ITEM 1. BUSINESS
Pacific Gulf Properties Inc. (together with its consolidated operating partnerships, PGP Inland Communities, L.P., Terrace Gardens -- PGP L.P., Morning View Terrace -- PGP L.P., PGP Northern Industrial L.P. and PGP Von Karman Properties, collectively the "Company") was incorporated in August 1993 in the State of Maryland and completed its initial public offering on February 18, 1994 (the "Offering"). Prior to February 18, 1994, the Company was a wholly-owned subsidiary of Santa Anita Realty Enterprises, Inc. ("Realty"). Its executive offices are located at 4220 Von Karman Drive, Newport Beach, California 92660.
The Company operates as a self-administered and self-managed equity real estate investment trust (a "REIT") which owns, operates, leases, acquires, rehabilitates and develops industrial and multifamily properties located in California and the Pacific Northwest.
The Company's properties are located in California and the Pacific Northwest, with the largest concentration in Southern California. The Company focuses on the industrial and multifamily properties in this geographic region due to management's extensive experience in these property types and markets and management's belief that these markets present potential for long-term economic growth. As of December 31, 1997, the Company owned a portfolio of 49 operating industrial properties, containing an aggregate of 10.7 million leasable square feet, two industrial properties being rehabilitated containing approximately 639,000 leasable square feet and four industrial properties being developed that will contain approximately 578,000 leasable square feet (the "Industrial Properties"). The Company also owns a portfolio of 24 operating multifamily properties, which includes 17 apartment communities containing 3,383 units, seven active senior apartment communities containing 1,272 units and one active senior apartment community being developed that contains 166 apartment units (the "Multifamily Properties," and collectively with the Industrial Properties, the "Properties"). As of December 31, 1997, the operating Industrial Properties and Multifamily Properties then owned by the Company experienced occupancy rates of 95% and 94%, respectively.
The following table presents information on the composition of the Company's operating properties based on the net book value at December 31, 1997:
The tables below set forth certain information relating to the Company's operating Industrial and Multifamily Properties by location and type as of December 31, 1997.
- --------------- (1) Based on rental revenues for the fourth quarter of 1997.
(2) Includes the eastern portion of Los Angeles County adjacent to the Riverside-San Bernardino metropolitan statistical area.
1997 DEVELOPMENTS
ACQUISITIONS
During 1997, the Company acquired approximately $302.6 million of industrial properties and $38.8 million of multifamily properties. The following tables set forth information regarding these properties and properties currently under rehabilitation and development.
As part of its acquisition program, the Company seeks properties whose financial performance can be enhanced through physical renovation and rehabilitation. The Company also periodically renovates and rehabilitates the properties it already owns. Rehabilitation activity generally involves updating older properties to conform to current market standards and may include the installation of additional loading facilities, sprinkler upgrades, mezzanine level upgrades, parking lot upgrades and cosmetic rehabilitation of the property. The Company capitalizes on senior management's experience with renovation and rehabilitation projects, as well as third party expertise, to expedite the renovation and rehabilitation process.
See "Industrial Properties" and "Multifamily Properties" for additional information regarding these properties as of December 31, 1997.
Operating Industrial Properties
- --------------- (1) Owned by PGP Northern Industrial, L.P., a limited partnership in which the Company has a minimum 59% equity interest and full management and control.
(2) Included under Eden Plaza.
Operating Multifamily Properties
- --------------- (1) Owned by Terrace Gardens-PGP L.P., a limited partnership in which the Company has an ownership interest of approximately 58%, full management and control, and the right to substantially all of the cash flow.
(2) Owned by Morning View Terrace-PGP L.P., a limited partnership in which the Company has an ownership interest of approximately 58%, full management and control, and the right to substantially all of the cash flow.
Rehabilitation Properties
Development Properties
- --------------- (1) Represents the Company's development of excess portions of properties previously acquired by the Company.
COMPLETION OF INDUSTRIAL REHABILITATION
In April 1997, the Company completed a $1.7 million rehabilitation of the former Bullock's Distribution Center, representing the first phase of this project, consisting of a 327,000 square foot warehouse and distribution facility located in the City of Industry, California, originally purchased by the Company in August 1996 for approximately $8.8 million. The project, now renamed Pacific Gulf Distribution Center, is currently 100% leased and has two major tenants, a food service distributor occupying 182,000 leasable square feet and a computer terminal distributor occupying 82,000 leasable square feet.
REDUCTION IN PUBLIC INDEBTEDNESS
In December 1996, the Company completed an exchange offer (the "Exchange Offer") pursuant to which it exchanged an aggregate of 2,440,002 shares of Common Stock in exchange for approximately $42.1 million in aggregate principal amount (58 shares of Common Stock for each $1,000 in principal amount) of its 8.375% Convertible Subordinated Debentures Due 2001 (the "Debentures"). Approximately $12.7 million in principal amount of Debentures remained outstanding at December 31, 1997. The Debentures are traded on the American Stock Exchange (the "ASE").
COMMON STOCK OFFERINGS
During 1997, the Company completed the following sales of its Common Stock:
- --------------- (1) Includes proceeds and shares from the underwriters' over-allotment exercised.
CLASS A SENIOR CUMULATIVE CONVERTIBLE PREFERRED STOCK
On December 31, 1996, the Company entered into an agreement to issue 1,351,351 shares of Class A Senior Cumulative Convertible Preferred Stock (the "Class A Preferred Shares") to Five Arrows Realty Securities L.L.C. ("Five Arrows") at a price of $18.50 per share. As of December 31, 1997, the Company has issued 1,351,351 shares of the Class A Preferred Shares.
The holders of the Class A Preferred Shares and the holders of the Common Stock vote together as a single class. Each Class A Preferred Share is convertible into one share of Common Stock, subject to adjustment upon certain events. The annual dividend per share on the Class A Preferred Shares is (i) $1.70 from the date of issuance until December 31, 1997, and (ii) the greater of $1.70 or 104% of the then-current dividend on the Common Stock thereafter. The liquidation preference of the Class A Preferred Shares is $18.50 per share, plus an amount equal to any accumulated, accrued and unpaid dividends. The Company may redeem the Class A Preferred Shares beginning on December 31, 2001 for cash in an amount equal to $18.50 per Class A Preferred Share plus accrued and unpaid dividends and plus a premium initially equal to 6.0% of $18.50. This premium decreases to zero after December 31, 2009.
The Company has granted to Five Arrows, for as long as Five Arrows maintains its ownership of either all of the Class A Preferred Shares or an amount of voting securities that, if converted into Common Stock, would exceed 10% of the outstanding Common Stock, a seat on the Company's Board of Directors. Mr. James E. Quigley 3rd has served on the Company's Board of Directors as Five Arrows' representative since January 1997. In addition, upon the occurrence of the failure of the Company to pay a quarterly dividend on the Common Stock in an amount of at least $.40 per share, the failure of the Company to meet certain earnings
before interest, depreciation and amortization budgets for three consecutive quarters or the failure of the Company to pay accrued dividends on the Class A Preferred Shares, Five Arrows would be granted one additional seat on the Board.
At that time, Five Arrows has the right, subject to certain conditions, to demand the Company effect the registration under the Securities Act of 1933, as amended, of the Class A Preferred Shares or the shares of Common Stock into which such Class A Preferred Shares have been converted.
CLASS B SENIOR CUMULATIVE CONVERTIBLE PREFERRED STOCK
In May 1997, the Company entered into a second agreement with Five Arrows to issue 1,411,765 shares of Class B Senior Cumulative Convertible Preferred Shares (the "Class B Preferred Shares") at a price of $21.25 per share. Since entering into this agreement, the Company has issued and sold to Five Arrows an aggregate of 1,411,765 Class B Preferred Shares for an aggregate purchase price of $30 million. Upon each issuance of Class B Preferred Shares, the Company paid a transaction fee of $0.75 per share. As part of this transaction, Five Arrows agreed to waive certain availability fees that were to be charged to the Company if all of the Class A Preferred Shares were not issued before July 1, 1997. Additionally, Five Arrows agreed that it would not transfer any Class A Preferred Shares or Class B Preferred Shares, or any shares of Common Stock into which such shares of Preferred Stock have been converted, until June 30, 1998. The terms of the Class B Preferred Shares are substantially similar to those of the Class A Preferred Shares, except that (i) the liquidation preference of the Class B Preferred Shares is $21.25 per share (plus accumulated, accrued and unpaid dividends) and (ii) Five Arrows will not be entitled to designate any additional representatives to the Company's Board of Directors while it owns both the Class A Preferred Shares and the Class B Preferred Shares.
DEBT FINANCING ACTIVITIES
Tax-Exempt Projects. The Company has established a pool agreement with the Federal National Mortgage Associations ("FNMA") to provide 30-year credit enhancement on the Company's tax-exempt projects. In June 1997, in conjunction with the Company's admission into the partnerships that own the Terrace Gardens and Morning View Terrace apartment communities, the partnerships refinanced their existing tax-exempt bond financing of $19.1 million through the FNMA facility. The effective interest rate on the bonds, after giving effect to credit enhancement and other costs, has been fixed at 6.4% for 10 years.
The Company also received from FNMA a forward commitment, expiring December 1, 1998, to provide credit enhancement for the Rancho Santa Margarita property, that the Company is currently developing. The commitment is subject to the completion of the project and the property achieving certain lease up and operating requirements. The effective interest rate on the currently outstanding bonds in this commitment, after giving effect to credit enhancement and other costs, has been fixed at 6.4% for 10 years.
Property Refinancings. In October 1997, the Company borrowed $34.0 million at an interest rate of 7.11% for a term of 10 years. The proceeds of this loan were used to repay $33.6 million of indebtedness under the Company's Line of Credit. The loan is secured by five warehouse/distribution centers acquired by the Company in July 1997.
Credit Facilities. The Company has a $65.0 million secured revolving line of credit (the "Line of Credit") which matures in July 1998. The Line of Credit bears interest at a rate of LIBOR plus 1.75%. As of December 31, 1997, the outstanding balance under the Company's Line of Credit was $17.2 million.
Subsequent to year-end, the Company entered into an agreement with a lender for a $40 million unsecured bridge loan agreement. The agreement has an expiration date of April 30, 1998 and bears interest at a rate of LIBOR plus 1.25%.
The Company and its lenders are currently negotiating the terms of a new unsecured credit facility. Terms being negotiated include an increase in the maximum loan amount, a decrease in the interest rate spread, extension of the term of the facility and conversion of the secured facility to an unsecured facility. There can be no assurance that any such terms will be agreed to by the lenders.
INDUSTRIAL PROPERTIES
The Company focuses on multi tenant business parks and mid-size warehouse/distribution facilities. Whenever possible, the Company seeks a significant market share in its principal sub-markets so that it can accommodate its tenants as their needs change and have an influence on trends in market rents. The Company also seeks properties that are well located and offer convenient access to major distribution points, such as shipping ports, major airports and major freeways.
Management believes that the Southern California industrial property market is recovering based upon an increasing level of leasing interest and a limited supply of new product. As evidence of this, the Company already has observed recent increases in the prices for industrial properties and tenant requests for longer term leases. With over 48% of its industrial leasable square footage subject to leases expiring during the next 24 months, the Company believes it is in a good position to capitalize on anticipated rental rate increases. Over 1,400 tenants currently occupy the Industrial Properties, and no one tenant accounts for more than 1.8% of the Company's total rental revenues.
The Company generally offers industrial leases in the one- to five-year range. Lease terms include, in most cases, annual adjustments based on changes in the consumer price index. The standard lease also includes some refurbishing and tenant improvement allowance with the amount varying depending upon the length of the lease, the size of the space leased and the use. The Company seeks tenants primarily involved in warehouse, distribution, assembly and light manufacturing activities.
The following table presents information concerning the Industrial Properties, including the actual average rent per square foot and percentage of the leasable square footage occupied by tenants as of December 31, 1997:
- --------------- (1) Subject to ground lease.
(2) Owned by PGP Northern Industrial, L.P., a limited partnership in which the Company has an ownership interest of approximately 59%, full management and control, and the right to substantially all of the cash flow.
(3) Estimated.
The following table shows scheduled lease expirations for all leases for the Industrial Properties (excluding properties under development) as of December 31, 1997.
- --------------- (1) As of December 31, 1997, 721,000 square feet of tenants were on month-to-month leases (which are not included above) and 525,000 square feet were unoccupied.
MULTIFAMILY PROPERTIES
The Company invests primarily in two types of multifamily apartment communities: communities for active seniors ages 55 and older, and communities oriented to family-style living.
The Company focuses on active senior housing for individuals ages 55 and older, where seniors can be involved in activities, social gatherings and other types of entertainment with residents of their own age group. The Company offers no assisted living or related services; the Company's properties are oriented to those seniors interested in renting versus owning and who are able to care for themselves. The Company believes that the senior population will continue to grow and that the market for rental housing for active seniors will be strong. In addition, management believes that active senior housing typically has lower operating and management costs due to lower tenant turnover.
The Company also owns family-style apartment communities with greater concentrations of two- and three-bedroom units with rents affordable by middle-income families. The Company believes that there is a strong demand among middle-income families for affordable rental housing such as that offered by the Company.
Each of the Multifamily Properties provides tenants with attractive amenities, including a swimming pool (except Inn at Laguna Hills) and clubhouse, and many include jacuzzis, tennis courts, sports courts and saunas. Many offer additional features such as vaulted ceilings, fireplaces, washers and dryers, cable television and limited access gates. None of the Multifamily Properties currently are subject to rent control or rent stabilization regulations. However certain of these properties are subject to restrictions based upon tax-exempt loan requirements, such as providing a percentage of units to low income tenants. There can be no assurances that rent control or rent stabilization regulations will not be imposed in the future.
While the Company has continued to adhere to the philosophy of focusing on industrial and multifamily product types, the Company has also experienced significantly increased competition for the acquisition of family-style apartment communities, thereby driving prices for such properties to levels at which the Company is not willing to acquire such properties. The Company does not anticipate a change in these circumstances for the foreseeable future. However, given the growing demand for senior rental housing, the Company continues to see opportunities for the acquisition and development of active senior rental housing. Consequently, the Company intends to explore the possibility of divestiture of its family-style apartment communities so as to redeploy its capital into industrial properties or active senior apartments with more favorable returns. There can be no assurance that the Company will actually dispose of such properties, nor can there be any assurance as to the timing of any such dispositions. Any such decision by the Company will be subject to numerous factors, including prices offered for the Company's family-style apartment communities and the availability of suitable alternate investment for the proceeds of such dispositions.
The following table presents information concerning the Multifamily Properties, including average gross scheduled rents per unit and percentage of units occupied as of December 31, 1997:
- --------------- (1) Properties serving active senior tenants (individuals 55 and older).
(2) Under rehabilitation.
(3) Owned by PGP Inland Communities, L.P., a limited partnership in which the Company has a minimum 78% equity interest, full management and control, and the right to 100% of cash flow until certain net operating income levels are achieved.
(4) Owned by Terrace Gardens-PGP L.P., a limited partnership in which the Company has an ownership interest of approximately 58%, full management and control, and the right to substantially all of the cash flow.
(5) Owned by Morning View Terrace-PGP L.P., a limited partnership in which the Company has an ownership interest of approximately 58%, full management and control, and the right to substantially all of the cash flow.
INDEBTEDNESS
The following table presents information on indebtedness encumbering the Industrial and Multifamily Properties, excluding borrowings outstanding under the Company's revolving line of credit, as of December 31, 1997:
- --------------- (a) Vista, Golden West and Garden Grove jointly collateralize the $16,900,000 note payable.
(b) PGDC-Fontana, PGDC-Chino, PGDC-Fremont, PGDC-Downey and PGDC-Rancho Bernardo jointly collateralize the $34,000,000 note payable.
(c) Bell Ranch Industrial Park, Pacific Park, North County, Bay San Marcos, Escondido Business Center and Riverview Industrial Park jointly collateralize the $24,500,000 note payable.
(d) The Company entered into an interest rate swap agreement that fixed the interest rate on $11,500,000 of the principal balance at 7.35% for five years commencing July 1, 1996.
(e) Construction loan relating to rehabilitation of Miramar Village. The maximum loan amount under the agreement is $10,238,000.
(f) Construction loan relating to rehabilitation of Algona II. The maximum loan amount under the agreement is $5,025,000.
(g) Applewood and Park Place jointly collateralize the $11,703,000 note payable; and Lora Lakes, Fulton's Landing and Fulton's Crossing jointly collateralize the $14,625,000 note payable.
(h) Interest rate is subject to periodic adjustments beginning March 10, 1996 based on the monthly weighted average 11th District Cost of Funds plus 2.8%.
(i) These tax-exempt mortgage loans (other than Tyler Springs) are financed tax-exempt bond financing supported by credit enhancement from FNMA. The collateral properties, which also include Heatherwood and Hollyridge, not listed above, are subject to restrictions requiring that a specified
percentage of the apartment units in such properties be made available to persons with lower and moderate income. As of December 31, 1997, 316 apartment units, or 7% of the total apartments owned, were required to have been made available to persons with lower or moderate income pursuant to these requirements, and the Company has complied with such requirements. In addition, state and local authorities in some cases impose certain restrictions on the amount of rent that can be charged.
(j) Interest rate is subject to periodic adjustments based on the Kenny Rate Index.
(k) Represents construction loan relating to development and construction of the Fountains multifamily community with a maximum loan amount of $6,400,000.
CORPORATE OFFICES
The Corporate offices are located in Newport Beach, California in approximately 16,000 square feet of a 26,000 square foot office building, which is 99% owned by the Company.
PROPERTY MANAGEMENT
Industrial Properties. The Company manages all of its existing Industrial Properties in California and Pacific Northwest using its network of six regional offices.
The Company offers industrial leases in the one- to five-year range. Lease terms include, in most cases, annual adjustments based on changes in the consumer price index and from one to three months' free rent. The standard lease also includes some refurbishing and tenant improvement allowance with the amount varying depending upon the length of the lease, the size of the space leased and the use. The Company will seek tenants primarily involved in warehouse, distribution, assembly and light manufacturing activities. Standard lease terms include a stipulated due date for rent payment, late charges (typically with no grace period), no offset or withholding provisions, security deposit clause, as well as many other provisions considered favorable to the landlord.
Multifamily Properties. The Company currently manages all of its Multifamily Properties in each of its regions. Each of the regions is managed by a Regional Manager who reports directly to the Vice President of Operations -- Apartments. Within each region, each of the Multifamily Properties is operated by a staff of approximately six to seven individuals, including a manager, assistant manager and/or leasing agents, and a maintenance and apartment preparation staff. The Company locates prospective tenants for its Multifamily Properties primarily by advertising in magazines listing available rentals and by using firms that assist tenants in locating apartments. The Company also does magazine and direct mail advertising. Policies and procedures utilized at the property sites, including procedures concerning lease contracts, on-site marketing, credit collection standards and eviction standards, follow established federal and state laws.
Individual property lease programs are structured to respond to local market conditions. The Company attempts to balance rent increases with high occupancy and low turnover. None of the Multifamily Properties are currently subject to rent control or rent stabilization regulations. However, certain of these properties are subject to restrictions based on tax-exempt loan requirements. Standard lease terms stipulate due dates for rent payments, late charges, no offset or withholding provisions, security deposits and damage reimbursement clauses, as well as many other provisions considered favorable to the property owner. Nonpayment of rent is generally handled at the properties within 15 days from the beginning of the month, with either commencement of collection or eviction proceedings occurring within that time period.
EMPLOYEES
At December 31, 1997, the Company employed approximately 169 persons, of which 145 were onsite or property related and 24 were executive office employees.
COMPETITIVE AND OTHER CONDITIONS
Competition. Within its geographic areas of operation, the Company is subject to competition from a variety of investors, including insurance companies, pension funds, corporate and individual real estate developers and investors and other REITs with investment objectives similar to those of the Company. Some of these competitors have more substantial financial resources and longer operating histories than the Company. As an owner of industrial and apartment real estate properties, the Company competes with other owners of similar properties in connection with their financing, sale, lease or other disposition and use.
While the Company has not experienced material competitive pressures confined to specific geographic regions, it is possible that material adverse changes in regional economies or in the operations of major regional employers (such as Boeing in the Pacific Northwest) could have a material adverse effect on the ability of the Company to lease its Properties and on the rents charged. Conversely, if any of the regional geographic areas in which the Company owns Properties experiences economic growth, the Company is likely to experience increased competition for acquisition and development projects, thereby increasing the Company's costs of acquisition and development and potentially reducing the Company's returns therefrom.
Insurance. The Company carries comprehensive liability, fire, extended coverage and rental loss insurance with respect to its Industrial Properties and Multifamily Properties, with policy specifications, insured limits and deductibles customarily carried for similar properties which the Company believes are adequate and appropriate under the circumstances. These are certain types of losses, such as those arising from acts of war, which are not generally insured because they are either uninsurable or not economically insurable. Presently the Company carries earthquake disaster insurance on its California properties which comprise 87% of the Company's total portfolio (as a percentage of real estate assets); however, such insurance may not be available in the future or may only be available at rates that, in the opinion of the Company, are prohibitive. In the event that an uninsured disaster or a loss in excess of insured limits should occur, the Company could suffer a substantial loss, including loss of anticipated future revenues, while remaining obligated on related mortgage indebtedness. The Company believes its properties were constructed in compliance with applicable construction standards in effect at the time of construction. The Company obtained customary title insurance insuring fee title to its properties upon their acquisition.
DISCLOSURE REGARDING FORWARD LOOKING STATEMENTS
The statements contained in Item 1 of this report that are not historical facts are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Actual results may differ materially from those included in the forward-looking statements. These forward-looking statements involve risks and uncertainties including, but not limited to, the following: changes in general economic conditions in the markets that could impact demand for the Company's product, competition and changes in financial markets and interest rates impacting the Company's ability to meet it financing needs and obligations.
ITEM 2.
ITEM 2. PROPERTIES
Information concerning properties owned by the Company is included under "Item 1. Business."
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is not presently subject to any litigation nor is any litigation threatened against the Company, other than routine litigation arising in the ordinary course of business.
ITEM 4.
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock of the Company has traded on the New York Stock Exchange ("NYSE") since October 29, 1996 under the symbol "PAG". Prior to that date and since its formation, the Company traded on the American Stock Exchange ("ASE"). The following table sets forth the high and low closing prices for the common stock on the respective exchange.
- --------------- (1) 68% of the distributions paid to beneficial owners in 1995 represented a return of capital ($1.06 per share).
(2) 45% of the distributions paid to beneficial owners in 1996 represented a return of capital ($.72 per share).
(3) 28.6% of the distributions paid to beneficial owners in 1997 are estimated to represent a capital gain distribution.
The minimum distribution requirement to maintain REIT status was approximately $2,300,000 for 1995, $4,758,000 for 1996 and $22,834,000 for 1997.
A regular quarterly distribution of $.42 per share was paid January 9, 1998. The closing price of the common stock on the New York Stock Exchange on March 24, 1998 was $22.875 per share. As of March 24, 1998, there were approximately 13,326 beneficial owners of common stock.
Future distributions by the Company will be at the discretion of the Board of Directors and will depend upon the actual Funds From Operations of the Company, its financial condition, capital requirements, the annual distribution requirements under the REIT provisions of the Internal Revenue Code, applicable legal restrictions and such other factors as the Board of Directors deems relevant. Although the Company intends to continue to make quarterly distributions to its stockholders, no assurances can be given as to the amount of distributions, if any, made in the future.
The statement on the face of this Annual Report on Form 10-K regarding the aggregate market value of voting stock of the Company held by non-affiliates of the Company is based on the assumption that all directors and officers of the Company were, for purposes of this calculation only (and not for any other purpose), affiliates of the Company.
ITEM 6.
ITEM 6. SELECTED FINANCIAL AND OPERATING DATA
The following table and footnotes set forth selected historical financial and operating data for the Company from February 18, 1994, the date of the Company's initial public offering, and for the predecessor multifamily and industrial operations acquired from Realty prior to that date.
- --------------- (a) Includes the combined historical operations of the Company from February 18 through December 31, 1994 and the predecessor multifamily and industrial operations acquired from Realty prior to February 18, 1994.
(b) Reflects the $3,596,000 nonrecurring loss incurred on the exchange of $42,069,000 aggregate principal amount of convertible subordinated debentures into 2,440,002 shares of common stock in December 1996.
(c) Earnings per share data for all periods presented reflects basic and diluted calculations in accordance with the new standard (Statement No. 128) and has been restated from the previous accounting standard of primary and fully diluted earnings per share. (See Part IV -- Financial Statements.)
(d) Per share data for 1994 was based on the weighted average common shares outstanding for the period February 18, 1994 (the closing date of the Company's initial public offerings) through December 31, 1994 and the Company's net loss for that period.
(e) Management considers FFO to be an appropriate measure of the performance of an equity REIT. The National Association of Real Estate Investment Trusts ("NAREIT") currently defines FFO as net income (computed in accordance with generally accepted accounting principles), excluding gains (or losses) from debt restructuring and sales of property, plus real estate depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. In addition, extraordinary or unusual items, along with significant non-recurring events that materially distort the comparative measure of FFO are typically disregarded in its calculation. Prior to March 1995 the NAREIT definition of FFO required
the add back of non-real estate depreciation and amortization, such as loan cost amortization. The Company adopted the new FFO definition prescribed by NAREIT as of January 1, 1996. The Company believes that in order to facilitate a clear understanding of the consolidated historical operating results of the Company, FFO should be examined in conjunction with net income as presented in the consolidated financial statements and data included elsewhere in this report. FFO is not defined by generally accepted accounting principles. FFO should not be considered as an alternative to net income or as an indication of the Company's operating performance or to net cash provided by operating activities as a measure of the Company's liquidity. Further, FFO as disclosed by other REITs may not be comparable to the Company's calculation.
CALCULATION OF FFO
(f) Represents dividends on Class A Preferred Shares and Class B Preferred Shares outstanding in 1997. (See Part IV -- Financial Statements)
(g) Earnings for the year ended December 31, 1996 were inadequate to cover fixed charges by approximately $0.2 million as a result primarily of the nonrecurring loss of $3,596,000 relating to the Company's exchange of debentures for common stock. The ratio of earnings to fixed charges excluding this $3.6 million non-cash item is 1.18 to 1.
Prior to completion of the Company's initial public offering in February 1994, the predecessor of the Company operated in a highly leveraged manner. As a result, although the Company and the predecessor have historically generated positive net cash flow, the financial statements of the predecessor show net losses for the periods prior to 1994. Consequently, the computation of the ratio of earnings to fixed charges for such period indicate that earnings were inadequate to cover fixed charges by approximately $1.6 million for the year ended December 31, 1993.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The following discussion should be read in conjunction with "Selected Financial and Operating Data" and the financial statements and notes thereto of the Company appearing elsewhere in this report. Such financial statements and information have been prepared to reflect the Company's financial position as of December 31, 1997, 1996 and 1995 together with the results of its operations and its cash flows for the years then ended.
Historical results and trends which might appear should not be taken as indicative of future operations. Management's representation statements contained in this report that are not historical facts are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Actual results may differ materially from those included in the forward-looking statements. These forward-looking statements involve risks and uncertainties including, but not limited to, the following: changes in general economic conditions in the
markets that could impact demand for the Company's properties, competition, and changes in financial markets and interest rates could impact the Company's ability to meet its financing needs and obligations.
The comparability of the financial information discussed below is impacted by the following: the acquisition of 27 operating industrial properties containing approximately 5,776,000 leasable square feet, the acquisition of three multifamily properties containing 824 apartment units, and the disposition of one multifamily property containing 279 apartment units during 1997; the acquisition of twelve industrial properties containing approximately 2,054,000 leasable square feet, the acquisition of one multifamily property containing 165 apartment units, and the disposition of 14 acres of land and a 55,656 square foot industrial building located in the Baldwin Industrial Park project during 1996; and the acquisition of twelve multifamily properties containing 1,736 apartment units, the acquisition of one industrial property containing approximately 476,000 leasable square feet, and the disposition of four multifamily properties consisting of 1,085 apartment units during 1995.
RESULTS OF OPERATIONS
Comparison of the Year Ended December 31, 1997 to the Year Ended December 31, 1996.
Industrial rental income increased by $15,627,000 or 75%, from $20,783,000 in 1996 to $36,410,000 in 1997. This increase was primarily attributable to the acquisition of 27 industrial properties in 1997. Industrial rental income for the year ended December 31, 1997 included $9,128,000 related to the 27 industrial acquisitions.
Multifamily rental income increased by $3,992,000 or 14%, from $29,104,000 in 1996 to $33,096,000 in 1997. This increase was primarily attributable to an increase in rental rates and to the acquisition of three multifamily properties containing 824 apartment units during 1997. Multifamily rental income for the year ended December 31, 1997 included $2,150,000 related to the three multifamily acquisitions.
As a result of these changes total revenues increased by $19,619,000 or 39%, from $49,887,000 in 1996 to $69,506,000 in 1997.
Industrial rental property expenses increased by $2,904,000, or 55%, from $5,308,000 in 1996 to $8,212,000 in 1997. This increase was primarily related to the Company's acquisitions in 1997. Industrial rental property expenses for the year ended December 31, 1997 included $1,839,000 related to the 27 industrial acquisitions.
Multifamily rental property expenses increased by $1,200,000, or 10%, from $11,554,000 in 1996 to $12,754,000 in 1997. This increase was primarily related to the Company's acquisitions in 1997. Multifamily rental property expenses for the year ended December 31, 1997 included $717,000 related to the three multifamily properties acquired during 1997.
Depreciation increased by $3,772,000 or 46%, from $8,236,000 in 1996 to $12,008,000 in 1997. The increases relate primarily to the acquisitions described above and the capital improvements made to rehabilitate existing properties.
Interest expense (including amortization of financing costs) decreased by $1,074,000, or 6%, from $18,411,000 in 1996 to $17,337,000 in 1997. This decrease was attributable to a decrease in convertible subordinated debentures outstanding, (primarily associated with the exchange of $42,069,000 aggregate principal amount of debentures into 2,440,002 shares of Common Stock). This decrease was offset by an increase in outstanding borrowings due to new acquisitions made during 1996 and 1997. Interest resulting from the amortization of financing costs decreased by $384,000 or 32% from $1,211,000 in 1996 to $827,000 in 1997. This decrease is attributable to the exchange in subordinated debentures which converted into shares of Common Stock in December 1996.
General and administrative expenses increased by $185,000, or 6%, from $2,974,000 in 1996 to $3,159,000 in 1997. This increase was primarily attributable to personnel increases related to the 1996 and 1997 acquisitions.
Minority interests in earnings of partnerships totaled $172,000 and represents earnings allocated to the minority partners in two partnerships in which the Company acquired a controlling general partner interest in June 1997 (Terrace Gardens, L.P. and Morning View Terrace L.P.). No earnings were allocated to the minority interests in the Company's other partnerships.
For the year ended December 31, 1997, the Company had net income of $20,603,000 compared with a net loss of $118,000 in 1996. The results in each year were impacted by non-recurring items. In 1996, a $3,596,000 non-recurring loss on the exchange of debentures was incurred (see Part I, Item 1 "Recent Developments-Reduction in Public Indebtedness") while in 1997 a $5,594,000 net gain on sale of real estate was recognized primarily from the sale of a 279 unit apartment community located in Oregon.
Comparison of the Year Ended December 31, 1996 to the Year Ended December 31, 1995.
Industrial rental income increased by $8,590,000 or 70%, from $12,193,000 in 1995 to $20,783,000 in 1996. This increase was primarily attributable to the acquisition of twelve industrial parks during 1996 containing approximately 2,054,000 leasable square feet. Industrial rental income for the year ended December 31, 1996 included $5,647,000 related to the twelve industrial acquisitions.
Multifamily rental income increased by $4,206,000 or 17%, from $24,898,000 in 1995 to $29,104,000 in 1996. This increase was primarily attributable to the acquisition of a 165 unit multifamily property in 1996 and the acquisition of twelve multifamily properties containing 1,736 apartment units in 1995, offset by the disposition of four multifamily properties containing 1,085 apartment units during the last quarter of 1995. Multifamily rental income for the year ended December 31, 1996 increased by $10,558,000 related to the 13 multifamily acquisitions during 1995 and 1996 and was reduced by the sale of the four multifamily properties in 1995.
As a result of these changes, total revenues increased by $12,796,000 or 34%, from $37,091,000 in 1995 to $49,887,000 in 1996.
Industrial rental property expenses increased by $2,741,000, or 107%, from $2,567,000 in 1995 to $5,308,000 in 1996. This increase was primarily related to the Company's acquisitions described above. Industrial rental property expenses for the year ended December 31, 1996 included $1,630,000 related to the twelve industrial acquisitions.
Multifamily rental property expenses increased by $1,339,000, or 13%, from $10,215,000 in 1995 to $11,554,000 in 1996. This increase was primarily related to the Company's acquisitions described above, offset by the sale of four properties in Texas in the prior year. Multifamily rental property expenses for the year ended December 31, 1996 increased by $4,422,000 related to the 13 multifamily properties acquired during 1996 and 1995 and was reduced by the sale of the four multifamily properties in 1995.
Depreciation increased by $2,155,000, or 35%, from $6,081,000 in 1995 to $8,236,000 in 1996. The increases relate primarily to the acquisition of the thirteen multifamily properties in 1996 and 1995, the twelve industrial properties acquired in 1996, and the capital improvements made to rehabilitate existing properties.
Interest expense (including amortization of financing costs) increased by $4,355,000, or 31%, from $14,066,000 in 1995 to $18,411,000 in 1996. This increase was attributable to increased borrowings outstanding during 1996, as compared to 1995, pursuant to new borrowings of $55,517,000 relating to the acquisition of multifamily properties and one industrial park during the last half of 1996. Interest resulting from the amortization of financing costs increased by $212,000 or 21% from $1,009,000 in 1995 to $1,221,000 in 1996. This increase is attributable primarily to amortization of loan fees associated with borrowings used to finance acquisitions completed during late 1995 and 1996.
General and administrative expenses increased by $551,000, or 23%, from $2,423,000 in 1995 to $2,974,000 in 1996. This increase was primarily attributable to personnel increases related to the 1995 and 1996 acquisitions.
For the year ended December 31, 1996, the Company incurred a net loss of $118,000 compared with net income of $8,403,000 in 1995. The results in each year were impacted by non-recurring items. In 1996, a
$3,596,000 non-recurring loss was incurred on the exchange of the convertible subordinated debentures for common stock (see Part I, Item 1) while in 1995 a $6,664,000 gain on sale of real estate was recognized from the sale of the four multifamily properties located in Texas.
Comparison of the Year Ended December 31, 1995 to the Year Ended December 31, 1994.
Industrial rental income increased by $4,986,000 or 69%, from $7,207,000 in 1994 to $12,193,000 in 1995. This increase was primarily attributable to the acquisition of three industrial properties during the last half of 1994 containing approximately 1,011,000 leasable square feet of space and one industrial acquisition in 1995. Industrial rental income for the year ended December 31, 1995 included $192,000 related to the 1995 industrial acquisition.
Multifamily rental income increased by $5,961,000 or 31%, from $18,937,000 in 1994 to $24,898,000 in 1995. This increase was primarily attributable to the acquisition of twelve multifamily properties containing 1,736 apartment units in 1995 offset by the disposition of four multifamily properties containing 1,085 apartment units during the last quarter of 1995. Multifamily rental income for the year ended December 31, 1995 included $3,990,000 related to the twelve multifamily acquisitions and $5,987,000 related to the four multifamily properties sold during the last quarter of 1995.
As a result of these changes, total revenues increased by $10,947,000, or 42% from $26,144,000 in 1994 to $37,091,000 in 1995.
Industrial rental property expenses increased by $1,026,000, or 67%, from $1,541,000 in 1994 to $2,567,000 in 1995. This increase was primarily attributable to the acquisition of three industrial parks during the last half of 1994 and one industrial acquisition in 1995. Industrial rental property expenses for the year ended December 31, 1995 included $25,000 related to the 1995 industrial acquisition.
Multifamily rental property expenses increased by $1,380,000, or 16%, from $8,835,000 in 1994 to $10,215,000 in 1995. This increase was primarily attributable to the acquisition of twelve multifamily properties containing 1,736 apartment units in 1995. Multifamily rental property expenses for the year ended December 31, 1995 included $1,779,000 related to twelve multifamily properties acquired during 1995 and included $2,403,000 related to the four multifamily properties sold during the last quarter of 1995.
Depreciation increased by $2,360,000, or 63%, from $3,721,000 in 1994 to $6,081,000 in 1995. The increases relate primarily to the acquisition of the twelve multifamily properties in 1995, the three industrial properties acquired in late 1994, and the capital improvements made to rehabilitate existing properties.
Interest expense (including amortization of financing costs) increased by $5,902,000, or 72%, from $8,164,000 in 1994 to $14,066,000 in 1995. This increase was attributable to increased borrowings outstanding during 1995, as compared to 1994, pursuant to new borrowings of $55,517,000 relating to the acquisition of twelve multifamily properties and one industrial park during the last half of 1995 and $24,850,000 of tax-exempt mortgage indebtedness assumed with the Company's recent acquisitions. Interest resulting from the amortization of financing costs increased by $386,000 or 62% from $623,000 in 1994 to $1,009,000 in 1995. This increase is attributable primarily to the additional amortization relating to the convertible subordinated debentures issued on February 18, 1994 and accordingly being outstanding for the entire year in 1995 and amortization of loan fees associated with borrowings used to finance acquisitions completed during late 1994 and 1995.
General and administrative expenses increased by $698,000, or 40%, from $1,725,000 in 1994 to $2,423,000 in 1995. This increase was primarily attributable to personnel increases related to the 1994 and 1995 acquisitions made during the second half of each year, respectively.
For the year ended December 31, 1995, the Company incurred net income of $8,403,000 compared with a net loss of $832,000 in 1994. These improved results are attributable to the foregoing, a $6,664,000 net gain in 1995 from the sale of four multifamily properties located in Texas (See Part IV -- Financial Statements) and a $2,990,000 loss from the extinguishment of debt in 1994 relating to the acquisition of certain of the properties from Realty.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Company had $1,466,000 of cash to meet its immediate short-term liquidity requirements. Future short-term liquidity requirements are anticipated to be met through the net cash flow from operations, existing working capital and, if necessary, funding from the Company's Line of Credit and unsecured bridge loan agreement.
The Company anticipates that adequate cash will be available to fund its operating and administrative expenses, continuing debt service obligations and the payment of dividends in accordance with REIT requirements in the foreseeable future.
Cash provided by operating activities increased from $7,138,000 for the year ended December 31, 1995 to $8,523,000 for the year ended December 31, 1996 and $27,684,000 for the year ended December 31, 1997. The primary reason for these increases related to the additional rental income contributed by properties acquired during 1995, 1996 and 1997.
Cash used in investing activities decreased from $84,480,000 for the year ended December 31, 1995 to $81,918,000 for the year ended December 31, 1996 and then increased to $350,597,000 for the year ended December 31, 1997 primarily as a result of acquisitions and improvements to properties which decreased from $113,663,000 in 1995 to $87,442,000 in 1996, and then increased to $332,324,000 in 1997, offset by $29,183,000 of proceeds from the sale of the four multifamily properties located in Texas in 1995, $7,695,000 from the sale of land and an industrial building to an existing tenant in 1996, and $15,115,000 from the sale of a multifamily community in Oregon in 1997, respectively.
Cash provided by financing activities decreased from $76,674,000 for the year ended December 31, 1995 to $72,071,000 for the year ended December 31, 1996 and then increased to $322,804,000 for the year ended December 31, 1997 primarily as a result of reduced borrowing activity associated with acquisitions in 1996 compared to 1995, the issuance of common stock in 1996 and 1997 and the issuance of preferred stock in 1997.
In order to qualify as a REIT for federal income tax purposes, the Company is required to make distributions to its shareholders of at least 95% of REIT taxable income. The Company expects to use its cash flow from operating activities for distributions to shareholders and for payment of other expenditures. The Company intends to invest amounts accumulated for distribution in short-term investments.
Line of Credit and Bridge Loan
The Company's Line of Credit has a maximum commitment amount of $65,000,000 and expires in July, 1998. As of December 31, 1997, the Company had borrowed $17,200,000 under this line.
Subsequent to year-end, the Company entered into an agreement with a lender for a $40 million unsecured bridge loan. The unsecured bridge loan agreement has an expiration date of April 30, 1998 and bears interest at a rate of LIBOR plus 1.25%. Proceeds from the unsecured loan agreement will be used for acquisitions and general corporate purposes.
The Company and its lenders are currently negotiating the terms of a new unsecured credit facility. Terms being negotiated include an increase in the maximum loan amount, a decrease in the interest rate spread, extension of the term of the facility and conversion of the Line of Credit facility to an unsecured facility. There can be no assurance that any such terms will be agreed to by the lenders.
Acquisitions
During 1997, the Company invested $332,324,000 in real estate assets. Proceeds for these investments were generated primarily by: a public offering in January 1997 which generated gross proceeds, including exercise of the underwriter's over-allotment option, of approximately $47,200,000; a public offering of Common Stock in June 1997 which generated gross proceeds, including exercise of the underwriter's over-allotment, of approximately $44,800,000; a public offering in November 1997 which generated gross proceeds, including over-allotment, of approximately $99,108,000; a public offering in December 1997 which generated
gross proceeds of approximately $20,000,000; and the issuance of Class A Preferred Shares and Class B Preferred Shares at various times throughout the year, which generated gross proceeds of $55,000,000. (See Part I -- Item 1, 1997 Developments.)
Subsequent to year-end, the Company acquired three additional properties (i) a 140,000 square foot industrial park in Upland, California for $5,100,000, (ii) a 125,000 square foot multi-tenant industrial park located in Chatsworth, California for $7,565,000 and (iii) a 300,000 square foot industrial center in Las Vegas, Nevada for $14,100,000. All of these 1998 industrial acquisitions were financed with borrowings from the Company's new unsecured bridge loan agreement.
The Company intends to acquire additional properties and may seek to fund these acquisitions through proceeds received from a combination of its Line of Credit, bridge loan, equity offerings or debt financings.
Debt Financings
Tax-exempt Projects. The company has established a pool agreement with the Federal National Mortgage Association ("FNMA") to provide 30-year credit enhancement on the Company's tax-exempt projects. In June 1997, in conjunction with the Company's admission into the partnerships that own the Terrace Gardens and Morning View Terrace apartment communities, the partnerships refinanced their existing tax-exempt bond financing of $19,100,000 through the FNMA facility. The effective interest rate on the bonds, after giving effect to credit enhancement and other costs, has been fixed at 6.4% for 10 years.
The Company also received from FNMA a forward commitment expiring December 1, 1998, to provide credit enhancement for the Fountains Senior Apartments that the Company is currently developing. The commitment is subject to the completion of the project and the property achieving certain lease up and operating requirements. The effective interest rate on the currently outstanding bonds in this commitment, after giving effect to credit enhancement and other costs, has been fixed at 6.4% for 10 years.
Property Refinancings. In October 1997, the Company borrowed $34,000,000 at an interest rate of 7.11% for a term of 10 years. The proceeds of this loan were used to repay $33,600,000 of indebtedness under the Company's Line of Credit. The loan is secured by five warehouse/distribution centers acquired by the Company in July 1997.
Convertible Subordinated Debentures
At December 31, 1997 the Company's outstanding convertible subordinated debentures total $12,592,000, net of unamortized discount of $102,000. Conversion of all the outstanding debentures, which are convertible into common shares at a rate of 53.6986 common shares of Common Stock per $1,000 of principal amount of debentures, would require the issuance of an additional 681,650 common shares. If the debentures were fully converted, the net income attributable to each common share would not be diluted. During 1997, $1,743,000 in aggregate principal amount of debentures ($1,635,000 net of discount) were converted into 93,564 shares of Common Stock.
Shelf Registrations
During 1997, the Company filed a shelf registration statement with the Securities and Exchange Commission for an aggregate amount of $250,000,000, covering the proposed issuance of debt, preferred or common stock securities and warrants to purchase securities of the Company (the "1997 Shelf Registration Statement"). The 1997 Shelf Registration statement was declared effective April 11, 1997. At December 31, 1997, the Company has $56,126,000 available under the 1997 Shelf Registration Statement.
On February 4, 1998, the Company filed a new shelf registration statement on Form S-3 covering a maximum aggregate offering price of $300,000,000 of the Company's Common Stock, Preferred Stock, debt securities and warrants to purchase such securities. It is anticipated that this filing will be declared effective in April of 1998.
Year 2000 Compliance
The Company has recognized the need to ensure that its systems, equipment and operations will not be adversely impacted by the change to the calendar year 2000. As such, the Company has taken steps to identify potential areas of risk and has begun addressing these in its planning, purchasing and daily operations. The total cost of converting all internal systems, equipment and operations into the year 2000 has not been fully quantified, but it is not expected to be a material cost to The Company. The Company does not anticipate any material adverse impact resulting from the failure of third party service providers and vendors to prepare for the year 2000. The Company continues to monitor those risks and is attempting to receive compliance certificates from all third parties that have a material impact on the Company's operations.
Capital Expenditures
The Company capitalizes the direct and indirect cost of expenditures for the acquisition or rehabilitation of its multifamily and industrial properties. The Company also capitalizes the direct cost of capital expenditures that are considered revenue producing ("Revenue Producing") and other expenditures that increase the service life of the Company's properties ("Restorations").
Revenue Producing expenditures are improvements which significantly increase the revenue-producing capability of the asset including tenant improvements at industrial properties, installation of washers and dryers at multifamily properties, and other value-added additions.
Rehabilitation expenditures are costs the Company determines are necessary during the due diligence phase immediately preceding the acquisition of a property. At newly acquired properties, the Company often finds it necessary to upgrade the physical appearance of such properties and to complete the maintenance and repair work that had been deferred by prior owners.
Restorations are nonrevenue-producing capital expenditures which recur on a regular basis, and have estimated useful lives of more than one year.
Make ready costs incurred after a property's rehabilitation, such as carpet and appliance replacement, interior painting and window coverings are expensed.
The following table summarizes capital expenditures incurred by the Company for the years ended December 31, 1997 and 1996 (all amounts are in thousands):
The Company anticipates incurring similar capital expenditures in 1998. The Company expects such expenditures will be funded from available cash balances, revolving lines of credit, equity offerings, and proceeds from refinancing.
ECONOMIC CONDITIONS
All of the Company's leases on its Multifamily Properties are for a period of one year or less. Substantially all of the Company's leases on its Industrial Properties, which have terms generally ranging from one to five years, contain provisions providing for rental increases based either on fixed increases or on increases in the Consumer Price Index. Management believes the nature of its multifamily leases and the provisions contained in its industrial leases that provide for increases in the tenants' base rent tend to mitigate the adverse impact of inflation.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Index to Financial Statements for a listing of the financial statements and supplementary data filed with this report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
The information required by this item is hereby incorporated by reference from the Proxy Statement under the caption "Election of Directors -- Nominees" and "Officers and Key Employees."
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is hereby incorporated by reference from the Proxy Statement under the caption "Officers and Key Employees -- Compensation."
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is hereby incorporated by reference from the Proxy Statement under the caption "Security Ownership of Certain Beneficial Owners and Management."
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND OTHER TRANSACTIONS
The information required by this item is hereby incorporated by reference from the Proxy Statement under the caption "Certain Transactions."
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report
1. Financial Statements. See Index to Financial Statements.
2. Financial Statement Schedule. See Index to Financial Statements.
3. Exhibits. See Exhibit Index on pages 33 and 34.
(b) Reports on Form 8-K.
The Company filed a report on Form 8-K filed December 23, 1997, under item 5 and 7 reporting the sale of 874,317 shares of common stock.
The Company filed a report on Form 8-K filed December 18, 1997, under item 2, 5 and 7 reporting the acquisition of California Commerce Parks portfolio,Bradshaw Business Center, Horn Road Business Com-
plex, Fullerton Business Center, Norwood Industrial Parks and the possible acquisition of an industrial portfolio.
The Company filed a report on Form 8-K filed November 21, 1997, under item 2, 5 and 7 reporting the issuance of 4,250,000 shares of its common stock (plus 637,500 shares of common stock issuable upon the exercise by the underwriters of an over-allotment option).
The Company filed a report on Form 8-K filed November 18, 1997, under item 2, 5 and 7 reporting the acquisition of a Eden Plaza/Eden Industrial, the possible acquisition of a business park portfolio, and a common stock offering for the issuance of 4,250,000 shares of its common stock.
The Company filed a report on Form 8-K filed October 31, 1997, under item 2, 5 and 7 reporting the probable acquisition of a Eden Plaza/Eden Industrial and other possible property acquisitions.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
PACIFIC GULF PROPERTIES INC.
By: /s/ GLENN L. CARPENTER ------------------------------------ Glenn L. Carpenter Chairman of the Board of Directors President and Chief Executive Officer
By: /s/ DONALD G. HERRMAN ------------------------------------ Donald G. Herrman Executive Vice President, Secretary, and Chief Financial Officer (Principal Financial and Accounting Officer)
Date: March 30, 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 Company and in the capacities and on the date indicated.
PACIFIC GULF PROPERTIES INC.
INDEX TO FINANCIAL STATEMENTS AND SCHEDULE
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Shareholders Pacific Gulf Properties Inc.
We have audited the accompanying consolidated balance sheets of Pacific Gulf Properties Inc. as of December 31, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. Our audits also included the financial statement schedule listed in the Index on page. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Pacific Gulf Properties Inc. at December 31, 1997 and 1996, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
ERNST & YOUNG LLP
Newport Beach, California February 13, 1998
PACIFIC GULF PROPERTIES INC.
CONSOLIDATED BALANCE SHEETS
See accompanying notes.
PACIFIC GULF PROPERTIES INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying notes.
PACIFIC GULF PROPERTIES INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
See accompanying notes.
PACIFIC GULF PROPERTIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes.
PACIFIC GULF PROPERTIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Pacific Gulf Properties Inc. is incorporated in Maryland and operates as a real estate investment trust ("REIT") under the Internal Revenue Code of 1986, as amended. Pacific Gulf Properties Inc. commenced operations on February 18, 1994 upon the completion of its initial public offerings and consummation of certain formation transactions.
Basis of Presentation
The consolidated financial statements include the accounts of Pacific Gulf Properties Inc., and all subsidiaries and partnerships over which it has control (the "Company"). The Company's controlled partnerships and subsidiaries include PGP Inland Communities, L.P., PGP -- Terrace Gardens Holdings Inc., PGP -- Morning View Terrace Holdings Inc., PGP Northern Industrial, L.P., Pacific Inland Communities LLC and PGP Von Karman Properties Minority interests represent the ownership interests of outside limited partners in certain of the partnerships controlled by the Company. All intercompany accounts and transactions have been eliminated in consolidation.
Real Estate Assets
Real estate assets consist of operating properties and properties under development. Operating properties are held for investment and stated at cost less accumulated depreciation. Cost includes the cost of land and completed buildings and related improvements. Expenditures that increase the service life of properties are capitalized; the cost of maintenance and repairs is charged to expense as incurred. Depreciation is generally provided on a straight-line basis over the estimated useful lives of the buildings and improvements, ranging primarily from 15 to 40 years. When depreciable property is retired or disposed of, the related costs and accumulated depreciation are removed from the accounts and any gain or loss reflected in operations.
Properties under development are stated at cost. The cost of development includes land and infrastructure costs, direct and indirect construction costs and carrying costs including interest and taxes, all of which are capitalized as incurred. Land acquisition and infrastructure costs are allocated to properties based on relative fair value. Interest and property taxes are capitalized to properties while development activities are in progress. When a project or property under development is completed, all related holding and operating costs are expensed or incurred.
Impairment losses are recorded on long-lived assets used in operations and properties under development when indicators of impairment are present and the assets' carrying amount is greater than the sum of the future undiscounted cash flows, excluding interest, estimated to be generated by those assets. As of December 31, 1997, no indicators of impairment existed and no impairment losses have been recorded.
Cash and Cash Equivalents
Certificates of deposit and short-term investments with remaining maturities of three months or less when acquired are considered cash equivalents.
Financing Costs
Financing costs are included in other assets and consist of loan fees, other loan costs and deferred debenture costs. Loan fees and other loan costs are amortized over the term of the respective loan. Costs relating to the convertible subordinated debentures offering are amortized over the term of the debentures using a method that approximates the effective interest method. Amortization of financing costs is included in interest expense.
PACIFIC GULF PROPERTIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Concentration of Credit Risk
Financial instruments that potentially subject the Company to a concentration of credit risk are primarily cash investments and accounts receivable from tenants. Cash is generally invested in investment-grade short- term instruments and the amount of credit exposure to any one commercial issuer is limited. Concentration of credit risk with respect to accounts receivable from tenants is limited. The Company performs credit evaluations of prospective tenants and security deposits are also obtained.
Fair Value of Financial Instruments
The carrying amounts of the Company's short-term investments and loans payable approximate their fair values as of December 31, 1997.
The fair value as of December 31, 1997 of the Company's convertible subordinated debentures, based on the closing price of the debentures on the last trading day in 1997 on the American Stock Exchange, was $13,329,000.
Dividend Reinvestment Plan
During the years ended December 31, 1997 and 1996, the Company issued 1,225 and 1,900 shares, respectively, under the Company's Dividend Reinvestment Plan.
Rental Income
Rental income from multifamily leases is recognized when due from tenants. Apartment units are rented under lease agreements with terms of one year or less.
Rental income from industrial leases is recognized on a straight-line basis over the related lease term. As a result, deferred rent is created when rental income is recognized during free rent periods of a lease. The deferred rent is included in other assets, evaluated for collectibility and amortized over the lease term.
Interest
Interest incurred (net of interest income) for the years ended December 31, 1997, 1996 and 1995 totaled $19,469,000, $18,626,000 and $14,026,000, respectively. Interest incurred in 1997, 1996 and 1995 includes $1,100,000, $4,720,000 and $4,736,000 related to the Company's convertible subordinated debentures (Note 4).
For the years ended December 31, 1997 and 1996, the Company capitalized $2,132,000 and $215,000 of interest related to properties under development.(Note 2).
Interest paid for the years ended December 31, 1997, 1996 and 1995 totaled $18,932,000, $18,803,000 and $11,785,000, respectively. In December 1996, the Company exchanged $42,069,000 in principal amount of convertible subordinated debentures in connection with the Company's tender offer (filed on December 11, 1996 with the Securities and Exchange Commission) to induce early conversion of its convertible subordinated debentures (Note 4). As a result, $1,282,000 of interest was paid to the debenture holders upon conversion; had the conversion not occurred, interest would have been paid to debenture holders in 1997.
Gain on Sale of Real Estate
Gains on sale of real estate are recognized by the Company when title to the real estate passes to the buyer, an adequate down payment is received, the collectibility of notes received from buyers is reasonably assured, and all other conditions necessary for profit recognition have been satisfied.
PACIFIC GULF PROPERTIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Income Taxes
The Company has elected to be taxed as a REIT. As a REIT, the Company is generally not subject to income taxes. To maintain its REIT status, the Company is required to distribute annually as dividends at least 95% of its REIT taxable income, as defined by the Internal Revenue Code, to its shareholders, among other requirements.
Per Share Data
The Company has adopted and reported earnings per share giving effect to the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 128 ("Statement No. 128")which requires the calculation and disclosure of basic and diluted earnings per share including a reconciliation of the weighted average shares utilized in the calculations. All earnings per share amounts for all periods presented reflect basic and diluted earnings per share and have been restated from the previous standard of primary and fully diluted earnings per share. See Note 10 for the disclosure requirements related to the computations and reconciliations of earnings per share amounts pursuant to Statement No. 128.
Use of Estimates
The preparation of the Company's financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of the assets and liabilities as of December 31, 1997 and 1996 and revenues and expenses for each of the three years in the period ended December 31, 1997. Actual results could differ from those estimates in the near term.
Recently Issued Accounting Standards
The Financial Accounting Standards Board has issued Statement No. 131, "Disclosures about Segments of an Enterprise and Related Information", which is required to be adopted on December 31, 1998. At that time, the Company will be required to report certain information about its operating segments, its products and services, the geographic areas in which the Company operates and its major customers. The Company's current financial statements include substantial information relating to its two operating segments: industrial and multifamily. The Company does not believe the additional requirements will have a significant impact on its disclosures.
Reclassifications
Certain prior year financial statement amounts have been reclassified to conform to the current year presentation.
PACIFIC GULF PROPERTIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. REAL ESTATE ASSETS
The Company's real estate assets consist of the following at December 31:
OPERATING PROPERTIES
OPERATING PROPERTIES
Industrial Properties
At December 31, 1997, the Company owns and operates 49 industrial properties containing an aggregate of 10,676,000 leasable square feet located in the states of California and Washington. During 1997, the Company purchased 27 industrial properties located in California and Washington containing an aggregate of 5,776,000 leasable square feet.
The Company's industrial properties are leased to tenants under operating leases with terms ranging from 1 to 5 years. The minimum future lease payments to be received from noncancelable industrial leases for each of the next five years ending December 31 and thereafter, are as follows:
PACIFIC GULF PROPERTIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Multifamily Properties
At December 31, 1997, the Company owns and operates 24 multifamily properties containing 4,655 apartment units located in Southern California and the Pacific Northwest. During 1997, the Company purchased three active senior multifamily properties containing 824 apartment units located in Southern California and sold a 279 unit multifamily property in Oregon. (Note 9.)
PROPERTIES UNDER DEVELOPMENT
PROPERTIES UNDER DEVELOPMENT
Industrial Properties
In April 1997, the Company completed the rehabilitation of an industrial property containing approximately 327,000 leasable square feet located in the City of Industry, California. Rehabilitation costs for this property were $1,652,000.
In 1997, the Company commenced development of four industrial properties that will contain approximately 578,000 leasable square feet, and the rehabilitation of two industrial properties containing approximately 639,000 leasable square feet, all of which are located in Southern California and Washington. Development and rehabilitation costs for these properties totaled $1,678,000 and $2,079,000, respectively through December 31, 1997.
Multifamily Properties
In 1996, the Company commenced development of a 166 unit multifamily property for active seniors located in the master planned community of Rancho Santa Margarita, California (Fountains Senior Apartments). The cost incurred for the year ended December 31, 1997 and 1996 totaled $5,205,000 and $2,171,000, respectively.
PACIFIC GULF PROPERTIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. LOANS PAYABLE
The Company's loans payable at December 31, 1997 and 1996 consist of the following:
Mortgage Notes
At December 31, 1997, the Company's conventional mortgage debt consists of 20 notes which are secured by multifamily and industrial properties, due in monthly installments and maturing at various dates through September 2025. Certain of the Company's conventional mortgage note agreements contain cross- collateralization provisions (see schedule III). Approximately $182,320,000 or 17 conventional mortgage notes bear fixed rates of interest ranging from 7.05% to 8.75% per annum. The remaining three conventional mortgage notes totaling $6,129,000 bear a variable rate of interest based on the Federal Home Loan Bank 11th District Rate plus 2.8%. The weighted average interest rate of the Company's conventional mortgage debt at December 31, 1997 was 7.78%. During the year ended December 31, 1997, the Federal Home Loan Bank 11th District Rate ranged from 4.76% to 4.94% and was 4.94% at December 31, 1997.
At December 31, 1997, the Company's tax-exempt mortgage debt consists of seven notes totaling $59,778,000 that are secured by nine multifamily properties. The Company's tax-exempt mortgage debt includes five notes originated as part of refinancings described in the following paragraph. The weighted average interest rate of the Company's tax-exempt mortgage notes, all of which bear fixed rates of interest, at December 31, 1997, was 6.27%.
The Company entered into a 30 year refunding agreement for all of its outstanding tax-exempt mortgage debt that closed in January 1997. As a result of the agreement, which is backed by credit and liquidity support from guaranteed mortgage pass-through certificates issued by the Federal National Mortgage Association ("FNMA"), the Company obtained three new loans from municipalities, the proceeds of which were funded from new tax-exempt mortgage bond financings of $24,850,000 maturing in January 2007. Standard & Poor's Rating Group assigned a rating of AAA to the bonds based on the collateral agreement with FNMA. Monthly principal and interest payments will be made on the loans to a trustee, which in turn will pay the bondholders when interest is due. The bonds will be remarketed periodically and will bear interest at fixed rates scheduled to increase from 3.75% to 5.20% through 2007. Principal payments will be amortized based on scheduled amounts over a 30-year period. As part of the refunding agreement, the Company is required to deposit impounds for property taxes, property and liability insurance and reserves for capital replacements on a semiannual basis with the trustee. Unamortized finance costs and fees related to the refinancing are included in other assets and totaled $1,484,000 and $1,451,000 at December 31, 1997 and 1996, respectively.
In June 1997, in conjunction with the Company's admission into the partnerships that own the Terrace Gardens and Morning View Terrace apartment communities (Note 6), the partnerships refinanced their existing tax-exempt notes and the related bond financing of $19,100,000 through the FNMA facility. The effective interest rate on the bonds, after giving effect to credit enhancement and other costs, has been fixed at 6.4% for 10 years.
PACIFIC GULF PROPERTIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Construction Loans
At December 31, 1997 the Company has three construction loans, which are payable to a bank, and are secured by a multifamily property for active seniors (The Fountains) and two industrial properties under development. The construction loans bear interest at the bank's prime rate payable monthly and mature between August and November 1998. Undisbursed funds on the construction loans at December 31, 1997 total $3,238,000. Upon completion of the properties, the Company has the option to convert the interest rate on the loans into a fixed rate of interest upon meeting certain conditions. At December 31, 1997, the prime rate was 8.5%.
The Company has a forward commitment from FNMA expiring December 1, 1998 related to the Fountains which is under development at December 31, 1997. The commitment is subject to the property achieving certain lease ups and operating requirements.
Revolving Line of Credit and Bridge Loan
The revolving line of credit as of December 31, 1997, which is payable to a bank, is secured by certain of the Company's real estate properties and matures in July, 1998. Under the terms of this revolving bank line of credit, the Company may borrow up to $65,000,000 at the London Interbank Offered Rate (LIBOR) plus 1.75%. For the year ended December 31, 1997, the weighted average interest rate of the revolving line of credit was 7.7%. At December 31, 1997, the LIBOR was 5.7%.
The Company's revolving line of credit agreement contains certain debt covenants. The most significant covenants require the Company to maintain a minimum tangible net worth, an interest coverage ratio in excess of 1.50 (measured as a four quarter trailing average) and a fixed charge coverage ratio of not less than 1.35. In addition, the revolving line of credit agreement contains a provision restricting the payment of dividends not to exceed Funds Available for Distribution (defined as the National Association of Real Estate Investment Trusts' Funds from Operations -- Old Definition less an agreed-upon amount of imputed capital expenditures) measured based on four consecutive quarters. As of December 31, 1997, the Company was in compliance with all debt covenants.
Subsequent to December 31, 1997, the Company entered into an unsecured bridge loan agreement with a bank. The loan, which has a commitment of $40,000,000, expires on April 30, 1998 and bears an interest rate of LIBOR plus 1.25%.
Interest Rate Swap Agreements
The Company has entered into interest rate swap agreements that effectively convert certain floating rate mortgage notes to a fixed-rate basis, thus reducing the impact on future earnings of fluctuations in interest rates. At December 31, 1997, the Company had interest rate swap agreements on notional amounts totaling $34,500,000 under which the Company pays fixed rates of interest and receives floating rates of interest based on an index that is reset weekly. The swap counterparties are all financial institutions rated AAA by Standard & Poor's. The rate differences to be paid or received are accrued and included in interest expense as a yield adjustment and the related payable or receivable from counterparties is included in accrued liabilities or other assets.
PACIFIC GULF PROPERTIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Loans Payable Maturities
Principal payments due on loans payable as of December 31 are as follows:
4. CONVERTIBLE SUBORDINATED DEBENTURES
At December 31, 1997 and 1996, outstanding convertible subordinated debentures totaled $12,592,000 and $14,227,000, net of unamortized discount of $102,000 and $210,000, respectively. The Company's debentures, which were issued in an aggregate principal amount of $56,551,000, bear interest at 8.375% annually (payable in semiannual installments due in February and August of each year), and mature in February 2001. The Company's convertible subordinated debentures are convertible into common shares at any time prior to maturity at the original conversion rate of 53.6986 common shares per $1,000 of debenture principal subject to certain restrictions (including ownership limits and other adjustments more fully described in the debentures' indenture agreement). In addition, the debentures are subordinate to all senior indebtedness of the Company and are redeemable by the Company, at their outstanding principal amount, at any time after February 15, 1999.
During 1997 and 1996, $1,743,000 and $42,114,000 in aggregate principal amount of debentures were converted into shares of common stock, including $42,069,000 exchanged in December 1996 in connection with the Company's tender offer to induce early conversion of its convertible subordinated debentures. Pursuant to the Company's offer, the debentures tendered were exchanged at the rate of 58 shares of common stock for each $1,000 debenture principal or 4.3014 shares in excess of the original conversion rate (the "excess common shares"). As part of the exchange, the Company issued a total of 2,440,002 common shares, and recognized a nonrecurring loss of $3,596,000 for the year ended December 31, 1996 directly associated with the issuance of 180,956 excess common shares at a price of $19.875 per share, the market price of the shares on the date of the exchange.
The debenture discount is amortized to expense producing an effective interest rate of 8.76%. Costs capitalized upon issuance of the debentures are included in other assets net of related amortization and conversions. Deferred debenture costs totaled $3,005,000 upon issuance of which $1,317,000 has been amortized to expense and $1,386,000 has been charged to additional paid in capital related to conversions of debentures into common stock through December 31, 1997. At December 31, 1997, unamortized deferred debenture costs included in other assets totaled $302,000.
At December 31, 1997, the Company was in compliance with the debenture covenants which impose certain restrictions on the payment of dividends by the Company in the event of certain defaults, except when the Company is required to pay such dividends in order to maintain its REIT status.
5. BENEFIT PLANS
1993 Share Option Plan
The Company has a share option plan to provide incentives to attract and retain officers and employees (the "1993 Share Option Plan"). The 1993 Share Option Plan provides for grants of stock options to purchase
PACIFIC GULF PROPERTIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
a specified number of shares of Common Stock, awards of restricted common shares and grants of stock appreciation rights. The total number of shares available for the 1993 Share Option Plan for such purposes is 1,050,000 common shares (150,000 of which have been reserved for awards to non-employee directors).
Stock Options
The Stock options listed in the table below primarily vest in equal installments over a five-year period from the date of the grant and expire ten years from the original grant date.
Pursuant to Statement No. 123, Accounting and Disclosure of Stock-Based Compensation, issued in October 1995, the Company applies the methodology prescribed by APB Opinion 25 and related interpretations to account for outstanding stock options. Accordingly, no compensation cost has been recognized in the financial statements related to stock options awarded to officers, directors and employees under the 1993 Share Option Plan. As required by Statement No. 123, for disclosure purposes only, the Company has measured the amount of compensation cost which would have been recognized related to stock options had the fair value of the options at the date of grant been used for accounting purposes. Based on such calculations, net income and earnings per share amounts would be approximately the same as the amounts reported by the Company. The Company estimated the fair value of the stock options at date of grant using a Black-Scholes option pricing model with the following weighted average assumptions: risk-free interest rate of 5.59%; a dividend yield of 7.07%; a volatility factor for the market price of the Company's common stock of 0.126; and a weighted average expected life of 8.7 years for the stock options.
Restricted Stock Awards
The Company awards restricted stock to its employees for compensation purposes. Compensation expense related to restricted stock awards is measured based on the market price of the stock on the date of the grant, and is expensed ratably over the vesting period of each award with the unamortized portion reflected as outstanding restricted stock in the shareholders' equity section in the Company's balance sheets.
The restricted stock awards listed in the table below were awarded to employees based on performance and vest over periods ranging between one to seven years.
PACIFIC GULF PROPERTIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In June 1995, the Company issued 56,300 shares of restricted stock to certain employees to replace substantially all of its liability to those employees accrued under deferred compensation agreements. The 56,300 shares of Common Stock issued vest over five to twelve years and the Company's original obligation to the employees will be satisfied through dividends and targeted appreciation in the value of the shares. At the time the shares were granted, the market price of the stock was $15.75 per share.
At December 31, 1997 and 1996, the unamortized amount of outstanding restricted stock issued to employees which will be charged to compensation expense in future periods totaled $818,000 and $877,000, respectively.
Thrift Plan
The Company has a thrift plan under which employees may elect to contribute up to 21% of their annual compensation, excluding bonuses, on a combination before-and-after tax basis. Contributions by the employee are matched by the Company at a 75% rate with total matching contributions not exceeding 4 1/2% of the contributing employee's annual compensation up to a maximum of 6% of compensation. Matching contributions are in the form of cash, which is used by the trustee to purchase shares of the Company's common stock. Employee contributions are invested in a fixed income fund, various growth funds, or a combination thereof, according to the employee's choice. The thrift plan provides for 20% vesting of contributions by the Company for each full year of service, increasing to 100% vesting after five years of service. Contributions made by the Company to the thrift plan for the years ended December 31, 1997, 1996 and 1995 totaled $29,000, $58,000 and $50,000 respectively.
Retirement Income Plan
The Company has a defined benefit retirement plan for full time employees who are at least 21 years of age with one or more years of service. Plan assets consist of investments in a life insurance group annuity contract. Plan benefits are based primarily on years of service and qualifying compensation during the final years of employment. Funding requirements comply with federal requirements that are imposed by law. The information set forth below relates to the Company's retirement income plan.
The Company's net periodic pension cost includes amortization of past service cost over a remaining period of 27 years. Based upon actuarial valuation dates as of December 31, 1997 and 1996, the present values of accumulated plan benefits were $833,000 and $570,000 (calculated using a discount rate of 7% in 1997 and 7.5% in 1996), respectively, and the plan's net assets available for benefits were $704,000 in 1997 and $531,000 in 1996.
PACIFIC GULF PROPERTIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company's net periodic pension cost for the years ended December 31, 1997, 1996, and 1995 are included in the following components:
The following table sets forth the funded status of the Company's retirement income plan and the related amounts recognized in the December 31, 1997 and 1996 consolidated balance sheets:
Actuarial present value of accumulated benefit obligations as of December 31:
Assumptions used in determining the status of the Company's retirement income plan are as follows:
Deferred Compensation Agreements
Prior to 1995, defined benefit deferred compensation agreements provided selected management employees with a fixed benefit at retirement. The plan benefits were based primarily on years of service and qualifying compensation during the final years of employment. In conjunction with its initial public offerings, the Company assumed the deferred compensation obligations attributable to employees who were previously employed by its predecessor. During 1995, the deferred compensation agreements were substantially replaced with restricted stock. (See "Restricted Stock Awards.")
PACIFIC GULF PROPERTIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. CONSOLIDATED REAL ESTATE PARTNERSHIPS
The Company's consolidated partnerships include the following:
PGP Inland Communities LP
PGP Inland Communities, L.P., a Delaware limited partnership (the "Partnership") was formed by the Company in August 1995 for the purpose of acquiring and operating 11 multifamily properties consisting of 1,368 apartment units located in Southern California (the "Properties") which were contributed by unrelated parties. In exchange for contributing the Properties to the Partnership, the unrelated parties received approximately 225,452 limited partnership units representing an initial ownership interest of approximately 22%. The Company is the sole general partner in the Partnership and currently holds an ownership interest of approximately 79%. The terms of the Partnership agreement provide that all net income (and cash flow) from the Properties are to be allocated (distributed) to the Company until the Properties have achieved a threshold net operating income of $6,200,000 for any given year, and cumulatively for all prior years. The Partnership's results of operations since 1995 have been fully allocated to the Company. As of December 31, 1997, limited partnership units can be tendered for redemption on a one-for-one basis at the election of the Company for cash or exchange for shares of common stock. As of December 31, 1997, 8,690 of these units have been tendered for cash, the cost of which has been capitalized to real estate assets.
Terrace Gardens -- PGP L.P. and Morning View Terrace -- PGP L.P.
In June 1997, the Company, through its subsidiaries, PGP Terrace Gardens Holdings Inc. and PGP Morning View Terrace Holdings Inc., acquired a controlling general partnership interest in two existing limited partnerships ("Terrace Gardens" and "Morning View") that own two adjacent active seniors apartment communities located in Escondido, California. The properties contain an aggregate of 551 apartment units. Following the acquisition, the Company became the sole general partner of the existing limited partnerships (Terrace Gardens-PGP L.P. and Morning View Terrace-PGP L.P.) that own and manage the properties. The existing partners of the partnerships received an aggregate of approximately 266,000 units of limited partnership interest in such partnerships valued at $5,596,000. The limited partnership units may be tendered for redemption to the Company any time beginning, in most cases, two years after the closing of the transaction. Upon tender, the Company, at its election, may either issue common shares for the units on a one-for-one basis (subject to certain adjustments) or pay cash for the units based on the then fair market value of the Company's common shares. During 1997, approximately 125,000 units were tendered for cash which was capitalized to the properties. As a result of the tender, the Company currently holds an ownership interest of approximately 58%. Net income from the partnership is allocated to the minority partner based on an amount equal to the dividend rate applied to the number of limited partnership units held and the remaining income is allocated to the Company. Distributions are made to the extent of cash flow available.
PGP Northern Industrial L.P
On October 20, 1997, the Company acquired a controlling general partner interest in a newly-formed California limited partnership ("PGP Northern")which owns two industrial properties ("Eden Plaza/Eden Industrial") containing approximately 501,000 leasable square feet located in Hayward, California for a cash contribution of approximately $3,977,000. The previous owners of Eden Plaza/Eden Industrial became limited partners in PGP Northern and received 143,391 limited partnership units valued at $2,869,000 in exchange for the contribution of the properties. The limited partnership units may be tendered for redemption to the Company any time beginning, in most cases, two years after the closing of the transaction. Upon tender, the Company, at its election, may either issue common shares for the units on a one-for-one basis (subject to certain adjustments) or pay cash for the units based on the then fair market value of the common shares. At December 31, 1997, the Company holds an ownership interest of approximately 59%. Net income from the
PACIFIC GULF PROPERTIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
partnership is allocated to the minority partner based on an amount equal to the dividend rate applied to the number of limited partnership units held and the remaining income is allocated to the Company. Distributions are made to the extent of cash flow available.
Condensed unaudited combined financial information for the consolidated real estate partnerships as of December 31, 1997 and 1996 and for the years ended December 31, 1997 and 1996 follows:
7. COMMITMENTS AND CONTINGENCIES
General Matters
The Company's commitments and contingencies include the usual obligations of real estate owners and operators in the normal course of business. In the opinion of management, these matters will not have a material adverse effect on the Company's consolidated financial statements.
As of December 31, 1997, 7% of the apartment units within the Company's multifamily portfolio were required to be set aside for residents within certain income levels and had limitations on the rent that could be charged to such tenants.
PACIFIC GULF PROPERTIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Ground Lease Commitments
One of the Company's industrial properties is subject to a 57-year ground lease that expires in July 2035 and is accounted for as an operating lease. Monthly ground lease payments total $22,000 and are subject to increases based on the Consumer Price Index each September, with the next adjustment in September 1998. Ground lease payments during 1997 and 1996 totaled $246,000 and $53,000, respectively. Additionally, the Company acquired the "PGBP-Irvine" and "PGBP-Cerritos" industrial properties in December 1997 which are subject to ground leases which expire in August 2029 and April 2034, respectively. Monthly ground lease payments total $25,000 and $38,000 and are subject to increases based on the Consumer Price Index, with the next adjustment in April 1999 and October 1999 for Irvine and Cerritos, respectively. Ground lease payments during 1997 on the Irvine and Cerritos properties totaled $6,700 and $9,800, respectively.
The minimum future ground lease payments to be made for each of the next five years ending December 31, and thereafter, are as follows:
8. CAPITAL STOCK
Shelf Registrations
During 1997, the Company filed a shelf registration statement with the Securities and Exchange Commission for an aggregate amount of $250,000,000, covering the proposed issuance of debt, preferred or common stock securities and warrants to purchase such securities of the Company (the "1997 Shelf Registration Statement"). The 1997 Shelf Registration statement was declared effective April 11, 1997 by the Securities and Exchange Commission. Availability under the 1997 Shelf Registration Statement at December 31, 1997 was $56,126,000. Subsequent to December 31, 1997, the Company filed a shelf registration statement on Form S-3 covering a maximum aggregate price of $300,000,000 in Common Stock, Preferred Stock, debt securities and warrants to purchase such securities.
During 1996, the Company filed a shelf registration statement with the Securities and Exchange Commission for an aggregate amount of $112 million covering the proposed issuance of debt, preferred or common stock securities of the Company (the "1996 Shelf Registration Statement").
1997 Common Stock Offerings
In January 1997, the Company completed a public offering of 2,000,000 shares of common stock (2,300,000 shares after exercise of overallotment option) under the 1996 Shelf Registration Statement at a price of $20.50 per share. Net proceeds from the offering totaled approximately $44,399,000 (net of fees and costs) and were used to acquire two industrial properties and to reduce outstanding indebtedness on the Company's revolving line of credit.
In June 1997, the Company received net proceeds of approximately $42,224,000 (net of fees and costs) from the issuance of 2,131,700 shares of common stock under the 1997 Shelf Registration Statement (including proceeds from the issuance of 31,700 shares of common stock sold pursuant to the exercise of the underwriter's overallotment option) at a price of $21.00 per share. The Company used the proceeds to repay debt and for general corporate purposes.
PACIFIC GULF PROPERTIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In November 1997, the Company received net proceeds of approximately $93,372,000 (net of fees and costs) from the issuance of 4,776,300 shares of common stock under the 1997 Shelf Registration Statement (including proceeds from the issuance of 526,300 shares of common stock sold pursuant to the exercise of the underwriter's overallotment option) at a price of $20.75 per share. The Company used the proceeds to fund the purchase of acquisitions, repay indebtedness outstanding under the Company's line of credit and general corporate purposes.
In December 1997, the Company received net proceeds of approximately $18,899,000 from the issuance of 874,317 shares of common stock under the 1997 Registration Statement at a price of $22.875. The Company used the proceeds to repay indebtedness outstanding under the Company's revolving line of credit and for general corporate purposes.
1996 Common Stock Offerings
In May 1996, the Company completed a public offering of 2,015,581 shares of common stock (2,435,581 shares after exercise of overallotment option) under the 1996 Shelf Registration Statement at a price of $16.375 per share. Proceeds from the offering totaled approximately $36,600,000 (net of fees and costs) and were primarily used to purchase nine industrial properties. Concurrent with the public offering, all of the Company's common stock held by Santa Anita Realty Enterprises was sold to the public.
Exchange of Debentures for Common Stock
In December 1996, the Company issued 2,440,002 shares of common stock under the 1996 Shelf Registration Statement in exchange for the debentures tendered pursuant to the Company's offer to induce early conversion of its convertible subordinated debentures (Note 4).
Preferred Stock
During 1997, the Company issued 1,351,351 shares of Class A Senior Cumulative Convertible Preferred Stock (the "Class A Preferred Shares") to an investor at a price of $18.50 per share pursuant to an agreement entered in December 1996. The Class A Preferred Shares were issued under the 1996 Shelf Registration Statement. The net proceeds which totaled approximately $24,224,000 (net of fees and costs) were used to pay off a portion of a mortgage note, to purchase a portion of an industrial property portfolio, and for general corporate purposes.
The Class A Preferred Shares are convertible into shares of common stock, on a one-for-one basis, subject to adjustment upon certain events. The annual dividend per share on the Class A Preferred Shares is $1.70 from the date of issuance until December 31, 1997 and thereafter, the greater of $1.70 per share or 104% of the then current dividend on the Company's common stock. At its option, the Company may redeem the Class A Preferred Shares beginning December 31, 2001 for cash at a premium of 6% over the initial $18.50 per share liquidation value, decreasing to zero % by December 31, 2009. The Class A Preferred Shares, or any shares of common stock into which such Class A Preferred Shares could be converted, are nontransferable until June 30, 1998.
In May 1997, the Company entered into a second agreement with Five Arrows to issue 1,411,765 shares of Class B Senior Cumulative Convertible Preferred Stock (the "Class B Preferred Shares") at a price of $21.25. On July 18, 1997, the Company, pursuant to this agreement, issued 470,588 shares of Class B Preferred Shares raising net proceeds of $9,014,000 (net of fees and costs). The proceeds were used together with funds from other sources to acquire an industrial portfolio consisting of five industrial properties. On October 23, 1997, the Company, pursuant to this agreement issued 235,294 additional Class B Preferred Shares raising net proceeds of $4,824,000 (net of fees and costs). The net proceeds were used for general corporate purposes. On December 23, 1997, the Company issued the remaining 705,883 Class B Preferred
PACIFIC GULF PROPERTIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Shares pursuant to the Five Arrows agreement and received net proceeds of $14,471,000 (net of fees and costs). The net proceeds were used to purchase a portion of an industrial property portfolio consisting of four industrial properties.
The terms of the Class B Preferred Shares are substantially similar to those of the Class A Preferred Shares, except that (i) the liquidation preference of the Class B Preferred Shares is $21.25 per share (plus accumulated, accrued and unpaid dividends) and (ii) Five Arrows will not be entitled to designate any additional representatives to the Company's Board of Directors while it owns both the Class A Preferred Shares and the Class B Preferred Shares.
9. GAIN ON SALE OF REAL ESTATE
In December 1997, the Company sold an apartment property located in Oregon consisting of 279 apartment units for $15,575,000 and recognized a gain on sale of $5,705,000.
In April 1997, the Company sold its 7,000 square foot Corporate office in Newport Beach, California for $850,000 and recognized a loss on the sale of $111,000. The Company has relocated to a newly acquired 26,000 square foot facility also located in Newport Beach, California.
In August 1996, the Company sold an undeveloped ten-acre parcel and a 55,656 square foot industrial building to an existing tenant pursuant to purchase options contained in the existing lease agreements. In connection with the sale, the Company received consideration totaling $7,695,000 and recognized a gain of $74,000. The rental income received under the existing lease agreements in 1996 totaled approximately $691,000.
In November 1995, the Company sold its Texas apartment portfolio to four entities controlled by the same buyer . The Texas multifamily portfolio consisted of four properties containing 1,085 apartment units in San Antonio, Austin and Houston, and represented the Company's entire holdings in the state of Texas. The Company received consideration totaling $31,125,000: $30,125,000 in cash and four notes receivable totaling $1,000,000. The notes receivable mature in seven years, bear interest at 9%, require monthly interest-only payments and are secured by limited partnership interests in the purchasing entities. The Company recognized a gain utilizing the cost recovery method on the sale of the Texas apartment portfolio totaling $6,664,000 (net of $1,000,000 deferred gain). The deferred gain is presented as a reduction of the notes and is included in accounts and other receivables in the Company's balance sheets.
10. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings (loss) per share which have been restated to comply with Statement No. 128:
PACIFIC GULF PROPERTIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Shares of Senior Cumulative Convertible Preferred Stock, convertible into 2,763,116 shares of Common Stock were outstanding during 1997 but were not included in computing diluted earnings per share. Including these shares in the computation increases earnings per share $.01, and are therefore considered antidilutive. Convertible subordinated debentures convertible into 682,000, 775,000 and 3,037,000 shares of Common Stock were outstanding during 1997, 1996 and 1995, respectively but were not included in the computation of diluted earnings per share because the effect would be antidilutive.
11. SELECTED QUARTERLY DATA (UNAUDITED)
The following tables set forth the quarterly results of operations of the Company for the years ended December 31, 1997 and 1996:
SCHEDULE III
PACIFIC GULF PROPERTIES INC.
REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1997
SCHEDULE III
PACIFIC GULF PROPERTIES INC.
REAL ESTATE AND ACCUMULATED DEPRECIATION -- (CONTINUED) DECEMBER 31, 1997
SCHEDULE III
PACIFIC GULF PROPERTIES INC.
REAL ESTATE AND ACCUMULATED DEPRECIATION -- (CONTINUED)
(a) The changes in total real estate for the years ended December 31, 1997, 1996, and 1995 are as follows:
(b) The changes in accumulated depreciation for the years ended December 31, 1997, 1996 and 1995 are as follows:
(c) These properties collateralize borrowings under the same mortgage note payable totaling $11,703,000.
(d) A portion of this property is currently under development.
(e) These properties collateralize borrowings under the same mortgage note payable totaling $14,625,000.
(f) These properties collateralize borrowings under the Company's revolving bank line of credit that has an outstanding balance of $17,200,000 as of December 31, 1997.
(g) These properties collateralize borrowings under the same mortgage note payable totaling $24,500,000.
(h) These properties collateralize borrowings under the same mortgage note payable totaling $12,000,000.
(i) These properties collateralize borrowings under the same mortgage note payable totaling $4,625,000.
(j) These properties collateralize borrowings under the same mortgage note payable totaling $34,000,000.
(k) Excludes construction loans of $18,425,000.
EXHIBIT INDEX
- ---------------