<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
[X]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1997
OR
[ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-8692
PACIFIC GATEWAY PROPERTIES, INC.
(Exact name of Registrant as specified in its charter)
NEW YORK 04-2816560
------------------------------- -------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
930 MONTGOMERY STREET, SUITE 400, SAN FRANCISCO, CALIFORNIA 94133
- -------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (415) 398-4800
- -------------------------------------------------------------------------------
(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 No X
------ -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of June 30, 1997:
$1.00 Par Value Common Stock 3,892,596
- ---------------------------- ------------------------------
(Title of Class) (Number of Shares Outstanding)
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
INDEX
Part I - Financial Information: PAGE NUMBER
Item 1. Consolidated Financial Statements
Condensed Consolidated Balance Sheet as of
June 30, 1997 and December 31, 1996 3
Condensed Consolidated Statement of Income for the
Three and Six Months Ended June 30, 1997
and 1996 4
Condensed Consolidated Statement of Cash Flows for
the Three and Six Months Ended June 30, 1997
and 1996 5-6
Notes to Condensed Consolidated Financial Statements 7-12
Item 2. Management's Discussion and
Analysis of Financial Condition
and Results of Operations 13-18
Part II - Other Information:
Item 1. Legal Proceedings None
Item 2. Changes in Security None
Item 3. Defaults Upon Senior Securities 18
Item 4. Submission of Matters to a Vote
of Security Holders 18
Item 5. Other Information None
Item 6. Exhibits and Reports on Form 8-K 18
Signatures 19
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEET (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
AS OF AS OF
JUNE 30, DECEMBER 31,
1997 1996
-------- ------------
ASSETS
Cash and cash equivalents $ 2,331 $ 2,899
Cash reserved for capital improvements,
acquisitions and debt service 1,909 9,975
Accounts receivable, prepaid taxes and other
current assets 641 1,179
Investment properties 68,687 46,632
Less-accumulated depreciation and provision
for write-down to net realizable value (15,179) (13,835)
------- -------
Investment properties, net 53,508 32,797
------- -------
Deferred tax asset 6,833 4,183
Capitalized loan costs, net 906 717
Capitalized lease commissions and rent
concessions, net 873 643
------- -------
Total assets $67,001 $52,393
------- -------
------- -------
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable, prepaid rent, tenant security
deposits and other current liabilities $ 1,427 $ 1,491
Debt related to investment properties 47,834 33,722
Deferred tax liability 16,832 15,012
------- -------
Total liabilities 66,093 50,225
------- -------
STOCKHOLDERS' EQUITY
Common stock $1.00 par value--
Authorized--10,000,000 shares
Issued--4,011,150 shares 4,011 4,011
Paid-in-deficit (10,038) (10,222)
Retained earnings 7,082 8,526
Treasury stock, at cost--118,554 common shares at
June 30, 1997 and December 31, 1996 (2,037) (2,037)
Warrants for common stock 1,890 1,890
------- -------
Total stockholders' equity 908 2,168
------- -------
Total liabilities and stockholders' equity $ 67,001 $ 52,393
------- -------
------- -------
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
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PACIFIC GATEWAY PROPERTIES, INC.
CONDENSED CONSOLIDATED STATEMENT OF INCOME (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------- -------------------
1997 1996 1997 1996
----- ---- ---- ----
<S> <C> <C> <C> <C>
INVESTMENT PROPERTIES:
Rental revenues $ 3,557 $ 2,546 $ 6,878 $ 5,720
Operating expenses (1,580) (1,334) (2,853) (2,600)
Interest expense (1,049) (605) (1,900) (1,508)
Depreciation and amortization (793) (634) (1,507) (1,238)
------- -------- ------- -------
Investment properties income (loss) 135 (27) 618 374
General and administrative expenses (280) (462) (700) (858)
Other income, net 64 210 101 214
------- -------- ------- -------
Income (loss) before hotel operations, estimated
property settlement obligation, property
transactions and taxes (81) (279) 19 (270)
Income (loss) from hotel operations 1 192 (93) 1,146
------- -------- ------- -------
Income (loss) before estimated settlement
obligation, property transactions
and taxes (80) (87) (74) 876
Estimated provision for settlement of the
reimbursement obligation (2,200) -- (2,200) --
Gain on sale of real estate assets, net -- 10,900 -- 10,900
------- -------- ------- -------
Income (loss) before taxes (2,280) 10,813 (2,274) 11,776
Income tax benefit (provision) 830 (4,434) 830 (4,808)
------- -------- ------- -------
Net income (loss) $(1,450) $ 6,379 $(1,444) $ 6,968
------- -------- ------- -------
------- -------- ------- -------
Income (loss) per share, primary $ (0.32) $ 1.49 $ (0.32) $ 1.67
------- -------- ------- -------
------- -------- ------- -------
Income (loss) per share, fully diluted $ (0.32) $ 1.46 $ (0.32) $ 1.60
------- -------- ------- -------
------- -------- ------- -------
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
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<TABLE>
PACIFIC GATEWAY PROPERTIES, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------- ------------------
1997 1996 1997 1996
----- ---- ---- ----
<S> <C> <C> <C> <S>
Cash flow from operating activities:
Net income (loss) $(1,450) $ 6,379 $ (1,444) $ 6,968
Non-cash revenues and expenses
included in net income (loss):
Depreciation and amortization 793 634 1,507 1,238
Estimated provision for settlement of the
reimbursement obligation 2,200 -- 2,200 --
Gain on sale of real estate assets, net -- (10,900) -- (10,900)
Change in assets and liabilities:
Accounts receivable, prepaid taxes and other
current assets (37) (337) 538 (250)
Accounts payable and other current liabilities (443) (666) (64) (992)
Current tax liability -- 626 -- 626
Deferred taxes (830) 3,625 (830) 3,999
-------- ------- -------- --------
NET CASH GENERATED BY (USED IN) OPERATING
ACTIVITIES 233 (639) 1,907 689
-------- ------- -------- --------
Cash flow from investing activities:
Additions to investment properties,
capitalized loan costs, capitalized
lease commissions and rent concessions (809) (875) (1,459) (1,093)
Proceeds from sale of property, net -- 19,122 -- 19,122
Acquisition of investment properties -- -- (10,975) --
-------- ------- -------- --------
NET CASH GENERATED BY (USED IN) INVESTING
ACTIVITIES (809) 18,247 (12,434) 18,029
-------- ------- -------- --------
Cash flow from financing activities:
Borrowings on debt related to investment
properties -- -- 2,112 --
Payments on debt related to investment properties (212) (388) (403) (1,062)
Mortgages satisfied in connection with
property dispositions -- (15,224) -- (15,224)
Proceeds from shareholder short-swing sale 184 -- 184 --
(Increase) decrease in cash reserved for
capital improvements, acquisitions,
and debt service, net (127) (29) 8,066 138
-------- ------- -------- --------
NET CASH GENERATED BY (USED IN) FINANCING
ACTIVITIES (155) (15,641) 9,959 (16,148)
-------- ------- -------- --------
Increase (decrease) in cash and cash equivalents (731) 1,967 (568) 2,570
Balance at beginning of period 3,062 779 2,899 176
-------- ------- -------- --------
Balance at end of period $ 2,331 $ 2,746 $ 2,331 $ 2,746
-------- ------- -------- --------
-------- ------- -------- --------
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
<PAGE>
<TABLE>
PACIFIC GATEWAY PROPERTIES, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------- -------------------
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Supplementary disclosures:
Cash paid for interest $ 972 $ 811 $ 1,900 $ 1,885
-------- ------- --------- -------
-------- ------- --------- -------
Cash paid for taxes $ -- $ 410 $ -- $ 410
-------- ------- --------- -------
-------- ------- --------- -------
Non-cash transactions:
Portion of acquisition of investment
properties funded by assumption of
mortgage debt $ -- $ -- $ 10,203 $ --
-------- ------- --------- -------
-------- ------- --------- -------
Increase in mortgage debt in connection with
reimbursement obligation $ 2,200 $ -- $ 2,200 $ --
-------- ------- --------- -------
-------- ------- --------- -------
</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 SIX MONTHS ENDED JUNE 30, 1997
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying unaudited condensed consolidated financial statements
should be read in conjunction with the Registrant's 1996 Form 10-K and Form 10-Q
for the quarter and six months ended June 30, 1996. 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.
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 six months ended June 30, 1997 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1997.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to be consistent with
current year 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. RINCON CENTER ASSOCIATES PARTNERSHIP (RCA)-- SAN FRANCISCO, CALIFORNIA
The Registrant owns general (non-managing) and limited partnership
interests in RCA totaling approximately 22.8% and, subject to the funding
agreement entered into with RCA's managing general partner, Perini Land &
Development Company (a wholly owned subsidiary of Perini Corporation), discussed
below, is responsible for 20% of cash requirements in excess of available
financing. The Registrant's minority, general (non-managing) and limited
partnership interests in RCA represent significant potential financial exposure.
This exposure includes and may not be limited to the potential tax liability
associated with the Registrant's negative tax basis, the joint and several
guarantees and letter-of-credit provided by the Registrant to the mortgage
lender on Rincon Center Phase Two and the master lessor on Rincon Center Phase
One, and the potential tax liability that would exist from the cancellation of
debt in connection with a possible debt restructuring. Except for the estimated
provision for settlement of the reimbursement obligation and deferred income tax
liabilities related to the tax that would result from any gain recognized from
the Registrant's negative tax basis in its partnership interest, the
accompanying financial statements do not include any adjustments for these
uncertainties.
RCA sold Rincon Center Phase One to Chrysler MacNally Corporation
(Chrysler) in June
7
<PAGE>
1988; subsequently, RCA leased the property back under a master lease which
is treated as an operating lease for financial reporting purposes. In July
1993, Chrysler completed a refinancing of Rincon Center Phase One. The
maturity date of this debt is July 1, 1998. Payments under the master lease
agreement may be adjusted to reflect adjustments in the rate of interest
payable by Chrysler on the Rincon Center Phase One debt. The master lease
also permits Chrysler to put the property back to RCA at stipulated prices
beginning January 1998 if long-term financing meeting certain conditions is
not obtained. RCA intends to try to obtain financing meeting the condition of
the master lease prior to January 1998. On June 30, 1997, RCA filed a
lawsuit against Chrysler in Superior Court in the State of California, County
of San Francisco. The lawsuit's primary cause of action alleges that
Chrysler has breached the master lease and a certain letter agreement because
the rent payments due from RCA after the 1993 refinancing of Rincon Center
Phase I, resulted in an increase in Chrysler's after tax rate of return from
rent payments. The lawsuit states that such excessive rent recalculations
directly contravene both the letter and the spirit of the master lease.
In September 1993, RCA completed a refinancing of Rincon Center Phase Two
with its existing lender. A portion of the security for the refinanced loan was
a $3.65 million letter-of-credit issued by a bank (the Issuing Bank) on behalf
of the Registrant in favor of the refinancing lender. The reimbursement
obligation of the Registrant to the Issuing Bank is full recourse to the
Registrant and is secured by the Registrant's 410 First Avenue property located
in Needham, Massachusetts. This property has a net book value of approximately
$2.2 million at June 30, 1997. The letter-of-credit for $3.65 million was drawn
by the refinancing lender prior to its expiration date of June 23, 1997. The
refinancing lender is currently holding the $3.65 million in a separate
restricted account on behalf of RCA and has not applied said funds to any
outstanding debt of RCA. The Registrant and the Issuing Bank are currently in
discussions to reach a mutually acceptable resolution since the letter-of-credit
was drawn. Alternative resolutions may include, among other things, (i)
arrangement of a substitute letter-of-credit from another bank, which would be
acceptable to the refinancing lender, which in turn would result in a return of
the funds drawn by the refinancing lender to the Issuing Bank, (ii) repayment by
the Registrant of the reimbursement obligation at a discount, or (iii)
foreclosure by the Issuing Bank on the 410 First Avenue property. The Issuing
Bank has made a demand on the Registrant to reimburse them for the $3.65 million
drawn on the letter-of-credit and has also notified the Registrant it is in
default with respect to the reimbursement obligation. In the event that the
Registrant and the Issuing Bank do not agree on a mutually acceptable resolution
on the restructuring or pay off of this debt, the Issuing Bank may commence
foreclosure proceedings against the Needham, Massachusetts property. In the
event of a foreclosure of the Needham, Massachusetts property, the Issuing Bank
may also seek to assert a deficiency claim against the Registrant for any
alleged difference between the value of the foreclosed property and the $3.65
million drawn on the letter-of-credit. The Registrant would vigorously defend
any such deficiency claim. Since any assets of the Registrant which are applied
to the reimbursement obligation would constitute additional investment in RCA,
which the Registrant considers of no value, the net book value of such assets
would be written off and charged to the earnings of the Registrant when said
assets were applied to the reimbursement obligation. In accordance with
generally accepted accounting principles, effective June 30, 1997, the
Registrant recorded an "estimated provision for settlement of reimbursement
obligation" in the amount of $2.2 million to provide for the ultimate settlement
of the reimbursement obligation. The accrued amount is equal to the net book
value of the Needham, Massachusetts property that serves as collateral for the
reimbursement obligation, resulting in an effective discount of the $3.65
million face value of the
8
<PAGE>
reimbursement obligation. Any difference between the estimated settlement of
reimbursement obligation and the amount ultimately settled upon will be
charged or credited to the Registrant's operations as such difference becomes
determinable. Management can provide no assurances as to the ultimate
settlement amount or method (and the timing thereof) relating to the
reimbursement obligation.
In 1993, the Registrant entered into an agreement with RCA's managing
general partner whereby such managing general partner agreed to advance funds to
RCA on behalf of the Registrant on an unsecured non-recourse basis, subject to
interest at prime plus 2% and certain annual fees (principal, unpaid interest
and fees are collectively referred to as the RCA Advances). This agreement does
not reduce the level of the Registrant's general and limited partner interest in
RCA. The RCA Advances are only required to be repaid from the Registrant's share
of future distributions from RCA, if any. During the first six months of 1997
and 1996, RCA incurred net losses of approximately $9,958,000 and $7,139,000,
respectively. The RCA Advances amount to approximately $5,243,000 at June 30,
1997 and as noted above, are not recorded on the Registrant's financial
statements since (i) the RCA Advances are only required to be repaid from the
Registrant's share of future distributions from RCA, if any, (ii) the Registrant
has no intention or legal obligation to repay the RCA Advances other than from
its share of distributions from RCA, if any, and (iii) the Registrant does not
anticipate any material cash distributions by RCA in the foreseeable future.
During 1997, the Registrant has asserted certain claims against RCA for
payment to the Registrant by RCA for leasing services provided to RCA by the
Registrant during 1996. The Registrant has not accrued for such claims pending
resolution of this matter with RCA's managing general partner.
Summary unaudited financial statement data for RCA is as follows (in
thousands):
AS OF JUNE 30, DECEMBER 31,
1997 1996
--------- -----------
Investment properties, net $ 100,548 $ 110,495
Other assets 30,785 21,042
--------- ---------
$ 131,333 $ 131,537
--------- ---------
--------- ---------
Debt $ 54,862 $ 56,012
Amounts due to partners 171,052 158,156
Other liabilities 10,722 12,703
Partners' deficit (105,303) (95,334)
--------- ---------
$ 131,333 $ 131,537
--------- ---------
--------- ---------
9
<PAGE>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ----------------
1997 1996 1997 1996
---- ---- ---- ----
Revenue $ 3,719 $ 5,483 $ 7,727 $ 10,824
Expenses:
Operating and lease expenses 4,608 3,289 9,015 6,680
Interest expense 3,759 4,682 7,239 9,394
Depreciation expense 720 945 1,431 1,889
------- ------- ------- --------
Net loss $(5,368) $(3,433) $(9,958) $ (7,139)
------- ------- ------- --------
------- ------- ------- --------
In 1996, the Registrant ceased recording any activity related to its
interest in RCA and has written down its equity investment in and loans to RCA
to zero.
3. PER SHARE DATA
Per share data is based on the weighted average number of the Registrant's
common shares and common share equivalents outstanding. Outstanding warrants and
stock options enter into the common shares outstanding using the Treasury Stock
Method. The weighted average number of common shares and common share
equivalents outstanding for the three months and six months ended June 30, 1997
and 1996, are as follows:
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
1997 1996 1997 1996
---- ---- ---- ----
Primary 4,564,800 4,284,697 4,476,107 4,166,097
--------- --------- --------- ---------
--------- --------- --------- ---------
Fully diluted 4,564,800 4,367,059 4,502,204 4,367,059
--------- --------- --------- ---------
--------- --------- --------- ---------
In March 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 128, Earnings Per Share (SFAS No. 128). SFAS
No. 128 requires the disclosure of basic earnings per share and modifies
existing guidance for computing diluted earnings per share. Under the new
standard, 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. The effective date of SFAS No. 128 is December
15, 1997, and early adoption is not permitted. The Registrant intends to adopt
provisions of SFAS No. 128 during the quarter and year ended December 31, 1997.
Had the provisions of SFAS No. 128 been applied to the Registrant's results of
operations for the three months ended June 30, 1997 and 1996, the Registrant's
basic earnings per share would have been ($0.36) and $1.59 per share,
respectively, and its diluted earnings per share would have been ($0.32) and
$1.47 per share, respectively. Had the provisions of SFAS No. 128 been applied
to the Registrant's results of operations for the six months ended June 30, 1997
and 1996, the Registrant's basic earnings per share would have been ($0.36) and
$1.74 per share, respectively, and its diluted earnings per share would have
been ($0.32) and $1.66 per share, respectively.
10
<PAGE>
4. ACQUISITION OF INVESTMENT PROPERTY
On January 17, 1997, the Registrant purchased two properties to complete
a tax deferred exchange in accordance with Section 1031 of the Internal
Revenue Code, in connection with the December 1996 sale of the Radisson
Suites Hotel. The first acquisition was West Valley Executive Park, a
multi-tenant, six building, 165,000 square foot campus style office park in
San Jose, California, that was acquired for $17,500,000. In connection with
the West Valley Executive Park acquisition, the Registrant assumed
approximately $10,200,000 in mortgage debt from Sun Life Assurance Company of
Canada (U.S.). The loan is amortized over twenty years at a fixed annual
interest rate of 9.125% and matures on June 30, 2005. The debt continues to
be assumable and is subject to a prepayment penalty if paid off prior to
maturity. The second acquisition was a multi-tenant, 23,000 square foot, six
story steel frame office building located at 930 Montgomery Street, San
Francisco, California, for $3,250,000. In connection with the 930 Montgomery
Street acquisition, the Registrant obtained $2,112,500 in mortgage debt from
Redwood Bank. The loan is amortized over twenty-five years at a floating
interest rate of 3% over the one year treasury bond rate, adjustable every
six months, and matures on February 1, 2002. The Redwood Bank debt can be
prepaid at any time without a penalty.
The following unaudited pro-forma information reflects adjustments to the
Registrant's historical results from these acquisitions and certain other
transactions as if they had occurred on January 1, 1996 (in thousands, except
share amounts):
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
1997 1996 1997 1996
---- ---- ---- ----
Revenues $ 3,557 $ 3,364 $ 7,023 $ 7,356
--------- --------- --------- ---------
--------- --------- --------- ---------
Income (loss) before hotel
operations, estimated
settlement obligation,
property transactions and
taxes $ (81) $ (183) $ 68 $ (78)
--------- --------- --------- ---------
--------- --------- --------- ---------
Income (loss) before hotel
operations, estimated
settlement obligation,
property transactions and
taxes per common share --
Primary $ (0.02) $ (0.04) $ 0.02 $ (0.02)
--------- --------- --------- ---------
--------- --------- --------- ---------
Fully diluted $ (0.02) $ (0.04) $ 0.02 $ (0.02)
--------- --------- --------- ---------
--------- --------- --------- ---------
Weighted average common
shares outstanding --
Primary 4,564,800 4,284,697 4,476,107 4,166,097
--------- --------- --------- ---------
--------- --------- --------- ---------
Fully diluted 4,564,800 4,367,059 4,502,204 4,367,059
--------- --------- --------- ---------
--------- --------- --------- ---------
11
<PAGE>
5. PAID-IN-DEFICIT
During the quarter ended June 30, 1997, the Registrant received
approximately $184,000 in cash from two shareholders as a result of their
compliance with the Securities Exchange Act's requirement that profits from
the sale of certain securities of a company that were held less than six
months by certain officers, directors and principal stockholders must be
returned to the Registrant. In accordance with generally accepted accounting
principles, the Registrant recorded such proceeds as a credit to the
Registrant's paid-in-deficit.
12
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
The Registrant is a New York corporation formed in 1984 for the purpose of
investing and managing income producing real estate. 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
four 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. 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 Form 10-K for 1996, quarterly report on Form 10-Q for the quarter
and six months ended June 30, 1996, and in conjunction with the Condensed
Consolidated Balance Sheet, Statement of Operations 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 six months ended June 30, 1997, there were additions to
investment properties amounting to approximately $809,000 and $1,459,000,
respectively, for tenant improvements, capital improvements and other deferred
costs which includes leasing commissions. The Registrant anticipates further
additions to investment properties of approximately $2,900,000 during the
remainder of 1997.
FINANCING -- Approximately $212,000 and $403,000 of debt principal was
repaid in the three and six months ended June 30, 1997, respectively, as
scheduled debt amortization. In connection with the acquisitions of investment
properties during the six months ended June 30, 1997, the Registrant assumed and
borrowed mortgage notes totaling approximately $12,315,000. Accordingly, at
June 30, 1997, the Registrant had fixed rate mortgage debt of approximately
$43.5 million bearing interest at a weighted average rate of 8.49%, one floating
rate mortgage of approximately $2.1 million bearing interest at a rate of 8.63%,
and a secured estimated settlement obligation recorded at $2,200,000, as more
fully discussed in Note 2 of the Registrant's unaudited condensed consolidated
financial statements.
MATERIAL CHANGES IN RESULTS OF OPERATIONS
INVESTMENT PROPERTIES - During the first six months of 1997, the income
from investment properties was $618,000 compared to income of $374,000 during
the first six
13
<PAGE>
months of 1996. During the second quarter of 1997 the income from investment
properties was $135,000 compared to a loss of $27,000 for the second quarter
of 1996. Interest expense increased from $1,508,000 during the first six
months of 1996 to $1,900,000 during the first six months of 1997, primarily
as a result of the debt associated with the properties acquired in January
1997. Depreciation and amortization expense increased as a result of
commencing depreciation of expenditures capitalized during 1996 and early
1997 relating to the Registrant's leasing activities and capital improvement
projects, and new investment property acquisitions completed in the first
quarter of 1997.
The following table identifies the impact of certain investment property
dispositions, acquisitions and properties owned in the three and six months
ended June 30, 1997 and 1996, respectively (in thousands):
<TABLE>
FOR THE THREE FOR THE SIX
MONTHS ENDED MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
INVESTMENT PROPERTIES OWNED IN
1997 AND 1996:
Rental revenue $ 2,697 $ 2,541 $ 5,287 $ 5,014
Operating expense (1,231) (1,473) (2,265) (2,481)
Interest expense (695) (595) (1,394) (1,239)
Depreciation expense (661) (634) (1,292) (1,238)
------- ------- ------- -------
110 (161) 336 56
------- ------- ------- -------
INVESTMENT PROPERTIES ACQUIRED IN
JANUARY 1997:
Rental revenue 860 -- 1,591 --
Operating expense (349) -- (588) --
Interest expense (354) -- (506) --
Depreciation expense (132) -- (215) --
------- ------- ------- -------
25 -- 282 --
------- ------- ------- -------
INVESTMENT PROPERTY SOLD IN APRIL 1996:
Rental revenue -- 5 -- 706
Operating expense -- 139 -- (119)
Interest expense -- (10) -- (269)
Depreciation expense -- 0 -- --
------- ------- ------- -------
-- 134 -- 318
------- ------- ------- -------
TOTAL INVESTMENT PROPERTIES:
Rental revenue 3,557 2,546 6,878 5,720
Operating expense (1,580) (1,334) (2,853) (2,600)
Interest expense (1,049) (605) (1,900) (1,508)
Depreciation expense (793) (634) (1,507) (1,238)
------- ------- ------- -------
TOTAL INVESTMENT PROPERTIES INCOME
(LOSS) $ 135 $ (27) $ 618 $ 374
------- ------- ------- -------
------- ------- ------- -------
</TABLE>
14
<PAGE>
GENERAL AND ADMINISTRATIVE EXPENSES - General and administrative expenses
in the first six months of 1997 amounted to $700,000 compared to $858,000 for
the first six months of 1996. General and administrative expenses for the
second quarter of 1997 and 1996 were $280,000 and $462,000, respectively. The
decrease is primarily attributable to a decrease in professional services and
personnel costs including severance to a former executive.
OTHER INCOME, NET - Other income, net, consisting primarily of interest
income, was $101,000 and $64,000 during the first six months and second quarter
of 1997, respectively. Other income, net, consisting primarily of business
advisory fees and income from the sale of vacant land in Colorado was $214,000
and $210,000 during the first six months and second quarter of 1996,
respectively.
HOTEL PROPERTY - The Registrant sold its hotel property in December 1996
and, accordingly, a comparison of the operations from the first six months and
second quarter of 1996 to the first six months and second quarter of 1997 is not
meaningful.
ESTIMATED PROVISION FOR SETTLEMENT OF THE REIMBURSEMENT OBLIGATION -
Effective June 30, 1997, the Registrant recorded an estimated provision of $2.2
million for the ultimate settlement of the letter-of-credit reimbursement
obligation, as more fully discussed in Note 2 to the Registrant's unaudited
condensed consolidated financial statements.
GAIN ON SALE OF REAL ESTATE ASSETS, NET - In April 1996, the Registrant
sold the Village Commons Shopping Center, located in West Palm Beach, Florida,
to an unrelated party and realized a gain of $10,900,000.
INCOME TAX BENEFIT (PROVISION) - A tax benefit of $830,000 has been
recorded in connection with the net loss for the three and six months ended
June 30, 1997. A tax provision is recorded in connection with the net income
for the three and six months ended June 30, 1996, of $4,434,000 and
$4,808,000, respectively. These amounts have been recorded in accordance
with Statement of Financial Accounting Standards No. 109.
LIQUIDITY AND CAPITAL RESOURCES
REGULATION AND SUPERVISION
Many jurisdictions have adopted laws and regulation 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 begun to show signs
that rental rates and property values have stabilized and in selected markets
have actually improved. Notwithstanding a stabilizing real estate market,
tenants may or may not continue to renew
15
<PAGE>
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 June 30, 1997, the Registrant had approximately $2.3 million of
unrestricted cash, investment properties with a net book value of approximately
$53.5 million, total non-recourse mortgage debt and secured estimated settlement
obligation of approximately $47.8 million and stockholders' equity of
approximately $.9 million. At June 30, 1997, the Registrant had approximately
$1.9 million of restricted cash. 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, and has
entered into an agreement with the managing general partner of RCA to limit the
Registrant's cash obligations to RCA. 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.
Scheduled principal maturities on the above described debt during the
twelve month period ending June 30, 1998, will amount to approximately
$904,000.
The Registrant is also obligated to fund reserves for building, tenant
improvements and leasing commissions in connection with its mortgage loans on
Walnut Creek Executive Park, North Tuscon Business Center and South Bay Office
Tower. Scheduled funding under the various loan agreements during the twelve
month period ending June 30, 1998, will amount to approximately $575,000.
As further discussed in Note 5 of the Registrant's unaudited condensed
consolidated financial statements, during the quarter ended June 30, 1997, the
Registrant received approximately $184,000 in cash from a shareholder as a
return of profit from the sale of certain securities. This amount has been
recorded as a credit to the Registrant's paid-in-deficit.
The Registrant's Massachusetts property is pledged as collateral for a
$3.65 million letter-of-credit that was drawn as of June 30, 1997. As discussed
in Note 2 of the Registrant's unaudited condensed consolidated financial
statements, the Registrant and the
16
<PAGE>
Issuing Bank are currently in discussions to reach a mutually acceptable
resolution since the letter-of-credit was drawn. The Issuing Bank had made a
demand on the Registrant to reimburse them for the $3.65 million drawn on the
letter-of-credit and has also notified the Registrant it is in default with
respect to the reimbursement obligation. In the event that the Registrant
and the Issuing Bank do not agree on a mutually acceptable resolution on the
restructuring or pay off of this debt, the Issuing Bank may commence
foreclosure proceedings against the Massachusetts property. If the Issuing
Bank completes a foreclosure on the Massachusetts property, the Registrant
will eliminate $3.65 million in secured debt on a property that is producing
approximately $240,000 in annual cash flow. In the event of a foreclosure of
the Massachusetts property, the Issuing Bank may also seek to assert a
deficiency claim against the Registrant for any alleged difference between
the value of the foreclosed property and the $3.65 million drawn on the
letter-of-credit. The Registrant would vigorously defend any such claim. In
accordance with generally accepted accounting principles, effective June 30,
1997, the Registrant recorded an "estimated provision for settlement of
reimbursement obligation" in the amount of $2.2 million to provide for the
ultimate settlement of the reimbursement obligation. The accrued amount is
equal to the net book value of the Needham, Massachusetts property that
serves as collateral for the reimbursement obligation, resulting in an
effective discount of the $3.65 million face value of the reimbursement
obligation. Any difference between that estimated settlement of
reimbursement obligation and the amount ultimately settled upon will be
charged or credited to the Registrant's operations as such difference becomes
determinable. Management can provide no assurances as to the ultimate
settlement amount or method (and the timing thereof) relating to the
reimbursement obligation.
The Registrant's minority, non-managing partnership interest in RCA
represents significant potential financial exposure. This exposure includes,
and may not be limited to, the potential tax liability associated with the
Registrant's negative tax basis, the joint and several guarantees and
letter-of-credit provided by the Registrant to the mortgage lender on Rincon
Center Phase Two and the master lessor on Rincon Center Phase One, and the
potential tax liability that would exist from the cancellation of debt in
connection with a possible debt restructuring. Additionally, RCA's managing
general partner agreed to advance funds to RCA on behalf of the Registrant on
an unsecured non-recourse basis, subject to interest at prime plus 2% and
certain annual fees (principal, unpaid interest, and fees are collectively
referred to as the RCA Advances). The RCA Advances amount to approximately
$5,243,000 at June 30, 1997, and are not recorded by the Registrant since (i)
the RCA Advances are only required to be repaid from the Registrant's share
of future distributions from RCA, if any, (ii) the Registrant has no
intention or legal obligation to repay the RCA Advances other than from its
share of distributions from RCA, if any, and (iii) the Registrant does not
anticipate any material cash distributions by RCA in the foreseeable future.
Except as described above, at June 30, 1997, the Registrant has no
contractual commitments for any material capital expenditures over the next
twelve months or beyond that are not expected to be funded from the cash
restricted for capital improvements, acquisitions and debt service 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,
in part, from the restricted cash described above, cash flow generated by
operating activities and funds generated from future debt refinancings or
property sales, if any.
The Registrant continued to experience more stabilized operating results in
its wholly
17
<PAGE>
owned properties during the first and second quarters of 1997, and except for
RCA, expects this trend to continue. In addition, the completion of certain
leasing transactions has continued to reduce the level of vacancy in the
Registrant's portfolio; however, the Registrant is continuing to aggressively
pursue new leases on currently available space and renew existing leases as
they expire.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
As more fully described in Note 2 of the Registrant's unaudited condensed
consolidated financial statements, the Registrant has not reimbursed the Issuing
Bank of a letter of credit issued on behalf of the Registrant for the $3,650,000
drawn.
ITEM 4. SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS
A Special in Lieu of Annual Meeting ("Annual Meeting") of Shareholders of
the Registrant was held on July 21, 1997. At the Annual Meeting, the
Shareholders elected six incumbent Directors and two new Directors. At the
Annual Meeting, 3,289,878 shares of a total of 3,892,596 shares were
represented. The following sets forth the results of the vote for each Nominee
for Director:
TOTAL VOTE FOR TOTAL VOTE WITHHELD
EACH DIRECTOR EACH DIRECTOR
------------- -------------
S.A. Calabrese 3,301,122 10,892
M.D. Grossi 3,301,338 10,676
L.B. Helzel 3,301,338 10,676
M.A. Jacobs 3,288,374 23,640
C.L. Jarratt 3,301,038 10,976
R.V. Marino 3,301,122 10,892
R.M. Osborne 3,301,038 10,976
M.S. Roher 3,301,338 10,676
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits:
No. Description
--- -----------
27 Financial Data Schedule
18
<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.
PACIFIC GATEWAY PROPERTIES, INC.
--------------------------------
Registrant
Date: November 10, 1997 /s/ Raymond V. Marino
-------------------------------------
Raymond V. Marino
President and Chief Executive Officer
Date: November 10, 1997 /s/ Melanie L. Adkins
-------------------------------------
Controller - Management Company
(Principal Accounting Officer)
Date: November 10, 1997 /s/ George S. Mercado
-------------------------------------
Controller - Corporate
(Principal Accounting Officer)
19
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<CASH> 4,240
<SECURITIES> 0
<RECEIVABLES> 351
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 4,881
<PP&E> 68,687
<DEPRECIATION> 15,179
<TOTAL-ASSETS> 67,001
<CURRENT-LIABILITIES> 1,427
<BONDS> 47,834
0
0
<COMMON> 4,011
<OTHER-SE> (3,103)
<TOTAL-LIABILITY-AND-EQUITY> 67,001
<SALES> 0
<TOTAL-REVENUES> 6,979
<CGS> 0
<TOTAL-COSTS> 4,360
<OTHER-EXPENSES> 93
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,900
<INCOME-PRETAX> (74)
<INCOME-TAX> (830)
<INCOME-CONTINUING> (1,444)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,444)
<EPS-PRIMARY> (0.32)
<EPS-DILUTED> (0.32)
</TABLE>
