 - increased operating expenses of $4.4 million attributable to $2.1 million of security and insurance expense primarily related to the events of September 11, 2001 and administration expense of $2.3 million including legal fees, bad debt expense and payroll costs. Resort/Hotel Segment On February 14, 2002, Crescent Real Estate executed an agreement with Crescent Operating, pursuant to which Crescent Operating transferred to subsidiaries of Crescent Real Estate, in lieu of foreclosure, Crescent Operating's lessee interests in the eight hotel properties leased to subsidiaries of Crescent Operating. The financial statements reflect the consolidation of the operations for these eight hotel properties for the period February 14, 2002 through September 30, 2002. Revenues prior to February 14, 2002 represent lease payments to Crescent Real Estate. FOR THE THREE MONTHS ENDED SEPTEMBER 30, VARIANCE -------------------------------------------------------------- 2002 2001 $ % ------- ------- ----- ---- (IN MILLIONS) Resort/Hotel Property Revenue $ 56.1 $ 12.4 Resort/Hotel Property Expense (44.6) -- ------- ------- ----- ---- Net Operating Income $ 11.5 $ 12.4 $(0.9) (7.3)% ======= ======= ===== ==== The decrease in hotel property net operating income is primarily due to the consolidation of the operations of eight of the hotel properties in 2002 as compared to the recognition of lease payments from these properties in 2001. Residential Development Segment On February 14, 2002, Crescent Real Estate executed an agreement with Crescent Operating, pursuant to which Crescent Operating transferred to subsidiaries of Crescent Real Estate, in lieu of foreclosure, Crescent Operating's voting interests in three of the residential development corporations: The Woodlands Land Company, Desert Mountain Development Corp. and CRDI. Crescent Real Estate fully consolidated the operations of the three residential development corporations beginning on the dates of the asset transfers. FOR THE THREE MONTHS ENDED SEPTEMBER 30, VARIANCE -------------------------------------------------------------------- 2002 2001 $ % ------- ------- ---- ---- (IN MILLIONS) Residential Development Property Revenue $ 43.8 $ -- Residential Development Property Expense (42.1) -- Depreciation/Amortization (2.0) -- Equity in net income of Unconsolidated Residential Development Properties 4.3 7.3 Minority Interests (0.4) -- Income Tax Benefit 0.2 -- -------- -------- -------- ----- Operating Results $ 3.8 $ 7.3 $ (3.5) (47.9)% ======== ======== ======== ===== The components of the decrease in residential development property net operating income are: - lower lot sales of $2.2 million at The Woodlands Land Company; 210 - lower gain recognized on disposition of properties of $1.7 million at The Woodlands Land Company; - a change in presentation of capitalized interest of $2.4 million, due to consolidation of Desert Mountain Development Corp. and CRDI in 2002; partially offset by - higher unit sales and other operating revenues of $1.7 million at CRDI; and - higher average price per lot of $1.1 million at Desert Mountain Development Corp. Temperature-Controlled Logistics Segment FOR THE THREE MONTHS ENDED SEPTEMBER 30, VARIANCE ---------------------------- ------------------------ 2002 2001 $ % ------- ------- ------- ----- (IN MILLIONS) Equity in net (loss) of unconsolidated Temperature-Controlled Logistics Properties $ (3.1) $ (2.1) $ (1.0) (47.6)% The decrease in equity in earnings of unconsolidated temperature-controlled logistics properties is primarily due to Crescent Real Estate's $4.5 million portion of deferred rent recorded in the third quarter of 2002 compared with the Crescent Real Estate's $3.5 million portion of deferred rent recorded in the third quarter of 2001. Nine Months Ended September 30, 2002 as Compared to Nine Months Ended September 30, 2001 Revenues Total revenues increased $223.0 million, or 41.5%, to $760.2 million for the nine months ended September 30, 2002, as compared to $537.2 million for the nine months ended September 30, 2001. The components of the increase are: - an increase in residential development property revenue of $176.9 million due to the consolidation of three residential development corporations beginning February 14, 2002, as a result of the Crescent Operating transaction (previously Crescent Real Estate recorded its share of earnings under the equity method); and - an increase in hotel property revenue of $103.7 million due to the consolidation of the operations of eight of the hotel properties beginning February 14, 2002, as a result of the Crescent Operating transaction (previously Crescent Real Estate recognized lease payments related to these properties); partially offset by - a decrease in interest and other income of $30.6 million, primarily due to: - the collection of $6.5 million from CBHS in 2001 on a working capital loan that was previously expensed in conjunction with the recapitalization of CBHS; - the income on marketable securities and the gain recognized on the sale of marketable securities aggregating $11.9 million in the first nine months of 2001; - the recognition in 2001 of $2.8 million of interest income on Crescent Operating notes; 211 - the recognition in 2001 of $2.3 million in lease commission and development fee revenue for 5 Houston Center office property which was under construction; - a decrease in interest income of $1.8 million in 2002 related to lower escrow balances for a plaza renovation at an office property that has been completed; - a decrease in interest income of $2.6 million on cash and certain notes receivable as a result of reduced interest rates; and - a decrease in office property revenue of $27.0 million primarily due to the disposition of five office properties in 2001, the contribution of two office properties to joint ventures in 2001 and the contribution of two office properties to joint ventures in 2002 ($29.7 million), and decreased lease termination fees of $2.5 million, partially offset by net insurance proceeds of approximately $5.0 million received in September 2002 as a result of an insurance claim on one of Crescent Real Estate's office properties that had been damaged as a result of a tornado. Expenses. Total expense increased $260.6 million, or 55.3%, to $731.5 million for the nine months ended September 30, 2002, as compared to $470.9 million for the nine months ended September 30, 2001. The primary components of this increase are: - an increase in residential development property expense of $161.3 million due to the consolidation of three residential development corporations beginning February 14, 2002, as a result of the Crescent Operating transaction (previously Crescent Real Estate recorded its share of earnings under the equity method); and - an increase in hotel property expense of $110.7 million due to the consolidation of the operations of eight of the hotel properties beginning February 14, 2002, as a result of the Crescent Operating transaction (previously Crescent Operating recognized lease payments related to these properties); and - an increase in depreciation and amortization expense of $16.0 million primarily due to the consolidation of the operations of three residential development corporations beginning February 14, 2002 as a result of the Crescent Operating transaction; partially offset by - a decrease due to the recognition in 2001 of $18.9 million in impairment charges primarily relating to behavioral healthcare properties of $7.0 million and the impairment of $11.9 million relating to the conversion of the Crescent Real Estate's preferred interest in Metropolitan Partners, LLC into common shares of Reckson Associates Realty Corp.; - a decrease in interest expense of $3.3 million primarily attributable to capitalizing $5.7 million of interest expense in 2002, a decrease in the weighted average interest rate of 19 basis points (from 7.93% to 7.74%), or $4.2 million of interest expense, due to the debt refinancing in May of 2001 and lower LIBOR rates, partially offset by an increase of $6.6 million due to a $70.6 million increase in the average debt balance, from $2,293 million to $2,408 million; and 212 - a decrease in office property operating expense of $7.2 million primarily due to a decrease of $11.0 million from the disposition of five office properties in 2001, the contribution of two office properties to joint ventures in 2001 and the contribution of two office properties to joint ventures in 2002, partially offset by increases in repairs and maintenance of $3.6 million due to timing of expenses. Other Income and Expense. Other income increased $2.2 million, or 5.9%, to $39.6 million for the nine months ended September 30, 2002, as compared to $37.5 million for the nine months ended September 30, 2001, primarily as a result of: - an increase in gain on property sales, net of $21.5 million, primarily due to a gain of $17.0 million on the partial sale of the Three Westlake Office Property, a gain of $5.5 million on the sale of Canyon Ranch - Tucson Land and a gain of $4.6 million on the partial sale of Miami Center, net of a loss of $4.9 million on the partial sale of Sonoma Mission Inn & Spa and the sale of Washington Harbour Land; partially offset by - a decrease in equity in net income of unconsolidated companies of $19.3 million, primarily due to the $5.2 million impairment of an investment in DBL Holdings, Inc. during 2002, and Crescent Real Estate's additional $3.1 million portion of AmeriCold Logistics' deferral of rent payable, $2.9 million due to the change in the base rent recognition method for the temperature-controlled logistics segment from straight-line to cash basis and $4.8 million due to the consolidation of three residential development corporations beginning February 14, 2002, as a result of the Crescent Operating transaction, (previously Crescent Real Estate recorded its investment in the residential development corporations under the equity method). Income Tax Benefit. Crescent Real Estate's $6.6 million total consolidated income tax expense for the nine months ended September 30, 2002 includes tax expense related to the operations of the hotel and residential development operations of $0.1 million, offset by a tax benefit of $6.7 million. The $6.7 million benefit results from the temporary difference between the financial reporting basis and the respective tax basis of the hotel leases acquired as part of Crescent Real Estate's agreement with Crescent Operating. This temporary difference will be reversed over an estimated five-year period, which is the remaining lease term of the hotel leases. Cash paid for income taxes totaled approximately $10.2 million for the nine months ended September 30, 2002. Discontinued Operations. The income from discontinued operations from assets held for sale increased $4.7 million, or 276.5%, to $6.4 million for the nine months ended September 30, 2002, compared to $1.7 million for the nine months ended September 30, 2001. This increase is primarily due to: - a gain on disposals of $6.9 million, net of minority interest, attributable to the sales of the five office properties in 2002; partially offset by - an impairment charge of $0.6 million in 2002, related to a behavioral healthcare property. This amount represents the difference between the carrying value and the estimated sales price less costs of the sale for this property; and 213 - a decline in operating income of $1.8 million for the five office properties sold in 2002 that contributed a full year of operating income in 2001 and a partial year of operating income in 2002. Cumulative Effect of a Change in Accounting Principle In conjunction with the implementation of SFAS No. 142, "Goodwill and Other Intangible Assets," Crescent Real Estate reported a cumulative effect of a change in accounting principle for the nine months ended September 30, 2002, which resulted in a charge of $10.5 million. This charge is due to an impairment (net of minority interests and taxes) of the goodwill of AmeriCold Logistics and CRDI. No such impairment charge was recognized for the nine months ended September 30, 2001. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. The statement is effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. The adoption of this statement did not materially affect Crescent Real Estate's interim or annual financial statements; however, for the three and nine months ended September 30, 2002, financial statement presentation was modified to report the results of operations, including any gains or losses recognized in accordance with this statement, and the financial position of Crescent Real Estate's real estate assets sold or classified as held for sale, as discontinued operations. As a result, Crescent Real Estate has reclassified certain amounts in prior period financial statements to conform with the new presentation requirements. Extraordinary Item In May 2001, $10.8 million of deferred financing costs were written off due to the early extinguishment of Crescent Real Estate's credit facility with UBS. The recognition of the write-off was treated as an Extraordinary Item for the six months ended June 30, 2001. No such event or write-off occurred during the nine months ended September 30, 2002. Segment Analysis Office Segment FOR THE NINE MONTHS ENDED SEPTEMBER 30, VARIANCE -------------------------- -------------------------- 2002 2001 $ % ------- ------- ------- ------- (IN MILLIONS) Office Property Revenue $ 429.3 $ 456.3 $ (27.0) (6.0)% Office Property Operating Expense 189.1 196.3 (7.2) (3.7) Equity in Earnings of Unconsolidated Office Properties 3.7 3.8 (0.1) (2.6) The primary components of the decrease in office property revenue are as follows: - decreased revenue of $29.7 million due to the disposition of five office properties in 2001, the contribution of two office properties to joint ventures in 2001 and the contribution of two office properties to joint ventures in 2002; and - decreased lease termination fees of $2.5 million; partially offset by 214 - net insurance proceeds of $5.0 million received in September 2002 as a result of an insurance claim on one of Crescent Real Estate's office properties that had been damaged as a result of a tornado. The primary components of the decrease in office property operating expense are as follows: - decreased expenses of $11.0 million due to the disposition of five office properties in 2001, the contribution of two office properties to joint ventures in 2001 and the contribution of two office properties to joint ventures in 2002; and - decreased office property utility expense of $8.5 million due to lower rates as a result of a one-year energy contract effective beginning in first quarter of 2002 for certain Texas Properties; partially offset by - increased operating expenses of $6.7 million attributable to security and insurance expense primarily related to the events of September 11, 2001 and $5.6 million primarily attributable to the timing of repairs and maintenance and increased administrative expenses, including legal fees, bad debt expense, and payroll costs. Resort/Hotel Segment On February 14, 2002, Crescent Real Estate executed an agreement with Crescent Operating, pursuant to which Crescent Operating transferred to subsidiaries of Crescent Real Estate, in lieu of foreclosure, Crescent Operating's lessee interests in the eight hotel properties leased to subsidiaries of Crescent Operating. The financial statements reflect the consolidation of the operations for these eight hotel properties for the period February 14, 2002 through September 30, 2002. Revenues prior to February 14, 2002 represent lease payments to Crescent Real Estate. FOR THE NINE MONTHS ENDED SEPTEMBER 30, VARIANCE --------------------------- ----------------------- 2002 2001 $ % ------- ------- ------- ------- (IN MILLIONS) Resort/Hotel Property Revenue $ 148.1 $ 44.5 Resort/Hotel Property Expense (110.7) -- ------- ------- ----- ----- Net Operating Income $ 37.4 $ 44.5 $(7.1) (16.0)% ======= ======= ===== ===== The decrease in hotel property net operating income is primarily due to the consolidation of the operations of eight of the hotel properties in 2002 as compared to the recognition of lease payments from these properties in 2001. In addition, net operating income decreased as a result of the following: - decreases in occupancy from 72% to 71% and decreases in revenue per available room from $331 to $319 (3.6% decrease) at the luxury and destination fitness resorts and spas; and - decreases in occupancy from 72% to 71%, and revenue per available room from $85 to $81 (4.7% decrease) at the business-class hotels. Residential Development Segment 215 On February 14, 2002, Crescent Real Estate executed an agreement with Crescent Operating, pursuant to which Crescent Operating transferred to subsidiaries of Crescent Real Estate, pursuant to a strict foreclosure, Crescent Operating's voting interests in three of the residential development corporations: The Woodlands Land Company, Desert Mountain Development Corp. and CRDI. Crescent Real Estate fully consolidated the operations of the three residential development corporations beginning on the dates of the asset transfers. FOR THE NINE MONTHS ENDED SEPTEMBER 30, VARIANCE ---------------------------- ----------------------------- 2002 2001 $ % -------- -------- -------- -------- (IN MILLIONS) Residential Development Property Revenue $ 176.9 $ -- Residential Development Property Expense (161.3) -- Depreciation/Amortization (4.9) -- Equity in net income of Unconsolidated Residential Development Properties 22.9 27.7 Minority Interests (3.0) -- Income Tax Provision (3.4) -- Cumulative effect of a change in accounting principle (1.4) -- -------- -------- -------- -------- Operating Results $ 25.8 $ 27.7 $ (1.9) (6.9)% ======== ======== ======== ======== The primary components of the decrease in residential development property net operating income are: - a decrease of $5.2 million resulting from a change in presentation of capitalized interest due to the consolidation of Desert Mountain Development Corp. and CRDI in 2002; and - a decrease of $1.4 million resulting from the cumulative effect of a change in accounting principle due to net goodwill impairment at CRDI resulting from the adoption of SFAS No. 142 on January 1, 2002; partially offset by higher lot and unit sales of $8.8 million at CRDI and Desert Mountain Development Corp. and $4.3 million due to the gain recognized on the disposition of two properties at The Woodlands; offset by lower lot sales of $8.1 million at The Woodlands Land Company and Mira Vista Development, Corp. Temperature-Controlled Logistics Segment FOR THE NINE MONTHS ENDED SEPTEMBER 30, VARIANCE ---------------------------- ----------------------------- 2002 2001 $ % -------- -------- -------- -------- (IN MILLIONS) Equity in earnings (loss) of unconsolidated Temperature-Controlled Logistics Properties $ (3.8) $ 2.3 $ (6.1) (265.2) This decrease in equity in earning of unconsolidated temperature-controlled logistics properties is primarily due to Crescent Real Estate's $8.2 million portion of the deferred rent in the first nine months of 2002 compared with the Crescent Real Estate's $5.1 million portion of deferred rent in the first nine months of 2001, and $2.9 million related to the change in base rent recognition from straight-line to seasonal for the year, partially offset by a decrease in interest expense of $0.8 million. 216 Year Ended December 31, 2001 as Compared to 2000 Revenues. Total revenues decreased $21.3 million, or 3.1%, to $686.2 million for the year ended December 31, 2001, as compared to $707.5 million for the year ended December 31, 2000. The primary components of the decrease in total revenues are discussed below. The increase in office property revenues of $5.2 million, or 0.9%, for the year ended December 31, 2001, as compared to the year ended December 31, 2000, is attributable to: - increased revenues of $32.1 million from the 69 consolidated office properties that Crescent Real Estate owned or had an interest in as of December 31, 2001, excluding the five office properties held for sale at December 31, 2001, primarily as a result of increased full-service weighted average rental rates (reflecting increases in both rental revenue and operating expense recoveries), and increased occupancy; and - increased other income of $4.2 million, primarily due to parking revenue; partially offset by - decreased revenues of $27.2 million due to the disposition of 11 office properties and four retail properties during 2000, compared to the disposition of five office properties and the joint ventures of two office properties during 2001; and - decreased lease termination fees (net of the write-off of deferred rent receivables) of $3.9 million, from $12.0 million for the year ended December 31, 2000, to $8.0 million for the year ended December 31, 2001. The decrease in Crescent Real Estate hotel property revenues of $26.4 million, or 36.6%, for the year ended December 31, 2001, as compared to the year ended December 31, 2000, is attributable to: - decreased revenues from the upscale business-class hotels of $8.1 million, due to the disposition of the Four Seasons Hotel -- Houston in November 2000; - decreased revenues of $6.3 million due to a decrease in rental income attributed to the softening of the economy and the events of September 11, 2001; and - decreased revenues of $12.0 million due to not recognizing revenue during the fourth quarter of 2001 under the leases with Crescent Operating. Expenses. Total expenses increased $95.1 million, or 15.3%, to $716.1 million for the year ended December 31, 2001, as compared to $621.0 million for the year ended December 31, 2000. The primary components of the increase in total expenses are discussed below. The increase in office property operating expenses of $13.6 million, or 5.6%, for the year ended December 31, 2001, as compared to the year ended December 31, 2000, is attributable to: - increased expenses of $24.7 million from the 69 consolidated office properties that Crescent Real Estate owned or had an interest in as of December 31, 2001, excluding the five office properties held for sale at December 31, 2001, primarily as a result of increased operating expenses for 217 utilities of $7.8 million, taxes of $3.6 million and other increased operating expenses such as insurance, security, and technology initiatives of $13.3 million during the year ended December 31, 2001, as compared to the same period in 2000; partially offset by - decreased expenses of $11.1 million due to the disposition of 11 office properties and four retail properties during 2000, compared to the disposition of five office properties and the joint ventures of two office properties during 2001. The decrease in interest expense of $20.8 million, or 10.2%, for the year ended December 31, 2001, as compared to the same period in 2000, is primarily attributable to a decrease in the weighted average interest rate of 0.61%, or $14.0 million of interest expense, combined with a decrease in the average debt balance of $104.0 million, or $8.0 million of interest expense. The increase in impairment and other charges related to real estate assets of $7.4 million is due to: - the conversion of Crescent Real Estate's preferred member interest in Metropolitan Partners, LLC, or Metropolitan, into common stock of Reckson Associates Realty Corp., or Reckson, which resulted in an impairment charge of $11.8 million; partially offset by - a decrease in the impairment loss of $3.5 million, from $8.5 million in 2000 to $5.0 million in 2001, recognized on a fund which holds real estate and marketable securities, in which Crescent Real Estate has an interest; and - a decrease in the impairment of the behavioral healthcare properties of $0.9 million. The increase in impairment and other charges related to Crescent Operating of $92.8 million is due to the reduction in net assets of $74.8 million, primarily attributable to the write-down of debt and rental obligations of Crescent Operating to the estimated underlying collateral value of assets to be received from Crescent Operating, and estimated Crescent Operating bankruptcy costs to be funded by Crescent Real Estate of $18.0 million. Other Income. Other income decreased $157.5 million, or 73.9%, to $55.76 million for the year ended December 31, 2001, as compared to $213.2 million for the year ended December 31, 2000. This decrease is due to: The decrease in equity in net income of unconsolidated companies of $24.5 million, or 32.4%, for the year ended December 31, 2001, as compared to the same period in 2000, is primarily attributable to: - a decrease in equity in net income of unconsolidated Crescent Real Estate residential development properties of $12.5 million, or 24%, primarily attributable to lower lot sales at Desert Mountain during the year ended December 31, 2001, resulting in a decrease of $16.3 million; partially offset by higher unit sales at CRDI, resulting in an increase of $4.5 million; - a decrease in equity in net income of the Crescent Real Estate temperature-controlled logistics properties of $6.3 million, or 85%, due to the lease restructuring in 2001 and an increase in deferred rent of $9.2 million; and - a decrease in equity in net income of other unconsolidated properties of $8.6 million, or 75.0%, primarily attributable to lower earnings of $3.8 million from Metropolitan due to the conversion of Crescent Real Estate's preferred member interest into common stock of Reckson in May 2001, 218 the $1.0 million write-off of Crescent Real Estate's investment in a retail distribution company and lower earnings from DBL Holdings, Inc., or DBL, of $1.7 million, due to an approximate $12.2 million return of investment received in March 2001; partially offset by - an increase in equity in net income of the unconsolidated office properties of $2.9 million, or 94.0%, primarily attributable to lower interest expense at one unconsolidated office property. The net decrease in gain on property sales of $133.1 million for the year ended December 31, 2001, as compared to the same period in 2000, is attributable to a decrease in net gains recognized primarily on office, hotel and behavioral healthcare property sales for the year ended December 31, 2001, as compared with the same period in 2000. Discontinued Operations. The income from discontinued operations from assets sold and held for sale decreased $1.4 million, or 46.7%, to $1.6 million for the year ended December 31, 2001, compared to $3.0 million for the year ended December 31, 2000. This decrease is primarily due to a decrease in net operating income of two office properties held for sale of approximately $1.8 million, partially offset by the increase in net operating income of two of the office properties held for sale of approximately $0.2 million. Extraordinary Items. The increase in extraordinary items of $6.9 million, or 176.9%, is attributable to the write-off of deferred financing costs related to the early extinguishment of the UBS Facility in May 2001 of $10.8 million, compared with the write-off of deferred financing costs related to the early extinguishment of the BankBoston Facility in February 2000 of $3.9 million. Year Ended December 31, 2000 as Compared to 1999 Revenues. Total revenues decreased $27.0 million, or 3.7%, to $707.4 million for the year ended December 31, 2000, as compared to $734.4 million for the year ended December 31, 1999. The decrease in office property revenues of $7.6 million, or 1.3%, for the year ended December 31, 2000, as compared to the same period in 1999, is attributable to: - decreased revenues of $37.2 million due to the disposition of 11 office properties and four retail properties during 2000, which contributed revenues during the full year of 1999, as compared to a partial year in 2000; partially offset by - increased revenues of $24.4 million from the 74 office properties owned as of December 31, 2000, excluding the four office properties held for sale at December 31, 2000, primarily as a result of increased weighted average full-service rental rates at these properties; and - increased revenues of $5.2 million from lease termination fees. The increase in Crescent Real Estate hotel property revenues of $6.9 million, or 10.6%, for the year ended December 31, 2000, as compared to the same period in 1999, is attributable to: 219 - increased revenues of $3.1 million at the luxury resorts and spas primarily due to an increase in percentage rents resulting from increased room revenue due to the 30-room expansion at the Sonoma Mission Inn & Spa that opened in April 2000; - increased revenues of $2.6 million at the business class hotels primarily due to (i) the reclassification of the Renaissance Houston Hotel from the office segment to the resort/hotel segment as a result of the restructuring of its lease on July 1, 1999, which resulted in $2.4 million of incremental revenues under the new lease and (ii) increased percentage rents due to higher room and occupancy rates at the Omni Austin Hotel, partially offset by (iii) decreased revenues of $1.2 million due to the disposition of one Crescent Real Estate hotel property during the fourth quarter of 2000, which contributed revenues during the full year of 1999, as compared to a partial year in 2000; and - increased revenues of $1.2 million at the destination fitness resorts and spas primarily due to an increase in percentage rents at the Canyon Ranch properties as a result of higher room rates. The decrease in interest and other income of $26.3 million, or 39.7%, for the year ended December 31, 2000, as compared to the same period in 1999, is primarily attributable to the recognition of rent from Charter Behavioral Health Systems, LLC, or CBHS, on a cash basis beginning in the third quarter of 1999, the filing of voluntary bankruptcy petitions by CBHS and its subsidiaries on February 16, 2000, and a rent stipulation agreed to by certain parties to the bankruptcy proceedings, which resulted in a reduction in Crescent Real Estate behavioral healthcare property revenues, which are included in interest and other income, to $15.4 million for the year ended December 31, 2000 as compared to $41.1 million for the same period in 1999. Expenses. Total expenses decreased $172.5 million, or 21.7%, to $621.0 million for the year ended December 31, 2000, as compared to $793.5 million for the year ended December 31, 1999. The decrease in office property operating expenses of $6.9 million, or 2.7%, for the year ended December 31, 2000, as compared to the same period in 1999, is attributable to: - decreased expenses of $17.0 million due to the disposition of 11 office properties and four retail properties during 2000, which incurred expenses during the full year of 1999, as compared to a partial year in 2000; partially offset by - increased expenses of $10.1 million from the 74 office properties owned as of December 31, 2000, excluding the four office properties held for sale at December 31, 2001, as a result of (i) increased general repair and maintenance expenses at these properties of $5.6 million and (ii) an increase in real estate taxes of $4.5 million. The increase in corporate general and administrative expense of $7.8 million, or 47.9%, for the year ended December 31, 2000, as compared to the same period in 1999, is primarily attributable to technology initiatives, employee retention programs, incentive compensation, and additional personnel. The increase in interest expense of $11.2 million, or 5.8%, for the year ended December 31, 2000, as compared to the same period in 1999, is primarily attributable to an increase in the weighted-average interest rate from 7.4% in 1999 to 8.4% in 2000, partially offset by a decrease in average debt balance outstanding from $2.6 billion in 1999 to $2.4 billion in 2000. 220 The decrease in depreciation and amortization expense of $7.8 million, or 6.0%, for the year ended December 31, 2000, as compared to the same period in 1999, is primarily attributable to the cessation of the recognition of depreciation expense on office properties and the Crescent Real Estate behavioral healthcare properties from the dates they were classified as held for disposition. An additional decrease in expenses of $176.8 million is primarily attributable to: - non-recurring costs of $15.0 million in connection with the settlement of litigation relating to the merger agreement entered into in January 1998 between Crescent Real Estate and Station Casinos, Inc. in the first quarter of 1999; and - a decrease of $169.5 million due to the $162.0 million impairment and other charges related to the Crescent Real Estate behavioral healthcare properties in the third quarter of 1999 and the $16.8 million impairment charge in the fourth quarter of 1999 on one of the office properties held for disposition as compared to the $9.3 million impairment related to the behavioral healthcare properties in the year ended December 31, 2000; partially offset by - an impairment loss of $8.5 million recognized in 2000 on a fund which primarily holds real estate investments and marketable securities, in which Crescent Real Estate has an interest. Other Income. Other income increased $144.9 million, or 212.2%, to $213.2 million for the year ended December 31, 2000, as compared to $68.3 million for the year ended December 31, 1999. The components of the increase in other income are discussed below. The increase in equity in unconsolidated companies of $7.4 million, or 10.8%, for the year ended December 31, 2000, as compared to the same period in 1999 is attributable to: - an increase in equity in net income of the residential development corporations of $10.6 million, or 24.7%, attributable to (i) an increase in average sales price per lot and an increase in membership conversion revenue at Desert Mountain, partially offset by a decrease in lot absorption, which resulted in an increase of $6.0 million in equity in net income to Crescent Real Estate; (ii) an increase in residential lot and commercial land sales and an increase in average sales price per lot at The Woodlands Land Development Company, L.P., partially offset by a decrease in average sales price per acre from commercial lands sales, which resulted in an increase of $5.9 million in equity in net income to Crescent Real Estate; and (iii) an increase in commercial acreage sales at CRDI, partially offset by a decrease in single family home sales, which resulted in an increase of $0.8 million in equity in net income to Crescent Real Estate; partially offset by (iv) a decrease in commercial land sales at Houston Area Development Corp., which resulted in a decrease of $2.1 million in equity in net income to Crescent Real Estate; and - an increase in equity in net income of the other unconsolidated companies of $6.5 million, or 127.5%, primarily as a result of (i) the dividend income attributable to the 7.5% per annum cash flow preference of Crescent Real Estate's $85.0 million preferred member interest in Metropolitan, which Crescent Real Estate purchased in May 1999; and (ii) an increase in the equity in earnings from DBL as a result of its investment in G2 Opportunity Fund, L.P., or G2 Opportunity Fund, which was made in the third quarter of 1999; partially offset by 221 - a decrease in equity in net income of the temperature-controlled logistics partnership of $7.6 million, or 50.7%, resulting primarily from the recognition of a rent receivable valuation allowance for the year ended December 31, 2000 of $6.5 million; and - a decrease in equity in net income of the unconsolidated office properties of $2.1 million, or 39.6%, primarily attributable to an increase in interest expense as a result of additional financing obtained in July 2000 and an increase in the average rate of debt at The Woodlands Commercial Properties Company. The increase in net gain on property sales of $137.5 million for the year ended December 31, 2000, as compared to the same period in 1999, is attributable to net gains primarily recognized on office, hotel and behavioral healthcare property sales. Discontinued Operations The income from discontinued operations from assets sold and held for sale decreased $0.7 million, or 18.9%, to $3.0 million for the year ended December 31, 2002, as compared to $3.7 million for the year ended December 31, 1999. The decrease is primarily due to a decrease in net operating income of three office properties held for sale of approximately $1.1 million, partially offset by the increase in net operating income of one of the office properties held for sale of approximately $0.4 million. LIQUIDITY AND CAPITAL RESOURCES Nine Months Ended September 30, 2002 Cash Flows. FOR THE NINE MONTHS ENDED, SEPTEMBER 30, --------------------------- 2002 2001 $ CHANGE ------- ------- ------- (IN MILLIONS) Cash Provided by Operating Activities $ 152.7 $ 253.8 $(101.1) Cash used in Investing Activities 106.0 166.6 (60.6) Cash used in Financing Activities (212.4) (426.2) 213.8 ------- ------- ------- Increase (Decrease) in Cash and Cash Equivalents $ 46.3 $ (5.8) $ 52.1 Cash and Cash Equivalents, Beginning of Period 36.3 39.0 (2.7) ------- ------- ------- Cash and Cash Equivalents, End of Period $ 82.6 $ 33.2 $ 49.4 ======= ======= ======= Operating Activities. Crescent Real Estate's cash provided by operating activities of $152.7 million is attributable to property operations. Investing Activities. Crescent Real Estate's cash provided by investing activities of $106.0 million is attributable to: - $164.1 million of proceeds from joint venture partners; - $76.6 million of net sales proceeds primarily attributable to the sale of five office properties, the sale of three behavioral healthcare properties, and the sale of two other assets; - $11.7 million from return of investment in unconsolidated residential development properties and office properties; 222 - $38.2 million in cash resulting from Crescent Real Estate's February 14, 2002 transaction with Crescent Operating; and - $12.7 million decrease in restricted cash. The cash provided by investing activities is partially offset by: - $97.4 million primarily for acquisition of one office property; - $36.6 million for incremental and non-incremental revenue generating tenant improvement and leasing costs for office properties; - $28.4 million of additional investment in unconsolidated companies, consisting primarily of investments in the upscale residential development properties, particularly related to CRDI's investment in the Tahoe Mountain Resorts from January 1 through February 14, 2002; - $25.3 million for property improvements for rental properties, primarily attributable to non-recoverable building improvements for the office properties and replacement of furniture, fixtures and equipment for the hotel properties; - $7.8 million increase in notes receivable due to a $7.5 million promissory note received in the sale of the Canyon Ranch - Tucson Land; and - $1.7 million for development of investment properties. Financing Activities. Crescent Real Estate's use of cash for financing activities of $212.4 million is primarily attributable to: - net payments under the Fleet Facility of $476.0 million; - redemptions from GMAC Commercial Mortgage Corporation of preferred interests in a subsidiary of Crescent Real Estate of $218.4 million; - a decrease in notes payable of $171.5 million; - distributions to common shareholders and unitholders of $132.5 million; - residential development properties notes payments of $84.9 million; - common share repurchase of $28.5 million; - $8.9 million of deferred financing costs for $375 million senior, unsecured notes; - distributions to preferred shareholders of $15.2 million; and - net capital distributions to joint venture partners of $8.5 million, primarily due to distributions to joint venture preferred equity partners. 223 The use of cash for financing activities is partially offset by: - gross proceeds of $375.0 from issuance of senior, unsecured notes: - net proceeds of $81.9 from offering of Series B preferred shares; - net proceeds of $48.2 from offering of Series A preferred shares; - residential development properties notes borrowings of $54.7 million; and - borrowings under the Fleet Facility of $372.0 million. Liquidity Requirements. As of September 30, 2002, Crescent Real Estate had unfunded capital expenditures of approximately $40.9 million relating to capital investments. The table below specifies Crescent Real Estate's total capital expenditures relating to these projects, amounts funded as of September 30, 2002, amounts remaining to be funded, and short-term and long-term capital requirements. CAPITAL REQUIREMENTS AMOUNT ----------------------------- FUNDED AS AMOUNT SHORT-TERM LONG-TERM TOTAL OF REMAINING (NEXT 12 (12+ PROJECT Cost(1) 09/30/02 TO FUND MONTHS)(2) MONTHS)(2) ------- ------- -------- ------- ----------- ---------- (IN MILLIONS) RESIDENTIAL DEVELOPMENT SEGMENT Tahoe Mountain Resorts $110.0 $ 99.0 $ 11.0 $ 11.0 $ -- ------ ------ ------ ------ ------ OTHER SunTx (3) $ 19.0 $ 7.8 $ 11.2 $ 4.0 $ 7.2 ------ ------ ------ ------ ------ Spinco (4) 15.5 -- 15.5 15.5 -- ------ ------ ------ ------ ------ Canyon Ranch - Tucson Land - Construction loan (5) 3.2 -- 3.2 1.6 1.6 ------ ------ ------ ------ ------ $ 37.7 $ 7.8 $ 29.9 $ 21.1 $ 8.8 TOTAL $147.7 $106.8 $ 40.9 $ 32.1 $ 8.8 ====== ====== ====== ====== ====== --------------------------------- (1) All amounts are approximate. (2) Reflects Crescent Real Estate's estimate of the breakdown between short-term and long-term capital expenditures. (3) This commitment is related to Crescent Real Estate's investment in a private equity fund. (4) Crescent Real Estate expects to form and capitalize a separate entity to be owned by Crescent Real Estate's shareholders and unitholders, and to cause the new entity to commit to acquire Crescent Operating's entire membership interest in AmeriCold Logistics. (5) Crescent Real Estate committed to a construction loan to the purchaser of the land which will be secured by 20 developed lots and a $0.6 million letter of credit. Crescent Real Estate expects to fund its short-term capital requirements of approximately $32.1 million through a combination of cash, net cash flow from operations, construction financing return of capital (investment) from the residential development corporations and borrowings under the Fleet Facility. Crescent Real Estate plans to meet its maturing debt obligations through December 31, 2003 of approximately $185.7 million, primarily through additional borrowings under the Fleet Facility and cash from operations of the residential development segment. Crescent Real Estate expects to meet its other short-term liquidity requirements, consisting of normal recurring operating expenses, regular debt service requirements (including debt service relating to additional and replacement debt), additional interest expense related to the cash flow hedge agreements, 224 recurring capital expenditures, non-recurring capital expenditures, such as tenant improvement and leasing costs, distributions to shareholders and unitholders, and unfunded expenses related to the Crescent Operating bankruptcy of approximately $3.2 million to $6.4 million, primarily through cash flow provided by operating activities. To the extent that Crescent Real Estate's cash flow from operating activities is not sufficient to finance such short-term liquidity requirements, Crescent Real Estate expects to finance such requirements with borrowings under the Fleet Facility. Crescent Real Estate's long-term liquidity requirements as of September 30, 2002 consist primarily of debt maturities after December 31, 2003, which totaled approximately $2.2 billion as of September 30, 2002. Crescent Real Estate also has $8.8 million of long-term capital requirements. Crescent Real Estate expects to meet these long-term liquidity requirements primarily through long-term secured and unsecured borrowings and other debt and equity financing alternatives as well as cash proceeds received from the sale or joint venture of properties. Debt and equity financing alternatives currently available to Crescent Real Estate to satisfy its liquidity requirements and commitments for material capital expenditures include: - Additional proceeds from the Fleet Facility, under which Crescent Real Estate had up to $205.8 million of borrowing capacity as of September 30, 2002; - Additional proceeds from the refinancing of existing secured and unsecured debt; - Additional debt secured by existing underleveraged investment properties; - Issuance of additional unsecured debt; - Equity offerings including preferred and/or convertible securities; and - Proceeds from joint ventures and property sales. The following factors could limit Crescent Real Estate's ability to utilize these financing alternatives: - The reduction in net operating income of the properties supporting the Fleet Facility to a level that would further reduce the availability under the line of credit. - Crescent Real Estate may be unable to obtain debt or equity financing on favorable terms, or at all, as a result of the financial condition of Crescent Real Estate or market conditions at the time Crescent Real Estate seeks additional financing; - Restrictions on Crescent Real Estate's debt instruments or outstanding equity may prohibit it from incurring debt or issuing equity at all, or on terms available under then-prevailing market conditions; and - Crescent Real Estate may be unable to service additional or replacement debt due to increases in interest rates or a decline in the Crescent Real Estate's operating performance. In addition to Crescent Real Estate's liquidity requirements stated above, as of September 30, 2002, Crescent Real Estate guaranteed or provided letters of credit related to approximately $55.9 million of unconsolidated debt and had obligations to potentially provide an additional $33.8 million in 225 guarantees, primarily related to construction loans. Crescent Real Estate also guaranteed $15.2 million in letters of credit under its Fleet Facility at September 30, 2002. See "Investments in Real Estate Mortgages and Equity of Unconsolidated Companies" and "Debt Financing Arrangements" included in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" for more information about Crescent Real Estate's unconsolidated investments and the underlying debt related to these investments. Year ended December 31, 2001 Cash and cash equivalents were $36.3 million and $39.0 million at December 31, 2001, and December 31, 2000, respectively. This 6.9% decrease is attributable to $425.5 million used in financing activities, partially offset by $210.0 million and $212.8 million provided by investing and operating activities, respectively. DECEMBER 31, 2001 ------------- (in millions) Cash Provided by Operating Activities $212.8 Cash Provided by Investing Activities 210.0 Cash Used in Financing Activities (425.5) ------ Decrease in Cash and Cash Equivalents $ (2.7) Cash and Cash Equivalents, Beginning of Period 39.0 ------ Cash and Cash Equivalents, End of Period $ 36.3 ====== Operating Activities. Crescent Real Estate's cash provided by operating activities of $212.8 million is attributable to: - $199.4 million from property operations; and - $13.4 million representing distributions received in excess of equity in earnings from unconsolidated companies. Investing Activities. Crescent Real Estate's cash provided by investing activities of $210.0 million is primarily attributable to: - $200.4 million of net sales proceeds primarily attributable to the disposition of the two Washington Harbour office properties, three Woodlands office properties and 18 Crescent Real Estate behavioral healthcare properties; - $129.7 million of proceeds from joint venture partners, primarily as a result of the proceeds of $116.7 million from the joint ventures of two existing office properties, Bank One Tower in Austin, Texas and Four Westlake Park in Houston, Texas and $12.9 million from the joint venture of 5 Houston Center office property, which is currently being developed; - $107.9 million of proceeds from the sale of marketable securities; and 226 - $32.0 million from return of investment in unconsolidated office properties, residential development properties and other unconsolidated companies. Crescent Real Estate's cash provided by investing activities is partially offset by: - $124.6 million of additional investment in unconsolidated companies, consisting of investments in (i) the upscale Crescent Real Estate residential development properties of $89.0 million, primarily as a result of CRDI's investment in Tahoe Mountain Resorts, (ii) Crescent Real Estate temperature-controlled logistics properties of $10.8 million, (iii) office properties of $16.4 million and (iv) other unconsolidated companies of $8.4 million; - $51.8 million for recurring and non-recurring tenant improvement and leasing costs for the office properties; - $46.4 million for capital expenditures for rental properties, primarily attributable to non-recoverable building improvements for the office properties and replacement of furniture, fixtures and equipment for the Crescent Real Estate hotel properties; - $23.7 million for the development of investment properties, including $12.3 million for development of the 5 Houston Center office property and expansions and renovations at the Crescent Real Estate hotel properties; - a $11.2 million increase in notes receivable, primarily as a result of approximately $10.0 million related to secured loans to AmeriCold Logistics; and - a $2.2 million increase in restricted cash and cash equivalents, primarily related to the escrow of funds to purchase a parking garage in Denver, Colorado, which was purchased during the first quarter of 2002, partially offset by escrow reimbursements for capital expenditures at the Crescent Real Estate hotel properties and the office properties. Financing Activities. Crescent Real Estate's use of cash for financing activities of $425.5 million is primarily attributable to: - net repayment of the UBS Facility of $553.5 million; - distributions to common shareholders and unitholders of $245.1 million; - repayment and retirement of the iStar Financial Note of $97.1 million; - repurchase of Crescent Real Estate's common shares for $77.4 million; - repayment and retirement of the Deutsche Bank Short-term Loan of $75.0 million; - net capital distributions to joint venture partners of $25.4 million, primarily due to distributions to joint venture preferred equity partners; - debt financing costs of $16.0 million; and - distributions to preferred shareholders of $13.5 million. 227 The use of cash for financing activities is partially offset by: - net borrowings under the Fleet Facility of $283.0 million; - proceeds from notes payable of $393.3 million, primarily attributable to the debt refinancing; and - proceeds from the exercise of common share options of $9.8 million. Crescent Operating. In April 1997, Crescent Real Estate established a new Delaware corporation, Crescent Operating. All of the outstanding common stock of Crescent Operating, valued at $0.99 per share, was distributed, effective June 12, 1997, to those persons who were limited partners of Crescent Partnership or shareholders of Crescent Real Estate on May 30, 1997, in a spin-off. Crescent Operating was formed to become a lessee and operator of various assets to be acquired by Crescent Real Estate and to perform the intercompany agreement between Crescent Operating and Crescent Real Estate, pursuant to which each agreed to provide the other with rights to participate in certain transactions. Crescent Real Estate was not permitted to operate or lease these assets under the tax laws in effect and applicable to REITs at that time. In connection with the formation and capitalization of Crescent Operating, and the subsequent operations and investments of Crescent Operating since 1997, Crescent Real Estate made loans to Crescent Operating under a line of credit and various term loans. On January 1, 2001, The REIT Modernization Act became effective. This legislation allows Crescent Real Estate, through its subsidiaries, to operate or lease certain of its investments that had been previously operated or leased by Crescent Operating. Crescent Operating and Crescent Real Estate entered into an asset and stock purchase agreement on June 28, 2001, in which Crescent Real Estate agreed to acquire the lessee interests in the eight Crescent Real Estate hotel properties leased to subsidiaries of Crescent Operating, the voting interests held by subsidiaries of Crescent Operating in three of Crescent Real Estate's residential development corporations and other assets in exchange for $78.4 million. In connection with that agreement, Crescent Real Estate agreed that it would not charge interest on its loans to Crescent Operating from May 1, 2001 and that it would allow Crescent Operating to defer all principal and interest payments due under the loans until December 31, 2001. Also on June 28, 2001, Crescent Real Estate entered into an agreement to make a $10.0 million investment in Crescent Machinery, a wholly owned subsidiary of Crescent Operating. This investment, together with capital from a third-party investment firm, was expected to put Crescent Machinery on solid financial footing. Following the date of the agreements relating to the acquisition of Crescent Operating assets and stock and the investment in Crescent Machinery, the results of operations for the Crescent Operating hotel operations and the Crescent Operating land development interests declined, due in part to the slowdown in the economy after September 11. In addition, Crescent Machinery's results of operations suffered because of the economic environment and the overall reduction in national construction levels that has affected the equipment rental and sale business, particularly post September 11. As a result, Crescent Real Estate believes that a significant additional investment would have been necessary to adequately capitalize Crescent Machinery and satisfy concerns of Crescent Machinery's lenders. 228 Crescent Real Estate stopped recording rent from the leases of the eight Crescent Real Estate hotel properties leased to subsidiaries of Crescent Operating on October 1, 2001, and recorded impairment and other adjustments related to Crescent Operating in the fourth quarter of 2001, based on the estimated fair value of the underlying assets. See "Note 16. Crescent Operating" included in Financial Statements of Crescent Real Estate for the year ended December 31, 2001 (audited) for a description of these charges. On January 22, 2002, Crescent Real Estate terminated the purchase agreement pursuant to which Crescent Real Estate would have acquired the lessee interests in the eight Crescent Real Estate hotel properties leased to subsidiaries of Crescent Operating the voting interests held by subsidiaries of Crescent Operating in three of the residential development corporations and other assets. On February 4, 2002, Crescent Real Estate terminated the agreement relating to its planned investment in Crescent Machinery. On February 6, 2002, Crescent Machinery filed for protection under the federal bankruptcy laws. On February 12, 2002, Crescent Real Estate delivered default notices to Crescent Operating relating to approximately $49.0 million of unpaid rent and approximately $76.2 million of principal and accrued interest due to Crescent Real Estate under certain secured loans. On February 14, 2002, Crescent Real Estate executed the original Settlement Agreement with Crescent Operating, pursuant to which Crescent Operating transferred to subsidiaries of Crescent Real Estate, in lieu of foreclosure, Crescent Operating's lessee interests in the eight Crescent Real Estate hotel properties leased to subsidiaries of Crescent Operating and, pursuant to a strict foreclosure, Crescent Operating's voting interests in three of Crescent Real Estate's residential development corporations and other assets and Crescent Real Estate agreed to assist and provide funding to Crescent Operating for the implementation of a prepackaged bankruptcy of Crescent Operating. In connection with the transfer, Crescent Operating's rent obligations to Crescent Real Estate were reduced by $23.6 million, and its debt obligations were reduced by $40.1 million. These amounts include $18.3 million of value attributed to the lessee interests transferred by Crescent Operating to Crescent Real Estate, however, in accordance with GAAP, Crescent Real Estate assigned no value to these interests for financial reporting purposes. Crescent Real Estate holds the lessee interests in the eight Crescent Real Estate hotel properties and the voting interests in the three residential development corporations through three newly organized entities that are each wholly owned taxable REIT subsidiaries of Crescent Real Estate. Crescent Real Estate included these assets in its resort/hotel segment and its residential development segment, and fully consolidated the operations of the eight Crescent Real Estate hotel properties and the three residential development corporations, beginning on the date of the transfers of these assets. The Settlement Agreement provides that Crescent Operating and Crescent Real Estate will jointly seek to have a pre-packaged bankruptcy plan for Crescent Operating, reflecting the terms of the Settlement Agreement, approved by the bankruptcy court. Under the Settlement Agreement, Crescent Real Estate agreed to provide approximately $14.0 million to Crescent Operating in the form of cash and common shares of Crescent Real Estate to fund costs, claims and expenses relating to the bankruptcy and related transactions, and to provide for the distribution of Crescent Real Estate's common shares to the Crescent Operating stockholders. Crescent Real Estate has also agreed, however, that it will issue common shares with a minimum dollar value of approximately $2.16 million to the Crescent Operating stockholders, even if it would cause the total costs, claims and expenses that it pays to exceed $14.0 million. Currently, Crescent Real Estate estimates that the value of the common shares that will be issued to the Crescent Operating stockholders will be approximately $2.16 million to $5.4 million. The actual value of the common shares issued to the Crescent Operating stockholders will not be determined until 229 the confirmation of Crescent Operating's bankruptcy plan and could vary from the estimated amounts, but will have a value of at least $2.16 million. In addition, Crescent Real Estate has agreed to use commercially reasonable efforts to assist Crescent Operating in arranging Crescent Operating's repayment of its $15.0 million obligation to Bank of America, together with accrued interest. Crescent Real Estate expects to form and capitalize a new entity, called Crescent Spinco, to be owned by the shareholders of Crescent Real Estate and the unitholders of Crescent Partnership. Crescent Spinco would then purchase Crescent Operating's interest in AmeriCold Logistics for between $15.0 million and $15.5 million. Crescent Operating has agreed that it will use the proceeds of the sale of the AmeriCold Logistics interest to repay Bank of America in full. Crescent Operating obtained the loan primarily to participate in investments with Crescent Real Estate. At the time Crescent Operating obtained the loan, Bank of America required, as a condition to making the loan, that Richard E. Rainwater, the Chairman of the Board, and John C. Goff, the Chief Executive Officer of Crescent Real Estate, enter into a support agreement with Crescent Operating and Bank of America, pursuant to which they agreed to make additional equity investments in Crescent Operating if Crescent Operating defaulted on payment obligations under its line of credit with Bank of America and the net proceeds of an offering of Crescent Operating securities were insufficient to allow Crescent Operating to pay Bank of America in full. Effective December 31, 2001, the parties executed an amendment to the line of credit providing that any defaults existing under the line of credit on or before March 8, 2002 are temporarily cured unless and until a new default shall occur. Previously, Crescent Real Estate held a first lien security interest in Crescent Operating's entire membership interest in AmeriCold Logistics. REIT rules prohibit Crescent Real Estate from acquiring or owning the membership interest that Crescent Operating owns in AmeriCold Logistics. Under the Settlement Agreement, Crescent Real Estate agreed to allow Crescent Operating to grant Bank of America a first priority security interest in the membership interest and to subordinate its own security interest to Bank of America. If the Crescent Operating bankruptcy plan is approved by the required vote of the shares of Crescent Operating common stock and confirmed by the bankruptcy court, the stockholders of Crescent Operating's common shares will receive Crescent Real Estate's common shares. As stockholders of Crescent Operating, Mr. Rainwater and Mr. Goff will also receive Crescent Real Estate's common shares. Pursuant to the Crescent Operating bankruptcy plan, the current and former directors and officers of Crescent Operating and the current and former directors and officers of Crescent Real Estate also have received a release from Crescent Operating of liability for any actions taken prior to February 14, 2002, and, depending on various factors, will receive certain liability releases from Crescent Operating and its stockholders. Completion and effectiveness of the bankruptcy plan for Crescent Operating is contingent upon a number of conditions, including the vote of Crescent Operating's stockholders, the approval of the bankruptcy plan by certain of Crescent Operating's creditors and the approval of the bankruptcy court. Investments in Real Estate Mortgages and Equity of Unconsolidated Companies. Investments in which Crescent Real Estate does not have a controlling interest are accounted for under the equity method. The following is a summary of Crescent Real Estate's ownership in significant unconsolidated joint ventures or equity investments as of September 30, 2002: 230 CRESCENT REAL ESTATE'S OWNERSHIP ENTITY CLASSIFICATION AS OF SEPTEMBER 30, 2002 ------ -------------- ------------------------ JOINT VENTURES Main Street Partners, L.P. Office (Bank One Center) 50.0%(1) Crescent Miami Center, L.L.C. Office (Miami Center) 40.0%(2) Crescent 5 Houston Center, L.P. Office (5 Houston Center) 25.0%(3) Austin PT BK One Tower Office Limited Partnership Office (Bank One Tower) 20.0%(4) Houston PT Four Westlake Office Limited Partnership Office (Four Westlake Park) 20.0%(4) Houston PT Three Westlake Office Limited Partnership Office (Three Westlake Park) 20.0%(4) EQUITY INVESTMENTS Mira Vista Development Corp. Residential Development Corporation 94.0%(5) Houston Area Development Corp. Residential Development Corporation 94.0%(6) The Woodlands Land Development Company, L.P. (7) Residential Development Corporation 42.5%(8)(9) Blue River Land Company, L.L.C. (7) Residential Development Corporation 31.8%(10) Manalapan Hotel Partners L.L.C. (7) Resort/Hotel (Ritz Carlton Palm Beach) 24.0%(11) Temperature-Controlled Logistics Partnership Temperature-Controlled Logistics 40.0%(12) The Woodlands Commercial Properties Company, L.P. Office 42.5%%(8)(9) DBL Holdings, Inc. Other 97.4%(13) CR License, L.L.C. Other 30.0%(14) Woodlands Operating Company, L.P. Other 42.5%(8)(9) Canyon Ranch Las Vegas Other 65.0%(15) SunTX Fulcrum Fund, L.P. Other 33.3%(16) --------------------------- (1) The remaining 50.0% interest in Main Street Partners, L.P. is owned by Trizec Properties, Inc. (2) The remaining 60% interest in Crescent Miami Center, L.L.C. is owned by a fund advised by JP Morgan Investment Management, Inc. Crescent Real Estate will continue to manage Miami Center on a fee basis. (3) The remaining 75% interest in Crescent 5 Houston Center, L.P. is owned by a pension fund advised by JP Morgan Investment Management, Inc. Crescent Real Estate recorded $1,142,000 in development, and leasing fees, related to this investment during the nine months ended September 30, 2002. The 5 Houston Center Office Property was completed on September 16, 2002. (4) The remaining 80% interest in Austin PT BK One Tower Office Limited Partnership, Houston PT Three Westlake Office Limited Partnership and Houston PT Four Westlake Office Limited Partnership is owned by an affiliate of General Electric Pension Fund. Crescent Real Estate recorded $473,000 in management and leasing fees for these office properties during the nine months ended September 30, 2002. (5) The remaining 6.0% interest in Mira Vista Development, Corp., or MVDC, which represents 100% of the voting stock, is owned 4.0% by DBL Holdings, Inc., or DBL, and 2.0% by third parties. (6) The remaining 6.0% interest in Houston Area Development Corp., or HADC, which represents 100% of the voting stock, is owned 4.0% by DBL and 2.0% by a third party. (7) On February 14, 2002, Crescent Real Estate executed an agreement with Crescent Operating, pursuant to which Crescent Operating transferred to subsidiaries of Crescent Real Estate, pursuant to a strict foreclosure, Crescent Operating's interests in the voting stock in three of Crescent Real Estate's residential development corporations (Desert Mountain Development Corp., The Woodlands Land Company, Inc. and CRDI, and in CRL Investments, Inc. Crescent Operating transferred its 60% general partner interest in COPI Colorado, L.P. which owns 10% of the voting stock in CRDI, which increased Crescent Real Estate's ownership interest in CRDI from 90% to 96%. As a result, Crescent Real Estate fully consolidated the operations of these entities beginning on the dates of the asset transfers. The Woodlands Land 231 Development Company, L.P. is an unconsolidated equity investment of The Woodlands Land Company. Blue River Land Company, L.L.C., and Manalapan Hotel Partners, L.L.C., are unconsolidated equity investments of CRDI. (8) The remaining 57.5% interest in The Woodlands Land Development Company L.P., The Woodlands Commercial Properties Company, L.P. and The Woodlands Operating Company, L.P. are owned by an affiliate of Morgan Stanley. (9) Distributions are made to partners based on specified payout percentages. During the nine months ended September 30, 2002, the payout percentage to Crescent Real Estate was 52.5%. (10) Of the remaining 68.2% interest in Blue River Land Company, L.L.C., 0.7% is indirectly owned by John Goff, Vice-Chairman of the Board of Trust Managers and Chief Executive Officer of Crescent Real Estate, through his 20% ownership of COPI Colorado, L.P. and 67.5% is owned by parties unrelated to Crescent Real Estate. (11) Of the remaining 76.0% interest in Manalapan Hotel Partners, L.L.C., 0.5% is indirectly owned by John Goff, Vice-Chairman of the Board of Trust Managers and Chief Executive Officer of Crescent Real Estate, through his 20% ownership of COPI Colorado, L.P. and 75.5% is owned by parties unrelated to Crescent Real Estate. (12) The remaining 60.0% interest in the Temperature-Controlled Logistics Partnership is owned by Vornado Realty Trust, L.P. (13) John Goff, Vice-Chairman of the Board of Trust Managers and Chief Executive Officer of Crescent Real Estate, obtained the remaining 2.6% economic interest in DBL (including 100% of the voting interest in DBL) in exchange for his voting interests in MVDC and HADC, originally valued at approximately $381,000, and approximately $63,000 in cash, or total consideration valued at approximately $444,000. At September 30, 2002, Mr. Goff's book value in DBL was approximately $401,000. (14) The remaining 70% interest in CR License, L.L.C. is owned by an affiliate of the management company of two of Crescent Real Estate's hotel properties. (15) The remaining 35% interest in Canyon Ranch Las Vegas is owned by an affiliate of the management company of two of Crescent Real Estate's hotel properties. (16) The objective of the SunTX Fulcrum Fund, L.P., or the Fund, is to invest in a portfolio of acquisitions that offer the potential for substantial capital appreciation. The remaining 66.7% of the Fund is owned by a group of individuals unrelated to Crescent Real Estate. Crescent Real Estate's ownership percentage will decline by the closing date of the Fund as capital commitments from third parties are secured. Crescent Real Estate's projected ownership interest at the closing of the Fund is approximately 7.5% based on the Fund manager's expectations for the final Fund capitalization. Crescent Real Estate accounts for its investment in the Fund under the cost method. Crescent Real Estate's investment at September 30, 2002 was $7,800,000. 232 Unconsolidated Debt Analysis. The significant terms of Crescent Real Estate's share of unconsolidated debt financing arrangements existing as of September 30, 2002 are shown below: COMPANY'S COMPANY'S DEBT SHARE OF CURRENT FIXED/VARIABLE OWNERSHIP % BALANCE BALANCE (4) RATE MATURITY SECURED/UNSECURED ----------- ------- ----------- ---- -------- ----------------- TEMPERATURE CONTROLLED LOGISTICS SEGMENT: AmeriCold Notes(1) 40% $ 541,326 216,530 7.0% 4/11/2008 Fixed/Secured OFFICE SEGMENT: Main Street Partners, L.P. (2)(3)(4) 50% 133,403 66,702 5.9% 12/1/2004 Variable/Secured Crescent 5 Houston Center, L.P. (5) 25% 48,654 12,164 4.1% 5/31/2004 Variable/Secured Austin PT Bk One Tower Office Limited Partnership 20% 38,012 7,602 7.1% 8/1/2006 Fixed/Secured Houston PT Four Westlake Office Limited Partnership 20% 48,873 9,775 7.1% 8/1/2006 Fixed/Secured Houston PT Three Westlake Office Limited Partnership 20% 33,000 6,600 5.6% 9/1/2007 Fixed/Secured Crescent Miami Center, LLC 40% 81,000 32,400 5.0% 9/1/2007 Fixed/Secured The Woodlands Commercial Properties Co. 42.5% Bank Boston credit facility(3) 64,861 27,566 4.3% 11/30/2002 Variable/Secured Fleet National Bank(3) 3,398 1,444 3.8% 10/31/2003 Variable/Secured 451,201 164,253 RESIDENTIAL DEVELOPMENT SEGMENT: The Woodlands Land Development Co. (6) 42.5% Fleet credit facility (3)(7)(8) 216,460 91,996 4.3% 11/30/2002 Variable/Secured Fleet National Bank (3)(9) 6,971 2,963 3.8% 10/31/2003 Variable/Secured Fleet National Bank (10) 24,531 10,426 4.6% 12/31/2005 Variable/Secured Jack Eckerd Corp. 101 43 4.8% 7/1/2005 Variable/Secured Mitchell Mortgage Company 2,734 1,162 5.8% 1/1/2004 Fixed/Secured Mitchell Mortgage Company 1,257 534 6.3% 7/1/2005 Fixed/Secured Mitchell Mortgage Company 1,962 834 5.5% 10/1/2005 Fixed/Secured Mitchell Mortgage Company 3,548 1,508 8.0% 4/1/2006 Fixed/Secured Mitchell Mortgage Company 1,405 597 7.0% 10/1/2006 Fixed/Secured 258,969 110,063 Resort Hotel Segment Manalapan Hotel Partners Dresdner Bank AG (11) 24% 65,470 15,713 9.8% 12/29/2002 Variable/Secured TOTAL UNCONSOLIDATED DEBT $1,316,966 $506,559 6.0% AVERAGE REMAINING TERM 3.4 years(12) ----------------------- (1) Consists of several notes. Maturity date is based on largest debt instrument. All interest rates are fixed. (2) Senior Note - Note A: $84.0 million at variable interest rate, LIBOR + 189 basis points, $4.9 million at variable interest rate; LIBOR + 250 basis points with a LIBOR floor of 2.50%. Note B: $24.7 million at variable interest rate, LIBOR + 650 basis points with a LIBOR floor of 2.50%. Mezzanine Note - $19.8 million at variable interest rate, LIBOR + 890 basis points with a LIBOR floor of 3.0%. Interest-rate cap agreement maximum LIBOR of 4.52% on all notes. All notes are amortized on a 25-year amortization schedule. (3) This facility has two one-year extension options. (4) Crescent Real Estate obtained a letter of credit to guarantee the repayment of up to $4.3 million of principal of the Main Street Partners, L.P. loan. (5) Crescent Real Estate has made a full and unconditional guarantee of loan from Fleet up to $82.5 million for the construction of 5 Houston Center. At September 30, 2002, $48.7 million was outstanding. (6) On February 14, 2002, Crescent Real Estate executed an agreement with Crescent Operating to transfer, pursuant to a strict foreclosure, Crescent Operating's 5% interest in The Woodlands Land Company. Therefore, as of February 14, 2002, The Woodlands Land Company is fully consolidated. This schedule reflects The Woodlands Land Company's 42.5% interest in The Woodlands Land Development Company. (7) There was an interest rate cap agreement executed with this agreement which limits interest rate exposure on the notional amount of $145.0 million to a maximum LIBOR rate of 9.0%. (8) To mitigate interest rate exposure, The Woodlands Land Development Company has entered into an interest rate swap against the $50.0 million notional amount to effectively fix the interest rate at 5.28%. The Woodlands Land Development Company has also entered into an interest rate swap against $50.0 million notional amount to effectively fix the interest rate at 4.855%. (9) There was an interest rate cap agreement executed with this agreement which limits interest rate exposure on the notional amount of $33.8 million to a maximum LIBOR rate of 9.0%. (10) There was an interest rate cap agreement executed with this agreement which limits interest rate exposure on the notional amount of $19.5 million to a maximum LIBOR rate of 8.5%. (11) Crescent Real Estate guarantees $3.0 million of this facility. 233 The following table shows, as of September 30, 2002, information about Crescent Real Estate's share of unconsolidated fixed and variable-rate debt and does not take into account any extension options, hedge arrangements or the entities' anticipated pay-off dates. WEIGHTED WEIGHTED AVERAGE AMOUNT % OF DEBT AVERAGE RATE MATURITY(1) ------ --------- ------------ ----------- (IN THOUSANDS) FIXED-RATE DEBT $ 277,542 55% 6.8% 5.4 years VARIABLE RATE DEBT 229,017 45% 5.1% 1.0 years ------------ --- --- --------- TOTAL DEBT $ 506,559 100% 6.0% 3.4 years ============ === === ========= -------------------- (1) Based on contractual maturities. Listed below are Crescent Real Estate's share of aggregate principal payments, year by year, required as of September 30, 2002 related to Crescent Real Estate's unconsolidated debt. Scheduled principal installments and amounts due at maturity are included. SECURED DEBT(1) --------------- (IN THOUSANDS) 2002 $ 136,063 2003 5,581 2004 78,944 2005 12,060 2006 18,381 Thereafter 255,530 ---------- $ 506,559 ========== ------------------------------------- (1) These amounts do not represent the effect of two one-year extension options on two of the Woodlands Fleet National Bank loans, totaling $95.0 million that have initial maturity dates of November 2002 and October 2003. Joint Venture Arrangements. 5 Houston Center On June 4, 2001, Crescent Real Estate entered into a joint venture arrangement with a pension fund advised by JPM, to construct the 5 Houston Center office property within Crescent Real Estate's Houston Center mixed-use office property complex in Houston, Texas. The Class A office property will consist of 577,000 net rentable square feet. The joint venture is structured such that the fund holds a 75% equity interest, and Crescent Real Estate holds a 25% equity interest in the property, which is accounted for under the equity method. Crescent Real Estate contributed approximately $8.5 million of land and $12.3 million of development costs to the joint venture entity and received $14.8 million in net proceeds. No gain or loss was recognized by Crescent Real Estate on this transaction. In addition, Crescent Real Estate is developing, and will manage and lease the property on a fee basis. During the year ended December 31, 2001, Crescent Real Estate recognized $2.3 million for these services. During the second quarter of 2001, the joint venture entity obtained an $82.5 million construction loan guaranteed by Crescent Real Estate, due May 2004, that bears interest at Prime (as defined in the loan agreement) plus 100 basis points or LIBOR plus 225 basis points, at the discretion of the borrower. The interest rate on the loan at December 31, 2001, was 4.12%. The balance outstanding on this construction loan at December 31, 2001, was $10.4 million. Four Westlake Park and Bank One Tower On July 30, 2001, Crescent Real Estate entered into joint venture arrangements with an affiliate GE, in which Crescent Real Estate contributed two office properties, Four Westlake Park in Houston, Texas, and Bank One Tower in Austin, Texas into the joint ventures and GE made a cash contribution. The joint ventures are structured such that GE holds an 80% equity interest in each of Four Westlake Park, a 560,000 square foot Class A office property located in the Katy Freeway submarket of Houston, and Bank One Tower, a 390,000 square foot Class A office property located in downtown Austin. 234 Crescent Real Estate continues to hold the remaining 20% equity interests in each property, which are accounted for under the equity method. The joint ventures generated approximately $120.0 million in net cash proceeds to Crescent Real Estate, including distributions to Crescent Real Estate resulting from the sale of its 80% equity interest and from mortgage financing at the joint venture level. None of the mortgage financing at the joint venture level is guaranteed by Crescent Real Estate. Crescent Real Estate has no commitment to reinvest the cash proceeds back into the joint ventures. The joint ventures were accounted for as partial sales of these office properties, resulting in a gain of approximately $7.6 million, net of a deferred gain of approximately $1.9 million. In addition, Crescent Real Estate manages and leases the office properties on a fee basis. During the year ended December 31, 2001, Crescent Real Estate recognized $0.2 million for these services. Three Westlake Park On August 21, 2002, Crescent Real Estate entered into a joint venture arrangement with an affiliate of GE. In connection with the formation of the venture, Crescent Real Estate contributed an office property, Three Westlake Park in Houston, Texas, and GE made a cash contribution. GE holds an 80% equity interest in the Three Westlake Park, a 415,000 square foot Class A Office Property located in the Katy Freeway submarket of Houston, and Crescent Real Estate continues to hold the remaining 20% equity interest in the office property, with Crescent Real Estate's interest accounted for under the equity method. The joint venture generated approximately $47.1 million in net cash proceeds to Crescent Real Estate, including distributions resulting from the sale of Crescent Real Estate's 80% equity interest and $6.6 million from Crescent Real Estate's portion of mortgage financing at the joint venture level. None of the mortgage financing at the joint venture level is guaranteed by either Crescent Real Estate or GE. Crescent Real Estate has no commitment to reinvest the cash proceeds back into the joint venture. The join