10-Q 1 a74847e10-q.txt FORM 10-Q QUARTER ENDED JUNE 30, 2001 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarterly period ended June 30, 2001 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 For the Transition Period from _______ to _______ Commission File Number: 1-12768 PACIFIC GULF PROPERTIES INC. (Exact name of Registrant as specified in its Charter) MARYLAND 33-0577520 State of Incorporation (I.R.S. Employer Identification No.) 4220 VON KARMAN, SECOND FLOOR, NEWPORT BEACH CALIFORNIA 92660-2002 (Address of principal executive offices, including zip code) 949-223-5000 (Registrant's telephone number, including area code) COMMON STOCK, PAR VALUE $.01 PER SHARE, 26,082,506 SHARES WERE OUTSTANDING AS OF AUGUST 10, 2001 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- 2 PACIFIC GULF PROPERTIES INC. FORM 10-Q PART I: FINANCIAL INFORMATION PAGE ---- INDEX TO FINANCIAL STATEMENTS Item 1. Financial Statements Consolidated Statements of Net Assets in Liquidation as of June 30, 2001 and December 31, 2000 1 Consolidated Statements of Operations for the Six Months Ended June 30, 2001 and June 30, 2000 2 Consolidated Statements of Operations for the Three Months Ended June 30, 2001 and June 30, 2000 3 Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2001 and June 30, 2000 4 Notes to Financial Statements 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Item 3. Quantitative and Qualitative Disclosures about Market Risk 12 PART II: OTHER INFORMATION 12 SIGNATURES 13 3 PACIFIC GULF PROPERTIES INC. CONSOLIDATED STATEMENTS OF NET ASSETS IN LIQUIDATION (in thousands, except share data)

See accompanying notes 1 4 PACIFIC GULF PROPERTIES INC. CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data) (Unaudited)

See accompanying notes 2 5 PACIFIC GULF PROPERTIES INC. CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data) (Unaudited)

See accompanying notes 3 6 PACIFIC GULF PROPERTIES INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (Unaudited))

See accompanying notes 4 7 NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 1. INTERIM FINANCIAL STATEMENTS Pacific Gulf Properties Inc. was incorporated in Maryland in August 1993 and commenced operations on February 18, 1994. The Company operates as a real estate investment trust ("REIT") under the Internal Revenue Code of 1986, as amended. On November 9, 2000, the Company's shareholders approved a plan to sell the Company's industrial properties portfolio to CalWest Industrial Properties LLC and to sell its remaining assets and liquidate and dissolve the Company (the "Liquidation Plan") without further approval by the shareholders. In accordance with this plan, the Company sold the majority of its industrial properties portfolio to CalWest Industrial Properties LLC on November 22, 2000 for an aggregate price of $852,989,000. Following the sale, the Company made a cash distribution to shareholders of $22 per share in December 2000. An additional liquidating distribution of $1.15 was made to shareholders on June 20, 2001. Prior to the Company's Liquidation Plan, the Company owned, operated, leased, acquired, rehabilitated and developed primarily light industrial and business park properties ("Industrial Properties")in the Western United States. In addition to its Industrial Properties, the Company owned, operated, acquired and developed unassisted rental housing for active seniors age 55 and older, focusing mainly in California. The Company also owned and operated family-style apartment communities. As a result of the shareholders' approval of the Liquidation Plan, the Company changed its basis of accounting from the going concern basis to the liquidation basis, effective December 31, 2000. Accordingly, consolidated statements of net assets in liquidation at June 30, 2001 and December 31, 2000 have been presented to provide more relevant information. On March 1, 2001, the Company entered into a definitive merger agreement (the "Merger Agreement") with FountainGlen Properties LLC, an affiliate of Prudential Real Estate Investors, pursuant to which the Company will be merged with and into FountainGlen Properties LLC. The merger is subject to shareholder approval which is being solicited at a special meeting of shareholders to be held on August 14, 2001. A proxy statement (the "Proxy") dated July 13, 2001 has been mailed to shareholders. Pursuant to the provisions of the Merger Agreement, FountainGlen Properties LLC will only acquire the Company's senior housing assets and the corporate office building in the merger. Prior to the consummation of the merger, and whether or not the merger is consummated, the Company will transfer any assets other than senior housing assets, the corporate office building and certain cash deposits, to a liquidating trust for the benefit of shareholders. The trust will be responsible for selling any assets transferred to it and distributing the proceeds received from such sales to the shareholders, as well as providing certain limited indemnities to FountainGlen Properties, LLC and other entities. The Company will not control the nature and timing of the sales of such transferred assets, the payment of such assumed liabilities or the nature, amount and timing of distributions from the trust. Instead, a trustee will be appointed to administer the trust in accordance with the terms of a liquidating trust agreement, which will govern the operation of the trust. In addition to the liquidating trust interests, under the terms of the Merger Agreement the Company's shareholders will receive, in exchange for their shares of Company stock, an aggregate amount of approximately $78 million in cash, or $3.00 per share, subject to certain adjustments. These adjustments are based on amounts that the Company has agreed to deliver at closing for items such as net working capital, total equity invested in the senior properties, total deposits for new senior properties and any increases in the development budgets for the senior properties. The Company currently estimates, based on the per share price in the merger and value of assets and cash expected to be distributed to shareholders from the trustee of the liquidating trust, after consideration of transaction costs, that shareholders may receive up to $5.20 per share in aggregate distributions. During the six months ended June 30, 2001, the Company incurred and expensed $989,000 of merger related costs and expenses. 5 8 2. REAL ESTATE As a result of the Liquidation Plan, as of December 31, 2000, all of the Company's real estate assets are deemed held for sale. In accordance with Statement of Financial Accounting Standards ("Statement") No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of, assets held for sale are reported at the lower of their net historical basis or estimated fair market value less costs to sell. The Company ceased depreciating its real estate assets in connection with the Liquidation Plan. Prior to the adoption of the Liquidation Plan, real estate assets consisted of operating properties and properties under development. Operating properties were held for investment and carried at historical cost less accumulated depreciation. Cost includes the cost of land and completed building 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 was generally provided on a straight-line basis over the estimated useful lives of the buildings and improvements, ranging primarily from 15 to 40 years. Upon the retirement or disposal of depreciable property, the related costs and accumulated depreciation are removed from the accounts and any gain or loss reflected in operations. Properties under development are carried at cost. The cost of development includes land acquisition and infrastructure costs, direct and indirect construction costs and carrying costs including interest and taxes. Land acquisition and infrastructure costs were allocated to components of properties based on relative fair value. Interest and property taxes were capitalized to properties while development activities are in progress. Upon the completion of a project or property under development, all related holding and operating costs are expensed as incurred. In March 2001, the Company sold a 140,020 square foot industrial building and a 68,134 square foot industrial building for $6,200,000 and $3,800,000, respectively. The Company recognized a total gain of $656,000 on the sale of these buildings which were located in Upland, California and Tempe, Arizona, respectively. In March 2001, the Company also sold its last remaining family style apartment property for $21,750,000. A gain of $9,845,000 was recognized on the sale. The property was located in Diamond Bar, California and contained 204 units. In April 2001, the Company sold an industrial property located in Anaheim, California for $6,400,000. A gain of $96,000 was recognized on the sale. At June 30, 2001, real estate properties held for sale consists of three industrial properties containing 780,904 square feet, six active senior properties consisting of 1,294 units and six active senior properties in various stages of development. A provision for impairment loss of $5,094,000 was recorded to reduce the carrying amount of the industrial property located in Sacramento to its estimated fair market value less costs to dispose. Real estate held for sale consists of the following at June 30, 2001 and December 31, 2000

Subsequent to June 30, 2001, the Company sold an industrial property located in Sunnyvale, California for $20,300,000. 3. LOANS PAYABLE The Company's loans payable at June 30, 2001 and December 31, 2000 consist of the following (in thousands): 2001 2000 ------- ------- Conventional mortgage notes Industrial properties $ 7,118 $ 7,219 Active Senior Apartments 4,450 4,487 Family style Apartments -- 9,912 ------- ------- 11,568 21,618 Tax-exempt mortgage notes Active Senior Apartments 38,351 38,642 Construction loans 22,008 15,082 ------- ------- $71,927 $75,342 ======= ======= 6 9 4. SHAREHOLDERS' EQUITY The Company has an effective shelf registration statement on file with the Securities and Exchange Commission for the public issuance of securities in the aggregate amount of $300,000,000, covering the possible future issuance of debt, preferred or common stock securities and warrants to purchase such securities of the Company, none of which have been issued. Based on the shareholders' approval on November 9, 2000 of the Company's liquidation plan, no future issuance of securities under the Company's shelf registration will be made. 5. PER COMMON SHARE DATA The following table sets forth the computation of basic and diluted earnings per share for the six months ended June 30, in accordance with the Statement of Financial Accounting Standards Board No. 128:

Shares of Senior Cumulative Convertible Class A Preferred Stock, convertible into 2,763,116 shares of common stock, were outstanding during 2000 but were not included in computing diluted earnings per share. Including these shares in the computation increases earnings per share $.01, and are/was considered antidilutive. 6. COMMON SHARE DISTRIBUTIONS As a result of the shareholders' approval of the Liquidation Plan, the Company made a partial liquidating distribution of $1.15 per share on June 20, 2001. 7 10 7. INTEREST Interest incurred for the six months ended June 30, consists of the following (in thousands): 2001 2000 ------- -------- Interest incurred $ 2,426 $ 15,798 Amortization: Line of credit financing costs -- 210 Long-term financing costs 39 147 Interest capitalized (1,519) (1,463) ------- -------- Interest expense $ 946 $ 14,692 ======= ======== 8. REPORTABLE SEGMENTS The Company complies with Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 131, Disclosures About Segments of an Enterprise and Related Information ("Statement No. 131"). Statement No. 131 superseded FASB Statement No. 14, Financial Reporting for Segments of a Business Enterprise. Statement No. 131 requires public business enterprises to report information regarding reportable operating segments. Prior to the approval by the shareholders of the liquidation plan, the Company operated and developed industrial properties and multifamily properties (consisting of active senior and family apartments). The properties generated rental and other income through the leasing of industrial space and apartment units to a diverse base of tenants. The Company separately evaluated the performance of its industrial and multifamily operating segments and allocated resources primarily based on Net Operating Income ("NOI"). NOI was defined by the Company as rental income less rental property expenses. Accordingly, NOI excludes certain expenses such as interest, depreciation and minority interests in consolidated partnerships which are included in the determination of Net Income under generally accepted accounting principles. NOI from industrial properties totaled $3,488,000 and $41,914,000 for the six months ended June 30, 2001 and 2000 respectively. NOI from multifamily properties totaled $3,869,000 and $9,015,000 for the six months ended June 30, 2001 and 2000 respectively. NOI from industrial properties totaled $1,602,000 and $21,502,000 for the quarters ended June 30, 2001 and 2000 respectively. NOI from multifamily properties totaled $1,693,000 and $4,541,000 for the quarters ended June 30, 2001 and 2000 respectively. All revenues are from external customers and no revenues are generated from transactions between segments. There are no tenants who contributed 10% or more of the Company's total revenues during 2001 or 2000. Interest expense on debt is not allocated to the segments or individual properties even if such debt is secured by the properties. Certain items in the consolidated statements of operations such as minority interest in consolidated partnerships are not allocated to the properties. Additionally, there is no provision for income taxes as the Company is organized as a REIT under the Internal Revenue Code. 9. NEW PRONOUNCEMENT Effective January 1, 2001, the Company adopted Financial Accounting Standards Board No. 133, as amended. Statement No. 133 outlines the accounting treatment for derivative instruments and hedging activities. The adoption of Statement No. 133 did not have a significant effect on its consolidated results of operations or financial position. 8 11 10. LEGAL PROCEEDINGS On September 13, 2000 an action was filed against the Company by JJ Acquisition Corporation d.b.a. California Job Journal ("CJJ") in the Superior Court of the State of California, County of Sacramento. The CJJ complaint contains six causes of action stemming from the alleged presence of mold in the plaintiff's leased premises: breach of lease, negligence, negligent misrepresentation, fraud and concealment, negligence and unfair business practices. Subsequent to this filing, a number of employees and related parties of CJJ have filed similar actions in the Superior Court of the State of California, County of Sacramento. On February 13, 2001, the Company filed its answer with affirmative defenses to the CJJ complaint and a cross complaint against CJJ with the following causes of action: equitable indemnity, contractual indemnity, breach of contract and declaratory relief. The Company has tendered these matters to its insurance carrier. The Company believes it has meritorious defenses to the claims, but there can be no assurance that such defenses will be successful and that the lawsuits will not have a material adverse effect on the Company's financial position, results of operations or cash flows. In addition, the timing of the final resolution of the proceedings is uncertain. On March 2, 2001, an alleged class action complaint was filed in the Superior Court of the State of California, County of Orange, naming as defendants the Company and the Directors of the Company. The lawsuit, filed on behalf of Kenneth Garvey, alleges, among other things, breach of fiduciary duty and self-dealing relating to the Merger Agreement with FountainGlen Properties LLC and seeks to enjoin the merger. The complaint alleges that the employment agreements to be received by certain members of management from FountainGlen Properties LLC pursuant to the merger are lucrative and result in more favorable treatment of management than other shareholders in the merger, and that the merger is intended to deprive the Company's shareholders of the future potential value of its properties. After significant negotiations during June and July, the Company and the named plaintiff have reached an agreement-in-principle to settle this lawsuit. Under the agreement, the Company has supplemented and amended the disclosure in the Proxy statement and has agreed to acknowledge that the pendency of the lawsuit was a factor the Company's board considered in declaring the special liquidating distribution to its shareholders of $1.15 per share in June 2001. In addition, the Company agreed that it would pay attorneys' fees, costs and expenses, subject to court approval of the settlement, in the aggregate amount of $470,000. This agreement-in-principle is subject to the completion of final documentation, preliminary approval of the court, the mailing of notice to the Company's shareholders and a final hearing on approval of the settlement. 9 12 PACIFIC GULF PROPERTIES INC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2001 TO THE SIX MONTHS ENDED JUNE 30, 2000 SIX MONTHS ENDED JUNE 30, ------------------------- 2001 2000 --------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) SUMMARY OF OPERATIONS Rental Income ......................... $ 10,893 $ 66,997 Rental property expenses .............. (3,536) (16,068) --------- --------- Property operating income ............. 7,357 50,929 Interest income ....................... 1,067 168 Less expenses: Depreciation ........................ -- 14,567 Interest ............................ 946 14,692 Provision for impairment loss on real estate .................... 5,094 -- General and administrative .......... 2,695 3,650 Minority partner's interest in earnings -- 604 --------- --------- Income (loss) before gains on sales of real estate ......................... (311) 17,584 Gains on sales of real estate ......... 10,597 3,415 --------- --------- Net income ............................ 10,286 20,999 Less preferred dividend requirements .. -- 2,529 --------- --------- Income available to common shareholders $ 10,286 $ 18,470 ========= ========= Basic earnings per share .............. $ 0.39 $ 0.89 ========= ========= SUMMARY OF FINANCIAL POSITION Real estate ........................... $ 161,572 $ 872,325 Total assets .......................... $ 196,949 $ 905,787 Loans payable ......................... $ 71,927 $ 430,157 Total liabilities ..................... $ 78,654 $ 477,325 Total shareholders' equity ............ $ 118,295 $ 428,462 Sales during the fourth quarter of 2000 of a majority of the Company's industrial and multifamily property portfolios is the primary factor in explaining the changes in operating results when the period ended June 30, 2001 is compared to the period ended June 30, 2000. Net income for the period ended June 30, 2001 was $10.3 million, or $0.39 per share (basic), as compared to $18.5 million, or $0.89 per share (basic), for the period ended June 30, 2000. Included in net income for the period ended June 30, 2001 were gains on sales of real estate of $10.6 million as compared to $3.4 million recognized a year ago. A provision for impairment of $5.1 million was also recorded in the 2001 period. In 2001, loss before gains on sales of real estate was $0.3 million as compared to income of $17.6 million in 2000. This decrease was due to a decrease in property operating income of $43.6 million, offset by a decrease in interest expense of $13.7 million, depreciation expense of $14.6 million, and general and administrative expense of $1.0 million. 10 13 LIQUIDITY AND CAPITAL RESOURCES Liquidity In the fourth quarter of 2000, the Company's shareholders approved a plan to sell the Company's assets and to liquidate and dissolve the Company. Net sales proceeds and available cash from the sale of the Company's assets and liquidation will be used to satisfy debts and obligations with remaining funds to be distributed to the shareholders. It is presently estimated that the liquidation will be substantially completed during 2001, although there can be no assurance thereof, and that net proceeds will be distributed as determined by the Board of Directors. As part of this liquidation, it is anticipated that the Company will establish a liquidating trust to which the Company will transfer, prior to the consummation of the merger with FountainGlen Properties, LLC, any remaining industrial assets, as well as the cash proceeds from any such sales and other cash balances. The Company will then distribute pro rata beneficial interests in the trust to its shareholders prior to the merger. Although it is expected that the Company will continue to qualify as a REIT until its dissolution, no assurance can be given that the Company will not lose or terminate its status as a REIT. As a result of the shareholders' approval of the Company's liquidation plan, the Company changed its basis of accounting from the going concern basis to the liquidation basis, effective December 31, 2000. Accordingly, a consolidated statement of net assets in liquidation at June 30, 2001 has been presented to provide more relevant information. At June 30, 2001, the Company had $23,519,000 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 and existing working capital. 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 decreased from $29,378,000 for the period ended June 30, 2000 to $1,486,000 for the period ended June 30, 2001. The decrease is due to the sale of a majority of the Company's assets as part of its liquidation plan. Cash from investing activities increased from a use of $12,883,000 for the period ended June 30, 2000 to funds provided of $23,559,000 for the period ended June 30, 2001 as a result of decreased development expenditures and increased proceeds from sales of real estate in 2001. Cash used in financing activities increased from $10,074,000 for the period ended June 30, 2000 to $35,018,000 for the period ended June 30, 2001 primarily from the repayment of debt and increase in minority interest distributions and in liquidating distributions paid in 2001, offset by a decrease in dividends paid in 2001. Historical results and trends should not be taken as indicative of future operations. Management's 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. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and is including this statement for purposes of complying with those safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Company, are generally identifiable by use of the words "believe," "expect," "intend," "anticipate," "estimate," "project," "prospects" or similar expressions. The Company's ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse affect on the operations and future prospects of the Company on a consolidated basis include, but are not limited to: changes in economic conditions generally and the real estate market specifically, legislative/regulatory changes (including changes to laws governing the taxation of REITs), availability of capital, interest rates, competition, supply and demand for industrial and multifamily properties in the Company's current and proposed market areas and general accounting principles, policies and guidelines applicable to REITs, and the performance by third parties of their contractual obligations to the Company. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Further information concerning the Company and its business, including additional factors that could materially affect the Company's financial results, is included herein and in the Company's other filings with the Securities and Exchange Commission. 11 14 IMPACT OF INFLATION Substantially all of the Company's leases on its industrial properties, which have terms generally ranging from one to five years, contain provisions for rental increases based either on fixed increases or on increases in the Consumer Price Index. 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 allow at the time of renewal for adjustments in the rent payable thereunder. Accordingly, management believes the provisions contained in its industrial leases and the nature of its multifamily leases tend to mitigate the adverse impact of inflation. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Refer to the Company's Annual Report on Form 10-K for the year ended December 31, 2000 for detailed disclosure about quantitative and qualitative disclosures about market risk. Quantitative and qualitative disclosures about market risk have not materially changed since December 31, 2000. PART II: OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS See Note 10 of the Notes to Financial Statements appearing in Part I, Item 1 of this report. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit Number Description ------ ----------- 4.1 Agreement and Plan of Merger by and between FountainGlen Properties LLC and Pacific Gulf Properties Inc. dated as of March 1, 2001 (incorporated by reference from the Company's Current Report on Form 8-K/A filed on or about July 11, 2001) (b) Reports on Form 8-K (i) The Company filed a report on Form 8-K on March 2, 2001 (and again on July 11, 2001 under a corrected SEC filing number), disclosing under Item 5 the execution of a definitive merger agreement with FountainGlen Properties LLC, an affiliate of Prudential Real Estate Investors. (ii) The Company filed a report on Form 8-K on June 14, 2001, disclosing under Item 2 the disposition of certain real estate assets and including pro forma condensed consolidated financial statements and notes thereto. 12 15 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PACIFIC GULF PROPERTIES INC. /s/ Glenn L. Carpenter /s/ Donald G. Herrman ---------------------------------------- ---------------------------------- Glenn L. Carpenter Donald G. Herrman Chairman and Chief Executive Officer Chief Financial Officer and Secretary DATED: August 13, 2001 13

PACIFIC GULF PROPERTIES INC 10-Q