UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2001
or
[ ] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from to
--------- --------
Commission File Number 1-10709
-------
PS BUSINESS PARKS, INC.
-----------------------
(Exact name of registrant as specified in its charter)
CALIFORNIA 95-4300881
---------- ----------
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation) Identification Number)
701 WESTERN AVENUE, GLENDALE, CALIFORNIA 91201-2397
---------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (818) 244-8080
--------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
---- ----
Number of shares outstanding of each of the issuer's classes of common stock, as
of August 10, 2001:
Common Stock, $0.01 par value, 22,478,378 shares outstanding
PS BUSINESS PARKS, INC.
INDEX
PAGE
-----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 2001 and December 31, 2000........ 2
Condensed Consolidated Statements of Income for the Three and Six Months Ended June 30,
2001 and 2000.......................................................................... 3
Condensed Consolidated Statement of Shareholders' Equity for the Six Months Ended June
30, 2001............................................................................... 4
Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2001
and 2000............................................................................... 5
Notes to Condensed Consolidated Financial Statements................................... 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................................... 19
Item 3. Quantitative and Qualitative Disclosures about Market Risk...................... 34
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................... 35
Item 4. Submission of Matters to a Vote of Security Holders............................. 35
Item 6. Exhibits and Reports on Form 8-K................................................ 36
PS BUSINESS PARKS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2001 2000
--------------------- --------------------
(unaudited)
ASSETS
------
Cash and cash equivalents............................... $ 24,054,000 $ 49,295,000
Marketable securities................................... 8,605,000 6,065,000
Real estate facilities, at cost:
Land............................................... 235,933,000 214,020,000
Buildings and equipment............................ 775,876,000 709,328,000
--------------------- --------------------
1,011,809,000 923,348,000
Accumulated depreciation........................... (102,375,000) (83,841,000)
--------------------- --------------------
909,434,000 839,507,000
Properties held for disposition, net.................... 5,110,000 -
Land held for development............................... 5,837,000 5,737,000
Construction in progress................................ 26,993,000 19,467,000
--------------------- --------------------
947,374,000 864,711,000
Receivables............................................. 496,000 461,000
Deferred rent receivables............................... 8,580,000 7,697,000
Intangible assets, net.................................. 830,000 981,000
Other assets............................................ 1,123,000 1,546,000
--------------------- --------------------
Total assets.............................. $ 991,062,000 $ 930,756,000
===================== ====================
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Accrued and other liabilities.............................. $ 32,414,000 $ 28,964,000
Mortgage notes payable..................................... 30,563,000 30,971,000
--------------------- --------------------
Total liabilities................................. 62,977,000 59,935,000
Minority interest:
Preferred units................................... 144,750,000 144,750,000
Common units...................................... 162,272,000 161,728,000
Shareholders' equity:
Preferred stock, $0.01 par value, 50,000,000 shares
authorized, 4,840 shares issued and outstanding at June
30, 2001 (2,200 shares issued and outstanding at
December 31, 2000)..................................... 121,000,000 55,000,000
Common stock, $0.01 par value, 100,000,000 shares
authorized, 22,475,178 shares issued and outstanding at
June 30, 2001 (23,044,635 shares issued and outstanding
at December 31, 2000).................................. 225,000 230,000
Paid-in capital......................................... 448,510,000 464,855,000
Cumulative net income................................... 149,285,000 124,990,000
Other comprehensive loss................................ (836,000) -
Cumulative distributions................................ (97,121,000) (80,732,000)
--------------------- --------------------
Total shareholders' equity........................ 621,063,000 564,343,000
--------------------- --------------------
Total liabilities and shareholders' equity... $ 991,062,000 $ 930,756,000
===================== ====================
See accompanying notes.
2
PS BUSINESS PARKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
For the Three Months For the Six Months
Ended June 30, Ended June 30,
---------------------------------- -----------------------------------
2001 2000 2001 2000
---------------- ---------------- ---------------- -----------------
Revenues:
Rental income................................. $ 40,281,000 $ 36,414,000 $ 78,674,000 $ 70,467,000
Facility management fees primarily from
affiliates.................................. 168,000 129,000 329,000 252,000
Business services............................. 76,000 267,000 233,000 267,000
Interest income............................... 553,000 741,000 1,313,000 2,011,000
Dividend income............................... 4,000 440,000 8,000 858,000
---------------- ---------------- ---------------- -----------------
41,082,000 37,991,000 80,557,000 73,855,000
---------------- ---------------- ---------------- -----------------
Expenses:
Cost of operations............................. 10,475,000 10,118,000 20,846,000 19,670,000
Cost of facility management.................... 37,000 25,000 73,000 50,000
Cost of business services...................... 129,000 64,000 313,000 64,000
Depreciation and amortization.................. 9,733,000 8,898,000 19,379,000 17,274,000
General and administrative..................... 992,000 981,000 2,120,000 1,864,000
Interest expense.............................. 157,000 370,000 394,000 744,000
---------------- ---------------- ---------------- -----------------
21,523,000 20,456,000 43,125,000 39,666,000
---------------- ---------------- ---------------- -----------------
Income before gain on investment and minority
interest......................................... 19,559,000 17,535,000 37,432,000 34,189,000
Gain on disposition of real estate............. - 97,000 - 97,000
Gain on investment in Pacific Gulf
Properties Inc................................ - - 15,000 -
---------------- ---------------- ---------------- -----------------
Income before minority interest.................. 19,559,000 17,632,000 37,447,000 34,286,000
Minority interest in income - preferred units.. (3,186,000) (2,921,000) (6,373,000) (5,841,000)
Minority interest in income - common units..... (3,543,000) (3,199,000) (6,779,000) (6,190,000)
---------------- ---------------- ---------------- -----------------
Net income....................................... $ 12,830,000 $ 11,512,000 $ 24,295,000 $ 22,255,000
================ ================ ================ =================
Net income allocation:
Allocable to preferred shareholders............ $ 1,903,000 $ 1,272,000 $ 3,175,000 $ 2,544,000
Allocable to common shareholders............... 10,927,000 10,240,000 21,120,000 19,711,000
---------------- ---------------- ---------------- -----------------
$ 12,830,000 $ 11,512,000 $ 24,295,000 $ 22,255,000
================ ================ ================ =================
Net income per common share:
Basic.......................................... $ 0.48 $ 0.44 $ 0.93 $ 0.84
================ ================ ================ =================
Diluted........................................ $ 0.48 $ 0.44 $ 0.92 $ 0.84
================ ================ ================ =================
Weighted average common shares outstanding:
Basic.......................................... 22,610,000 23,356,000 22,814,000 23,474,000
================ ================ ================ =================
Diluted........................................ 22,679,000 23,428,000 22,885,000 23,537,000
================ ================ ================ =================
See accompanying notes.
3
PS BUSINESS PARKS, INC.
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2001
(UNAUDITED)
Preferred Stock Common Stock
------------------------- --------------------------- Paid-in Cumulative
Shares Amount Shares Amount Capital Net Income
--------- -------------- ------------ -------------- --------------- --------------
BALANCES AT DECEMBER 31, 2000...... 2,200 $55,000,000 23,044,635 $ 230,000 $464,855,000 $124,990,000
Issuance of preferred stock...... 2,640 66,000,000 - - (1,474,000) -
Exercise of stock options........ - - 78,443 1,000 1,330,000 -
Unrealized loss - depreciation
in marketable securities...... - - - - - -
Repurchase of common stock...... - - (647,900) (6,000) (17,385,000) -
Net income...................... - - - - - 24,295,000
Distributions paid:
Preferred stock............. - - - - - -
Common stock................ - - - - - -
Adjustment to reflect minority
interest to underlying ownership
interest.......................... - - - - 1,184,000 -
--------- -------------- ------------ -------------- --------------- --------------
BALANCES AT JUNE 30, 2001.......... 4,840 $121,000,000 22,475,178 $ 225,000 $448,510,000 $149,285,000
========= ============== ============ ============== =============== ==============
Other
Comprehensive Cumulative Shareholders'
Loss Distributions Equity
---------------- ---------------- -----------------
BALANCES AT DECEMBER 31, 2000...... - $ (80,732,000) $ 564,343,000
Issuance of preferred stock...... - - 64,526,000
Exercise of stock options........ - - 1,331,000
Unrealized loss - depreciation
in marketable securities...... (836,000) - (836,000)
Repurchase of common stock...... - - (17,391,000)
Net income...................... - - 24,295,000
Distributions paid:
Preferred stock............. - (3,175,000) (3,175,000)
Common stock................ - (13,214,000) (13,214,000)
Adjustment to reflect minority
interest to underlying ownership
interest.......................... - - 1,184,000
---------------- ---------------- -----------------
BALANCES AT JUNE 30, 2001.......... $ (836,000) $ (97,121,000) $ 621,063,000
================ ================ =================
See accompanying notes.
4
PS BUSINESS PARKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Six Months
Ended June 30,
-----------------------------------------
2001 2000
-------------------- -------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income....................................................... $ 24,295,000 $ 22,255,000
Adjustments to reconcile net income to net cash provided by
operating activities:
Gain on investment in Pacific Gulf Properties Inc............ (15,000) -
Depreciation and amortization expense........................ 19,379,000 17,274,000
Minority interest in income.................................. 13,152,000 12,031,000
Decrease in receivables and other assets..................... (495,000) (1,778,000)
Increase in accrued and other liabilities.................... 3,445,000 5,289,000
-------------------- -------------------
Total adjustments....................................... 35,466,000 32,816,000
-------------------- -------------------
Net cash provided by operating activities.................. 59,761,000 55,071,000
-------------------- -------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in marketable securities.......................... (9,440,000) (1,732,000)
Sale of marketable securities................................ 6,079,000 -
Acquisition of real estate facilities........................ (90,425,000) (29,497,000)
Disposition of real estate facilities........................ - 5,756,000
Capital improvements to real estate facilities............... (3,840,000) (4,747,000)
Land held for development and construction in progress....... (7,626,000) (8,414,000)
-------------------- -------------------
Net cash used in investing activities...................... (105,252,000) (38,634,000)
-------------------- -------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on mortgage notes payable................. (408,000) (5,704,000)
Net proceeds from the issuance of preferred stock............ 64,526,000 -
Exercise of stock options.................................... 1,331,000 60,000
Repurchase of common stock................................... (17,391,000) (12,378,000)
Redemption of common operating partnership units............. (808,000) -
Distributions paid to preferred shareholders................. (3,175,000) (2,544,000)
Distributions paid to minority interests - preferred units... (6,373,000) (5,841,000)
Distributions paid to common shareholders.................... (13,214,000) (11,702,000)
Distributions paid to minority interests - common units...... (4,238,000) (3,695,000)
-------------------- -------------------
Net cash provided by (used in) financing activities........ 20,250,000 (41,804,000)
-------------------- -------------------
Net decrease in cash and cash equivalents........................... (25,241,000) (25,367,000)
Cash and cash equivalents at the beginning of the period............ 49,295,000 74,220,000
-------------------- -------------------
Cash and cash equivalents at the end of the period.................. $ 24,054,000 $ 48,853,000
==================== ===================
See accompanying notes.
5
PS BUSINESS PARKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Six Months
Ended June 30,
-----------------------------------------
2001 2000
-------------------- -------------------
SUPPLEMENTAL SCHEDULE OF NON CASH INVESTING AND FINANCING
ACTIVITIES:
Conversion of common OP units into shares of common stock:
Minority interest - common units............................ $ - $ (2,531,000)
Common stock................................................ - 1,000
Paid-in capital............................................. - 2,530,000
Adjustment to reflect minority interest to underlying ownership
interest:
Minority interest - common units............................ (1,184,000) 1,501,000
Paid-in capital............................................. 1,184,000 (1,501,000)
Capitalization of developed properties:
Real estate facilities...................................... - (3,323,000)
Construction in progress.................................... - 3,323,000
Unrealized gain/loss:
Marketable securities....................................... 836,000 (4,809,000)
Other comprehensive (loss) income........................... (836,000) 4,809,000
See accompanying notes.
6
PS BUSINESS PARKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001
1. Organization and description of business
PS Business Parks, Inc. ("PSB") was incorporated in the state of California
in 1990. As of June 30, 2001, PSB owned an approximate 75% general and
limited partnership interest in PS Business Parks, L.P. (the "Operating
Partnership" or "OP"). PSB, as the sole general partner of the Operating
Partnership, has full, exclusive and complete responsibility and discretion
in managing and controlling the Operating Partnership. PSB and the
Operating Partnership are collectively referred to as the "Company."
The Company is a fully-integrated, self-advised and self-managed real
estate investment trust ("REIT") that acquires, develops, owns and operates
commercial properties containing commercial and industrial rental space. As
of June 30, 2001, the Company owned and operated approximately 13.3 million
net rentable square feet located in 9 states. The Company also managed
approximately 1.3 million net rentable square feet on behalf of Public
Storage, Inc. ("PSI"), affiliated entities and a third party owner.
2. Summary of significant accounting policies
Basis of presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with accounting principles generally accepted
in the United States for interim financial information and with
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by
accounting principles generally accepted in the United States for complete
financial statements. The preparation of the condensed consolidated
financial statements in conformity with accounting principles generally
accepted in the United States requires management to make estimates and
assumptions that affect the amounts reported in the condensed consolidated
financial statements and accompanying notes. Actual results could differ
from estimates. In the opinion of management, all adjustments (consisting
of normal recurring accruals) necessary for a fair presentation have been
included. Operating results for the three and six months ended June 30,
2001 are not necessarily indicative of the results that may be expected for
the year ended December 31, 2001. For further information, refer to the
consolidated financial statements and footnotes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2000.
The condensed consolidated financial statements include the accounts of PSB
and the Operating Partnership. All significant intercompany balances and
transactions have been eliminated in the condensed consolidated financial
statements.
Finanical instruments
The methods and assumptions used to estimate the fair value of financial
instruments is described below. The Company has estimated the fair value of
financial instruments using available market information and appropriate
valuation methodologies. Considerable judgment is required in interpreting
market data to develop estimates of market value. Accordingly, estimated
fair values are not necessarily indicative of the amounts that could be
realized in current market exchanges.
The Company considers all highly liquid investments with an original
maturity of three months or less at the date of purchase to be cash
equivalents. Due to the short period to maturity of the Company's cash and
cash equivalents, accounts receivable, other assets and accrued and other
liabilities, the carrying values as presented on the condensed consolidated
balance sheets are reasonable estimates of fair value. Based on borrowing
rates currently available to the Company, the carrying amount of debt
approximates fair value.
7
PS BUSINESS PARKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001
Financial assets that are exposed to credit risk consist primarily of cash
and cash equivalents and accounts receivable. Cash and cash equivalents,
which consist primarily of short-term investments, including commercial
paper, are only invested in entities with an investment grade rating.
Accounts receivable are not a significant portion of total assets and are
comprised of a large number of customers.
Marketable securities
Marketable securities are classified as "available-for-sale" in accordance
with Statement of Financial Accounting Standards ("SFAS") No. 115,
Accounting for Certain Investments in Debt and Equity Securities.
Investments are reflected on the balance sheet at fair market value based
upon the quoted market price. The unrealized loss of $836,000 is excluded
from earnings and reported in a separate component of shareholders' equity.
Dividend income is recognized when earned.
The Company sold its investment in Pacific Gulf Properties Inc. during the
six months ended June 30, 2001 and recognized a gain of $15,000.
Real estate facilities
Real estate facilities are recorded at cost. Costs related to the
renovation or improvement of the properties are capitalized. Expenditures
for repairs and maintenance are expensed as incurred. Buildings and
equipment are depreciated on the straight-line method over the estimated
useful lives, which are generally 30 and 5 years, respectively.
Interest cost and property taxes incurred during the period of construction
of real estate facilities are capitalized. The Company capitalized $898,000
and $688,000 of interest expense during the six months ended June 30, 2001
and 2000, respectively.
Intangible assets
Intangible assets consist of property management contracts for properties
managed, but not owned, by the Company. The intangible assets are being
amortized over seven years. Intangible assets are net of accumulated
amortization of $1,326,000 and $1,175,000 at June 30, 2001 and December 31,
2000, respectively.
Evaluation of asset impairment
The Company evaluates its assets used in operations by identifying
indicators of impairment and by comparing the sum of the estimated
undiscounted future cash flows for each asset to the asset's carrying
amount. When indicators of impairment are present and the sum of the
undiscounted future cash flows is less than the carrying value of such
asset, an impairment loss is recorded equal to the difference between the
asset's current carrying value and its value based on discounting its
estimated future cash flows. At June 30, 2001, no such indicators of
impairment have been identified.
Loans to affiliate
The Company loaned an aggregate of $77 million to PSI and received $153,000
in interest income during the period of January 5, 2000 through March 20,
2000. The notes bore interest at 5.9% (per annum) and were repaid as of
March 20, 2000.
8
PS BUSINESS PARKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001
Revenue and expense recognition
All leases are classified as operating leases. Rental income is recognized
on a straight-line basis over the terms of the leases. Reimbursements from
tenants for real estate taxes and other recoverable operating expenses are
recognized as revenues in the period the applicable costs are incurred.
Costs incurred in connection with leasing (primarily tenant improvements
and leasing commissions) are capitalized and amortized over the lease
period.
Property management fees are recognized in the period earned.
General and administrative expense
General and administrative expense includes executive compensation, office
expense, professional fees, state income taxes, cost of acquisition
personnel and other such administrative items. Such amounts include amounts
incurred by PSI on behalf of the Company, which were subsequently charged
to the Company in accordance with the allocation methodology set forth in
the cost allocation and administrative service agreement between the
Company and PSI.
Acquisition costs
In March 1998, the Emerging Issues Task Force ("EITF") of the Financial
Accounting Standards Board issued guidance (the "97-11 Guidance") with
respect to Issue No. 97-11, "Accounting for Internal Acquisition Costs
Relating to Real Estate Property Acquisitions." The 97-11 Guidance provides
that a company shall expense internal pre-acquisition costs (such as costs
of an internal acquisitions department) related to the purchase of an
operating property. The Company does not capitalize such internal
pre-acquisition costs with respect to the acquisition of operating real
estate facilities. Accordingly, the 97-11 Guidance had no impact upon the
consolidated financial statements and would have had no impact upon
financial statements for periods prior to the issuance of the 97-11
Guidance
Income taxes
The Company qualified and intends to continue to qualify as a REIT, as
defined in Section 856 of the Internal Revenue Code. As a REIT, the Company
is not subject to federal income tax to the extent that it distributes its
taxable income to its shareholders. A REIT must distribute at least 90% of
its taxable income each year. In addition, REITs are subject to a number of
organizational and operating requirements. If the Company fails to qualify
as a REIT in any taxable year, the Company will be subject to federal
income tax (including any applicable alternative minimum tax) based on its
taxable income using corporate income tax rates. Even if the Company
qualifies for taxation as a REIT, the Company may be subject to certain
state and local taxes on its income and property and to federal income and
excise taxes on its undistributed taxable income. The Company believes it
met all organization and operating requirements to maintain its REIT status
during 2000 and intends to continue to meet such requirements for 2001.
Accordingly, no provision for income taxes has been made in the
accompanying financial statements.
9
PS BUSINESS PARKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001
Net income per common share
Per share amounts are computed using the weighted average common shares
outstanding. "Diluted" weighted average common shares outstanding include
the dilutive effect of stock options under the treasury stock method.
"Basic" weighted average common shares outstanding excludes such effect.
Earnings per share has been calculated as follows:
For the Three Months For the Six Months
Ended June 30, Ended June 30,
---------------------------------- ---------------------------------
2001 2000 2001 2000
----------------- ---------------- ---------------- ----------------
Net income allocable to common shareholders.................... $ 10,927,000 $ 10,240,000 $ 21,120,000 $ 19,711,000
================= ================ ================ ================
Weighted average common shares outstanding:
Basic weighted average common shares outstanding............ 22,610,000 23,356,000 22,814,000 23,474,000
Net effect of dilutive stock options - based on treasury
stock method using average market price................... 69,000 72,000 71,000 63,000
----------------- ---------------- ---------------- ----------------
Diluted weighted average common shares outstanding.......... 22,679,000 23,428,000 22,885,000 23,537,000
================= ================ ================ ================
Basic earnings per common share................................ $ 0.48 $ 0.44 $ 0.93 $ 0.84
================= ================ ================ ================
Diluted earnings per common share.............................. $ 0.48 $ 0.44 $ 0.92 $ 0.84
================= ================ ================ ================
Reclassifications
Certain reclassifications have been made to the condensed consolidated
financial statements for 2000 in order to conform to the 2001 presentation.
10
PS BUSINESS PARKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001
3. Real Estate Facilities
The activity in real estate facilities for the six months ended June 30,
2001 is as follows:
Accumulated
Land Buildings Depreciation Total
----------------- ------------------ ----------------- ------------------
Balances at December 31, 2000...... $ 214,020,000 $ 709,328,000 $ (83,841,000) $ 839,507,000
Property acquisitions.............. 23,147,000 67,278,000 - 90,425,000
Capital improvements............... - 3,840,000 - 3,840,000
Properties held for disposition.... (1,234,000) (4,570,000) 694,000 (5,110,000)
Depreciation expense............... - - (19,228,000) (19,228,000)
----------------- ------------------ ----------------- ------------------
Balances at June 30, 2001.......... $ 235,933,000 $ 775,876,000 $ (102,375,000) $ 909,434,000
================= ================== ================= ==================
During the six months ended June 30, 2001, the Company incurred $7,626,000
in development costs.
Certain properties have been identified as not meeting the Company's
ongoing investment strategy and have been designated as properties held for
disposition at June 30, 2001. These properties are currently being marketed
and the Company anticipates a gain on the sale during this fiscal year. The
following summarizes the condensed results of operations of the properties
held for disposition which are included in the condensed consolidated
statements of income:
For the Six Months
Ended June 30,
--------------------------------
2001 2000
--------------- ----------------
Rental income........................ $ 891,000 $ 770,000
Cost of operations................... (385,000) (273,000)
Depreciation......................... (82,000) (79,000)
--------------- ----------------
Net operating income................. $ 424,000 $ 418,000
=============== ================
11
PS BUSINESS PARKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001
4. Leasing activity
The Company leases space in its real estate facilities to tenants under
non-cancelable leases generally ranging from one to ten years. Future
minimum rental revenues excluding recovery of expenses as of June 30, 2001
under these leases are as follows:
2001 (July - December).............. $ 69,310,000
2002................................ 116,525,000
2003................................ 90,012,000
2004................................ 63,635,000
2005................................ 44,540,000
Thereafter.......................... 56,165,000
-------------------
$ 440,187,000
===================
In addition to minimum rental payments, tenants pay reimbursements for
their pro rata share of specified operating expenses, which amounted to
$11,038,000 and $9,175,000 for the six months ended June 30, 2001 and 2000,
respectively. These amounts are included as rental income and cost of
operations in the accompanying condensed consolidated statements of income.
5. Revolving line of credit
In September 2000, the Company extended its unsecured line of credit (the
"Credit Facility") with Wells Fargo Bank. The Credit Facility has a
borrowing limit of $100 million and an expiration date of August 6, 2003.
The expiration date may be extended by one year on each anniversary of the
Credit Facility. Interest on outstanding borrowings is payable monthly. At
the option of the Company, the rate of interest charged is equal to (i) the
prime rate or (ii) a rate ranging from the London Interbank Offered Rate
("LIBOR") plus 0.75% to LIBOR plus 1.35% depending on the Company's credit
ratings and coverage ratios, as defined (currently LIBOR plus 1.00%). In
addition, the Company is required to pay an annual commitment fee of 0.25%
of the borrowing limit. The Company had no outstanding balance and $100
million available on its line of credit at June 30, 2001 and December 31,
2000.
The Credit Facility requires the Company to meet certain covenants
including (i) maintaining a balance sheet leverage ratio (as defined) of
less than 0.50 to 1.00, (ii) maintaining interest and fixed charge coverage
ratios (as defined) of not less than 2.25 to 1.0 and 1.75 to 1.0,
respectively, (iii) maintaining a minimum total shareholders' equity (as
defined) and (iv) limiting distributions to 95% of funds from operations.
In addition, the Company is limited in its ability to incur additional
borrowings (the Company is required to maintain unencumbered assets with an
aggregate book value equal to or greater than two times the Company's
unsecured recourse debt) or sell assets. The Company was in compliance with
the covenants of the Credit Facility at June 30, 2001.
12
PS BUSINESS PARKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001
6. Mortgage notes payable
Mortgage notes consist of the following:
June 30, December 31,
2001 2000
------------------ -------------------
7.050% mortgage note, principal and interest payable monthly, due
May 2006...................................................... $ 8,474,000 $ 8,570,000
8.190% mortgage note, principal and interest payable monthly, due
March 2007.................................................... 6,384,000 6,482,000
7.290% mortgage note, principal and interest payable monthly, due
February 2009................................................. 6,219,000 6,272,000
7.280% mortgage note, principal and interest payable monthly, due
February 2003................................................. 4,124,000 4,186,000
8.000% mortgage note, principal and interest payable monthly, due
April 2003.................................................... 1,977,000 2,022,000
8.500% mortgage note, principal and interest payable monthly, due
July 2007..................................................... 1,824,000 1,850,000
8.000% mortgage note, principal and interest payable monthly, due
April 2003.................................................... 1,561,000 1,589,000
------------------ -------------------
$30,563,000 $30,971,000
================== ===================
At June 30, 2001, approximate principal maturities of mortgage notes
payable are as follows:
2001 (July - December).............. $ 423,000
2002................................ 898,000
2003................................ 7,874,000
2004................................ 699,000
2005................................ 755,000
Thereafter.......................... 19,914,000
-----------------
$ 30,563,000
=================
13
PS BUSINESS PARKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001
7. Minority interest
Common units
The Company presents the accounts of PSB and the Operating Partnership on a
consolidated basis. Ownership interests in the Operating Partnership, other
than PSB's interest, are classified as minority interest in the condensed
consolidated financial statements. Minority interest in income consists of
the minority interests' share of the condensed consolidated operating
results.
Beginning one year from the date of admission as a limited partner and
subject to certain limitations described below, each limited partner other
than PSB has the right to require the redemption of its partnership
interest.
A limited partner that exercises its redemption right will receive cash
from the Operating Partnership in an amount equal to the market value (as
defined in the Operating Partnership Agreement) of the partnership
interests redeemed. In lieu of the Operating Partnership redeeming the
partner for cash, PSB, as general partner, has the right to elect to
acquire the partnership interest directly from a limited partner exercising
its redemption right, in exchange for cash in the amount specified above or
by issuance of one share of PSB common stock for each unit of limited
partnership interest redeemed.
A limited partner cannot exercise its redemption right if delivery of
shares of PSB common stock would be prohibited under the Company's articles
of incorporation or if the general partner believes that there is a risk
that delivery of shares of common stock would cause the general partner to
no longer qualify as a REIT, would cause a violation of the applicable
securities laws, or would result in the Operating Partnership no longer
being treated as a partnership for federal income tax purposes.
On January 12, 2001, the Company redeemed 30,484 common units from
unaffiliated third parties for an aggregate cost of $808,000.
At June 30, 2001, there were 7,305,355 OP units owned by PSI and affiliated
entities. On a fully converted basis, assuming all 7,305,355 minority
interest OP units were converted into shares of common stock of PSB at June
30, 2001, the minority interest units would convert into approximately 25%
of the common shares outstanding. At the end of each reporting period, PSB
determines the amount of equity (book value of net assets) which is
allocable to the minority interest based upon the ownership interest and an
adjustment is made to the minority interest, with a corresponding
adjustment to paid-in capital, to reflect the minority interest's equity in
the Company.
Preferred units
On April 23, 1999, the Operating Partnership completed a private placement
of 510,000 preferred units with a preferred distribution rate of 8 7/8%.
The net proceeds from the placement of preferred units were approximately
$12.5 million and were used to repay borrowings from an affiliate.
On September 3, 1999, the Operating Partnership completed a private
placement of 3,200,000 preferred units with a preferred distribution rate
of 8 3/4%. The net proceeds from the placement of preferred units were
approximately $78 million and part of the proceeds was used to prepay a
mortgage note payable of approximately $8.5 million.
14
PS BUSINESS PARKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001
On September 7 and 23, 1999, the Operating Partnership completed private
placements of 1,200,000 and 400,000 preferred units, respectively, with a
preferred distribution rate of 8 7/8%. The net proceeds from the placement
of preferred units were approximately $39.2 million.
On July 12, 2000, the Operating Partnership completed a private placement
of 480,000 preferred units with a preferred distribution rate of 8 7/8%.
The net proceeds from the placement of preferred units were approximately
$11.7 million.
The Operating Partnership has the right to redeem preferred units on or
after the fifth anniversary of the applicable issuance date at the original
capital contribution plus the cumulative priority return, as defined, to
the redemption date to the extent not previously distributed. The preferred
units are exchangeable for Cumulative Redeemable Preferred Stock of the
respective series of PS Business Parks, Inc. on or after the tenth
anniversary of the date of issuance at the option of the Operating
Partnership or a majority of the holders of the respective preferred units.
The Preferred Stock will have the same distribution rate and par value as
the respective units and will have equivalent terms to those described in
Note 9.
8. Property management contracts
The Operating Partnership manages industrial, office and retail facilities
for PSI and affiliated entities. These facilities, all located in the
United States, operate under the "Public Storage" or "PS Business Parks"
name. In addition, the Operating Partnership manages an office building for
a third party owner.
The property management contracts provide for compensation of a percentage
of the gross revenues of the facilities managed. Under the supervision of
the property owners, the Operating Partnership coordinates rental policies,
rent collections, marketing activities, the purchase of equipment and
supplies, maintenance activities, and the selection and engagement of
vendors, suppliers and independent contractors. In addition, the Operating
Partnership assists and advises the property owners in establishing
policies for the hire, discharge and supervision of employees for the
operation of these facilities, including property managers and leasing,
billing and maintenance personnel.
The property management contract with PSI is for a seven year term with the
term being extended one year on each anniversary. The property management
contracts with affiliates of PSI are cancelable by either party upon sixty
days notice.
9. Shareholders' Equity
Preferred stock
As of June 30, 2001 and December 31, 2000, the Company had the following
series of preferred stock outstanding:
June 30, 2001 December 31, 2000
-----------------------------------------------------------------------------
Shares Carrying Shares Carrying
Series Dividend Rate Outstanding Amount Outstanding Amount
--------------- ------------------ ------------------- ------------------ ------------------ -------------------
Series A 9.250% 2,200 $ 55,000,000 2,200 $ 55,000,000
Series D 9.500% 2,640 66,000,000 - -
------------------- ------------------ ------------------ -------------------
4,840 $ 121,000,000 2,200 $ 55,000,000
=================== ================== ================== ===================
15
PS BUSINESS PARKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001
On April 30, 1999, the Company issued 2,200,000 depositary shares, each
representing 1/1,000 of a share of 9 1/4% Cumulative Preferred Stock,
Series A. Net proceeds from the public perpetual preferred stock offering
were approximately $53.1 million and were used to repay borrowings from an
affiliate and a mortgage note payable of approximately $11 million. The
remaining proceeds were used for investment in real estate.
On May 10, 2001, the Company issued 1,840,000 depositary shares, each
representing 1/1,000 of a share of 9 1/2% Cumulative Preferred Stock,
Series D in a public offering. On June 18, 2001, the Company issued 800,000
depositary shares, each representing 1/1,000 of a share of 9 1/2%
Cumulative Preferred Stock, Series D in a directed placement. Net proceeds
from the offerings were approximately $64.5 million and were used for
investment in real estate and general corporate purposes.
Holders of the Company's preferred stock will not be entitled to vote on
most matters, except under certain conditions. In the event of a cumulative
arrearage equal to six quarterly dividends, the holders of the preferred
stock will have the right to elect two additional members to serve on the
Company's Board of Directors until all events of default have been cured.
At June 30, 2001, there were no dividends in arrears.
Except under certain conditions relating to the Company's qualification as
a REIT, the preferred stock is not redeemable prior to the following dates:
Series A - April 30, 2004 and Series D - May 10, 2006. On or after the
respective dates, the respective series of preferred stock will be
redeemable, at the option of the Company, in whole or in part, at $25 per
depositary share, plus any accrued and unpaid dividends.
The Company paid $3,175,000 and $2,544,000 in distributions to its
preferred shareholders for the six months ended June 30, 2001 and 2000,
respectively.
Common stock
On March 2, 2000, the Board of Directors authorized the repurchase from
time to time of up to 1,000,000 shares of the Company's common stock on the
open market or in privately negotiated transactions. On July 27, 2000, the
Board of Directors authorized the repurchase of up to an additional 600,000
shares of the Company's common stock on the open market or in privately
negotiated transactions. On May 8, 2001, the Board of Directors increased
the number of common shares authorized for repurchase from 1,600,000 to
2,500,000. Purchases will be made subject to market conditions and other
investment opportunities available to the Company. As of December 31, 2000,
the Company had repurchased 722,600 shares of common stock at an aggregate
cost of approximately $16.6 million. The Company repurchased an additional
647,900 shares of common stock at an aggregate cost of approximately $17.4
million for the six months ended June 30, 2001.
On March 31, 2000, a holder of common OP units exercised its option and
converted its 107,517 common OP units into an equal number of shares of PSB
common stock. The conversion resulted in an increase in shareholders'
equity and a corresponding decrease in minority interest of approximately
$2,531,000, representing the book value of the OP units at the time of
conversion.
The Company paid $13,214,000 ($0.58 per common share) and $11,702,000
($0.50 per common share) in distributions to its common shareholders for
the six months ended June 30, 2001 and 2000, respectively. Pursuant to
restrictions on the Credit Facility, distributions may not exceed 95% of
funds from operations, as defined.
16
PS BUSINESS PARKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001
Equity stock
In addition to common and preferred stock, the Company is authorized to
issue 100,000,000 shares of Equity Stock. The Articles of Incorporation
provide that the Equity Stock may be issued from time to time in one or
more series and gives the Board of Directors broad authority to fix the
dividend and distribution rights, conversion and voting rights, redemption
provisions and liquidation rights of each series of Equity Stock.
10. Recent accounting pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which is
required to be adopted by the Company on January 1, 2001. This statement
provides a comprehensive and consistent standard for the recognition and
measurement of derivatives and hedging activities. The Company adopted SFAS
No. 133 on January 1, 2001. This adoption had no material impact on the
Company's consolidated financial statements.
11. Commitments and contingencies
Substantially all of the Company's properties have been subjected to Phase
I environmental reviews. Such reviews have not revealed, nor is management
aware of, any probable or reasonably possible environmental costs that
management believes would have a material adverse effect on the Company's
business, assets or results of operations, nor is the Company aware of any
potentially material environmental liability, except as discussed below.
The Company acquired a property in Beaverton, Oregon ("Creekside Corporate
Park") in May 1998. A portion of Creekside Corporate Park, as well as
properties adjacent to Creekside Corporate Park, are currently the subject
of an environmental remedial investigation/feasibility study ("RI/FS") that
is being conducted by two current and past owner/operators of an industrial
facility on adjacent property, pursuant to an order issued by the Oregon
Department of Environmental Quality ("ODEQ"). As part of that study, ODEQ
ordered the owner/operators of the industrial facility to sample soil and
groundwater on the Company's property to determine the nature and extent of
contamination resulting from past operations at the industrial facility.
The Company, which is not a party to the Order on Consent, executed
separate Access Agreements with the two owner/operators to allow access to
portions of Creekside Corporate Park to conduct the required sampling and
testing. The sampling and testing is ongoing; results to date indicate that
the contamination from the industrial facility has migrated onto portions
of Creekside Corporate Park owned by the Company.
There is no evidence that the Company's past or current use of the
Creekside Corporate Park property contributed in any way to the
contamination that is the subject of the current investigation.
Nevertheless, upon completion of the RI/FS, it is likely that removal or
remedial measures will be required to address contamination detected during
the current investigation, including any contamination on or under the
Creekside Corporate Park property. Because of the preliminary nature of the
investigation, the Company cannot predict the outcome of the investigation,
nor can it estimate the costs of any remediation or removal activities that
may be required.
One of the two owner/operators that are conducting the RI/FS pursuant to
the Order on Consent recently filed for Chapter 11 bankruptcy protection.
It is not clear at this point what impact, if any, this filing will have on
the completion of the RI/FS, or on any removal or remedial activities
ordered by the ODEQ. It is possible that the ODEQ could require the Company
to participate in completing the RI/FS and implementing removal or remedial
actions that may be required on the Company's property, or to pay a portion
of the costs to do so. In the event the Company is ultimately deemed
responsible for any costs relating to this matter, the Company believes
that the party from whom the property was purchased will be responsible for
any expenses or liabilities that the Company may incur as a result of this
contamination. In addition, the Company believes it may have recourse
17
PS BUSINESS PARKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001
against other potentially responsible parties, including, but not limited
to, one or both of the owner/operators of the adjacent industrial facility.
On November 3, 1999, the Company field an action entitled PS BUSINESS
PARKS, INC. V. LARRY HOWARD, ET AL. (Case No. BC219580) in the Los Angeles
Superior court seeking damages in excess of $1 million, as well as
equitable relief. The complaint alleges that Mr. Howard and entitles
controlled by him engaged in unfair trade practices, including (1)
negotiating kickbacks, secret rebates and/or unearned discounts from third
party suppliers for "providing" Company business to those suppliers and (2)
disrupting the Company's relationship with various suppliers. Mr. Howard is
not an officer, employee or authorized agent of the Company. On November
13, 2000, the Court entered a summary judgement against the Company. The
Company appealed the Court's decision, and on June 4, 2001, the Court of
Appeal filed its opinion reversing the grant of summary judgement against
the Company, and permitted the Company to amend its complaint to add, among
other things, Mary Jane Howard as a defendant. The litigation is
proceeding.
On or about February 14, 2000, Mr. Howard and entitles controlled by him
field a cross-complaint against the Company, Public Storage, Inc., and
several other cross-defendants alleging, among other things, (1)
interference with Mr. Howard's contractual relations with various third
party suppliers, (2) violation of Title VII of the Civil Rights Act and (3)
abuse of process. None of the cross-complaints assigned any dollar amount
in the cross-complaint to the claims. All of the claims in this
cross-complaint against the Company has been dismissed with the exception
of one claim for interference. The Company intends to vigorously contest
this remaining claim in the cross-complaint.
On November 27, 2000, Mary Jayne Howard, a former officer of the Company,
filed a demand for arbitration with the American Arbitration alleging
claims against the Company for breach of contract, gender discrimination,
marital discrimination, and wrongful termination based on public policy.
The demand seeks damages of approximately $2 million. On June 8, 2001, Mrs.
Howard filed an amended claim. The Company plans to vigorously contest
these claims.
On November 27, 2000, the Company filed an action in the Los Angeles
Superior Court seeking damages in excess of $1 million, as well as
equitable relief, against Mr. Howard, entitles controlled by him, and Mrs.
Howard alleging claims for breach of fiduciary duty, fraud, constructive
fraud, aiding and abetting, intentional interference with prospective
economic advantage and unfair competition, among other things. This action
was filed for protective purposes, and in view of the ruling by the Court
of Appeal in the Larry Howard case described above, the Company expects to
voluntarily dismiss this action without prejudice in the near future.
On February 2, 2000, the Company filed an action against Mary Piper, its
former Vice President of operations, in Riverside County Superior Court,
alleging claims for breach of fiduciary duties, fraud and deceit,
constructive fraud, negligent misrepresentation, violation of Section 17000
of the Business and Professions Code, violation of Section 17200 of the
Business and Professions Code and culpable negligence. The Company's claims
arose from Ms. Piper's alleged participation in a plan that resulted in the
payment of improper kickbacks to Larry Howard, a former vendor of the
Company and the husband of Mary Jayne Howard, a former officer of the
Company.
On March 6, 2000, Ms. Piper filed a cross-complaint against the Company,
alleging that the Company had breached her written stock option agreement
by refusing to allow her to exercise certain options. Thereafter, on July
19, 2001, Ms. Piper obtained leave to file an amended cross-complaint
against the Company, alleging a number of additional claims arising from
the termination of her employment on February 2, 2000. Specifically, Ms.
Piper's cross-complaint alleged claims for breach of an oral employment
agreement, wrongful termination based on gender discrimination, breach of
the implied covenant of good faith and fair dealing, intentional infliction
of emotional distress, breach of a written contract for stock options and
age discrimination. Ms. Piper's amended cross-complaint seeks $103,773.62
in alleged lost profits with respect to the stock options, additional
compensatory damages according to proof, attorneys' fees, prejudgment
interest and punitive damages. No trial date has been set. The Company
denies Ms. Piper's allegations and intends to vigorously contest these
claims.
The Company currently is neither subject to any other material litigation
nor, to management's knowledge, is any material litigation currently
threatened against the Company other than routine litigation and
administrative proceedings arising in the ordinary course of business.
Management believes that these items will not have a material adverse
impact on the Company's condensed consolidated financial position or
results of operations.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Forward-Looking Statements: Forward-looking statements are made
throughout this Quarterly Report on Form 10-Q. For this purpose, any statements
contained herein that are not statements of historical fact may be deemed to be
forward-looking statements. Without limiting the foregoing, the words
"believes," "anticipates," "plans," "expects," "seeks," "estimates," and similar
expressions are intended to identify forward-looking statements. There are a
number of important factors that could cause the results of the Company to
differ materially from those indicated by such forward-looking statements,
including those detailed under the heading "Item 2A. Risk Factors." In light of
the significant uncertainties inherent in the forward-looking statements
included herein, the inclusion of such information should not be regarded as a
representation by us or any other person that our objectives and plans will be
achieved. Moreover, we assume no obligation to update these forward-looking
statements to reflect actual results, changes in assumptions or changes in other
factors affecting such forward-looking statements.
Overview: During 2000 and the six months ended June 30, 2001, the
Company focused on increasing cash flow from its existing core portfolio of
properties, expanding its presence in existing markets through strategic
acquisitions and developments and strengthening its balance sheet primarily
through the issuance of preferred stock/units. The Company has maintained low
debt and overall leverage levels including preferred stock/units to facilitate
future growth.
During the six months ended June 30, 2001, the Company expanded its
presence in Northern Viriginia. The Company acquired 12 buildings known as the
Prosperity Business Campus in Fairfax County, Virginia at a cost of $88.4
million. The acquisition was funded with the Company's existing cash, including
proceeds from the issuance of depositary shares. The 12 buildings consist of
four office buildings (355,000 square feet) and eight flex-space buildings
(302,000 square feet). The Company plans to continue to build its presence in
existing markets by acquiring high quality facilities in selected markets. The
Company targets properties with below market rents which offer the Company the
ability to raise rents to market as leases expire in addition to achieving
economies of scale resulting in more efficient operations.
During 2000, the Company added approximately 0.8 million square feet to
its portfolio at an aggregate cost of approximately $82 million. These
acquisitions increased the Company's presence in its existing markets, which the
Company believes have the characteristics necessary for long-term growth. The
Company acquired 454,000 square feet in Southern California for $40 million,
178,000 square feet in Northern California for $23 million, 210,000 square feet
in Northern Virginia for approximately $19 million. In addition, the Company
completed development on a property totaling 22,000 square feet in Oregon for
approximately $3 million. The Company also sold five properties aggregating
627,000 square feet for approximately $23.8 million in non-core markets.
Results of Operations: Net income for the three months ended June 30,
2001 was $12,830,000 compared to $11,512,000 for the same period in 2000. Net
income allocable to common shareholders (net income less preferred stock
dividends) for the three months ended June 30, 2001 was $10,927,000 compared to
$10,240,000 for the same period in 2000. Net income per common share on a
diluted basis was $0.48 for the three months ended June 30, 2001 compared to
$0.44 for the same period in 2000 (based on weighted average diluted common
shares outstanding of 22,679,000 and 23,428,000, respectively). Net income for
the six months ended June 30, 2001 was $24,295,000 compared to $22,255,000 for
the same period in 2000. Net income allocable to common shareholders (net income
less preferred stock dividends) for the six months ended June 30, 2001 was
$21,120,000 compared to $19,711,000 for the same period in 2000. Net income per
common share on a diluted basis was $0.92 for the six months ended June 30, 2001
compared to $0.84 for the same period in 2000 (based on weighted average diluted
common shares outstanding of 22,885,000 and 23,537,000, respectively).
19
The Company's property operations account for almost all of the net
operating income earned by the Company. The following table presents the
pre-depreciation operating results of the properties:
Three Months Ended
June 30,
--------------------------------
2001 2000 Change
---------------- --------------- ------------
Rental income:
"Same Park" facilities (11.5 million net rentable square feet)
$35,922,000 $33,940,000 5.8%
Other facilities............................................ 4,359,000 2,474,000 76.2%
---------------- ---------------
Total rental income......................................... $40,281,000 $36,414,000 10.6%
================ ===============
Cost of operations (excluding depreciation):
"Same Park" facilities...................................... $9,441,000 $9,406,000 0.4%
Other facilities............................................ 1,034,000 712,000 45.2%
---------------- ---------------
Total cost of operations.................................... $10,475,000 $10,118,000 3.5%
================ ===============
Net operating income (rental income less cost of operations):
"Same Park" facilities...................................... $26,481,000 $24,534,000 7.9%
Other facilities............................................ 3,325,000 1,762,000 88.7%
---------------- ---------------
Total net operating income.................................. $29,806,000 $26,296,000 13.3%
================ ===============
Six Months Ended
June 30,
--------------------------------
2001 2000 Change
---------------- --------------- ------------
Rental income:
"Same Park" facilities (11.5 million net rentable square feet)
$70,819,000 $66,276,000 6.9%
Other facilities............................................ 7,855,000 4,191,000 87.4%
---------------- ---------------
Total rental income......................................... $78,674,000 $70,467,000 11.6%
================ ===============
Cost of operations (excluding depreciation):
"Same Park" facilities...................................... $18,895,000 $18,250,000 3.5%
Other facilities............................................ 1,951,000 1,420,000 37.4%
---------------- ---------------
Total cost of operations.................................... $20,846,000 $19,670,000 6.0%
================ ===============
Net operating income (rental income less cost of operations):
"Same Park" facilities...................................... $51,924,000 $48,026,000 8.1%
Other facilities............................................ 5,904,000 2,771,000 113.1%
---------------- ---------------
Total net operating income.................................. $57,828,000 $50,797,000 13.8%
================ ===============
20
Rental income and rental income less cost of operations or net
operating income ("NOI") prior to depreciation are summarized for the three
months ended June 30, 2001 by major geographic region below:
Square Percent Rental Percent Percent
Region Footage of Total Income of Total NOI of Total
- -------------------------- ---------------- -------------- --------------- ------------ -------------- ---------------
Southern California 3,548,000 26.8% $11,099,000 27.5% $8,321,000 27.9%
Northern California 1,495,000 11.3% 4,883,000 12.1% 3,765,000 12.6%
Southern Texas 1,032,000 7.8% 3,020,000 7.5% 1,975,000 6.6%
Northern Texas 1,849,000 13.9% 4,587,000 11.4% 3,134,000 10.5%
Virginia 2,480,000 18.7% 7,802,000 19.4% 5,933,000 19.9%
Maryland 866,000 6.5% 2,410,000 6.0% 1,882,000 6.3%
Oregon 1,191,000 9.0% 4,656,000 11.6% 3,757,000 12.6%
Other 797,000 6.0% 1,824,000 4.5% 1,039,000 3.6%
---------------- -------------- --------------- ------------ -------------- ---------------
13,258,000 100.0% $40,281,000 100.0% $29,806,000 100.0%
================ ============== =============== ============ ============== ===============
Rental income and rental income less cost of operations or net
operating income ("NOI") prior to depreciation are summarized for the six months
ended June 30, 2001 by major geographic region below:
Square Percent Rental Percent Percent
Region Footage of Total Income of Total NOI of Total
- -------------------------- ---------------- -------------- --------------- ------------ -------------- ---------------
Southern California 3,548,000 26.8% $21,857,000 27.8% $16,300,000 28.2%
Northern California 1,495,000 11.3% 9,511,000 12.1% 7,301,000 12.6%
Southern Texas 1,032,000 7.8% 5,963,000 7.6% 3,677,000 6.4%
Northern Texas 1,849,000 13.9% 9,333,000 11.9% 6,500,000 11.2%
Virginia 2,480,000 18.7% 14,139,000 18.0% 10,549,000 18.2%
Maryland 866,000 6.5% 4,899,000 6.2% 3,733,000 6.5%
Oregon 1,191,000 9.0% 9,305,000 11.8% 7,522,000 13.0%
Other 797,000 6.0% 3,667,000 4.6% 2,246,000 3.9%
---------------- -------------- --------------- ------------ -------------- ---------------
13,258,000 100.0% $78,674,000 100.0% $57,828,000 100.0%
================ ============== =============== ============ ============== ===============
Supplemental Property Data and Trends: In order to evaluate the
performance of the Company's overall portfolio, management analyzes the
operating performance of a consistent group of properties (11.5 million net
rentable square feet). These properties in which the Company currently has an
ownership interest (herein referred to as the "Same Park" facilities) have been
owned and operated by the Company for the comparable periods. The square footage
has been reduced since the end of the first quarter of 2001 for planned
dispositions. The "Same Park" facilities represent approximately 86% of the
square footage of the Company's portfolio at June 30, 2001.
21
The following table summarizes the pre-depreciation historical
operating results of the "Same Park" facilities excluding the effects of
accounting for rental income on a straight-line basis.
"SAME PARK" FACILITIES (11.5 MILLION SQUARE FEET)
--------------------------------------------------
Three Months Ended
June 30,
-------------------------------------
2001 2000 Change
----------------- ------------------ -------------
Rental income (1).................................... $ 35,465,000 $ 33,386,000 6.2%
Cost of operations................................... 9,441,000 9,406,000 0.4%
----------------- ------------------
Net operating income................................. $ 26,024,000 $ 23,980,000 8.5%
================= ==================
Gross margin (2)..................................... 73.4% 71.8% 1.6%
WEIGHTED AVERAGE FOR PERIOD:
Occupancy........................................ 95.5% 96.5% (1.0%)
Annualized realized rent per occupied sq. ft.(3). $12.86 $11.98 7.3%
Six Months Ended
June 30,
-------------------------------------
2001 2000 Change
----------------- ------------------ -------------
Rental income (1).................................... $ 70,024,000 $ 65,125,000 7.5%
Cost of operations................................... 18,895,000 18,250,000 3.5%
----------------- ------------------
Net operating income................................. $ 51,129,000 $ 46,875,000 9.1%
================= ==================
Gross margin (2)..................................... 73.0% 72.0% 1.0%
Weighted average for period:
----------------------------
Occupancy........................................ 95.9% 96.5% (0.6%)
Annualized realized rent per occupied sq. ft.(3). $12.64 $11.69 8.1%
(1) Rental income does not include the effect of straight-line accounting.
(2) Gross margin is computed by dividing property net operating income by rental
income.
(3) Realized rent per square foot represents the actual revenues earned per
occupied square foot.
22
The following tables summarize the "Same Park" operating results by major
geographic region for the three months ended June 30, 2001 and 2000:
Revenues Revenues Increase NOI NOI Increase
Region 2001 2000 (Decrease) 2001 2000 (Decrease)
- -------------------------- --------------- -------------- ------------- -------------- -------------- -------------
Southern California..... $9,337,000 $8,915,000 4.7% $7,175,000 $6,817,000 5.3%
Northern California..... 4,153,000 3,648,000 13.8% 3,148,000 2,626,000 19.9%
Southern Texas.......... 3,021,000 2,626,000 15.0% 1,955,000 1,501,000 30.2%
Northern Texas.......... 4,477,000 4,385,000 2.1% 3,023,000 2,893,000 4.5%
Virginia................ 6,078,000 5,741,000 5.9% 4,449,000 4,134,000 7.6%
Maryland................ 2,410,000 2,472,000 (2.5%) 1,871,000 1,847,000 1.3%
Oregon.................. 4,103,000 3,798,000 8.0% 3,344,000 3,075,000 8.7%
Other................... 1,886,000 1,801,000 4.7% 1,059,000 1,087,000 (2.6%)
--------------- -------------- -------------- --------------
$35,465,000 $33,386,000 6.2% $26,024,000 $23,980,000 8.5%
=============== ============== ============== ==============
Northern California and Oregon continue to benefit from the expirations of
leases with below market rents. Southern Texas revenues increased in comparison
to 2000 primarily due to increased occupancy and rental rate increases at
certain Austin facilities. Other markets grew to a lesser extent resulting in
revenue and NOI increases in most of our markets.
The following tables summarize the "Same Park" operating results by major
geographic region for the six months ended June 30, 2001 and 2000:
Revenues Revenues NOI NOI
Region 2001 2000 Increase 2001 2000 Increase
- -------------------------- --------------- -------------- ------------- -------------- -------------- -------------
Southern California..... $18,385,000 $17,279,000 6.4% $14,016,000 $13,243,000 5.8%
Northern California..... 8,019,000 7,213,000 11.2% 6,046,000 5,235,000 15.5%
Southern Texas.......... 5,941,000 5,172,000 14.9% 3,629,000 2,986,000 21.5%
Northern Texas.......... 9,097,000 8,561,000 6.3% 6,284,000 5,652,000 11.2%
Virginia................ 11,758,000 11,003,000 6.9% 8,507,000 7,962,000 6.8%
Maryland................ 4,882,000 4,851,000 0.6% 3,701,000 3,587,000 3.2%
Oregon.................. 8,153,000 7,452,000 9.4% 6,644,000 6,028,000 10.2%
Other................... 3,789,000 3,594,000 5.4% 2,302,000 2,182,000 5.5%
--------------- -------------- -------------- --------------
$70,024,000 $65,125,000 7.5% $51,129,000 $46,875,000 9.1%
=============== ============== ============== ==============
Northern California and Oregon continue to benefit from the expirations
of leases with below market rents. Southern Texas revenues increased in
comparison to 2000 primarily due to increased occupancy and rental rate
increases at certain Austin facilities. Other markets grew to a lesser extent
resulting in revenue and NOI increases in all of our markets.
23
Facility Management Operations: The Company's facility management
accounts for a small portion of the Company's net operating income. During the
three months ended June 30, 2001, $131,000 in net operating income was
recognized from facility management operations compared to $104,000 for the same
period in 2000. During the six months ended June 30, 2001, $256,000 in net
operating income was recognized from facility management operations compared to
$202,000 for the same period in 2000. Facility management fees have increased
due to the increase in rental rates of the properties managed by the Company and
an additional property brought under management during 2000.
Business Services: Business services include construction management
fees and fees from telecommunication service providers. During the three months
ended June 30, 2001, the Company generated a net operating loss of $53,000
compared to net operating income of $203,000 for the same period in 2000. During
the six months ended June 30, 2001, the Company generated a net operating loss
of $80,000 compared to net operating income of $203,000 for the same period in
2000.
Interest Income: Interest income reflects earnings on cash balances.
Interest income was $553,000 for the three months ended June 30, 2001 compared
to $741,000 for the same period in 2000. Interest income was $1,313,000 for the
six months ended June 30, 2001 compared to $2,011,000 for the same period in
2000. The decreases are attributable to lower average cash balances and interest
rates. Average cash balances for the three months ended June 30, 2001 were
approximately $51 million compared to $49 million for the same period in 2000.
Average cash balances for the six months ended June 30, 2001 were approximately
$55 million compared to $70 million for the same period in 2000.
Dividend Income: Dividend income reflects dividends received from
marketable securities. Dividend income was $4,000 for the three months ended
June 30, 2001 compared to $440,000 for the same period in 2000. Dividend income
was $8,000 for the six months ended June 30, 2001 compared to $858,000 for the
same period in 2000. No dividend income was received from Pacific Gulf
Properties, Inc. during the three and six months ended June 30, 2001.
Cost of Operations: Cost of operations for the three months ended June
30, 2001 was $10,475,000 compared to $10,118,000 for the same period in 2000.
Cost of operations for the six months ended June 30, 2001 was $20,846,000
compared to $19,670,000 for the same period in 2000. The increases are due
primarily to increased utilities, repairs and maintenance and payroll costs and
the growth in the total square footage of the Company's portfolio of properties.
Cost of operations for the three months ended June 30, 2001 consisted primarily
of property taxes ($3,487,000), property maintenance ($1,947,000), utilities
($1,605,000) and direct payroll ($1,557,000). Cost of operations for the six
months ended June 30, 2001 consisted primarily of property taxes ($6,860,000),
property maintenance ($4,016,000), utilities ($3,542,000) and direct payroll
($3,267,000). Cost of operations as a percentage of rental income decreased from
27.8% to 26.0% and from 27.9% to 26.5% for the three and six months ended June
30, 2001, respectively, as a result of economies of scale achieved through the
acquisition and development of properties in core markets and the disposition of
properties outside of the Company's core markets in addition to revenue
increases in excess of expense increases at the Company's "Same Park"
facilities.
Depreciation and Amortization Expense: Depreciation and amortization
expense for the three months ended June 30, 2001 was $9,733,000 compared to
$8,898,000 for the same period in 2000. Depreciation and amortization expense
for the six months ended June 30, 2001 was $19,379,000 compared to $17,274,000
for the same period in 2000. The increase is primarily due to the acquisition
and development of real estate facilities during 2000 and 2001.
24
General and Administrative Expense: General and administrative expense
was $992,000 for the three months ended June 30, 2001 compared to $981,000 for
the same period in 2000. General and administrative expense was $2,120,000 for
the six months ended June 30, 2001 compared to $1,864,000 for the same period in
2000. The increases are due primarily to the increased size and activities of
the Company. Included in general and administrative costs are acquisition costs
and abandoned transaction costs. Acquisition expenses were $114,000 and $117,000
for the three months ended June 30, 2001 and 2000, respectively. Abandoned
transaction costs were $5,000 and none for the three months ended June 30, 2001
and 2000, respectively. Acquisition expenses were $317,000 and $248,000 for the
six months ended June 30, 2001 and 2000, respectively. Abandoned transaction
costs were $7,000 and $7,000 for the six months ended June 30, 2001 and 2000,
respectively.
Interest Expense: Interest expense was $157,000 for the three months
ended June 30, 2001 compared to $370,000 for the same period in 2000. Interest
expense was $394,000 for the six months ended June 30, 2001 compared to $744,000
for the same period in 2000. The decreases are attributable to lower average
debt balances during the period and greater capitalized interest in 2001 as a
result of greater construction in progress. Interest expense of $486,000 and
$290,000 was capitalized as part of building costs associated with properties
under development during the three months ended June 30, 2001 and 2000,
respectively. Interest expense of $898,000 and $688,000 was capitalized as part
of building costs associated with properties under development during the six
months ended June 30, 2001 and 2000, respectively.
Gain on Investment in Pacific Gulf Properties Inc. ("PAG"): The Company
sold its investment in PAG during the six months ended June 30, 2001 and
recognized a gain of $15,000.
Minority Interest in Income: Minority interest in income reflects the
income allocable to equity interests in the Operating Partnership that are not
owned by the Company. Minority interest in income for the three months ended
June 30, 2001 was $6,729,000 ($3,186,000 allocated to preferred unitholders and
$3,543,000 allocated to common unitholders) compared to $6,120,000 ($2,921,000
allocated to preferred unitholders and $3,199,000 allocated to common
unitholders) for the same period in 2000. Minority interest in income for the
six months ended June 30, 2001 was $13,152,000 ($6,373,000 allocated to
preferred unitholders and $6,779,000 allocated to common unitholders) compared
to $12,031,000 ($5,841,000 allocated to preferred unitholders and $6,190,000
allocated to common unitholders) for the same period in 2000. The increases in
minority interest in income are due primarily to the issuance of preferred
operating partnership units during 2000 and higher earnings at the operating
partnership level, partially offset by a conversion of units to common stock
during 2000.
25
Liquidity and Capital Resources
- -------------------------------
Net cash provided by operating activities for the six months ended June
30, 2001 and 2000 was $59,761,000 and $55,071,000, respectively. Management
believes that its internally generated net cash provided by operating activities
will continue to be sufficient to enable it to meet its operating expenses,
capital improvements and debt service requirements and to maintain the current
level of distributions to shareholders.
The following table summarizes the Company's cash flow from operating
activities:
Six Months Ended
June 30,
----------------------------------
2001 2000
----------------- ----------------
Net income............................................................ $ 24,295,000 $ 22,255,000
Gain on investment in Pacific Gulf Properties, Inc.................... (15,000) -
Depreciation and amortization......................................... 19,379,000 17,274,000
Minority interest in income........................................... 13,152,000 12,031,000
Change in working capital............................................. (2,950,000) 3,511,000
----------------- ----------------
Net cash provided by operating activities............................. 59,761,000 55,071,000
Maintenance capital expenditures...................................... (1,223,000) (1,181,000)
Tenant improvements................................................... (1,638,000) (2,074,000)
Capitalized lease commissions......................................... (979,000) (1,492,000)
----------------- ----------------
Funds available for distributions to shareholders, minority interests,
acquisitions and other corporate purposes........................... 55,921,000 50,324,000
Cash distributions to shareholders and minority interests............. (27,000,000) (23,782,000)
----------------- ----------------
Excess funds available for principal payments on debt, investments in
real estate and other corporate purposes............................ $ 28,921,000 $ 26,542,000
================= ================
The Company's capital structure is characterized by a low level of
leverage. As of June 30, 2001, the Company had seven fixed rate mortgage notes
payable totaling $30,563,000, which represented 3.2% of its total capitalization
(based on book value, including minority interest and debt). The weighted
average interest rate for the mortgage notes is 7.56%.
The Company expects to fund its growth strategies with permanent
capital, including issuances of common and preferred stock, and retained
internally generated cash flows. In addition, the Company may sell properties
that no longer meet its investment criteria. The Company may finance
acquisitions on a temporary basis with borrowings from its unsecured line of
credit (the "Credit Facility"). The Company intends to repay amounts borrowed
under the Credit Facility from undistributed cash flow or, as market conditions
permit and as determined to be advantageous, from the public or private
placement of preferred and common stock/OP units of the Company or Operating
Partnership or the formation of joint ventures. The Company targets a leverage
ratio of 40% (defined as debt and preferred equity as a percentage of market
capitalization). In addition, the Company targets a Funds from Operations
("FFO") to combined fixed charges and preferred distributions ratio of 3.0 to
1.0. As of June 30, 2001 and for the six months then ended, the leverage ratio
was 26% and the FFO to fixed charges and preferred distributions coverage ratio
was 5.2 to 1.0.
26
On May 10, 2001, the Company issued 1,840,000 depositary shares, each
representing 1/1,000 of a share of 9 1/2% Cumulative Preferred Stock, Series D
in a public offering. On June 18, 2001, the Company issued 800,000 depositary
shares, each representing 1/1,000 of a share of 9 1/2% Cumulative Preferred
Stock, Series D in a directed placement. Net proceeds from the offerings were
approximately $64.5 million and were used for investment in real estate and
general corporate purposes.
In September 2000, the Company extended its Credit Facility with Wells
Fargo Bank. The Credit Facility has a borrowing limit of $100 million and an
expiration date of August 6, 2003. The expiration date may be extended by one
year on each anniversary of the Credit Facility. Interest on outstanding
borrowings is payable monthly. At the option of the Company, the rate of
interest charged is equal to (i) the prime rate or (ii) a rate ranging from the
London Interbank Offered Rate ("LIBOR") plus 0.75% to LIBOR plus 1.35% depending
on the Company's credit ratings and coverage ratios, as defined (currently LIBOR
plus 1.00%). In addition, the Company is required to pay an annual commitment
fee of 0.25% of the borrowing limit. As of June 30, 2001, the Company had no
balance outstanding on the Credit Facility.
Funds from Operations: FFO is defined as net income, computed in
accordance with accounting principles generally accepted in the United States,
before depreciation, amortization, minority interest in income, straight-line
rent adjustments and extraordinary or non-recurring items. FFO is presented
because the Company considers FFO to be a useful measure of the operating
performance of a REIT which, together with net income and cash flows, provides
investors with a basis to evaluate the operating and cash flow performances of a
REIT. FFO does not represent net income or cash flows from operations as defined
by accounting principles generally accepted in the United States. FFO does not
take into consideration scheduled principal payments on debt or capital
improvements. Accordingly, FFO is not necessarily a substitute for cash flow or
net income as a measure of liquidity or operating performance or ability to make
acquisitions and capital improvements or ability to pay distributions or debt
principal payments. Also, FFO as computed and disclosed by the Company may not
be comparable to FFO computed and disclosed by other REITs.
FFO for the Company is computed as follows:
Six Months Ended
June 30,
----------------------------------
2001 2000
----------------- ----------------
Net income allocable to common shareholders........................ $ 21,120,000 $ 19,711,000
Less: Gain on investment in Pacific Gulf Properties Inc......... (15,000) -
Less: Gain on disposition of real estate........................ - (97,000)
Depreciation and amortization.................................... 19,379,000 17,274,000
Minority interest in income - common units....................... 6,779,000 6,190,000
Less: Straight-line rent adjustment............................. (883,000) (1,224,000)
----------------- ----------------
Consolidated FFO allocable to common shareholders and minority
interests.......................................................... 46,380,000 41,854,000
FFO allocated to common minority interest - common units........... (11,270,000) (10,003,000)
----------------- ----------------
FFO allocated to common shareholders............................... $ 35,110,000 $ 31,851,000
================= ================
Capital Expenditures: During the six months ended June 30, 2001, the
Company incurred $3.8 million in maintenance capital expenditures, tenant
improvements and capitalized lease commissions. On a recurring annual basis, the
Company expects $0.90 to $1.20 per square foot in recurring capital expenditures
($12 - $16 million based on square footage at June 30, 2001). In addition, the
Company expects to make $1.0 million in renovations on a property in Southern
California during the second half of 2001.
27
Stock Repurchase: On May 8, 2001, the Board of Directors increased the
number of common shares authorized to be repurchased from 1,600,000 to
2,500,000. The shares may be repurchased periodically on the open market or in
privately negotiated transactions. The Company repurchased 647,900 shares of
common stock at an aggregate cost of approximately $17.4 million during the six
months ended June 30, 2001.
Distributions: The Company has elected and intends to qualify as a REIT
for federal income tax purposes. In order to maintain its status as a REIT, the
Company must meet, among other tests, sources of income, share ownership and
certain asset tests. As a REIT, the Company is not taxed on that portion of its
taxable income that is distributed to its shareholders provided that at least
90% of its taxable income is distributed to its shareholders prior to filing of
its tax return.
28
ITEM 2A. RISK FACTORS
In addition to the other information in this Form 10-Q, the following
factors should be considered in evaluating our company and our business.
PSI has significant influence over us.
- --------------------------------------
PSI owns a substantial number of our shares: At June 30, 2001, PSI owned
24% of the outstanding shares of our common stock (43% upon conversion of its
interest in our operating partnership). Consequently, PSI has the ability to
significantly influence all matters submitted to a vote of our shareholders,
including electing directors, changing our articles of incorporation, dissolving
and approving other extraordinary transactions. In addition, PSI's ownership may
make it more difficult for another party to take over our company without PSI's
approval.
PSI has a voting agreement with another large shareholder: PSI and an
institutional shareholder owning 27% of our common stock as of June 30, 2001
have both agreed to vote their shares to support specified nominees to our board
of directors until the voting agreement expires, which is not before December
2001. This voting agreement may further increase PSI's influence over our
company.
Provisions in our organizational documents may prevent changes in control.
- --------------------------------------------------------------------------
Our articles generally prohibit owning more than 7% of our shares: Our
articles of incorporation restrict the number of shares that may be owned by any
person (other than PSI and certain other specified shareholders), and the
partnership agreement of our operating partnership contains an anti-takeover
provision. No shareholder (other than PSI and certain other specified
shareholders) may own more than 7% of the outstanding shares of our common
stock, unless our board of directors waives this limitation. We imposed this
limitation to avoid, to the extent possible, a concentration of ownership that
might jeopardize our ability to qualify as a real estate investment trust, or
REIT. This limitation, however, also makes a change of control much more
difficult even if it may be favorable to our public shareholders. These
provisions will prevent future takeover attempts not approved by PSI even if a
majority of our public shareholders consider it to be in their best interests
because they would receive a premium for their shares over the shares' then
market value or for other reasons.
Our board can set the terms of certain securities without shareholder
approval: Our board of directors is authorized, without shareholder approval, to
issue up to 50,000,000 shares of preferred stock and up to 100,000,000 shares of
equity stock, in each case in one or more series. Our board has the right to set
the terms of each of these series of stock. Consequently, the board could set
the terms of a series of stock that could make it difficult (if not impossible)
for another party to take over our company even if it might be favorable to our
public shareholders. Our articles of incorporation also contain other provisions
that could have the same effect. We can also cause our operating partnership to
issue additional interests for cash or in exchange for property.
The partnership agreeement of our operating partnership restricts
mergers: The partnership agreement of our operating partnership provides that
generally we may not merge or engage in a similar transaction unless limited
partners of our operating partnership are entitled to receive the same
proportionate payments as our shareholders. In addition, we have agreed not to
merge with another entity unless the merger would have been approved had the
limited partners been able to vote together with our shareholders. These
provisions may make it more difficult for us to merge with another entity.
Our operating partnership poses additional risks to us.
- -------------------------------------------------------
Limited partners of our operating partnership, including PSI, have the
right to vote on certain changes to the partnership agreement. They may vote in
a way that is contrary to the interests of our shareholders. Also, as general
partner of our operating partnership, we are required to protect the interests
of the limited partners of our operating partnership. The interests of the
limited partners and of our shareholders may differ.
29
We cannot sell certain properties without PSI's approval.
- ---------------------------------------------------------
Before 2007, we may not sell 13 specified properties without PSI's
approval. Since PSI would be taxed on a sale of these properties, the interests
of PSI and our shareholders may differ as to the best time to sell.
Certain institutional investors have special rights.
- ----------------------------------------------------
Certain institutional investors have rights, such as the right to
approve nominees to our board of directors, the right to purchase our securities
in certain circumstances and the right to require registration of their shares,
not available to our public shareholders.
We would incur adverse tax consequences if we fail to qualify as a REIT.
- ------------------------------------------------------------------------
Our cash flow would be reduced if we fail to qualify as a REIT: While
we believe that we have qualified since 1990 to be taxed as a REIT, and will
continue to be qualified, we cannot be certain. To continue to qualify as a
REIT, we need to satisfy certain requirements under the federal income tax laws
relating to our income, assets, distributions to shareholders and shareholder
base. In this regard, the share ownership limits in our articles of
incorporation do not necessarily ensure that our shareholder base is
sufficiently diverse for us to qualify as a REIT. For any year we fail to
qualify as a REIT, we would be taxed at regular corporate tax rates on our
taxable income unless certain relief provisions apply. Taxes would reduce our
cash available for distributions to shareholders or for reinvestment, which
could adversely affect us and our shareholders. Also we would not be allowed to
elect REIT status for five years after we fail to qualify unless certain relief
provisions apply.
Our cash flow would be reduced if our predecessor failed to qualify as
a REIT: For us to qualify to be taxed as a REIT, our predecessor, American
Office Park Properties, also needed to qualify to be taxed as a REIT. We believe
American Office Park Properties qualified as a REIT beginning in 1997 until its
March 1998 merger with us. If it is determined that it did not qualify as a
REIT, we could also lose our REIT qualification. Before 1997, our predecessor
was a taxable corporation and, to qualify as a REIT, was required to distribute
all of its profits before the end of 1996. While we believe American Office Park
Properties qualified as a REIT since 1997, we did not obtain an opinion of an
outside expert at the time of its merger with us.
We may need to borrow funds to meet our REIT distribution requirements:
To qualify as a REIT, we must generally distribute to our shareholders 90% of
our taxable income. Our income consists primarily of our share of our operating
partnership's income. We intend to make sufficient distributions to qualify as a
REIT and otherwise avoid corporate tax. However, differences in timing between
income and expenses and the need to make nondeductible expenditures such as
capital improvements and principal payments on debt could force us to borrow
funds to make necessary shareholder distributions.
Since we buy and operate real estate, we are subject to general real estate
- --------------------------------------------------------------------------------
investment and operating risks.
- -------------------------------
Summary of real estate risks: We own and operate commercial properties
and are subject to the risks of owning real estate generally and commercial
properties in particular. These risks include:
o the national, state and local economic climate and real estate
conditions, such as oversupply of or reduced demand for space and
changes in market rental rates;
o how prospective tenants perceive the attractiveness, convenience and
safety of our properties;
o our ability to provide adequate management, maintenance and insurance;
o our ability to collect rent from tenants on a timely basis;
o the expense of periodically renovating,repairing and reletting spaces;
30
o increasing operating costs, including real estate taxes and utilities,
if these increased costs cannot be passed through to tenants; and
o changes in tax, real estate and zoning laws.
Certain significant costs, such as mortgage payments, real estate
taxes, insurance and maintenance costs, generally are not reduced even when a
property's rental income is reduced. In addition, environmental and tax laws,
interest rate levels, the availability of financing and other factors may affect
real estate values and property income. Furthermore, the supply of commercial
space fluctuates with market conditions.
If our properties do not generate sufficient income to meet operating
expenses, including any debt service, tenant improvements, leasing commissions
and other capital expenditures, we may have to borrow additional amounts to
cover fixed costs, and we may have to reduce our distributions to shareholders.
We may encounter significant delays in reletting vacant space,
resulting in losses of income: When leases expire, we will incur expenses and we
may not be able to release the space on the same terms. Certain leases provide
tenants with the right to terminate early if they pay a fee. While we have
estimated our cost of renewing leases that expire in 2001, our estimates could
be wrong. If we are unable to release space promptly, if the terms are
significantly less favorable than anticipated or if the costs are higher, we may
have to reduce our distributions to shareholders.
Tenant defaults and bankruptcies may reduce our cash flow and
distributions: We may have difficulty in collecting from tenants in default,
particularly if they declare bankruptcies. This could reduce our cash flow and
distributions to shareholders.
We may be adversely affected by significant competition among
commercial properties: Many other commercial properties compete with our
properties for tenants and we expect that new properties will be built in our
markets. Also, we compete with other buyers, many of whom are larger than us, in
seeking to acquire commercial properties. Therefore, we may not be able to grow
as rapidly as we would like.
We may be adversely affected if losses on our properties are not
covered by insurance: We carry insurance on our properties that we believe is
comparable to the insurance carried by other operators for similar properties.
However, we could suffer uninsured losses that adversely affect us or even
result in loss of the property. We might still remain liable on any mortgage
debt related to that property.
The illiquidity of our real estate investments may prevent us from
adjusting our portfolio to respond to market changes: There may be delays and
difficulties in selling real estate. Therefore, we cannot easily change our
portfolio when economic conditions change. Also, tax laws limit a REIT's ability
to sell properties held for less than four years.
We many be adversely affected by changes in laws: Increases in income
and service taxes may reduce our cash flow and ability to make expected
distributions to our shareholders. Our properties are also subject to various
federal, state and local regulatory requirements, such as state and local fire
and safety codes. If we fail to comply with these requirements, governmental
authorities could fine us or courts could award damages against us. We believe
our properties comply with all significant legal requirements. However, these
requirements could change in a way that would reduce our cash flow and ability
to make distributions to shareholders.
We may incur significant environmental remediation costs: Under various
federal, state and local environmental laws an owner or operator of real estate
interests may have to clean spills or other releases of hazardous or toxic
substances on or from a property. Certain environmental laws impose liability
whether or not the owner knew of, or was responsible for, the presence of the
hazardous or toxic substances. In some cases, liability may exceed the value of
the property. The presence of toxic substances, or the failure to properly
remedy any resulting contamination, may make it more difficult for the owner or
31
operator to sell, lease or operate its property or to borrow money using its
property as collateral. Future environmental laws may impose additional material
liabilities on us.
We acquired a property in Beaverton, Oregon in May 1998 known as
Creekside Corporate Park. A portion of Creekside Corporate Park, as well as
properties adjacent to Creekside Corporate Park, are currently the subject of an
environmental remedial investigation/feasibility study, or RI/FS, that is being
conducted by two current and past owner/operators of an industrial facility on
adjacent property, pursuant to a consent order issued by the Oregon Department
of Environmental Quality, or ODEQ. As part of that study, ODEQ ordered the
owner/operators of the industrial facility to sample soil and groundwater on our
property to determine the nature and extent of contamination resulting from past
operations at the industrial facility. Because we are not a party to the consent
order, we executed separate agreements with the two owner/operators to allow
them access to portions of Creekside Corporate Park to conduct the required
sampling and testing. The sampling and testing is ongoing; results to date
indicate that the contamination from the industrial facility has migrated onto
portions of Creekside Corporate Park owned by us.
There is no evidence that our past or current use of the Creekside
Corporate Park property contributed in any way to the contamination that is the
subject of the current investigation. Nevertheless, upon completion of the
RI/FS, it is likely that removal or remedial measures will be required to
address contamination detected during the current investigation, including any
contamination on or under the Creekside Corporate Park property. Because of the
preliminary nature of the investigation, we cannot predict the outcome of the
investigation, nor can we estimate the costs of any remediation or removal
activities that may be required.
One of the two owner/operators that are conducting the RI/FS pursuant
to the consent order recently filed for Chapter 11 bankruptcy protection. It is
not clear at this point what impact, if any, this filing will have on the
completion of the RI/FS, or on any removal or remedial activities ordered by the
ODEQ. It is possible that the ODEQ could require us to participate in completing
the RI/FS and implementing removal or remedial actions that may be required on
our property, or to pay a portion of the costs to do so. In the event we are
ultimately deemed responsible for any costs relating to this matter, we believe
that the party from whom the property was purchased will be responsible for any
expenses or liabilities that we may incur as a result of this contamination. In
addition, we believe that we may have recourse against other potentially
responsible parties, including, but not limited to, one or both of the
owner/operators of the adjacent industrial facility. However, if we are deemed
responsible for any expenses related to removal or remedial actions on the
property, and we are not successful in obtaining reimbursement from one or more
third parties, our operations and financial condition could be harmed.
We may be affected by the Americans with Disabilities Act: The
Americans with Disabilities Act of 1990 requires that access and use by disabled
persons of all public accommodations and commercial properties be facilitated.
Existing commercial properties must be made accessible to disabled persons.
While we have not estimated the cost of complying with this act, we do not
believe the cost will be material.
Our ability to control our properties may be adversely affected by ownership
- --------------------------------------------------------------------------------
through partnerships and joint ventures.
- ----------------------------------------
We own most of our properties through our operating partnership. Our
organizational documents do not limit our ability to invest funds with others in
partnerships or joint ventures. This type of investment may present additional
risks. For example, our partners may have interests that differ from ours or
that conflict with ours, or our partners may become bankrupt.
We can change our business policies and increase our level of debt without
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shareholder approval.
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Our board of directors establishes our investment, financing,
distribution and our other business policies and may change these policies
without shareholder approval. Our organizational documents do not limit our
level of debt. A change in our policies or an increase in our level of debt
could adversely affect our operations or the price of our common stock.
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We can issue additional securities without shareholder approval.
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We can issue preferred and common stock without shareholder approval.
Holders of preferred stock have priority over holders of common stock, and the
issuance of additional shares of common stock reduces the interest of existing
holders in our company.
Increases in interest rates may adversely affect the market price of our common
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stock.
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One of the factors that influences the market price of our common stock
is the annual rate of distributions that we pay on our common stock, as compared
with interest rates. An increase in interest rates may lead purchasers of REIT
shares to demand higher annual distribution rates, which could adversely affect
the market price of our common stock.
Shares that become available for future sale may adversely affect the market
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price of our common stock.
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Substantial sales of our common stock, or the perception that
substantial sales may occur, could adversely affect the market price of our
common stock. Certain of our shareholders hold significant numbers of shares of
our common stock and, subject to compliance with applicable securities laws,
could sell their shares.
We depend on key personnel.
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We depend on our executive officers, including Ronald L. Havner, Jr.,
our chief executive officer and president. The loss of Mr. Havner could
adversely affect our operations. We maintain no key person insurance on him.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
To limit the Company's exposure to market risk, the Company principally
finances its operations and growth with permanent equity capital consisting of
either common or preferred stock. At June 30, 2001, the Company's debt as a
percentage of shareholders' equity (based on book values) was 4.9%.
The Company's market risk sensitive instruments include mortgage notes
payable which totaled $30,563,000 at June 30, 2001. All of the Company's
mortgage notes payable bear interest at fixed rates. See Note 6 of the Notes to
Consolidated Financial Statements for terms, valuations and approximate
principal maturities of the mortgage notes payable as of June 30, 2001. Based on
borrowing rates currently available to the Company, the carrying amount of debt
approximates fair value.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On February 2, 2000, the Company filed an action against Mary Piper,
its former Vice President of operations, in Riverside County Superior Court,
alleging claims for breach of fiduciary duties, fraud and deceit, constructive
fraud, negligent misrepresentation, violation of Section 17000 of the Business
and Professions Code, violation of Section 17200 of the Business and Professions
Code and culpable negligence. The Company's claims arose from Ms. Piper's
alleged participation in a plan that resulted in the payment of improper
kickbacks to Larry Howard, a former vendor of the Company and the husband of
Mary Jayne Howard, a former officer of the Company.
On March 6, 2000, Ms. Piper filed a cross-complaint against the
Company, alleging that the Company had breached her written stock option
agreement by refusing to allow her to exercise certain options. Thereafter, on
July 19, 2001, Ms. Piper obtained leave to file an amended cross-complaint
against the Company, alleging a number of additional claims arising from the
termination of her employment on February 2, 2000. Specifically, Ms. Piper's
cross-complaint alleged claims for breach of an oral employment agreement,
wrongful termination based on gender discrimination, breach of the implied
covenant of good faith and fair dealing, intentional infliction of emotional
distress, breach of a written contract for stock options and age discrimination.
Ms. Piper's amended cross-complaint seeks $103,773.62 in alleged lost profits
with respect to the stock options, additional compensatory damages according to
proof, attorneys' fees, prejudgment interest and punitive damages. No trial date
has been set. The Company denies Ms. Piper's allegations and intends to
vigorously contest these claims.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held an annual meeting of shareholders on May 8, 2001.
Proxies for the annual meeting were solicited pursuant to Regulation 14 under
the Securities Exchange Act of 1934. The annual meeting involved the following
matter:
Election of Directors
Number of Shares of Common Stock
------------------------------------
Voted For Withheld
---------------------------------- ------------------ -----------------
Ronald L. Havner, Jr. 12,945,497 1,879,679
Harvey Lenkin 14,678,424 146,752
Vern O. Curtis 14,799,324 25,852
Arthur M. Friedman 14,798,824 26,352
James H. Kropp 14,678,924 146,252
Alan K. Pribble 14,799,324 25,852
Jack D. Steele 14,797,824 27,352
There was no solicitation in opposition to the management's nominees to
the Board of Directors listed in the proxy statement.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
12 Statement re: Computation of Ratio of Earnings to Fixed Charges.
Filed herewith.
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(b) Reports on Form 8-K
The Registrant filed a Current Report on Form 8-K dated May 3, 2001
(filed May 4, 2001) pursuant to Item 9, relating to Regulation FD
Disclosure.
The Registrant filed a Current Report on Form 8-K dated May 7, 2001
(filed May 9, 2001) pursuant to Item 5, which filed certain exhibits
relating to the Registrant's public offering of Depositary Shares, each
representing 1/1,000 of a share of the Company's 9 1/2% Cumulative
Preferred Stock, Series D.
The Registrant filed a Current Report on Form 8-K dated June 1, 2001
(filed June 4, 2001) pursuant to Item 9, relating to Regulation FD
Disclosure.
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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.
Dated: August 10, 2001
PS BUSINESS PARKS, INC.
BY: /S/ JACK CORRIGAN
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Jack Corrigan
Vice President and Chief Financial Officer
37