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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NUMBER 1-8692
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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
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
---------------------------------------- ---------------------------------
Common Stock, $1.00 par value American Stock Exchange
per share
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE
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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 by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Section229.405 of this chapter) is not contained herein,
and will not be contained, to the best of Registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K / /.
State the aggregate market value of the voting stock held by non-affiliates
of the Registrant as of March 20, 1998: Common Stock, Par Value
$1.00--$13,880,229.
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of March 20, 1998: Common Stock, Par Value
$1.00--3,899,596 shares.
DOCUMENT INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement for its 1998 annual
meeting of shareholders, are incorporated by reference into Part III.
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PART I
ITEM 1. BUSINESS
GENERAL
Pacific Gateway Properties, Inc. (the Registrant) was incorporated under the
laws of the State of New York in January 1984 and began its operations in April
1984 upon the transfer to it of certain assets formerly owned by Perini
Corporation and the distribution of shares of the Registrant's Common Stock to
the stockholders of Perini Corporation in May 1984.
The Registrant holds interests in income producing real estate. As of
December 31, 1997, the Registrant's portfolio of operating properties consists
of economic interests in the following:
(i) Walnut Creek Executive Park, Walnut Creek, California--a 419,000
square foot office park consisting of twelve low-rise (two- and three-story)
office buildings--100% owned;
(ii) South Bay Office Tower, San Jose, California--a 161,000 square
foot, twelve-story office building--100% owned;
(iii) North Tucson Business Center, Tucson, Arizona--a 91,000 square
foot, single-story office/ industrial building--100% owned;
(iv) Weston Office Building, Fort Lauderdale, Florida--a 15,000 square
foot, three-story office building--100% owned;
(v) 410 First Avenue, Needham, Massachusetts--a 38,000 square foot,
single-story office/ industrial building located in a suburb of Boston--100%
owned;
(vi) West Valley Executive Park, San Jose, California--a 164,000 square
foot, campus style office park comprised of five two-story buildings and one
single-story building--100% owned;
(vii) 930 Montgomery Street, San Francisco, California--a 23,000 square
foot, six-story, steel frame office building--100% owned; and
(viii) Rincon Center, San Francisco, California--a mixed-use (retail,
office, apartment) complex in downtown San Francisco. This two phase project
contains 63,000 square feet of retail space, 414,000 square feet of office
space and 320 apartment units. The Registrant owns general (non-managing)
and limited partnership interests totaling approximately 22.8% in the
partnership that in turn owns Rincon Center. See "Item 3--Legal Proceedings"
and Note 2 to the Registrant's Consolidated Financial Statements for
information regarding pending litigation and other risks associated with
this project.
MANAGEMENT OF PROPERTIES
The Registrant manages its 100% owned operating properties directly or
through third party management companies. During 1996, the Registrant also
provided leasing, construction and/or property management services to Rincon
Center and other third party owned properties.
PROPERTY OWNED IN PARTNERSHIP WITH OTHERS
The Registrant's portfolio includes its general (non-managing) and limited
partnership interests in Rincon Center Associates, a California limited
partnership (RCA). RCA owns Rincon Center. The Registrant is not the managing
general partner of RCA. Operating and other decisions with respect to RCA and
Rincon Center are generally controlled by the managing general partner, an
entity that is unrelated to the Registrant; therefore, the Registrant has less
flexibility with respect to such asset, than if it owned it outright.
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BUSINESS PLAN AND POLICIES
The Registrant's overall business plan has been to assemble a substantial
portfolio of income producing properties. The Registrant has 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 investment on the West Coast with 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 Registrant regularly examines each asset in its portfolio, focusing on
each property's current cash flow, anticipated cash requirements, the economics
of its local marketplace, as well as the asset's position in that market and the
potential for sale, refinancing and return on additional investment. In
conjunction with this process, the Registrant from time to time offers for sale
certain assets to reduce its involvement in certain markets, create liquidity
and advance the geographic and property type concentration and efficiency of the
Registrant's operations. In 1996, the Registrant sold its hotel property in
Arizona and its shopping center property in Florida, and completed the
refinancing of $14.3 million of mortgage debt on the Weston Office Building,
North Tucson Business Center and South Bay Office Tower. In 1997, the Registrant
acquired two office properties in California. These transactions are more fully
discussed in the pages that follow. The Registrant intends to continue to make
use of borrowed money or leveraging, as is customary with the types of
properties it intends to own. The amount of mortgage debt supported by each
project depends on, among other factors, its cash flow available to service such
debt.
COMPETITION
Within its geographic areas of operation, the Registrant is subject to
competition from a variety of investors, including insurance companies, pension
funds, corporate and individual real estate developers, real estate investment
trusts, and investors with similar investment objectives to those of the
Registrant. Some of these competitors have greater financial resources, larger
staffs and longer operating histories than the Registrant. As an owner of
commercial real estate properties, the Registrant competes with other owners of
similar properties in connection with their financing, sale, or leasing
transactions.
EMPLOYEES
As of December 31, 1997, the Registrant had 13 full-time employees and one
part-time employee, compared to 12 full-time employees and no part-time
employees as of December 31, 1996. The increase in personnel is primarily
related to the acquisition of two additional properties in January 1997.
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS, SEASONALITY AND OTHER FACTORS
The Registrant is engaged in the business of owning and managing income
producing real estate. The requirement for industry segment presentation is not
applicable. The Registrant's business is not affected by seasonal factors,
except for its former hotel property investment. All of the Registrant's
operations are located in the United States.
PROPERTY INSURANCE
The Registrant believes that all of the wholly owned properties and property
owned in partnership with others are adequately covered by insurance. The
Registrant's wholly owned San Francisco Bay Area properties do not maintain
earthquake insurance.
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TENANTS
There are no individual tenants in any of the Registrant's wholly owned
properties that contributed 15% or more to consolidated investment property
revenues for the year ended December 31, 1997. For the years ended December 31,
1996 and 1995, one tenant, AirTouch Communications, Inc. (a tenant at Walnut
Creek Executive Park), contributed 16.8% and 17.2% respectively, to consolidated
investment property revenues. Generally, lease terms range from one to five
years. Leases of approximately 73,800 square feet of rental space, or
approximately 9% of the leases in the Registrant's investment portfolio as of
December 31, 1997, will expire in 1998.
ITEM 2. PROPERTIES
As of December 31, 1997, the Registrant had an economic interest in eight
operating properties.
For information concerning encumbrances on the Registrant's properties,
reference is made to "Other Matters Relating to Properties" below and to Note 3
of the Notes to the Registrant's Consolidated Financial Statements included
elsewhere in this annual report.
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The following table sets forth certain information regarding the
Registrant's properties which were owned as of December 31, 1997:
<TABLE>
<CAPTION>
GENERAL # OF UNITS AND/OR # OF TENANTS
PROPERTY NAME DESCRIPTION LOCATION LEASABLE SQ. FT. AND OCCUPANCY %
- ---------------------------------- ---------------------------- ----------------- ------------------- -------------------
<S> <C> <C> <C> <C>
Walnut Creek Executive Park 11 two-story wood framed Walnut Creek, 419,000 sq. ft. 67 tenants;
garden office buildings, and California 91% occupancy
one three-story structural
steel frame office building
South Bay Office Tower Twelve-story office building San Jose, 161,000 sq. ft. 47 tenants;
California 89% occupancy
North Tucson Business Center Single-story office/ Tucson, Arizona 91,000 sq. ft. 2 tenants;
industrial building 100% occupancy
Weston Office Building Three-story office building Ft. Lauderdale, 15,000 sq. ft. 3 tenants;
Florida 100% occupancy
410 First Avenue Single-story office/ Needham, 38,000 sq. ft. 1 tenant;
industrial building Massachusetts 100% occupancy
West Valley Executive Park Campus style office park San Jose, 164,000 sq. ft. 71 tenants;
with five two-story and one California 61% occupancy
single-story wood frame
buildings
930 Montgomery Street Six-story, steel frame San Francisco, 23,000 sq. ft. 7 tenants;
office building California 98% occupancy
Rincon Center Major mixed-use project in San Francisco, 63,000 sq. ft. of Retail Space--
downtown San Francisco California retail space; 31 tenants;
88% occupancy
414,000 sq. ft. of Office Space--
office space; 9 tenants;
100% occupancy
320 apartments Apartments--
99% occupancy
<CAPTION>
OWNED % REGISTRANT
PROPERTY NAME BY OWNERSHIP
- ---------------------------------- ------------ -------------
<S> <C> <C>
Walnut Creek Executive Park Registrant 100%
South Bay Office Tower Registrant 100%
North Tucson Business Center Registrant 100%
Weston Office Building Registrant 100%
410 First Avenue Registrant 100%
West Valley Executive Park Registrant 100%
930 Montgomery Street Registrant 100%
Rincon Center RCA 22.8%
</TABLE>
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OTHER MATTERS RELATING TO PROPERTIES
WEST VALLEY EXECUTIVE PARK (WVEP) ACQUISITION
On January 17, 1997, the Registrant completed the purchase of WVEP which is
a multi-tenant, six building campus style office park located at 4000-4050
Moorpark Avenue, San Jose, California for $17,500,000 or $106.70 per square
foot. WVEP's six buildings contain approximately 164,000 square feet and are
situated on 7.7 acres. The Registrant purchased WVEP from Peter Paulsen. In
connection with this acquisition, the Registrant assumed approximately
$10,203,000 in debt from Sun Life Assurance Company of Canada (U.S.) which is
amortized over 20 years at a fixed annual interest rate of 9.13%, and matures on
June 30, 2005. The debt continues to be assumable and is subject to a prepayment
penalty if repaid prior to maturity.
930 MONTGOMERY STREET ACQUISITION
On January 17, 1997, the Registrant completed the purchase of 930 Montgomery
Street which is 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 or $141.30 per square foot. The Registrant purchased 930 Montgomery
Street from Donlon H. Gabrielsen and Agnes H. Gabrielsen. In connection with
this acquisition, the Registrant obtained new debt of $2,112,500 from Redwood
Bank which is amortized over 25 years at a floating annual interest rate of 3%
over the one year treasury bond rate, adjustable every six months, and maturing
on February 1, 2002. This debt may be prepaid at any time without a penalty and
is non-recourse to the Registrant.
PRINCIPAL BUSINESS CARRIED ON IN OR FROM THE PROPERTIES
Walnut Creek Executive Park tenants include banking, healthcare,
telecommunications, research and development enterprises, and professional
service companies. South Bay Office Tower tenants include healthcare,
telecommunications, research and development enterprises, and professional
service companies. North Tucson Business Center tenants include printing and
telemarketing companies. Weston Office Building tenants include banking,
financial services and real estate development companies. 410 First Avenue's
tenant is a computer hardware and software products company. West Valley
Executive Park tenants include healthcare, high-tech and software related
companies, financial services and other professional service companies. 930
Montgomery Street tenants include multi-media, software products and
professional service companies.
ITEM 3. LEGAL PROCEEDINGS
On March 20, 1997, the Registrant filed a Complaint in the San Francisco
Superior Court, Case No. 985464, against Rincon Center Associates and Perini
Land and Development Company seeking to recover approximately $812,000 in
commissions due for leasing and construction services performed for Rincon
Center. The Complaint has been answered and a Cross-Complaint has been filed.
The Cross-Complaint seeks indemnity concerning the claim for leasing commissions
on the ground that the Registrant is also a general partner of RCA, and further
seeks to rescind or otherwise avoid the effect of a letter agreement of June 22,
1993, regarding non-recourse loans from Perini Land and Development Company to
the Registrant, together with restitution of amounts loaned to the Registrant
pursuant to such letter agreement. A trial date has been set for August 3, 1998,
however the case is only in the beginning stages of discovery, and the
Registrant is not in a position at this time to opine as to the likelihood or
remoteness of liability, or the amount of damages should liability be
established.
See Note 2 to the Registrant's Consolidated Financial Statements concerning
the $3.65 million letter of credit issued by the Bank of America National Trust
and Savings Association (the Issuing Bank) as a portion of the security for the
refinancing of Rincon Center, Phase Two. On August 18, 1997, the Issuing Bank
commenced an action against the Registrant in the Land Court Department of the
Trial Court of
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Massachusetts, to obtain a conditional judgement in the full amount of the
Registrant's indebtedness to the Issuing Bank, which the Issuing Bank alleges is
in excess of $3.7 million. In the event that the Registrant fails to pay such
conditional judgement, the complaint seeks, among other remedies, to foreclose
on the 410 First Avenue property and obtain a deficiency judgement. Under
Massachusetts law, such foreclosure cannot take place until at least three years
and two months after the issuance of a conditional judgement. However, if the
Issuing Bank should obtain a conditional judgement, the Issuing Bank could take
possession of the property and receive rents paid thereon during the three-year
period preceding foreclosure. The Registrant is vigorously defending the action.
The Registrant filed a complaint against the Issuing Bank on November 21, 1997
in the Superior Court Department of the Trial Court of the Commonwealth of
Massachusetts seeking damages, equitable relief and a jury trial for causes of
action flowing from the Issuing Bank's conduct regarding the letter of credit.
The result of the action brought by the Issuing Bank against the Registrant is
uncertain, and it is not possible at this time to project a likely outcome of
the proceeding.
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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below is certain information concerning persons who are executive
officers of the Registrant.
RAYMOND V. MARINO (AGE 39). Mr. Marino has been Chief Executive Officer and
President of the Registrant since January 1996 and a Director since March 1996.
Mr. Marino had been Vice President and Chief Financial Officer of the Registrant
since August 1992. Previously, he was with Hunting Gate Investments, a private
British real estate investment and management company, as Vice President of
Finance and Controller. Mr. Marino has a Bachelor of Science degree in
Accounting from Santa Clara University and a Masters degree in Taxation from
Golden Gate University. Mr. Marino maintains an active license as a California
Certified Public Accountant, and is a member of the American Institute of CPA's,
California Society of CPA's, and National Association of Real Estate Investment
Trusts.
CHRISTOPHER M. WATSON (AGE 39). Mr. Watson had been Vice President of the
Registrant since September 1992, and became Executive Vice President as of
January 1996. His responsibilities include the management of personnel in the
marketing and leasing operations of the Registrant. Previously, he was Vice
President for Coldwell Banker Commercial Real Estate Services Inc., as a
licensed real estate agent representing both property owners and investors in
commercial real estate leasing and acquisitions. Mr. Watson has a Bachelor of
Arts degree from the University of California at Berkeley.
STEPHEN J. LOPRESTI (AGE 37). Mr. LoPresti has been Vice President, Finance
of the Registrant since November 1997. His responsibilities include financings,
acquisitions and dispositions. Previously, Mr. LoPresti worked as a consultant
for Ernst & Young Kenneth Leventhal Real Estate Group. Prior to obtaining his
masters degree, Mr. LoPresti was the principal and founder of LoPresti and
Associates. Mr. LoPresti has a Bachelor of Arts degree from Harvard University
and a Masters in Business Administration from the Anderson School at U.C.L.A.
Mr. LoPresti maintains an active real estate license in the Commonwealth of
Massachusetts.
Each executive officer holds office at the discretion of the Board of
Directors.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
COMMON STOCK
On March 20, 1998, there were approximately 1,073 holders of record of the
Registrant's Common Stock. The Registrant's Common Stock is traded on the
American Stock Exchange under the symbol "PGP".
The table below sets forth, for the indicated periods, the high and low
prices per share of the Registrant's Common Stock as reported on the American
Stock Exchange Consolidated Reporting System.
<TABLE>
<CAPTION>
HIGH LOW
-------- ---------
<S> <C> <C>
1998
First Quarter (through March 20, 1998)..................................... $ 8 $ 4 1/4
1997
First Quarter.............................................................. 4 1/2 3 1/4
Second Quarter............................................................. 6 4 1/4
Third Quarter.............................................................. 5 7/8 4 5/8
Fourth Quarter............................................................. 5 3/8 4 3/4
1996
First Quarter.............................................................. 3 7/16 2 1/2
Second Quarter............................................................. 4 3/4 2 7/8
Third Quarter.............................................................. 4 3/4 3 1/4
Fourth Quarter............................................................. 3 3/4 2 3/8
</TABLE>
During the third quarter of 1990, the Registrant's Board of Directors
determined to suspend dividend payments until operating cash flows can again
support such payments. The Registrant has not paid dividends since the third
quarter of 1990 and will continue to periodically review its ability to resume
dividends.
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ITEM 6. SELECTED FINANCIAL DATA.
The selected financial data should be read in conjunction with the
Consolidated Financial Statements of the Registrant and related notes listed in
Item 14 of this annual report and included elsewhere herein. The selected
financial data is not covered by the report of the independent public
accountants. (In thousands, except per share data)
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- --------- --------- ----------
<S> <C> <C> <C> <C> <C>
FINANCIAL POSITION
Investment properties, net................................ $ 54,225 $ 32,797 $ 33,572 $ 58,359 $ 75,786
Properties held for sale, net............................. -- -- 22,230 -- --
Equity investment and loans to RCA........................ -- -- -- 4,020 6,491
Deferred tax asset........................................ 8,203 4,183 6,831 6,845 --
Other assets.............................................. 6,283 15,413 3,254 2,210 2,313
--------- --------- --------- --------- ----------
Total assets.............................................. $ 68,711 $ 52,393 $ 65,887 $ 71,434 $ 84,590
--------- --------- --------- --------- ----------
--------- --------- --------- --------- ----------
Debt...................................................... $ 47,402 $ 33,722 $ 61,778 $ 63,099 $ 98,916
--------- --------- --------- --------- ----------
--------- --------- --------- --------- ----------
Deferred tax liability.................................... $ 17,983 $ 15,012 $ 10,514 $ 12,209 $ --
--------- --------- --------- --------- ----------
--------- --------- --------- --------- ----------
Excess of cash distributions received over equity in
earnings of Golden Gateway Center....................... $ -- $ -- $ -- $ -- $ 18,126
--------- --------- --------- --------- ----------
--------- --------- --------- --------- ----------
Stockholders' equity (deficit)............................ $ 648 $ 2,168 $ (9,186) $ (6,502) $ (35,321)
--------- --------- --------- --------- ----------
--------- --------- --------- --------- ----------
Stockholders' equity (deficit) per share.................. $ 0.17 $ 0.56 $ (2.36) $ (1.68) $ (9.11)
--------- --------- --------- --------- ----------
--------- --------- --------- --------- ----------
</TABLE>
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The selected financial data should be read in conjunction with the
Consolidated Financial Statements of the Registrant and related notes listed in
Item 14 of this annual report and included elsewhere herein. The selected
financial data is not covered by the report of the independent public
accountants. (In thousands, except share and per share data)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
INCOME RESULTS
Revenue from investment properties......................... $ 13,721 $ 11,011 $ 12,200 $ 11,027 $ 14,193
Revenue from hotel property................................ $ -- $ 6,111 $ 7,009 $ 7,357 $ 7,837
Investment in partnership, net............................. $ -- $ 2,940 $ (4,090) $ (1,298) $ (1,719)
Gain on redemption of partnership interests................ $ -- $ -- $ -- $ 39,078 $ 3,602
Provision for settlement of reimbursement obligation....... $ (2,200) $ -- $ -- $ -- $ --
Gain on sale of real estate assets, net.................... $ -- $ 16,714 $ 177 $ 664 $ 1,045
Provision for write-down to estimated net
realizable value......................................... $ -- $ -- $ (540) $ (1,000) $ (1,000)
Extraordinary items........................................ $ -- $ 766 $ (233) $ (325) $ 4,850
Net income (loss).......................................... $ (1,726) $ 11,354 $ (2,729) $ 28,817 $ 4,583
Income (loss) per share, basic:
Income (loss) before extraordinary items................. $ (0.44) $ 2.72 $ (0.64) $ 7.51 $ (0.07)
Extraordinary items...................................... -- 0.20 (0.06) (0.08) 1.25
--------- --------- --------- --------- ---------
Net income (loss)........................................ $ (0.44) $ 2.92 $ (0.70) $ 7.43 $ 1.18
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Number of common shares and share equivalents
outstanding, basic..................................... 3,893 3,893 3,893 3,880 3,879
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Income (loss) per share, diluted:
Income (loss) before extraordinary items................. $ (0.44) $ 2.58 $ (0.64) $ 7.09 $ (0.07)
Extraordinary items...................................... -- 0.19 (0.06) (0.08) 1.25
--------- --------- --------- --------- ---------
Net income (loss)........................................ $ (0.44) $ 2.77 $ (0.70) $ 7.01 $ 1.18
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Number of common shares and share equivalents
outstanding, diluted................................... 3,893 4,100 3,893 4,111 3,881
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FINANCIAL CONDITION
CAPITAL IMPROVEMENTS, TENANT IMPROVEMENTS AND OTHER DEFERRED COSTS--In
January 1997, the Registrant acquired two investment properties for a total cost
of approximately $21,000,000, including capitalized acquisitions fees. In 1997,
there were other additions to investment properties amounting to approximately
$4,161,000 for tenant improvements, capital improvements and other deferred
costs which includes leasing commissions. Additionally, the Registrant incurred
$236,000 in 1997 relating to loan costs. The Registrant anticipates additions to
investment properties will amount to approximately $3,500,000 in 1998.
FINANCING--In connection with the acquisition of investment properties in
January 1997, the Registrant assumed and borrowed mortgage notes totaling
approximately $12,315,000. A total of approximately $835,000 of debt principal
was repaid in 1997 as scheduled debt amortization. Lastly, a liability of $2.2
million was recorded as a result of recording an estimated settlement obligation
related to a drawn letter-of-credit. Accordingly, at December 31, 1997, the
Registrant has fixed rate mortgage debt of approximately $43.1 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 8.75%, and a secured
estimated settlement obligation recorded at $2.2 million (accruing interest at a
rate of prime plus 3% on the stated
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settlement obligation of $3.65 million). The estimated settlement obligation is
more fully discussed in Note 2 to the Registrant's Consolidated Financial
Statements.
NET INCOME (LOSS)
INVESTMENT PROPERTIES--During 1997, income from investment properties was
$599,000 compared to a loss of $1,181,000 for 1996. The increase in rental
revenues for 1997 compared to 1996 is due to the acquisition of two investment
properties and increased rental rates at various properties. The increase in
operating expenses for 1997 compared to 1996 is due to the acquisition of two
investment properties, offset by decreased payroll costs and a property tax
refund received in 1997. Interest expense decreased slightly from $4,092,000 in
1996 to $4,058,000 in 1997. Included in interest expense for 1997 is $227,000 of
interest recorded on the settlement obligation as described above. Depreciation
and amortization expense increased as a result of commencing depreciation on
expenditures capitalized during 1997 relating to leasing activities and capital
improvement projects, and new investment property acquisitions completed in
January 1997.
During 1996, the loss from investment properties was $1,181,000 compared to
income of $747,000 during 1995. The decrease in rental revenues for 1996
compared to 1995 is due to the sale of Village Commons Shopping Center (VCSC)and
decreased occupancy at Walnut Creek Executive Park (WCEP). The decrease in
operating expenses for 1996 compared to 1995 is primarily attributed to the sale
of VCSC and reduced costs at WCEP. The increase in interest expense for 1996
compared to 1995 is the result of the Registrant's 1996 debt refinancings. The
increase in depreciation and amortization expense for 1996 compared to 1995 is
the result of increased capital expenditures in 1996. This additional expense
was partially offset by the cessation of depreciation on the VCSC property which
was held for sale.
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The following table identifies the impact of certain investment property
dispositions, acquisitions, and properties owned in the three years ended
December 31, 1997, 1996 and 1995, respectively (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
INVESTMENT PROPERTIES OWNED IN 1997, 1996 AND 1995:
Rental revenues............................................ $ 10,747 $ 10,305 $ 9,539
Operating expenses......................................... (4,618) (5,371) (4,478)
Interest expense........................................... (3,002) (3,823) (2,235)
Depreciation expense....................................... (2,597) (2,632) (2,399)
--------- --------- ---------
530 (1,521) 427
--------- --------- ---------
INVESTMENT PROPERTIES ACQUIRED IN JANUARY 1997:
Rental revenues............................................ 2,974 -- --
Operating expenses......................................... (1,337) -- --
Interest expense........................................... (1,056) -- --
Depreciation expense....................................... (512) -- --
--------- --------- ---------
69 -- --
--------- --------- ---------
INVESTMENT PROPERTY SOLD IN APRIL 1996:
Rental revenues............................................ -- 706 2,661
Operating expenses......................................... -- (97) (1,039)
Interest expense........................................... -- (269) (1,120)
Depreciation expense....................................... -- -- (182)
--------- --------- ---------
-- 340 320
--------- --------- ---------
TOTAL INVESTMENT PROPERTIES:
Rental revenues............................................ 13,721 11,011 12,200
Operating expenses......................................... (5,955) (5,468) (5,517)
Interest expense........................................... (4,058) (4,092) (3,355)
Depreciation expense....................................... (3,109) (2,632) (2,581)
--------- --------- ---------
TOTAL INVESTMENT PROPERTIES INCOME (LOSS).................... $ 599 $ (1,181) $ 747
--------- --------- ---------
--------- --------- ---------
</TABLE>
HOTEL PROPERTY--The Registrant sold the hotel property in December 1996 and,
accordingly, a comparison of operations from 1996 to 1997 is not meaningful.
During 1996, income from the hotel property was $1,013,000 compared to
$1,158,000 during 1995. The decrease in revenues for 1996 compared to 1995 is
due to the decrease in occupancy which was offset in part by an increase in the
average daily room rate. Operating expenses were constant between 1996 and 1995.
However, operating expenses in 1996 included an asset management fee of $446,745
which was paid to the buyer of the hotel as consideration for the one year
extended close of escrow during 1996. The decrease in interest expense for 1996
compared to 1995 is the result of the Registrant's debt restructuring. The
decrease in depreciation and amortization expense is the result of the cessation
of depreciation since this property was held for sale.
INVESTMENT IN PARTNERSHIP--Subsequent to 1994, the Registrant's partnership
interests consisted of its 22.8% combined general (non-managing) and limited
partnership interests in RCA. In 1996, the Registrant ceased recording any
activity related to its interest in RCA because (i) in 1995, it had written-down
its equity investment in and loans to RCA to zero, and (ii) the Registrant
currently has no obligation, prospects or plans to invest further in or on
behalf of RCA.
During 1995, the Registrant recorded its 22.8% equity interest in RCA's net
loss which amounted to $4,090,000. Additionally, in 1995, the Registrant
recorded a $540,000 provision for net realizable value to
12
<PAGE>
write-down the remaining balance of its equity investment in and loans to RCA to
zero as the Registrant attributed no value to its equity investment in RCA.
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). The agreement does
not reduce the level of the Registrant's general and limited partnership
interests in RCA. The RCA Advances are only required to be repaid from the
Registrant's share of future distributions from RCA, if any. During 1996, the
Registrant recorded a credit to income ("Reversal of debt related to investment
in RCA" on the Registrant's Consolidated Statement of Income (Loss)) to
eliminate the previously recorded liability for the RCA Advances of $2,940,000.
During 1997, 1996 and 1995, RCA incurred net losses of approximately
$37,923,000, $16,451,000 and $17,924,000, respectively. The RCA Advances amount
to approximately $6,748,000 at December 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,
if any, (ii) the Registrant has no intent 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.
The Registrant projects a negative tax basis for its partnership investment
in RCA of approximately $22,261,000, as of December 31, 1997, since the
Registrant's share of tax losses exceeds its investment in RCA. 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.
GENERAL AND ADMINISTRATIVE EXPENSES--General and administrative expenses
decreased from $1,603,000 in 1996 to $1,250,000 in 1997. This decrease is
primarily attributable to a decrease in professional services and personnel
costs including severance to a former executive. General and administrative
expenses increased to $1,603,000 in 1996 from $1,476,000 in 1995. The increase
in general and administrative expenses for 1996 compared to 1995 is attributable
to increased professional fees offset by a reduction in payroll costs.
INTEREST EXPENSE ON PARTNERSHIP AND OTHER CORPORATE DEBT--During 1995, the
Registrant recorded interest and fees related to the RCA Advances of $340,000,
as previously discussed.
OTHER INCOME (EXPENSE)--Other income was $192,000 in 1997 compared to
$540,000 in 1996. Other income was $540,000 in 1996 compared to an expense of
$15,000 in 1995. In 1997, other income consists primarily of interest earned,
net of depreciation on corporate fixed assets. Other income for 1996 included
the gain from the sale of vacant land in Colorado and business advisory fees,
net of depreciation on corporate fixed assets. In 1995, other expense consisted
primarily of depreciation on corporate fixed assets.
PROVISION FOR SETTLEMENT OF REIMBURSEMENT OBLIGATION--The Registrant
recorded a provision of $2,200,000 for the ultimate settlement of a
letter-of-credit reimbursement obligation, as more fully discussed in Note 2 to
the Registrant's Consolidated Financial Statements.
GAIN ON SALE OF REAL ESTATE ASSETS, NET--In December 1996, the Registrant
sold the Radisson Suites Hotel in Tucson, Arizona to an unrelated party and
realized a gain for financial reporting purposes of $5,814,000. In April 1996,
the Registrant sold the Village Commons Shopping Center in West Palm Beach,
Florida, to an unrelated party and realized a gain for financial reporting
purposes of $10,900,000. In June 1995, the Registrant disposed of a parcel of
land in Walnut Creek, California, to an unrelated party and realized a gain of
$177,000.
PROVISION FOR WRITE-DOWN TO ESTIMATED NET REALIZABLE VALUE--In 1995, the
Registrant recorded a provision of approximately $540,000 for the write-down to
zero of its investment in RCA, as previously discussed.
13
<PAGE>
INCOME TAX (PROVISION) BENEFIT--In 1997, the Registrant recorded an income
tax benefit of 37% of loss before taxes. This amount was less than the 41%
effective rate recorded in 1996 and 1995, due to certain 1997 taxable items
which were not included in income for financial statement purposes.
EXTRAORDINARY GAIN (LOSS) FROM EXTINGUISHMENT OF DEBT--In December 1996, the
Registrant completed the sale of the Radisson Suites Hotel. As a result of this
sale, the Registrant was able to pay off debt to the hotel's mortgage lender
resulting in an extraordinary gain on extinguishment of debt of $766,000 which
results from the difference between the face value of the debt principal and the
amount required to extinguish the related obligation, net of the related write
off of loan fees. In June 1995, the Registrant completed the refinancing of $20
million of debt related to WCEP. As a result of this refinancing, the Registrant
had written off the unamortized loan fees of $233,000.
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 has 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'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 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 December 31, 1997, the Registrant had
approximately $2.1 million of unrestricted cash, $1.7 million of restricted
cash, investment properties with a net book value of approximately $54.2 million
(including the 410 First Avenue property recorded at its estimated net
realizable value of $2.2 million), total non-recourse mortgage debt and secured
estimated settlement obligation of approximately $47.4 million and stockholders'
equity of approximately $.6 million. Given the Registrant's desire to increase
its liquidity, the Registrant has actively pursued the sale of
14
<PAGE>
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.
As of December 31, 1997, the Registrant's mortgage debt had scheduled annual
principal maturities as follows (in thousands):
<TABLE>
<CAPTION>
CURRENT
---------
<S> <C>
1998............................................................................... $ 3,152
1999............................................................................... 1,025
2000............................................................................... 1,115
2001............................................................................... 1,997
2002............................................................................... 1,265
Thereafter......................................................................... 38,848
---------
$ 47,402
---------
---------
</TABLE>
The 1998 scheduled principal maturities of $3,152,000 includes the
$2,200,000 liability related to the reimbursement obligation as described below.
As discussed in the Registrant's Consolidated Financial Statements, 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 over the twelve
months ending December 31, 1998, amounts to approximately $597,000.
The Registrant's 410 First Avenue 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 Consolidated Financial Statements, the Issuing
Bank made a demand on the Registrant to reimburse them for the $3.65 million
drawn on the letter-of-credit and also notified the Registrant that it is in
default with respect to the reimbursement obligation. The reimbursement
obligation of the Registrant to the Issuing Bank is full recourse to the
Registrant and is secured by the 410 First Avenue property. On August 21, 1997,
the Issuing Bank commenced an action for conditional judgement seeking, among
other remedies, to foreclose on the 410 First Avenue property. Under
Massachusetts law, such foreclosure could not take place until at least three
years and two months after the issuance of the conditional judgement. However,
if the Registrant does not pay the amount of the conditional judgement within
two months after its issuance, the Issuing Bank could take possession of the
property during the three year period preceding foreclosure. If the Issuing Bank
completes a foreclosure on the 410 First Avenue property, the Registrant will
eliminate $3.65 million in secured debt (currently recorded at $2.2 million) on
a property that is producing approximately $240,000 in annual cash flow. In such
action, the Issuing Bank is seeking 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 including
outstanding interest and fees. The Registrant intends to vigorously defend any
such deficiency claim. In accordance with generally accepted accounting
principles, effective June 30, 1997, the Registrant recorded a "provision for
settlement of reimbursement obligation" in the amount of $2.2 million. The
accrued amount is equal to the net book value at June 30, 1997, of the 410 First
Avenue 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. The Registrant has recorded rental revenue and
operating expenses related to this property, as well as accrued interest on the
$3.65 million settlement obligation at the prime rate plus three percent. Any
difference between the provision for settlement of reimbursement obligation and
the amount ultimately settled upon may be charged or credited to the
Registrant's operations as such difference becomes
15
<PAGE>
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, 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 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 the prime rate plus 2% and certain
fees (principal, unpaid interest and fees are collectively referred to as the
RCA Advances). As indicated previously, RCA's managing general partner is
seeking to void the letter agreement under which these loans were made and is
also seeking restitution of the loans advanced. The RCA Advances amount to
$6,748,000 at December 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. The managing
general partner of RCA is currently in negotiations to refinance the debt on
Rincon Center Phases One and Two as more fully described in Note 2 to the
Registrant's Consolidated Financial Statements. The proposed refinancing is
subject to a number of conditions and approvals among the parties involved in
the refinancing. The managing general partner of RCA and the Registrant can make
no assurances that the refinancing will be completed.
Except as described above, at December 31, 1997, 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.
The Registrant continued to experience more stabilized operating results in
its wholly owned properties during 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 and the
Registrant is continuing to aggressively pursue new leases on currently
available space and renew existing leases as they expire.
YEAR 2000 COMPLIANCE
To the extent that the Registrant's software applications contain source
code that is unable to appropriately interpret the upcoming calendar year "2000"
and beyond, some level of modification or replacement of such applications will
be necessary. The Registrant has received notification from its primary software
vendor indicating that the software application used by the Registrant will be
Year 2000 compliant by the end of 1998, at a minimal cost to the Registrant.
FORWARD-LOOKING STATEMENTS; FACTORS THAT MAY AFFECT OPERATING RESULTS
Certain information included in this Form 10-K 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
16
<PAGE>
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-K, investors are cautioned not to place undue reliance on any forward-looking
statements.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data required by this Item 8 are
included in Part IV as indexed under Items 14(a)1 and 2.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
The information called for by Part III is hereby incorporated by reference
from the information set forth under the captions "Election of Directors",
"Ownership of Common Stock" and "Executive Compensation" in Pacific Gateway
Properties, Inc.'s (the Company) definitive Proxy Statement for its 1998 Annual
Meeting of Shareholders, which meeting involves the election of directors, such
definitive Proxy Statement to be filed with the Securities and Exchange
Commission pursuant to Regulation 14A within 120 days after the end of the
fiscal year covered by this Annual Report on Form 10-K. In addition, information
on Registrant's executive officers has been included in Part I above under the
caption "Executive Officers of the Registrant".
17
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)1. The following financial statements and supplementary financial
information are filed as part of this report:
<TABLE>
<CAPTION>
FINANCIAL STATEMENTS OF THE REGISTRANT PAGES
- -------------------------------------------------------------------------------------------------------- ---------
<S> <C>
Consolidated Balance Sheet as of December 31, 1997 and 1996............................................. 21
Consolidated Statement of Income (Loss) for the three years ended December 31, 1997, 1996 and 1995...... 22
Consolidated Statement of Stockholders' Equity (Deficit) for the three years ended December, 1997, 1996
and 1995.............................................................................................. 23
Consolidated Statement of Cash Flows for the three years ended December 31, 1997, 1996 and 1995......... 24
Notes to Consolidated Financial Statements.............................................................. 25 - 40
Report of Independent Public Accountants................................................................ 41
(a)2. The following financial statement schedule is filed as part of this report:
Schedule III-- Real Estate and Accumulated Depreciation as of December 31, 1997......................... 42 - 43
</TABLE>
All other schedules are omitted because of the absence of the conditions
under which they are required or because the required information is included in
the Consolidated Financial Statements or in the Notes thereto.
<TABLE>
<S> <C>
(a)3. Exhibits
This section to be completed by amendment.
21. Subsidiaries of the Registrant............................................... 44
(b) The Registrant filed a Form 8-K dated January 30, 1997, reporting under Items
2 and 7.
The Registrant filed a Form 8-K/A dated March 24, 1997, reporting under Items
2 and 7.
The Registrant filed a Form 10-Q/A dated November 13, 1997, reporting under
Part I, Items 1 and 2, and Part II, Items 3, 4 and 6.
The Registrant filed a Form 10-K/A dated November 25, 1997, reporting under
Items 2, 7 and 8.
The Registrant filed a Form S-8 dated August 28, 1997.
The Registrant filed a Post-effective Amendment No. 1 to Form S-8 dated
November 26, 1997.
</TABLE>
18
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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)
By: /s/ RAYMOND V. MARINO
-----------------------------------------
Raymond V. Marino
PRESIDENT AND CHIEF EXECUTIVE OFFICER
Dated: March 16, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- ------------------------------ --------------------------- -------------------
Director, President and
RAYMOND V. MARINO Chief Executive Officer
- ------------------------------ and Chief Financial March 16, 1998
Raymond V. Marino Officer
MELANIE L. ADKINS
- ------------------------------ Controller (Principal March 16, 1998
Melanie L. Adkins Accounting Officer)
STEVEN A. CALABRESE
- ------------------------------ Director March 16, 1998
Steven A. Calabrese
MARK D. GROSSI
- ------------------------------ Director March 16, 1998
Mark D. Grossi
LAWRENCE B. HELZEL
- ------------------------------ Director March 16, 1998
Lawrence B. Helzel
MARSHALL A. JACOBS
- ------------------------------ Director March 16, 1998
Marshall A. Jacobs
CHRISTOPHER L. JARRATT
- ------------------------------ Director March 16, 1998
Christopher L. Jarratt
RICHARD M. OSBORNE
- ------------------------------ Director March 16, 1998
Richard M. Osborne
MARTIN S. ROHER
- ------------------------------ Director March 16, 1998
Martin S. Roher
19
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1997 AND 1996
AND FOR THE YEARS ENDED
DECEMBER 31, 1997, 1996 AND 1995
20
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
----------------------
1997 1996
---------- ----------
<S> <C> <C>
ASSETS
Cash and cash equivalents................................................................. $ 2,065 $ 2,899
Restricted cash........................................................................... 1,746 9,975
Accounts receivable....................................................................... 112 359
Prepaid taxes............................................................................. 54 280
Other current assets...................................................................... 86 540
Investment properties:
Land.................................................................................... 9,631 5,481
Buildings............................................................................... 49,665 31,847
Building and other improvements......................................................... 11,360 9,304
---------- ----------
Subtotal investment properties........................................................ 70,656 46,632
Less-accumulated depreciation and reserve for write-down to net realizable value........ (16,431) (13,835)
---------- ----------
Investment properties, net............................................................ 54,225 32,797
---------- ----------
Deferred tax asset........................................................................ 8,203 4,183
Capitalized loan costs, net of accumulated amortization of $134 and $46 at December 31,
1997 and 1996, respectively............................................................. 818 670
Capitalized lease commissions, rent concessions and other deferred costs, net of
accumulated amortization of $1,476 and $1,351 at December 31, 1997 and 1996,
respectively............................................................................ 1,402 690
---------- ----------
Total assets...................................................................... $ 68,711 $ 52,393
---------- ----------
---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable.......................................................................... $ 1,109 $ 612
Accrued payroll, property and sales taxes................................................. 195 195
Accrued interest on debt.................................................................. 385 --
Unearned rental revenue................................................................... 286 418
Tenant security deposits.................................................................. 703 266
Debt related to investment properties..................................................... 47,402 33,722
Deferred tax liability.................................................................... 17,983 15,012
---------- ----------
Total liabilities................................................................... 68,063 50,225
---------- ----------
Stockholders' equity:
Common stock $1.00 par value--
Authorized--10,000,000 shares; Issued--4,018,150 shares at December 31, 1997 and
4,011,150 shares at December 31, 1996................................................. 4,018 4,011
Paid-in-deficit........................................................................... (10,023) (10,222)
Retained earnings......................................................................... 6,800 8,526
Treasury stock, at cost--118,554 common shares at December 31, 1997 and December 31,
1996.................................................................................... (2,037) (2,037)
Warrants for common stock................................................................. 1,890 1,890
---------- ----------
Total stockholders' equity.......................................................... 648 2,168
---------- ----------
Total liabilities and stockholders' equity........................................ $ 68,711 $ 52,393
---------- ----------
---------- ----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
21
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
CONSOLIDATED STATEMENT OF INCOME (LOSS)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
INVESTMENT PROPERTIES:
Rental revenues............................................................... $ 13,721 $ 11,011 $ 12,200
Operating expenses............................................................ (5,955) (5,468) (5,517)
Interest expense.............................................................. (4,058) (4,092) (3,355)
Depreciation and amortization................................................. (3,109) (2,632) (2,581)
--------- --------- ---------
Investment properties income (loss)......................................... 599 (1,181) 747
--------- --------- ---------
HOTEL PROPERTY:
Revenues...................................................................... -- 6,111 7,009
Operating expenses............................................................ (93) (4,695) (4,697)
Interest expense.............................................................. -- (403) (491)
Depreciation and amortization................................................. -- -- (663)
--------- --------- ---------
Hotel property income (loss)................................................ (93) 1,013 1,158
--------- --------- ---------
INVESTMENT IN PARTNERSHIP:
Equity in partnership losses, net............................................. -- -- (4,090)
Reversal of debt related to investment in RCA................................. -- 2,940 --
--------- --------- ---------
Investment in partnership................................................... -- 2,940 (4,090)
--------- --------- ---------
General and administrative expenses............................................... (1,250) (1,603) (1,476)
Interest expense on partnership and other corporate debt.......................... -- -- (340)
Other income (expense)............................................................ 192 540 (15)
--------- --------- ---------
Income (loss) before settlement obligation, property transactions,
write-downs, income taxes and extraordinary items........................... (552) 1,709 (4,016)
Provision for settlement of reimbursement obligation.............................. (2,200) -- --
Gain on sale of real estate assets, net........................................... -- 16,714 177
Provision for write-down to estimated net realizable value........................ -- -- (540)
--------- --------- ---------
Income (loss) before income taxes and extraordinary items......................... (2,752) 18,423 (4,379)
Income tax (provision) benefit.................................................... 1,026 (7,835) 1,883
--------- --------- ---------
Income (loss) before extraordinary items.......................................... (1,726) 10,588 (2,496)
Extraordinary gain (loss) from extinguishment of debt............................. -- 766 (233)
--------- --------- ---------
Net income (loss)............................................................. $ (1,726) $ 11,354 $ (2,729)
--------- --------- ---------
--------- --------- ---------
Income (loss) per share, basic:
Income (loss) before extraordinary items........................................ $ (0.44) $ 2.72 $ (0.64)
Extraordinary items............................................................. -- 0.20 (0.06)
--------- --------- ---------
Net income (loss)............................................................. $ (0.44) $ 2.92 $ (0.70)
--------- --------- ---------
--------- --------- ---------
Income (loss) per share, diluted:
Income (loss) before extraordinary items........................................ $ (0.44) $ 2.58 $ (0.64)
Extraordinary items............................................................. -- 0.19 (0.06)
--------- --------- ---------
Net income (loss)............................................................. $ (0.44) $ 2.77 $ (0.70)
--------- --------- ---------
--------- --------- ---------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
22
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
WARRANTS
RETAINED FOR
COMMON PAID-IN- EARNINGS TREASURY COMMON
STOCK DEFICIT (DEFICIT) STOCK STOCK TOTAL
----------- ---------- ----------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994............................. $ 4,011 $ (10,222) $ (99) $ (2,082) $ 1,890 $ (6,502)
Net loss............................................... -- -- (2,729) -- -- (2,729)
Issuance of treasury stock............................. -- -- -- 45 -- 45
----------- ---------- ----------- --------- ----------- ---------
Balance at December 31, 1995............................. 4,011 (10,222) (2,828) (2,037) 1,890 (9,186)
Net income............................................. -- -- 11,354 -- -- 11,354
----------- ---------- ----------- --------- ----------- ---------
Balance at December 31, 1996............................. $ 4,011 $ (10,222) $ 8,526 $ (2,037) $ 1,890 $ 2,168
Net loss............................................... -- -- (1,726) -- -- (1,726)
Issuance of common stock from exercise of stock
options.............................................. 7 15 -- -- -- 22
Return of profit from shareholder short-swing sale..... -- 184 -- -- -- 184
----------- ---------- ----------- --------- ----------- ---------
Balance at December 31, 1997............................. $ 4,018 $ (10,023) $ 6,800 $ (2,037) $ 1,890 $ 648
----------- ---------- ----------- --------- ----------- ---------
----------- ---------- ----------- --------- ----------- ---------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
23
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Cash flow from operating activities:
Net income (loss)........................................................... $ (1,726) $ 11,354 $ (2,729)
Non-cash revenues and expenses included in income:
Depreciation and amortization............................................. 3,109 2,632 3,275
Equity in partnership losses.............................................. -- -- 4,090
Provision for settlement of reimbursment obligation....................... 2,200 -- --
Provision for write-down to estimated net realizable value................ -- -- 540
Gain on sale of real estate assets, net................................... -- (16,714) (177)
Reversal of debt related to investment in RCA............................. -- (2,940) --
Extraordinary items....................................................... -- (766) 233
Deferred taxes, net....................................................... (1,049) 7,146 (1,681)
Changes in assets and liabilities:
Accounts receivable, prepaid taxes and other assets......................... 927 89 (14)
Accounts payable and other current liabilities.............................. 1,187 (1,290) 154
---------- ---------- ----------
NET CASH GENERATED BY (USED IN) OPERATING ACTIVITIES.......................... 4,648 (489) 3,691
---------- ---------- ----------
Cash flow from investing activities:
Additions to building and other improvements, capitalized lease commissions,
rent concessions and other deferred costs................................. (4,161) (1,876) (2,768)
Acquisition of investment properties........................................ (10,797) -- --
Proceeds from sale of properties............................................ -- 39,432 510
Contributions to RCA........................................................ -- -- (1,035)
Distributions from RCA...................................................... -- -- 424
---------- ---------- ----------
NET CASH GENERATED BY (USED IN) INVESTING ACTIVITIES.......................... (14,958) 37,556 (2,869)
---------- ---------- ----------
Cash flow from financing activities:
Borrowings under debt related to investment properties...................... 2,112 14,300 20,986
Borrowings in connection with investment in RCA, net........................ -- -- 990
Payments on debt............................................................ (835) (38,460) (23,297)
Payment of loan costs and fees.............................................. (236) (450) (85)
Proceeds from shareholder short-swing sale reimbursement.................... 184 -- --
(Increase) decrease in restricted cash...................................... 8,229 (9,734) 356
Purchase of treasury stock.................................................. -- -- 45
Proceeds from exercise of stock options..................................... 22 -- --
---------- ---------- ----------
NET CASH GENERATED BY (USED IN) FINANCING ACTIVITIES.......................... 9,476 (34,344) (1,005)
---------- ---------- ----------
Increase (decrease) in cash and cash equivalents.............................. (834) 2,723 (183)
Balance at beginning of year.................................................. 2,899 176 359
---------- ---------- ----------
Balance at end of year........................................................ $ 2,065 $ 2,899 $ 176
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
24
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
SUPPLEMENTARY DISCLOSURES:
Cash paid for interest...................................................... $ 3,673 $ 4,495 $ 4,486
---------- ---------- ----------
---------- ---------- ----------
Cash paid for taxes......................................................... $ -- $ 510 $ 483
---------- ---------- ----------
---------- ---------- ----------
Non-cash transactions:
Portion of acquisition of investment properties funded by assumption of debt
related to investment properties.......................................... $ 10,203 $ -- $ --
---------- ---------- ----------
---------- ---------- ----------
Increase in debt related to investment properties in connection with
reimbursement obligation.................................................. $ 2,200 $ -- $ --
---------- ---------- ----------
---------- ---------- ----------
Reduction of debt related to investment properties due to Statement of
Accounting Standards No. 15............................................... $ -- $ 956 $ --
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
25
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
Pacific Gateway Properties, Inc., (the Company) is a New York corporation
formed in 1984 for the purpose of investing and managing income producing real
estate. The Company's overall business plan has been to assemble a substantial
portfolio of income producing properties. The Company historically focused its
property acquisitions in four markets: Northern California, Arizona, Florida and
Massachusetts. The Company'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 Company 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 Company's current
property portfolio is concentrated on the West Coast; and (2) the Company
believes that geographic concentration will create operational efficiencies.
PRINCIPLES OF CONSOLIDATION
The Company's Consolidated Financial Statements include the accounts of the
Company and all wholly owned subsidiaries. Significant intercompany accounts and
transactions have been eliminated in consolidation. The investment in RCA in
which the Company has a 22.8% interest and has no management control, is
accounted for using the equity method.
REVENUE RECOGNITION
Rental revenues are recognized on a straight-line basis over the term of
occupancy in accordance with the provisions of the leases.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash, commercial paper and money market
accounts, all of which have original maturities of three months or less.
RESTRICTED CASH
As of December 31, 1997, restricted cash is comprised of the following (in
thousands):
<TABLE>
<S> <C>
Capital, tenant improvement and lease commission reserves........... $ 1,316
Security deposits from certain tenants.............................. 196
Debt service, property tax and insurance reserves................... 234
---------
Total............................................................... $ 1,746
---------
---------
</TABLE>
INVESTMENT PROPERTIES AND OTHER DEFERRED COSTS
Land, buildings and improvements are recorded at cost. Depreciation on
investment properties is provided using the straight-line method over estimated
useful lives ranging from 28 to 40 years. Capitalized loan costs consist of loan
fees, legal, accounting, engineering, appraisal, and other costs associated with
financings and are amortized using the straight-line method over the primary
term of related debt
26
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
instrument. Costs associated with a lease are amortized over the term of the
lease. The remaining deferred costs are amortized using the straight-line method
over the estimated useful life of the asset to which they relate. Repairs and
maintenance are charged to expense as incurred.
The Company periodically reviews its long-lived assets for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. An impairment loss would be recognized when
expected undiscounted cash flows are less than the carrying value of the asset.
Measurement of impairment is based upon the fair value of the asset.
INCOME TAXES
The Company accounts for taxes under Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" (SFAS 109). Under SFAS 109,
deferred taxes are computed based on the difference between the financial
statement and income tax basis of assets and liabilities using the enacted
marginal tax rate.
GAIN ON SALE OF REAL ESTATE ASSETS, NET
Gain on sale of real estate assets consists of the following (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Radisson Suites Hotel............................. $ -- $ 5,814 $ --
Village Commons Shopping Center................... -- 10,900 --
Walnut Creek parcel of land....................... -- -- 177
------- ------- -------
Total............................................. $ -- $16,714 $ 177
------- ------- -------
------- ------- -------
</TABLE>
EARNINGS PER SHARE
In March 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128 (SFAS No. 128), "Earnings Per Share".
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. Outstanding warrants and stock options enter
into the weighted average shares outstanding when computing diluted earnings per
share using the Treasury Stock Method. The effective date of SFAS No. 128 is
December 15, 1997. Earnings per share for all periods presented have been
restated to conform to the new standard. The number of weighted average common
shares and potential common shares used in the earnings per share calculations
are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Basic.................................................. 3,893,133 3,892,596 3,892,596
Stock options and warrants............................. -- 207,504 --
---------- ---------- ----------
Diluted................................................ 3,893,133 4,100,100 3,892,596
</TABLE>
27
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In 1997 and 1995, due to the Company's loss position, the inclusion of stock
options and warrants would have been anti-dilutive, and accordingly the number
of outstanding shares used in calculating basic and diluted earnings per share
for these years are the same.
RISKS AND UNCERTAINTIES AND USE OF ESTIMATES
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.
The Company's ability to (i) meet its debt obligations, (ii) provide
dividends either from operations, or the ultimate disposition of the Company's
properties or (iii) continue as a going concern may be impacted by changes in
interest rates, property values, geographic economic conditions, or the entry of
other competitors to the market. The Company's wholly owned San Francisco Bay
Area properties do not maintain earthquake insurance. The accompanying
Consolidated Financial Statements do not provide for any adjustments with regard
to these uncertainties.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform with the
current year presentation.
2. REAL ESTATE PARTNERSHIP INVESTMENTS
RINCON CENTER ASSOCIATES PARTNERSHIP (RCA)--SAN FRANCISCO, CALIFORNIA
The Company 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 Company'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 Company's
negative tax basis, the joint and several guarantees provided by the Company 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 provision for settlement of reimbursement obligation and deferred income
tax liabilities related to the tax that would result from any gain recognized
from the Company'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
28
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
2. REAL ESTATE PARTNERSHIP INVESTMENTS (CONTINUED)
January 1998 if long-term financing meeting certain conditions is not obtained.
As of January 1, 1998, no new commitment had been secured although negotiations
with the current lender were in progress. In order to allow those discussions to
continue, Chrysler agreed to temporarily delay the enforcement of the purchase
requirements. RCA can make no assurances about the outcome of this negotiation.
As a result of the current loan negotiations, RCA has written-down the carrying
value of the assets related to this segment of the property by $17,150,000 in
1997 to the estimated net realizable value. 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 One,
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 Citibank. The residential portion of Rincon Center Phase Two is being
financed with redevelopment bonds from the Redevelopment Agency of the City and
County of San Francisco, California, which are due December 1, 2006. The bonds
are secured by an irrevocable letter-of-credit issued by Citibank in the name of
RCA. In the event that drawings are made on the letter-of-credit, RCA has agreed
to reimburse Citibank for such drawings pursuant to the terms of the
Reimbursement Agreement which is secured by a deed of trust on Rincon Center
Phase Two and other guarantees. During 1997, the irrevocable letter-of-credit
was due to expire. RCA is currently in negotiations with Citibank to extend the
letter-of-credit and no assurances can be made about the outcome of this
negotiation. Currently, the letter-of-credit has been extended to June 1, 1998.
The commercial portion of Rincon Center Phase Two was financed pursuant to a
Construction Loan Agreement between RCA and Citibank. The Construction Loan
Agreement is secured by a deed of trust on the commercial portion of Rincon
Center Phase Two. In 1993, RCA extended the loan to October 1, 1998. RCA is
currently in negotiations with Citibank to extend the loan and no assurances can
be made about the outcome of this negotiation. A portion of the security for the
Construction Loan Agreement was a $3.65 million letter-of-credit issued by Bank
of America National Trust and Savings Association (the Issuing Bank) on behalf
of the Company in favor of Citibank.
The reimbursement obligation of the Company to the Issuing Bank is full
recourse to the Company and is secured by the Company's 410 First Avenue
property located in Needham, Massachusetts. The letter-of-credit for $3.65
million was drawn by Citibank prior to its expiration date of June 23, 1997.
Citibank 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 Issuing Bank made a demand on the Company to reimburse them for the $3.65
million drawn on the letter-of-credit and also notified the Company it is in
default with respect to the reimbursement obligation. On August 21, 1997, the
Issuing Bank commenced an action for conditional judgement seeking, among other
remedies, to foreclose on the 410 First Avenue property. Under Massachusetts
law, such foreclosure could not take place until at least three years and two
months after the issuance of the conditional judgement. However, if the Company
does not pay the amount of the conditional judgement within two months after its
issuance, the Issuing Bank could take possession of the property during the
three year period preceding foreclosure. In such action, the Issuing Bank is
seeking to assert a deficiency claim against the Company for any alleged
difference between the
29
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
2. REAL ESTATE PARTNERSHIP INVESTMENTS (CONTINUED)
value of the foreclosed property and the $3.65 million drawn on the
letter-of-credit including outstanding interest and fees. The Company intends to
vigorously defend such deficiency claim. Since any assets of the Company which
are applied to the reimbursement obligation would constitute additional
investment in RCA, which the Company considers of no value, the net book value
of such assets would be written off and charged to the earnings of the Company
when said assets were applied to the reimbursement obligation. In accordance
with generally accepted accounting principles, effective June 30, 1997, the
Company recorded a "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 at
June 30, 1997, of the 410 First Avenue 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. The Company has continued to
record rental revenue and operating expenses related to this property, as well
as accrued interest on the $3.65 million reimbursement obligation at a rate of
prime plus three percent. Any difference between the provision for settlement of
reimbursement obligation and the amount ultimately settled upon may be charged
or credited to the Company's operations as such difference becomes determinable.
Management can provide no assurances as the ultimate settlement amount or method
(and the timing thereof) relating to the reimbursement obligation.
In 1996, the Company ceased recording any activity related to its interest
in RCA because (i) it had previously written-down its equity investment in and
loans to RCA to zero in 1995 and (ii) the Company currently has no obligation,
prospects or plans to invest further in or on behalf of RCA. During 1995, the
Company recorded its 22.8% equity interest in RCA's net loss which amounted to
$4,090,000. Additionally, in 1995, the Company recorded a $540,000 provision for
net realizable value to write-down the remaining balance of its equity
investment in and loans to RCA to zero as the Company attributed no value to its
equity investment in RCA.
In 1993, the Company 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 Company 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 Company's general and limited partnership interests in RCA. The
RCA Advances are only required to be repaid from the Company's share of future
distributions from RCA, if any. At December 31, 1995, the RCA Advances amounted
to $2,940,000. During 1996, the Company recorded a credit to income ("Reversal
of Debt Related to Investment in RCA" on the Company's Consolidated Statement of
Income (Loss)) to eliminate the previously recorded liability for the RCA
Advances of $2,940,000. During 1997, 1996 and 1995, RCA incurred net losses of
approximately $37,923,000, $16,451,000 and $17,924,000, respectively. The RCA
Advances amount to $6,748,000 at December 31, 1997 and as noted above, are not
recorded on the Company's consolidated financial statements since (i) the RCA
Advances are only required to be repaid from the Company's share of future
distributions from RCA, if any, (ii) the Company 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 Company does not anticipate any material cash
distributions by RCA in the foreseeable future.
During 1995, the Company recorded interest and fees related to the RCA
Advances of $340,000. As previously discussed, the Company ceased recording any
activity relating to RCA in 1996.
30
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
2. REAL ESTATE PARTNERSHIP INVESTMENTS (CONTINUED)
During 1997, the Company asserted certain claims against RCA for payment to
the Company by RCA for leasing services provided to RCA by the Company during
1996. The Company has not accrued for such claims pending resolution of this
matter with RCA's managing general partner.
Summary financial statement data for RCA is as follows (in thousands):
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1997 1996
- -------------------------------------------------------------------- ----------- ----------
<S> <C> <C>
Investment properties, net.......................................... $ 107,045 $ 110,495
Other assets........................................................ 6,857 21,042
----------- ----------
----------- ----------
$ 113,902 $ 131,537
----------- ----------
Debt................................................................ $ 49,228 $ 56,012
Amounts due to partners............................................. 185,208 158,156
Other liabilities................................................... 12,723 12,703
Partners' deficit................................................... (133,257) (95,334)
----------- ----------
$ 113,902 $ 131,537
----------- ----------
----------- ----------
</TABLE>
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1997 1996 1995
- ---------------------------------------------------------- ---------- ---------- ----------
<S> <C> <C> <C>
Revenue................................................... $ 16,772 $ 20,705 $ 20,165
---------- ---------- ----------
Expenses:
Operating and lease expenses............................ 19,429 18,519 19,572
Provision for write-down of note receivable............. 17,150 -- --
Financing............................................... 15,017 14,712 14,402
Depreciation and amortization........................... 3,099 3,925 4,115
---------- ---------- ----------
54,695 37,156 38,089
---------- ---------- ----------
Net loss.................................................. $ (37,923) $ (16,451) $ (17,924)
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
31
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
3. DEBT
As of December 31, 1997 and 1996, the Company had the following debt related
to investment properties outstanding (in thousands):
<TABLE>
<CAPTION>
1997 1996
--------- ---------
<S> <C> <C>
South Bay Office Tower, interest fixed at 8.66%, due January 2007....... $ 9,348 $ 9,450
Walnut Creek Executive Park, interest fixed at 7.85%, due June 2005..... 19,002 19,438
Weston Office Building, interest fixed at 8.45%, due October 2001....... 959 993
North Tucson Business Center, interest fixed at 9.62%, due October
2006.................................................................. 3,801 3,841
West Valley Executive Park, interest fixed at 9.13%, due June 2005...... 10,000 --
930 Montgomery Street, interest at 8.75% as of December 31, 1997
(floating rate of 3% over the one year treasury bond rate adjustable
every six months), due February 2002.................................. 2,092 --
410 First Avenue (See Note 2)........................................... 2,200 --
--------- ---------
$ 47,402 $ 33,722
--------- ---------
--------- ---------
</TABLE>
MORTGAGES ON REAL ESTATE
SOUTH BAY OFFICE TOWER
In December 1996, the Company completed the refinancing of $9.45 million of
debt related to South Bay Office Tower. The loan bears interest at 8.66% through
maturity and requires fixed monthly payments of $77,000. The loan is amortized
over 25 years and is due January 2007. This loan may be prepaid any time after
the first day of the fifth (5th) loan year with a 30-day written notice to the
lender. A prepayment consideration of the greater of one percent of the loan
balance, or the present value of all remaining payments of principal and
interest is payable on the prepayment date. The loan is non-recourse to the
Company. Concurrent with the closing, the Company deposited $701,000 with the
lender to fund future capital improvements. As of December 31, 1997, $458,000
has been reimbursed to the Company by the lender. In addition, the lender held
in escrow additional debt proceeds of $940,000 to be released to the Company
upon the completion of certain leasing transactions that were in process as of
December 31, 1996. These transactions were completed in 1997 and the funds were
returned to the Company. Also, the loan requires an additional $22,100 per month
to be deposited for future tenant improvements and leasing commissions until the
reserve equals $668,000. The Company is then required to maintain this minimum
balance of $668,000 during the term of the loan. The portion of reserves funded
and unspent through December 31, 1997, including interest, amounted to
approximately $537,000 and is classified as restrictd cash on the Company's
Consolidated Balance Sheet.
32
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
3. DEBT (CONTINUED)
WALNUT CREEK EXECUTIVE PARK
In June 1995, the Company completed the refinancing of $20,000,000 of debt
related to Walnut Creek Executive Park. The new loan carries a 7.85% annual
interest rate until maturity with fixed monthly payments of approximately
$162,000. The loan is amortized over 20 years and is due June 2005. The new loan
has a prepayment penalty and is non-recourse to the Company. In addition, the
new loan requires the Company to fund a reserve for future tenant improvements
of $9,300 per month in the first twenty-four (24) months of the loan, and
increasing to $17,600 per month in months twenty-five (25) through sixty-eight
(68) of the loan. The balance of the reserve as of December 31, 1997, including
interest, amounted to approximately $316,000 and is classified as restricted
cash on the Company's Consolidated Balance Sheet. As a result of this
refinancing, the Company wrote-off the unamortized portion of the loan fees
associated with the debt that was retired, which amounted to $233,000 and is
recorded as an extraordinary item in 1995.
WESTON OFFICE BUILDING
In October 1996, the Company completed the refinancing of $1,000,000 of debt
related to Weston Office Building in Florida. The loan carries an 8.45% annual
interest rate until maturity with fixed monthly payments of approximately
$9,800. The loan is amortized over 15 years and is due October 2001. The loan
has no prepayment penalty. This loan is an obligation of a subsidiary of the
Company and the Company has provided a guarantee of the lessor of $500,000 or
50% of the outstanding loan balance.
NORTH TUCSON BUSINESS CENTER
In September 1996, the Company completed the refinancing of $3,850,000 of
debt related to North Tucson Business Center in Arizona. The loan carries a
9.62% annual interest rate until maturity with fixed monthly payments of
approximately $34,000. The loan is amortized over 25 years and is due October
2006. The loan is non-recourse to the Company. Concurrent with the closing, the
Company deposited $40,800 with the lender to fund future tenant improvements and
leasing commissions during the term of the loan. The loan also requires an
additional $3,400 per month to be deposited for future tenant improvements and
leasing commissions and $1,100 per month to be deposited in a replacement
reserve during the term of the loan. In addition, the Company is required to
fund a debt service reserve of $8,200 per month until $295,000 has been funded.
The debt service, tenant improvement and leasing commission reserves may be
reduced if certain tenant renewals occur. The portion of the reserves funded and
unspect through December 31, 1997, including interest, amounted to approximately
$236,000 and is classified as restricted cash on the Company's Consolidated
Balance Sheet.
WEST VALLEY EXECUTIVE PARK
In connection with the January 17, 1997 acquisition of this property, the
Company assumed approximately $10,203,000 in non-recourse mortgage debt. The
loan carries a 9.13% annual interest rate until maturity. The loan is amortized
over 20 years and is due June 2005. The debt continues to be assumable and is
subject to a prepayment penalty if paid off prior to maturity.
33
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
3. DEBT (CONTINUED)
930 MONTGOMERY STREET
In connection with the January 17, 1997 acquisition of this property, the
Company obtained $2,112,500 in mortgage debt. The loan is amortized over
twenty-five (25) years at a floating annual interest rate of 3% over the one
year treasury bond rate, adjustable every six months, and is due February 2002.
This debt can be prepaid at any time without a penalty and is non-recourse to
the Company.
410 FIRST AVENUE
See Note 2 to the Consolidated Financial Statements for discussion of the
$2.2 million estimated settlement obligation.
CORPORATE DEBT
In December 1993, the Company completed a restructuring of its non-revolving
line-of-credit, letter-of-credit, unsecured bonds, and certain mortgages. This
debt was paid in full in 1996 using the proceeds from the sale of the Radisson
Suites Hotel.
In connection with the 1993 restructuring, the Company issued to the primary
lender warrants to acquire up to two million shares of the Company's common
stock. One million of the warrants have been canceled leaving one million
exercisable warrants outstanding at December 31, 1997. The exercise price for
the warrants is $2.875 per share. The outstanding warrants expire December 11,
1998. The warrants have customary anti-dilution protection that addresses stock
splits, stock dividends, recombinations and reclassifications, and certain other
issuances of additional common stock. The Company also has a right of first
offer to acquire the shares of common stock or warrants prior to any transfer
thereof. The Company has valued the one million warrants at $1.89 million which
is recorded as equity in the Company's Consolidated Balance Sheet.
Statement of Financial Accounting Standards No. 15 required the Company to
account for future interest resulting from the debt restructuring using an
imputed interest rate versus the stated rates on the Notes A and B. In addition,
the primary lender's cancellation of debt of $4 million at the time of the
restructuring was effectively amortized for financial reporting purposes. In
connection with the retirement of Notes A and B in 1996, the Company recorded an
extraordinary gain on extinguishment of debt of $766,000 resulting from the
difference in the face value and the amount required to extinguish the debt, net
of the write-off of related loan fees.
34
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
3. DEBT (CONTINUED)
LOAN MATURITIES
The maturities of debt outstanding as of December 31, 1997, and required
minimum principal payments in each of the next five years and thereafter are
summarized as follows (in thousands):
<TABLE>
<CAPTION>
CURRENT
---------
<S> <C>
1998............................................................................... $ 3,152
1999............................................................................... 1,025
2000............................................................................... 1,115
2001............................................................................... 1,997
2002............................................................................... 1,265
Thereafter......................................................................... 38,848
---------
$ 47,402
---------
---------
</TABLE>
The 1998 scheduled principal maturities of $3,152,000 includes the
$2,200,000 liability related to the reimbursement obligation, as discussed in
Note 2 to the Consolidated Financial Statements.
4. ACQUISITION AND DISPOSITION OF INVESTMENT PROPERTIES
On January 17, 1997, the Company purchased two properties to complete a tax
deferred exchange in accordance with Section 1031 of the Internal Revenue Code,
in connection with the sale of the Radisson Suites Hotel. The first acquisition
was West Valley Executive Park, a multi-tenant, six building, 164,000 square
foot campus style office park in San Jose, California, that was acquired for
$17,500,000. 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. See Note 3 for discussion of the mortgage
debt assumed and borrowed in connection with these acquisitions.
In April 1996, the Company sold the Village Commons Shopping Center property
to an unrelated party for $19,300,000 and recognized a gain for financial
reporting purposes of $10,900,000. In December 1996, the Company sold the
Radisson Suites Hotel property to an unrelated party for $21,307,000 and
recognized a gain for financial reporting purposes of $5,814,000.
35
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
4. ACQUISITION AND DISPOSITION OF INVESTMENT PROPERTIES (CONTINUED)
The following unaudited pro forma information reflects adjustments to the
Company's historical results from these acquisitions and dispositions as if they
had occurred on January 1, 1996 (in thousands, except per share and share
amounts):
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31, 1996
------------------
<S> <C>
Revenues.................................................................. $ 13,578
----------
Net income................................................................ 953
----------
Net income per common share--
Basic................................................................... $ 0.24
----------
Diluted................................................................. $ 0.23
----------
Weighted average common shares outstanding--
Basic................................................................... 3,892,596
----------
----------
Diluted................................................................. 4,100,100
----------
----------
</TABLE>
5. INCOME TAXES
The Company provides for income taxes under the liability method in
accordance with Statement of Financial Accounting Standards No. 109, "Accounting
for Income Taxes" (SFAS 109).
The deferred income tax (provision) benefit represents the tax effect of
temporary differences between income (loss) determined for financial reporting
and for income tax purposes. As of December 31, 1997, the Company has a tax net
operating loss carryover for Federal income tax purposes of approximately $13.0
million, which will expire between 2006 and 2012. The Company has an investment
tax credit carryover totaling approximately $1.5 million which will expire
between 2000 and 2003. The Company also has an alternative minimum tax credit
carryover for Federal income tax purposes of approximately $.9 million which can
be carried forward indefinitely.
36
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
5. INCOME TAXES (CONTINUED)
The components of the deferred tax assets and deferred tax liabilities are
as follows at December 31, 1997 (in thousands):
<TABLE>
<CAPTION>
FEDERAL STATE TOTAL
------- ------ -------
<S> <C> <C> <C>
Deferred tax assets:
Net operating loss carryover........................ $ 3,966 $ 730 $ 4,696
Tax credits carryover............................... 2,344 -- 2,344
State deferred tax.................................. 1,038 -- 1,038
Unearned rental revenue............................. 100 25 125
------- ------ -------
$ 7,448 $ 755 $ 8,203
------- ------ -------
------- ------ -------
Deferred tax liabilities:
Excess tax depreciation............................. $ 4,400 $1,101 $ 5,501
Debt relating to the RCA Advances................... 2,081 521 2,602
Excess partnership losses from RCA.................. 7,791 1,950 9,741
Straight-line rent.................................. 112 27 139
------- ------ -------
$14,384 $3,599 $17,983
------- ------ -------
------- ------ -------
</TABLE>
The table below reconciles the difference between the statutory Federal
income tax rate and the effective rate in the Company's Consolidated Statement
of Income (Loss).
<TABLE>
<CAPTION>
(PROVISION) BENEFIT
PERCENTAGES
-----------------------
<S> <C> <C> <C>
1997 1996 1995
----- ----- -----
Statutory Federal income tax rate...................... 34% (34)% 34%
State income tax....................................... 6 (7) 7
Taxable items not recognized for financial reporting
purposes............................................. (3) -- --
----- ----- -----
Effective tax rate (provision) benefit................. 37% (41)% 41%
----- ----- -----
----- ----- -----
</TABLE>
The components of the (provision) benefit for income taxes were as follows
(in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------ ------- ------
<S> <C> <C> <C>
Federal--current....................................... $ (17) $ (142) $ --
Federal--deferred...................................... 992 (5,977) 1,608
State--current......................................... (6) (376) --
State--deferred........................................ 57 (1,340) 275
------ ------- ------
$1,026 $(7,835) $1,883
------ ------- ------
------ ------- ------
</TABLE>
6. LESSOR ARRANGEMENTS
As of December 31, 1997, approximately 792,000 of a total of approximately
911,000 square feet or 87% of the Company's wholly owned commercial space was
leased. The terms of the leases generally require tenants to pay base rent plus
their proportionate share of certain operating expenses or expense
37
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
6. LESSOR ARRANGEMENTS (CONTINUED)
increases. Minimum rental amounts due to the Company pursuant to these operating
leases through expiration are as follows (in thousands):
<TABLE>
<CAPTION>
CURRENT
---------
<S> <C>
1998............................................................................... $ 11,410
1999............................................................................... 9,542
2000............................................................................... 7,842
2001............................................................................... 4,571
2002............................................................................... 2,885
Thereafter......................................................................... 6,264
---------
$ 42,514
---------
---------
</TABLE>
7. STOCK OPTIONS, WARRANTS AND EMPLOYEE BENEFIT PLANS
INCENTIVE STOCK OPTION PLAN
The Company has two stock option plans, the 1985 Incentive Stock Option Plan
(the "1985 Plan") and the 1996 Stock Option Plan (the "1996 Plan"). Under the
1985 Plan, 200,000 shares of the Company's common stock were reserved for
issuance. This plan provides for options to be granted at fair market value on
the date of grant for terms not exceeding ten years. During 1997, under the 1985
Plan, options to purchase 4,000 shares were exercised and options to purchase
11,000 shares were canceled. As of December 31, 1997, a total of 42,350 options
were outstanding under the 1985 Plan and no additional grants may be made. Of
such outstanding options, 30,000 are exercisable in equal cumulative
installments over five years beginning in 1993 at prices ranging from $2.97 to
$3.13 per share and 12,350 outstanding options are exercisable in equal
cumulative installments over five years beginning in 1995 at prices ranging from
$3.69 to $4.56 per share.
Under the 1996 Plan, a total of 200,000 shares of Common Stock have been
reserved for issuance. This plan provides for options to be granted at fair
market value on the date of grant for terms not exceeding ten years. During
1996, options to purchase an aggregate of 150,000 shares of Common Stock were
granted at an exercise price of $2.56. During 1997, options to purchase an
aggregate of 30,000 shares of Common Stock were granted at an exercise price of
$4.94. During 1997, options to purchase 3,000 shares were exercised, and options
to purchase 12,000 shares were canceled. As of December 31, 1997, a total of
165,000 options were outstanding under the 1996 plan. Of such options
outstanding under the 1996 Plan, 40,000 were exercisable in 1996, 47,000 were
exercisable in 1997, 33,000 are exercisable in 1998, 13,000 are exercisable in
1999, 2000 and 2001, respectively, and 6,000 are exercisable in 2002.
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 123 "Accounting for Stock Based
Compensation" (SFAS 123), which establishes financial accounting and reporting
standards for stock based compensation plans. As permitted by SFAS 123, the
Company will continue to account for these plans under APB Opinion No. 25, under
which no compensation expense will be recognized. The additional compensation
expense that would have been recorded if the Company had adopted SFAS 123 is not
material in 1997 and 1996. The fair value of each option grant is estimated on
the date of grant using the Black-Scholes option-pricing model with the
following
38
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
7. STOCK OPTIONS, WARRANTS AND EMPLOYEE BENEFIT PLANS (CONTINUED)
weighted-average assumptions used for grants during 1997: expected dividend
yield of 0%, expected volatility of 46.6%, risk-free interest rate of 5.97% and
expected life of 10 years.
A summary of the status of the Company's two stock option plans and stock
warrants at December 31, 1997, 1996, and 1995 and changes during the years then
ended is presented in the table and narrative below:
<TABLE>
<CAPTION>
1997 1996 1995
------------------------- ------------------------- -------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------------ ----------- ------------ ----------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year................ 1,207,350* $ 2.86 1,182,850* $ 2.97 1,182,850* $ 2.97
Granted......................................... 30,000 4.94 150,000 2.56 -- --
Exercised....................................... (7,000) 3.13 -- -- -- --
Expired......................................... (23,000) 2.91 (125,500) 3.58 -- --
------------ ------------ ------------
Outstanding at end of year...................... 1,207,350 $ 2.91 1,207,350 $ 2.86 1,182,850 $ 2.97
------------ ------------ ------------
------------ ------------ ------------
Exercisable at end of year...................... 1,124,410 1,076,940 92,570
------------ ------------ ------------
------------ ------------ ------------
Weighted Average Fair Value of Options
Granted....................................... $ 3.30 $ 1.68 $ 0.00
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
* Included in this amount are one million warrants related to the 1993 debt
restructuring. These warrants will expire on December 11, 1998. (See Note 3
to the Consolidated Financial Statements for further discussion.)
401(k) PLAN
Effective January 1, 1996, the Company adopted a discretionary
non-contributory 401(k) Plan. All 401(k) Plan contributions are fully vested.
The level of any Company contributions are subject to annual review and approval
of the Company's Board of Directors. The Board of Directors approved a 1997
contribution of three percent of qualified employee compensation which amounted
to $27,836. No contribution was made in 1996.
39
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
8. QUARTERLY FINANCIAL DATA (UNAUDITED)
The following tables set forth unaudited quarterly financial data (in
thousands, except per share amounts) for each of the two years ended December
31, 1997 and December 31, 1996:
<TABLE>
<CAPTION>
BY QUARTER
-----------------------------------------------------
1997 FIRST SECOND THIRD FOURTH TOTAL
- ---------------------------------------------------------------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Investment properties income (loss)............................. $ 471 $ 135 $ (165) $ 158 $ 599
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Hotel property income (loss).................................... (94) 1 -- -- (93)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Provision for settlement of reimbursement obligation............ -- (2,200) -- -- (2,200)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Net income (loss)............................................... $ 6 $ (1,450) $ (245) $ (37) $ (1,726)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Income (loss) per share, basic:
Income (loss) before extraordinary items...................... $ -- $ (0.37) $ (0.06) $ (0.01) $ (0.44)
Extraordinary items........................................... -- -- -- -- --
--------- --------- --------- --------- ---------
Net income (loss)............................................. $ -- $ (0.37) $ (0.06) $ (0.01) $ (0.44)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Income (loss) per share, diluted:
Income (loss) before extraordinary items...................... $ -- $ (0.37) $ (0.06) $ (0.01) $ (0.44)
Extraordinary items........................................... -- -- -- -- --
--------- --------- --------- --------- ---------
Net income (loss)............................................. $ -- $ (0.37) $ (0.06) $ (0.01) $ (0.44)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
40
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
8. QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED)
<TABLE>
<CAPTION>
BY QUARTER
-----------------------------------------------------
1996 FIRST SECOND THIRD FOURTH TOTAL
- ---------------------------------------------------------------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Investment properties income (loss)............................. $ 401 $ (27) $ (79) $ (1,476) $ (1,181)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Hotel property income (loss).................................... 954 192 (108) (25) 1,013
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Gain on sale of real estate assets, net......................... -- 10,900 -- 5,814 16,714
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Extraordinary gain from extinguishment of debt.................. -- -- -- 766 766
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Net income (loss)............................................... $ 589 $ 6,379 $ (549) $ 4,935 $ 11,354
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Income (loss) per share, basic:
Income (loss) before extraordinary items...................... $ 0.15 $ 1.64 $ (0.14) $ 1.07 $ 2.72
Extraordinary items........................................... -- -- -- 0.20 0.20
--------- --------- --------- --------- ---------
Net income (loss)............................................. $ 0.15 $ 1.64 $ (0.14) $ 1.27 $ 2.92
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Income (loss) per share, diluted:
Income (loss) before extraordinary items...................... $ 0.15 $ 1.51 $ (0.14) $ 1.03 $ 2.58
Extraordinary items........................................... -- -- -- 0.19 0.19
--------- --------- --------- --------- ---------
Net income (loss)............................................. $ 0.15 $ 1.51 $ (0.14) $ 1.22 $ 2.77
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
41
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Pacific Gateway Properties, Inc.:
We have audited the accompanying consolidated balance sheets of Pacific
Gateway Properties, Inc. (a New York corporation) and subsidiaries as of
December 31, 1997 and 1996, and the related consolidated statements of income
(loss), stockholders' equity (deficit) and cash flows for each of the three
years in the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Pacific
Gateway Properties, Inc. and subsidiaries as of December 31, 1997 and 1996, and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 1997, in conformity with generally accepted
accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The schedule listed in the
index of financial statements is presented for purposes of complying with the
Securities and Exchange Commission's rules and is not part of the basic
consolidated financial statements. The schedule has been subject to the auditing
procedures applied in the audit of the basic consolidated financial statements
and, in our opinion, fairly states in all material respects the financial data
required to be set forth therein in relation to the basic consolidated financial
statements taken as a whole.
ARTHUR ANDERSEN LLP
San Francisco, California
March 2, 1998
42
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
SCHEDULE III--REAL ESTATE AND ACCUMULATED DEPRECIATION
AS OF DECEMBER 31, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
ACCUMULATED
DEPRECIATION
AND PROVISION
INITIAL COST GROSS CARRYING AMOUNT AT FOR WRITE- DOWN
TO COMPANY SUBSEQUENT DECEMBER 31, 1997 TO NET
---------------------- COSTS, ------------------------ REALIZABLE 1997
ENCUMBRANCES BUILDINGS AND CAPITALIZED BUILDINGS AND TOTAL VALUE PROJECTED
DESCRIPTION (NOTE 3) LAND IMPROVEMENTS IMPROVEMENTS IMPROVEMENTS (NOTE 1) (NOTE 2 AND 5) TAX BASIS
- --------------- ------------- ------- ------------- ------------- ------------- --------- -------------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Walnut Creek
Executive
Park......... $19,002 $1,357 $12,086 $ 8,009 $20,095 $ 21,452 $ 6,559 $16,748
South Bay
Office
Tower........ 9,348 3,439 13,754 3,547 17,301 20,740 6,200 11,477
North Tucson
Business
Center....... 3,801 147 621 628 1,249 1,396 431 1,205
Weston Office
Building..... 959 44 299 5 304 348 73 295
410 First
Avenue (Note
4 and 5)..... 2,200 494 4,006 364 4,370 4,864 2,702 2,099
West Valley
Executive
Park......... 10,000 3,500 14,187 680 14,867 18,367 357 7,712
930 Montgomery
Street....... 2,092 650 2,597 180 2,777 3,427 86 1,961
Corporate
Leasehold
Improvements... -- -- -- 62 62 62 23 40
------------- ------- ------------- ------------- ------------- --------- ------- ----------
TOTAL.......... $47,402 $9,631 $47,550 $13,475 $61,025 $ 70,656 $16,431 $41,537
------------- ------- ------------- ------------- ------------- --------- ------- ----------
------------- ------- ------------- ------------- ------------- --------- ------- ----------
<CAPTION>
DATE OF
CONSTRUCTION/
DESCRIPTION ACQUISITION
- --------------- -------------
<S> <C>
Walnut Creek
Executive
Park......... 1975 to
1986/1988
South Bay
Office
Tower........ 1972/1985
North Tucson
Business
Center....... 1987/1988
Weston Office
Building..... 1986/1988
410 First
Avenue (Note
4 and 5)..... 1961/1984
West Valley
Executive
Park......... 1978/1997
930 Montgomery
Street....... 1927/1997
Corporate
Leasehold
Improvements...
TOTAL..........
</TABLE>
43
<PAGE>
PACIFIC GATEWAY PROPERTIES, INC.
SCHEDULE III--REAL ESTATE AND ACCUMULATED DEPRECIATION--(CONTINUED)
DECEMBER 31, 1997
(IN THOUSANDS)
NOTE 1 The changes in the total cost of land, buildings, and improvements for
the three years ended December 31, are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
--------- ---------- ---------
<S> <C> <C> <C>
Balance at beginning of period.......................... $ 46,632 $ 76,684 $ 76,500
Additions............................................... 3,245 1,527 2,177
Cost of acquired properties............................. 20,934 -- --
Write-off of fully amortized items...................... (155) (526) (1,679)
Cost of disposed properties............................. -- (31,053) (314)
--------- ---------- ---------
Balance at end of period................................ $ 70,656 $ 46,632 $ 76,684
--------- ---------- ---------
--------- ---------- ---------
</TABLE>
NOTE 2 The changes in accumulated depreciation and amortization and the
provision for write-down to net realizable value for the three years
ended December 31, are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Balance at beginning of period........................... $ 13,835 $ 20,882 $ 19,807
Depreciation expense..................................... 2,751 2,239 2,795
Write-off of fully amortized items....................... (155) (526) (1,679)
Relief of accumulated balances related to disposed
properties............................................. -- (8,760) (41)
--------- --------- ---------
Balance at end of period................................. $ 16,431 $ 13,835 $ 20,882
--------- --------- ---------
--------- --------- ---------
</TABLE>
NOTE 3 Refer to Note 3 in the Registrant's Consolidated Financial Statements.
NOTE 4 This property was pledged in support of a $3.65 million letter-of-credit
in favor of the lender on Rincon Center. Prior to its expiration date of
June 23, 1997, the letter-of-credit was drawn by the refinancing lender.
Refer to Note 2 in the Registrant's Consolidated Financial Statements.
NOTE 5 The total reserve for write-down to net realizable value pertains to 410
First Avenue property in Needham, Massachusetts.
44
<PAGE>
EXHIBIT 21
PACIFIC GATEWAY PROPERTIES, INC.
SUBSIDIARIES OF THE REGISTRANT
<TABLE>
<CAPTION>
PERCENTAGE
INTEREST OF
PLACE OF VOTING
NAME ORGANIZATION SECURITIES OWNED
- ------------------------------------------------------------------------- --------------------- -----------------
<S> <C> <C>
Pacific Gateway Properties, Inc.......................................... New York 100%
Pacific Gateway Properties Management Corporation........................ California 100%
Pacific Gateway Properties Hotels, Inc................................... California 100%
Perini Investment Properties Executive Suites, Inc....................... California 100%
Maritime Plaza Associates................................................ California 100%
PGP--South Bay Office Tower, Inc......................................... California 100%
PGP--North Tucson Business Center, Inc................................... California 100%
PGP--Weston, Inc......................................................... California 100%
Rincon Center Associates................................................. California Limited 22.8%
Partnership
</TABLE>
45
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 3,811
<SECURITIES> 0
<RECEIVABLES> 112
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 4,063
<PP&E> 70,656
<DEPRECIATION> 16,431
<TOTAL-ASSETS> 68,711
<CURRENT-LIABILITIES> 2,678
<BONDS> 47,402
0
0
<COMMON> 4,018
<OTHER-SE> (3,370)
<TOTAL-LIABILITY-AND-EQUITY> 68,711
<SALES> 0
<TOTAL-REVENUES> 13,721
<CGS> 0
<TOTAL-COSTS> 5,955
<OTHER-EXPENSES> 93
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 4,058
<INCOME-PRETAX> (2,752)
<INCOME-TAX> (1,026)
<INCOME-CONTINUING> (1,726)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,726)
<EPS-PRIMARY> (0.44)
<EPS-DILUTED> (0.44)
</TABLE>
