Attached files
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.)
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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
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Page
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|||
Explanatory
Note
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||||
PART
I – FINANCIAL INFORMATION
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||||
Item
1. Financial Statements (unaudited)
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4 | |||
Item
2. Management’s Discussion and Analysis of Financial Condition and Results
of Operations
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37 | |||
Item
3. Quantitative and Qualitative Disclosures About Market
Risk
|
54 | |||
Item
4T. Controls and Procedures
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54 | |||
PART
II – OTHER INFORMATION
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||||
Item
1. Legal Proceedings
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55 | |||
Item
1A. Risk Factors
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55 | |||
Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds
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56 | |||
Item
3. Defaults Upon Senior Securities
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56 | |||
Item
4. Submission of Matters to a Vote of Security Holders
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56 | |||
Item
5. Other Information
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56 | |||
Item
6. Exhibits
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57 | |||
Certification
of the Chief Executive Officer
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||||
Certification
of the Chief Financial Officer
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||||
Certification
of the Chief Executive Officer and Chief Financial Officer
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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
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$ | 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
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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
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$ | 10,486 | $ | 10,899 | ||||
Tenant
reimbursements
|
5,163 | 5,583 | ||||||
Parking
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2,012 | 1,981 | ||||||
Other
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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.
5
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
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$ | 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.
7
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.
8
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.
9
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
|
18,179 | 4,700 | 1,160 | 24,039 | ||||||||||||
Loss
before equity in net earnings of unconsolidated
|
||||||||||||||||
joint
ventures and non-operating income
|
$ | (4,136 | ) | $ | (1,052 | ) | $ | (1,107 | ) | $ | (6,295 | ) | ||||
Equity
in net earnings of unconsolidated joint ventures
|
189 | |||||||||||||||
Non-operating
income
|
2 | |||||||||||||||
Net
loss attributable to non-controlling interests
|
4,863 | |||||||||||||||
Net
loss attributable to common stockholders
|
$ | (1,241 | ) | |||||||||||||
For
the nine months ended September 30, 2009
|
||||||||||||||||
|
Honolulu
|
Western
U.S.
|
Corporate
|
Total
|
||||||||||||
Revenue:
|
||||||||||||||||
Rental
|
$ | 22,292 | $ | 9,696 | $ | 11 | $ | 31,999 | ||||||||
Tenant
reimbursements
|
15,363 | 821 | — | 16,184 | ||||||||||||
Parking
|
5,338 | 742 | — | 6,080 | ||||||||||||
Other
|
97 | 24 | 149 | 270 | ||||||||||||
Total
revenue
|
43,090 | 11,283 | 160 | 54,533 | ||||||||||||
Expenses:
|
||||||||||||||||
Rental
property operating
|
23,423 | 5,933 | — | 29,356 | ||||||||||||
General
and administrative
|
— | — | 1,997 | 1,997 | ||||||||||||
Depreciation
and amortization
|
14,780 | 5,690 | — | 20,470 | ||||||||||||
Interest
|
15,857 | 2,523 | 1,968 | 20,348 | ||||||||||||
Loss
on extinguishment of debt
|
— | — | 171 | 171 | ||||||||||||
Total
expenses
|
54,060 | 14,146 | 4,136 | 72,342 | ||||||||||||
Loss
before equity in net earnings of unconsolidated
|
||||||||||||||||
joint
ventures and non-operating income
|
$ | (10,970 | ) | $ | (2,863 | ) | $ | (3,976 | ) | $ | (17,809 | ) | ||||
Equity
in net earnings of unconsolidated joint ventures
|
406 | |||||||||||||||
Non-operating
income
|
6 | |||||||||||||||
Net
loss attributable to non-controlling interests
|
13,984 | |||||||||||||||
Net
loss attributable to common stockholders
|
$ | (3,413 | ) |
34
Pacific Office Properties Trust,
Inc.
Notes
to Condensed Combined Consolidated Financial Statements
For
the three months ended September 30, 2008
|
||||||||||||||||
|
Honolulu
|
Western
U.S.
|
Corporate
|
Total
|
||||||||||||
Revenue:
|
||||||||||||||||
Rental
|
$ | 7,440 | $ | 3,455 | $ | 4 | $ | 10,899 | ||||||||
Tenant
reimbursements
|
5,239 | 344 | — | 5,583 | ||||||||||||
Parking
|
1,716 | 265 | — | 1,981 | ||||||||||||
Other
|
64 | 15 | 57 | 136 | ||||||||||||
Total
revenue
|
14,459 | 4,079 | 61 | 18,599 | ||||||||||||
Expenses:
|
||||||||||||||||
Rental
property operating
|
8,818 | 2,249 | — | 11,067 | ||||||||||||
General
and administrative
|
— | — | 429 | 429 | ||||||||||||
Depreciation
and amortization
|
4,581 | 2,159 | — | 6,740 | ||||||||||||
Interest
|
5,345 | 993 | 431 | 6,769 | ||||||||||||
Total
expenses
|
18,744 | 5,401 | 860 | 25,005 | ||||||||||||
Loss
before equity in net earnings of unconsolidated
|
||||||||||||||||
joint
ventures and non-operating income
|
$ | (4,285 | ) | $ | (1,322 | ) | $ | (799 | ) | $ | (6,406 | ) | ||||
Equity
in net earnings of unconsolidated joint ventures
|
185 | |||||||||||||||
Net
loss attributable to non-controlling interests
|
5,033 | |||||||||||||||
Net
loss attributable to common stockholders
|
$ | (1,188 | ) | |||||||||||||
For
the nine months ended September 30, 2008
|
||||||||||||||||
|
Honolulu
|
Western
U.S.
|
Corporate
|
Total
|
||||||||||||
Revenue:
|
||||||||||||||||
Rental
|
$ | 19,018 | $ | 7,375 | $ | 8 | $ | 26,401 | ||||||||
Tenant
reimbursements
|
12,031 | 709 | — | 12,740 | ||||||||||||
Parking
|
4,291 | 564 | — | 4,855 | ||||||||||||
Other
|
124 | 103 | 118 | 345 | ||||||||||||
Total
revenue
|
35,464 | 8,751 | 126 | 44,341 | ||||||||||||
Expenses:
|
||||||||||||||||
Rental
property operating
|
21,899 | 4,513 | — | 26,412 | ||||||||||||
General
and administrative
|
— | 4 | 1,639 | 1,643 | ||||||||||||
Share-based
compensation
|
— | — | 16,194 | 16,194 | ||||||||||||
Depreciation
and amortization
|
10,775 | 4,728 | — | 15,503 | ||||||||||||
Interest
|
12,891 | 2,144 | 787 | 15,822 | ||||||||||||
Other
|
108 | 35 | — | 143 | ||||||||||||
Total
expenses
|
45,673 | 11,424 | 18,620 | 75,717 | ||||||||||||
Loss
before equity in net earnings of unconsolidated
|
||||||||||||||||
joint
ventures and non-operating income
|
$ | (10,209 | ) | $ | (2,673 | ) | $ | (18,494 | ) | $ | (31,376 | ) | ||||
Equity
in net earnings of unconsolidated joint ventures
|
156 | |||||||||||||||
Net
loss attributable to non-controlling interests
|
24,563 | |||||||||||||||
Net
loss attributable to common stockholders
|
$ | (6,657 | ) | |||||||||||||
35
Pacific Office Properties Trust,
Inc.
Notes
to Condensed Combined Consolidated Financial Statements
The
following table summarizes total assets, goodwill and capital expenditures, by
region, of our wholly-owned consolidated properties as of September 30, 2009 and
December 31, 2008 (in thousands):
|
Honolulu
|
Western U.S.
|
Corporate
|
Total
|
||||||||||||
As
of September 30, 2009:
|
||||||||||||||||
Total
assets
|
$ | 374,572 | $ | 126,499 | $ | 12,149 | $ | 513,220 | ||||||||
Goodwill
|
$ | 40,416 | $ | 21,603 | $ | — | $ | 62,019 | ||||||||
Capital
expenditures
|
$ | 3,608 | $ | 861 | $ | — | $ | 4,469 | ||||||||
As
of December 31, 2008:
|
||||||||||||||||
Total
assets
|
$ | 383,966 | $ | 130,062 | $ | 15,869 | $ | 529,897 | ||||||||
Goodwill
|
$ | 40,144 | $ | 21,375 | $ | — | $ | 61,519 | ||||||||
Capital
expenditures
|
$ | 7,000 | $ | 1,514 | $ | — | $ | 8,514 |
15. Fair
Value of Financial Instruments
The fair
market value of debt is determined using the trading price of public debt or a
discounted cash flow technique that incorporates a market interest yield curve
with adjustments for duration, optionality and risk profile, including the
Company’s non-performance risk. Considerable judgment is necessary to interpret
market data and develop estimated fair value. The use of different market
assumptions or estimation methods may have a material effect on the estimated
fair value amounts.
The
carrying amounts for cash and cash equivalents, restricted cash, rents and other
receivables, accounts payable and other liabilities approximate fair value
because of the short-term nature of these instruments. We calculate the fair
value of our mortgage and other loans, and unsecured notes payable based on
currently available market rates, assuming the loans are outstanding through
maturity and considering the collateral. The carrying value of our revolving
line of credit approximates its fair value.
At
September 30, 2009, the carrying value and estimated fair value of the mortgage
and other loans were $403.3 million and $378.2 million,
respectively. At December 31, 2008, the carrying value and
estimated fair value of the mortgage and other loans were $400.1 million
and $390.4 million, respectively. At September 30, 2009, the carrying value
and estimated fair value of the unsecured notes payable to related parties were
$21.1 million and $22.7 million, respectively. At December 31,
2008, the carrying value and estimated fair value of the unsecured notes payable
to related parties were $23.8 million and $24.6 million,
respectively.
16. Subsequent
Events
We have
evaluated subsequent events through November 23, 2009, which is the date the
financial statements were available to be issued.
36
Pacific
Office Properties Trust, Inc.
Item 2. Management’s Discussion and
Analysis of Financial Condition and Results of Operations
The
following discussion should be read in conjunction with the condensed combined
consolidated financial statements and the related notes thereto that appear in
Item 1 of this Quarterly Report on Form 10-Q. The following discussion of the
Company’s financial information was significantly affected by the consummation
of the Transactions. It was determined for purposes of the Transactions that the
Contributed Properties were not under common control. In accordance with SFAS
No. 141(R), 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 through the Effective Date. Additional explanatory notations
are contained in this Quarterly Report on Form 10-Q to distinguish the
historical information of Waterfront from that of the Company. Historical
results set forth in the condensed combined consolidated financial statements
included in Item 1 and this Section should not be taken as indicative of our
future operations.
Note
Regarding Forward-Looking Statements
Our
disclosure and analysis in this Quarterly Report on Form 10-Q contains
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended (the “Exchange Act”), which include information relating to future
events, future financial performance, strategies, expectations, risks and
uncertainties. From time to time, we also provide forward-looking statements in
other materials we release to the public as well as oral forward-looking
statements. These forward-looking statements include, without limitation,
statements regarding: projections, predictions, expectations, estimates or
forecasts as to our business, financial and operational results and future
economic performance; statements regarding strategic transactions such as
mergers or acquisitions or a possible dissolution of the Company; and statements
of management’s goals and objectives and other similar expressions. Such
statements give our current expectations or forecasts of future events; they do
not relate strictly to historical or current facts. Words such as “believe”,
“may”, “will”, “should”, “could”, “would”, “predict”, “potential”, “continue”,
“plan”, “anticipate”, “estimate”, “expect”, “intend”, “objective”, “seek”,
“strive” and similar expressions, as well as statements in future tense,
identify forward-looking statements.
Certain
matters discussed in this Quarterly Report on Form 10-Q are forward-looking
statements. The risks and uncertainties inherent in such statements may cause
actual future events or results to differ materially and adversely from those
described in the forward-looking statements.
We cannot
guarantee that any forward-looking statement will be realized, although we
believe we have been prudent in our plans and assumptions. Achievement of future
results is subject to risks, uncertainties and potentially inaccurate
assumptions. Should known or unknown risks or uncertainties materialize, or
should underlying assumptions prove inaccurate, actual results could differ
materially from past results and those anticipated, estimated or projected.
These factors include the risks and uncertainties described in “Risk Factors” in
this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the
year ended December 31, 2008. You should bear this in mind as you consider
forward-looking statements.
We
undertake no obligation to publicly update forward-looking statements, whether
as a result of new information, future events or otherwise. You are advised,
however, to consult any further disclosures we make on related subjects in our
Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports
on Form 8-K filed with the SEC.
Overview
We are a
Maryland corporation and have elected to be treated as a REIT under the Code.
Our common stock is currently listed and publicly traded on the NYSE Amex under
the symbol “PCE”. We are primarily focused on owning and operating 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. For a detailed discussion of our segment operations,
please see Note 15 to the condensed combined consolidated financial statements
included in this Quarterly Report on Form 10-Q.
37
Pacific
Office Properties Trust, Inc.
Through
the Operating Partnership we own eight wholly-owned fee simple and leasehold
office properties and interests in fifteen office properties which we hold
through six joint ventures. Our current portfolio totals approximately 4.3
million rentable square feet (see the table in Note 1, “Organization and
Ownership” for a breakdown between wholly-owned and joint venture properties).
We are advised by the Advisor, an entity owned and controlled by our founder,
The Shidler Group, pursuant to the Advisory Agreement. The Advisor is
responsible for the day-to-day operation and management of the
Company.
We
maintain a website at www.pacificofficeproperties.com.
Information on this website shall not constitute part of this Form 10-Q. Copies
of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current
Reports on Form 8-K and amendments to such reports are available without charge
on our website. In addition, our Corporate Governance Guidelines, Code of
Business Conduct and Ethics, Audit Committee Charter, Compensation Committee
Charter, Nominating and Corporate Governance Committee Charter, along with
supplemental financial and operating information prepared by us, are all
available without charge on our website or upon request to us. We also post or
otherwise make available on our website from time to time other information that
may be of interest to our investors.
Our
property statistics as of September 30, 2009 for our wholly-owned properties are
as follows:
Consolidated
Properties
RENTABLE
|
|||||||||
PROPERTY
|
MARKET
|
BUILDINGS
|
SQ.
FT.
|
||||||
Waterfront
Plaza
|
Honolulu
|
1 | 534,475 | ||||||
500
Ala Moana Boulevard
|
|||||||||
Davies
Pacific Center
|
Honolulu
|
1 | 353,224 | ||||||
841
Bishop Street
|
|||||||||
Pan
Am Building
|
Honolulu
|
1 | 209,889 | ||||||
1600
Kapiolani Boulevard
|
|||||||||
First
Insurance Center
|
Honolulu
|
1 | 202,992 | ||||||
1100
Ward Avenue
|
|||||||||
Pacific
Business News Building
|
Honolulu
|
1 | 90,559 | ||||||
1833
Kalakaua Avenue
|
|||||||||
Clifford
Center
|
Honolulu
|
1 | 72,415 | ||||||
810
Richards Street
|
|||||||||
City
Square
|
Phoenix
|
3 | 738,422 | ||||||
3800
North Central Avenue
|
|||||||||
3838
North Central Avenue
|
|||||||||
4000
North Central Avenue
|
|||||||||
Sorrento
Technology Center
|
San
Diego
|
2 | 63,363 | ||||||
10140
Barnes Canyon Road
|
|||||||||
10180
Barnes Canyon Road
|
|||||||||
Total
— Consolidated Properties
|
11 | 2,265,339 |
We also
own managing ownership interests in six joint ventures which own fifteen
commercial office properties (the “Unconsolidated Joint Ventures”). The
Unconsolidated Joint Ventures are accounted for under the equity method of
accounting. Property statistics as of September 30, 2009 for our Unconsolidated
Joint Ventures are as follows:
38
Pacific
Office Properties Trust, Inc.
Joint Venture
Properties
PROPERTY
|
MARKET
|
BUILDINGS
|
RENTABLE
SQ. FT.
|
PERCENTAGE
OWNERSHIP
|
|||||||||
Seville
Plaza
|
San
Diego
|
3 | 138,576 | 7.50 | % | ||||||||
5469
Kearny Villa Road
|
|||||||||||||
5471
Kearny Villa Road
|
|||||||||||||
5473
Kearny Villa Road
|
|||||||||||||
Torrey
Hills Corporate Center
|
San
Diego
|
1 | 24,066 | 32.17 | % | ||||||||
11250
El Camino Real
|
|||||||||||||
Palomar
Heights Plaza
|
San
Diego
|
3 | 45,538 | 32.17 | % | ||||||||
5860
Owens Avenue (Building A)
|
|||||||||||||
5876
Owens Avenue (Building B)
|
|||||||||||||
5868
Owens Avenue (Building C)
|
|||||||||||||
Palomar
Heights Corporate Center
|
San
Diego
|
1 | 64,812 | 32.17 | % | ||||||||
5857
Owens Avenue (Corporate Center)
|
|||||||||||||
Scripps
Ranch Business Park
|
San
Diego
|
2 | 47,248 | 32.17 | % | ||||||||
9775
Business Park Avenue
|
|||||||||||||
10021
Willow Creek Road
|
|||||||||||||
Black
Canyon Corporate Center
|
Phoenix
|
1 | 218,694 | 17.50 | % | ||||||||
16404
N. Black Canyon Highway
|
|||||||||||||
U.S.
Bank Center
|
Phoenix
|
2 | 372,676 | 7.50 | % | ||||||||
101
N. First Avenue
|
|||||||||||||
21
West Van Buren Street
|
|||||||||||||
Bank
of Hawaii Waikiki Center
|
Honolulu
|
1 | 152,288 | 17.50 | % | ||||||||
2155
Kalakaua Avenue
|
|||||||||||||
South
Coast Executive Center
|
Orange
County
|
1 | 61,025 | 10.00 | % | ||||||||
1503
South Coast Drive
|
|||||||||||||
Via
Frontera Business Park
|
San
Diego
|
2 | 78,819 | 10.00 | % | ||||||||
10965
Via Frontera Drive
|
|||||||||||||
10993
Via Frontera Drive
|
|||||||||||||
Poway
Flex
|
San
Diego
|
1 | 112,000 | 10.00 | % | ||||||||
13550
Stowe Drive (Poway)
|
|||||||||||||
Carlsbad
Corporate Center
|
San
Diego
|
1 | 121,528 | 10.00 | % | ||||||||
1950
Camino Vida Roble
|
|||||||||||||
Savi
Tech Center
|
Orange
County
|
4 | 372,327 | 10.00 | % | ||||||||
Savi
Tech -22705 Savi Ranch Parkway
|
|||||||||||||
Savi
Tech -22715 Savi Ranch Parkway
|
|||||||||||||
Savi
Tech -22725 Savi Ranch Parkway
|
|||||||||||||
Savi
Tech -22745 Savi Ranch Parkway
|
|||||||||||||
Yorba
Linda Business Park
|
Orange
County
|
5 | 166,042 | 10.00 | % | ||||||||
22343
La Palma Avenue
|
|||||||||||||
22345
La Palma Avenue
|
|||||||||||||
22347
La Palma Avenue
|
|||||||||||||
22349
La Palma Avenue
|
|||||||||||||
22833
La Palma Avenue
|
|||||||||||||
Gateway
Corporate Center
|
San
Gabriel
|
1 | 85,216 | 10.00 | % | ||||||||
1370
Valley Vista Drive
|
|||||||||||||
Total
— Joint Venture Properties
|
29 | 2,060,855 | |||||||||||
PORTFOLIO TOTALS:
|
40 | 4,326,194 |
Our
corporate strategy is to continue to own high-quality office buildings
concentrated in our target markets. Historically, the Property Portfolio has
been leased to tenants on both a full service gross and net lease basis. A full
service gross lease has a base year expense stop, whereby the tenant pays a
stated amount of expenses as part of the rent payment, while future increases
(above the base year stop) in property operating expenses are billed to the
tenant based on the tenant’s proportionate square footage in the property. The
increased property operating expenses billed are reflected in operating expense
and amounts recovered from tenants are reflected as tenant recoveries in the
statements of operations. In a net lease, the tenant is responsible for all
property taxes, insurance, and operating expenses. As such, the base rent
payment does not include operating expenses, but rather all such expenses are
billed to the tenant. The full amount of the expenses for this lease type is
reflected in operating expenses, and the reimbursement is reflected in tenant
recoveries. We expect to emphasize net leases in the future, although we expect
some leases will remain gross leased in the future due to tenant expectations
and market customs.
39
Pacific
Office Properties Trust, Inc.
The
Transactions Included in the Master Agreement
We
consummated the Transactions included in the Master Agreement on the Effective
Date. As part of the Transactions, AZL merged with and into its wholly-owned
subsidiary, the Company, with the Company being the surviving corporation (the
“Reincorporation”). 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 partnership, the
Operating Partnership, in which we became the sole general partner and Venture
became a limited partner.
In
consideration for the Contributed Properties, the Operating Partnership issued
to Venture 13,576,165 Common Units and 4,545,300 Preferred Units. The Common
Units are redeemable by the holders for shares of our common stock or cash, at
our election, no earlier than two years after the Effective Date. Each Preferred
Unit is convertible into 7.1717 Common Units, but no earlier than the later of
March 19, 2010 and 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, at our election, but no earlier
than one year after the date of their conversion from Preferred Units to Common
Units.
As a
result of the Reincorporation, AZL’s common stock, which traded under the symbol
“AZL,” ceased trading on the American Stock Exchange (“AMEX”) following the
close of trading on March 19, 2008. On March 20, 2008, the Company’s common
stock began trading on the NYSE Amex, successor to AMEX, under the symbol “PCE.”
For purposes of Rule 12g-3(a) of the Exchange Act, the Company is the successor
issuer to AZL.
Market
Information
Market
and industry data and other statistical information used throughout this section
are based on independent industry publications, including CB Richard Ellis as it
relates to our Honolulu office market and Grubb & Ellis as it relates to all
our other office markets. Some data are also based on our good faith estimates,
which are derived from our review of management’s knowledge of the industry and
independent sources. Although we are not aware of any misstatements regarding
the industry data that we present in this Form 10-Q, our estimates involve risks
and uncertainties and are subject to change based on various factors, including
those discussed under “Risk Factors” in this Quarterly Report on Form 10-Q and
in our Annual Report on Form 10-K for the year ended December 31, 2008, and
under “Note Regarding Forward-Looking Statements” included in this Quarterly
Report on Form 10-Q.
Honolulu
Segment
Honolulu
Office Market
We have
seven properties that represent approximately 1,490,200 effective rentable
square feet (or 59.0% of our Effective Portfolio) located in the Honolulu office
submarkets of Honolulu Downtown (Central Business District), Waikiki and
Kapiolani at September 30, 2009. These office submarkets, based on a combined
weighted average, experienced net negative absorption of approximately 8,900
square feet during the third quarter of 2009. Based on a combined weighted
average, the total percent occupied within these submarkets decreased from 87.0%
occupied as of June 30, 2009 to 86.6% occupied as of September 30, 2009. During
the third quarter of 2009, average asking rents decreased from $36.00 per
annualized square foot as of June 30, 2009 to $35.34 per annualized square foot
as of September 30, 2009.
40
Pacific Office Properties Trust,
Inc.
Western United States
Segment
Phoenix
Office Market
We have
three properties that represent approximately 804,600 effective rentable square
feet (or 31.9% of our Effective Portfolio) located in the Phoenix office
submarkets of Phoenix Downtown North, Downtown South and Deer Valley at
September 30, 2009. These office submarkets, based upon a combined weighted
average, experienced net negative absorption of approximately 250,900 square
feet during the third quarter of 2009. Based on a combined weighted average, the
total percent occupied within these submarkets decreased from 81.9% occupied as
of June 30, 2009 to 80.3% occupied as of September 30, 2009 because of the
addition of completed construction. During the third quarter of 2009, average
asking rents decreased from $25.75 per annualized square foot as of June 30,
2009 to $24.87 per square foot annually as of September 30, 2009.
San
Diego Office Market
We have
nine properties that represent approximately 163,400 effective rentable square
feet (or 6.5% of our Effective Portfolio) located in the San Diego office
submarkets of San Diego North County and Central County at September 30, 2009.
These office submarkets, based upon a combined weighted average, experienced net
negative absorption of approximately 271,100 square feet during the third
quarter of 2009. Based on a combined weighted average, the total percent
occupied within these submarkets decreased from 83.5% occupied as of June 30,
2009 to 83.0% occupied as of September 30, 2009. During the third quarter of
2009, average asking rents decreased from $27.60 per annualized square foot as
of June 30, 2009 to $27.43 per annualized square foot as of September 30,
2009.
Critical
Accounting Policies
This
discussion and analysis of the historical financial condition and results of
operations is based upon the accompanying condensed combined consolidated
financial statements which have been prepared in accordance with GAAP. The
preparation of these financial statements in conformity with GAAP requires
management to make estimates and assumptions in certain circumstances that
affect the reported amounts of assets and liabilities at the date of the
financial statements and the reported amount of revenues and expenses in the
reporting period. Actual amounts may differ from these estimates and
assumptions. Summarized below are those accounting policies that require
material subjective or complex judgments and that have the most significant
impact on financial conditions and results of operations. These estimates have
been evaluated on an ongoing basis, based upon information currently available
and on various assumptions that management believes are reasonable as of the
date hereof. In addition, other companies in similar businesses may use
different estimation policies and methodologies, which may impact the
comparability of the results of operations and financial conditions to those of
other companies.
Investment in
Real Estate. For financial accounting purposes, Waterfront was designated
as the acquiring entity in the business combination pursuant to the Transactions
and its assets and liabilities have been recorded at their historical cost
basis. In that regard, substantially all of the commercial real estate assets
and related liabilities of Venture and substantially all of the assets and
certain liabilities of AZL were deemed to be acquired by Waterfront. The
commercial real estate assets of Venture that were deemed to be acquired by
Waterfront consisted of the Contributed Properties. Further, the assets of AZL
deemed to be acquired by Waterfront primarily consisted of cash and cash
equivalents, investments in marketable securities, other assets and related
liabilities. Immediately prior to the Effective Date, Mr. Shidler owned a 56.25%
controlling interest in Waterfront but did not own a controlling interest in the
other Contributed Properties. However, Mr. Shidler did have a controlling
interest in Venture whereby he had the power to direct the transfer of the
Contributed Properties to the Operating Partnership. Accordingly, Mr. Shidler’s
transfer of his ownership interests in the remaining Contributed Properties to
Waterfront, the accounting acquirer he controls, was deemed to be a transfer
under common control. As such, Mr. Shidler’s ownership interests in the
Contributed Properties are recorded at historical cost. Ownership interests in
the Contributed Properties not owned by Mr. Shidler are recorded at the
estimated fair value of the acquired assets and assumed
liabilities.
41
Pacific Office Properties Trust,
Inc.
The price
of the common stock of AZL was determined to be $5.10 per share at the Effective
Date. The fair value of a Preferred Unit at the Effective Date was estimated to
be $37.31 after taking into account the AZL common stock price of $5.10 and
various other factors that determine the value of a convertible
security.
Acquisitions
of properties and other business combinations are accounted for using the
purchase method and, accordingly, the results of operations of acquired
properties are included in our result of operations from the respective dates of
acquisition. Estimates of future cash flows and other valuation techniques are
used to allocate the purchase price of acquired property between land, buildings
and improvements, equipment and identifiable intangible assets and liabilities
such as amounts related to in-place market leases, acquired below and above
market leases and tenant relationships. Our allocations are typically
based on the relative fair value of the assets acquired and initial valuations
are subject to change until such information is finalized no later than 12
months from the acquisition date. Each of these estimates requires a great deal
of judgment, and some of the estimates involve complex calculations. These
allocation assessments have a direct impact on our results of operations because
if we were to allocate more value to land there would be no depreciation with
respect to such amount. If we were to allocate more value to the buildings as
opposed to tenant leases, this amount would be recognized as an expense over a
much longer period of time, since the amounts allocated to buildings are
depreciated over the estimated lives of the buildings whereas amounts allocated
to tenant leases are amortized over the remaining terms of the
leases.
Land,
buildings and improvements, and furniture, fixtures and equipment are recorded
at cost. 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.
Impairment of
Long-Lived Assets. 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 carrying value is reduced to
fair value and impairment loss is recognized. We did not recognize an impairment
loss on our long-lived assets during the three and nine months ended September
30, 2009.
Goodwill.
We record the excess 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. 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.
42
Pacific
Office Properties Trust, Inc.
Revenue
Recognition. All tenant leases are classified as operating leases. For
all lease terms exceeding one year, rental income is recognized on a
straight-line basis over the terms of the leases. Deferred rent receivables
represent rental revenue recognized on a straight-line basis in excess of billed
rents. Reimbursements from tenants for real estate taxes and other recoverable
operating expenses are recognized as revenues in the period the applicable costs
are incurred.
Rental
revenue from parking operations and rental revenue from 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, which are included in rental income in the accompanying
condensed combined consolidated statements of operations, are recognized when
the related leases are canceled and where no corresponding continuing obligation
to provide services to such former tenants exists.
Other
income on the accompanying condensed combined consolidated statements of
operations generally includes income incidental to operations and are recognized
when earned.
Monitoring of
Rents and Other Receivables. An allowance is maintained for estimated
losses that may result from the inability of tenants to make required payments.
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 generally do not require collateral or other security from
our tenants, other than security deposits or letters of credit. If estimates of
collectability differ from the cash received, the timing and amount of reported
revenue could be impacted.
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. 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.
Income
Taxes. We have elected to be taxed as a REIT under 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. Based on our
estimates, we do not believe that we have generated taxable income during the
period from March 20, 2008 to September 30, 2009. 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 were considered a TRS.
Results
of Operations
The
following discussion regarding the results of operations was significantly
affected by the Transactions. Our discussion below addresses the historical
information for the three and nine months ended September 30, 2009 for the
Company, and the historical information for the period January 1, 2008 to March
19, 2008 for Waterfront, plus the period from March 20, 2008 to September 30,
2008 for the Company, on a combined basis (the “Combined Entity”).
Overview
As of
September 30, 2009, the Property Portfolio and Effective Portfolio were 85.5%
and 84.9% leased, respectively, to a total of 1,016 tenants. Approximately 5.1%
of our Property Portfolio leased square footage expires during the remainder of
2009 and approximately 11.9% of our Property Portfolio leased square footage
expires during 2010. We receive income primarily from rental revenue (including
tenant reimbursements) from our office properties, and to a lesser extent, from
our parking revenues. Our office properties are typically leased to tenants for
terms ranging from 2 to 20 years. See Item 1A. Risk Factors in Part I of our
Annual Report on Form 10-K for the year ended December 31, 2008 for a discussion
of risk factors pertaining to the current credit market
environment.
43
Pacific
Office Properties Trust, Inc.
As of
September 30, 2009, our consolidated Honolulu portfolio was 90.7% leased, with
approximately 136,500 square feet available. Our Honolulu portfolio attributable
to our unconsolidated joint ventures was 86.5% leased, with approximately 20,600
square feet available. Our effective Honolulu portfolio was 90.6% leased, with
approximately 157,100 square feet available.
As of
September 30, 2009, our consolidated Phoenix portfolio was 71.8% leased, with
approximately 208,100 square feet available. Our Phoenix portfolio attributable
to our unconsolidated joint ventures was 73.8% leased, with approximately
154,800 square feet available. Our effective Phoenix portfolio was 71.7% leased,
with approximately 363,000 square feet available.
As of
September 30, 2009, our consolidated San Diego portfolio, which consists of our
Sorrento Technology Center property, was 100% leased. Our San Diego portfolio
attributable to our unconsolidated joint ventures was 92.5% leased, with
approximately 47,360 square feet available. Our effective San Diego portfolio
was 95.8% leased, with approximately 47,400 square feet available.
Comparison
of Property Portfolio for the three months ended September 30, 2009 to the three
months ended September 30, 2008
2009
|
2008
|
$
Change
|
%
Change
|
|||||||||||||
Revenue:
|
||||||||||||||||
Rental
|
$ | 10,486 | $ | 10,899 | $ | (413 | ) | (3.8 | %) | |||||||
Tenant
reimbursements
|
5,163 | 5,583 | (420 | ) | (7.5 | %) | ||||||||||
Parking
|
2,012 | 1,981 | 31 | 1.6 | % | |||||||||||
Other
|
83 | 136 | (53 | ) | (39.0 | %) | ||||||||||
Total
revenue
|
17,744 | 18,599 | (855 | ) | (4.6 | %) | ||||||||||
Expenses:
|
||||||||||||||||
Rental
property operating
|
9,781 | 11,067 | (1,286 | ) | (11.6 | %) | ||||||||||
General
and administrative
|
351 | 429 | (78 | ) | (18.2 | %) | ||||||||||
Depreciation
and amortization
|
6,913 | 6,740 | 173 | 2.6 | % | |||||||||||
Interest
|
6,823 | 6,769 | 54 | 0.8 | % | |||||||||||
Loss
from extinguishment of debt
|
171 | - | 171 | - | % | |||||||||||
Total
expenses
|
24,039 | 25,005 | (966 | ) | (3.9 | %) | ||||||||||
Loss
before equity in net earnings of unconsolidated
|
||||||||||||||||
joint
ventures and non-operating income
|
(6,295 | ) | (6,406 | ) | 111 | 1.7 | % | |||||||||
Equity
in net earnings of unconsolidated
|
||||||||||||||||
joint
ventures
|
189 | 185 | 4 | 2.2 | % | |||||||||||
Non-operating
income
|
2 | - | 2 | 100.0 | % | |||||||||||
Net
loss
|
$ | (6,104 | ) | $ | (6,221 | ) | $ | 117 | 1.9 | % | ||||||
44
Pacific Office Properties Trust,
Inc.
Revenues
Rental Revenue. Rental
revenue decreased by $0.4 million, or 3.8%, for the three months ended September
30, 2009 compared to the three months ended September 30, 2008. The decrease was
primarily due to decreased average occupancy at our City Square property and
lower below market rent amortization, which resulted in a decrease of $0.3
million in rental revenue.
Tenant Reimbursements. Tenant
reimbursements decreased by $0.4 million, or 7.5%, for the three months ended
September 30, 2009 compared to the three months ended September 30, 2008. The
decrease is due to a significant decline in electricity costs in Hawaii and a
corresponding decrease in tenant reimbursements in the current
year.
Expenses
Rental Property Operating Expenses.
Rental property operating expenses decreased by $1.3 million, or 11.6%,
for the three months ended September 30, 2009 compared to the three months ended
September 30, 2008. The decrease was primarily attributable to lower electricity
rates in Hawaii during the current year compared to the prior
year. Electricity costs in Hawaii during the current year decreased
$1.0 million due to lower oil prices in 2009. In addition, bad debt
expense decreased by $0.2 million.
General and Administrative.
General and administrative expense decreased by $0.1 million, or 18.2%, for the
three months ended September 30, 2009 compared to the three months ended
September 30, 2008. The decrease is primarily due to a reduction in audit
fees.
Loss from extinguishment of debt.
We recognized a $0.2 million loss from extinguishment of debt during the
three months ended September 30, 2009 due to the write-off of unamortized loan
costs related to the September 2009 termination of the KeyBank Credit
Facility. We did not recognize any comparable losses in the prior
year.
45
Pacific Office Properties Trust,
Inc.
Comparison
of the Property Portfolio for the nine months ended September 30, 2009 to the
nine months ended September 30, 2008
2009
|
2008
(1)
|
$
Change
|
%
Change
|
|||||||||||||
Revenue:
|
||||||||||||||||
Rental
|
$ | 31,999 | $ | 26,401 | $ | 5,598 | 21.2 | % | ||||||||
Tenant
reimbursements
|
16,184 | 12,740 | 3,444 | 27.0 | % | |||||||||||
Parking
|
6,080 | 4,855 | 1,225 | 25.2 | % | |||||||||||
Other
|
270 | 345 | (75 | ) | (21.7 | %) | ||||||||||
Total
revenue
|
54,533 | 44,341 | 10,192 | 23.0 | % | |||||||||||
Expenses:
|
||||||||||||||||
Rental
property operating
|
29,356 | 26,412 | 2,944 | 11.1 | % | |||||||||||
General
and administrative
|
1,997 | 17,837 | (15,840 | ) | (88.8 | %) | ||||||||||
Depreciation
and amortization
|
20,470 | 15,503 | 4,967 | 32.0 | % | |||||||||||
Interest
|
20,348 | 15,822 | 4,526 | 28.6 | % | |||||||||||
Loss
from extinguishment of debt
|
171 | - | 171 | 100.0 | % | |||||||||||
Other
|
- | 143 | (143 | ) | (100.0 | %) | ||||||||||
Total
expenses
|
72,342 | 75,717 | (3,375 | ) | (4.5 | %) | ||||||||||
Loss
before equity in net earnings of unconsolidated
|
||||||||||||||||
joint
ventures and non-operating income
|
(17,809 | ) | (31,376 | ) | 13,567 | 43.2 | % | |||||||||
Equity
in net earnings of unconsolidated
|
||||||||||||||||
joint
ventures
|
406 | 156 | 250 | 160.3 | % | |||||||||||
Non-operating
income
|
6 | - | 6 | 100.0 | % | |||||||||||
Net
loss
|
$ | (17,397 | ) | $ | (31,220 | ) | $ | 13,823 | 44.3 | % | ||||||
(1)
|
Amounts reflected in 2008
represent the sum of the results of the Company for the period from March
21, 2008 to June 30, 2008 and the results of Waterfront for the period
from January 1, 2008 to March 20,
2008.
|
Revenues
Rental Revenue. Rental
revenue increased by $5.6 million, or 21.2%, for the nine months ended September
30, 2009 compared to the nine months ended September 30, 2008. An increase of
$6.0 million was primarily attributable to the number of days the properties
acquired at the Effective Date were in our portfolio during 2009 compared to
2008. The increase is partially offset by a $0.4 million decrease due
to decreased average occupancy, rental rates and below market rent amortization
at our City Square property.
Tenant Reimbursements. Tenant
reimbursements increased by $3.4 million, or 27.0%, for the nine months ended
September 30, 2009 compared to the nine months ended September 30, 2008. An
increase of $3.5 million was primarily attributable to the number of days the
properties acquired at the Effective Date were in our portfolio during 2009
compared to 2008. This increase is partially offset by a decrease in
electricity costs (and corresponding decrease in tenant reimbursements) in
Hawaii in 2009.
Parking Revenue. Parking
revenue increased by $1.2 million, or 25.2%, for the nine months ended September
30, 2009 compared to the nine months ended September 30, 2008. The increase was
primarily attributable to the number of days the properties acquired at the
Effective Date were in our portfolio during 2009 compared to 2008.
46
Pacific Office Properties Trust,
Inc.
Expenses
Rental Property Operating Expenses.
Rental property operating expenses increased by $2.9 million, or 11.1%,
for the nine months ended September 30, 2009 compared to the nine months ended
September 30, 2008. An increase of $5.2 million was primarily attributable to
the number of days the properties acquired at the Effective Date were in our
portfolio during 2009 compared to 2008. In addition, we increased our
bad debt reserves by $0.2 million. These increases are partially
offset by a $1.9 million decrease in electricity costs in Hawaii due to lower
oil prices in 2009.
General and Administrative.
General and administrative expense decreased by $15.8 million, or 88.8%, for the
nine months ended September 30, 2009 compared to the nine months ended September
30, 2008. The decrease is primarily due to a $16.2 million share-based
compensation charge resulting from the Transactions during the nine months ended
September 30, 2008. The decrease is also due to the non-recurrence of
certain expenses of $0.4 million related to the Transactions and a $0.1 million
decrease in professional fees relating to Sarbanes-Oxley
compliance.
Depreciation and Amortization
Expense. Depreciation and amortization expense increased by $5.0 million,
or 32.0%, for the nine months ended September 30, 2009 compared to the nine
months ended September 30, 2008. The increase was primarily attributable to the
number of days the properties acquired at the Effective Date were in our
portfolio during 2009 compared to 2008.
Interest Expense. Interest
expense increased by $4.5 million, or 28.6%, for the nine months ended September
30, 2009 compared to the nine months ended September 30, 2008. An increase of
$4.3 million was primarily attributable to the number of days the properties
acquired at the Effective Date were in our portfolio during the 2009 compared to
2008. The additional increase of $0.2 million was due to interest incurred on
the credit facility which was not in place in the prior year offset by a
decrease in the interest rate on our variable interest rate debt.
Loss from extinguishment of debt.
We recognized a $0.2 million loss from extinguishment of debt during the
nine months ended September 30, 2009 due to the write-off of unamortized loan
costs related to the September 2009 termination of the KeyBank Credit
Facility. We did not recognize any comparable losses in the prior
year.
Equity
in net earnings of unconsolidated joint ventures
Equity
in net earnings of unconsolidated joint ventures increased by $0.3 million, or
160.3%, for the nine months ended September 30, 2009 compared to the nine months
ended September 30, 2008. The increase was primarily attributable to the
addition of the SoCal II joint venture in August 2008.
Liquidity
and Capital Resources
Cash
Balances, Available Borrowings and Capital Resources
As of
September 30, 2009, we had $3.4 million in cash and cash equivalents as compared
to $4.5 million as of December 31, 2008. In addition, we had restricted cash
balances of $5.4 million as of September 30, 2009 as compared to $7.3 million as
of December 31, 2008. Restricted cash primarily consists of interest bearing
cash deposits required by certain of our mortgage loans to fund anticipated
expenditures for real estate taxes, insurance, debt service and leasing costs.
In addition, we have a revolving credit facility with outstanding borrowings of
$5.8 million as of September 30, 2009. We anticipate that our restricted
reserves, as well as other sources of liquidity, including existing cash on
hand, our credit facility, our cash flows from operations, financing and
investing activities will be sufficient to fund our capital expenditures or
needs for our existing Property Portfolio during the next twelve
months.
We expect
to finance our operations, non-acquisition-related capital expenditures and
long-term indebtedness repayment obligations primarily with internally generated
cash flow, existing cash on hand, proceeds from refinancing of existing
indebtedness and through other available investment and financing activities. We
may plan for our future financing activities to include selling a portion of the
equity in the properties in which we currently hold whole interests. We believe
these sources of liquidity will be sufficient to fund our short-term liquidity
needs for our existing Property Portfolio over the next twelve months, including
recurring non-revenue enhancing capital expenditures in our portfolio, debt
service requirements, dividend and distribution payments, tenant improvements
and leasing commissions. In addition, we have $66.4 million in
aggregate principal indebtedness maturing in 2010. We expect to meet
these obligations through the refinancing of existing indebtedness and through
proceeds from capital market activities, including but not limited to the
issuance of equity securities.
47
Pacific Office Properties Trust,
Inc.
We expect
to meet our long-term liquidity and capital requirements such as scheduled
principal maturities, property acquisitions costs, if any, and other
non-recurring capital expenditures through net cash provided by operations,
existing cash on hand, refinancing of existing indebtedness, proceeds from our
anticipated Senior Common Stock offering and through other available investment
and financing activities, including the assumption of mortgage indebtedness upon
acquisition or the procurement of new acquisition mortgage
indebtedness.
We expect
that we will fund only 10% to 20% of the required equity for new office
properties acquired in the future. The balance of the equity investment is
expected to be funded, on a transaction-by-transaction basis, by one or more
co-investors. We have pre-existing relationships with a number of potential
co-investors that we believe will provide ample opportunities to fund
anticipated acquisitions. Our business strategy provides us with the opportunity
to earn greater returns on invested equity through incentive participation and
management fees.
As of
September 30, 2009, our total consolidated debt was approximately $424.5 million
with a weighted average interest rate of 5.82% and a weighted average remaining
term of 5.7 years.
Cash
Flows
Net cash
provided by operating activities for the Company for the nine months ended
September 30, 2009 was $3.3 million compared to $1.7 million for the Combined
Entity for the nine months ended September 30, 2008. The increase of $1.6
million for the Company compared to the Combined Entity was primarily
attributable to improved vendor payment management in addition to incremental
cash flow due to the number of days the properties acquired at the Effective
Date were in our portfolio, 270 days in the 2009 period compared to 192 days in
the 2008 period.
Net cash
used in investing activities for the Company for the nine months ended September
30, 2009 was $1.5 million compared to $6.3 million used in investing activities
for the Combined Entity for the nine months ended September 30,
2008. During 2009, our restricted cash decreased by $3.3 million due
to a return of escrow deposits and property tax payments made from our reserve
accounts. In addition, we decreased our capital expenditures related
to real estate by $2.5 million compared to the same period in the prior year and
we received $1.5 million in capital distributions from our investments in
unconsolidated joint ventures and a catch up in distributions from another joint
venture that we did not elect to receive in the prior year. In addition, we
received $6.5 million from Contributed Properties upon the Effective Date. This
was offset by our payment of $4.1 million of acquisition costs related to the
Transactions during the nine months ended September 30, 2008, which did not
recur during the nine months ended September 30, 2009.
Net cash
used in financing activities was $2.8 million for the nine months ended
September 30, 2009 compared to $8.1 million in net cash provided by financing
activities for the Combined Entity for the nine months ended September 30,
2008. Our cash used during the 2009 period was primarily attributable
to $3.8 million in distributions paid to non-controlling interests, which we
expect to continue paying. During 2008, we received $6.4 million from the
issuance of equity securities, as a result of the Transactions. In addition, in
2008, the Combined Entity also received $2.7 million in net equity contributions
from the previous partners. We do not, however, expect to continue to
receive equity contributions in a manner similar to that received during the
2008 period based on our capital structure after the Transactions. We
intend to continue to increase our cash flow provided by financing activities
from the issuance of equity securities from time to time, subject to the
effective registration by the SEC (or an applicable exemption from registration)
of the securities we contemplate selling and the existence of optimal market and
selling conditions.
48
Pacific Office Properties Trust,
Inc.
Indebtedness
Mortgage
and Other Loans
The
following table sets forth information relating to the material borrowings with
respect to our properties as of September 30, 2009. Unless otherwise indicated
in the footnotes to the table, each loan requires monthly payments of interest
only and balloon payments at maturity, and all numbers, other than percentages,
are reported in thousands:
PROPERTY
|
AMOUNT
|
INTEREST
RATE
|
MATURITY
DATE
|
BALANCE
DUE AT MATURITY DATE
|
PREPAYMENT/ DEFEASANCE
|
||||||||||||
Clifford
Center (1)
|
3,567 | 6.00 | % |
8/15/2011
|
3,032 | (2) | |||||||||||
Davies
Pacific Center
|
95,000 | 5.86 | % |
11/11/2016
|
95,000 | (3) | |||||||||||
First
Insurance Center
|
38,000 | 5.74 | % |
1/1/2016
|
38,000 | (4) | |||||||||||
First
Insurance Center
|
14,000 | 5.40 | % |
1/6/2016
|
14,000 | (5) | |||||||||||
Pacific
Business News
|
|||||||||||||||||
Building
(6)
|
11,691 | 6.98 | % |
4/6/2010
|
11,613 | (7) | |||||||||||
Pan
Am Building
|
60,000 | 6.17 | % |
8/11/2016
|
60,000 | (8) | |||||||||||
Waterfront
Plaza
|
100,000 | 6.37 | % |
9/11/2016
|
100,000 | (9) | |||||||||||
Waterfront
Plaza
|
11,000 | 6.37 | % |
9/11/2016
|
11,000 | (10) | |||||||||||
City
Square
|
27,500 | 5.58 | % |
9/1/2010
|
27,500 | (11) | |||||||||||
City
Square (12)
|
27,017 |
LIBOR
+ 2.35%
|
9/1/2010
|
26,612 | (13) | ||||||||||||
Sorrento
Technology
|
|||||||||||||||||
Center
(14)
|
11,800 | 5.75 | % (15) |
1/11/2016
(15)
|
10,825 | (16) | |||||||||||
Subtotal
|
$ | 399,575 |
|
||||||||||||||
Revolving
line of
|
|||||||||||||||||
credit
(17)
|
5,847 | 1.85 | % |
9/2/2011
|
5,847 | ||||||||||||
Outstanding
principal balance
|
$ | 405,422 | |||||||||||||||
Less:
Unamortized discount, net
|
(2,075 | ) | |||||||||||||||
Net
|
$ | 403,347 | |||||||||||||||
______________________
(1)
Requires monthly principal and interest payments of $39.8. The initial
maturity date is August 15, 2011. We have the option to extend
the maturity date to August, 15, 2014 for a nominal
fee.
|
(2)
|
Loan
is prepayable, subject to prepayment premium equal to greater of 2% of
amount prepaid or yield
maintenance.
|
(3)
|
Loan
is prepayable, after second anniversary of its securitization, subject to
prepayment premium equal to greater of (a) 1% of amount prepaid or (b)
yield maintenance. No premium due after August 11,
2016.
|
(4)
|
Loan
is prepayable subject to a prepayment premium in an amount equal to the
greater of 3% of outstanding principal amount or yield
maintenance. No premium due after October 1,
2015. Loan may also be defeased after earlier of December 2008
or two years after the “start-up date” of the loan, if
securitized.
|
(5)
|
Loan
is not prepayable until October 6, 2015; however, loan may be defeased
after earlier of August 2009 and two years after the “start-up date” of
the loan, if securitized. No premium is due upon
prepayment.
|
(6)
|
Requires
monthly principal and interest payments of
$81.
|
(7)
|
Loan
may not be prepaid until February 6, 2010. No premium is due
upon prepayment. Loan may be defeased after the earlier of
September 2008 or two years after the “start-up date” of the loan, if
securitized.
|
(8)
|
Loan
may be prepaid following second anniversary of its securitization subject
to a prepayment premium equal to greater of 1% of principal balance of
loan or yield maintenance. No premium is due after May 11,
2016.
|
(9)
|
Loan
may be prepaid subject to payment of a yield maintenance-based prepayment
premium; no premium is due after June 11, 2016. Loan may also
be defeased after the date that is two years from the “start-up date” of
the loan, if securitized.
|
(10)
|
Loan
may be prepaid subject to payment of a yield maintenance-based prepayment
premium; no premium is due after June 11,
2016.
|
(11)
|
Loan
may not be prepaid until June 1, 2010. Loan may be defeased at
any time.
|
(12)
|
Maximum
loan amount to be advanced is $28.5 million. 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.
|
(13)
|
Loan
may be prepaid subject to payment of a fee in amount of
$142.
|
(14) From
and after January 11, 2010, requires monthly principal and interest payments in
the amount of $69.
(15)
|
Although
the maturity date is January 11, 2036, January 11, 2016 is the anticipated
repayment date because the interest rate adjusts as of January 11, 2016 to
greater of 7.75% or treasury rate plus 70 basis points, plus
2.0%.
|
(16)
|
No
prepayment is permitted prior to October 11, 2016. Loan may be
defeased after the earlier of December 15, 2009 or second anniversary of
the “start-up date” of the loan, if
securitized.
|
(17)
|
The
revolving line of credit matures on September 2, 2011. See
“Revolving Line of Credit” below.
|
|
49
Pacific Office Properties Trust,
Inc.
Our
variable rate debt, as reflected in the above schedule and in Note 8 to our
condensed combined consolidated financial statements included in this Quarterly
Report on Form 10-Q, bears interest at a rate based on 30-day LIBOR, which was
0.25% as of September 30, 2009, plus a spread. Our variable rate debt at
September 30, 2009 has an initial term that matures in September
2010.
The debt
secured by our properties is owed at the property level rather than by the
Company or the Operating Partnership. This debt is non-recourse to the Operating
Partnership except for customary recourse carve-outs for borrower misconduct and
environmental liabilities and one fully recourse mortgage loan for the
Contributed Property known as Clifford Center. The recourse liability
for borrower misconduct and environmental liabilities was guaranteed by Mr.
Shidler and James C. Reynolds, an affiliate of The Shidler Group, and entities
wholly-owned or controlled by them, and the Operating Partnership has
indemnified them to the extent of their guaranty liability. This debt
strategy isolates mortgage liabilities in separate, stand-alone entities,
allowing us to have only our property-specific equity investment at
risk.
As of
September 30, 2009, our ratio of total consolidated debt to total consolidated
market capitalization was approximately 65.8%. Our total consolidated market
capitalization of $644.7 million includes our total consolidated debt of $424.5
million and the market value of our common stock and common stock equivalents
outstanding of $220.2 million (based on the closing price of our common stock of
$4.34 per share on the NYSE Amex on September 30, 2009).
At
September 30, 2009, the Operating Partnership was subject to a $1.5 million
recourse commitment that it provided on behalf of POP San Diego I joint venture
in connection with certain of that joint venture’s mortgage loans. The
contractual provisions of these mortgage loans provide for the full release of
this recourse commitment upon the satisfaction of certain conditions within the
control of management. We believe that the subject conditions will be satisfied
by management prior to, or during, the fourth quarter ending December 31, 2009,
and will therefore result in the immediate and full release of the Operating
Partnership from this recourse commitment. As such, we have not
recorded this as a liability because the probability for recourse is
remote.
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.
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.
50
Pacific Office Properties Trust,
Inc.
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.
Subordinated
Promissory Notes
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.
Distributions
We have
made an election to be taxed as a REIT under Sections 856 through 860 of the
Code, and related regulations and intend to continue to operate so as to remain
qualified as a REIT for federal income tax purposes. We generally will not be
subject to federal income tax on income that we distribute to our stockholders
and UPREIT unit holders, provided that we distribute 100% of our REIT taxable
income and meet certain other requirements for qualifying as a REIT. If we fail
to qualify as a REIT in any taxable year, we will be subject to federal income
tax on our taxable income at regular corporate rates and will not be permitted
to qualify for treatment as a REIT for federal income tax purposes for four
years following the year during which qualification is lost. Such an event could
materially affect our income and our ability to pay dividends. We believe we
have been organized as, and our past and present operations qualify the Company
as, a REIT.
In
connection with the Transactions, we received a representation from our
predecessor, AZL, that it qualified as a REIT under the provisions of the Code.
However, in early 2009, we became aware that AZL may have failed to meet certain
asset tests required to be satisfied under the 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 (the
“IRS”) were to successfully challenge our position, the IRS 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.
51
Pacific Office Properties Trust,
Inc.
Accordingly,
as of September 30, 2009, we recorded an estimate in the amount of $0.5 million
for such penalties and related costs, which is included in accounts payable and
other liabilities in our condensed combined consolidated balance sheet, based on
the information we have to date.
One of
our primary objectives, consistent with our policy of retaining sufficient cash
for reserves and working capital purposes and maintaining our status as a REIT,
is to distribute a substantial portion of our funds available from operations to
our common stockholders and UPREIT unit holders in the form of dividends or
distributions on a quarterly basis. Dividends and distributions by the Company
are contingent upon the Company’s receipt of distributions on the Common Units
from the Operating Partnership. The Operating Partnership is prohibited from
making distributions on the Common Units unless all accumulated distributions on
the Preferred Units have been paid, except to pay certain operating expenses of
the Company and for the purposes of maintaining our qualification as a REIT. As
of September 30, 2009, we considered market factors and our performance in
addition to REIT requirements in determining distribution levels.
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.
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.
Although
we currently estimate taxable losses for the year ending December 31, 2009, we
expect to continue to declare and pay dividends as a return of capital to our
stockholders.
Related
Party Transactions
We are
externally advised by the Advisor, an entity affiliated with and owned by our
founder, The Shidler Group. For a more detailed discussion of the Advisor and
other related party transactions, see Note 12 to our condensed combined
consolidated financial statements included in this Quarterly Report on Form
10-Q.
New
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.
52
Pacific Office Properties Trust,
Inc.
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.
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 requires fair value measurement of any non-controlling equity
investment retained in a deconsolidation. We adopted the guidance on January 1,
2009.
53
Pacific Office Properties Trust,
Inc.
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.
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 to our
condensed combined consolidated financial statements included in this Quarterly
Report on Form 10-Q. 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.
Item
3. Quantitative and Qualitative Disclosures About Market Risk.
Not
required.
Item 4T. Controls and
Procedures.
Evaluation
of disclosure controls and procedures.
As
required by Rule 13a-15(b) of the Exchange Act, in connection with the filing of
this Quarterly Report on Form 10-Q, we carried out an evaluation, under the
supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of the end of the period
covered by this Quarterly Report on Form 10-Q. In connection with the
preparation of the financial statements included in this Quarterly Report on
Form 10-Q, we determined that we had not properly recorded certain non-cash fair
value measurements of the common units of the Operating Partnership in
accordance with the Company’s adoption on January 1, 2009 of guidance issued by
the Financial Accounting Standards Board which required the Company to evaluate
the presentation of the limited partnership common and preferred interests in
our audited consolidated financial statements as of and for the year ended
December 31, 2008 and our unaudited consolidated financial statements as of and
for the quarterly periods ended March 31, 2009 and June 30, 2009. On
November 18, 2009, we determined that we would restate our financial statements
for these periods. Because of these restatements, management
determined that a material weakness in internal control over financial reporting
existed as of September 30, 2009. Based on the existence of this
material weakness, our Chief Executive Officer and Chief Financial Officer
concluded that our disclosure controls and procedures were not effective as of
September 30, 2009, the end of the period covered by this report.
54
Pacific Office Properties Trust,
Inc.
Changes
in Internal Control Over Financial Reporting
There
have been no changes in our internal control over financial reporting that
occurred during the quarter covered by this Quarterly Report on Form 10-Q that
have materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting.
Subsequent
to September 30, 2009, we identified a material weakness in our internal
controls over the financial reporting close process with respect to our
recording of certain non-cash fair value measurements of the common units of our
operating partnership, Pacific Office Properties, L.P., which resulted in the
restatement of the amounts previously reported in the non-controlling interests,
additional paid in capital and retained deficit of our consolidated balance
sheets for the year ended December 31, 2008 and subsequent quarters.
During the quarter ended December 31, 2009, we have begun to execute
actions to remediate these weaknesses by revising our financial statement close
process to include a more rigorous review process, the use of more comprehensive
checklists and engaging experienced consultants to assist us in the
interpretation and application of generally accepted accounting principles.
For the period ended December 31, 2008 and the first and second quarters
of 2009, we previously recorded our redeemable common operating partnership
units of our operating partnership at its historical cost. We subsequently
discovered that this accounting treatment did not appropriately reflect the
measurement provisions for redeemable non-controlling interests as required by
ASC 480-10-S99-3 which discusses the accounting for classification and
measurement of redeemable securities. These errors will be remediated
during the quarter ended December 31, 2009. We may make further changes in
our internal control processes from time to time in the future.
PART
II — OTHER INFORMATION
Item
1. Legal Proceedings.
We are
not currently a party, as plaintiff or defendant, to any legal proceedings
which, individually or in the aggregate, are expected by us to have a material
effect on our business, financial condition or results of operation if
determined adversely to us.
Item
1A. Risk Factors
Important
factors that could cause our actual results to be materially different from the
forward-looking statements include the risks factors previously disclosed our
Annual Report on Form 10-K for the year ended December 31, 2008 and our
Quarterly Report on Form 10-Q for the three months ended March 31, 2009 as well
as the risk factors set forth below. In addition to the other
information set forth in this report, you should carefully consider these risk
factors, which could materially affect our business, financial condition and
results of operations.
If
our common stock fails to meet all applicable listing standards, it could be
delisted from the NYSE Amex, which could adversely affect the market price and
liquidity of our common stock and harm our financial condition and
business.
Our
common stock currently is listed and traded on the NYSE Amex under the symbol
“PCE.” If we fail to meet any of the continued listing standards of the NYSE
Amex, our common stock could be delisted from the NYSE Amex. Because
our stockholders’ equity balance currently is not in compliance with the
standards of the exchange, although we expect to again be in compliance as of
December 31, 2009, there can be no assurance that the NYSE Amex will not
consider initiating suspension or delisting procedures. The NYSE Amex
will consider the removal of a listed security on its exchange when, in the
opinion of the NYSE Amex, the financial condition and/or operating results of
the issuer appear to be unsatisfactory, it appears that the extent of public
distribution or the aggregate market value of the security has become so reduced
as to make further dealings on the NYSE Amex inadvisable, the issuer has sold or
otherwise disposed of its principal operating assets or has ceased to be an
operating company, the issuer has failed to comply with its listing agreements
with the NYSE Amex or any other event shall occur or any condition shall exist
which makes further dealings on the NYSE Amex unwarranted.
55
Pacific Office Properties Trust,
Inc.
If our
common stock were to be delisted from the NYSE Amex, our common stock could be
traded in the over-the-counter market or on an automated quotation system, such
as the OTC Bulletin Board or the Pink Sheets. Any delisting could adversely
affect the market price and the liquidity of our common stock and negatively
impact our financial condition and business.
Failure to
maintain effective internal control over financial reporting could have an
adverse effect on our operations, financial results or stock
price.
On
November 18, 2009, the Company determined that there was a material weakness in
its internal control over financial reporting that existed as of September 30,
2009 and, as a result, the Company determined that its disclosure controls and
procedures were not effective as of September 30, 2009. As a result of this
material weakness, errors occurred in the Company’s audited consolidated
financial statements as of and for the year ended December 31, 2008 and its
unaudited consolidated financial statements as of and for the quarterly periods
ended March 31, 2009 and June 30, 2009 related to the fair value measurements of
the common units of the Operating Partnership. These errors were not
detected on a timely basis and ultimately resulted in [(or will result in)] the
restatement of the Company’s financial statements for these periods. Although
the Company has subsequently remediated the material weakness in its internal
control over financial reporting, the Company may fail to maintain effective
internal control over financial reporting in the future. Failure to maintain
effective internal control over financial reporting could result in
investigations or sanctions by regulatory authorities, and could have a material
adverse effect on our operating results, investor confidence in our reported
financial information, and the market price of our common stock.
Item
2. Unregistered Sales of Equity Securities and Use of Proceeds.
The
information required by this item was previously included in the Company’s
Current Report on Form 8-K filed with the SEC on September 28,
2009.
Item
3. Defaults Upon Senior Securities.
None.
Item
4. Submission of Matters to a Vote of Security Holders.
None.
Item
5. Other Information.
On
November 20, 2009, the Company filed with the Maryland State Department of
Assessments and Taxation (i) articles supplementary to its charter reclassifying
199,900 authorized but unissued shares of Class B Common Stock as common stock,
and (ii) articles of amendment to its charter increasing the number of
authorized shares of common stock by 40,000,000 shares. These
articles supplementary and articles of amendment are filed as Exhibits 3.2 and
3.3, respectively, to this Quarterly Report on Form 10-Q.
56
Pacific Office Properties Trust,
Inc.
Item
6. Exhibits.
Exhibit No.
|
Description
|
3.1
|
Articles
of Amendment and Restatement (Filed herewith).
|
3.2
|
Articles
Supplementary of the Company (Filed herewith).
|
3.3
|
Articles
of Amendment of the Company (Filed herewith).
|
3.4
|
Amended
and Restated Bylaws (previously filed as Exhibit 3.2 to the Company’s
Current Report on Form 8-K filed on March 25, 2008 and incorporated herein
by reference).
|
10.1
|
Credit
Agreement dated as of September 2, 2009 between Pacific Office Properties,
L.P. and First Hawaiian Bank (previously filed as Exhibit 10.1 to the
Company’s Current Report on Form 8-K filed September 4, 2009 and
incorporated herein by reference).
|
10.2
|
Promissory
Note dated September 2, 2009 issued by Pacific Office Properties, L.P. to
First Hawaiian Bank (previously filed as Exhibit 10.2 to the Company’s
Current Report on Form 8-K filed September 4, 2009 and incorporated herein
by reference).
|
10.3
|
Indemnification
Agreement dated as of September 2, 2009 between Pacific Office Properties,
L.P. and Shidler Equities L.P. (previously filed as Exhibit 10.3 to the
Company’s Current Report on Form 8-K filed September 4, 2009 and
incorporated herein by reference).
|
10.4
|
Exchange
Agreement, dated as of September 23, 2009, by and among Pacific Office
Properties, L.P., Shidler Equities, L.P., Reynolds Partners, L.P., MJR
Equities, LLC, JRI Equities, LLC and Lawrence J. Taff (previously filed as
Exhibit 10.1 to the Company’s Current Report on Form 8-K filed September
28, 2009 and incorporated herein by reference).
|
10.5
|
Third
Amendment to Amended and Restated Agreement of Limited Partnership of
Pacific Office Properties, L.P. dated as of September 25, 2009 (previously
filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K filed
September 28, 2009 and incorporated herein by
reference).
|
10.6
|
First
Amendment to Amended and Restated Advisory Agreement dated as of September
25, 2009, by and among Pacific Office Properties Trust, Inc., Pacific
Office Properties, L.P. and Pacific Office Management, Inc. (previously
filed as Exhibit 10.3 to the Company’s Current Report on Form 8-K filed
September 28, 2009 and incorporated herein by
reference).
|
31.1
|
Certification
of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002. (Filed herewith.)
|
31.2
|
Certification
of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002. (Filed herewith.)
|
32.1
|
Certification
of Chief Executive Officer pursuant to 18 U.S.C. § 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (Filed
herewith.)
|
32.2
|
Certification
of Chief Financial Officer pursuant to 18 U.S.C. § 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (Filed
herewith.)
|
57
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
PACIFIC OFFICE PROPERTIES TRUST,
INC.
Date:
November 23,
2009 /s/ Jay H.
Shidler
Jay H. Shidler
Chief Executive Officer
/s/ Lawrence J.
Taff
Lawrence J. Taff
Chief Financial
Officer