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EX-3.2 - EXHIBIT 3.2 - PACIFIC OFFICE PROPERTIES TRUST, INC.exh3_2.htm
EX-3.3 - EXHIBIT 3.3 - PACIFIC OFFICE PROPERTIES TRUST, INC.exh3_3.htm
EX-3.1 - EXHIBIT 3.1 - PACIFIC OFFICE PROPERTIES TRUST, INC.exh3_1.htm
EX-32.2 - SEC 906 CERTIFICATION - CFO - PACIFIC OFFICE PROPERTIES TRUST, INC.exh32_2.htm
EX-31.2 - SEC 302 CERTIFICATION - CFO - PACIFIC OFFICE PROPERTIES TRUST, INC.exh31_2.htm
EX-31.1 - SEC 302 CERTIFICATION - CEO - PACIFIC OFFICE PROPERTIES TRUST, INC.exh31_1.htm
EX-32.1 - SEC 906 CERTIFICATION - CEO - PACIFIC OFFICE PROPERTIES TRUST, INC.exh32_1.htm


UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

 
R
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2009

OR

 
£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from   to __________

Commission file number:    1-9900

PACIFIC OFFICE PROPERTIES TRUST, INC.
(Exact name of registrant as specified in its charter)

Maryland
86-0602478
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
233 Wilshire Boulevard, Suite 310
Santa Monica, CA  90401
(Address of principal executive offices) (Zip Code)

(Registrant’s telephone number, including area code): (310) 395-2083

233 Wilshire Boulevard, Suite 830
Santa Monica, CA  90401
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes R No £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes £ No £

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):

Large accelerated filer £
Accelerated filer £
Non-accelerated filer £
(Do not check if a smaller reporting company)
Smaller Reporting Company R

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No R

APPLICABLE ONLY TO CORPORATE ISSUERS:

As of November 23, 2009 there were 3,850,420 shares of common stock, par value $0.0001 per share (the “common stock”), and 100 shares of Class B Common Stock, par value $0.0001 per share (the “Class B Common Stock”), issued and outstanding.


 
 

 

PACIFIC OFFICE PROPERTIES TRUST, INC.
TABLE OF CONTENTS
FORM 10-Q

 
 
Page
 
Explanatory Note
     
PART I – FINANCIAL INFORMATION
     
Item 1. Financial Statements (unaudited)
    4  
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
    37  
Item 3. Quantitative and Qualitative Disclosures About Market Risk
    54  
Item 4T. Controls and Procedures
    54  
PART II – OTHER INFORMATION
       
Item 1. Legal Proceedings
    55  
Item 1A. Risk Factors
    55  
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    56  
Item 3. Defaults Upon Senior Securities
    56  
Item 4. Submission of Matters to a Vote of Security Holders
    56  
Item 5. Other Information
    56  
Item 6. Exhibits
    57  
Certification of the Chief Executive Officer
       
Certification of the Chief Financial Officer
       
Certification of the Chief Executive Officer and Chief Financial Officer
       

 
 2

 


PACIFIC OFFICE PROPERTIES TRUST, INC.
FORM 10-Q

Explanatory Note

On March 19, 2008 (the “Effective Date”), Arizona Land Income Corporation, an Arizona corporation (“AZL”), and POP Venture, LLC, a Delaware limited liability company (“Venture”), consummated the transactions (the “Transactions”) contemplated by a Master Formation and Contribution Agreement, dated as of October 3, 2006, as amended (the “Master Agreement”). As part of the Transactions, AZL merged with and into its wholly-owned subsidiary, Pacific Office Properties Trust, Inc., a Maryland corporation (the “Company”), with the Company being the surviving corporation. Substantially all of the assets and certain liabilities of AZL and substantially all of the commercial real estate assets and related liabilities of Venture were contributed to a newly formed Delaware limited partnership, Pacific Office Properties, L.P. (the “Operating Partnership” or “UPREIT”), in which the Company became the sole general partner and Venture became a limited partner, with corresponding 18.25% and 81.75% common ownership interests in the UPREIT, respectively. The commercial real estate assets of Venture contributed to the UPREIT consisted of eight office properties and a 7.5% joint venture interest in one office property, comprising approximately 2.4 million square feet of rentable area in the Honolulu, San Diego and Phoenix metropolitan areas (the “Contributed Properties”).

Waterfront Partners OP, LLC (“Waterfront”), which had the largest interest in Venture, was designated as the acquiring entity in the business combination for financial accounting purposes. Accordingly, historical financial information for Waterfront has also been presented in our Earnings per Share calculation in Note 11 of our condensed combined consolidated financial statements in this Quarterly Report on Form 10-Q for the period from January 1, 2008 through the Effective Date. Additional explanatory notations are contained in this Quarterly Report on Form 10-Q to distinguish the historical financial information of Waterfront from that of the Company.

 
  3

 


PART I – FINANCIAL INFORMATION

Item 1. Financial Statements (unaudited).

Pacific Office Properties Trust, Inc.
Condensed Consolidated Balance Sheets
(in thousands, except share data)
(unaudited)

 
   
September 30, 2009
   
December 31, 2008
 
ASSETS
           
Investments in real estate, net
  $ 385,431     $ 392,657  
Cash and cash equivalents
    3,405       4,463  
Restricted cash
    5,444       7,267  
Rents and other receivables, net
    6,004       6,342  
Intangible assets, net
    35,079       41,379  
Other assets, net
    5,822       4,680  
Goodwill
    62,019       61,519  
Investment in unconsolidated joint ventures
    10,016       11,590  
Total assets
  $ 513,220     $ 529,897  
                 
LIABILITIES AND EQUITY
               
Mortgage and other loans, net
  $ 403,347     $ 400,108  
Unsecured notes payable to related parties
    21,104       23,776  
Accounts payable and other liabilities
    20,257       17,088  
Acquired below market leases, net
    9,997       11,817  
Total liabilities
    454,705       452,789  
                 
Commitments and contingencies
               
                 
Non-controlling interests
    130,679       133,250  
                 
Equity:
               
Proportionate Voting Preferred Stock
    -       -  
Preferred stock, $0.0001 par value, 100,000,000 shares authorized,
               
no shares issued and outstanding at September 30, 2009 and December 31, 2008
    -       -  
Common Stock, $0.0001 par value, 200,000,000 shares authorized,
               
3,850,420 shares issued and outstanding at September 30, 2009 and December 31, 2008
    185       185  
Class B Common Stock, $0.0001 par value, 200,000 shares authorized,
               
100 shares issued and outstanding at September 30, 2009 and December 31, 2008
    -       -  
Additional paid-in capital
    -       -  
Retained deficit
    (72,349 )     (56,327 )
Total equity
    (72,164 )     (56,142 )
Total liabilities and equity
  $ 513,220     $ 529,897  
                 

See accompanying notes to condensed combined consolidated financial statements.

 
  4

 

Pacific Office Properties Trust, Inc.
Condensed Consolidated Statements of Operations
(in thousands, except share and per share data)
(unaudited)
 

   
For the three months ended September 30,
 
   
2009
   
2008
 
             
Revenue:
           
Rental
  $ 10,486     $ 10,899  
Tenant reimbursements
    5,163       5,583  
Parking
    2,012       1,981  
Other
    83       136  
Total revenue
    17,744       18,599  
                 
Expenses:
               
Rental property operating
    9,781       11,067  
General and administrative
    351       429  
Depreciation and amortization
    6,913       6,740  
Interest
    6,823       6,769  
Loss on extinguishment of debt
    171       -  
Total expenses
    24,039       25,005  
                 
Loss before equity in net earnings of unconsolidated
               
joint ventures and non-operating income
    (6,295 )     (6,406 )
Equity in net earnings of unconsolidated
               
joint ventures
    189       185  
Non-operating income
    2       -  
Net loss
    (6,104 )     (6,221 )
Less: net loss attributable to non-controlling
               
interests
    4,863       5,033  
Net loss attributable to common stockholders
  $ (1,241 )   $ (1,188 )
                 
Net loss per common share - basic and diluted
  $ (0.40 )   $ (0.39 )
                 
Weighted average number of common shares
               
outstanding - basic and diluted
    3,112,888       3,031,125  
                 

See accompanying notes to condensed combined consolidated financial statements.

 

 

Pacific Office Properties Trust, Inc.
Condensed Combined Consolidated Statements of Operations
(in thousands, except share and per share data)
(unaudited)


   
For the nine months ended September 30,
 
   
2009
   
2008 (1)
 
             
Revenue:
           
Rental
  $ 31,999     $ 26,401  
Tenant reimbursements
    16,184       12,740  
Parking
    6,080       4,855  
Other
    270       345  
Total revenue
    54,533       44,341  
                 
Expenses:
               
Rental property operating
    29,356       26,412  
General and administrative
    1,997       17,837  
Depreciation and amortization
    20,470       15,503  
Interest
    20,348       15,822  
Loss on extinguishment of debt
    171       -  
Other
    -       143  
Total expenses
    72,342       75,717  
                 
Loss before equity in net earnings of unconsolidated
         
joint ventures and non-operating income
    (17,809 )     (31,376 )
Equity in net earnings of unconsolidated
               
joint ventures
    406       156  
Non-operating income
    6       -  
Net loss
    (17,397 )     (31,220 )
Less: net loss attributable to non-controlling
               
interests
    13,984       24,563  
Net loss attributable to common stockholders
  $ (3,413 )   $ (6,657 )
                 
Net loss per common share - basic and diluted
  $ (1.12 )     (2)  
                 
Weighted average number of common shares
               
outstanding - basic and diluted
    3,059,678       (2)  
                 

_________
(1)  
Amounts reflected in 2008 represent the sum of the amounts included herein as the consolidated results of operations of Waterfront and the Company (the “Combined Entity”) for the period from January 1, 2008 through September 30, 2008.
(2)  
Refer to Note 11 for our Earnings per Share calculation for the Combined Entity.

See accompanying notes to condensed combined consolidated financial statements.

 
 6

 

Pacific Office Properties Trust, Inc.
Condensed Combined Consolidated Statements of Cash Flows
(in thousands and unaudited)

   
For the nine months ended September 30, 2009
 
For the nine months ended September 30, 2008 (1)
 
             
Operating activities
           
Net loss
  $ (17,397 )   $ (31,220 )
Adjustments to reconcile net loss to net cash
               
provided by (used in) operating activities:
               
Depreciation and amortization
    20,470       15,503  
Interest amortization
    1,135       520  
Share based compensation charge attributable to the Transaction
    -       16,194  
Other share based compensation
    140       53  
Loss from extinguishment of debt
    171       -  
Below market lease amortization, net
    (1,820 )     (1,726 )
Equity in net earnings of unconsolidated joint ventures
    (406 )     (156 )
Net operating distributions received from unconsolidated
 
   joint ventures
    179       119  
Bad debt expense
    663       419  
Other
    -       365  
Changes in operating assets and liabilities:
         
Rents and other receivables
    (325 )     576  
Other assets
    (775 )     500  
Accounts payable and other liabilities
    1,292       596  
Net cash provided by operating activities
    3,326       1,743  
Investing activities
               
Acquisition and improvement of real estate
    (4,469 )     (6,921 )
Capital distributions from equity investees
    1,801       313  
Payment of leasing commissions
    (699 )     (556 )
Cash held by properties upon Effective Date
    -       6,470  
Deferred acquisition costs and other
    -       (4,059 )
Decrease (increase) in restricted cash
    1,823       (1,525 )
Net cash used in investing activities
    (1,544 )     (6,278 )
Financing activities
               
Proceeds from issuance of equity securities
    -       6,350  
Repayment of mortgage notes payable
    (706 )     (152 )
Proceeds from mortgage notes payable
    811       -  
Repayments of revolving credit facility
    (3,000 )     -  
Borrowings from revolving credit facility
    5,847       -  
Deferred financing costs
    (178 )     (936 )
Offering costs
    (1,178 )     -  
Security deposits
    (86 )     70  
Dividends
    (501 )     -  
Distributions to non-controlling interests
    (3,849 )     -  
Equity contributions
    -       4,167  
Equity distributions
    -       (1,425 )
Net cash (used in) provided by financing activities
    (2,840 )     8,074  
(Decrease) increase in cash and cash equivalents
    (1,058 )     3,539  
Balance at beginning of period
    4,463       2,619  
Balance at end of period
  $ 3,405     $ 6,158  
Supplemental cash flow information
               
Interest paid
  $ 17,660     $ 13,966  
                 
Supplemental Disclosure of Non-Cash Investing and Financing Activities
 
                 
Exchange of unsecured notes payable to related parties
  $ 3,014     $ -  
for common units
               
                 
Assets, net, acquired on the Effective Date
  $ -     $ 484,325  
                 
Liabilities, net, assumed on the Effective Date
  $ -     $ 325,985  
                 
Issuance of unsecured notes payable to related parties
  $ -     $ 7,285  
to acquire managing interests in joint ventures
         
                 
Issuance of common units to acquire managing joint venture interests
  $ -     $ 4,824  
                 
Accrued capital expenditures
  $ 722     $ 204  
                 

______________________________
(1)
Amounts reflected in 2008 represent the sum of the amounts included herein as the consolidated cash flows of the Combined Entity for the period from January 1, 2008 through September 30, 2008.

See accompanying notes to condensed combined consolidated financial statements.

 

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements



1. Organization and Ownership

Pacific Office Properties

The terms “us,” “we,” and “our” as used in this Quarterly Report on Form 10-Q refer to Pacific Office Properties Trust, Inc. (the “Company”) and its subsidiaries and joint ventures. Through the Company’s controlling interest in Pacific Office Properties, L.P. (the “UPREIT” or the “Operating Partnership”), of which the Company is the sole general partner and holds a 21.22% common ownership interest as of September 30, 2009, and the subsidiaries of the Operating Partnership, we own and operate office properties in the western United States, concentrating initially on the long-term growth submarkets of Honolulu, Southern California, and the greater Phoenix metropolitan area. We operate as a real estate investment trust (“REIT”) for federal income tax purposes. We are externally advised by Pacific Office Management, Inc., a Delaware corporation (the “Advisor”), an entity affiliated with and owned by our founder, The Shidler Group, which is a business name utilized by a number of affiliates controlled by Jay H. Shidler, our Chairman of the Board who is currently serving as our CEO. The Advisor is responsible for our day-to-day operation and management.

Through the Operating Partnership, as of September 30, 2009, we owned eight wholly-owned fee simple and leasehold properties, and owned interests in fifteen properties which we held through six joint ventures. Our current portfolio totals approximately 4.3 million rentable square feet (the “Property Portfolio”). As of September 30, 2009, the portion of our Property Portfolio that was effectively owned by us (representing the rentable square feet of our wholly-owned properties and our respective ownership interests in our unconsolidated joint venture properties) (the “Effective Portfolio”), comprised approximately 2.5 million rentable square feet. Our property statistics as of September 30, 2009, were as follows:

         
PROPERTY
   
EFFECTIVE
 
   
NUMBER OF
   
PORTFOLIO
   
PORTFOLIO
 
 
 
PROPERTIES
   
BUILDINGS
   
SQ. FT.
   
SQ. FT.
 
                         
Wholly-owned properties
    8       11       2,265,339       2,265,339  
Unconsolidated joint venture properties
    15       29       2,060,855       261,397  
Total
    23       40       4,326,194       2,526,736  

Transactions

On March 19, 2008 (the “Effective Date”), Arizona Land Income Corporation, an Arizona corporation (“AZL”), and POP Venture, LLC, a Delaware limited liability company (“Venture”), consummated the transactions (the “Transactions”) contemplated by a Master Formation and Contribution Agreement, dated as of October 3, 2006, as amended (the “Master Agreement”). As part of the Transactions, AZL merged with and into its wholly owned subsidiary, Pacific Office Properties Trust, Inc., a Maryland corporation (the “Company”), with the Company being the surviving corporation. Substantially all of the assets and liabilities of AZL and substantially all of the commercial real estate assets and liabilities of Venture, which included eight office properties and a 7.5% joint venture interest in one office property (the “Contributed Properties”), were contributed to a newly formed Delaware limited partnership, the Operating Partnership, in which the Company became the sole general partner and Venture became a limited partner with corresponding 18.2% and 81.8% common ownership interests, respectively.

For financial accounting purposes, Waterfront Partners OP, LLC (“Waterfront”), which had the largest interest in Venture, was designated as the acquiring entity in the business combination. Accordingly, historical financial information for Waterfront has also been presented in our Earnings per Share calculation in Note 11of our condensed combined consolidated financial statements in this Quarterly Report on Form 10-Q through the Effective Date. Additional explanatory notations are contained in this Quarterly Report on Form 10-Q to distinguish the historical financial information of Waterfront from that of the Company.

The agreed upon gross asset value of the Contributed Properties, including related intangible assets, was $563.0 million. The aggregate net asset value of the Contributed Properties, including related intangible assets, was $151.5 million on the Effective Date. In exchange for its contribution to the Operating Partnership, Venture received 13,576,165 common limited partner unit interests (“Common Units”) and 4,545,300 convertible preferred limited partner unit interests (“Preferred Units”) in the Operating Partnership. The assets of AZL contributed into the Operating Partnership primarily consisted of cash and cash equivalents, investments in marketable securities, other assets and related liabilities having an aggregate net asset value of approximately $3.03 million on the Effective Date.

 

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements


The Common Units received by Venture represented 28.99% of the total estimated fair value of the Common and Preferred Units issued in the Transactions and were valued using an estimated fair value per share of $2.79 per share. The Common Units are redeemable by the holders on a one-for-one basis for shares of our common stock or cash, as elected by the Company, but no earlier than two years after the Effective Date. The Preferred Units represented 71.01% of the total estimated fair value of the units issued in the Transactions. The contractual terms and provisions of the Preferred Units include a beneficial conversion feature (“BCF”) because it provides the holders with a security whose market price was in excess of the carrying value of the corresponding Common Units at the date of their issuance, March 19, 2008. See Note 11 for a detailed discussion of our equity securities.

As part of the Transactions, we issued to the Advisor one share of Proportionate Voting Preferred Stock (the “Proportionate Voting Preferred Stock”), which entitles the Advisor to vote on any matters presented to our stockholders, and which represents that number of votes equal to the total number of shares of common stock issuable upon redemption of the Common Units and Preferred Units that were issued in connection with the Transactions. As of September 30, 2009, that share of Proportionate Voting Preferred Stock represented approximately 92.3% of our voting power. This number will decrease to the extent that these Operating Partnership units are redeemed for shares of common stock in the future, but will not increase in the event of future unit issuances by the Operating Partnership. Venture, as the holder of these Operating Partnership units, has a contractual right to require the Advisor to vote the Proportionate Voting Preferred Stock as directed by Venture.

As of September 30, 2009, Venture owned 46,173,693 shares of our common stock assuming that all Operating Partnership units were fully redeemed for shares on such date, notwithstanding the prohibition on redemption for at least two years after the Transactions in the case of the Common Units, and for at least three years, in the case of the Preferred Units. Assuming the immediate redemption of all the Operating Partnership units held by Venture, Venture and its related parties control approximately 93.8% and 95.9% of the total economic interest and voting power, respectively, in the Company.

As part of the Transactions, we issued promissory notes payable by the Operating Partnership to certain members of Venture in the aggregate principal amount of $16.70 million in consideration for such members’ contribution of certain properties. The promissory notes accrue interest at a rate of 7% per annum, with interest payable quarterly, subject to the Operating Partnership’s right to defer the interest payments for any or all periods up until the date of maturity. The promissory notes mature on various dates commencing March 19, 2013 through August 31, 2013, but the Operating Partnership may elect to extend maturity for one additional year. Maturity accelerates upon the occurrence of a) a qualified public offering, as defined under the Master Agreement; b) the sale of substantially all the assets of the Company; or c) the merger of the Company with another entity. The promissory notes are unsecured obligations of the Operating Partnership.

As part of the Transactions, we issued one million shares of our common stock to related party designees of Venture for $5.00 per share in cash and 180,000 shares of our common stock to an unrelated third party designee of Venture for $7.50 per share in cash. We contributed the proceeds received from these common stock issuances, along with substantially all of our assets and liabilities, to the Operating Partnership on the Effective Date.

In accordance with the partnership agreement of the Operating Partnership (the “Partnership Agreement”), we allocate all distributions and profits and losses in proportion to the percentage ownership interests of the respective partners.  As the sole general partner of the Operating Partnership, we are required to take such reasonable efforts, as determined by us in our sole discretion, to cause the Operating Partnership to make sufficient distributions to avoid any federal income or excise tax at the company level and to maintain our status as a REIT for federal income tax purposes.

 

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements



Advisor

We are externally advised by the Advisor, an entity owned and controlled by our founder, The Shidler Group. The Advisor manages, operates and administers the Company’s day-to-day operations, business and affairs pursuant to an Amended and Restated Advisory Agreement dated as of March 3, 2009 (the “Advisory Agreement”). See Note 12 for a detailed discussion of the Advisor’s role and the Advisory Agreement.

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed combined consolidated financial statements and related disclosures included herein have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted in accordance with such rules and regulations. In the opinion of management, the condensed combined consolidated financial statements include all adjustments, consisting of only normal recurring adjustments, necessary to present fairly the financial information in accordance with GAAP.

As further described in the Explanatory Note on page 3 of this Quarterly Report on Form 10-Q, Waterfront was designated as the acquiring entity in the business combination for accounting purposes. Accordingly, historical financial information for Waterfront has also been presented in our Earnings per Share calculation in Note 11 of our condensed combined consolidated financial statements in this Quarterly Report on Form 10-Q. Explanatory notations have been made where appropriate in this Quarterly Report on Form 10-Q to distinguish the historical financial information of Waterfront from that of the Company.

The financial statements of the Company for all periods presented herein have not been audited by an independent registered public accounting firm. Further, the interim results of operations for the aforementioned periods are not necessarily indicative of the results of operations that might be expected for a given fiscal year.

The accompanying condensed combined consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008 and the Explanatory Note on page 3 of this Quarterly Report on Form 10-Q.

Certain amounts in the condensed combined consolidated financial statements for prior periods have been reclassified to conform to the current period presentation with no corresponding net effect on the previously reported consolidated results of operations, financial position of the Company or cash flows from operations.

Principles of Consolidation

The accompanying condensed combined consolidated financial statements include the account balances and transactions of consolidated subsidiaries, which are wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

Investment in Unconsolidated Joint Ventures

Our investments in joint ventures that are not variable interest entities are accounted for under the equity method of accounting because we exercise significant influence over, but do not control, our joint ventures. Our joint venture partners have substantive participating rights, including approval of and participation in setting operating budgets. Accordingly, we have determined that the equity method of accounting is appropriate for our investments in joint ventures.  We have determined that one of our joint ventures is a variable interest entity. We are not deemed to be the primary beneficiary of that variable interest entity.

 
10 

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements


Investments in unconsolidated joint ventures are initially recorded at cost and are subsequently adjusted for our proportionate equity in the net income or net loss of the joint ventures, contributions made to, or distributions received from, the joint ventures and other adjustments. We record distributions of operating profit from our investments as part of cash flows from operating activities and distributions related to a capital transaction, such as a refinancing transaction or sale, as investing activities in the condensed combined consolidated statements of cash flows. A description of our impairment policy is set forth in this Note 2.

The difference between the initial cost of the investment in our joint ventures included in our condensed combined consolidated balance sheet and the underlying equity in net assets of the respective joint ventures (“JV Basis Differential”) is amortized as an adjustment to equity in net income or net loss of the joint ventures in our condensed combined consolidated statement of operations over the estimated useful lives of the underlying assets of the respective joint ventures.

Income Taxes

We have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”). To qualify as a REIT, we must meet a number of organizational and operational requirements, including a requirement that we currently distribute at least 90% of our REIT taxable income to our stockholders. Also, at least 95% of gross income in any year must be derived from qualifying sources. We intend to adhere to these requirements and maintain our REIT status. As a REIT, we generally will not be subject to corporate level federal income tax on taxable income that we distribute currently to our stockholders. However, we may be subject to certain state and local taxes on our income and property, and to federal income and excise taxes on our undistributed taxable income, if any. Management believes that it has distributed and will continue to distribute a sufficient majority of its taxable income in the form of dividends and distributions to its stockholders and unit holders. Accordingly, no provision for income taxes has been recognized by the Company.

Pursuant to the Code, we may elect to treat certain of our newly created corporate subsidiaries as taxable REIT subsidiaries (“TRS”).  In general, a TRS may perform non-customary services for our tenants, hold assets that we cannot hold directly and generally engage in any real estate or non-real estate related business.  A TRS is subject to corporate federal income tax.  As of September 30, 2009, none of our subsidiaries was considered a TRS.

Earnings per Share

Pacific Office Properties Trust, Inc.

We present both basic and diluted earnings per share (“EPS”).  Basic EPS is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during each period.

Diluted EPS is computed by dividing net income available to common stockholders for the period by the number of common shares that would have been earned and outstanding, assuming the issuance of common shares for all potentially dilutive common shares outstanding during such period.

Waterfront

We computed net loss per Common Unit for the period prior to the Transactions by increasing the historical net loss of Waterfront by the 2% cumulative distributions payable on the Preferred Units received by the former owners of Waterfront and dividing that total by the weighted average number of Common Units received by the former owners of Waterfront. We did not include the dilution impact of Preferred Units because the units are contingently convertible and the probability that the contingency will be satisfied is currently not determinable.


 
 11

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements



Real Estate Properties

Acquisitions

We account for acquisitions utilizing the acquisition method and, accordingly, the results of operations of acquired properties are included in our results of operations from the respective dates of acquisition.

Investments in real estate are stated at cost, less accumulated depreciation and amortization, except for the assets of Waterfront and certain assets comprising the Contributed Properties. The assets of Waterfront are stated at their historical net cost basis as Waterfront was designated as the acquiring entity in the business combination for accounting purposes. A portion of certain assets comprising the Contributed Properties are stated at their historical net cost basis in an amount attributable to the ownership interests in the Contributed Properties owned by the controlling owner of Waterfront. Additions to land, buildings and improvements, furniture, fixtures and equipment and construction in progress are recorded at cost.

Costs associated with developing space for its intended use are capitalized and amortized over their estimated useful lives, commencing at the earlier of the lease execution date or the lease commencement date.

Estimates of future cash flows and other valuation techniques are used to allocate the acquisition cost of acquired properties among land, buildings and improvements, and identifiable intangible assets and liabilities such as amounts related to in-place at-market leases, acquired above- and below-market leases, and acquired above- and below-market ground leases.

The fair values of real estate assets acquired are determined on an “as-if-vacant” basis. The “as-if-vacant” fair value is allocated to land, and where applicable, buildings, tenant improvements and equipment based on comparable sales and other relevant information obtained in connection with the acquisition of the property.

Fair value is assigned to above-market and below-market leases based on the difference between (a) the contractual amounts to be paid by the tenant based on the existing lease and (b) management’s estimate of current market lease rates for the corresponding in-place leases, over the remaining terms of the in-place leases. Capitalized above and below-market lease amounts are reflected in “Acquired below market leases, net” in the condensed combined consolidated balance sheets. Capitalized above-market lease amounts are amortized as a decrease to rental revenue over the remaining terms of the respective leases. Capitalized below-market lease amounts are amortized as an increase in rental revenue over the remaining terms of the respective leases. If a tenant vacates its space prior to the contractual termination of the lease and no rental payments are being made on the lease, any unamortized balance, net of the security deposit, of the related intangible is written off.

The aggregate value of other acquired intangible assets consists of acquired in-place leases. The fair value allocated to acquired in-place leases consists of a variety of components including, but not necessarily limited to: (a) the value associated with avoiding the cost of originating the acquired in-place lease (i.e. the market cost to execute a lease, including leasing commissions and legal fees, if any); (b) the value associated with lost revenue related to tenant reimbursable operating costs estimated to be incurred during the assumed lease-up period (i.e. real estate taxes, insurance and other operating expenses); (c) the value associated with lost rental revenue from existing leases during the assumed lease-up period; and (d) the value associated with any other inducements to secure a tenant lease. The value assigned to acquired in-place leases is amortized over the remaining lives of the related leases.


 
 12

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements

We record the excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired (including identified intangible assets) and liabilities assumed as goodwill. Goodwill is not amortized but is tested for impairment at a level of reporting referred to as a reporting unit on an annual basis, during the fourth quarter of each calendar year, or more frequently, if events or changes in circumstances indicate that the asset might be impaired. An impairment loss for an asset group is allocated to the long-lived assets of the group on a pro-rata basis using the relative carrying amounts of those assets, except that the loss allocated to an individual long-lived asset shall not reduce the carrying amount of that asset below its fair value. A description of our testing policy is set forth in this Note 2. During the nine months ended September 30, 2009, we recorded an adjustment to the purchase price allocation we previously recorded upon consummation of the formation transactions. This adjustment resulted in an increase to goodwill and accounts payable and other liabilities by approximately $0.5 million in our condensed combined consolidated balance sheet at September 30, 2009.  In connection with the Transactions, we received a representation from our predecessor, AZL that it qualified as a REIT under the provisions of the Internal Revenue Code. However, in early 2009, we became aware that AZL may have failed to meet certain asset tests required to be satisfied under the Internal Revenue Code to qualify for, and maintain, its REIT status as a result of certain of its investments that exceeded the permissible amount allowed at a given period. If we were found not to have complied with the asset tests, we could be subject to a penalty tax as a result of any such violations, but we do not believe that any such penalty tax would be material. However, such noncompliance should not adversely affect our qualification as a REIT as long as such noncompliance was due to reasonable cause and not due to willful neglect, and as long as certain other requirements are met. Based on the information we currently have, we believe that any noncompliance was due to reasonable cause and not due to willful neglect.  Additionally, we believe that we have complied with the other requirements of the mitigation provisions of the Code with respect to such potential noncompliance with the asset tests, including paying the appropriate penalty tax, and therefore our qualification and that of our predecessor, AZL, as a REIT should not be affected.  However, if the Internal Revenue Service were to successfully challenge our position, the Internal Revenue Service could determine that we did not satisfy the asset tests and, consequently, could determine that we failed to qualify as a REIT in one or more of our taxable years.

Mortgage and Other Loans

Mortgage and other loans assumed upon acquisition of related real estate properties are stated at estimated fair value upon their respective dates of assumption, net of unamortized discounts or premiums to their outstanding contractual balances.

Amortization of discount and the accretion of premiums on mortgage and other loans assumed upon acquisition of related real estate properties are recognized from the date of assumption through their contractual maturity date using the straight line method, which approximates the effective interest method.

Depreciation

Depreciation and amortization are computed using the straight-line method for financial reporting purposes. Buildings and improvements are depreciated over their estimated useful lives which range from 18 to 42 years. Tenant improvement costs recorded as capital assets are depreciated over the shorter of (i) the tenant’s remaining lease term or (ii) the life of the improvement. Furniture, fixtures and equipment are depreciated over three to seven years.  Properties that are acquired that are subject to ground leases are depreciated over the remaining life of the related leases as of the date of assumption of the lease.

Revenue Recognition

All of our tenant leases are classified as operating leases. For all leases with scheduled rent increases or other adjustments, minimum rental income is recognized on a straight-line basis over the terms of the related leases. Straight line rent receivable represents rental revenue recognized on a straight-line basis in excess of billed rents and this amount is included in “Rents and other receivables, net” on the accompanying condensed combined consolidated balance sheets. Reimbursements from tenants for real estate taxes, excise taxes and other recoverable operating expenses are recognized as revenues in the period the applicable costs are incurred.

We have leased space to certain tenants under non-cancelable operating leases, which provide for percentage rents based upon tenant revenues. Percentage rental income is recorded in rental revenues in the condensed combined consolidated statements of operations.

Rental revenue from parking operations and month-to-month leases or leases with no scheduled rent increases or other adjustments is recognized on a monthly basis when earned.

Lease termination fees, net of the write-off of associated intangible assets and liabilities and straight-line rent balances which are included in “Other” in the revenue section of the accompanying condensed combined consolidated statements of operations, are recognized when the related leases are canceled and we have no continuing obligation to provide services to such former tenants.

 
 13

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements


Other revenue on the accompanying consolidated statements of operations generally includes income incidental to our operations and is recognized when earned.

Cash and Cash Equivalents

We consider all short-term cash investments with maturities of three months or less when purchased to be cash equivalents. Restricted cash is excluded from cash and cash equivalents for the purpose of preparing our condensed combined consolidated statements of cash flows.

We maintain cash balances in various financial institutions. At times, the amounts of cash held in financial institutions may exceed the maximum amount insured by the Federal Deposit Insurance Corporation. We do not believe that we are exposed to any significant credit risk on our cash and cash equivalents.

Restricted Cash

Restricted cash includes escrow accounts for real property taxes, insurance, capital expenditures and tenant improvements, debt service and leasing costs held by lenders.

Impairment

We assess the potential for impairment of our long-lived assets, including real estate properties, whenever events occur or a change in circumstances indicate that the recorded value might not be fully recoverable. We determine whether impairment in value has occurred by comparing the estimated future undiscounted cash flows expected from the use and eventual disposition of the asset to its carrying value. If the undiscounted cash flows do not exceed the carrying value, the real estate or intangible carrying value is reduced to fair value and impairment loss is recognized. Assets to be disposed of are reported at the lower of the carrying amount or fair value, less costs to sell. Based upon such periodic assessments, no indications of impairment were identified for the periods presented in the accompanying condensed combined consolidated statements of operations.

Goodwill is reviewed for impairment on an annual basis during the fourth quarter of each calendar year, or more frequently if circumstances indicate that a possible impairment has occurred. The assessment of impairment involves a two-step process whereby an initial assessment for potential impairment is performed, followed by a measurement of the amount of impairment, if any. Impairment testing is performed using the fair value approach, which requires the use of estimates and judgment, at the “reporting unit” level. A reporting unit is the operating segment, or a business that is one level below the operating segment if discrete financial information is prepared and regularly reviewed by management at that level. The determination of a reporting unit’s fair value is based on management’s best estimate, which generally considers the market-based earning multiples of the unit’s peer companies or expected future cash flows. If the carrying value of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any.  An impairment is recognized as a charge against income equal to the excess of the carrying value of goodwill over its implied value on the date of the impairment. As of September 30, 2009, nothing has come to our attention to cause us to believe that our carrying amount of goodwill is impaired.  The factors that may cause an impairment in goodwill include, but may not be limited to, a sustained decline in our stock price and the occurrence, or sustained existence, of adverse economic conditions.

Other-Than-Temporary Impairment

Our investment in unconsolidated joint ventures is subject to a periodic impairment review and is considered to be impaired when a decline in fair value is judged to be other-than-temporary. An investment in an unconsolidated joint venture that we identify as having an indicator of impairment is subject to further analysis to determine if the investment is other than temporarily impaired, in which case we write down the investment to its estimated fair value. We did not recognize an impairment loss on our investment in unconsolidated joint ventures during the three and nine months ended September 30, 2009.

 
 14

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements


Repairs, Maintenance and Major Improvements

The costs of ordinary repairs and maintenance are charged to operations when incurred. Major improvements that extend the life of an asset are capitalized and depreciated over the remaining useful life of the asset. Various lenders have required us to maintain reserve accounts for the funding of future repairs and capital expenditures, and the balances of these accounts are classified as restricted cash on the accompanying condensed combined consolidated balance sheets.

Tenant Receivables

Tenant receivables are recorded and carried at the amount billable per the applicable lease agreement, less any allowance for doubtful accounts. An allowance for doubtful accounts is made when collection of the full amounts is no longer considered probable. Tenant receivables are included in “Rents and other receivables, net”, in the accompanying condensed combined consolidated balance sheets. If a tenant fails to make contractual payments beyond any allowance, we may recognize bad debt expense in future periods equal to the amount of unpaid rent and deferred rent. We take into consideration factors to evaluate the level of reserve necessary, including historical termination, default activity and current economic conditions. At September 30, 2009, the balance of the allowance for doubtful accounts was $1.0 million, compared to $0.8 million at December 31, 2008.

Preferred Units

Preferred Units have fixed rights to distributions at an annual rate of 2% of their liquidation preference of $25 per Preferred Unit. Accordingly, income or loss of the Operating Partnership is allocated among the general partner interest and limited partner common interests after taking into consideration distribution rights allocable to the Preferred Units.

Deferred Loan Fees

Deferred loan fees include fees and costs incurred in conjunction with long-term financings and are amortized over the terms of the related debt using a method that approximates the interest method. Deferred loan fees are included in “Other assets, net” in the accompanying condensed combined consolidated balance sheets. Amortization of deferred loan fees is included in “Interest” in the accompanying condensed combined consolidated statements of operations.

Equity Offering Costs

Costs from potential equity offerings are reflected in “Other Assets, net” and will be reclassified as a reduction in additional paid-in capital upon successful completion of the offering.

Leasing Commissions

Leasing commissions are capitalized and amortized over the life of the related lease.  The payment of leasing commissions is included in cash used in investing activities on the accompanying condensed combined consolidated statement of cash flows because we believe that paying leasing commissions for good tenants is a prudent investment in increasing the value of our income-producing assets.

Use of Estimates in Financial Statements

We are required by GAAP to make estimates and assumptions that affect amounts reported in the condensed combined consolidated financial statements and accompanying notes. The accounting estimates that require our most significant, difficult and subjective judgments include:

 
the initial valuation and underlying allocations of purchase price for investments in real estate;

 
the assessment of recoverability of long-lived assets;

 
 15

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements


 
the valuation of investments in unconsolidated joint ventures;

 
the valuation and recognition of equity instruments issued, including:

—        non-controlling interests; and

—        share-based compensation;

 
the valuation and recognition of derivative financial instruments; and

 
the determination of useful lives of investments in real estate and related assets and liabilities.

Stock-Based Compensation

All share-based payments to employees, including directors, are recognized in the statement of operations based on their fair values. See Note 13 for a more detailed discussion.

Segments

We own and operate office properties in the western United States.  We have concentrated initially on two long-term growth submarkets, Honolulu and the western United States mainland (in particular, Southern California and the greater Phoenix metropolitan area).  We consider each of our properties to be an operating segment.  We aggregate the operating segments into two geographic segments on the basis of similar economic characteristics.

Recent Accounting Pronouncements

Pronouncements Affecting Fair Value Measurement

In September 2006, the FASB issued guidance for using fair value to measure assets and liabilities. We adopted this guidance for the valuation of financial assets and liabilities in 2008 and the valuation of non-financial assets and liabilities as of January 1, 2009.  Our adoption of this guidance did not have a material impact on our consolidated results of operations, financial position or cash flow, as our derivative value is not significant.

In April 2009, the FASB issued guidance requiring disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. Our adoption of this guidance on April 1, 2009 resulted in additional disclosures but did not have a material impact on our consolidated financial position, results of operations or cash flows.

Pronouncements Affecting Future Property Acquisitions

In December 2007, the FASB issued guidance broadening the fair value measurement and recognition of assets acquired, liabilities assumed and interests transferred as a result of business combinations. Under this pronouncement, acquisition-related costs must be expensed rather than capitalized as part of the basis of the acquired business. Companies are also required to enhance disclosure to improve the ability of financial statement users to evaluate the nature and financial effects of business combinations. We adopted the guidance on January 1, 2009 and believe that such adoption could materially impact our future consolidated financial results to the extent that we acquire significant amounts of real estate or real estate related businesses, as related acquisition costs will be expensed as incurred compared to the current practice of capitalizing such costs and amortizing them over the estimated useful life of the assets or real estate related businesses acquired.

In April 2009, the FASB issued guidance to address application issues raised by preparers, auditors, and members of the legal profession on initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination.  Assets and liabilities arising from contingencies are recognized at fair value on the acquisition date.  We adopted this guidance on July 1, 2009 and will apply it prospectively to business combinations completed on or after that date.  The impact of the adoption will depend on the nature of acquisitions completed after July 1, 2009.

 
 16

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements


Pronouncements Pertaining to our Investment in Unconsolidated Joint Ventures

In November 2008, the FASB provided guidance for the accounting of contingent consideration, recognition of other-than-temporary impairment (OTTI) of an equity method investee, and change in level of ownership or degree of influence. The accounting of contingent consideration might result in the recording of a liability with an increase to the corresponding investment balance. The investor must recognize its share of the investee’s impairment charges. A gain or loss to the investor resulting from a change in level of ownership or influence must be recognized in earnings of the investor. We adopted the guidance on January 1, 2009 and it did not have an impact on our consolidated financial position, results of operations or cash flows. In the event that we acquire a controlling interest in our existing investments in unconsolidated joint ventures, we believe that the adoption of this guidance could materially impact our future consolidated financial results.

        In June 2009, the FASB issued guidance which requires us to perform an on-going reassessment of whether our enterprise is the primary beneficiary of a variable interest entity.  This analysis identifies the primary beneficiary of a variable interest entity as the enterprise that has both of the following characteristics: (i) the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance, and (ii) the obligation to absorb losses of the entity that could potentially be significant to the variable interest entity or the right to receive benefits from the entity that could potentially be significant to the variable interest entity.  This guidance is effective for us beginning January 1, 2010 and we are in the process of quantifying the impact of the adoption of this standard on our consolidated financial statements.

Pronouncements Pertaining to the Non-controlling Interests in our Operating Partnership

In December 2007, the FASB issued guidance which requires a non-controlling interest in a subsidiary to be reported as equity and the amount of consolidated net income specifically attributable to the non-controlling interest to be identified in the condensed combined consolidated financial statements. We must also be consistent in the manner of reporting changes in the parent’s ownership interest and the guidance requires fair value measurement of any non-controlling equity investment retained in a deconsolidation. We adopted the guidance on January 1, 2009.

Concurrently with the adoption of the guidance regarding non-controlling interests, we also adopted guidance which required us to present the limited partnership common and preferred interests in the UPREIT in the mezzanine section of our consolidated balance sheets because the decision to redeem for cash or Company shares is not solely within the control of the Company. Because some of the Company’s directors also own limited partnership common and preferred interests indirectly through Venture combined with the existence of the Proportionate Voting Preferred Stock, we have determined that there are hypothetical situations where the holders of our partnership units could control the method of redemption (cash or Company shares) and therefore these partnership units require mezzanine presentation in our consolidated balance sheets. In addition, we are required to measure our outstanding Common Units at their redemption value because the units are considered redeemable for shares or cash after March 19, 2010.  Our Preferred Units do not require redemption value measurement because these units are not considered redeemable until no earlier than the later of (i) March 19, 2010, and (ii) the date we consummate an underwritten public offering (of at least $75 million) of our common stock.  In the current capital market environment, management does not consider the completion of the public stock offering probable at this time.  Furthermore, in the event that we acquire a controlling interest in our existing investments in unconsolidated joint ventures, we believe that the adoption of this guidance could materially impact our future consolidated financial results, as our existing investments would be adjusted to fair value at the date of acquisition of the controlling interest.


 
 17

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements


Pronouncement Affecting Treatment of Nonvested Share-Based Payments in Net Loss Available to Common Stockholders per Share

In June 2008, the FASB issued guidance that requires that share-based payment awards that are not fully vested and contain non-forfeitable rights to receive dividends or dividend equivalents declared on our common stock be treated as participating securities in the computation of EPS pursuant to the two-class method.  Dividend equivalents corresponding to the cash dividends declared on our common stock are forfeitable for unvested restricted stock unit awards granted to our board of directors, as described in Note 13, “Share-Based Payments”.  We applied this guidance retrospectively to all periods presented for fiscal years beginning after December 15, 2008, which for us means January 1, 2009. The adoption of this guidance did not have an impact on our consolidated financial position, results of operations and cash flows.

Pronouncements Resulting in Modified Disclosures in the Financial Statements

In May 2009, the FASB established general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued.  We adopted this guidance during the quarter ended June 30, 2009 and it resulted in additional disclosure but did not have a material impact on our financial statements.

In June 2009, the FASB Accounting Standards Codification was established as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP.  The guidance does not change GAAP but changed how we reference GAAP in our consolidated financial statements beginning with this Form 10-Q.

3. Investments in Real Estate, net

Our investments in real estate, net, at September 30, 2009, and at December 31, 2008, are summarized as follows (in thousands):


   
September 30, 2009
   
December 31, 2008
 
             
Land and land improvements
  $ 76,054     $ 76,008  
Building and building improvements
    310,240       308,125  
Tenant improvements
    27,130       24,489  
Furniture, fixtures and equipment
    1,385       1,210  
Construction in progress
    3,064       4,082  
Investments in real estate
    417,873       413,914  
Less:  accumulated depreciation
    (32,442 )     (21,257 )
Investments in real estate, net
  $ 385,431     $ 392,657  
                 


Acquisitions of Consolidated Properties

See Transactions in Note 1 for a discussion of the properties acquired on March 19, 2008.


 
 18

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements


4. Intangible Assets and Acquired Above and Below Market Lease Liabilities

Our identifiable intangible assets and acquired above and below market leases, net at September 30, 2009, and at December 31, 2008, are summarized as follows (in thousands):


 
 
September 30, 2009
   
December 31, 2008
 
   
 
   
 
 
Acquired leasing commissions
 
 
   
 
 
          Gross amount
  $ 8,689     $ 8,316  
          Accumulated amortization
    (3,903 )     (2,950 )
          Net balance
  $ 4,786     $ 5,366  
                 
Acquired leases in place
               
          Gross amount
  $ 17,551     $ 18,109  
          Accumulated amortization
    (9,635 )     (6,724 )
          Net balance
  $ 7,916     $ 11,385  
                 
Acquired tenant relationship costs
               
          Gross amount
  $ 19,581     $ 19,588  
          Accumulated amortization
    (3,799 )     (1,941 )
          Net balance
  $ 15,782     $ 17,647  
                 
Acquired other intangibles
               
          Gross amount
  $ 7,802     $ 7,879  
          Accumulated amortization
    (1,207 )     (898 )
          Net balance
  $ 6,595     $ 6,981  
                 
Intangible assets, net
  $ 35,079     $ 41,379  
                 
Acquired below market leases
               
          Gross amount
  $ 15,655     $ 16,608  
          Accumulated amortization
    (4,926 )     (3,755 )
 Net balance
    10,729       12,853  
                 
Acquired above market leases
               
          Gross amount
  $ 2,393     $ 2,449  
          Accumulated amortization
    (1,661 )     (1,413 )
 Net balance
    732       1,036  
Acquired below market leases, net
  $ 9,997     $ 11,817  
                 
 
 
5. Investment in Unconsolidated Joint Ventures

We own managing interests in six joint ventures, consisting of 15 office properties, including 29 office buildings, comprising approximately 2.06 million rentable square feet. Our ownership interest percentages in these joint ventures range from approximately 7.5% to 32.2%.  In exchange for our managing ownership interest and related equity investment in these joint ventures, we are entitled to fees, preferential allocations of earnings and cash flows from each respective joint venture. We are also entitled to incentive interests in excess of our ownership percentages ranging from approximately 21.4% to 36.0%, subject to returns on invested capital.

 
  19

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements


At September 30, 2009, the JV Basis Differential, net, was approximately $1.5 million and is included in investments in unconsolidated joint ventures in our condensed combined consolidated balance sheet. For the three and nine months ended September 30, 2009, we recognized approximately $0.01 million and $0.05 million of amortization expense, respectively, attributable to the JV Basis Differential, which is included in equity in net earnings of unconsolidated joint ventures in our condensed combined consolidated statement of operations.

The following tables summarize financial information for our unconsolidated joint ventures (in thousands):

 
   
Three months ended Sept 30, 2009
   
Nine months ended Sept 30, 2009
   
Three months ended Sept 30, 2008
   
Nine months ended Sept 30, 2008
 
Revenues:
                       
Rental
  $ 9,513     $ 28,255     $ 9,805     $ 27,979  
Other
    2,160       6,352       2,132       6,471  
Total revenues
    11,673       34,607       11,937       34,450  
                                 
Expenses:
                               
Rental operating expenses
    4,768       14,467       5,153       14,223  
Depreciation and amortization
    4,486       13,442       4,431       14,578  
Interest
    3,972       11,877       4,484       12,581  
Total expenses
    13,226       39,786       14,068       41,382  
Net loss
  $ (1,553 )   $ (5,179 )   $ (2,131 )   $ (6,932 )
                                 
Equity in net income (loss)
                               
   of unconsolidated joint venture
  $ 189     $ 406     $ 185     $ 156  
 
                               


 
 
As of
   
As of
 
 
 
Sept 30, 2009
   
December 31, 2008
 
Investment in real estate, net
  $ 328,757     $ 336,409  
Other assets
    58,241       61,591  
Total assets
  $ 386,998     $ 398,000  
                 
Mortgage and other collateralized loans
  $ 318,091     $ 314,324  
Other liabilities
    13,104       18,139  
Total liabilities
  $ 331,195     $ 332,463  
                 
Investment in unconsolidated joint ventures
  $ 10,016     $ 11,590  
                 


 
20 

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements


Acquisitions of Unconsolidated Joint Ventures

On April 1, 2008, we and our joint venture partner in Seville Plaza entered into an Amended Operating Agreement. Based on this amendment, which served to modify and provide substantive participating rights to the non-managing member, we have accounted for our 7.5% investment in Seville Plaza under the equity method of accounting. Prior to the date of such amendment, we had consolidated our 7.5% investment in Seville Plaza. The JV Basis Differential attributable to Seville Plaza upon the Effective Date was $0.04 million.

In a series of transactions occurring on April 30, 2008, May 30, 2008 and June 19, 2008, following exercise of an option granted to us by Venture and its affiliates as part of the Transactions (the “Option”), we consummated the acquisition, through the Operating Partnership, of a 32.167% managing ownership interest in the POP San Diego I Joint Venture that owns a portfolio of seven commercial office buildings totaling 181,664 rentable square feet located throughout San Diego, California and Carlsbad, California. We acquired the managing ownership interest pursuant to the Option and assumed the rights and obligations of an affiliate of The Shidler Group (a “Shidler Affiliate”) under a previously executed purchase and sale agreement. The acquisition price for our managing ownership interest was approximately $2.6 million. This acquisition price was funded by issuing 396,526 Common Units on April 30, 2008 which Common Units were valued at $6.5589 per unit. Upon acquisition, there was no JV Basis Differential attributable to the POP San Diego I Joint Venture, including with respect to the acquisitions consummated on May 30, 2008 and June 19, 2008.

On April 30, 2008, following the exercise of the Option, we consummated with certain Shidler Affiliates the acquisition, through the Operating Partnership, of a 17.5% managing ownership interest in a joint venture that owns a commercial office building totaling 221,784 rentable square feet located in Phoenix, Arizona (the “Black Canyon Corporate Center”). The acquisition price for the managing ownership interest in the Black Canyon Corporate Center was $1.0 million, payable in the form of a subordinated note issued by the Operating Partnership to a Shidler Affiliate. The purchase price for the managing ownership interest in the Black Canyon Corporate Center was approximately equal to the Shidler Affiliates’ cost of investment in the Black Canyon Corporate Center. The JV Basis Differential attributable to the Black Canyon Corporate Center upon acquisition was $0.08 million.

On May 23, 2008, following the exercise of the Option, we consummated with certain Shidler Affiliates the acquisition, through the Operating Partnership, of a 7.5% managing ownership interest in a joint venture that owns a commercial office building and a separate parking and retail complex totaling approximately 355,000 rentable square feet of office space and approximately 15,000 rentable square feet of retail space, located in Phoenix, Arizona (the “US Bank Center”). The acquisition price for the managing ownership interest in the US Bank Center was $1.2 million, payable in the form of a subordinated note issued by the Operating Partnership. The purchase price for the managing ownership interest in the US Bank Center was approximately equal to the Shidler Affiliates’ cost of investment in the US Bank Center. The JV Basis Differential attributable to the US Bank Center upon acquisition was $0.89 million.

On May 23, 2008, following the exercise of the Option, we consummated with certain Shidler Affiliates the acquisition, through the Operating Partnership, of a 17.5% managing ownership interest in a joint venture that owns a commercial office building totaling 152,288 rentable square feet, located in Honolulu, Hawaii (the “Bank of Hawaii Waikiki Center”; which was formerly known as Kalakaua Business Center). The acquisition price for the managing ownership interest in the Bank of Hawaii Waikiki Center was $0.79 million, payable in the form of a subordinated note issued by the Operating Partnership. The purchase price for the managing ownership interest in the Bank of Hawaii Waikiki Center was approximately equal to the Shidler Affiliates’ cost of investment in the Bank of Hawaii Waikiki Center. The JV Basis Differential attributable to the Bank of Hawaii Waikiki Center upon acquisition was $(0.09) million.

On May 30, 2008, the POP San Diego I Joint Venture consummated with certain Shidler Affiliates the acquisition of the managing ownership interest in the Scripps Ranch Business Park. Pursuant to the terms of the Option, the POP San Diego I Joint Venture assumed the rights and obligations of a Shidler Affiliate to acquire the managing ownership interest in the Scripps Ranch Business Park for approximately $2.8 million in cash, including customary closing costs, and the assumption of approximately $5.3 million of existing mortgage indebtedness.

 
 21

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements


On June 19, 2008, the POP San Diego I Joint Venture acquired two commercial office buildings totaling approximately 81,000 rentable square feet located in San Diego, California. Pursuant to the terms of the Option, the POP San Diego I Joint Venture assumed the rights and obligations of a Shidler Affiliate, under the respective purchase agreements. The acquisition price for such buildings was approximately $19.2 million, including assumption of approximately $12.7 million of mortgage debt and customary closing costs. The acquisition price was funded by issuing 326,576 Common Units on June 19, 2008, which Common Units were valued at $6.8107 per unit.

On August 14, 2008, following exercise of the Option, we consummated with certain Shidler Affiliates the acquisition, through the Operating Partnership, of a 10% managing ownership interest in a joint venture (the “SoCal II Joint Venture”) that owns a portfolio of fifteen office and flex buildings totaling over 1,000,000 rentable square feet, situated on seven properties in Los Angeles, Orange and San Diego counties in Southern California. The acquisition price for the managing ownership interest was approximately $4.2 million, payable in the form of a subordinated note issued by the Operating Partnership to a Shidler Affiliate. The purchase price for the managing ownership interest was approximately equal to the Shidler Affiliates’ cost of investment in the SoCal II Joint Venture. The JV Basis Differential attributable to the SoCal II Joint Venture upon acquisition was $0.2 million.

We account for our investments in joint ventures under the equity method of accounting.

6.
Other Assets, net

Other assets, net consist of the following (in thousands):

 
 
September 30, 2009
   
December 31, 2008
 
Deferred loan fees, net of accumulated amortization of $1.4 million
           
and $0.8 million at September 30, 2009 and December 31, 2008,
           
respectively
  $ 2,186     $ 3,447  
Prepaid expenses
    2,458       1,232  
Equity offering costs
    1,178       -  
Other
    -       1  
Total other assets, net
  $ 5,822     $ 4,680  

7.  Accounts Payable and Other Liabilities

Accounts payable and other liabilities consist of the following (in thousands):

 
22 

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements



 
 
 
September 30, 2009
   
December 31, 2008
 
Accounts payable
  $ 707     $ 1,276  
Interest payable
    2,240       1,353  
Deferred revenue
    1,493       1,278  
Security deposits
    2,485       2,558  
Deferred straight-line ground rent
    5,554       2,811  
Related party payable (Note 12 )
    1,078       1,060  
Accrued expenses
    6,101       6,281  
Asset retirement obligations
    599       471  
Total accounts payable and other liabilities
  $ 20,257     $ 17,088  


8. Mortgage and Other Loans

A summary of our mortgage and other loans, net, at September 30, 2009 is as follows (in thousands):

                             
PROPERTY
 
OUTSTANDING PRINCIPAL BALANCE
   
UNAMORTIZED PREMIUM (DISCOUNT)
   
NET
   
INTEREST RATE AT SEPTEMBER 30, 2009
 
MATURITY DATE
AMORTIZATION
Clifford Center
  $ 3,567     $ -     $ 3,567       6.00 %
8/15/2011(a)
132 months
Davies Pacific
                                   
Center
    95,000       (958 )     94,042       5.86 %
11/11/2016
Interest Only
First Insurance
                                   
Center
    38,000       (584 )     37,416       5.74 %
1/1/2016
Interest Only
First Insurance
                                   
Center
    14,000       (218 )     13,782       5.40 %
1/6/2016
Interest Only
Pacific
                                   
Business
                                   
News Building
    11,691       25       11,716       6.98 %
4/6/2010
360 months
Pan Am
                                   
Building
    60,000       (38 )     59,962       6.17 %
8/11/2016
Interest Only
Waterfront
                                   
Plaza
    100,000       -       100,000       6.37 %
9/11/2016
Interest Only
Waterfront
                                   
Plaza
    11,000       -       11,000       6.37 %
9/11/2016
Interest Only
City Square
    27,500       (119 )     27,381       5.58 %
9/1/2010
Interest Only
City Square (b)
    27,017       -       27,017    
LIBOR + 2.35%
 
9/1/2010
Interest Only
Sorrento
                                   
Techonology
                                   
Center
    11,800       (183 )     11,617       5.75 %
1/11/2016
Interest Only
Subtotal
  $ 399,575     $ (2,075 )   $ 397,500          
 
 
Revolving line of
                                   
  credit (c)
    5,847       -       5,847       1.85 %
9/2/2011
Interest Only
Total
  $ 405,422     $ (2,075 )   $ 403,347              
                                     

____________
(a)
The terms of the Clifford Center note payable provide the Company with the option to extend the maturity date to August 15, 2014 subject to a nominal fee, which the Company expects to exercise.

 
23 

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements


(b)
The City Square note payable with an outstanding balance of $27.0 million at September 30, 2009 has an additional $1.5 million available to be drawn. In addition, the Company has an interest rate cap on this loan for the notional amount of $28.5 million, which effectively limits the LIBOR rate on this loan to 7.45%. The interest rate cap expires on September 1, 2010, commensurate with the maturity date of this note payable.

(c)
The revolving line of credit matures on September 2, 2011. Amounts borrowed under the FHB Credit Facility will bear interest at a fluctuating annual rate equal to the effective rate of interest paid by the Lender on time certificates of deposit, plus 1.00%.  See “Revolving Line of Credit” below.

The lenders’ collateral for notes payable, with the exception of the Clifford Center note payable, is the property and, in some instances, cash reserve accounts, ownership interests in the underlying entity owning the real property, leasehold interests in certain ground leases, rights under certain service agreements, and letters of credit posted by certain related parties of the Company. The lenders’ collateral for the Clifford Center note payable is the leasehold property as well as guarantees from affiliates of the Company.

The scheduled maturities for our mortgages and other loans for the periods succeeding September 30, 2009 are as follows (in thousands and includes schedule principal paydowns):


   
 
 
October 1, 2009 to December 31, 2009
  $ 104  
2010
    66,446  
2011
    9,072  
2012
    -  
2013
    -  
Thereafter
    329,800  
Total
  $ 405,422  
         

Revolving Line of Credit

We entered into a Credit Agreement dated as of August 25, 2008 (the “KeyBank Credit Facility”) with KeyBank National Association (“KeyBank”) and KeyBanc Capital Markets. As of June 30, 2009 we had outstanding borrowings of $3.0 million under the KeyBank Credit Facility.
 
On September 3, 2009, we entered into a Termination and Release Agreement (the “Termination Agreement”) with KeyBank terminating the KeyBank Credit Facility.  In connection with the Termination Agreement, we paid to KeyBank on September 3, 2009 a total payoff amount of approximately $2.8 million, representing the total principal amount owed together with all accrued and unpaid contractual interest and fees, less a prorated amount of certain fees paid by us in connection with the origination of the KeyBank Credit Facility.  KeyBank has released all claims to the assets held as security for the KeyBank Credit Facility, and KeyBank and the Company have provided each other with a general release of all claims arising in connection with the KeyBank Credit Facility or any of the related loan documents.
 
On September 2, 2009, we entered into a Credit Agreement (the “FHB Credit Facility”) with First Hawaiian Bank (the “Lender”).  The FHB Credit Facility provides us with a revolving line of credit in the principal sum of $10.0 million.  Amounts borrowed under the FHB Credit Facility will bear interest at a fluctuating annual rate equal to the effective rate of interest paid by the Lender on time certificates of deposit, plus 1.00%.  We are permitted to use the proceeds of the line of credit for working capital and general corporate purposes, consistent with our real estate operations and for such other purposes as the Lender may approve.  As of September 30, 2009, we had outstanding borrowings of $5.8 million under the FHB Credit Facility.

 
24 

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements


The FHB Credit Facility matures on September 2, 2011.  As security for the FHB Credit Facility, Shidler Equities L.P., a Hawaii limited partnership controlled by Jay H. Shidler, the chairman of the Company’s board of directors, has pledged to the Lender a certificate of deposit in the principal amount of $10.0 million. Pursuant to an indemnification agreement, we have agreed to pay Shidler Equities L.P. an annual fee of 2% on the $10.0 million certificate of deposit.  In addition, to the extent that all or any portion of the certificate of deposit is withdrawn by the Lender and applied to the payment of principal, interest and/or charges under the FHB Credit Facility, we have agreed to pay to Shidler Equities L.P. interest on the withdrawn amount at a rate of 7.00% per annum from the date of withdrawal until the date of repayment in full by us to Shidler Equities L.P.

The FHB Credit Facility contains various customary covenants, including covenants relating to disclosure of financial and other information to the Lender, maintenance and performance of our material contracts, our maintenance of adequate insurance, payment of the Lender’s fees and expenses, and other customary terms and conditions.

9. Unsecured Notes Payable to Related Parties

At September 30, 2009, we had promissory notes payable by the Operating Partnership to certain affiliates of The Shidler Group in the aggregate principal amount of $21.1 million. The promissory notes accrue interest at a rate of 7% per annum, with interest payable quarterly, subject to the Operating Partnership’s right to defer the payment of interest for any or all periods up until the date of maturity. The promissory notes mature on various dates commencing on March 19, 2013 through August 31, 2013, but the Operating Partnership may elect to extend maturity for one additional year. Maturity accelerates upon the occurrence of a) a qualified public offering, as defined under the Master Agreement; b) the sale of substantially all the assets of the Company; or c) the merger of the Company with another entity. The promissory notes are unsecured obligations of the Operating Partnership.

On September 23, 2009, the Operating Partnership entered into an Exchange Agreement (the “Exchange Agreement”) with certain affiliates of The Shidler Group (collectively, the “Transferors”).  Pursuant to the terms and conditions of the Exchange Agreement, on September 25, 2009, certain unsecured subordinated promissory notes, in the aggregate outstanding amount (including principal and accrued interest) of approximately $3.0 million, issued by the Operating Partnership to the Transferors were exchanged for 789,095 shares of common stock, par value $0.0001 per share, of the Company.  The price per share of the Company’s common stock issued pursuant to the Exchange Agreement was $3.82, which represented the volume-weighted average closing market price per share of the Company’s common stock on the NYSE Amex for the thirty trading days preceding the date of the Exchange Agreement.

For the period from March 20, 2008 through September 30, 2009, interest payments on the unsecured notes payable to related parties of The Shidler Group have been deferred with the exception of $0.3 million which was related to the notes exchanged pursuant to the Exchange Agreement.  At September 30, 2009 and at December 31, 2008, $2.2 million and $1.2 million, respectively, of accrued interest attributable to unsecured notes payable to related parties is included in accounts payable and other liabilities in the accompanying condensed combined consolidated balance sheets.

10. Commitments and Contingencies

Minimum Future Ground Rents

We have ground lease agreements for both Clifford Center and Waterfront Plaza.  The Clifford Center property ground lease expires May 31, 2035. The annual rental obligation is a combination of a base rent amount plus 3% of base rental income from tenants. On June 1, 2016 and 2026, the annual rental obligation will reset to an amount equal to 6% of the fair market value of the land. However, the ground rent cannot be less than the rent for the prior period. For the period prior to June 1, 2016, only the base rent component is included in the minimum future payments. For the periods succeeding May 31, 2016, we estimated the annual minimum future rental payments to be an amount equal to the rent paid for the immediately preceding 12-month period.

The Waterfront Plaza ground lease expires December 31, 2060. The annual rental obligation has fixed increases at 5-year intervals until it resets on January 1, 2036, 2041, 2046, 2051, and 2056 to an amount equal to 8.0% of the fair market value of the land. However, the ground lease rent cannot be less than the rent for the prior period. For the periods succeeding December 31, 2035, we estimated the annual minimum future rental payments to be an amount equal to the rent paid for the immediately preceding 12-month period.

 
 25

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements


Contingencies

From time to time, we may be subject to various legal proceedings and claims that arise in the ordinary course of business. These matters are generally covered by insurance, subject to deductibles and other customary limitations on recoveries. We believe that the ultimate settlement of these actions will not have a material adverse effect on our consolidated financial position and results of operations or cash flows.

Concentration of Credit Risk

Our operating properties are located in Honolulu, San Diego, Los Angeles, Orange County and Phoenix. The ability of the tenants to honor the terms of their respective leases is dependent upon the economic, regulatory and social factors affecting the markets in which the tenants operate. No single tenant accounts for 10% or more of our total annualized base rents.  We perform ongoing credit evaluations of our tenants for potential credit losses.

Financial instruments that subject us to credit risk consist primarily of cash, accounts receivable, deferred rents receivable and an interest rate contract. We maintain our cash and cash equivalents and restricted cash on deposit with what management believes are relatively stable financial institutions. Accounts at each institution are insured by the Federal Deposit Insurance Corporation up to the maximum amount; and, to date, we have not experienced any losses on our invested cash. Restricted cash held by lenders is held by those lenders in accounts maintained at major financial institutions.

Conditional Asset Retirement Obligations

We record a liability for a conditional asset retirement obligation, defined as a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement is conditional on a future event that may or may not be within a company’s control, when the fair value of the obligation can be reasonably estimated.  Depending on the age of the construction, certain properties in our portfolio may contain non-friable asbestos. If these properties undergo major renovations or are demolished, certain environmental regulations are in place, which specify the manner in which the asbestos, if present, must be handled and disposed. Based on our evaluation of the physical condition and attributes of certain of our properties acquired in the Transactions, we recorded conditional asset retirement obligations related to asbestos removal. As of September 30, 2009 and December 31, 2008, the liability in our condensed combined consolidated balance sheets for conditional asset retirement obligations was $0.3 million for both periods. The accretion expense was $0.01 and $0.03 million for the three and nine months ended September 30, 2009. No accretion was recorded for the three and nine months ended September 30, 2008.

Clifford Center Ground Lease

We are subject to a surrender clause under the Clifford Center property ground lease that provides the lessor with the right to require us, at our own expense, to raze and remove all improvements from the leased land if we have not complied with certain other provisions of the ground lease. These provisions require us to: (1) only make significant improvements or alterations to the building under the supervision of a licensed architect and/or structural engineer with lessor’s written approval; (2) comply with the Americans with Disabilities Act of 1990; and (3) comply with all federal, state, and local laws regarding the handling and use of hazardous materials. The requirement to remove the improvements is contingent, first, on our failure to comply with the terms of the lease and, second, upon the cost of compliance with the lease exceeding the estimated value of the improvements. To our knowledge, we are in substantial compliance with the Americans with Disabilities Act of 1990, all work is supervised by licensed professionals, and we are not aware of any violations of laws regarding the handling or use of hazardous materials at the Clifford Center property. If we fail to satisfy any of these requirements in the future, the obligation is subject to the lessor’s decision to require the improvements to be removed. We believe that it is improbable that there will ever be an obligation to retire the Clifford Center improvements pursuant to this provision.

 
26 

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements


Waterfront Plaza Ground Lease

We are subject to a surrender clause under the Waterfront Plaza ground lease that provides the lessor with the right to require us, at our own expense, to raze and remove all improvements from the leased land, contingent on the lessor’s decision at the time the ground lease expires on December 31, 2060. Accordingly, as of September 30, 2009 and December 31, 2008, the liability in our condensed combined consolidated balance sheets for this asset retirement obligation was $0.3 million for both periods. The accretion expense was not significant for the three and nine months ended September 30, 2009. No accretion was recorded for the three and nine months ended September 30, 2008.

Restaurant Row Theatre Venture Lease Termination

We entered into a Termination of Lease Agreement on October 29, 2007 with a tenant that has been leasing 21,541 square feet at the Waterfront Property under a long term lease since 1993, at rates that we believe are currently below market rates. The total termination fee paid to the tenant under the Termination of Lease Agreement was $2.5 million, $0.3 million of which we deposited in escrow upon executing the Termination of Lease Agreement.  The remaining balance due at termination of $2.2 million was included in accounts payable and other liabilities on the accompanying condensed combined consolidated balance sheets at December 31, 2008. On July 13, 2009, we exercised our option to terminate the lease and paid the balance of the lease termination fee into escrow.  The tenant vacated the space on August 7, 2009, and the lease termination fee was paid to the tenant out of escrow.  We have no further liabilities related to this lease termination.

Purchase Commitments

We are required by certain leases and loan agreements to complete tenant and building improvements. As of September 30, 2009, this amount is projected to be $12.8 million, of which $1.6 million will be funded through reserves currently classified as restricted cash.  We anticipate that our reserves, as well as other sources of liquidity, including existing cash on hand, our cash flows from operations, financing and investing activities will be sufficient to fund our capital expenditures.

Tax Protection Arrangements

The Contributed Properties are subject to certain sale restrictions for ten years after the Effective Date. In the event we decide to sell a Contributed Property that would not provide continued tax deferral to Venture, we are required to notify Venture and to cooperate with it in considering strategies to defer or mitigate the recognition of gain under the Code by any of the equity interest holders of the recipient of the Operating Partnership units.

11. Description of Equity Securities and Calculation of Non-controlling Interests and Earnings per Share

The partnership interests of the Operating Partnership are divided into (i) the general partnership interest and (ii) the limited partnership interests, consisting of Common Units and Preferred Units. The general partnership interest may be expressed as a number of Common Units, Preferred Units or any other Operating Partnership unit. The general partnership interest is denominated as a number of Common Units equal to the number of shares of common stock and Class B Common Stock outstanding.

Each Preferred Unit is convertible into 7.1717 Common Units, but no earlier than the later of (i) March 19, 2010, and (ii) the date we consummate an underwritten public offering (of at least $75 million) of our common stock. Upon conversion of the Preferred Units to Common Units, the Common Units are redeemable by the holders on a one-for-one basis for shares of our common stock or cash, as elected by the Company, but no earlier than one year after the date of their conversion from Preferred Units to Common Units. The Preferred Units have fixed rights to annual distributions at an annual rate of 2% of their liquidation preference of $25 per Preferred Unit and priority over Common Units in the event of a liquidation of the Operating Partnership. At September 30, 2009, the cumulative unpaid distributions attributable to Preferred Units were $0.6 million.

 
27 

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements


The contractual terms and provisions of the Preferred Units include a BCF because they provide the holders with a security whose market price was in excess of the carrying value of the corresponding Common Units at the date of their issuance, March 19, 2008. The aggregate market price attributable to the Preferred Units is $223.3 million, based on a market price per share of the Company’s common stock of $6.85 relative to 32,597,528 common unit equivalents attributable to the 4,545,300 Preferred Units that were issued and are outstanding. The aggregate carrying value of Preferred Units was $70.4 million as of the date of their issuance. The aggregate amount of the unrecorded BCF at September 30, 2009 was $62.1 million. The aggregate amount of the BCF will be recognized by the UPREIT upon the consummation of an underwritten public offering (of at least $75 million) of our common stock resulting in a increase in the carrying amount of non-controlling interests, and a corresponding decrease in retained deficit, in our condensed combined consolidated balance sheets. In addition, the BCF will be accreted by the UPREIT through the period ending on the earliest occurrence of either (i) the date we consummate an underwritten public offering (of at least $75 million) of our common stock or (ii) March 19, 2010. The accretion of the BCF is expected to result in an increase in the carrying amount of our non-controlling interests and a corresponding decrease to our retained deficit in our condensed combined consolidated balance sheets, resulting in no net impact to our consolidated financial position or consolidated net income or loss.

Common Units and Preferred Units of the Operating Partnership do not have any right to vote on any matters presented to our stockholders. However, Venture, as the initial holder of these units, has the contractual right to require the Advisor to vote the Proportionate Voting Preferred Stock as directed by Venture. The Proportionate Voting Preferred Stock has no dividend rights and minimal rights to distributions in the event of liquidation. The Proportionate Voting Preferred Stock entitles the Advisor to vote on all matters for which the common stockholders are entitled to vote. The number of votes that the Advisor is entitled to cast at the direction of Venture, as the Operating Partnership unit holder, equals the total number of common shares issuable upon redemption for shares of the Common Units and Preferred Units issued in connection with the Transactions. This number will decrease to the extent that these Operating Partnership units are redeemed for shares of common stock in the future. The number will not increase in the event of future unit issuances by the Operating Partnership.  The Company has the option to redeem the Proportionate Voting Preferred Stock at the Company’s election if the Advisory Agreement is terminated and the Company becomes self-advised.

Our common stock and Class B Common Stock are identical in all respects, except that in the event of liquidation the Class B Common Stock will not be entitled to any portion of our net assets, which will be allocated and distributed to the holders of the common stock. Shares of our common stock and Class B Common Stock vote together as a single class and each share is entitled to one vote on each matter to be voted upon by our stockholders. Dividends on the common stock and Class B Common Stock are payable at the discretion of our Board of Directors.

Non-controlling interests include the interests in the Operating Partnership that are not owned by us, which amounted to 78.78% of the Common Units and all of the Preferred Units outstanding as of September 30, 2009. During the three and nine months ended September 30, 2009, no Operating Partnership units were redeemed or issued. As of September 30, 2009, 46,896,795 shares of our common stock were reserved for issuance upon redemption of outstanding Operating Partnership units.

We present both basic and diluted earnings per share. Basic EPS is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding during each period. Diluted EPS is computed by dividing net loss available to common stockholders for the period by the number of common shares that would have been outstanding assuming the issuance of common shares for all potentially dilutive common shares outstanding during each period. Net income or loss in the Operating Partnership is allocated in accordance with the Partnership Agreement among our general partner and limited partner Common Unit holders in accordance with their ownership percentages in the Operating Partnership of 21.22% and 78.78%, respectively, after taking into consideration the priority distributions allocated to the limited partner preferred unit holders in the Operating Partnership.

Upon adoption of new guidance effective on January 1, 2009, previously reported noncontrolling interests have been restated as the Common Units have been measured at their redemption value. A reconciliation between the amounts previously reported and their current measurements at December 31, 2008 is shown below (there was no impact on December 31, 2007 presentation):

 
28 

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements




                   
   
Non-Controlling
   
Additional Paid-in
   
Retained
 
   
Interests
   
Capital
   
Deficit
 
Balance at December 31, 2008, as previously reported
  $ 75,823     $ 8,144     $ (7,044 )
Fair value measurement of Common Units
    57,427       (8,144 )     (49,283 )
Balances at December 31, 2008, as restated
  $ 133,250     $ -     $ (56,327 )

The changes in total equity for the period from December 31, 2008 to September 30, 2009 are shown below (in thousands):

 
   
Pacific Office Properties Trust, Inc.
   
Non-controlling interests
   
Total
 
                   
Balance at December 31, 2008
  $ (56,142 )   $ 133,250     $ 77,108  
Net loss
    (3,413 )     (13,984 )     (17,397 )
Stock compensation
    140       -       140  
Note exchange
    3,014       -       3,014  
Basis adjustment
    309       (309 )     -  
Fair value measurement of Common Units
    (15,573 )     15,573       -  
Dividends and distributions
    (499 )     (3,851 )     (4,350 )
Balance at September 30, 2009
  $ (72,164 )   $ 130,679     $ 58,515  
                         


Loss per Share/Loss per Unit

The following is the basic and diluted loss per share/unit (in thousands, except share/unit and per share/unit amounts):

 
   
For the three months ended September 30,
 
   
2009
   
2008
 
             
Net loss attributable to common
           
share/unit holders - basic and diluted (1)
  $ (1,241 )   $ (1,188 )
                 
Weighted average number of common shares
    3,112,888       3,031,125  
Potentially dilutive common shares (2)
               
Restricted Stock Units (RSU)
           
Weighted average number of common
               
shares/units outstanding — basic and diluted
    3,112,888       3,031,125  
Net loss per share — basic and diluted
  $ (0.40 )   $ (0.39 )
                 


 
29 

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements

 

 
 
Pacific Office Properties Trust, Inc.
   
Total
   
Pacific Office Properties Trust, Inc.
   
Waterfront
 
   
For the nine months ended September 30, 2009
   
For the period from January 1, 2008 through September 30, 2008
   
For the period from March 20, 2008 through September 30, 2008
   
For the period from January 1, 2008 through March 19, 2008
 
                         
Net loss attributable to common
                       
share/unit holders - basic and diluted (1)
  $ (3,413 )   $ (6,657 )   $ (5,578 )   $ (1,079 )
                                 
Weighted average number of common shares
    3,059,678               3,031,125          
Potentially dilutive common shares (2)
                               
Restricted Stock Units (RSU)
                           
Weighted average number of common
                               
shares/units outstanding — basic and diluted
    3,059,678               3,031,125          
Net loss per share — basic and diluted
  $ (1.12 )           $ (1.84 )        
Weighted average number of units
                               
outstanding — basic and diluted
                            3,494,624  
Net loss per unit — basic and diluted(3)
                          $ (0.31 )
                                 

_________________________
Notes:

(1)  
For the three and nine months ended September 30, 2009, net loss attributable to common stockholders includes $0.6 million and $1.7 million of priority allocation to preferred unit holders, respectively, which is included in non-controlling interests in the condensed combined consolidated statements of operations.  For the three months ended September 30, 2008 and the period from March 20, 2008 through September 30, 2008, net loss attributable to common stockholders includes $0.6 million and $1.1 million of priority allocation to preferred unit holders, respectively, which is included in non-controlling interests in the condensed combined consolidated statements of operations. For the period from January 1, 2008 through March 19, 2008, net loss attributable to common stockholders included $0.1 million of priority allocation to preferred unit holders.

(2)  
For the three and nine months ended September 30, 2009, the potentially dilutive effect of 52,630 restricted stock units were not included in the net loss per share calculation as their effect is anti-dilutive. For the three and nine months ended September 30, 2008, the potentially dilutive effect of 24,240 restricted stock units were not included in the net loss per share calculation as their effect is anti-dilutive.

(3)  
We computed net loss per Common Unit for the period prior to the Transactions by increasing the historical net loss of Waterfront by the 2% cumulative distributions payable on the Preferred Units received by the former owners of Waterfront and dividing that total by the weighted average number of Common Units received by the former owners of Waterfront. We did not include the dilution impact of Preferred Units because the units are contingently convertible and the probability that the contingency will be satisfied is currently not determinable.

Dividends and Distributions

On September 10, 2009, our Board of Directors declared a cash dividend of $0.05 per share of our common stock for the third quarter of 2009. The dividend was paid on October 15, 2009 to holders of record of common stock on September 30, 2009. Commensurate with our declaration of a quarterly cash dividend, we paid distributions to holders of record of Common Units at September 30, 2009 in the amount of $0.05 per Common Unit, on October 15, 2009. In addition, we paid 2% distributions, or $.125 per unit, to holders of record of Preferred Units at September 30, 2009, on October 15, 2009.

Amounts accumulated for distribution to stockholders and UPREIT unit holders are invested primarily in interest-bearing accounts which are consistent with our intention to maintain our qualification as a REIT. At September 30, 2009, the cumulative unpaid distributions attributable to Preferred Units were $0.57 million, which were paid on October 15, 2009.

 
30 

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements


On May 12, 2009, our Board of Directors declared a cash dividend of $0.05 per share of our common stock for the second quarter of 2009. The dividend was paid on July 15, 2009 to holders of record of common stock on June 30, 2009. Commensurate with our declaration of a quarterly cash dividend, we paid distributions to holders of record of Common Units at June 30, 2009 in the amount of $0.05 per Common Unit, on July 15 2009. In addition, we paid 2% distributions, or $.125 per unit, to holders of record of Preferred Units at June 30, 2009, on July 15, 2009.

Dividends declared are included in retained deficit in the accompanying condensed combined consolidated balance sheets. Distributions on Common and Preferred Units are included in non-controlling interests in the accompanying condensed combined consolidated balance sheets.

12. Related Party Transactions

We are externally advised by the Advisor, an entity owned and controlled by our founder, The Shidler Group. The Advisor manages, operates and administers the Company’s day-to-day operations, business and affairs pursuant to the Advisory Agreement. The Advisor is entitled to an annual corporate management fee of one tenth of one percent (0.1%) of the gross cost basis of our total property portfolio (less accumulated depreciation and amortization), but in no event less than $1.5 million per annum. The corporate management fee is subject to reduction of up to $750,000 based upon the amounts of certain direct costs that we bear. Additionally, the Advisor and its affiliates are entitled to receive real property management fees of 2.5% to 4.5% of the rental cash receipts collected by the properties, as well as property transaction management fees in an amount equal to 1% of the contract price of any acquired or disposed property, provided, however, that such real property management fees and property transaction management fees must be consistent with prevailing market rates for similar services provided on an arms-length basis in the area in which the subject property is located. Pursuant to the Advisory Agreement, the Advisor shall bear the cost for any expenses incurred by the Advisor in the course of performing its advisory services for the Company.

The Advisor is also entitled to certain fees related to any placement of debt or equity that we may undertake, including (i) 0.50% of the total amount of co-investment equity capital procured, (ii) 0.50% of the total gross offering proceeds including, but not limited to, the issuance or placement of equity securities and the issuance of Operating Partnership units, and (iii) 0.50% of the principal amount of any new indebtedness related to properties that we wholly own, and on properties owned in a joint venture with co-investment partners or entity-level financings, as well as on amounts available on our credit facilities and on the principal amount of indebtedness we may issue.

The Advisory Agreement terminates on March 19, 2018. Prior to that date, however, we retain the right to terminate the Advisory Agreement upon 30 days prior written notice at any time for any reason. In the event we decide to terminate the Advisory Agreement in order to internalize management and become self-managed, we would be obligated to pay the Advisor an internalization fee equal to $1.0 million, plus certain accrued and unreimbursed expenses. Further, the Advisor retains the right to terminate the Advisory Agreement upon 30 days prior written notice in the event we default in the performance or observance of any material provision of the Advisory Agreement.

During the three and nine months ended September 30, 2009, we incurred $0.2 million, net and $0.6 million, net, respectively, in corporate management fees attributable to the Advisor which have been included in general and administrative expenses in the accompanying condensed combined consolidated statements of operations. During the three and nine months ended September 30, 2008, we incurred $0.2 million, net, and $0.4 million, net, respectively, in corporate management fees attributable to the Advisor.  Other than as indicated below, no other amounts were incurred under the Advisory Agreement during the three and nine months ended September 30, 2009. Included in accounts payable and other liabilities in our condensed combined consolidated balance sheets at September 30, 2009 and December 31, 2008, was $1.1 million, respectively, of amounts payable to related parties of The Shidler Group which primarily consist of rental revenues received by us subsequent to the date of the formation transactions, but that related to the Contributed Properties prior to the date of the formation transactions.

 
  31

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements


We and Waterfront paid amounts to certain related entities of The Shidler Group for services provided relating to leasing, property management and property acquisition underwriting, and property financing. The fees paid are summarized in the table below for the indicated periods (in thousands):


 
 
For the three months ended September 30, 2009
   
For the three months ended September 30, 2008
   
For the nine months ended September 30, 2009
   
For the nine months ended September 30, 2008
 
Property management fees
                       
  to affiliates of Advisor
  $ 764     $ 661     $ 2,544     $ 1,774  
Leasing commissions
    86       111       245       298  
Corporate management fees to Advisor
    188       188       563       375  
Interest
    500       383       1,379       700  
Construction management fees
                               
  and other
    14       48       49       72  
Total
  $ 1,552     $ 1,391     $ 4,780     $ 3,219  
                                 

Leasing commissions are capitalized as deferred leasing costs and included in “Intangible assets, net” in the accompanying condensed combined consolidated balance sheets. These costs are amortized over the life of the related lease.

Property management fees are calculated as a percentage of the rental cash receipts collected by the properties plus the payroll costs of on-site employees and are included in “Rental property operating” expenses in the accompanying condensed combined consolidated statements of operations.

Property financing fees paid to the Advisor are capitalized and included as other assets in the accompanying condensed combined consolidated balance sheets. These costs are amortized over the term of the related loan.

We lease commercial office space to affiliated entities. The annual rents from these leases totaled $0.2 million and $0.5 million for the three and nine months ended September 30, 2009.  We received $0.1 million and $0.3 million from these leases for the three and nine months ended September 30, 2008, respectively.

During 2008, following exercise of the Option, we consummated the acquisition of managing ownership interests in five joint ventures. Additionally, we and our joint venture partner in Seville Plaza entered into an Amended Operating Agreement, which caused the method of accounting to change to the equity method. Please see Note 5 for further discussion on our acquisitions of unconsolidated joint ventures.

Related Party Financing Transactions

On August 19, 2009, we entered into an interim financing agreement with Shidler Equities, L.P., (“Shidler Equities”) a Hawaii limited partnership controlled by Jay H. Shidler, the chairman of the Company’s board of directors.  Upon execution, Shidler Equities provided us with a principal sum of $3.0 million, bearing interest of 7.0% per annum.  The maturity date of the note was ninety days following the date of the promissory note.  We repaid the $3.0 million note on September 22, 2009, in addition to $0.02 million of accrued interest.

 
 32

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements


On September 2, 2009, as security for the FHB Credit Facility, Shidler Equities pledged to the Lender (the “Shidler Equities Pledge”) a certificate of deposit in the principal amount of $10 million (the “Certificate of Deposit”).  As a condition to the Shidler Equities Pledge, our Operating Partnership and Shidler Equities entered into an Indemnification Agreement, effective as of September 2, 2009 (the “Indemnification Agreement”), pursuant to which we agreed to indemnify Shidler Equities from any losses, damages, costs and expenses incurred by Shidler Equities in connection with the Shidler Equities Pledge.  In addition, to the extent that all or any portion of the Certificate of Deposit is withdrawn by the Lender and applied to the payment of principal, interest and/or charges under the FHB Credit Facility, we agreed to pay to Shidler Equities interest on the withdrawn amount at a rate of 7.0% per annum from the date of the withdrawal until the date of repayment in full to Shidler Equities.  Pursuant to the Indemnification Agreement, we also agreed to pay to Shidler Equities an annual fee of 2.0% of the entire $10.0 million principal amount of the Certificate of Deposit.  As of September 30, 2009, we have $0.02 million of accrued interest attributable to the Shidler Equities Pledge included in accounts payable and other liabilities in the accompanying condensed combined consolidated balance sheets.  See Note 8 for more discussion on the FHB Credit Facility.

At September 30, 2009, $2.2 million of accrued interest attributable to unsecured notes payable to related parties is included in accounts payable and other liabilities in the accompanying condensed combined consolidated balance sheets. See Note 9 for a detailed discussion on these notes payable.

13. Share-Based Payments

On May 21, 2008, the Board of Directors of the Company adopted the 2008 Directors’ Stock Plan, as amended and restated (the “2008 Directors’ Plan”), subject to stockholder approval. The Company reserved 150,000 shares of the Company’s common stock under the 2008 Directors’ Plan for the issuance of stock options, restricted stock awards, stock appreciation rights and performance awards. The 2008 Directors’ Plan was approved by our shareholders at our annual meeting of stockholders on May 12, 2009.

On May 21, 2008, the Company issued restricted stock awards representing 24,240 shares under the 2008 Directors’ Plan, which awards vested on the date of the Company’s 2009 annual meeting. The grant date fair value of each restricted stock unit was $6.60, which was the closing stock price on May 21, 2008. On June 19, 2009, the Company issued a restricted stock award representing 6,060 shares under the 2008 Directors’ Plan, which vested immediately upon issuance. The grant date fair value of each restricted stock unit was $3.80, which was the closing stock price on June 19, 2009. Accordingly, the Company recognized $0.05 million and $0.14 million of compensation expense attributable to the 2008 Directors’ Plan during the three and nine months ended September 30, 2009, respectively. These amounts are included in general and administrative expenses in the accompanying condensed combined consolidated statement of operations for the three and nine months ended September 30, 2009. As of September 30, 2009, all of our share-based payments to directors in 2008 are vested.

On June 19, 2009, the Company issued restricted stock units representing 52,630 shares under the 2008 Directors’ Plan, which awards vest on the date of the Company’s 2010 annual meeting.  The grant date fair value of each restricted stock unit was $3.80, which was the Company’s closing stock price on June 19, 2009.

Upon the Effective Date and in connection with the Transactions, certain employees and officers of the Advisor and the Company were granted fully vested indirect ownership interests in the Operating Partnership with an estimated fair value upon the Effective Date of $16.2 million. Accordingly, the Company recognized a one-time non-cash compensation charge in the amount of $16.2 million for the period from March 20, 2008 through September 30, 2008. This amount has been included in the condensed combined consolidated statements of operations for the period from March 20, 2008 through September 30, 2008.

14. Segment Reporting

We own and operate office properties, concentrating initially on the long-term growth submarkets of Honolulu and the western United States, including Southern California and the greater Phoenix metropolitan area. We are aggregating our operations by geographic region into two reportable segments (Honolulu and the Western United States mainland) based on the similar economic characteristics of the properties located in each of these regions. The products at all our properties include primarily rental of office space and other tenant services, including parking and storage space rental.  We also have certain corporate level income and expenses related to our credit facility and legal, accounting, finance and management activities, which are not considered separate operating segments.

 
33 

 
Pacific Office Properties Trust, Inc.
Notes to Condensed Combined Consolidated Financial Statements


The following tables summarize the statements of operations by region of our wholly-owned consolidated properties for the three and nine months ended September 30, 2009 and 2008 (in thousands):

   
For the three months ended September 30, 2009
       
 
 
Honolulu
   
Western U.S.
   
Corporate
   
Total
 
Revenue:
                       
Rental
  $ 7,303     $ 3,179     $ 4     $ 10,486  
Tenant reimbursements
    4,945       218             5,163  
Parking
    1,761       251             2,012  
Other
    34       -       49       83  
Total revenue
    14,043       3,648       53       17,744  
Expenses:
                               
Rental property operating
    7,794       1,987             9,781  
General and administrative
                351       351  
Depreciation and amortization
    5,044       1,869             6,913  
Interest
    5,341       844       638       6,823  
Loss on extinguishment of debt
                171       171  
Total expenses