ITEM 1. BUSINESS
We are a self-administered and self-managed real estate investment trust, or REIT. Our portfolio consists principally of community and neighborhood shopping centers predominantly located in five key Western U.S. markets.
At December 31, 2005, 2004 and 2003, our total assets were $2,098,764,000, $1,995,444,000 and $1,863,348,000, respectively. At December 31, 2005, we owned a portfolio comprised of 138 shopping center properties, of which 133 are located in the Western United States in our five key markets including 43 in Northern California, 38 in Southern California, 21 in Oregon, 16 in Washington and 15 in Nevada. The portfolio includes approximately 22.5 million square feet of retail space, which was 97.1% leased to a diverse mix of 3,468 tenants.
On January 17, 2003, we acquired Center Trust, Inc., a Maryland corporation. The transaction was a stock for stock exchange including assumption of debt whereby each share of Center Trust common stock was exchanged for 0.218 newly issued shares of our common stock. As a result, we issued 6,084,499 shares of our common stock to Center Trust stockholders and were obligated to issue up to 284,263 shares of our common stock to limited partners of CT Operating Partnership, L.P. upon the exchange of operating partnership units held by them. In 2003, 33,964 units were redeemed for cash of $1,246,000. No units were redeemed during 2005 and 2004.
We employed 129 people as of December 31, 2005, including 13 executive officers and senior personnel, in the areas of administration, accounting services, property management, maintenance, leasing, acquisitions and business development. Our executive offices are located at 1631-B South Melrose Drive, Vista, California 92081, and our telephone number is (760) 727-1002. In addition to personnel located at our executive offices, we operate regional offices in Las Vegas, Nevada; Kent, Washington; Portland, Oregon; and Sacramento, California. Each of our regional offices is responsible for property management, maintenance and leasing.
We have elected to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended. We believe that we have been organized and have operated in such a manner so as to qualify for taxation as a REIT under the Internal Revenue Code, and we intend to continue to operate in such a manner, but we cannot assure you that we will continue to operate in such a manner so as to qualify or remain qualified. Even if we qualify for taxation as a REIT, we may be subject to certain federal, state and local taxes on our revenue and properties.
You can access free of charge a copy of the periodic and current reports we file with the Securities and Exchange Commission at www.sec.gov. Additionally, our periodic and current reports, such as our Forms 10-K, 10-Q and 8-K as well as all amendments to those filings, are made available on our website at www.pprp.com as soon as reasonably practicable after these reports are filed with the Securities and Exchange Commission. You can also access on our website our Code for Senior Officers, Policy for Reporting Complaints and Violations, Corporate Governance Guidelines, Audit Committee Charter, Nominating/Corporate Governance Committee Charter and Compensation Committee Charter.
Business Strategies
Our business strategies involve three fundamental practices:
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Owning, operating, acquiring, expanding and developing shopping centers in select markets with strong economic and demographic characteristics in order to establish and maintain a portfolio of real estate assets with stable income and the potential for long-term growth;
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Developing local and regional market expertise through the hands-on participation of senior management in property operations and leasing in order to capitalize on market trends, retailing trends and acquisition opportunities; and
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Establishing and maintaining a diversified and complementary tenant mix with an emphasis on tenants that provide day-to-day consumer necessities in order to provide steady rental revenue.
Growth Strategies
Our principal growth strategy is to acquire shopping centers that provide an opportunity to expand in current markets or which allow us to establish a presence in targeted markets with favorable economic and demographic characteristics.
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We seek to acquire properties that can benefit from our hands-on management, that may require repositioning, redevelopment or renovation, or which can be purchased at attractive capitalization rates and are consistent in terms of quality and location with our existing portfolio.
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We seek to continue to utilize our in-depth market knowledge within our five key markets to pursue our strategy of opportunistic acquisitions of shopping centers for long-term investment. We believe that significant opportunities continue to exist within these markets to acquire shopping center properties that are consistent with our existing portfolio in terms of quality of construction, positive neighborhood demographics and location attributes and that provide attractive initial investment yields with potential for growth in cash flow.
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We further believe we have certain competitive advantages which enhance our ability to identify and capitalize on acquisition opportunities, including: (i) long-standing relationships with institutional and other owners of shopping center properties in our five key markets; (ii) fully integrated real estate operations which enable us to respond quickly to acquisition opportunities and to capitalize on the resulting economies of scale; and (iii) access to capital as a public company.
We also seek to maximize the cash flow from our properties by continuing to enhance the operating performance of each property through our in-house leasing and property management programs.
We pursue:
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the leasing of currently available space;
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the renewal or releasing of expiring leases at higher rental rates which we believe currently are available based on current market conditions and our recent leasing activity; and
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economies of scale in the management and leasing of properties that may be realized by focusing our acquisition activities within our five key markets.
Financing Strategies
Our financing strategies are to maintain a strong and flexible financial position by maintaining a prudent level of leverage, maintaining a pool of unencumbered assets and managing our variable interest rate exposure. We intend to finance future acquisitions with the most advantageous source of capital available to us at the time of an acquisition, which may include the sale of common stock, preferred stock or debt securities through public offerings or private placements, the incurrence of additional indebtedness through secured or unsecured borrowings and the issuance of operating units of a subsidiary in exchange for contributed property.
We are a 50% general partner of a joint venture that owns North Coast Health Center, a medical office building in Encinitas, California. At December 31, 2005 and 2004, the balance of the joint venture’s note payable to purchase the building on the property, which bears interest at 7%, was $17,846,000 and $17,560,000, respectively. The note payable is secured by the property and is not guaranteed by us. This is the only off-balance-sheet transaction to which we are a party. In the fourth quarter of 2005, we assumed a note receivable as part of an agreement to extend financing to the joint venture to construct another building at the project. At December 31, 2005, the balance on this note receivable, which bears interest at 7%, was $478,000. We account for our investment in this joint venture under the equity method.
In 2003, we received a return of capital of $5,790,000 from our investment in Plaza Escuela Holding Co., LLC. In February 2004, we received a return of capital of $600,000. We received a return of capital for our remaining equity investment of $1,205,000 during the second quarter of 2004. We were entitled to receive 25% of the
operating cash flows from the property through November 2008. In the fourth quarter of 2004, we agreed to receive $1,354,000 in exchange for our right to receive these future operating cash flows. This amount was recorded as other revenue in the accompanying 2004 consolidated statement of income. Proceeds from the returns of capital and cash flow participation were used primarily to repay borrowings under our revolving credit facility.
On November 5, 2002, we entered into an Agreement and Plan of Merger with Center Trust, Inc., a Maryland corporation. The transaction, which closed January 17, 2003, included interests in 27 shopping centers, two regional malls and two single tenant assets. The transaction was a stock for stock exchange, including assumption of $362,257,000 of debt, whereby each share of Center Trust common stock was exchanged for 0.218 newly issued shares of our common stock. As a result, we issued 6,084,499 shares of our common stock to Center Trust stockholders and 284,263 units were issued to limited partners of CT Operating Partnership, L.P. upon the exchange of operating partnership units held by them. Distributions are made to the limited partners at a rate equal to the dividend distribution paid by us on a share of our common stock.
In June 2003, we issued $75,000,000 in aggregate principal amount of 4.70% senior notes due June 2013. We sold these notes at 99.755% of the principal amount and used the net proceeds from the offering to repay borrowings under our line of credit.
During 2003, nine non-strategic assets were sold, including two regional malls that were acquired as part of the Center Trust acquisition, which generated net cash proceeds of approximately $190,000,000 which were used primarily to repay borrowings under our revolving credit facility.
In September 2004, we entered into an amended and restated unsecured $300,000,000 revolving credit facility which bears interest, at our option, at either LIBOR plus 0.65% or a reference rate and expires in March 2007. At December 31, 2005 and 2004, the amount drawn on this line of credit was $44,500,000 and $113,000,000, respectively, and the interest rate was 5.10% and 3.18%, respectively. The credit facility requires a quarterly fee of 0.20% per annum on the total aggregate commitment. We, at our sole option, may increase the amount of the commitment up to $400,000,000 and extend the maturity date to March 2008, assuming satisfaction of certain conditions. We believe we are in compliance with all covenants contained in the revolving credit facility agreement at December 31, 2005.
In February 2004, we repaid $50,000,000 in aggregate principal amount of 7.88% senior notes on the original maturity date of the notes. We borrowed on our line of credit to fund the repayment.
In May 2004, we issued $50,000,000 in aggregate principal amount of 5.95% senior notes due June 2014. We sold these notes at 99.182% of the principal amount. In July 2004, we issued an additional $50,000,000 in aggregate principal amount of the 5.95% senior notes due June 2014. We sold these notes at 101.586% of the principal amount. The net proceeds from the offerings were used to repay borrowings under our line of credit.
In August 2005, we issued $100,000,000 in aggregate principal amount of 5.25% senior notes due September 2015. We sold these notes at 99.429% of the principal amount and used the net proceeds from the offering to repay a portion of the borrowings under our line of credit.
Dispositions
We dispose of non-strategic assets if we can obtain attractive terms on the sale and redeploy the proceeds into acquisitions in our core markets with growth opportunities or use the proceeds to paydown our line of credit.
During 2003, we disposed of two regional malls acquired in the Center Trust merger, six shopping centers and an office building parcel. We took back a portion of the proceeds on these sales in the form of three notes receivable secured by deeds of trust, two of which were paid off by December 31, 2003. The balance of the net proceeds on the sales was received in cash. On four of the sales, the cash proceeds were placed with an exchange accommodator and used to acquire other strategic shopping center properties in like-kind exchange transactions pursuant to Section 1031 of the Internal Revenue Code.
During 2004, we disposed of three shopping centers and a parcel of land. We took back a portion of the proceeds on these sales in the form of one short-term note receivable secured by a deed of trust which was paid off by December 31, 2004. The balance of the net proceeds on the sales was received in cash. On two of the sales, the cash proceeds were placed with an exchange accommodator and used to acquire another strategic shopping center property in a like-kind exchange transaction pursuant to Section 1031 of the Internal Revenue Code.
During 2005, we disposed of one shopping center. The net proceeds on the sale, received in cash, were placed with an exchange accommodator and was used to acquire another strategic shopping center property in a like-kind exchange transaction pursuant to Section 1031 of the Internal Revenue Code.
We may dispose of certain non-strategic assets over the next year. However, if after taking into account the tax consequences of any disposition, including our continued ability to qualify as a REIT, we determine that a disposition would not be in our best interest, we will not dispose of such asset.
Competition
There are numerous other developers and real estate companies (both public and private), financial institutions and other investors engaged in the development, acquisition and operation of shopping centers and commercial property which compete with us in our trade areas. This results in competition for both acquisitions of existing income-producing properties and for tenants to occupy the space that we and our competitors develop, acquire and manage.
We believe that the principal competitive factors in attracting tenants in our market areas are location, price, anchor tenants and maintenance of properties. We also believe that our competitive advantages include the favorable locations of our properties, our ability to provide a retailer with multiple locations with anchor tenants and the practice of continuous maintenance and renovation of our properties as is appropriate.
No single competitor or group of competitors in any of our chosen markets is believed to be dominant in that market. However, their competition may:
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reduce the number of properties available for acquisition or development;
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increase the cost of properties available for acquisition or development;
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reduce rents payable to us;
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interfere with our ability to attract and retain tenants; and
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lead to increased vacancy rates at our properties.
Retailers at our properties also face increasing competition from outlet stores, discount shopping clubs, and other forms of marketing of goods, such as direct mail, internet marketing and telemarketing. This competition could contribute to lease defaults and insolvency of our tenants.
ITEM 1A.
ITEM 1A. RISK FACTORS
You should carefully consider the risks described below as well as the risks described elsewhere in this report, which risks are incorporated by reference into this section, before making an investment decision regarding our company. The risks and uncertainties described herein are not the only ones facing us and there may be additional risks that we do not presently know of or that we currently consider not likely to have a significant impact. All of these risks could adversely affect our business, financial condition, results of operations and cash flows.
There are Certain Risks Inherent to Investment in Real Estate. Real property investments are subject to varying degrees of risk. The yields available from equity investments in real estate depend in large part on the amount of income generated and expenses incurred. If our properties do not generate revenue sufficient to meet operating expenses, including debt service, tenant improvements, leasing commissions and other capital expenditures, we may have to borrow additional amounts to cover fixed costs. This would adversely affect our cash flow and ability to service our debt and make distributions to our stockholders.
Our revenue and the value of our properties may be adversely affected by a number of factors, including:
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the national economic climate;
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the local economic climate;
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local real estate conditions;
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changes in retail expenditures by consumers;
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the perceptions of prospective tenants of the attractiveness of the properties;
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the success of our anchor tenants;
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our ability to manage and maintain the properties and secure adequate insurance;
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our ability to collect rent from our tenants;
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increases in operating costs (including real estate taxes, insurance and utilities);
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inability to finance property development and acquisitions on favorable terms; and
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natural disasters, future acts of terrorism or war or risk of war.
In addition, real estate values and income from properties are also affected by factors such as applicable laws, including tax laws, interest rate levels and the availability of financing.
We May be Unable to Retain Tenants and Relet Space. We will be subject to the risks that, upon expiration or termination, leases may not be renewed, the space may not be relet or the terms of renewal or reletting (including the cost of required renovations) may be less favorable than current lease terms. Leases covering a total of approximately 8.5% and 57.5% of the leased gross leasable area, or GLA, of our properties will expire through the end of 2006 and 2010, respectively. We budget for renovation and reletting expenses, which takes into consideration our view of both the current and expected market conditions in the geographic regions in which our properties are located, but budgeted amounts may be insufficient to cover these costs. Our cash flow and ability to make expected distributions to stockholders could be adversely affected, if:
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we are unable to promptly relet or renew leases for all or a substantial portion of this space;
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the rental rates upon renewal or reletting are significantly lower than expected; or
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our budgeted amounts for these purposes prove inadequate.
Changes in the Economic or Other Market Conditions in Certain Geographic Regions Could Adversely Affect Our Results of Operations. As of December 31, 2005, we have 43 properties with total GLA of 5,762,000 square feet located in Northern California, 38 properties with total GLA of 7,486,000 square feet located in Southern California, 21 properties with total GLA of 3,414,000 square feet located in Oregon, 16 properties with total GLA of 2,673,000 square feet located in Washington and 15 properties with total GLA of 2,472,000 square feet located in Nevada. To the extent that general economic or other relevant conditions in these regions decline and result in a decrease in consumer demand in these regions, the results of our operations may be adversely affected.
We May Not be Able to Respond Quickly to Changing Market Conditions Due to the Illiquidity of Real Estate. Equity real estate investments are relatively illiquid. This illiquidity limits our ability to adjust our portfolio promptly in response to changes in economic or other conditions. In addition, the Internal Revenue Code limits a REIT’s ability to sell properties held for fewer than four years, which may limit our ability to sell our properties at optimal times and for the highest price.
Competition with Other Developers and Real Estate Companies Could Materially Affect Our Ability to Generate Net Income, Service Our Debt and Make Distributions to Our Stockholders. There are numerous commercial developers and real estate companies that compete with us in seeking tenants for properties, properties for acquisition and land for development. There are numerous shopping facilities that compete with our properties in attracting retailers to lease space. In addition, retailers at our properties face increasing competition from outlet stores, discount shopping clubs, and other forms of marketing of goods, such as direct mail, internet marketing and telemarketing. This competition may reduce properties available for acquisition or development, reduce percentage rents payable to us and may, through the introduction of competition, contribute to lease defaults or insolvency of tenants. Thus, competition could materially affect our ability to generate net income, service our debt and make distributions to our stockholders.
Compliance with Changes in Laws May Result in Significant Unexpected Expenditures. Because increases in income, service or transfer taxes are generally not passed through to tenants under leases, these increases may adversely affect our cash flow and our ability to service our debt and make distributions to stockholders. Our properties are also subject to various federal, state and local regulatory requirements, such as requirements of the Americans with Disabilities Act of 1990 and state and local fire and life safety requirements. Failure to comply with these requirements could result in the imposition of fines by governmental authorities or awards of damages to private litigants. In addition, these requirements may not be changed and new requirements may be imposed that would require significant unanticipated expenditures by us. Any of these events could adversely affect our cash flow and expected distributions.
We Rely on Certain Tenants and Anchors and the Closing of One or More Anchor-Occupied Store Could Adversely Affect that Property, Resulting in Lease Terminations and Reductions in Rent. Our income and funds from operations could be adversely affected in the event of the bankruptcy or insolvency, or a downturn in the business, of any anchor store, or if any anchor tenant does not renew its lease when it expires. If tenant sales at our properties were to decline, tenants might be unable to pay their rent or other occupancy costs. In the event of default by a tenant, delays and costs in enforcing our rights could be experienced. In addition, the closing of one or more anchor-occupied stores or lease termination by one or more anchor tenants of a shopping center, whose leases may permit termination or as a result of bankruptcy or insolvency, could adversely impact that property and result in lease terminations or reductions in rent by other tenants, whose leases may permit termination or rent reduction in those circumstances. This could adversely affect our ability to re-lease the space that is vacated. Each of these developments could adversely affect our funds from operations and our ability to service our debt and make expected distributions to stockholders. For the year ended December 31, 2005 our annualized base rent attributable to anchor tenants was 38.5% of our total annualized base rent.
There is a Lack of Operating History With Respect to Our Recent Acquisition and Development of Properties and We May Not Succeed in the Integration or Management of Additional Properties. At December 31, 2005, we owned and operated 138 properties, consisting of approximately 22.5 million square feet of space. Fifty-three of our properties were acquired during 2000, primarily through the acquisition of Western. These properties, together with other individual acquisitions and the 31 properties which we acquired in 2003 in connection with our acquisition of Center Trust, some of which have been sold, may have characteristics or deficiencies currently unknown to us that affect their value or revenue potential. It is also possible that the operating performance of these properties may decline under our management. As we acquire additional properties, we will be subject to risks associated with managing new properties, including lease-up and tenant retention. In addition, our ability to manage our growth effectively will require us to successfully integrate our new acquisitions into our existing management structure. We may not succeed with this integration or effectively manage additional properties. Also, newly acquired properties may not perform as expected.
Our Indebtedness Could Adversely Affect Our Financial Results. We are subject to risks normally associated with debt financing, including:
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the risk that our cash flow will be insufficient to meet required payments of principal and interest;
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the risk that existing indebtedness on our properties (which in all cases will not have been fully amortized at maturity) will not be able to be refinanced; or
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the terms of any refinancing will not be as favorable as the terms of existing indebtedness.
At December 31, 2005, we had outstanding indebtedness of approximately $1,088,540,000. Since we anticipate that only a small portion of the principal of the indebtedness will be repaid prior to maturity, and that we will not have funds on hand sufficient to repay the balance of the indebtedness in full at maturity, it will be necessary for us to refinance the debt either through additional borrowings or equity or debt offerings. If principal payments due at maturity cannot be refinanced, extended or paid with proceeds of other capital transactions, we expect that our cash flow will not be sufficient in all years to pay distributions at expected levels and to repay all of this maturing debt. Also, if prevailing interest rates or other factors at the time of refinancing (such as the reluctance of lenders to make commercial real estate loans) result in higher interest rates upon refinancing, the interest expense relating to refinanced indebtedness would increase. This could adversely affect our cash flow and our ability to make expected distributions to our stockholders. In addition, if we are unable to refinance the indebtedness on acceptable terms, we might dispose of properties upon disadvantageous terms, which might result in losses to us and might adversely affect funds available for distribution to stockholders.
Potential Defaults Under Mortgage Financing Could Negatively Impact Our Financial Results. At December 31, 2005, we had approximately $390,132,000 of mortgage financing and property level bonds. The payment and other obligations under certain of the mortgage financing is secured by cross-collateralized and cross-defaulted first mortgage liens in the aggregate amount of approximately $50,773,000 on four properties, $49,457,000 on four other properties, $48,791,000 on four other properties, $40,461,000 on three properties, $15,172,000 on three other properties and $30,924,000 on two properties (the obligations on these two properties were subsequently paid off in January 2006). If we are unable to meet our obligations under the mortgage financing, the properties securing that debt could be foreclosed upon. This could have a material adverse effect on us and our ability to make expected distributions and could threaten our continued viability.
Rising Interest Rates on Our Variable-Rate Debt Could Negatively Impact our Financial Results. Advances under our revolving credit agreement bear variable-rate interest, at our option, at either LIBOR plus 0.65% or a reference rate. At December 31, 2005, the amount drawn under our revolving credit agreement was $44,500,000 and the interest rate was 5.10%. In addition, we may incur other variable-rate indebtedness in the future. Increases in interest rates on that indebtedness would increase our interest expense, which could adversely affect our cash flow and our ability to service our debt and pay expected distributions to stockholders.
Loss of Our Tax Status as a Real Estate Investment Trust Would Have Significant Adverse Consequence to Us and the Value of Our Securities. Commencing with our taxable year ended December 31, 1997, we believe that we have qualified as a REIT under the Internal Revenue Code. We have not requested and do not plan to request a ruling from the IRS that we qualify as a REIT, and the statements in the Form 10-K are not binding on the IRS or any court. We can give no assurance that we have qualified or will continue to quality as a REIT for tax purposes. Qualification as a REIT involves the satisfaction of numerous requirements (some on an annual and some on a quarterly basis) established under highly technical and complex Internal Revenue Code provisions for which there are only limited judicial and administrative interpretations. These requirements involve the determination of various facts and circumstances not entirely within our control. Legislation, new regulations, administrative interpretations or court decisions may adversely affect, possibly retroactively, our ability to qualify as a REIT or the federal income tax consequences of such qualification.
If we fail to qualify as a REIT in any taxable year, among other things:
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we will not be allowed a deduction for distributions to stockholders in computing our taxable income;
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we will be subject to federal income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates;
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we will be subject to increased state and local taxes;
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we will be disqualified from treatment as a real estate investment trust for the four taxable years following the year during which we lost our qualification (unless entitled to relief under certain statutory provisions);
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distributions to stockholders would be subject to tax as ordinary corporate distributions; and
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we would not be required to make distributions to stockholders.
As a result of these factors, our failure to qualify as a real estate investment trust also could impair our ability to expand our business and raise capital, could substantially reduce the funds available for distribution to our stockholders and could reduce the trading price of our common stock.
We are Subject to Certain Distribution Requirements Which Could Require Us to Borrow on a Short-Term Basis. To maintain our status as a REIT for federal income tax purposes, we generally are required to distribute to our stockholders at least 90% of our REIT taxable income determined without regard to the dividends paid deduction and by excluding net capital gains each year. We also are subject to tax at regular corporate rates to the extent that we distribute less than 100% of our REIT taxable income (including net capital gains) each year. At least 95% of our gross income in any year must be derived from qualifying sources, and we must satisfy a number of requirements regarding the composition of our assets. In addition, we are subject to a 4% nondeductible excise tax on the amount, if any, by which certain distributions we pay, with respect to any calendar year, are less than the sum of 85% of our ordinary income for that calendar year, 95% of our capital gain net income for the calendar year, and any amount of that income that was not distributed in prior years.
We intend to continue to make distributions to our stockholders to comply with the distribution requirements of the Internal Revenue Code and to reduce exposure to federal income taxes and the nondeductible excise tax. Differences in timing between the receipt of income and the payment of expenses in arriving at taxable income and the effect of required debt amortization payments could require us to borrow funds to meet the distribution requirements that are necessary to achieve the tax benefits associated with qualifying as a REIT.
Acquisition and Development Investments May Not Perform as Expected. We intend to continue acquiring, developing and redeveloping shopping center properties. Acquisitions of retail properties entail risks that investments will fail to perform as expected. Estimates of development costs and costs of improvements, to bring an acquired property up to standards established for the market position intended for that property, may prove inaccurate.
We intend to expand or renovate our properties from time to time. Expansion and renovation projects generally require expenditure of capital as well as various government and other approvals, which we may not receive. While our policies with respect to expansion and renovation activities are intended to limit some of the risks otherwise associated with such activities, we will still incur certain risks, including expenditures of funds on, and devotion of management’s time to, projects that may not be completed. We intend to renovate properties only to the extent necessary to keep the properties in good working order. These renovations generally involve minor as-needed projects such as painting and landscaping.
We anticipate that future acquisitions, development and renovations will be financed through a combination of advances under our revolving credit agreement and other forms of secured or unsecured financing. If new developments are financed through construction loans, there is a risk that, upon completion of construction, permanent financing for newly developed properties may not be available or may be available only on disadvantageous terms.
It is possible that we will expand our business to new geographic markets in the future. We will not initially possess the same level of familiarity with new markets outside of the geographic areas in which our properties are currently located. This could adversely affect our ability to acquire, develop, manage or lease properties in any new localities.
We also intend to develop and construct shopping centers in accordance with our business and growth strategies. Risks associated with our development and construction activities may include:
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abandonment of development opportunities;
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construction costs of a property exceeding original estimates, possibly making the property uneconomical;
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occupancy rates and rents at a newly completed property may not be sufficient to make the property profitable;
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delay or refusal in obtaining all necessary zoning, land use, building occupancy and other government permits and authorizations;
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financing may not be available at all or on favorable terms for development of a property; and
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construction and lease-up may not be completed on schedule, resulting in increased debt service expense and construction costs.
In addition, new development activities, regardless of whether they would ultimately be successful, typically require a substantial portion of management’s time and attention. Development activities would also be subject to risks relating to our inability to obtain, or delays in obtaining, all necessary zoning, land use, building, occupancy, and other required governmental permits and authorizations.
Our Properties May Be Subject to Unknown Environmental Liabilities. We are required to comply with federal, state and local laws, ordinances and regulations regarding health and safety and the protection of the environment. Under various federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real estate may be required to investigate and clean up hazardous or toxic substances or petroleum product releases at the property. A current or previous owner or operator may also be held liable to a governmental entity or to third parties for property damage and for investigation and clean-up costs incurred by these parties in connection with any such contamination. These laws typically impose clean-up responsibility and liability without regard to fault or whether the owner knew of or caused the presence of the contaminants. Liability under these laws may still be imposed even when the contaminants were associated with previous owners or operators and the liability under these laws has been interpreted to be joint and several, unless the harm is divisible and there is a reasonable basis for allocation of responsibility. The costs of investigation, remediation or removal of these substances may be substantial, and the presence of these substances, or the failure to properly remediate the contamination on the property, may adversely affect the owner’s ability to sell or rent the property or to borrow using the property as collateral. The presence of contamination at a property can impair the value of the property even if the contamination is migrating onto the property from an adjoining property.
A current or previous owner or operator who arranges for the disposal or treatment of hazardous or toxic substances at a disposal or treatment facility may be held liable for the costs of removal or remediation of a release of hazardous or toxic substances at the disposal or treatment facility if a leak or contamination is discovered at the disposal or treatment facility, whether or not the facility is owned or operated by them. In addition, some environmental laws create a lien on the contaminated site in favor of the government for damages and costs incurred in connection with the contamination. The remedy to remediate contamination may include deed restriction or institutional control which can restrict how the property may be used. Finally, the owner of a site may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination stemming from the site, including toxic tort claims.
Some federal, state and local laws, regulations and ordinances govern the removal, encapsulation or disturbance of asbestos containing materials, or ACMs, when these materials are in poor condition or in the event of construction, remodeling, renovation or demolition of a building. These laws may impose liability for release of ACMs and may allow third parties to seek recovery from owners or operators of real properties for personal injury associated with ACMs. In connection with our ownership and operation of our properties, we may be potentially liable for ACM related costs.
The presence of hazardous substances on or under a property may adversely affect our ability to sell that property and we may incur substantial remediation costs. Although our leases generally require our tenants to operate in compliance with all applicable federal, state and local laws, ordinance and regulations and to indemnify us against any environmental liabilities arising from the tenant’s activities on the property, we could nevertheless be subject to strict liability by virtue of our ownership interest, and there can be no assurance that our tenants would satisfy their indemnification obligations under the leases. The discovery of environmental liabilities attached to our properties could have a material adverse effect on our results of operations or financial condition or our ability to make distributions to stockholders.
Shopping centers may have businesses such as dry cleaners and auto repair or servicing businesses that handle, store and generate small quantities of hazardous wastes. The operation may result in spills or releases that may result in soil or groundwater contamination. Independent environmental consultants have conducted or updated Phase I Environmental Site Assessments at our properties in conformance with the scope and limitations of the American Society of Testing and Materials Practice E1527, Standard Practice for Environmental Site Assessments: Phase I Environmental Site Assessment Process. These Phase I Assessments have included, among other things, a
visual inspection of our properties and the surrounding area and a review of relevant state, federal and historical documents. When recommended in the Phase I Assessments, we have conducted Phase II subsurface investigations in conformance with American Society of Testing and Materials Guide E1903, Standard Guide for Environmental Site Assessments: Phase II Environmental Site Assessment Process. The Phase I and Phase II investigations of our properties have not revealed any environmental liability that we believe would have a material adverse effect on our business, assets or results of operations taken as a whole, nor are we aware of any material environmental liability. It is still possible that our Phase I and Phase II investigations have not revealed all environmental liabilities or that there are material environmental liabilities of which we are unaware. Moreover, future laws, ordinances or regulations may impose material environmental liability and the current environmental condition of our properties may be affected by tenants, by the condition of land or operations in the vicinity of our properties, such as the presence of underground storage tanks, or by third parties unrelated to us. While we believe we are in substantial compliance with applicable federal, state and local laws, ordinances and regulations regarding health and safety and the protection of the environment, we cannot assure you that environmental matters will not rise in the future at properties where no problem is currently known to us.
There is No Limitation on Amount of Indebtedness We May Incur Which Could Increase the Risk of Default on Our Indebtedness. Our total market capitalization at December 31, 2005 was approximately $3,852,490,000, based on the market closing price of our common stock at December 31, 2005 of $66.89 per share (assuming the conversion of 619,755 operating subsidiary units to common stock) and our debt outstanding of approximately $1,088,540,000 (exclusive of accounts payable and accrued expenses). At December 31, 2005, our debt to total market capitalization ratio was approximately 28.3% (assuming the conversion of all operating subsidiary units). We currently have a board of directors approved policy of incurring debt only if upon incurrence the debt to total market capitalization ratio would be 50% or less. It should be noted, however, that our organizational documents do not contain any limitation on the amount of indebtedness we may incur. Accordingly, our board of directors could alter or eliminate this policy. If this policy were changed, we could become more highly leveraged, resulting in an increase in debt service that could adversely affect our cash flow and, consequently, reduce the amount available for distribution to stockholders. This could also increase the risk of default on our indebtedness.
Certain Types of Losses May Exceed Insurance Coverage. We carry comprehensive liability, public area liability, fire, earthquake, flood, boiler and machinery, extended coverage and rental loss insurance covering our properties, with policy specifications and insured limits that we believe are adequate and appropriate under the circumstances. There are, however, certain types of losses that are not generally insured because it is not economically feasible to insure against these losses. If an uninsured loss or a loss exceeding insured limits occurs, we could lose our capital invested in the property, as well as the anticipated future revenue from the property. In the case of debt which is with recourse to us, we would remain obligated for any mortgage debt or other financial obligations related to the property. In these circumstances, any loss would adversely affect us.
We May be Subject to Tax Upon Disposition of Properties with Built-In Gain. In connection with our formation in 1997, certain entities taxable as “C” corporations were merged either into us or into our subsidiaries which qualified as “qualified REIT subsidiaries”. Certain of these entities held 13 properties with “built-in gain” at the time the entities were merged into us or into our subsidiaries. During 2002, Oregon Real Estate Services, Inc., a “C” corporation, was merged into us. At the time Oregon Real Estate Services, Inc. was merged into us, it held 10 properties and land with “built-in gain”. A property has “built-in gain” if (i) on the day it was acquired, the former owner’s tax basis in the property was less than the property’s fair market value, and (ii) it was acquired in a transaction in which our tax basis in the property was determined by reference to the former owner’s tax basis in the property. Under the applicable Treasury Regulations, if these properties are sold within 10 years of the date we acquired them, we may be required to pay taxes on the built-in gain that would have been realized if the merging “C” corporation had liquidated on the day before the date of the merger. Therefore, we may have less flexibility in determining whether or not to dispose of these properties. If we desire to dispose of these properties at some future date within the 10 year periods, we may be subject to tax on the built-in gain.
Future Acts of Terrorism, War, Risk of War or Natural Disasters May Have a Negative Impact on Our Business. The continued threat of terrorism and continued military action and heightened security measures in response to this threat may cause significant disruption to commerce. There can be no assurance that the armed hostilities will not escalate or that these terrorist attacks, or the United States’ responses to them, will not lead to further acts of terrorism and civil disturbances, which may further contribute to economic instability. Any civil unrest, additional terrorist activities, or continued armed conflict and the attendant political instability and societal disruption, may adversely affect our results of operations, financial condition, the ability to raise capital or our future growth. In addition, natural disasters such as major floods, hurricanes and earthquakes could also adversely impact our business and operating results.
Ownership of Partnership Interest Could Jeopardize Our Status as a REIT. We have direct or indirect control of certain partnerships in which we are a partner and intend to continue to operate them in a manner consistent with the requirements for qualification as a real estate investment trust. If a partnership in which we own an interest takes or expects to take actions which could jeopardize our status as a REIT or require us to pay tax, we may be forced to dispose of our interest in that entity. In addition, it is possible that a partnership could take an action which could cause us to fail a REIT income or asset test, and that we would not become aware of such action in a time frame which would allow us to dispose of our interest in the partnership or take other corrective action on a timely basis. In such a case, we could fail to qualify as a REIT.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2. PROPERTIES
General
As of December 31, 2005, we owned and operated 138 neighborhood and community shopping centers containing 22.5 million square feet of which 19.8 million square feet is owned by us with the balance owned by certain retailers. These properties are primarily situated in five key Western U.S. markets including Northern California, Southern California, Oregon, Washington and Nevada, each of which we believe has attractive economic and demographic characteristics. The largest concentration of properties, consisting of 32% of our owned gross leasable area, is located in Southern California. Another 27% of our owned gross leasable area is located in Northern California, 16% in Oregon, 12% in Nevada and 11% in Washington. In addition, properties consisting of the remaining 2% of our owned gross leasable area are located in Arizona, New Mexico, Tennessee and Kentucky. As of December 31, 2005, 97.1% of our total owned gross leasable area was leased by tenants under 3,468 leases.
These properties are regionally managed under active central control by our executive officers. Property management, leasing, capital expenditures, construction and acquisition decisions are centrally administered at our corporate office. We also employ property managers at each of our regional offices to oversee and direct the day-to-day operations of these properties, as well as on-site personnel. Property managers communicate daily with our corporate offices to implement our policies and procedures.
As a result of our in-house leasing program, these properties benefit from a diversified merchandising mix. At December 31, 2005, 58% of the total owned and occupied gross leasable area was leased to national tenants, 19% leased to regional tenants and 23% to local tenants. To promote stability and attract non-anchor tenants, we generally enter into long-term leases (typically 15 to 20 years) with major or anchor tenants, those with 15,000 square feet or more, which usually contain provisions permitting tenants to renew their leases at rates which often include fixed rent increases or consumer price index adjustments from the prior base rent. At December 31, 2005, anchor tenants leased 57% of the total owned gross leasable area, with 77% of anchor-leased gross leasable area (45% of the total owned gross leasable area) scheduled to expire within the next 10 years. To take advantage of improving market conditions and changing retail trends, we generally enter into shorter term leases (typically three to five years) with non-anchor tenants. Our leases are generally on a triple-net basis, which require the tenants to pay their pro rata share of all real property taxes, insurance and property operating expenses.
The following tables provide information about our properties, our tenants and lease expirations.
Portfolio Geographic Diversification
(1) Represents gross leasable area (‘GLA’) owned by the Company. Excludes 2,657,435 square feet owned by certain retailers.
(2) Annualized base rent for all leases in place at December 31, 2005 is calculated as follows: total base rent to be received during the entire term of each lease, divided by the terms in months for such leases, multiplied by 12.
(3) Annualized base rent divided by the owned GLA leased at December 31, 2005.
Property Summary
12/31/2005
Property Summary
12/31/2005
Property Summary
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Property Summary
12/31/2005
Property Summary
12/31/2005
Property Summary
12/31/2005
Property Summary
12/31/2005
Property Summary
12/31/2005
Property Summary
12/31/2005
Property Summary
12/31/2005
Property Summary
12/31/2005
(1) Annualized base rent for all leases in place at December 31, 2005 is calculated as follows: total base rent to be received during the entire term of each lease, divided by the terms in months for such leases, multiplied by 12.
(2) These retailers own their own space and are not tenants of the company.
(3) Annualized base rent divided by the owned GLA leased at December 31, 2005.
(4) Percent leased and total number of tenants includes month to month leases.
(5) Tenant is dark.
(6) Tenant is Pak ‘N’ Save, a division of Safeway.
(7) Sak ‘n Save is a division of Scolari’s Supermarket.
(8) QFC is a division of Kroger.
Tenant Diversification Summary
(1) The company defines a national tenant as any tenant that operates in at least four metropolitan areas located in more than one region, (i.e. northwest, northeast, midwest, southwest or southeast); regional tenant as any tenant that operates in two or more metropolitan areas located within the same region; local tenant as any tenant that operates stores only within the same metropolitan area as the shopping center.
(2) The Company defines anchors as tenants which lease 15,000 square feet or more and non-anchors as tenants which lease less than 15,000 square feet.
(3) Annualized base rent for all leases in place is calculated as follows: total base rent, calculated in accordance with GAAP, to be received during the entire term of each lease, divided by the terms in months for such leases, multiplied by 12.
(4) Annualized base rent divided by GLA leased.
Pan Pacific Retail Properties
Major Tenants as of December 31, 2005
(1) Annualized base rent for all leases in place at 12/31/2005 calculated as follows: total base rent, calculated in accordance with GAAP, to be received during the entire term of each lease, divided by the terms in months for such leases, multiplied by 12.
(2) Annualized base rent divided by gross leasable area.
Lease Expiration Analysis *
As of 12/31/2005
Note: Number of Leases expiring does not include tenants on a month-to-month agreement, whose combined occupancy totals 256,428 sq. ft.
* Assumes no renewal options are exercised.
(1) The company defines anchors as single tenants which lease 15,000 square feet or more, non-anchors defined as tenants which lease less than 15,000 square feet.
(2) Annualized base rent for all leases in place at report date calculated as follows: total base rent, calculated in accordance with GAAP, to be received during the entire term of each lease, divided by the term in months for such leases, multiplied by 12.
(3) Annualized base rent divided by gross leaseable area as of report date.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are a party to legal proceedings that arise in the normal course of business, which matters are generally covered by insurance. The resolution of these matters cannot be predicted with certainty. However, in the opinion of management, based upon currently available information, any liability resulting from such proceedings, either individually or in the aggregate, will not have a material adverse effect on our consolidated financial statements taken as a whole.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 2005, no matters were submitted to a vote of our stockholders.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock began trading on the New York Stock Exchange on August 8, 1997, under the symbol “PNP”. On February 16, 2006, we had approximately 1,201 stockholders of record and approximately 20,750 beneficial owners. The following table sets forth, for the periods indicated, the high and low sales prices as reported by the New York Stock Exchange and the dividends declared by us.
The fourth quarter 2005 and 2004 dividends on an annualized basis amount to $2.36 and $2.17 per share, respectively. All dividends will be made by us at the discretion of our board of directors and will depend upon our earnings, our financial condition and any other factors our board of directors deems relevant. In order to qualify for the beneficial tax treatment accorded to REITs under the Internal Revenue Code, we are required to make distributions to holders of our shares in an amount at least equal to 90% of our “real estate investment trust taxable income,” as defined in Section 857 of the Internal Revenue Code.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth our selected financial data on a historical basis. The following data should be read in connection with management’s discussion and analysis of financial condition and results of operations and the consolidated financial statements and notes thereto located elsewhere in this report.
SELECTED CONSOLIDATED FINANCIAL DATA
(In thousands, except share data)
(1) Our consolidated statements of income and consolidated statements of cash flows have been revised from those originally reported to separately reflect the results of discontinued operations for properties that were sold during the years ended December 31, 2005, 2004, 2003 and 2002. The revision had no impact on our consolidated balance sheets or statements of stockholders’ equity. The revision had no impact on net income or net income per share of common stock for the years ended December 31, 2004, 2003, 2002 and 2001.
(2) Income from continuing operations includes minority interests and gain on sale of real estate (excluding the amount included in discontinued operations in 2005, 2004 and 2003).
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Revision of Consolidated Statements of Income and Consolidated Statements of Cash Flows
Our consolidated statements of income and consolidated statements of cash flows have been revised, pursuant to SFAS No. 144, from those originally reported for the years ended December 31, 2004 and 2003 to separately reflect the results of discontinued operations for properties that have since been sold or classified as held for sale. The revision had no impact on our consolidated balance sheets or our statements of stockholders’ equity. The revision had no impact on net income or net income per share of common stock for the years ended December 31, 2004 and 2003. See the discussions of discontinued operations in the “Results of Operations” section below.
Cautionary Language
The discussions in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 which reflect management’s current views with respect to future events and financial performance. Forward-looking statements are subject to risks and uncertainties. Factors that could cause actual results to differ materially from expectations include market valuations of our stock, financial performance and operations of our shopping centers, real estate market conditions, execution of shopping center development programs, successful completion of renovations, completion of pending acquisitions and dispositions, including the completion of customary due diligence and closing conditions, the Company’s ability to successfully integrate acquired assets, changes in the availability of additional acquisitions and disposition opportunities, changes in local or national economic conditions, changes in tax laws, acts of terrorism or war and other risks detailed from time to time in reports filed with the Securities and Exchange Commission.
Critical Accounting Policies
The following discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, and the notes thereto, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these consolidated financial statements requires us to make a number of estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements. On an ongoing basis, we evaluate our estimates and assumptions based upon historical experience and various other factors and circumstances. We believe that our estimates and assumptions are reasonable for our current circumstances; however, actual results may differ from these estimates and assumptions under different future conditions.
We believe that the estimates and assumptions that are most important to the portrayal of our financial condition and results of operations, in that they require our most subjective judgments, form the basis for the accounting policies deemed to be most critical. These critical accounting policies include our estimates of useful lives in calculating depreciation expense on our shopping center properties and the ultimate recoverability, or impairment, of each shopping center asset. If actual useful lives are different from our estimates this could result in changes to the results of our operations. Future adverse changes in market conditions or poor operating results of our shopping center properties could result in losses or an inability to recover the carrying value of the properties that may not be reflected in the properties’ current carrying value, thereby possibly requiring an impairment charge in the future.
Overview
We receive income primarily from rental revenue from shopping center properties, including recoveries from tenants, offset by operating and overhead expenses. Primarily as a result of our acquisition program, the financial data shows increases in total revenue and total expenses from period to period.
During the year ended December 31, 2005, six shopping center assets were acquired and one non-strategic asset was sold, the proceeds of which were used to pay down a portion of the borrowings under our revolving credit facility. During the year ended December 31, 2004, four non-strategic assets were sold. The cash proceeds were used toward the purchase of two shopping center assets and to pay down a portion of the borrowings under our revolving credit facility.
A significant portion of our historic growth has come through acquisitions. However, the acquisition environment has become more competitive over the last several years and it has become increasingly difficult to find
acquisitions that meet our financial return objectives. Given this difficult acquisition market and our current expectations, we anticipate a slower growth rate over the next year or two. We will continue to strategically manage our portfolio by selectively pursuing acquisitions in markets where attractive opportunities exist and upgrading our portfolio by disposing of underperforming properties.
Results of Operations
Comparison of the Year ended December 31, 2005 to the Year ended December 31,
Revenue
The increase in rental revenue, which includes base rent and percentage rent, resulted principally from the increase in rental rates we are achieving through our leasing initiatives and the acquisitions of six shopping center assets in 2005 and five shopping center assets in 2004.
The increase in recoveries from tenants, which represents reimbursements from tenants for property operating expenses and property taxes, resulted primarily from the acquisitions of shopping center assets in 2005 and 2004. In addition, recoveries from tenants increased because recoverable expenses increased. The increase in the tenant recovery percentage is due to lower bad debt expense, which is non-recoverable, and stronger expense recovery language in leases that we renew.
The decrease in other income resulted primarily from miscellaneous income recorded in 2004 that related to future cash flow participation in a property that was paid off in advance as well as income from the reversal of the remaining balance of a general legal accrual that was established at the time of the Center Trust acquisition. Additionally, the decrease is attributable to a decrease in income related to tenants who have defaulted on their leases and income on a miscellaneous note receivable recorded in 2004. These decreases are offset by an increase due to the reduction of a portion of the environmental reserves that had been recorded upon the acquisition of certain properties.
Expenses
The increase in property operating expenses was primarily due to the acquisitions of shopping center assets in 2005 and 2004, as well as increases in common area costs, including cleaning costs, repairs and grounds maintenance, general building expenses, insurance costs, security costs and utilities. These increases were offset by decreases in bad debt expense and legal costs.
The increase in property taxes was primarily the result of the acquisitions of shopping center assets in 2005 and 2004.
The increase in depreciation and amortization was primarily due to the amortization of the value of the leases in place for properties acquired in 2005 and 2004, as well as depreciation related to properties acquired in 2005 and 2004.
The increase in interest expense was a result of additional amounts drawn on our revolving credit facility to finance property acquisitions during 2005 and 2004. In addition, our cost to borrow funds under our revolving credit facility has been increasing due to the Federal Reserve raising interest rates. Interest expense also increased as a result of our issuance of $100,000,000 in aggregate principal amount of senior notes in August 2005, our issuance of $50,000,000 in aggregate principal amount of senior notes in July 2004 and our issuance of $50,000,000 in aggregate principal amount of senior notes in May 2004. The stated interest rates of 5.25%, 5.95% and 5.95%, respectively, on the senior notes, and the related amortization of prepaid financing costs, are higher than our cost to borrow funds under our revolving credit facility which was paid down with the net proceeds of the notes offerings. The borrowing on our credit line had a weighted average interest rate of 5.10% at December 31, 2005.
The increase in general and administrative expenses resulted primarily from an increase in compensation costs and an increase in audit expense recognized related to Sarbanes-Oxley 404 compliance work. These increases were offset by a decrease in consultant fees related to Sarbanes-Oxley 404 compliance work. As a percentage of total revenue, general and administrative expenses were 4.9% for the year ended December 31, 2005 as compared to 4.5% for the year ended December 31, 2004.
The impairment loss of $642,000 for the year ended December 31, 2004 represents a charge related to a parcel of land in Reno, Nevada, originally acquired in the Western Properties Trust merger transaction, that had been held for potential development. In the third quarter of 2004, we sold the land parcel for less than the recorded book value, which resulted in the impairment loss.
The decrease in other expense resulted primarily from the write down during the year ended December 31, 2004, of a receivable related to a lawsuit we brought against insurance carriers to recover our legal and settlement expenses incurred in connection with a shareholder suit related to our acquisition of Western Properties Trust in November 2000. This decrease was offset by higher costs in 2005 related to potential property acquisitions that we did not complete.
Discontinued operations for the year ended December 31, 2005 of $14,467,000 reflects the operating results of one non-strategic asset that was sold during 2005 and one non-strategic asset that was classified as held for sale at December 31, 2005. Included in this amount is gain on the sale of the asset of $13,087,000. Discontinued operations for the year ended December 31, 2004 of $10,409,000 reflects the operating results of three of four non-strategic assets that were sold during 2004. Included in this amount is gain on the sales of the four assets of $8,245,000.
Comparison of the Year ended December 31, 2004 to the Year ended December 31, 2003
Revenue
The increase in rental revenue, which includes base rent and percentage rent, resulted principally from the acquisition and lease-up of the Center Trust portfolio, the addition of Olympia Place as an operating property which had been under development in 2003, and was placed into service in January 2004, and the acquisitions of seven other shopping center assets in 2004 and 2003.
The increase in recoveries from tenants resulted primarily from the acquisition of the Center Trust portfolio, the addition of Olympia Place as an operating property which had been under development in 2003 and the acquisitions of seven other shopping center assets in 2004 and 2003. In addition, recoveries from tenants increased because recoverable expenses increased. The increase in recovery percentage compared to the prior year period reflects the impact of the lease-up and re-leasing of the Center Trust portfolio.
The increase in other income resulted primarily from miscellaneous income related to future cash flow participation in a property that was paid off in advance as well as income from the reversal of the remaining balance of a general legal accrual that was established at the time of the Center Trust acquisition.
Expenses
The increase in property taxes was primarily the result of the addition of Olympia Place as an operating property which had been under development in 2003 and the acquisitions of other shopping center assets in 2004 and 2003.
The increase in depreciation and amortization was primarily due to depreciation on Olympia Place and expansion space at El Camino North which were under development in 2003, amortization of in-place lease value as well as depreciation on properties acquired in 2004 and 2003.
The increase in interest expense was partially the result of the debt we assumed in the Center Trust acquisition as well as amounts we borrowed on our revolving credit facility to repay Center Trust’s line of credit and to pay off certain notes payable. The increase was also a result of additional amounts drawn on our revolving credit facility to finance properties acquired during 2004 and 2003. Our cost to borrow funds under our revolving credit facility has been increasing due to the Federal Reserve raising interest rates. Interest expense also increased as a result of our
issuance of $75,000,000 in aggregate principal amount of senior notes in June 2003, our issuance of $50,000,000 in aggregate principal amount of senior notes in May 2004 and our issuance of $50,000,000 in aggregate principal amount of senior notes in July 2004. The stated interest rates of 4.70%, 5.95% and 5.95%, respectively, on the senior notes, and the related amortization of prepaid financing costs, are higher than our cost to borrow funds under our revolving credit facility which was paid down with the net proceeds of the notes offerings. These increases in interest expense were partially offset by a decrease in interest expense resulting from the payoff of $50,000,000 of 7.88% senior notes in February 2004 with a borrowing on our credit line which had a weighted average interest rate of 3.18% at December 31, 2004.
The increase in general and administrative expenses resulted primarily from annual compensation increases. As a percentage of total revenue, general and administrative expenses were 4.5% for the year ended December 31, 2004 as compared to 4.9% for the year ended December 31, 2003.
The impairment loss of $642,000 represents a charge related to a parcel of land in Reno, Nevada, originally acquired in the Western Properties Trust merger transaction, that had been held for potential development. In the third quarter of 2004, we sold the land parcel for less than the recorded book value which resulted in the impairment loss.
The increase in other expense resulted primarily from a write down of a receivable related to a lawsuit we brought against insurance carriers to recover our legal and settlement expenses incurred in connection with a shareholder suit related to our acquisition of Western Properties Trust in November 2000.
Discontinued operations for the year ended December 31, 2004 of $10,409,000 reflects the operating results of three of four non-strategic assets that were sold during 2004. Included in this amount is gain on sale of $8,245,000. Discontinued operations for the year ended December 31, 2003 of $18,088,000 reflects the operating results of eight of nine non-strategic assets that were sold during 2003 and three of four non-strategic assets that were sold during 2004. Included in this amount is gain on sale of $10,571,000.
Cash Flows
Comparison of the Year ended December 31, 2005 to the Year ended December 31, 2004
Net cash provided by continuing operating activities increased by $19,302,000 to $151,425,000 for the year ended December 31, 2005, as compared to $132,123,000 for the year ended December 31, 2004. The increase was primarily the result of operating income arising from properties acquired in 2005 and 2004 and an increase in accounts payable, accrued expenses and other liabilities, offset by a decrease in accounts receivable.
Net cash used in continuing investing activities decreased by $76,580,000 to $98,918,000 for the year ended December 31, 2005, as compared to $175,498,000 for the year ended December 31, 2004. The decrease was primarily due to a decrease in acquisitions of and additions to properties and acquired lease-related intangibles and an increase in the collections of notes receivable.
Net cash used in financing activities increased by $90,842,000 to $79,194,000 for the year ended December 31, 2005, as compared to net cash provided by financing activities of $11,648,000 for the year ended December 31, 2004. The increase primarily resulted from a net reduction in line of credit borrowings and an increase in distributions paid, offset by a decrease in notes payable payments and the repayment of senior notes during the year ended December 31, 2004.
Comparison of the Year ended December 31, 2004 to the Year ended December 31, 2003
Net cash provided by continuing operating activities increased by $6,986,000 to $132,123,000 for the year ended December 31, 2004, as compared to $125,137,000 for the year ended December 31, 2003. The increase was primarily the result of operating income arising from properties acquired in 2004 and 2003, offset by an increase in prepaid expenses and a decrease in accounts payable, accrued expenses and other liabilities.
Net cash used in continuing investing activities increased by $101,345,000 to $175,498,000 for the year ended December 31, 2004, as compared to $74,153,000 for the year ended December 31, 2003. The increase was primarily the result of an increase in acquisitions of and additions to properties and acquired lease-related intangibles and a decrease in the collections of notes receivable, offset by a decrease in cash used in the acquisition of Center Trust.
Net cash provided by financing activities increased by $255,598,000 to $11,648,000 for the year ended December 31, 2004, as compared to net cash used in financing activities of $243,950,000 for the year ended December 31, 2003. The increase primarily resulted from a decrease in notes payable payments, an increase in line of credit proceeds and an increase in issuance of senior notes offset by an increase in line of credit payments, a repayment of senior notes and an increase in distributions paid.
Liquidity and Capital Resources
Our total market capitalization at December 31, 2005 was approximately $3,852,490,000, based on the market closing price of our common stock at December 31, 2005 of $66.89 per share (assuming the conversion of 619,755 operating subsidiary units to common stock) and our debt outstanding of approximately $1,088,540,000 (exclusive of accounts payable and accrued expenses). As a result, our debt to total market capitalization ratio was approximately 28.3% at December 31, 2005. Our board of directors adopted a policy of limiting our indebtedness to approximately 50% of our total market capitalization. However, our board of directors may from time to time modify our debt policy in light of current economic or market conditions including, but not limited to, the relative costs of debt and equity capital, market conditions for debt and equity securities and fluctuations in the market price of our common stock. Accordingly, we may increase or decrease our debt to market capitalization ratio beyond the limit described above.
In September 2004, we entered into an amended and restated $300,000,000 revolving credit facility with a maturity date of March 2007. At December 31, 2005, we had $44,500,000 drawn on our revolving credit facility leaving $255,500,000 available to borrow. At our option, amounts borrowed under our revolving credit facility bear interest at either LIBOR plus 0.65% or a reference rate. The weighted average interest rate for short-term LIBOR contracts under our revolving credit facility at December 31, 2005 was 5.10%. We will continue to use our revolving credit facility to take advantage of select acquisition opportunities as well as to provide funds for general corporate purposes. The amended and restated revolving credit facility contains certain financial and other covenants which we believe we are in compliance with at December 31, 2005.
In August 2005, we issued $100,000,000 of 5.25% senior notes due September 1, 2015. In May 2004, we issued $50,000,000 of 5.95% senior notes due June 1, 2014. In July 2004, we issued an additional $50,000,000 of the 5.95% senior notes due June 1, 2014. In June 2003, we issued $75,000,000 of 4.70% senior notes due June 1, 2013. The net proceeds from the offerings were used to repay a portion of the borrowings under our revolving credit facility. Consistent with senior notes previously issued by us, we are bound by certain financial covenants which we believe we are in compliance with at December 31, 2005.
We may in the future enter into derivative financial instruments such as interest rate swaps, caps and treasury locks in order to mitigate our interest rate risk on a related financial instrument; however, we are not a party to any derivative financial instruments at December 31, 2005. Further, we do not enter into derivative or interest rate transactions for speculative or trading purposes nor do we enter into energy or commodity contracts.
We expect to make distributions from net cash provided by operations. Operating cash flows in excess of amounts to be used for distributions will be invested primarily in short-term investments such as collateralized securities of the United States government or its agencies, high-grade commercial paper and bank deposits or be used to pay down outstanding balances on our revolving credit facility, if any.
The following table provides recent historical distribution information:
We expect to meet our short-term liquidity requirements generally through our current working capital and net cash provided by operations. We believe that our net cash provided by operations will be sufficient to allow us to make the distributions necessary to enable us to continue to qualify as a REIT. We also believe that the foregoing sources of liquidity will be sufficient to fund our short-term liquidity needs for the foreseeable future.
We expect to meet our long-term liquidity requirements such as property acquisitions and developments, scheduled debt maturities, renovations, expansions and other non-recurring capital improvements through long-term secured and unsecured indebtedness, the issuance of additional equity or debt securities and the use of net proceeds from the disposition of non-strategic assets. We also expect to use funds available under our revolving credit facility to finance acquisition and development activities and capital improvements on an interim basis.
Off-Balance Sheet Arrangements
In 2003, we received a return of capital of $5,790,000 from our investment in Plaza Escuela Holding Co., LLC. In February 2004, we received a return of capital of $600,000. We received a return of capital for our remaining equity investment of $1,205,000 during the second quarter of 2004. We were entitled to receive 25% of the operating cash flows from the property through November 2008. In the fourth quarter of 2004, we agreed to receive $1,354,000 in exchange for our right to receive these future operating cash flows. This amount was recorded as other revenue in the accompanying 2004 consolidated statement of income. Proceeds from the returns of capital and cash flow participation were used primarily to repay borrowings under our revolving credit facility.
We are a 50% general partner of a joint venture that owns North Coast Health Center, a medical office building in Encinitas, California. At December 31, 2005, the balance of the joint venture’s note payable to purchase the building on the property, which bears interest at 7%, was $17,846,000. The note payable is secured by the property and is not guaranteed by us. This is the only off-balance sheet transaction to which we are a party. In the fourth quarter of 2005, we assumed a note receivable as part of an agreement to extend financing to the joint venture to construct another building at the project. At December 31, 2005, the balance on this note receivable, which bears interest at 7%, was $478,000. We account for this joint venture under the equity method.
Contractual Obligations and Contingent Liabilities
Our indebtedness outstanding at December 31, 2005, which includes debt discounts and premiums of $200,000 and excludes interest, representing regularly scheduled principal reductions, balloon payments, scheduled senior note redemptions and amounts due on our revolving credit facility, is as follows:
Payments due in 2006 include senior note redemptions of $25,000,000. Payments due in 2007 include the balance drawn on our revolving credit facility at December 31, 2005 of $44,500,000 and senior note redemptions of $55,000,000. Payments due in 2008, 2010, 2011, 2013, 2014 and 2015 include senior note redemptions of $25,000,000, $25,000,000, $150,000,000, $175,000,000, $100,000,000 and $100,000,000, respectively. Payments due in 2015 also include property level bonds of $6,000,000. With regard to the payments noted above, it is likely that we will not have sufficient funds on hand to repay these amounts at maturity. Therefore, we expect to refinance this debt either through additional debt financings secured by individual properties or groups of properties, by unsecured private or public debt offerings or by additional equity offerings.
We have future obligations relating to construction contracts and leases for real estate and office equipment under operating leases expiring at various dates through 2084. Rental expense was $1,729,000, $2,038,000 and $1,782,000 for the years ended December 31, 2005, 2004 and 2003, respectively. Committed amounts under construction contracts due in 2006 total approximately $3,322,000. Committed amounts under construction contracts and minimum rentals under noncancellable operating leases in effect at December 31, 2005 were as follows:
Inflation
Substantially all of our leases provide for the recovery of all or a significant portion of all real estate taxes and operating expenses we incur. In addition, many of the leases provide for fixed base rent increases or indexed escalations (based on the consumer price index or other measures) and percentage rent. We believe that inflationary increases in expenses will be substantially offset by expense reimbursements, contractual rent increases and percentage rent.
Our revolving credit facility bears interest at a variable rate, which will be influenced by changes in short-term interest rates, and will be sensitive to inflation.
Impact of New Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment. This Statement is a revision of SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123R supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recorded as an expense based on their fair values. The grant-date fair value of employee share options and similar instruments will be estimated using an option-pricing model adjusted for any unique characteristics of a particular instrument. If an equity award is modified after the grant date, incremental compensation cost will be recognized in an amount equal to the excess of the fair value of the modified award over the fair value of the original award immediately before the modification. In April 2005, the Securities and Exchange Commission delayed the effective date of required adoption of SFAS No. 123R to the first fiscal year beginning after June 15, 2005. The adoption of this Statement will not have a material effect on our financial position or results of operations.
In March 2005, the FASB issued Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations-an interpretation of FASB Statement No. 143 (FIN 47). FIN 47 clarifies the term conditional asset retirement obligation and requires a liability to be recorded if the fair value of the obligation can be reasonably estimated. The types of asset retirement obligations that are covered by FIN 47 are those for which an entity has a legal obligation to perform an asset retirement activity; however, the timing and/or method of settling the obligation are conditional on a future event that may or may not be within the control of the entity. FIN 47 also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. FIN 47 is effective for fiscal years ending after December 15, 2005. The adoption of FIN 47 did not have a material effect on our financial position or results of operations.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections. SFAS No. 154 replaces Accounting Principle Board Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS No. 154 changes the requirements for the accounting for and reporting of a change in accounting principles. It requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 did not have a material effect on our financial position or results of operations.
Emerging Issues Task Force (EITF) Issue 04-5, Determining Whether a General Partner or the General Partners, as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners have Certain Rights was ratified by the FASB in June 2005. At issue is what rights held by the limited partner(s) preclude consolidation in circumstances in which the sole general partner would consolidate the limited partnership in accordance with U.S. generally accepted accounting principles. The assessment of limited partners’ rights and their impact on the presumption of control of the limited partnership by the sole general partner should be made when an investor becomes the sole general partner and should be reassessed if (a) there is a change to the terms or in the exercisability of the rights of the limited partners, (b) the sole general partner increases or decreases its ownership of limited partnership interests, or (c) there is an increase or decrease in the number of outstanding limited partnership interests. This Issue is effective no later than for fiscal years beginning after December 15, 2005 and as of June 29, 2005 for new or modified arrangements. We will not be required to consolidate our current unconsolidated investment nor will this EITF have a material effect on our financial position or results of operations.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to interest rate changes primarily as a result of our credit agreements and long-term debt used to maintain liquidity and fund capital expenditures and expansion of our real estate investment portfolio and operations. Our interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs. To achieve our objectives, we borrow primarily at fixed rates, although we use our line of credit for short-term borrowing purposes, and could enter into derivative financial instruments such as interest rate swaps, caps and treasury locks in order to mitigate our interest rate risk on a related financial instrument. We are not a party to any derivative financial instruments at December 31, 2005. We do not enter into derivative or interest rate transactions for speculative or trading purposes nor do we enter into energy or commodity contracts. Additionally, we do not believe that the interest rate risk represented by our floating rate debt is material as of December 31, 2005 in relation to total assets of $2,098,764,000 and an equity market capitalization of $2,763,949,000 (assuming the conversion of 619,755 operating subsidiary units to common stock).
Our interest rate risk is monitored using a variety of techniques. The table below presents the principal amounts, weighted average interest rates, fair values as of December 31, 2005 and other terms required by year of expected maturity to evaluate the expected cash flows and sensitivity to interest rate changes.
(1) Principal amounts shown are in thousands.
(2) Excludes unamortized discounts and premium on senior notes, net of unamortized discounts and premiums on notes payable, of $(200,000).
The table incorporates only those exposures that exist as of December 31, 2005, and does not consider those exposures or positions which could arise after that date. Moreover, because firm commitments are not presented in the table above, the information presented therein has limited predictive value. As a result, our interest rate fluctuations will depend on the exposures that arise during the period and interest rates.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data required by Regulation S-X are included in this Annual Report on Form 10-K commencing on page and are hereby incorporated herein by reference.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Also, we have an investment in an unconsolidated entity. As we do not control or manage this entity, our disclosure controls and procedures with respect to such entity are necessarily substantially more limited than those we maintain with respect to our consolidated subsidiaries.
As required by Rule 13(a)-15(b) under the Securities Exchange Act of 1934, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective and were operating at a reasonable assurance level.
Changes in Internal Control Over Financial Reporting
There have been no significant changes in our internal controls over financial reporting during the quarter ended December 31, 2005, that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act of 1934 Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting. Our management has used the framework set forth in the report entitled “Internal Control-Integrated Framework” published by the Committee of Sponsoring Organizations (“COSO”) of the Treadway Commission to evaluate the effectiveness of the Company’s internal control over financial reporting. Based on our evaluation, management has concluded that the Company’s internal control over financial reporting was effective as of December 31, 2005. KPMG LLP, our independent registered public accounting firm, has issued an attestation report on management’s assessment of the Company’s internal control over financial reporting as of December 31, 2005, as stated in their report which is included herein.
Limitations of Internal Control
Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design safeguards into the process to reduce, though not eliminate, this risk.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
Not applicable.
PART III
Certain information required by Part III is omitted from this annual report on Form 10-K in that we will file a definitive proxy statement within 120 days after the end of our fiscal year pursuant to Regulation 14A for our Annual Meeting of Stockholders to be held in April 2006 (the “Proxy Statement”) and the information included therein is incorporated herein by reference.
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information contained in the section captioned “Proposal One: Election of Directors” of the Proxy Statement is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information contained in the section captioned “Executive Compensation” of the Proxy Statement is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information contained in the section captioned “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” of the Proxy Statement is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information contained in the section captioned “Certain Relationships and Related Transactions” of the Proxy Statement is incorporated herein by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information contained in the section captioned “Principal Accountant Fees and Services” of the Proxy Statement is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
(a) Financial Statements and Schedules
The following consolidated financial information is filed as a part of and is included in Item 8 of this Annual Report on Form 10-K.
1. Consolidated Financial Statements:
2. Consolidated Financial Statement Schedule:
Schedule III-Properties and Accumulated Depreciation
3. Exhibits:
* Management contract or compensatory plan or arrangement
** Filed Herewith
(b) Item 601 Exhibits
Reference is hereby made to the Index of Exhibits under Item 15(a)(3) of Part IV of this report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 on February 21, 2006.
PAN PACIFIC RETAIL PROPERTIES, INC.
By:
/s/ Stuart A. Tanz
By:
/s/ Joseph B. Tyson
Stuart A. Tanz
Joseph B. Tyson, CPA
Director, Chairman, Chief Executive Officer and President
Executive Vice President, Chief Financial Officer and Secretary (Principal Financial and Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Report of Independent Registered Public Accounting Firm
The Board of Directors
Pan Pacific Retail Properties, Inc.:
We have audited the accompanying consolidated balance sheets of Pan Pacific Retail Properties, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2005. In connection with our audits of the consolidated financial statements, we have also audited the accompanying financial statement schedule III. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Pan Pacific Retail Properties, Inc. and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule III, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Pan Pacific Retail Properties, Inc.’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 21, 2006 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.
KPMG LLP
San Diego, California
February 21, 2006
Report of Independent Registered Public Accounting Firm
The Board of Directors
Pan Pacific Retail Properties, Inc.:
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Pan Pacific Retail Properties, Inc. maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Pan Pacific Retail Properties, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that Pan Pacific Retail Properties, Inc. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Pan Pacific Retail Properties, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Pan Pacific Retail Properties, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2005, and our report dated February 21, 2006 expressed an unqualified opinion on those consolidated financial statements.
KPMG LLP
San Diego, California
February 21, 2006
PAN PACIFIC RETAIL PROPERTIES, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
See accompanying notes to consolidated financial statements.
PAN PACIFIC RETAIL PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except share data)
See accompanying notes to consolidated financial statements.
PAN PACIFIC RETAIL PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands, except share data)
See accompanying notes to consolidated financial statements.
PAN PACIFIC RETAIL PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(continued)
PAN PACIFIC RETAIL PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(In thousands)
See accompanying notes to consolidated financial statements.
PAN PACIFIC RETAIL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2005, 2004 and 2003
(Tabular amounts are in thousands, except unit, option and share data)
1. Organization and basis of presentation
Pan Pacific Retail Properties, Inc. (together with its subsidiaries, the “Company”) is an equity real estate investment trust (“REIT”) that owns, leases and manages neighborhood and community shopping centers. As of December 31, 2005, the Company owned a portfolio comprised of 138 properties located primarily in the Western region of the United States. The Company believes it qualifies as a REIT under Sections 856 through 860 of the Internal Revenue Code.
In accordance with SFAS No. 144, our consolidated statements of income and consolidated statements of cash flows have been revised from those originally reported for the years ended December 31, 2004 and 2003 to separately reflect the results of discontinued operations for properties that were sold and held for sale during the years ended December 31, 2005 and 2004. The revision had no impact on our consolidated balance sheets or statements of stockholders’ equity. The revision had no impact on net income or net income per share of common stock for the years ended December 31, 2004 or 2003. See Note 3 to the consolidated financial statements.
In 1998 and 1999, the Company formed certain operating subsidiaries to acquire shopping center properties. The Company is the managing member and in exchange for the properties which were contributed to the operating subsidiaries, units were issued to the non-managing members. These operating subsidiaries were primarily formed for tax planning purposes for the non-managing members who contributed the properties. A non-managing member can seek redemption of the units after the first anniversary of the date of issuance. The Company, at its option, may redeem the units by either (i) issuing common stock at the rate of one share of common stock for each unit, or (ii) paying cash to the non-managing member based on the average trading price of its common stock. Distributions are made to the non-managing members at a rate equal to the distribution being paid by the Company on a share of common stock. Net income or loss is allocated to the non-managing members in an amount equal to the cumulative distributions earned by such members. All remaining net income or loss is allocated to the Company as the managing member. In 2003, 100,000 units were redeemed for common stock and 131,590 units were redeemed for cash of $5,540,000. In 2004, 125,000 units were redeemed for cash of $5,971,000. In 2005, 76,027 units were redeemed for cash of $4,896,000. The following table summarizes the activity for these operating subsidiaries as of December 31, 2005:
PAN PACIFIC RETAIL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2005, 2004 and 2003
(Tabular amounts are in thousands, except unit, option and share data)
1. Organization and basis of presentation (continued)
In connection with the 2000 acquisition of Western Properties Trust (“Western”), the Company has an investment in an operating partnership. Pan Pacific (Pinecreek), L.P. issued units convertible into shares of Company common stock or cash, at the Company’s option. Distributions are made to the limited partners after a 10% preferred return to the Company as general partner. Net income is allocated to the Company, as general partner, and to the limited partners in amounts equal to the cumulative distributions earned by such partners and thereafter based on their ownership interests. Losses are allocated 99% to the Company as general partner and 1% to the limited partners. The following table summarizes the activity for this operating subsidiary as of December 31, 2005:
In connection with the 2003 acquisition of Center Trust, the Company has a 96% general partner investment in an operating partnership. CT Operating Partnership, L.P. issued units convertible into shares of Company common stock or cash, at the Company’s option. Distributions are being made to the limited partners at a rate equal to the distribution being paid by the Company on a share of common stock. Net income is allocated to the limited partners in an amount equal to the cumulative distributions earned by such partners. All remaining net income and all loss is allocated to the Company as general partner. In 2003, 33,964 units were redeemed for cash of $1,246,000. The following table summarizes the activity for this operating subsidiary as of December 31, 2005:
PAN PACIFIC RETAIL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2005, 2004 and 2003
(Tabular amounts are in thousands, except unit, option and share data)
2. Summary of significant accounting policies and practices
(a) Principles of consolidation
The consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries, and partnerships and limited liability companies it controls. All material intercompany transactions and balances have been eliminated. The Company consolidates entities, including variable interest entities, that the Company controls and records a minority interest for the portions not owned by the Company. Control is determined, where applicable, by the sufficiency of equity invested and the rights of the equity holders, and by the ownership of a majority of the voting interests, with consideration given to the existence of approval or veto rights granted to the minority shareholder. If the minority shareholder holds substantive participation rights, it overcomes the presumption of control by the majority voting interest holder. In contrast, if the minority shareholder simply holds protective rights (such as consent rights over certain actions), it does not overcome the presumption of control by the majority voting interest holder. With respect to the partnerships and limited liability companies, the Company determines control through a consideration of each parties’ financial interests in profits and losses and the ability to participate in major decisions such as the acquisition, sale or refinancing of principal assets.
(b) Cash and cash equivalents
For purposes of reporting cash flows, highly liquid investments with an original maturity of three months or less are considered cash equivalents. Restricted cash totaled $229,000 and $414,000 at December 31, 2005 and 2004, respectively.
(c) Accounts receivable and revenue recognition
Rental revenue on the Company’s leases with its tenants is recognized on a straight-line basis over the terms of the leases. In determining what constitutes the leased asset, the Company evaluates whether or not the lessee is the owner, for accounting purposes, of the tenant improvements. The determination of who is the owner, for accounting purposes, of the tenant improvements dictates the nature of the leased asset and when revenue recognition under a lease begins. If the Company is the owner of the tenant improvements, revenue recognition begins when the lessee takes possession of the finished space. If the Company is not the owner of the tenant improvements, revenue recognition begins when the lessee takes possession of the unimproved space to construct its own improvements.
The rental revenue is recognized less an allowance for doubtful accounts relating to accounts receivable and accrued rent receivable for amounts deemed uncollectible and for leases which may be terminated before the end of the contracted term. The Company considers tenant specific issues such as financial stability and ability to pay rent when determining collectibility of accounts receivable and appropriate allowances to record. The Company considers tenant retention in determining an appropriate allowance to record for the accrued rent receivable recorded in recognizing rental income on a straight-line basis. Percentage rent is recorded at the time tenants meet specified sales thresholds. The Company receives reimbursement for real estate taxes and certain other operating expenses. Such reimbursements are recognized at the time the related expenses are incurred. The value of acquired above and below market leases is amortized to rental revenue over the life of the related acquired lease. The Company accounts for all property sales in accordance with SFAS No. 66, “Accounting for Sales of Real Estate”.
Bad debt expense, included in property operating expenses in the Company’s financial statements, was $1,383,000, $4,070,000 and $4,061,000 for the years ended December 31, 2005, 2004 and 2003, respectively.
PAN PACIFIC RETAIL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2005, 2004 and 2003
(Tabular amounts are in thousands, except unit, option and share data)
2. Summary of significant accounting policies and practices (continued)
(d) Capitalization of acquisition and development costs
The Company capitalizes certain acquisition and development related costs to the carrying costs of the property acquired or developed. The Company uses estimates and assumptions of items such as market rents, time required to lease vacant spaces, lease terms for incoming tenants, estimated tenant improvement costs and credit worthiness of tenants in determining the as-if-vacant value, in-place lease value and above and below market rents value in allocating purchase price to tangible and identified intangible assets upon acquisition of a shopping center asset. These costs are depreciated over the estimated useful lives of the properties commencing at the time the property is ready for its intended use or is acquired. The capitalized costs associated with unsuccessful acquisitions are charged to expense when the acquisition is abandoned.
(e) Depreciation and amortization
Depreciation on buildings and improvements is provided using a forty-year straight-line basis. Management believes forty years is an appropriate estimated useful life for buildings and improvements. Tenant improvements and costs incurred in obtaining leases, including leases in place at the time of an acquisition, are amortized on a straight-line basis over the shorter of the life of the respective lease or the expected economic life of the asset.
Prepaid financing costs are amortized over the lives of the loans and the related amortization expense is included as a component of interest expense. Premiums and discounts on indebtedness are amortized over the life of the related debt using the straight-line method, which approximates the effective interest method, and are included as a component of interest expense.
In accordance with SFAS No. 141, the Company has identified and recorded the value of intangibles at the property acquisition date. Such intangibles include the value of in-place leases, above-market leases and below-market leases. Acquired lease intangible assets (in-place lease value and above-market leases) are recorded in other assets. Acquired lease intangible liabilities (below-market leases) are recorded in accounts payable, accrued expenses and other liabilities. These acquired intangibles are amortized using the straight-line method over the remaining terms of the related leases. The amortization of above-market and below-market leases is recorded as an adjustment to rental revenue. The amortization of in-place lease value is recorded to depreciation and amortization expense.
(f) Impairment of long-lived assets and long-lived assets to be disposed of
The Company reviews long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows, undiscounted and without interest, expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
The Company recorded an impairment loss of $642,000 related to a non-strategic parcel of land for the year ended December 31, 2004. There were no impairment losses recorded for the years ended December 31, 2005 and 2003.
PAN PACIFIC RETAIL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2005, 2004 and 2003
(Tabular amounts are in thousands, except unit, option and share data)
2. Summary of significant accounting policies and practices (continued)
(g) Income taxes
As of April 16, 1997, the Company elected to be taxed as a REIT pursuant to the Internal Revenue Code, as amended. In general, a corporation that distributes at least 90% of its REIT taxable income to stockholders in any taxable year and complies with certain other requirements (relating primarily to the nature of its assets and the sources of its revenue) is not subject to federal income taxation to the extent of the income which it distributes. Management believes that the Company has qualified and intends for it to continue to qualify as a REIT in the future. As discussed more fully in Note 9, management also does not expect that the Company will pay income taxes on “built-in gains” on certain of its assets. Based on these considerations, management does not believe that the Company will be liable for income taxes at the federal level or in most of the states in which it operates in future years.
(h) Credit and concentration risk
The Company predominantly operates in one industry segment: real estate ownership, management and development. No single tenant accounts for 10% or more of rental revenue. Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments and receivables. The Company places its temporary cash investments with financial institutions which the Company believes are of high credit quality. Concentration of credit risk with respect to receivables is limited due to the large number of tenants comprising the Company’s customer base, and their dispersion across many areas within the Western region of the United States. At December 31, 2005 and 2004, management believes the Company had no significant concentration of credit risk.
(i) Net income per share
Basic earnings per share (EPS) is computed by dividing earnings available to common stockholders during the period by the weighted average number of common shares outstanding during each period. Diluted EPS is computed by dividing the adjusted amount of earnings available to common stockholders during the period by the weighted average number of shares that would have been outstanding assuming the issuance of common shares for all dilutive potential common shares outstanding during the reporting period including operating subsidiary units, net of shares assumed to be repurchased using the treasury stock method.
PAN PACIFIC RETAIL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2005, 2004 and 2003
(Tabular amounts are in thousands, except unit, option and share data)
2. Summary of significant accounting policies and practices (continued)
The following is a reconciliation of the numerator and denominator for the calculation of basic and diluted EPS (all net income is available to common stockholders for the periods presented):
At December 31, 2005, 2004 and 2003, all stock options, both vested and unvested, and operating subsidiary units were dilutive and included in the calculation of diluted weighted-average shares.
(j) Stock plans
The Company accounts for its stock plans in accordance with the provisions of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations. As such, compensation expense is recorded on the date of option grants only if the current market price of the underlying stock exceeds the exercise price. Compensation expense for restricted stock grants is determined on the grant date based on the market price and is recognized over the vesting period. Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (SFAS No. 123), permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made as if the fair-value-based method defined in SFAS No. 123 had been applied. The Company has elected to, for all periods presented, apply the provisions of APB Opinion No. 25 and provide the annual pro forma disclosures required by SFAS No. 123, as amended by Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure” (SFAS No. 148) for its stock option grants.
PAN PACIFIC RETAIL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2005, 2004 and 2003
(Tabular amounts are in thousands, except unit, option and share data)
2. Summary of significant accounting policies and practices (continued)
The following table shows the Company’s pro forma net income had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123:
Pro forma net income reflects options granted since adoption of the 1997 Plan and the 2000 Plan. The last grant of stock options occurred in 2002. All options were fully vested as of March 31, 2005, as such future years will not reflect any option-related compensation expense under the SFAS 148 pro forma disclosure requirements unless additional stock options are granted. SFAS No. 123R is effective for the fiscal periods beginning after January 1, 2006. We believe that the adoption of this Statement will not have a material effect on the financial position or results reported by the Company.
(k) Use of estimates
Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reporting of revenue and expenses during the reporting period to prepare these financial statements in conformity with U.S. generally accepted accounting principles. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and reported amounts of revenue and expenses that are not readily apparent from other sources. Actual results could differ from those estimates under different assumptions or conditions.
PAN PACIFIC RETAIL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2005, 2004 and 2003
(Tabular amounts are in thousands, except unit, option and share data)
2. Summary of significant accounting policies and practices (continued)
Management considers those estimates and assumptions that are most important to the portrayal of the Company’s financial condition and results of operations, in that they require management’s most subjective judgments, to form the basis for the accounting policies used by the Company. These estimates and assumptions include items such as market rents, time required to lease vacant spaces, lease terms for incoming tenants and credit worthiness of tenants in determining the as-if-vacant value, in-place lease value and above and below market rents value in allocating purchase price to tangible and identified intangible assets upon acquisition of a shopping center asset. Management also applies certain assumptions about incremental leasing costs in determining the appropriate amount of internal leasing costs to capitalize. These accounting policies also include management’s estimates of useful lives in calculating depreciation expense on its shopping center properties and the ultimate recoverability (or impairment) of each shopping center asset. If the useful lives of buildings and improvements are different from 40 years, it could result in changes to the future results of operations of the Company. Future adverse changes in market conditions or poor operating results of shopping center properties could result in losses or an inability to recover the carrying value of the properties that may not be reflected in the properties’ current carrying value, thereby possibly requiring an impairment charge in the future.
(l) Reclassifications
Certain reclassifications of 2004 and 2003 amounts have been made in order to conform to 2005 presentation.
(m) Revisions to Consolidated Statements of Cash Flows
In 2005, the Company has separately disclosed the investing portions of the cash flows attributable to its discontinued operations, which in prior periods, were reported on a combined basis as a single amount.
3. Discontinued operations
The Company reports each individual property as a component for determining discontinued operations. The operations of one property sold during the year ended December 31, 2005 and one property held for sale at December 31, 2005 were reported as income from discontinued operations in 2005, and their respective 2004 and 2003 operations were reclassified to income from discontinued operations. The operations of three properties sold during the year ended December 31, 2004 were reported as income from discontinued operations in 2004, and their respective 2003 operations were reclassified to income from discontinued operations. The operations of eight properties sold during the year ended December 31, 2003 were reported as income from discontinued operations in 2003. The following is a summary of our income from discontinued operations for the years ended December 31, 2005, 2004 and 2003:
PAN PACIFIC RETAIL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2005, 2004 and 2003
(Tabular amounts are in thousands, except unit, option and share data)
4. Investments in unconsolidated entities
The accompanying consolidated financial statements include investments in entities in which the Company does not own a controlling interest. At December 31, 2005 and 2004, the Company owned a 50% general partner interest in North Coast Health Center. At December 31, 2003, the Company owned a 12% non-managing member interest in Plaza Escuela and a 50% general partner interest in North Coast Health Center. These investments are reported using the equity method. Neither entity has been deemed to be a variable interest entity.
Summarized financial information for the entities is presented below:
PAN PACIFIC RETAIL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2005, 2004 and 2003
(Tabular amounts are in thousands, except unit, option and share data)
5. Indebtedness
(a) Notes payable and other
PAN PACIFIC RETAIL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2005, 2004 and 2003
(Tabular amounts are in thousands, except unit, option and share data)
5. Indebtedness (continued)
The net carrying value of properties secured by these notes payable is $557,865,000 and $492,736,000 at December 31, 2005 and 2004, respectively.
(b) Line of credit payable
In September 2004, the Company entered into an amended and restated unsecured $300,000,000 revolving credit facility which bears interest, at the Company’s option, at either LIBOR plus 0.65% or a reference rate and expires in March 2007. At December 31, 2005 and 2004 the amount drawn on this line of credit was $44,500,000 and $113,000,000, respectively, and the interest rate was 5.10% and 3.18%, respectively. The credit facility requires a quarterly fee of 0.20% per annum on the total aggregate commitment. The Company at its sole option may increase the amount of the commitment up to $400,000,000 and extend the maturity date to March 2008, assuming satisfaction of certain conditions. The Company believes it is in compliance with all covenants contained in the revolving credit facility agreement at December 31, 2005.
(c) Senior notes
PAN PACIFIC RETAIL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2005, 2004 and 2003
(Tabular amounts are in thousands, except unit, option and share data)
5. Indebtedness (continued)
(d) Long-term debt maturities
Principal payments due on the notes payable and other, revolving credit facility and senior notes are as follows:
6. Financial instruments
The following methods and assumptions were used to estimate fair value of each class of financial instruments:
(a) Cash and cash equivalents, accounts receivable and accounts payable, accrued expenses and other liabilities
The carrying amounts approximate fair values because of the short-term nature of these instruments.
(b) Notes receivable
The carrying amounts of notes receivable with balances of $50,000 and $4,679,000 at December 31, 2005 and 2004, respectively, approximate fair values because of the short-term nature of these instruments.
It was not practicable to estimate the fair value of a note receivable with a balance of $214,000 and $339,000 at December 31, 2005 and 2004, respectively, due to the uncertainty of the timing of repayment.
The fair value of notes receivable with balances of $2,782,000 and $2,493,000 at December 31, 2005 and 2004, respectively, approximates the carrying amounts based on market rates for the same or other instruments with similar risk, security and remaining maturities.
(c) Notes payable, line of credit and senior notes payable
The fair value of fixed-rate notes payable and senior notes payable of $1,042,441,000 and $894,688,000 at December 31, 2005 and 2004, respectively, approximates the carrying amount based on the current rates offered for loans with similar risks and maturities.
The fair value of our variable-rate line of credit approximates the carrying amount based on the current rates offered for loans with similar risks and maturities.
PAN PACIFIC RETAIL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2005, 2004 and 2003
(Tabular amounts are in thousands, except unit, option and share data)
7. Sale of real estate
The Company recorded a gain on sale of real estate of $13,087,000 during the year ended December 31, 2005. The gain is included in discontinued operations and relates to the sale of one shopping center. The total sales proceeds for this sale of $30,390,000 were received in cash.
The Company recorded a gain on sale of real estate of $8,245,000 during the year ended December 31, 2004. The gain is included in discontinued operations and relates to the sale of three shopping centers. The total sales proceeds for these sales of $25,925,000 were received in cash and one short-term note, which was paid off prior to December 31, 2004. The Company also sold a parcel of land during the year ended December 31, 2004 and recorded an impairment loss of $642,000 related to this sale. The total sales proceeds of $2,104,000 for this land sale were received in cash.
The Company recorded a gain on sale of real estate of $10,571,000 during the year ended December 31, 2003. The gain is included in discontinued operations and related to the sale of three shopping centers and an office building parcel. The total sales proceeds for these sales of $34,021,000 were received in cash and one short-term note receivable which was paid off prior to December 31, 2003. The Company also sold another five shopping centers during the year ended December 31, 2003 and recorded no gain or loss on these sales. The total sales proceeds of $210,681,000 were received in cash and two notes receivable, one which was paid off prior to December 31, 2003.
8. Stock plans
In August 1997, the Company established the 1997 Stock Option and Incentive Plan (the “1997 Plan”) pursuant to which the Company’s Board of Directors may grant stock, restricted stock awards and stock options to officers, directors and key employees. The 1997 Plan authorizes up to 1,620,000 shares of authorized but unissued common stock. In March 2000, the Company established the 2000 Stock Incentive Plan (the “2000 Plan”) pursuant to which the Company’s Board of Directors may grant stock, restricted stock awards and stock options to officers, directors and key employees. The 2000 Plan authorizes up to 489,971 shares of authorized but unissued common stock and was approved by the Company’s stockholders. In November 2000, the number of shares available for grant pursuant to the 2000 Plan was increased to 1,786,695 shares upon approval by the Company’s stockholders. During 2003 the number of shares available for grant pursuant to the 2000 Plan was increased by 668,832 shares to 2,455,527 shares upon approval by the Company’s stockholders. At December 31, 2005, there were 1,189,850 additional shares available for grant under the 1997 Plan and the 2000 Plan.
PAN PACIFIC RETAIL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2005, 2004 and 2003
(Tabular amounts are in thousands, except unit, option and share data)
8. Stock plans (continued)
(a) Stock options
Stock options are granted with an exercise price equal to the stock’s fair value at the date of grant. The stock options have seven-year terms and vest 33 1/3% per year over three years from the date of grant, except for the options granted to the independent directors which vest 33 1/3% immediately, with the remainder vesting ratably over two years. No stock options were granted during 2005, 2004 and 2003. The Company applied APB Opinion No. 25 in accounting for the 1997 Plan and 2000 Plan and, accordingly, no compensation cost has been recognized for its stock options in the financial statements.
Stock option activity during the periods presented is as follows:
At December 31, 2005, two stock option grants had remaining fully vested shares:
PAN PACIFIC RETAIL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2005, 2004 and 2003
(Tabular amounts are in thousands, except unit, option and share data)
8. Stock plans (continued)
(b) Restricted stock and stock grants
During 2005, the Company granted 75,000 shares of restricted stock to certain officers pursuant to the 2000 Plan. The restricted shares are accounted for in accordance with APB 25 and related Interpretations. The shares shall become vested over three years in one-third installments so long as the Company attains certain performance goals for a particular vesting date. If these criteria are not met, such restricted shares will vest ten years from the date of grant. During 2005, the Company granted 8,000 shares of restricted stock to four independent directors of the Board pursuant to the 2000 Plan. The restricted shares vest over three years from the date of grant. During 2005, the Company granted 2,000 shares of restricted stock to one independent director of the Board pursuant to the 2000 Plan. The restricted shares vest over two years from the date of grant. Compensation expense for the portion of restricted stock grants that vested during 2005 of $4,825,000 has been recognized in general and administrative expenses. During 2005, 12,214 shares of restricted stock granted in prior years were forfeited. Accordingly, deferred compensation was reduced by $447,000. Compensation expense related to the shares granted in 2005 and the grants from 2004, 2003, 2002 and 2001 to be recognized in future periods is $6,695,000 at December 31, 2005.
During 2004, the Company granted 36,250 shares of restricted stock to certain officers and key employees pursuant to the 2000 Plan. The restricted shares vest over three years from the date of grant. During 2004, the Company granted 8,000 shares of restricted stock to four independent directors of the Board pursuant to the 2000 Plan. The restricted shares vest over three years from the date of grant. During 2004, the Company granted 1,000 shares of stock and 2,000 shares of restricted stock to one independent director pursuant to the 2000 Plan. The restricted shares vest over two years from the date of grant. Compensation expense for the stock grant and the portion of restricted stock grants that vested during 2004 of $3,827,000 has been recognized in general and administrative expenses. During 2004, 4,978 shares of restricted stock granted in 2004 and prior years were forfeited. Accordingly, deferred compensation was reduced by $205,000.
During 2003, the Company granted 153,000 shares of restricted stock to certain officers and key employees pursuant to the 2000 Plan. The restricted shares vest over five years from the date of grant. During 2003, the Company granted 8,000 shares of restricted stock to four independent directors of the Board pursuant to the 2000 Plan. The restricted shares vest over three years from the date of grant. During 2003, the Company granted 2,000 shares of restricted stock to one independent director pursuant to the 2000 Plan. The restricted shares vest over two years from the date of grant. Compensation expense for the portion of restricted stock grants that vested during 2003 of $2,207,000 has been recognized in general and administrative expenses.
PAN PACIFIC RETAIL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2005, 2004 and 2003
(Tabular amounts are in thousands, except unit, option and share data)
9. Income taxes
As discussed in Note 2(g), the Company elected to be taxed as a REIT, effective April 16, 1997. Management believes that the Company qualified and management’s intent is to continue to qualify as a REIT and therefore does not expect the Company will be liable for income taxes at the federal level or in most states in future years. Accordingly, for the years ended December 31, 2005, 2004 and 2003, no provision was recorded for federal or substantially all state income taxes.
In connection with its election to be taxed as a REIT, the Company also elected to be subject to the “built-in gain” rules. Under these rules, taxes may be payable at the time and to the extent that the net unrealized gains on the Company’s assets at the date of conversion to REIT status are recognized in taxable dispositions in the ten-year period following conversion. Such net unrealized gains were approximately $80,000,000 at December 31, 2005. Management believes that the Company will not be required to make payments of income taxes on $55,000,000 of built-in gains during the ten-year period ending December 31, 2007, or on $25,000,000 of built-in gains during the ten-year period ending December 31, 2012. It is the intent of the Company, and the Company has the ability to defer asset dispositions to periods when related gains will not be subject to the built-in gains income taxes or otherwise to defer the recognition of the built-in gains. However, it may be necessary to recognize a liability for such income taxes in the future if management’s plans and intentions with respect to asset dispositions, or the related tax laws, change.
The following unaudited table reconciles the Company’s book net income to REIT taxable income before dividends paid deduction:
(a) Includes depreciation of properties in discontinued operations (see Note 3).
(b) Based on other adjustments permitted by the Internal Revenue Code.
PAN PACIFIC RETAIL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2005, 2004 and 2003
(Tabular amounts are in thousands, except unit, option and share data)
9. Income taxes (continued)
The Company pays distributions quarterly to the stockholders. The following presents the per share federal income tax characterization of distributions paid or deemed to be paid to stockholders:
10. Future lease revenue
Total future minimum lease receipts due under noncancellable operating tenant leases in effect at December 31, 2005 are as follows:
11. Employee benefit plan
All employees of the Company who meet certain minimum age and period of service requirements are eligible to participate in a Section 401(k) plan as defined by the Internal Revenue Code. The employee benefit plan, sponsored by the Company, allows eligible employees to defer a percentage of compensation on a pre-tax basis up to a maximum of $14,000, $13,000 and $12,000 in 2005, 2004 and 2003, respectively. Employees over 50 years of age were able to add an additional $4,000, $3,000 and $2,000 in 2005, 2004 and 2003, respectively. The amounts contributed by employees are immediately vested and non-forfeitable. The Company, at management’s discretion, may match employee contributions. The Company’s matching contributions for the years ended December 31, 2005, 2004 and 2003 were approximately $104,000, $98,000 and $92,000, respectively.
PAN PACIFIC RETAIL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2005, 2004 and 2003
(Tabular amounts are in thousands, except unit, option and share data)
12. Commitments and contingencies
(a) The Company has entered into construction contracts and also leases certain real estate and office equipment under operating leases expiring at various dates through 2084. Rental expense was $1,729,000, $2,038,000 and $1,782,000 for the years ended December 31, 2005, 2004 and 2003, respectively. Committed amounts under construction contracts due in 2006 totaled approximately $3,322,000. Committed amounts under construction contracts and minimum rentals under noncancellable operating leases in effect at December 31, 2005 were as follows:
(b) Various claims and legal proceedings arise in the ordinary course of business. The ultimate amount of liability from all claims and actions cannot be determined with certainty, but in the opinion of management, the ultimate liability from all pending and threatened legal claims will not materially affect the Company’s financial position or results of operations.
(c) The Company acquired a land parcel in Northern California in July of 2004 with the intent to build a retail shopping center. At December 31, 2005, the projected development costs for the project had not yet been determined.
PAN PACIFIC RETAIL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2005, 2004 and 2003
(Tabular amounts are in thousands, except unit, option and share data)
13. Financial instruments subject to mandatory redemption
The Company is the general partner in a consolidated limited partnership which owns a shopping center. The limited partnership has a defined termination date of December 31, 2074. The limited partner is entitled to receive 25% of the liquidation proceeds after debts and creditor obligations of the partnership have been satisfied. If termination of the partnership occurred on December 31, 2005 the amount payable to the limited partner is estimated to be $3,899,000.
The Company is a general partner in a general partnership and a limited partnership which collectively own a shopping center. The general partnership has a defined termination date of April 1, 2070. The limited partnership has a defined termination date of December 31, 2069. The other general partner and the limited partner are entitled to receive 66% of the liquidation proceeds after debts and creditor obligations of the partnerships have been satisfied. If termination of the partnership occurred on December 31, 2005, the amounts payable to the other general partner and the limited partner are estimated to be $12,411,000.
14. Segment reporting
The Company operates in one industry segment - real estate ownership, management and development. As of December 31, 2005 and 2004, the Company owned 138 and 133 community shopping centers, respectively, primarily located in the Western United States. Management reviews operating and financial data for each property separately and independently from all other properties when making resource allocation decisions and measuring performance. Therefore, the Company defines operating segments as individual properties with no segment representing more than 10% of the net operating income of the Company. No single tenant accounts for 10% or more of rental revenue and none of the shopping centers are located in a foreign country.
PAN PACIFIC RETAIL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2005, 2004 and 2003
(Tabular amounts are in thousands, except unit, option and share data)
15. Quarterly financial data (unaudited)
The following summarizes the condensed quarterly financial information for the Company. Certain prior quarter amounts have been reclassified to give effect to the Company’s discontinued operations, in accordance with SFAS No. 144.
PAN PACIFIC RETAIL PROPERTIES, INC.
SCHEDULE III
PROPERTIES AND ACCUMULATED DEPRECIATION
December 31, 2005
(In thousands)
(continued)
PAN PACIFIC RETAIL PROPERTIES, INC.
SCHEDULE III
PROPERTIES AND ACCUMULATED DEPRECIATION (Continued)
December 31, 2005
(In thousands)
(continued)
PAN PACIFIC RETAIL PROPERTIES, INC.
SCHEDULE III
PROPERTIES AND ACCUMULATED DEPRECIATION (Continued)
December 31, 2005
(In thousands)
(continued)
PAN PACIFIC RETAIL PROPERTIES, INC.
SCHEDULE III
PROPERTIES AND ACCUMULATED DEPRECIATION (Continued)
December 31, 2005
(In thousands)
(continued)
PAN PACIFIC RETAIL PROPERTIES, INC.
SCHEDULE III
PROPERTIES AND ACCUMULATED DEPRECIATION (Continued)
December 31, 2005
(In thousands)
(continued)
PAN PACIFIC RETAIL PROPERTIES, INC.
SCHEDULE III
PROPERTIES AND ACCUMULATED DEPRECIATION (Continued)
December 31, 2005
(In thousands)
(continued)
PAN PACIFIC RETAIL PROPERTIES, INC.
SCHEDULE III
PROPERTIES AND ACCUMULATED DEPRECIATION (Continued)
December 31, 2005
(In thousands)
Notes:
(1) The aggregate gross cost of the properties owned by Pan Pacific Retail Properties, Inc. for federal income tax purposes, approximated $2,071,215 as of December 31, 2005.
(2) Net of write-offs of fully depreciated assets.
(3) The following table reconciles the historical cost and related accumulated depreciation and amortization of Pan Pacific Retail Properties, Inc. from January 1, 2003 through December 31, 2005:
See accompanying report of independent registered public accounting firm.