<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
(MARK ONE)
<TABLE>
<C> <S>
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
</TABLE>
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
OR
<TABLE>
<C> <S>
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
</TABLE>
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NUMBER 1-8692
------------------------
PACIFIC GATEWAY PROPERTIES, INC.
(Exact name of Registrant as specified in its charter)
<TABLE>
<S> <C>
MARYLAND 04-2816560
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
930 MONTGOMERY STREET, SUITE 400, SAN 94133
FRANCISCO, CALIFORNIA (Zip Code)
(Address of principal executive
offices)
</TABLE>
(415) 398-4800
(Registrant's telephone number, including area code)
[NOT APPLICABLE]
(Former name, former address and former fiscal year, if changed since last
report)
------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate the number of shares outstanding of each of the issuer's classes of
stock, as of the latest practicable date of November 2, 1999:
3,933,536 shares of Common Stock, $1.00 par value and 300,000 shares of
Series 1 Convertible Preferred Stock, $1.00 par value.
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<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
INDEX
<TABLE>
<CAPTION>
PAGE NUMBER
-----------
<S> <C>
PART I -- FINANCIAL INFORMATION:
Item 1. Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of September
30, 1999 and
December 31, 1998..................................... 3
Condensed Consolidated Statements of Operations for the
Three and Nine Months Ended September 30, 1999 and
1998.................................................. 4
Condensed Consolidated Statement of Stockholders' Equity
for the Nine Months Ended September 30, 1999.......... 5
Condensed Consolidated Statements of Cash Flows for the
Three and Nine Months Ended September 30, 1999 and
1998.................................................. 6
Notes to Condensed Consolidated Financial Statements
(Unaudited)........................................... 7-8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations......... 9-13
PART II -- OTHER INFORMATION:
Item 1. Legal Proceedings.............................. 14
Item 2. Changes in Security............................ None
Item 3. Defaults Upon Senior Securities................ None
Item 4. Submission of Matters to a Vote of Security
Holders............................................... None
Item 5. Other Information.............................. None
Item 6. Exhibits and Reports on Form 8-K............... 14
Signatures.................................................. 15
</TABLE>
2
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
AS OF AS OF
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
ASSETS
Cash and cash equivalents................................... $ 5,477 $ 6,535
Restricted cash............................................. 1,866 1,573
Accounts receivable, prepaid taxes and other current
assets.................................................... 311 230
Investment properties:...................................... 69,451 68,138
Less-accumulated depreciation............................. (18,675) (16,205)
-------- --------
Investment properties, net.............................. 50,776 51,933
-------- --------
Property held for sale, net of accumulated depreciation and
reserve for write-down to net realizable value of $2,733
at December 31, 1998...................................... -- 2,480
Deferred tax asset.......................................... 1,564 10,216
Capitalized loan costs, net................................. 633 743
Capitalized lease commissions, rent concessions and other
deferred costs, net....................................... 1,885 1,841
-------- --------
Total assets............................................ $ 62,512 $ 75,551
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable, prepaid rent, tenant security deposits,
accrued interest and other current liabilities............ $ 2,752 $ 3,453
Current taxes payable....................................... 7,836 --
Debt related to investment properties....................... 44,767 48,707
Deferred tax liability...................................... 5,479 20,274
-------- --------
Total liabilities....................................... 60,834 72,434
-------- --------
STOCKHOLDERS' EQUITY
Common stock $1.00 par value:
Authorized--10,000,000 shares Issued--4,052,090 shares as
of September 30, 1999 and December 31, 1998............. 4,052 4,052
Series 1 Convertible Preferred Stock $1.00 par value,
$3,000,000 preference in liquidation:
Authorized and issued and outstanding--300,000 shares..... 2,889 2,889
Paid-in-deficit............................................. (8,968) (8,968)
Retained earnings........................................... 5,742 7,181
Treasury stock, at cost--118,554 common shares at September
30, 1999 and December 31, 1998............................ (2,037) (2,037)
-------- --------
Total stockholders' equity.............................. 1,678 3,117
-------- --------
Total liabilities and stockholders' equity............ $ 62,512 $ 75,551
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
--------------------- -------------------
1999 1998 1999 1998
--------- --------- -------- --------
<S> <C> <C> <C> <C>
INVESTMENT PROPERTIES:
Rental revenues................................... $4,497 $4,133 $13,338 $12,197
Operating expenses................................ (1,708) (1,658) (4,797) (4,703)
Interest expense.................................. (946) (1,088) (2,878) (3,212)
Depreciation and amortization..................... (988) (938) (2,861) (2,748)
------ ------ ------- -------
Investment properties income.................... 855 449 2,802 1,534
General and administrative expenses................. (402) (223) (1,384) (917)
Other income, net................................... 87 49 244 103
------ ------ ------- -------
Income before taxes................................. 540 275 1,662 720
Income tax provision................................ (1,262) (113) (1,704) (305)
------ ------ ------- -------
Net income (loss)................................. $ (722) $ 162 $ (42) $ 415
====== ====== ======= =======
Preferred dividends................................. (39) -- (99) --
------ ------ ------- -------
Net income (loss) available to common
stockholders.................................... $ (761) $ 162 $ (141) $ 415
====== ====== ======= =======
Income (loss) per common share, basic............... $(0.18) $ 0.04 $ (0.03) $ 0.11
====== ====== ======= =======
Income (loss) per common share, diluted............. $(0.18) $ 0.04 $ (0.03) $ 0.10
====== ====== ======= =======
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999
(IN THOUSANDS)
<TABLE>
<CAPTION>
SERIES 1
COMMON PREFERRED PAID-IN- RETAINED TREASURY
STOCK STOCK DEFICIT EARNINGS STOCK TOTAL
-------- --------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1998............... $4,052 $2,889 $(8,968) $ 7,181 $(2,037) $ 3,117
Net income (loss)........................ -- 99 -- (141) -- (42)
Dividend payments........................ -- (99) -- (1,298) -- (1,397)
------ ------ ------- ------- ------- -------
Balance at September 30, 1999.............. $4,052 $2,889 $(8,968) $ 5,472 $(2,037) $ 1,678
====== ====== ======= ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements
5
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
---------------------- ----------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Cash flow from operating activities:
Net income (loss).................................... $ (722) $ 162 $ (42) $ 415
Non-cash revenues and expenses included in net
income:
Depreciation and amortization...................... 995 938 2,861 2,748
Deferred taxes, net................................ (6,564) 9 (6,143) 194
Current taxes payable.............................. 7,836 -- 7,836 --
Gain on settlement of reimbursement obligation,
net.............................................. -- -- (6) --
Change in assets and liabilities:
Accounts receivable, prepaid taxes and other
current assets................................... (65) 94 (81) 66
Accounts payable and other current liabilities..... 343 (134) (60) 498
------- ------- ------- -------
NET CASH GENERATED BY OPERATING ACTIVITIES........... 1,823 1,069 4,365 3,921
------- ------- ------- -------
Cash flow from investing activities:
Additions to building and other improvements,
capitalized lease commissions, rent concessions,
and other deferred costs........................... (641) (401) (1,636) (3,272)
Proceeds from sale of property, net.................. -- -- 3,785 --
(Increase) decrease in restricted cash............... (281) 55 (293) 35
------- ------- ------- -------
Net cash generated by (used in) investing
activities......................................... (922) (346) 1,856 (3,237)
------- ------- ------- -------
Cash flow from financing activities:
Payment to settle reimbursement obligation........... -- -- (4,200) --
Payment of dividends................................. (549) -- (1,397) --
Borrowings under debt related to investment
properties......................................... -- 2,697 -- 4,272
Payments on debt..................................... (256) (2,307) (1,682) (2,807)
Payments of loan costs and fees...................... -- (21) -- (62)
Repurchase of warrants............................... -- -- -- (1,007)
Proceeds from sale of preferred stock, net of
issuance costs..................................... -- 2,889 -- 2,889
Proceeds from stock options exercised................ -- 99 -- 99
Tax benefit from exercise of stock options........... -- 104 -- 104
Proceeds from shareholder short-swing sale........... -- 3 -- 3
------- ------- ------- -------
NET CASH GENERATED BY (USED IN) FINANCING
ACTIVITIES......................................... (805) 3,464 (7,279) 3,491
------- ------- ------- -------
Increase (decrease) in cash and cash equivalents....... 96 4,187 (1,058) 4,175
Balance at beginning of period......................... 5,381 2,053 6,535 2,065
------- ------- ------- -------
Balance at end of period............................... $ 5,477 $ 6,240 $ 5,477 $ 6,240
======= ======= ======= =======
Supplementary disclosures:
Cash paid for interest............................... $ 945 $ 952 $ 3,523 $ 2,944
======= ======= ======= =======
Cash paid for taxes.................................. $ -- $ -- $ 10 $ 7
======= ======= ======= =======
Non-cash transactions:
Increase in paid-in-capital from repurchase of
warrants......................................... $ -- $ -- $ -- $ 883
======= ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
6
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE QUARTER AND NINE MONTHS ENDED SEPTEMBER 30, 1999
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying unaudited condensed consolidated financial statements
should be read in conjunction with Pacific Gateway Properties, Inc.'s (the
"Company") 1998 Forms 10-K and 10-K/A, and quarterly report on Form 10-Q for the
quarter and nine months ended September 30, 1998. These statements have been
prepared in accordance with the instructions of the Securities and Exchange
Commission Form 10-Q and do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. On September 1, 1999, the Company reincorporated to a Maryland
corporation from New York.
In the opinion of the Registrant, all material adjustments of a normal
recurring nature considered necessary for a fair presentation of results of
operations for the interim periods have been included. The results of
consolidated operations for the three and nine months ended September 30, 1999
are not necessarily indicative of the results that may be expected for the year
ending December 31, 1999.
RECLASSIFICATIONS
Certain prior period amounts have been reclassified to be consistent with
current period classifications.
ESTIMATES AND ASSUMPTIONS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results will differ from those estimates.
2. REAL ESTATE PARTNERSHIP INVESTMENTS
RINCON CENTER ASSOCIATES PARTNERSHIP (RCA)--SAN FRANCISCO, CALIFORNIA
The Company owns general (non-managing) and limited partnership interests in
Rincon Center Associates ("RCA"), a California limited partnership, totaling
approximately 22.8%. On October 12, 1999, several actions were taken relating to
RCA.
On October 12, 1999, the Company executed Amendment No. 3 to the Limited
Partnership Agreement of RCA (the "Amendment"), which allocated gross income to
the Company for fiscal year 1999 to the extent that the Company had a deficit
capital account in RCA. As a result of the Amendment, the Company estimates that
it incurred a tax gain of approximately $28.4 million. In addition, a loan to
RCA from the managing general partner of RCA in the amount of approximately
$8.6 million was cancelled, and the agreement obligating the managing general
partner to continue making loans to RCA on behalf of the Company was terminated.
As a result of the Amendment and cancellation of the loan, the Company estimates
that it incurred a total tax gain of approximately $37.2 million. The Company
further estimates that the net tax liability after utilizing the Company's net
operating loss carryover and unused tax credits will amount to approximately
$6.8 million. The Company had written off its investment in RCA to zero in 1995,
and has fully reserved for the tax liability described above. The Company will
fund the estimated tax liability from its cash reserves, cash flow from
operations, additional borrowing, or a possible asset sale.
7
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE QUARTER AND NINE MONTHS ENDED SEPTEMBER 30, 1999
2. REAL ESTATE PARTNERSHIP INVESTMENTS (CONTINUED)
In a separate transaction, RCA completed the disposition of its sole asset,
Rincon Center located in San Francisco, California, to an unrelated party on
October 12, 1999. RCA's disposition of Rincon Center will have no impact on the
Company's financial statements. In connection with the disposition, all
contingent liabilities associated with RCA were eliminated, pending litigation
among the parties involved in Rincon Center were dismissed with prejudice, and
mutual settlement and release agreements were executed by all parties. The
Company and the managing general partner of RCA have agreed to wind up the
affairs of RCA partnership on or before December 31, 1999. The winding up of the
RCA partnership will have no financial impact on the Company's financial
statements.
3. DEBT
WESTON OFFICE BUILDING
In May 1999, the Company paid off approximately $897,000 in mortgage debt on
the Weston office building. Loan fees associated with this debt of approximately
$24,000 were written off in the third quarter of 1999. The Company did not incur
any prepayment penalties in connection with the pay-off of this debt.
4. PER SHARE DATA
Basic earnings per share is computed as earnings divided by weighted average
shares, excluding the dilutive effects of stock options and other potentially
dilutive securities. Outstanding stock options enter into the weighted average
shares outstanding when computing diluted earnings per share using the Treasury
Stock Method.
The number of weighted average common shares and potential common shares
used in the earnings per share calculations for the three and nine months ended
September 30, 1999 and 1998, are as follows:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
--------------------- ---------------------
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Basic............................................. 3,933,536 3,933,167 3,933,536 3,910,868
Stock options..................................... 99,192 111,096 93,277 100,164
--------- --------- --------- ---------
Diluted........................................... 4,032,728 4,044,263 4,026,813 4,011,032
========= ========= ========= =========
</TABLE>
The Company's Series 1 Convertible Preferred Stock was excluded from diluted
earnings per share for the three and nine months ended September 30, 1999, as
inclusion would have been anti-dilutive.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
Pacific Gateway Properties, Inc. (the "Registrant") is a Maryland
corporation that reincorporated from New York effective September 1, 1999. On
October 13, 1999, the Company announced the disposition of the Rincon Center,
held by Rincon Center Associates, a California limited partnership in which the
Company owns general (non-managing) and limited partner interests and the
engagement of Prudential Securities Incorporated to assist the Board of
Directors in pursuing a possible sale or merger of the Registrant.
The Registrant's overall business plan has been to assemble a substantial
portfolio of income producing properties. The Registrant historically focused
its property acquisitions in the following markets: Northern California,
Arizona, Florida and Massachusetts. The Registrant's long-term objectives
continue to be maximizing net cash flow from operations and achieving growth
through appreciation of asset values. The current strategic plan of the
Registrant is to focus on real estate investments on the West Coast with a
specific emphasis on the San Francisco Bay Area. The current investment emphasis
is on commercial properties which require aggressive management and leasing in
order to maximize their potential values. This strategy is influenced by the
following factors: (1) the Registrant's current property portfolio is
concentrated on the West Coast; and (2) the Registrant believes that geographic
concentration will enhance operational efficiencies.
The following discussion should be read in conjunction with the Registrant's
Forms 10-K and 10-K/A for 1998, quarterly report on Form 10-Q for the quarter
and nine months ended September 30, 1998, and in conjunction with the Unaudited
Condensed Consolidated Balance Sheets, Statements of Income and Cash Flows and
the notes thereto. Unless otherwise defined in this report, or unless the
context otherwise requires, the capitalized words or phrases used in this
section either (i) describe accounting terms that are used as line items in such
financial statements, or (ii) have the meanings ascribed to them in such
financial statements and the notes thereto.
FINANCIAL CONDITION
CAPITAL IMPROVEMENTS, TENANT IMPROVEMENTS AND OTHER DEFERRED COSTS--During
the three and nine months ended September 30, 1999, there were additions to
investment properties amounting to approximately $641,000 and $1,636,000,
respectively, for tenant improvements, capital improvements and other deferred
costs which includes leasing commissions. Additionally, the Registrant
anticipates further additions to investment properties of approximately $760,000
during the remainder of 1999, which will be funded from cash, restricted cash
and future cash flow generated by operating activities.
FINANCING--Approximately $256,000 and $785,000 of debt principal was repaid
in the three and nine months ended September 30, 1999, respectively, as
scheduled debt amortization. In addition, in May 1999 the Registrant prepaid
approximately $897,000 in mortgage debt on its Weston (Florida) property. Loan
fees associated with this debt of approximately $24,000 were written off in the
third quarter of 1999. The Company did not incur any prepayment penalty in
connection with repayment of this debt.
MATERIAL CHANGES IN RESULTS OF OPERATIONS
INVESTMENT PROPERTIES--During the first nine months of 1999, the income from
investment properties was $2,802,000 compared to income of $1,534,000 during the
first nine months of 1998. The increase of $1,268,000 in income from investment
properties for the first nine months of 1999 is attributable to new leases
completed during 1998 leading to increased occupancy and renewal of existing
leases at higher rates, offset by approximately $227,000 and $340,000 net
decreases in rental revenue due to the sale of the 410 First Avenue property and
a one-time buyout received in 1998 from a tenant at Walnut Creek Executive
9
<PAGE>
Park, respectively. Occupancy increased from approximately 97% at September 30,
1998 to approximately 99% at September 30, 1999.
During the third quarter of 1999 the income from investment properties was
$855,000 compared to income of $449,000 for the third quarter of 1998.
The increase in operating expenses is primarily due to higher occupancy at
the Registrant's California properties. Interest expense decreased to $2,878,000
during the first nine months of 1999 from $3,212,000 during the first nine
months of 1998 primarily as a result of eliminating $314,000 of interest expense
related to the settlement obligation on the 410 First Avenue property.
Depreciation and amortization expense increased as a result of commencing
depreciation of expenditures capitalized during 1998 and early 1999 relating to
the Registrant's leasing activities and capital improvement projects, offset by
depreciation expense no longer incurred on the 410 First Avenue property. In
addition, the Registrant wrote off $96,000 of unamortized leasing costs related
to the lease buyout at Walnut Creek Executive Park in the second quarter of
1998.
GENERAL AND ADMINISTRATIVE EXPENSES--General and administrative expenses in
the first nine months of 1999 amounted to $1,384,000 compared to $917,000 for
the first nine months of 1998. General and administrative expenses for the third
quarter of 1999 and 1998 were $402,000 and $223,000, respectively. The increase
is primarily attributable to increases in personnel costs and professional
services attributable to RCA.
OTHER INCOME, NET--Other income, net, consisting primarily of interest
income, was $244,000 and $103,000 during the first nine months of 1999 and 1998,
respectively. The increase is primarily due to additional cash invested
resulting from the issuance of Series 1 Convertible Preferred Stock in
September 1998.
INCOME TAX PROVISION--A tax provision of $1,262,000 and $1,704,000 has been
recorded in connection with the net income for the three and nine months ended
September 30, 1999, respectively. The difference between the effective book and
statutory tax rates is attributable to the disposition of RCA and the 410 First
Avenue property. A tax provision of $113,000 and $305,000 was recorded in
connection with the net income for the three and nine months ended
September 30, 1998, respectively.
LIQUIDITY AND CAPITAL RESOURCES
REGULATION AND SUPERVISION
Many jurisdictions have adopted laws and regulations relating to the
ownership of real estate. Compliance with these requirements from time to time
may require capital expenditures by the Registrant (for example, expenditures
necessary in order to comply with the Americans with Disabilities Act or changes
in local building or other codes). In addition, the Registrant may from time to
time have to expend capital for environmental control facilities. While the
ownership of real estate may entail environmental risks and liabilities to the
owner, the Registrant's management is sensitive to environmental issues and is
not currently aware of and does not expect any material effects on current or
future capital expenditures, earnings or competitive position resulting from
compliance with present federal, state or local environmental control
provisions.
DISCUSSION OF KNOWN TRENDS, EVENTS AND UNCERTAINTIES
The economic climate for commercial real estate has shown signs that rental
rates and property values have stabilized and in selected markets have improved.
The Registrant continued to experience more stabilized operating results in its
properties during the first three quarters of 1999, and presently expects this
trend to continue based on the Registrant's current assessment of the market,
economic and other factors. In addition, the level of vacancies in the
Registrant's portfolio has remained stable over the last
10
<PAGE>
two quarters at approximately 1%. The Registrant is continuing to aggressively
pursue new leases on currently available space and renew existing leases as they
expire.
Notwithstanding a stabilizing real estate market, tenants may or may not
continue to renew leases as they expire or may renew on less favorable terms.
Conditions differ in each market in which the Registrant's properties are
located. Because of the continuing uncertainty of future economic developments
in each market, the impact these developments will have on the Registrant's
future cash flow and results of operations is uncertain.
Inflation, inflationary expectations and their effect on interest rates may
affect the Registrant in the future by changing the underlying value of the
Registrant's real estate or by impacting the costs of financing the Registrant's
operations.
LIQUIDITY AND CAPITAL RESOURCES
The bulk of the Registrant's resources are committed to relatively
non-liquid real estate assets. These assets, due to their value and cash flow,
have provided the Registrant with an ability to generate capital as required,
both internally and externally, through asset-based financings. In addition,
since 1992, assets or portions thereof were sold to provide further liquidity.
The Registrant has taken several actions to generate and conserve cash, and
continues to review and analyze alternative actions. At the same time, the
Registrant is seeking to retain value and identify future opportunities for
investment. At September 30, 1999, the Registrant had approximately
$5.5 million of unrestricted cash, approximately $1.9 million of restricted
cash, investment properties with a net book value of approximately
$50.8 million, total non-recourse mortgage debt of approximately $44.8 million
and stockholders' equity of $2.7 million. Given the Registrant's desire to
increase its liquidity, the Registrant has actively pursued the sale of selected
real estate assets in the past, has restructured and refinanced its mortgage
debt. The Registrant continues to evaluate various alternatives to improve its
liquidity through debt refinancing and the sale of properties which do not fit
within its long term strategy. Funds raised in the preceding fashion would be
used for tenant improvements and other capital requirements, certain mandatory
debt reductions, and possible new investments.
The Registrant is also obligated to fund reserves for building and tenant
improvements, leasing commissions and debt service in connection with its
mortgage loans on Walnut Creek Executive Park, North Tucson Business Center and
South Bay Office Tower. Scheduled funding under the various loan agreements
during the twelve month period ending September 30, 2000, will amount to
approximately $597,000 and will be funded from future cash flow generated by
operating activities.
Scheduled principal maturities on the above described debt during the twelve
month period ending September 30, 2000, will amount to approximately $1,068,000.
Approximately $785,000 of debt principal was repaid in the nine months ended
September 30, 1999 as scheduled debt amortization. In addition, in May 1999, the
Registrant paid off approximately $897,000 in mortgage debt on its Weston
(Florida) property.
The Registrant owns general (non-managing) and limited partner interests in
Rincon Center Associates ("RCA"), a California limited partnership, totaling
approximately 22.8%. On October 12, 1999, several actions were taken relating to
RCA.
On October 12, 1999, the Registrant executed Amendment No. 3 to the Limited
Partnership Agreement of RCA (the "Amendment"), which allocated gross income to
the Registrant for fiscal year 1999 to the extent that the Registrant had a
deficit capital account in RCA. As a result of the Amendment, the Registrant
estimates that it incurred a tax gain of approximately $28.4 million. In
addition, a loan to RCA from the managing general partner of RCA in the amount
of approximately $8.6 million was cancelled, and the agreement obligating the
managing general partner to continue making loans to RCA on behalf of the
Registrant was terminated. As a result of the Amendment and cancellation of the
loan, the
11
<PAGE>
Registrant estimates that it incurred a total tax gain of approximately
$37.2 million. The Registrant further estimates that the net tax liability after
utilizing the Registrant's net operating loss carryover and unused tax credits
will amount to approximately $6.8 million. The Registrant had written off its
investment in RCA to zero in 1995, and has fully reserved for the tax liability
described above. The Registrant will fund the estimated tax liability from its
cash reserves, cash flow from operations, additional borrowing, or a possible
asset sale.
In a separate transaction, RCA completed the disposition of its sole asset,
Rincon Center located in San Francisco, California, to an unrelated party on
October 12, 1999. RCA's disposition of Rincon Center will have no impact on the
Registrant's financial statements. In connection with the disposition, all
contingent liabilities associated with RCA were eliminated, pending litigation
among the parties involved in Rincon Center were dismissed with prejudice, and
mutual settlement and release agreements were executed by all parties. The
Registrant and the managing general partner of RCA have agreed to wind up the
affairs of RCA partnership on or before December 31, 1999. The winding up of the
RCA partnership will have no financial impact on the Registrant's financial
statements.
Except as described above, at September 30, 1999, the Registrant's material
capital expenditures over the next twelve months and beyond are expected to be
funded from restricted cash or future cash flow generated by operating
activities. Ongoing repair and maintenance expenditures are expected to be
funded from cash flow generated by operating activities. Future tenant
improvements and leasing commissions will be funded from restricted cash, cash
flow generated by operating activities and funds generated from future debt
refinancings or property sales, if any.
YEAR 2000 COMPLIANCE
The inability of computers, software and other equipment utilizing
microprocessors to recognize and properly process data fields containing a
two-digit year is commonly referred to as the Year 2000 compliance issue. As the
Year 2000 approaches, such systems may be unable to accurately process certain
date-based information. As used by the Registrant, "Year 2000 ready" means that
a system will function in the Year 2000 without modification or adjustment, or
with a one-time manual adjustment.
THE REGISTRANT'S STATE OF READINESS. The Registrant utilizes a number of
computer software programs and operating systems across its entire organization
including applications used in financial business systems and various
administrative functions. The Registrant has established an action plan for
addressing Year 2000 issues. The Registrant's action plan for addressing Year
2000 compliance issues in its information technology ("IT") and non-IT systems
covers four phases: (i) identification of all IT and non-IT systems;
(ii) assessment of Year 2000 issues; (iii) repair of IT and non-IT systems, if
necessary; and (iv) creation of a contingency plan to address any potential Year
2000 failures. The Registrant is also contacting third parties with which it
deals (such as financial institutions and vendors) to evaluate their Year 2000
readiness and determine whether any Year 2000 failure will affect their ability
to perform as the Year 2000 approaches and arrives.
As of September 30, 1999, the Registrant has completed all four phases of
its Year 2000 action plan with respect to its IT systems. The Registrant has
identified all of its IT systems, assessed the Year 2000 readiness of these
systems (which involved review and testing by internal personnel) made the
necessary repairs, and has created a contingency plan to address any potential
year 2000 failures. As of December 31, 1998, the Registrant had completed its
Year 2000 action plan with respect to its non-IT systems. The Registrant had
identified all of its non-IT systems (which are comprised of embedded systems
contained in its properties), assessed the Year 2000 readiness of these systems
through review and testing and concluded that any failure of these systems to be
Year 2000 ready is not reasonably likely to have a material adverse effect on
the Registrant's financial condition and results of operations.
The Registrant has received assurances from a majority of its suppliers and
third parties with which it interacts that they have addressed their Year 2000
issues. The Registrant is evaluating these assurances for
12
<PAGE>
their adequacy and accuracy and, in cases where the Registrant has not received
assurances from third parties, is initiating further mail or phone
correspondence. As a general matter, the Registrant is vulnerable to failures by
third parties to address their own Year 2000 issues. The Registrant relies
heavily upon third parties for utility services, maintenance labor, financial
services, building materials and office supplies. There can be no assurance that
the Registrant's suppliers and other third parties will adequately address their
Year 2000 issues, and any such issues could have a material adverse affect upon
the Registrant's financial condition and results of operations.
COST OF ADDRESSING THE REGISTRANT'S YEAR 2000 ISSUES. The Registrant has
not spent a material amount of financial resources to remediate Year 2000
problems and does not anticipate that it will spend a material amount of
financial resources to remediate Year 2000 problems in the future. The costs of
such remediation will be paid out as part of the Registrant's general and
administrative expenses or operating expenses for property level remediation.
RISKS OF THE REGISTRANT'S YEAR 2000 ISSUES. Based upon the Registrant's
assessment and remediation efforts to date, and the planned, normal
course-of-business upgrades, management believes that any residual Year 2000
risk is limited to non-material, non-critical business applications and support
hardware. No assurance can be given, however, that all of the Registrant's
systems will be Year 2000 ready or that non-compliance, if any, will not have a
material adverse effect on the Registrant's future liquidity or results of
operations or ability to service debt. In addition, the failure to address Year
2000 issues by the Registrant's suppliers and other third parties with which it
interacts could have a material adverse effect upon the Registrant's financial
condition and results of operations.
THE REGISTRANT'S CONTINGENCY PLANS. The Registrant's Year 2000 action plan
calls for the Registrant to develop a Year 2000 contingency plan. The Registrant
has developed such a plan as part of the results of its Year 2000 action plan.
FORWARD-LOOKING STATEMENTS; FACTORS THAT MAY AFFECT OPERATING RESULTS
Certain information included in this Form 10-Q (including statements in this
Management's Discussion and Analysis section regarding the Registrant's
expectations regarding stabilized operating results) and other materials filed
or to be filed by the Registrant with the Securities and Exchange Commission may
constitute forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. Such forward-looking information
involves known and unforeseen risks, uncertainties and other factors that may
cause actual results or performance to be materially different from those
expressed or implied by such forward-looking statements. These risks and
uncertainties include, but are not limited to, uncertainties affecting the real
estate business generally, such as lease renewals and the financial stability of
tenants, general economic conditions and conditions in the Registrant's markets,
risks relating to acquisitions and dispositions of properties, risks relating to
interest rate levels and fluctuations, the availability of financing, and
regulatory risks. Given these and other risks described elsewhere in this
Form 10-Q, investors are cautioned not to place undue reliance on any
forward-looking statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Market risk is the risk of loss from adverse changes in the market prices
and interest rates. The Registrant has fixed rate mortgage debt of approximately
$40.6 million and floating rate mortgage debt of approximately $4.2 million
carrying an interest rate of 2.875% over the one year treasury bond rate,
adjustable semi-annually which is presently at 7.75% as of September 30, 1999.
The Registrant has not invested in any market rate sensitive instruments either
for trading purposes or otherwise and is not a party to any interest rate hedge
contracts. There has been no material change in the Registrant's market risk
since the filing of the Registrant's Annual Report on Form 10-K for the year
ended December 31, 1998.
13
<PAGE>
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On October 14, 1999, the San Francisco Superior Court dismissed with
prejudice the Registrant's litigation against Rincon Center Associates and
Perini Land and Development Company (Case No. 985464), relating to commissions
for leasing and construction services performed for Rincon Center. On
October 13, 1999, the San Francisco Superior Court dismissed with prejudice the
Registrant's litigation against Perini Land and Development Company and Perini
Corporation (Case No. 301993), relating to allegations that the defendants
usurped the opportunity of the Rincon Center Associates to purchase the fee
interest upon which Rincon Center sits. On October 13, 1999, the Supreme Court
of New York, County of New York, dismissed with prejudice the Registrant's
litigation against Citibank (Case No. 99/119-800) relating to allegations that
Citibank's failure to accept a substitute letter of credit for delivery to
Citibank in connection with Rincon Center resulted in damage to the Registrant
arising from the subsequent draw on the existing letter by Citibank and the
resultant reimbursement obligations to Bank of America, the original letter of
credit issuer.
The Registrant is involved in various other claims and lawsuits incidental
to its business. In the opinion of the Registrant, these other claims and
lawsuits in the aggregate will not have a material adverse impact on the
Registrant's financial condition.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits:
<TABLE>
<CAPTION>
NO. DESCRIPTION
- --------------------- -----------
<C> <S>
27 Financial Data Schedule
</TABLE>
b) Reports on Form 8-K:
On September 7, 1999 the Registrant filed a report on Form 8-K, reporting
under Item 5 on the consummation of its reincorporation from New York to
Maryland.
14
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
<TABLE>
<S> <C>
PACIFIC GATEWAY PROPERTIES, INC.
------------------------------------------------------------
REGISTRANT
</TABLE>
<TABLE>
<S> <C> <C>
Date: November 15, 1999 /s/ RAYMOND V. MARINO
------------------------------------------
Raymond V. Marino
President and Chief Executive Officer
(Principal Executive and Financial Officer)
Date: November 15, 1999 /s/ MELANIE L. ADKINS
------------------------------------------
Melanie L. Adkins
Controller--Corporate
(Principal Accounting Officer)
Date: November 15, 1999 /s/ NEIL C. MARCK
------------------------------------------
Neil C. Marck
Controller--Management Company
(Principal Accounting Officer)
</TABLE>
15
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 7,343
<SECURITIES> 0
<RECEIVABLES> 135
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 7,654
<PP&E> 69,451
<DEPRECIATION> 18,675
<TOTAL-ASSETS> 62,512
<CURRENT-LIABILITIES> 10,588
<BONDS> 44,767
2,889
0
<COMMON> 4,052
<OTHER-SE> (4,270)
<TOTAL-LIABILITY-AND-EQUITY> 62,512
<SALES> 0
<TOTAL-REVENUES> 13,338
<CGS> 0
<TOTAL-COSTS> 4,797
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,878
<INCOME-PRETAX> 1,662
<INCOME-TAX> 1,704
<INCOME-CONTINUING> (141)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (141)
<EPS-BASIC> 0.22
<EPS-DILUTED> 0.21
</TABLE>
