<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 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
101 SPEAR STREET, SUITE 215, SAN FRANCISCO, CALIFORNIA 94105
- - --------------------------------------------------------------------------------
(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 March 31, 1997:
$1.00 PAR VALUE COMMON STOCK 3,892,596
- - ---------------------------- ------------------------------
(Title of Class) (Number of Shares Outstanding)
1
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
INDEX
PAGE NUMBER
Part I - Financial Information: -----------
Item 1. Consolidated Financial Statements
Condensed Consolidated Balance Sheet as of
March 31, 1997 and December 31, 1996 3
Condensed Consolidated Statement of Income for the
Three Months Ended March 31, 1997 and 1996 4
Condensed Consolidated Statement of Cash Flows for the
Three Months Ended March 31, 1997
and 1996 5
Notes to Condensed Consolidated Financial Statements 6-10
Item 2. Management's Discussion and
Analysis of Financial Condition
and Results of Operations 11-15
Part II - Other Information
Item 1. Legal Proceedings None
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 16
Signatures 17
2
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEET (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
AS OF AS OF
MARCH 31, DECEMBER 31,
1997 1996
ASSETS ---- ----
<S> <C> <C>
Cash and cash equivalents $ 3,062 $ 2,899
Cash reserved for capital improvements,
acquisitions and debt service 1,782 9,975
Accounts receivable, prepaid taxes and other
current assets 604 1,179
Investment properties 67,891 46,632
Less-accumulated depreciation and provision
for write-down to net realizable value (14,474) (13,835)
--------- ---------
Investment properties, net 53,417 32,797
--------- ---------
Deferred tax asset 4,783 4,183
Capitalized loan costs, net 1,026 717
Capitalized lease commissions and rent concessions,
net 828 643
--------- ---------
Total assets $ 65,502 $ 52,393
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable, prepaid rent, tenant security
deposits and other current liabilities $ 1,870 $ 1,491
Debt related to investment properties 45,846 33,722
Deferred tax liability 15,612 15,012
--------- ---------
Total liabilities 63,328 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 (10,222) (10,222)
Retained earnings 8,532 8,526
Treasury stock, at cost--118,554 common shares at
March 31, 1997 and December 31, 1996 (2,037) (2,037)
Warrants for common stock 1,890 1,890
--------- ---------
Total stockholders' equity 2,174 2,168
--------- ---------
Total liabilities and stockholders' equity $ 65,502 $ 52,393
--------- ---------
--------- ---------
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
CONDENSED CONSOLIDATED STATEMENT OF INCOME (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS
ENDED MARCH 31,
---------------
1997 1996
---- ----
<S> <C> <C>
INVESTMENT PROPERTIES:
Rental revenues $ 3,309 $ 3,174
Operating expenses (1,273) (1,266)
Interest expense (851) (903)
Depreciation and amortization (714) (604)
------- -------
Investment properties income 471 401
General and administrative expenses (419) (396)
Other income, net 48 4
------- -------
Income before hotel operations and income taxes 100 9
Income (loss) from hotel operations (94) 954
------- -------
Income before taxes 6 963
Income tax provision -- (374)
------- -------
Net income $ 6 $ 589
------- -------
------- -------
Income per share, primary $ -- $ 0.15
------- -------
------- -------
Income per share, fully diluted $ -- $ 0.14
------- -------
------- -------
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements
4
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS
ENDED MARCH 31,
---------------
1997 1996
---- ----
<S> <C> <C>
Cash flow from operating activities:
Net income $ 6 $ 589
Non-cash revenues and expenses included in income:
Depreciation and amortization 714 604
Change in assets and liabilities:
Accounts receivable, prepaid taxes and other current
assets 575 87
Accounts payable and other current liabilities 379 (326)
Deferred taxes -- 374
------- -------
NET CASH GENERATED BY OPERATING ACTIVITIES 1,674 1,328
------- -------
Cash flow from investing activities:
Additions to investment properties, capitalized loan
costs and capitalized lease commissions and rent
concessions (650) (218)
Acquisitions of investment properties (10,975) --
------- -------
NET CASH USED IN INVESTING ACTIVITIES (11,625) (218)
------- -------
Cash flow from financing activities:
Borrowings on debt related to investment properties 2,112 --
Payments on debt related to investment properties (191) (674)
Decrease in cash reserved for capital improvements,
acquisitions and debt service, net 8,193 167
------- -------
NET CASH GENERATED BY (USED IN) FINANCING ACTIVITIES 10,114 (507)
------- -------
Increase in cash and cash equivalents 163 603
Balance at beginning of period 2,899 176
------- -------
Balance at end of period $ 3,062 $ 779
------- -------
------- -------
Supplementary disclosures:
Cash paid for interest $ 943 $ 1,074
------- -------
------- -------
Cash paid for taxes $ 1 $ 1
------- -------
------- -------
Non-cash transaction -- portion of acquisition of
investment properties funded by assumption of
mortgage debt $ 10,203 $ --
------- -------
------- -------
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE QUARTER ENDED MARCH 31, 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 three months ended March 31, 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 months ended March 31, 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 income tax effect
6
<PAGE>
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 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.
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 major national 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 $2.5 million at March 31, 1997. The
letter-of-credit currently expires on June 23, 1997, and the issuing bank
informed the Registrant in April 1997 that it did not intend to renew the
letter-of-credit. Since that time, the Registrant has continued to negotiate
a renewal of the letter-of-credit with the issuing bank and has commenced
efforts to find a replacement letter-of-credit. Most recently, the issuing
bank has indicated (without firm commitment) that it may be willing to renew
the letter-of-credit if the Registrant posts certain additional collateral
for the letter-of-credit, however no assurances can be made that a negotiated
renewal will occur. At this time, an appraisal of the Needham, Massachusetts
property is underway to determine the amount (if any) of additional
collateral that the issuing bank may require for a renewal of the
letter-of-credit. The Registrant is also continuing efforts to find a
suitable replacement letter-of-credit, although no assurances can be given
that such a replacement letter-of-credit will be available or will be
available on conditions that the Registrant finds acceptable. If the issuing
bank or another financial institution requires collateral in addition to the
Needham, Massachusetts property as a condition to issuing a renewal
letter-of-credit, the Registrant may decide not to post such additional
collateral. In such event, it is likely that the holder of the existing
letter-of-credit will draw on the letter-of-credit prior to its expiration
and apply the proceeds to the outstanding balance of the RCA debt. Following
a draw on the letter-of-credit, the issuing bank would likely demand
reimbursement from the Registrant and would commence foreclosure proceedings
against the Needham, Massachusetts property. Following any 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 draw 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
7
<PAGE>
the earnings of the Registrant when said assets were applied to the
reimbursement obligation. The accompanying consolidated unaudited financial
statements do not include any adjustments for this uncertainty.
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 partnership
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
three months of 1997 and 1996, RCA incurred net losses of approximately
$4,590,000 and $3,706,000, respectively. The RCA Advances amount to
approximately $4,539,000 at March 31, 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):
<TABLE>
<CAPTION>
AS OF MARCH 31, DECEMBER 31,
1997 1996
---- ----
<S> <C> <C>
Investment Properties, net $ 101,087 $ 110,495
Other assets 27,813 21,042
--------- ---------
$ 128,900 $ 131,537
--------- ---------
--------- ---------
Debt $ 55,437 $ 56,012
Amounts due to partners 162,422 158,156
Other liabilities 11,059 12,703
Partners' deficit (100,018) (95,334)
--------- ---------
$ 128,900 $ 131,537
--------- ---------
--------- ---------
</TABLE>
8
<PAGE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
---------------------------
1997 1996
---- ----
<S> <C> <C>
Revenue $ 4,008 $ 5,341
Expenses:
Operating and lease expenses 4,407 3,391
Interest expense 3,480 4,712
Depreciation expense 711 944
------- -------
Net loss ($ 4,590) ($ 3,706)
------- -------
------- -------
</TABLE>
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 ended March 31, 1997 and 1996, are
as follows:
<TABLE>
<CAPTION>
AS OF MARCH 31, 1997 1996
---- ----
<S> <C> <C>
Primary 4,371,953 4,020,729
--------- ---------
--------- ---------
Fully diluted 4,452,714 4,093,404
--------- ---------
--------- ---------
</TABLE>
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 fully diluted earings 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
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 quarters ended March 31, 1997 and 1996, the Registrant's
basic earnings per share would have been $0.00 and $0.15 per share,
respectively, and its fully diluted earnings per share would have been $0.00 and
$0.15 per share, respectively.
4. ACQUISITION OF INVESTMENT PROPERTIES
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 acquisition, the
Registrant assumed approximately $10,200,000 in mortgage debt from Sun Life
9
<PAGE>
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):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
---------
1997 1996
---- ----
<S> <C> <C>
Revenues $3,454 $3,992
------ ------
------ ------
Net income $ 55 $ (269)
------ ------
------ ------
Net income per common share --
Primary $ 0.01 ($0.07)
------ ------
------ ------
Fully diluted $ 0.01 ($0.07)
------ ------
------ ------
Weighted average common shares outstanding --
Primary 4,371,953 4,020,729
--------- ---------
--------- ---------
Fully diluted 4,452,714 4,093,404
--------- ---------
--------- ---------
</TABLE>
10
<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 three
months ended March 31, 1996, and in conjunction with the Condensed Consolidated
Balance Sheet, Statements 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 first three months of 1997, there were additions to investment
properties amounting to approximately $650,000 for tenant improvements, capital
improvements and other deferred costs which includes leasing commissions. The
Registrant anticipates further additions to investment properties of
approximately $1,500,000 during the remainder of 1997.
FINANCING -- Approximately $191,000 of debt was repaid in the first three
months of 1997 as scheduled debt amortization, as more fully discussed in the
Registrant's Consolidated Financial Statements. In connection with the
acquisitions of investment properties during the three months ended March 31,
1997, the Registrant assumed and borrowed mortgage notes totalling approximately
$12,315,000. Accordingly, at March 31, 1997, the Registrant had fixed rate
mortgage debt of approximately $43.7 million bearing interest at a weighted
average rate of 8.49% and one floating rate mortgage of approximately $2.1
million bearing interest at a rate of 8.63%.
MATERIAL CHANGES FROM RESULTS OF OPERATIONS
INVESTMENT PROPERTIES - During the first three months of 1997, investment
properties' income was $471,000 compared to $401,000 during the first three
11
<PAGE>
months of 1996. Interest expense decreased from $903,000 during the first
three months of 1996 to $851,000 during the first three months of 1997
primarily as a result of reduced debt balances. Depreciation and
amortization expense increased as 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 indentifies the impact of certain investment property
dispositions, acquisitions and properties owned in the first quarter of 1997
and 1996, respectively (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
---------
1997 1996
---- ----
<S> <C> <C>
INVESTMENT PROPERTIES OWNED IN 1997 AND 1996:
Rental revenue $ 2,578 $ 2,474
Operating expenses (1,034) (1,008)
Interest expense (699) (645)
Depreciation expense (631) (604)
------- -------
214 217
------- -------
INVESTMENT PROPERTIES ACQUIRED IN JANUARY 1997:
Rental revenue 731 --
Operating expenses (239) --
Interest expense (152) --
Depreciation expense (83) --
------- -------
257 --
------- -------
INVESTMENT PROPERTY SOLD IN APRIL 1996:
Rental revenue -- 700
Operating expenses -- (258)
Interest expense -- (258)
Depreciation expense -- --
------- -------
-- 184
------- -------
TOTAL INVESTMENT PROPERTIES:
Rental revenue 3,309 3,174
Operating expenses (1,273) (1,266)
Interest expense (851) (903)
Depreciation expense (714) (604)
------- -------
Total investment properties income $ 471 $ 401
------- -------
------- -------
</TABLE>
12
<PAGE>
GENERAL AND ADMINISTRATIVE EXPENSES - General and administrative
expenses in the first three months of 1997 amounted to $419,000 compared to
$396,000 for the first three months of 1996. The increase is primarily
attributable to an increase in legal fees and other professional service fees.
OTHER INCOME, NET - Other income, net, was $48,000 and $4,000 during the
first three months of 1997 and 1996, respectively. The increase is primarily
due to increased interest income.
HOTEL PROPERTY - The Registrant sold its hotel property in December 1996
and, accordingly, a comparison of the operations from the first quarter of
1996 to the first quarter of 1997 is not meaningful.
EQUITY IN PARTNERSHIP LOSS - RINCON CENTER ASSOCIATES (RCA) - 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. The
Registrant projects a negative tax basis for its partnership investment in
RCA of approximately $22,000,000, as of December 31, 1996, since the
Registrant's share of tax losses exceeds its investment in RCA. The exact
amount of the negative tax basis for its partnership investment in RCA as of
December 31, 1996 will not be known until the managing general partner
completes the RCA 1996 partnership tax returns later this year. The
Registrant's negative tax basis in RCA indicates that the Registrant will
face a substantial taxable gain if and when its interest in RCA is ever
disposed of.
Additionally, as discussed in Note 2 of the Registrant's Unaudited
Condensed Consolidated Financial Statements, the Registrant's earnings will
be subjected to a substantial charge if a letter-of-credit provided by the
Registrant to secure an RCA obligation is drawn on.
INCOME TAX PROVISION - A tax provision of $374,000 is recorded in
connection with the net income for the three months ended March 31, 1996 in
accordance with Statement of Financial Accounting Standards No. 109. No
provision for income taxes has been recorded for the first three months of
1997.
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 American 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
13
<PAGE>
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 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' 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 as
discussed below 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 March 31, 1997, the Registrant had
approximately $3.1 million of unrestricted cash, investment properties with a
net book value of approximately $53.4 million, total non-recourse mortgage
debt of approximately $45.8 million and stockholders' equity of
approximately $2.2 million. At March 31, 1997, the Registrant had
approximately $1.8 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 March 31, 1998, will amount to approximately
$884,000.
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 Tucson Business Center and South Bay
Office Tower. Scheduled funding under the various mortgage loan agreements
during the twelve month period ending March 31, 1998, will amount to
approximately $550,000.
Additionally, the Registrant is contingently liable under a bank
letter-of-credit posted on behalf of RCA in the amount of $3.65 million. The
letter-of-credit is undrawn at March 31, 1997 and matures on June 23, 1997.
The Registrant's Massachusetts property is pledged as collateral for the
letter-of-
14
<PAGE>
credit. As discussed in Note 2 of the Registrant's Unaudited Condensed
Consolidated Financial Statements, the bank issuing the letter-of-credit has
indicated it is not willing to renew said letter-of-credit unless it receives
additional collateral, and while the bank and Registrant await the completion
of an appraisal of the Massachusetts property the Registrant is evaluating
various options that are available.
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
$4,539,000 at March 31, 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 March 31, 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 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
refinancing or property sales, if any.
The Registrant continued to experience more stabilized operating results
in its wholly owned properties during the first quarter 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.
15
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits:
No. Description
--- -----------
27 Financial Data Schedule
b) The Registrant filed a Form 8-K dated January 30, 1997 and Form
8-K/A dated March 20, 1997, reporting under Items 2 and 7.
16
<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: MAY 13, 1997 /s/ RAYMOND V. MARINO
------------ ---------------------
Raymond V. Marino
President and Chief Executive
Officer
Date: MAY 13, 1997 /s/ MELANIE L. ADKINS
------------ ---------------------
Melanie L. Adkins
Controller
(Principal Accounting Officer)
17
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 4,844
<SECURITIES> 0
<RECEIVABLES> 147
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 5,448
<PP&E> 67,891
<DEPRECIATION> 14,474
<TOTAL-ASSETS> 65,502
<CURRENT-LIABILITIES> 1,870
<BONDS> 45,846
0
0
<COMMON> 4,011
<OTHER-SE> (1,837)
<TOTAL-LIABILITY-AND-EQUITY> 65,502
<SALES> 0
<TOTAL-REVENUES> 3,357
<CGS> 0
<TOTAL-COSTS> 1,987
<OTHER-EXPENSES> 94
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 851
<INCOME-PRETAX> 6
<INCOME-TAX> 0
<INCOME-CONTINUING> 6
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
