10-Q 1 f10q1stqtr2004.htm <B>SECURITIES AND EXCHANGE COMMISSION

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549


FORM 10-Q



 X   

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

For the quarterly period ended March 31, 2004.


      

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

For the transition period from ________________ to _______________.


Commission File Number 1-12222


BEDFORD PROPERTY INVESTORS, INC.

(Exact name of registrant as specified in its charter)



           MARYLAND

68-0306514

(State or other jurisdiction of

(I.R.S. Employer

incorporation or organization)

Identification No.)



270 Lafayette Circle, Lafayette, CA

94549    

(Address of principal executive offices)

(Zip Code)



(925) 283-8910

(Registrant's telephone number, including area code)



Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  X   No___


Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes  X   No___


Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.



           Class                                                                

Outstanding as of May 6, 2004             

Common Stock, $0.02 par value              

16,363, 666










BEDFORD PROPERTY INVESTORS, INC.


INDEX



PART I.  FINANCIAL INFORMATION

Page


Item 1.  Financial Statements


Statement

1


Consolidated Balance Sheets as of March 31, 2004

and December 31, 2003 (Unaudited)

2


Consolidated Statements of Income for the three months ended

March 31, 2004 and 2003 (Unaudited)

3


Consolidated Statement of Stockholders' Equity for the

three months ended March 31, 2004 (Unaudited)

4


Consolidated Statements of Cash Flows for the three months ended

March 31, 2004 and 2003 (Unaudited)

5


Notes to Consolidated Financial Statements

6-15


Item 2.  Management's Discussion and Analysis of

Financial Condition and Results of Operations

16-37


Item 3.  Quantitative and Qualitative Disclosures

about Market Risk

38


Item 4.  Controls and Procedures

38


PART II.  OTHER INFORMATION


Items 1 - 6

39-41


SIGNATURES

41


EXHIBIT INDEX

42





BEDFORD PROPERTY INVESTORS, INC.





PART I.  FINANCIAL INFORMATION


Item 1.  Financial Statements


STATEMENT


We have prepared the following unaudited interim financial statements in accordance with accounting principles generally accepted in the United States of America and pursuant to the rules and regulations of the Securities and Exchange Commission. In our opinion, the interim financial statements presented reflect all adjustments, consisting only of normally recurring adjustments, which are necessary for a fair presentation of our financial condition and results of operations. These financial statements should be read in conjunction with the notes to consolidated financial statements appearing in the annual report to stockholders for the year ended December 31, 2003.


When used in this Form 10-Q, the words "believe," "expect," "intend," "anticipate" and similar expressions are intended to identify forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are subject to risks and uncertainties and actual results could differ materially from those expressed, expected or implied by the forward-looking statements. The risks and uncertainties that could cause our actual results to differ from management’s estimates and expectations are contained in our filings with the Securities and Exchange Commission, including our 2003 Annual Report on Form 10-K, and as set forth in the section below entitled “Potential Factors Affecting Future Operating Results.” Readers are cautioned not to place undue reliance on these forward-looking statements since they only reflect information available as of the date of this filing. We do not undertake to update forward-looking information contained herein or elsewhere to reflect actual results, changes in assumptions or changes in other factors affecting such forward-looking information.




















1


BEDFORD PROPERTY INVESTORS, INC.

CONSOLIDATED BALANCE SHEETS

AS OF MARCH 31, 2004 AND DECEMBER 31, 2003

(Unaudited)   

(in thousands, except share and per share amounts)


 


March 31, 2004


December 31, 2003

Assets:

Real estate investments:

  

  Industrial buildings

$416,370

$414,392

  Office buildings

342,956

375,844

  Properties under development

32,052

-

  Land held for development

12,335

14,071

 

803,713

804,307

  Less accumulated depreciation

83,621

81,638

Total real estate investments

720,092

722,669


Cash and cash equivalents


8,975


7,598

Other assets

42,803

43,352


Total assets


$771,870


$773,619


Liabilities and Stockholders' Equity:

  


Bank loans payable


$  72,175


$  68,978

Mortgage loans payable

366,814

368,542

Accounts payable and accrued expenses

8,457

8,874

Dividends payable

8,417

8,319

Other liabilities

14,762

15,007


  Total liabilities


470,625


469,720


Commitments and contingencies (Note 8)

  


Stockholders' equity:

 Preferred stock, $0.01 par value; authorized

    9,195,000 shares; issued none




-




-

 Series A 8.75% cumulative redeemable preferred stock,

    $0.01 par value; authorized and issued 805,000

    shares at March 31, 2004 and December 31, 2003;

     stated liquidation preference of $40,250    




38,947




38,947

 Common stock, $0.02 par value; authorized

    50,000,000 shares; issued and outstanding 16,503,871

    shares at March 31, 2004 and 16,311,955 shares at

    December 31, 2003




330




326

 Additional paid-in capital

294,540

289,734

 Deferred stock compensation

(9,131)

(5,476)

 Accumulated dividends in excess of net income

(23,402)

(19,721)

 Accumulated other comprehensive (loss) income

(39)

89


      Total stockholders' equity


301,245


303,899


Total liabilities and stockholders' equity


$771,870


$773,619


See accompanying notes to consolidated  financial statements.

2


BEDFORD PROPERTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF INCOME

FOR THE THREE MONTHS ENDED MARCH 31, 2004 AND 2003

(Unaudited)

(in thousands, except share and per share amounts)


 

              2004

              2003

Property operations:

   Rental income


$28,048


$26,953

   Rental expenses:

        Operating expenses


4,942


4,576

        Real estate taxes

2,974

2,678

        Depreciation and amortization

6,908

4,910


Income from property operations


13,224


14,789


General and administrative expenses


(1,506)


(1,684)

Interest income

19

39

Interest expense

(6,121)

(5,472)


Net income


5,616


7,672

Preferred dividends – Series A

(880)

-


Net income available to common

  stockholders



$  4,736



$  7,672


Income per common share – basic


$    0.30


$    0.48


Weighted average number of shares - basic


15,958,868


16,078,897


Income per common share – diluted


$    0.29


$    0.47


Weighted average number of shares – diluted


16,273,156


16,370,146


Dividends declared per common share


$    0.51


$    0.50


See accompanying notes to consolidated financial statements.

3




BEDFORD PROPERTY INVESTORS, INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

FOR THE THREE MONTHS ENDED MARCH 31, 2004

(Unaudited)

(in thousands, except per share amounts)


 


Series A

Preferred

Stock



Common

Stock


Additional

Paid-in

Capital


Deferred

Stock

Compensation

Accumulated

Dividends

in Excess of

Net Income

Accumulated

Other

Comprehensive

Income (loss)


Total

Stockholders'

Equity


Balance, December 31, 2003


$38,947


$326


$289,734


$(5,476)


$(19,721)


$   89


$303,899


Issuance of common stock


-


2


1,562


-


-


-


1,564


Repurchase and retirement of

  common  stock



-



(1)



(1,124)



-



-



-



(1,125)


Stock option expense


-


-


30


-


-


-


30


Issuance of restricted stock


-


3


4,363


(4,366)


-


-


-


Forfeiture of restricted stock


-


-


(25)


25


-


-


-


Amortization of restricted

  stock



-



-



-



686



-



-



686


Dividends to common

 stockholders ($0.51 per share)



-



-



-



-



(8,417)



-



(8,417)


Dividends to preferred

 stockholders ($1.09375 per share)



-



-



-



-



(880)



-



(880)

Subtotal

38,947

330

294,540

(9,131)

(29,018)

89

295,757


Net income


-


-


-


-


5,616


-


5,616

Other comprehensive loss

-

-

-

-

-

(128)

(128)

Comprehensive income (loss)

-

-

-

-

5,616

(128)

5,488


Balance, March 31, 2004


$38,947


$330


$294,540


$(9,131)


$(23,402)


$(39)


$301,245



See accompanying notes to consolidated financial statements.

4




BEDFORD PROPERTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED MARCH 31, 2004 AND 2003

(Unaudited)

(in thousands)


 

                  2004

 2003

Operating Activities:

  Net income


$   5,616


$     7,672

  Adjustments to reconcile net income to net cash

     provided by operating activities:

  

        Depreciation and amortization, including amortization

           of deferred loan costs


7,401


5,413

        Amortization of deferred compensation

686

582

        Stock compensation expense

30

54

        Uncollectible accounts expense

88

(23)

        Change in other assets

(936)

216

        Change in accounts payable and accrued expenses

(419)

(3,705)

        Change in other liabilities

(284)

(556)


Net cash provided by operating activities


12,182


9,653


Investing Activities:

  Investments in real estate



(2,133)



(772)


Net cash used by investing activities


(2,133)


(772)


Financing Activities:

  Proceeds from bank loans payable, net of loan costs



7,841



26,834

  Repayments of bank loans payable

(6,000)

(53,208)

  (Payment) refund of loan costs

(25)

485

  Proceeds from mortgage loans payable, net of loan costs

-

48,387

  Repayments of mortgage loans payable

(1,728)

(19,539)

  Issuance of common stock

1,564

1,752

  Repurchase and retirement of common stock

(1,125)

(2,272)

  Payment of dividends and distributions

(9,199)

(8,222)


Net cash used by financing activities


(8,672)


(5,783)


Net increase in cash and cash equivalents


1,377


3,098

Cash and cash equivalents at beginning of period

7,598

3,727


Cash and cash equivalents at end of period


$   8,975


$     6,825


Supplemental disclosure of cash flow information:

Cash paid for interest, net of amounts capitalized of

   $139 in 2004 and $37 in 2003




$   5,686




$     5,148


Cash paid during the year for income taxes


$        12


$        300


See accompanying notes to consolidated financial statements


5





BEDFORD PROPERTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2004



Note 1 - Organization and Summary of Significant Accounting Policies and Practices

 

The Company

Bedford Property Investors, Inc. is a real estate investment trust (REIT) incorporated in 1993 as a Maryland corporation. We are a self-administered and self-managed equity REIT engaged in the business of owning, managing, acquiring and developing industrial and suburban office properties concentrated in the western United States. Our common stock, par value $0.02 per share, trades under the symbol "BED" on both the New York Stock Exchange and the Pacific Exchange.


Basis of Presentation

We have prepared the accompanying unaudited interim financial statements in accordance with the requirements of Form 10-Q as set forth by the United States Securities and Exchange Commission. Therefore, they do not include all information and footnotes necessary for a presentation of financial condition, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America (GAAP). In our opinion, the interim financial statements presented reflect all adjustments, consisting only of normally recurring adjustments, which are necessary for a fair presentation of our financial condition and results of operations. These unaudited financial statements should be read in conjunction with the notes to the 2003 audited financial statements contained in our annual report on Form 10-K for the year ended December 31, 2003.


Basis of Consolidation

Our consolidated financial statements have been prepared in accordance with GAAP. Our consolidated financial statements include the financial information of Bedford Property Investors, Inc., six wholly-owned corporations, and three wholly-owned limited liability companies. All significant inter-entity balances have been eliminated in consolidation.


Stock-Based Compensation

In prior years, we accounted for our stock-based compensation plans using the intrinsic value method prescribed by Accounting Principles Board Opinion (APB) 25 and all related interpretations. As of January 1, 2003, we adopted Statement of Financial Accounting Standards (SFAS) 148, “Accounting for Stock-Based Compensation — Transition and Disclosure — an amendment of SFAS 123,” on a modified prospective basis. SFAS 148 amends SFAS 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. The impact of adopting SFAS 148 in accordance with the modified prospective basis was an increase in compensation expense of $30,000 and $54,000 in the three months ended March 31, 2004 and 2003, respectively.


Per Share Data

Per share data are based on the weighted average number of shares of our common stock outstanding during the year. We include stock options issued under our stock option plans and non-vested restricted stock in the calculation of diluted per share data if, upon exercise or vestiture, they would have a dilutive effect.


6





Recent Accounting Pronouncements

In December 2003, the FASB issued FIN 46-R, “Consolidation of Variable Interest Entities – an interpretation of ARB No. 51.” FIN 46-R requires that any entity meeting certain rules relating to a company’s equity investment at risk and level of financial control be consolidated as a variable interest entity. The statement is applicable to all variable interest entities created or acquired after January 31, 2003, and the first interim or annual reporting period beginning after December 15, 2003, for variable interest entities in which a company holds a variable interest that was acquired before February 1, 2003. We have adopted FIN 46-R in the time frames as required by the statement. There is no significant effect on our financial position, results of operations, or cash flows as a result of the initial adoption of this standard in regard to existing variable interest entities; however, future newly formed entities could meet these requirements and will be recorded as appropriate. At March 31, 2004, we did not own any equity investments created or acquired after January 31, 2003, that qualified as variable interest entities.


Reclassifications

Certain amounts in the prior period financial statements have been reclassified to conform to the current period presentation, with no effect on our financial position, cash flows, or net income.



7




Note 2 – Real Estate Investments


As of March 31, 2004, our real estate investments were diversified by property type as follows (dollars in

thousands):


 

Number of

Properties

Gross

Cost

Percent

of Total


Industrial buildings


61


$416,370


52%

Office buildings

30

342,956

43%

Properties under development

3

32,052

4%

Land held for development

9

12,335

1%


Total


103


$803,713


100%


The following table sets forth our real estate investments at March 31, 2004 and December 31, 2003 (in thousands):


 



Land



Building


Development

In-Progress

           Less

Accumulated

Depreciation



Total


Industrial buildings

Northern California



$  68,084



$138,863



$            -



$23,265



$183,682

Arizona

25,643

83,463

-

11,659

97,447

Southern California

17,235

42,377

-

7,652

51,960

Northwest

3,408

10,825

-

3,502

10,731

Nevada

7,787

18,685

-

490

25,982


Total industrial buildings


122,157


294,213


-


46,568


369,802


Office buildings

Northern California



6,073



25,500



-



4,403



27,170

Arizona

10,588

25,875

-

3,793

32,670

Southern California

15,414

50,731

-

4,174

61,971

Northwest

6,648

77,319

-

10,892

73,075

Colorado

13,706

97,639

-

11,828

99,517

Nevada

2,102

11,361

-

1,963

11,500


Total office buildings


54,531


288,425


-


37,053


305,903


Properties under development

Southern California



-



-



1,854



-



1,854

Northwest

-

-

30,198

-

30,198


Total properties under development


-


-


32,052


-


32,052


Land held for

  development

Northern California




5,893




-




-




-




5,893

Arizona

637

-

-

-

637

Southern California

710

-

-

-

710

Northwest

1,146

-

-

-

1,146

Colorado

3,949

-

-

-

3,949


Total land held for development


12,335


-


-


-


12,335


Total as of March 31, 2004


$189,023


$582,638


$32,052


$83,621


$720,092


Total as of December 31, 2003


$200,836


$603,471


$          -


$81,638


$722,669

8




Our personnel directly manage all but three of our properties from regional offices in Lafayette, California; Tustin, California; Phoenix, Arizona; Denver, Colorado; and Seattle, Washington. We have retained outside managers to assist in some of the management functions for U.S. Bank Centre in Reno, Nevada; Russell Commerce Center in Las Vegas, Nevada; and Northport Business Center in North Las Vegas, Nevada. All financial record keeping is centralized at our corporate office in Lafayette, California.


Note 3. Debt


Bank Loans Payable


On March 31, 2004, we renewed our revolving credit facility with a six-bank lending group led by Bank of America. The facility, which matures on March 31, 2007, consists of a $150 million secured line with an accordion feature that gives us the option to expand the facility to $200 million, if needed. Interest on the facility is at a floating rate equal to either the lender’s prime rate or LIBOR plus a margin ranging from 1.30% to 1.75%, depending on our leverage level as defined in the credit agreement. As of March 31, 2004, the facility had a total outstanding balance of $72,175,000 and an effective interest rate of 3.62%, and was collateralized by our interests in 21 properties. These properties collectively accounted for approximately 23% of our annualized base rent for 2004 and approximately 23% of our total real estate assets at March 31, 2004.


Including both the current $150 million revolving credit facility and the $40 million unsecured bridge facility that existed at March 30, 2003, the daily weighted average outstanding balances were $71,683,000 and $131,882,000 for the three months ended March 31, 2004 and 2003, respectively. The weighted average annual interest rates under the credit facilities in each of these periods were 2.79% and 3.55%, respectively.


The credit facilities contain various restrictive covenants including, among other things, a covenant limiting quarterly dividends to 95% of our average Funds From Operations (FFO). We were in compliance with the various covenants and requirements of our credit facilities during the three months ended March 31, 2004 and during the year ended December 31, 2003.



9




Mortgage Loans Payable


Mortgage loans payable at March 31, 2004 consist of the following (in thousands):



    

Collateral as of March 31, 2004



Lender



Maturity Date


Interest Rate at

March 31, 2004 +



Balance


Number of

Properties

% of Annualized

Base Rent

% of Total

Real Estate

Assets

Union Bank

November 19, 2004

3.01%(1)

$  20,531

9

3.75%

3.72%

TIAA-CREF

June 1, 2005

7.17%

25,126

5

5.42%

4.22%

Security Life of Denver

 Insurance Company


September 1, 2005


3.00%(2)


21,313


6


3.46%


3.80%

Security Life of Denver

 Insurance Company


September 1, 2005


3.00%(2)


3,305


2


0.84%


0.85%

Nationwide Life

 Insurance


November 1, 2005


4.61%


21,938


4


4.35%


4.53%

Prudential Insurance

July 31, 2006

8.90%

7,641

1

2.46%

1.68%

Prudential Insurance

July 31, 2006

6.91%

18,534

4

6.33%

4.85%

TIAA-CREF

December 1, 2006

7.95%

20,731

5

3.70%

4.20%

TIAA-CREF

June 1, 2007

7.17%

34,175

4

6.61%

5.57%

John Hancock

December 1, 2008

4.60%

11,800

5

2.67%

3.08%

Sun Life Assurance Co.

April 1, 2009

7.00%

1,642

1

0.74%

0.79%

Sun Life Assurance Co.

April 1, 2009

7.25%

1,459

*

*

*

TIAA-CREF

June 1, 2009

7.17%

39,917

8

8.71%

9.21%

John Hancock

December 1, 2010

4.95%

27,900

3

6.66%

5.44%

Washington Mutual

August 1, 2011

3.84%(3)

16,664

1

-

3.76%

TIAA-CREF

April 1, 2013

5.60%

47,913

5

8.10%

6.54%

Bank of America

November 1, 2013

5.45%

9,900

1

1.97%

2.09%

Bank of America

December 1, 2013

5.55%

11,400

4

2.32%

2.70%

JP Morgan

December 1, 2013

5.74%

24,925

1

5.50%

4.27%

 


Total

 


$366,814


69


73.59%


71.30%


(1)

Floating rate based on LIBOR plus 1.60%. The interest rate of 3.01% is fixed to maturity.

(2)

Floating rate based on 30-day LIBOR plus 1.40% (adjusted monthly). Effective July 3, 2003, the floating 30-day LIBOR rate was swapped to a fixed rate of 1.595% for an all-in rate of 2.995% until maturity.

(3)

Floating rate based on a 12-month average of U.S. Treasury security yields plus 2.60% (adjusted semi-annually).

+

Interest rates are fixed unless otherwise indicated by footnote.

*

The two Sun Life Assurance Company mortgages are collateralized by a single property.


We were in compliance with the covenants and requirements of our various mortgages during the three months ended March 31, 2004 and during the year ended December 31, 2003.

  

The following table presents scheduled principal payments on mortgage loans for each of the twelve-month periods ending March 31 (in thousands):


2005

$  27,106

2006

74,690

2007

48,697

2008

35,399

2009

15,643

Thereafter

165,279

     Total

$366,814


10


Note 4.  Stockholders' Equity


On August 5, 2003, we issued and sold 805,000 shares of our 8.75% Series A Cumulative Redeemable Preferred Stock at a price of $50.00 per share for a total of $40,250,000. The offering was made only to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended. We pay cumulative dividends on the shares from the date of original issuance at the rate of 8.75% of the $50.00 liquidation preference per share per year, which is equivalent to $4.375 per share per year. Dividends on the shares are paid quarterly in arrears. The initial dividend of $685,000 was declared on October 1, 2003 and paid on October 15, 2003 for the period from August 5, 2003 through October 14, 2003. A dividend of $880,000 was declared on January 2, 2004 and paid on January 15, 2004 for the period from October 15, 2003 through January 14, 2004. Dividends are recorded when declared.


The Series A preferred shares have no stated maturity, are not subject to any sinking fund or mandatory redemption, and are not convertible into any other securities. The shares are redeemable at our option beginning in August 2008, or earlier if necessary in limited circumstances to preserve our status as a REIT.


The net proceeds of approximately $39 million from the sale of the Series A preferred stock were used to finance a portion of the $85 million in property acquisitions during the third and fourth quarters of 2003.


The following schedule presents changes in the number of outstanding shares of common stock and preferred stock during the period from January 1, 2004 through March 31, 2004 (in thousands):


 

Common

Stock

 

Preferred

Stock

    

Balance, December 31, 2003

16,311,955

 

805,000

Issuance of common stock

79,935

 

-

Repurchase and retirement of common

  Stock (1)


(38,885)

 


-

Issuance of restricted stock

151,899

 

-

Forfeiture of restricted stock

(1,033)

 

-

Balance, March 31, 2004

16,503,871

 

805,000


(1)

Repurchases of common stock only include shares acquired from employees in consideration for satisfying payroll tax obligations and  in connection with stock option exercises.


11




 Note 5. Segment Disclosure


We have five reportable segments organized by the regions in which we own properties as follows: Northern California (Northern California and Nevada), Arizona, Southern California, Northwest (greater Seattle, Washington and Portland, Oregon) and Colorado.


The accounting policies of the segments are the same as those described in the summary of significant accounting policies. We evaluate performance based upon income from property operations from the combined properties in each segment.


 

For the three months ended March 31, 2004 (in thousands, except percentages)

        
 

Northern

California


Arizona

Southern

California


Northwest


Colorado

Corporate

& Other


Consolidated


Rental income


$    9,395


$    5,043


$    5,701


$    4,413


$  3,496


$          -


$  28,048

Operating expenses and

   real estate taxes


2,176


1,502


1,246


1,569


1,423


-


7,916

Depreciation and

    amortization


1,924


1,289


1,679


921


1,095


-


6,908


Income from property

    operations



5,295



2,252



2,776



1,923



978



-



13,224


General and administrative

    expenses



-



-



-



-



-



(1,506)



(1,506)

Interest income (1)

6

-

-

3

-

10

19

Interest expense

-

-

-

-

-

(6,121)

(6,121)


Net income (loss)


$    5,301


$    2,252


$    2,776


$    1,926


$    978


$(7,617)


$    5,616


Percent of income from

    property operations



40%



17%



21%



15%



7%



-



100%


Real estate investments


$257,875


$146,207


$154,793


$129,544


$115,294


$          -


$803,713


Additions of real

    estate investments (2)



$    1,491



$       238



$       719



$ (3,075)



$         33



$          -



$    (594)


Total assets


$274,580


$133,257


$157,063


$117,260


$  87,022


$  2,688


$771,870

        


(1)

The interest income in the Northern California and Northwest segments represents interest earned from tenant notes receivable.

(2)

The negative amount in the Northwest segment is due to the transfer of an operating property to development at net book value.



12





 

For the three months ended March 31, 2003 (in thousands, except percentages)

        
 

Northern

California


Arizona

Southern

California


Northwest


Colorado

Corporate

& Other


Consolidated


Rental income


$  10,535


$     4,519


$     3,528


$     4,739


$     3,632


$          -


$  26,953

Operating expenses and

   real estate taxes


2,270


1,460


691


1,385


1,448


-


7,254

Depreciation and

    amortization


    1,626


       946


       564


       949


       825


         -


     4,910


Income from property

    operations



6,639



2,113



2,273



2,405



1,359



-



14,789


General and administrative

    expenses



-



-



-



-



-



(1,684)



(1,684)

Interest income (1)

8

-

-

9

-

22

39

Interest expense

           -

           -

           -

           -

           -

 (5,472)

  (5,472)


Net income (loss)


$    6,647


$    2,113


$    2,273


$    2,414


$    1,359


$ (7,134)


$    7,672


Percent of income from

    property operations



     45%



     14%



     16%



     16%



       9%



           -



   100%


Real estate investments


$257,027


$132,843


$  92,150


$132,257


$111,553


$           -


$725,830


Additions of real

    estate investments



$         74



$         65



$       195



$       138



$       170



$           -



$       642


Total assets


$268,193


$118,411


$106,632


$118,837


$  78,845


$   1,244


$692,162




(1)

The interest income in the Northern California and Northwest segments represents interest earned from tenant notes receivable.








13




Note 6.  Earnings Per Share


Following is a reconciliation of earnings per share (in thousands, except share and per share amounts):


 

Three Months Ended

March 31, 2004

 

Three Months Ended

March 31, 2003

Basic:

   

Net income

$    5,616

 

$    7,672

Less:  preferred dividends – Series A

(880)

 

           -


Net income available to common stockholders


$    4,736

 


$    7,672


Weighted average number of shares - basic


15,958,868

 


16,078,897


Income per common share – basic


$      0.30

 


$      0.48


Diluted:

   

Net income

$    5,616

 

$    7,672

Less:  preferred dividends – Series A

(880)

 

           -


Net income available to common stockholders


$    4,736

 


$    7,672


Weighted average number of shares – basic


15,958,868

 


16,078,897

Weighted average shares of dilutive stock

       options using average period stock price

       under the treasury stock method



147,685

 



158,277

Weighted average shares of non-vested

        restricted stock using average period

        stock price under the treasury stock method



166,603

 



132,972


Weighted average number of shares – diluted


16,273,156

 


16,370,146


Income per common share – diluted


$      0.29

 


$     0.47


Since their effect would have been antidilutive, 187 and 167,000 of our stock options and restricted stock awards have been excluded from the weighted average number of shares - diluted for the three months ended March 31, 2004 and 2003, respectively.

14




Note 7. Related Party Transactions


We occasionally use the services of the law firm Bartko, Zankel, Tarrant & Miller of which a member of our Board of Directors, Martin I. Zankel, is a partner. During the three months ended March 31, 2004 and 2003, we paid Bartko, Zankel, Tarrant & Miller approximately $200 and $26,000, respectively.

 

Note 8. Commitments and Contingencies


As of March 31, 2004, we had outstanding contractual construction commitments of approximately $2 million relating to development in progress and tenant improvements on recently developed properties. We had outstanding undrawn letters of credit against our credit facility of approximately $6,657,000 as of March 31, 2004.


From time to time, we are subject to legal claims in the ordinary course of business. We are not aware of any legal proceedings or claims that we believe will have, individually or in the aggregate, a material adverse effect on our business, prospects, financial condition, operating results or cash flows.


Note 9. Subsequent Events


On April 1, 2004, we declared dividends on our Series A preferred stock of approximately $880,000 for the period from January 15, 2004 through April 14, 2004. On April 15, 2004, these dividends were paid to the holders of our Series A preferred stock.


On April 6, 2004, we completed a public offering of 2,400,000 shares of our 7.625% Series B Cumulative Redeemable Preferred Stock at $25 per share. Dividends on the Series B preferred stock are cumulative from the date of original issuance and are payable quarterly in arrears, beginning on July 15, 2004. We may not redeem the Series B preferred stock before April 6, 2009, except under limited circumstances to preserve our status as a real estate investment trust. Beginning on April 6, 2009, we may redeem the Series B preferred stock, in whole or in part, for cash at $25 per share plus accrued and unpaid dividends, if any, to and including the redemption date. The Series B preferred stock has no maturity date and will remain outstanding indefinitely unless redeemed.


On April 5, 2004, we purchased a 111,200 square-foot office building in Scottsdale, Arizona for $17,310,000. The acquisition was funded by the proceeds from the Series B preferred stock offering.


On April 8, 2004, we purchased a two-building 126,809 square-foot office/R&D complex in Hillsboro, Oregon for $19,390,000. The acquisition was funded by the proceeds from the Series B preferred stock offering.


On April 15, 2004, we purchased a 2.27 acre lot in Las Vegas, Nevada for $700,000. The acquisition was funded by the proceeds from the Series B preferred stock offering.


On April 21, 2004, we purchased a 130,639 square-foot industrial building in Phoenix, Arizona for $9,145,000. The acquisition was funded by the proceeds from the Series B preferred stock offering.

15


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations



GENERAL


Bedford Property Investors, Inc. is a self-administered and self-managed equity real estate investment trust (REIT). We own, manage, acquire and develop industrial and suburban office properties proximate to metropolitan areas in the western United States. As of March 31, 2004, we owned 91 operating properties totaling approximately 7.5 million rentable square feet and 9 parcels of land totaling approximately 46 acres. In addition, we owned one office building that is currently being redeveloped and two parcels of land currently under development. Of the 91 operating properties, 61 are industrial buildings and 30 are suburban offices. Our properties are located in Northern California, Southern California, Arizona, Washington, Colorado, and Nevada.


The following discussion and analysis of financial condition and results of operations should be read in conjunction with the financial statements and notes to financial statements included in this report, as well as our annual report on Form 10-K for the year ended December 31, 2003. When used in the following discussion, the words “believe,” “expect,” “intend,” “plan,” “anticipate” and similar expressions are intended to identify forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed, expected or implied by the forward-looking statements. These risks and uncertainties are described in our filings with the Securities and Exchange Commission, including our annual report on Form 10-K, and are set forth in the section below entitled "Potential Factors Affecting Future Operating Results." Readers are cautioned not to place undue reliance on these forward-looking statements because they only reflect information available as of the date of this filing. We do not undertake to update forward-looking information contained herein or elsewhere to reflect actual results, changes in assumptions or changes in other factors affecting such forward-looking information.


OVERVIEW


Significant Events During the Quarter


On March 31, 2004, we renewed our revolving credit facility with a six-bank lending group led by Bank of America. The facility, which matures on March 31, 2007, consists of a $150 million secured line with an accordion feature that gives us the option to expand the facility to $200 million, if needed. Interest on the facility is at a floating rate equal to either the lender’s prime rate or LIBOR plus a margin ranging from 1.30% to 1.75%, depending on our leverage level as defined in the credit agreement.


Market Conditions


The Northwest Region


We believe that the Puget Sound area is still experiencing the effects of significant job loss resulting from the technology and telecommunication slowdown. We also believe that these economic conditions have affected most commercial real estate markets causing excess space, both direct and sub-lease, and weaker deal terms. At March 31, 2004, our Northwest operating portfolio was 92% occupied with 55,000 square feet vacant in three properties. We believe that this comparatively strong occupancy has insulated us from the worst effects of local market conditions. In February 2004, one of our largest tenants in this region vacated our 334,000 square-foot five-building complex upon expiration of its lease. We have transferred this property to our development portfolio and have commenced a program to re-position the asset with plans to introduce it to the market as a campus-style office park in mid-2004.


The Northern California Region


Our properties in Northern California are located throughout the San Francisco Bay Area and include one property in Reno, Nevada. The Bay Area market has been impacted by the technology industry slowdown, particularly in the Silicon Valley area, where we own 14 properties totaling 1,207,865 square feet. In this sub-market, we believe that the job loss

16


associated with the recent recession has been significant, resulting in increased vacancy and reduced rental rates. In addition, we expect higher than usual lease expirations in the Silicon Valley during the next two years, which create the potential for increasing vacancy in our portfolio. In order to retain good credit tenants in the current market, we have engaged in a strategy to negotiate lower rental rates in exchange for extended lease terms, which we refer to as “blend and extend” leases.


Another Bay Area sub-market that has demonstrated weakness during the last two years is the South San Francisco industrial market. In this sub-market, we have faced rental rate declines in renewals and an increase in the vacancy rate of our five-building portfolio from 1% at the end of 2002 to 24% at the end of 2003. In the first quarter of 2004, this market showed some improvement, and we were able to reduce our vacancy rate to 12%. However, weak demand and a surplus of space continue to create a depressed market. Other Bay Area sub-markets have not been as dramatically affected as the Fremont, Milpitas, and San Jose markets in Silicon Valley and the South San Francisco industrial market. In Sonoma County, Napa County, and Contra Costa County, while demand has slowed during the past two years, vacancy rates have not climbed to the extent they have in the Silicon Valley.


The Southern California Region


In Southern California, we have properties in three relatively healthy sub-markets. These sub-markets are Orange County, San Diego, and the Inland Empire. We have two properties in Orange County and maintained them at, or close to, 100% leased during 2003 and in the first quarter of 2004. In the Inland Empire, we have a bulk industrial property in Ontario, California, which was 96% leased on March 31, 2004. Additionally, we have two new development properties, the Jurupa Business Center Phase I, which was 100% leased as of March 31, 2004, and Jurupa Business Center Phase II, which was 76% leased as of March 31, 2004. Finally, in San Diego, we were 100% occupied during the year 2003. In one of our San Diego properties, we had an early termination on January 31, 2004 in a 50,000 square-foot single-tenant building. As of March 31, 2004, this building was vacant; however, we have subsequently re-leased the building with the lease commencing on May 1, 2004.


The Arizona Region


Most of our properties in Arizona are in Phoenix, a market that has been characterized by the same weakness in demand for office, R&D, and industrial space that we have experienced in our other regions. We have responded to these challenges by improving our marketing processes and the marketability of our vacant spaces. We are making capital improvements to our vacant spaces to render them to near move-in condition for prospective tenants. Notwithstanding these efforts, however, leasing in Phoenix remains a slow process, and we expect our vacant suites to remain vacant for longer periods than we have previously experienced.


The Colorado Region


All of our properties in Colorado are in the southeast Denver suburban office market. We believe that market conditions in Denver reflect the job loss experienced during the last several years, similar to our other markets. In July 2003, we were successful in executing a significant lease with a large insurance company for the top two floors of our 4601 DTC Boulevard property, representing 20% of the total square footage of the building. This ten-story office property is 80% leased to a single tenant under a lease that will expire on January 31, 2005, and that tenant has notified us that it does not plan to renew. We are planning to make significant capital improvements to the property during 2004 in preparation of this anticipated vacancy.

17


Future Trends and Events


Acquisitions


In April 2004, we purchased three properties and a 2.27 acre parcel of land totaling approximately $46.5 million. We plan to continue to seek out potential acquisition properties that meet our required capitalization rate and have stabilized rents. While capitalization rates continue to remain low as the result of the large amount of capital available in the market place and the low cost of debt, we have been successful at identifying several properties that we believe will enhance our portfolio. We plan to purchase an additional $150 million of properties during the remainder of 2004; however, such purchases will be dependent upon the availability of properties that meet our requirements.


Dispositions


We currently do not have plans to dispose of any properties. However, with the low capitalization rate market, we plan to continually evaluate potential sales as an exit and support strategy to our property acquisition and share repurchase programs.


Development and Redevelopment


In response to decreasing demand for office and industrial space, our development activities over the past two years have been limited to our Jurupa Business Center project in Ontario, California. As of March 31, 2004, the 41,726 square-foot phase I was 100% leased, and the 41,390 square-foot phase II, which was shell complete in December 2002, was 76% leased. In March 2004, we commenced development on the final two phases, phases III and IV. Both phases will be constructed concurrently over an expected 7-month period, taking advantage of the project momentum generated with the recent leasing activities of phases I and II. We estimate the total cost of construction of these two phases, including the purchase price of the land, to be approximately $6.1 million.


In March 2004, we also began our redevelopment of the recently vacated 334,000 square-foot five-building facility in Renton, Washington. The construction process for site work, shell enhancement, construction of lobbies, and the upgrade of common areas is expected to take place over a 48-month period. The construction will be completed in phases, with the completion and leasing of some of the buildings occurring prior to the end of the 48-month period. We expect to incur costs of approximately $21.5 million to renovate and re-tenant the project.  


Capital Expenditures


We expect higher than usual lease expirations in our portfolio during 2004 and 2005. As a result, we expect to incur higher capital expenditures, including the costs of leasing commissions and tenant improvements, related to renewing or replacing the expiring leases. In several instances, these lease expirations may occur in markets that have experienced considerable weakness due to job loss and excess inventory. This market weakness, combined with a higher level of lease expirations, may require us to incur more capital expenditures to renew or re-lease these spaces then we have experienced historically.


In addition, we anticipate renovating several older properties that are currently leased by tenants who may not renew their leases. We believe that these renovations are necessary to render the properties competitive in their respective markets.


The combination of these two situations will require that we manage our capital resources carefully. We intend to closely monitor these situations and continually assess our actual expenditures against our planned expenditures. We believe that we will have sufficient funds to meet the needs of these situations. We plan to spend approximately $14.5 million in capital expenditures during 2004, of which approximately $2.5 million has been spent during the first quarter.


18


Share Repurchases


Since the inception of our share repurchase program in November of 1998, we have repurchased a total of 8,071,137 shares of our common stock at an average cost of $18.79 per share, which represents 36% of the shares of common stock outstanding at November 1998. We intend to continue to repurchase shares of our common stock on the open market when the opportunities exist. Our share repurchase strategy takes into consideration several factors, including the dividend yield on our stock price, the cost of capital and its alternative uses, existing yields on potential acquisitions, market trading volume, trading regulations, and debt covenants. We currently have board approval to repurchase up to a total of 10 million shares of our common stock. We did not repurchase any shares of our common stock on the open market during the quarter ended March 31, 2004.


Occupancy and Rental Rates


As of March 31, 2004, our portfolio was 92% occupied, a decrease of one percentage point over the prior quarter. Occupancy has been our highest priority during the recent economic downturn. In order to retain tenants in the current market, we sometimes find it necessary to negotiate lower rental rates in exchange for extended terms, which we refer to as “blend and extend” leases. While this has a negative impact on our income from operations, we believe the impact of losing good credit tenants would surpass the incremental loss due to reduced rental rates. During the first quarter of 2004, we renewed or re-leased 94% of the expiring square footage and experienced a 20% decline in weighted average rental rates on these leases. We intend to continue this strategy of maximizing our occupancy until market conditions improve.


Leasing


During the three months ended March 31, 2004, we successfully renewed or re-leased 30 leases, or 94% of our expiring square footage.


Over the next three years, we will be facing significant lease rollovers. During the remainder of 2004, 2005, and 2006, leases representing 11%, 23%, and 17% of annualized base rent, respectively, will expire. The expirations as a percentage of annualized base rent by region are as follows:



 

2004

2005

2006

Northern California

5%

9%

6%

Arizona

2%

3%

3%

Southern California

1%

3%

5%

Northwest

1%

2%

1%

Colorado

1%

5%

1%

Nevada

1%

1%

1%

     Total

11%

23%

17%



In order to be successful in sustaining our occupancy, we have developed a plan to focus our attention on a group of 90 tenants. At the time we implemented the plan in the second quarter 2003, these “mighty ninety” tenants represented approximately 20% of our tenant population and over 50% of our annualized base rent, with leases expiring through the end of 2006.  For each of these tenants, we are taking a proactive approach by creating specific strategies for renewal, which may include blend and extend offers, early renewals, and other appropriate measures. As of March 31, 2004, we had renewed or re-leased 26 of these leases, nine of which were "blend and extend" leases.


19


CRITICAL ACCOUNTING POLICIES AND ESTIMATES


The preparation of our financial statements in accordance with accounting principles generally accepted in the United States of America requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We believe that our critical accounting policies are those that require significant judgments and estimates such as those related to valuation of real estate investments, revenue recognition, allowance for doubtful accounts, stock compensation expense, and qualification as a REIT. These estimates are made and evaluated on an on-going basis using information that is currently available as well as various other assumptions believed to be reasonable under the circumstances. Actual results could vary from those estimates, and those estimates could be different under different assumptions or conditions.


Real Estate Investments


Real estate investments are recorded at cost less accumulated depreciation. The cost of real estate includes purchase price, other acquisition costs, and costs to develop properties which include interest and real estate taxes. In accordance with Statement of Financial Accounting Standards (SFAS) 141, “Business Combinations,” a portion of the purchase price is allocated to tenant improvements and identifiable intangible assets or liabilities. For acquired properties with rental guarantees from the seller, amounts received under the rental guarantee are recorded as a reduction to the basis of the asset upon receipt. Expenditures for maintenance and repairs that do not add to the value or prolong the useful life of the property are expensed. Expenditures for asset replacements or significant improvements that extend the life or increase the property’s value are capitalized. Real estate properties are depreciated using the straight-line method over estimated useful lives. When circumstances such as adverse market conditions indicate an impairment of a property, we will recognize a loss to the extent that the carrying value exceeds the fair value of the property.


Revenue Recognition and Allowance for Doubtful Accounts


Base rental income is recognized on a straight-line basis over the terms of the respective lease agreements. Differences between rental income recognized and amounts contractually due under the lease agreements are credited or charged, as applicable, to rent receivable. The amount of straight-line rent receivable is charged against income upon early termination of a lease or as a reduction of gain on sale of the property. Lease termination income is recorded in the period the lease terminates according to the lease termination agreement. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of tenants to make required payments, which results in a reduction to income. Management determines the adequacy of this allowance by continually evaluating individual tenant receivables considering the tenant’s financial condition, security deposits, letters of credit, lease guarantees, and current economic conditions.


Stock Compensation Expense


Beginning January 1, 2003, we voluntarily adopted the recognition provisions of SFAS 123, “Accounting for Stock-Based Compensation,” using the modified prospective method as prescribed in SFAS 148, “Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of SFAS 123.” The modified prospective method provides for the calculation of the compensation expense as if the fair value based accounting method had been used to account for all stock options granted in fiscal years after December 15, 1994.


20


Qualification as a REIT


We have elected to be taxed as a REIT under Sections 856 to 860 of the Internal Revenue Code of 1986, as amended. A REIT is generally not subject to federal income tax on that portion of real estate investment trust taxable income that is distributed to stockholders, provided that at least 90% of such taxable income is distributed and other requirements are met. If we were to fail to qualify as a REIT, we would be, among other things, required to provide for federal income taxes on our income and reduce the level of distributions made to our stockholders.


RESULTS OF OPERATIONS


Our operations consist of developing, owning and operating industrial and suburban office properties located primarily in the western United States.


Variances in revenues, expenses, net income and cash flows for the three months ended March 31, 2004 when compared with the same period in 2003 were due primarily to the acquisition, development and redevelopment of operating properties as follows:


 


Office Properties


Industrial Properties


Total Operating Properties

 


Number of

Properties


Square

Feet


Number of

Properties


Square

Feet


Number of

Properties


Square

Feet


Total at January 1, 2003


30


2,592,000


56


4,565,000


86


7,157,000

Activity from January 1, 2003 through March 31, 2003:

      

     Development+

-

-

1

41,000

1

41,000

Total at March 31, 2003

30

2,592,000

57

4,606,000

87

7,198,000

       

Activity from April 1, 2003 through March 31, 2004:

      

     Acquisitions

1

205,000

4

454,000

5

659,000

     Redevelopment++

(1)

(334,000)

-

-

(1)

(334,000)

Total at March 31, 2004

30

2,463,000

61

5,060,000

91

7,523,000


+

The property is included as development based on the date of shell completion.

++

The property was transferred from operating to development on March 1, 2004 as a redevelopment project.


Three Months Ended March 31, 2004 Compared with Three Months Ended March 31, 2003


Income from Property Operations


Income from property operations (defined as rental income less rental expenses) decreased $1,565,000 or 11% in 2004 compared with 2003. This decrease is attributable to an increase in rental income of $1,095,000, offset by an increase in rental expenses (which include operating expenses, real estate taxes, and depreciation and amortization) of $2,660,000.


21


The following table presents the change in income from property operations for the three months ended March 31, 2004 compared with the same period in 2003, detailing amounts contributed from properties acquired, the property transferred to redevelopment, the property developed, and properties that remained stable during the period from January 1, 2003 to March 31, 2004:


 

Acquisitions

Redevelopment+

Development++

Stabilized

Total

      

Rental income

$2,665,000

$(202,000)

$116,000

$(1,484,000)

$  1,095,000

Rental expenses:

     Operating expenses


(441,000)


(4,000)


(12,000)


91,000


(366,000)

     Real estate taxes

(171,000)

(63,000)

(10,000)

(52,000)

(296,000)

     Depreciation and

           amortization


(1,245,000)


43,000


(52,000)


(744,000)


(1,998,000)

Total rental expenses

(1,857,000)

(24,000)

(74,000)

(705,000)

(2,660,000)

Income from property

     operations


$808,000


$(226,000)


$  42,000


$(2,189,000)


$(1,565,000)


+

Includes one property transferred from operating to development on March 1, 2004.

++

Includes one property with a shell completion date of January 1, 2003.


Rental Income


The net increase in rental income of $1,095,000 is primarily attributable to property acquisitions, partially offset by a decrease in rental income on stabilized properties. The decrease in rental income of $1,484,000 on the stabilized properties is generally attributable to decreased rental rates on new leases, renewed leases, and blend and extend leases, as well as decreased occupancy.


Rental Expenses


The net increase in rental expenses of $2,660,000 is primarily attributable to property acquisitions and stabilized properties. The increase in operating expenses on stabilized properties of $705,000 is generally attributable to higher depreciation and amortization. This is due to a greater level of capital improvement spending required to obtain tenants.


General and Administrative Expenses


General and administrative expenses decreased $178,000 or 11% in 2004 compared with 2003, primarily as a result of approximately $167,000 of state income tax refunds in 2004 for the 2001 and 2002 tax years. These refunds were a result of a cost segregation study performed in 2003, which allowed us to accelerate our tax depreciation and therefore reduce our state income tax liability.


Interest Expense


Interest expense, which includes amortization of loan fees, increased $649,000 or 12% in 2004 compared with 2003. The increase is attributable to a higher level of weighted average outstanding debt in 2004 due to the funding of property acquisitions in 2003. The amortization of loan fees was $440,000 and $426,000 in 2004 and 2003, respectively.


22



Dividends


Common stock dividends to stockholders declared for the first quarter of 2004 were $0.51 per share. Common stock dividends to stockholders declared for the first quarter of 2003 were $0.50 per share. Consistent with our policy, dividends were paid in the quarter following the quarter in which they were declared. Dividends on our Series A preferred stock of $880,000, or $1.09375 per share, were declared on January 2, 2004 and paid on January 15, 2004.



LIQUIDITY AND CAPITAL RESOURCES

 

Liquidity


We expect to fund the cost of acquisitions, capital expenditures, costs associated with lease renewals and re-letting of space, repayment of indebtedness, share repurchases, development of properties, and dividends from:

-

cash flow from operations;

-

borrowings under our credit facility and, if available, other indebtedness which may include indebtedness assumed in acquisitions;

-

the sale of certain real estate investments; and

-

preferred stock issuance.


On April 6, 2004, we completed a public offering of 2,400,000 shares of our 7.625% Series B Cumulative Redeemable Preferred Stock at $25 per share. A significant portion of the net proceeds of approximately $58 million was used to finance the purchase of three operating properties and a 2.27 acre parcel of land in April 2004, which totaled approximately $46.5 million.


Our line of credit, which has a total commitment of $150 million plus an accordion feature for expansion of $50 million, had an outstanding balance of $72,175,000 and letters of credit issued and undrawn of $6,657,000 at March 31, 2004, leaving $121,168,000 of available borrowing. We anticipate utilizing this available borrowing as well as other potential sources of financing such as new mortgages and/or additional preferred equity offerings to fund additional acquisitions after April 2004 of approximately $150 million, development costs of approximately $26 million, and capital expenditures of approximately $12 million. We anticipate that the cash flow generated by our real estate investments and funds available under our credit facility will be sufficient to meet our short-term liquidity requirements.


Cash Flows


Operating Activities


Net cash provided by operating activities was $12,182,000 and $9,653,000 for the three months ended March 31, 2004 and 2003, respectively. The increase of $2,529,000 for the three months ended March 31, 2004 as compared to 2003 is primarily due to an increase in rental receipts of $1,975,000, a decrease in real estate tax payments of $1,678,000, and a decrease in payments of general and administrative costs of $651,000. These increases in cash flows were partially offset by increased payments of operating expenses of $129,000, interest expense of $538,000, lease commissions of $176,000 and escrow deposits of $724,000.






23



Investing Activities


Net cash used by investing activities was $2,133,000 and $772,000 for the three months ended March 31, 2004 and 2003, respectively. The increase in cash used for investing activities of $1,361,000 is primarily due to increased spending for building improvements and tenant improvements on existing operating properties.


Financing Activities


Net cash used by financing activities was $8,672,000 and $5,783,000 for the three months ended March 31, 2004 and 2003, respectively. The increase in cash used for financing activities of $2,889,000 was primarily due to decreased proceeds from mortgages of $48,387,000, increased payment of dividends and distributions of $977,000, decreased net loan refunds and payments of $510,000, and decreased proceeds from the issuance of common stock of $188,000, partially offset by net decreased payments and borrowings of $28,215,000 on our credit facilities, decreased payments on mortgages of $17,811,000 due to the payoff of an $18 million mortgage in 2003, and decreased payments to repurchase and retire our common stock of $1,147,000.


Debt Financing


Our ability to continue to finance operations is subject to several uncertainties. For example, our ability to obtain mortgage loans on income producing property is dependent upon our ability to attract and retain tenants and the economics of the various markets in which the properties are located, as well as the willingness of mortgage-lending institutions to make loans secured by real property. Approximately 94% of our real estate investments served as collateral for our existing indebtedness as of March 31, 2004. Our ability to sell real estate investments is partially dependent upon the ability of purchasers to obtain financing at reasonable commercial rates.


We currently have a revolving credit facility with a bank group led by Bank of America. The facility, which matures on March 31, 2007, consists of a $150 million secured line with an accordion feature that allows us at our option to expand the facility to $200 million, if needed. Interest on the facility is at a floating rate equal to either the lender’s prime rate or LIBOR plus a margin ranging from 1.30% to 1.75%, depending on our leverage level. As of March 31, 2004, the facility had an outstanding balance of $72,175,000 and an effective interest rate of 3.62%.







24



Mortgage loans payable at March 31, 2004 consist of the following (in thousands):



    

Collateral as of March 31, 2004



Lender



Maturity Date


Interest Rate at

March 31, 2004 +



Balance


Number of

Properties

% of Annualized

Base Rent

% of Total

Real Estate

Assets

Union Bank

November 19, 2004

3.01%(1)

$  20,531

9

3.75%

3.72%

TIAA-CREF

June 1, 2005

7.17%

25,126

5

5.42%

4.22%

Security Life of Denver

 Insurance Company


September 1, 2005


3.00%(2)


21,313


6


3.46%


3.80%

Security Life of Denver

 Insurance Company


September 1, 2005


3.00%(2)


3,305


2


0.84%


0.85%

Nationwide Life

 Insurance


November 1, 2005


4.61%


21,938


4


4.35%


4.53%

Prudential Insurance

July 31, 2006

8.90%

7,641

1

2.46%

1.68%

Prudential Insurance

July 31, 2006

6.91%

18,534

4

6.33%

4.85%

TIAA-CREF

December 1, 2006

7.95%

20,731

5

3.70%

4.20%

TIAA-CREF

June 1, 2007

7.17%

34,175

4

6.61%

5.57%

John Hancock

December 1, 2008

4.60%

11,800

5

2.67%

3.08%

Sun Life Assurance Co.

April 1, 2009

7.00%

1,642

1

0.74%

0.79%

Sun Life Assurance Co.

April 1, 2009

7.25%

1,459

*

*

*

TIAA-CREF

June 1, 2009

7.17%

39,917

8

8.71%

9.21%

John Hancock

December 1, 2010

4.95%

27,900

3

6.66%

5.44%

Washington Mutual

August 1, 2011

3.84%(3)

16,664

1

-

3.76%

TIAA-CREF

April 1, 2013

5.60%

47,913

5

8.10%

6.54%

Bank of America

November 1, 2013

5.45%

9,900

1

1.97%

2.09%

Bank of America

December 1, 2013

5.55%

11,400

4

2.32%

2.70%

JP Morgan

December 1, 2013

5.74%

24,925

1

5.50%

4.27%

 


Total

 


$366,814


69


73.59%


71.30%


(1)

Floating rate based on LIBOR plus 1.60%. The interest rate of 3.01% is fixed to maturity.

(2)

Floating rate based on 30-day LIBOR plus 1.40% (adjusted monthly). Effective July 3, 2003, the floating 30-day LIBOR rate was swapped to a fixed rate of 1.595% for an all-in rate of 2.995% until maturity.

(3)

Floating rate based on a 12-month average of U.S. Treasury security yields plus 2.60% (adjusted semi-annually).

+

Interest rates are fixed unless otherwise indicated by footnote.

*

The two Sun Life Assurance Company mortgages are collateralized by a single property.


We were in compliance with the various covenants and other requirements of our debt financing instruments during the three months ended March 31, 2004.  






25


CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS


The following summarizes our contractual obligations and other commitments at March 31, 2004, and the effect such obligations could have on our liquidity and cash flow in future periods (in thousands):


 

Amount of Commitment Expiring by Period



Less

Than

1 Year



1-3

Years



4-5

Years



Over 5

Years




Total


Bank loan payable


$          -


$  72,175


$          -


$            -


$  72,175

Mortgage loans payable

27,106

123,387

51,042

165,279

366,814

Interest obligations on bank loan

  and mortgage loans


23,344


38,507


20,943


25,056


107,850

Construction contract

  commitments


2,000


-


-


-


2,000

Standby letters of credit

6,657

-

-

-

6,657


Total


$59,107


$234,069


$71,985


$190,335


$555,496



RELATED PARTY TRANSACTIONS


We occasionally use the services of the law firm Bartko, Zankel, Tarrant & Miller of which a member of our Board of Directors, Martin I. Zankel, is a partner. During the three months ended March 31, 2004 and 2003, we paid Bartko, Zankel, Tarrant & Miller approximately $200 and $26,000, respectively.


OFF-BALANCE SHEET ARRANGEMENTS


At March 31, 2004 and 2003, we did not have any relationships with unconsolidated entities or financial partnerships, including entities often referred to as structured finance or special purpose entities, that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Therefore, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we were engaged in such relationships.


26


POTENTIAL FACTORS AFFECTING FUTURE OPERATING RESULTS


Many factors affect our actual financial performance and may cause our future results to be different from past performance or trends. These factors include the following:


We could experience a reduction in rental income if we are unable to renew or re-let space on expiring leases on current lease terms, or at all.


A significant portion of our leases is scheduled to expire in the near future. As of March 31, 2004, leases representing 11%, 23%, 17%, and 12% of our total annualized base rent were scheduled to expire during the remainder of 2004, 2005, 2006, and 2007, respectively. If the rental rates upon re-letting or renewal of leases were significantly lower than current rates, or if we were unable to lease a significant amount of space on economically favorable terms, or at all, our results of operations could suffer. We are subject to the risk that, upon expiration, some of these or other leases will not be renewed, the space may not be re-let, or the terms of renewal or re-letting, including the costs of required renovations or concessions to tenants, may be less favorable than current lease terms. We could face difficulties re-letting our space on commercially acceptable terms when it becomes available. In addition, we expect to incur costs in making improvements or repairs to our properties required by new or renewing tenants and expenses associated with brokerage commissions payable in connection with the re-letting of space. Similarly, our rental income could be reduced by vacancies resulting from lease expirations or by rental rates that are less favorable than our current terms. If we are unable to promptly renew leases or re-let space or if the expenses relating to tenant turnover are greater than expected, our financial results could be harmed.


Our leases with our 25 largest tenants generate approximately 41% of our base rent, and the loss of one or more of these tenants, as well as the inability to re-lease this space on equivalent terms, could harm our results of operations.


As of March 31, 2004, our 25 largest tenants accounted for approximately 41% of our total annualized base rent. We have been advised by a large tenant in Denver, Colorado, that it will not renew the 190,000 square feet that it currently leases. This tenant, whose lease expires on January 31, 2005, represents approximately 4% of our annualized base rent. The re-leasing of the footage in the Denver market will require considerable capital expenditures and an indeterminate period of time. Further losses of our larger tenants and our inability to re-lease vacated properties on favorable terms could limit our ability to make distributions to our stockholders.


A significant portion of our base rent is generated by properties in California, and our business could be harmed by an economic downturn in the California real estate market or a significant earthquake.


As of March 31, 2004, approximately 54% of our total annualized base rent was generated by our properties located in the State of California. As a result of this geographic concentration, the performance of the commercial real estate markets and the local economies in various areas within California could affect the value of these properties and the rental income from these properties and, in turn, our results of operations. In addition, the geographic concentration of our properties in California in close proximity to regions known for their seismic activity exposes us to the risk that our operating results could be harmed by a significant earthquake.




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Future declines in the demand for office and light industrial space in the greater San Francisco Bay Area could harm our results of operations and, consequently, our ability to make distributions to our stockholders.


Approximately 14% of our net operating income for the three months ended March 31, 2004 was generated by our office properties and flex industrial properties located in the greater San Francisco Bay Area. As a result, our business is somewhat dependent on the condition of the San Francisco Bay Area economy in general and the market for office space in the San Francisco Bay Area in particular. The market for this space in the San Francisco Bay Area is in the midst of one of the most severe downturns of the past several decades. This downturn has been precipitated by the unprecedented collapse of many technology and so-called “dot com” businesses that, during the past several years, had been chiefly responsible for generating demand for and increased prices of local office properties. This downturn has harmed, and may continue to harm, our results of operations. For example, during the first quarter of 2004, we experienced a 20% decline in weighted average rental rates on new leases and renewed leases combined compared to the prior rents for these spaces. In the event this downturn continues or economic conditions in the San Francisco Bay Area worsen, it could harm the market value of our properties, the results derived from such properties and our ability to make distributions to our stockholders.


Real estate investments are inherently risky, and many of the risks involved are beyond our ability to control.


Real property investments are subject to numerous risks. The yields available from an equity investment in real estate depend on the amount of income generated and costs incurred by the related properties. If the properties in which we invest do not generate sufficient income to meet costs, including debt service, tenant improvements, third-party leasing commissions, and capital expenditures, our results of operations and ability to make distributions to our stockholders could suffer. Revenues and values of our properties may also be harmed by a number of other factors, some of which are beyond our control, including:


-

the national economic climate;

-

the local economic climate;

-

local real estate conditions, including an oversupply of space or a reduction in demand for real estate in an area;

-

the attractiveness of our properties to tenants;

-

competition from other available space;

-

our ability to provide adequate maintenance and insurance to cover other operating costs, government regulations and changes in real estate, zoning or tax laws, and interest rate levels;

-

the availability of financing; and

-

potential liabilities under environmental and other laws.



28





If our tenants experience financial difficulty or seek the protection of bankruptcy laws, our cash from operating activities could suffer.


Our commercial tenants may, from time to time, experience downturns in their business operations and finances due to adverse economic conditions, which may result in their failure to make rental payments to us on a timely basis or at all. Missed rental payments, in the aggregate, could impair our cash flows and, as a result, our ability to make distributions to our stockholders.


At any time, a tenant could seek the protection of the bankruptcy laws, which might result in the modification or termination of the tenant’s lease and cause a reduction in our cash flow. During the three months ended March 31, 2004, none of our tenants had filed for bankruptcy. However, in the event of default by or bankruptcy of a tenant, we may experience delays in enforcing our rights as lessor and may incur substantial costs in protecting our investment. The default, bankruptcy, or insolvency of a major tenant may harm us and our ability to pay dividends to our stockholders.


Our dependence on smaller businesses to rent office space could negatively affect our cash flow.


Many of the tenants in our properties operate smaller businesses that may not have the financial strength of larger corporate tenants. Smaller companies generally experience a higher rate of failure and are generally more susceptible to financial risks than large, well-capitalized enterprises. Dependence on these companies could create a higher risk of tenant defaults, turnover, and bankruptcies, all of which could harm our ability to pay dividends.


The acquisition and development of real estate is subject to numerous risks, and the cost of bringing any acquired property to standards for its intended market position could exceed our estimates.


A significant portion of our leases is scheduled to expire in the remainder of 2004, 2005, and 2006. To supplement the losses in net operating income caused by the leasing turnover, we expanded our acquisitions program in 2003. Acquisitions totaled approximately $85 million in 2003 and $46.5 million in April of 2004, and we expect to continue to focus on property acquisitions in the near future. As a part of the acquisitions program, we may acquire industrial and suburban office properties and portfolios of these properties, which may include the acquisition of other companies and business entities owning the properties. Although we engage in due diligence review for each new acquisition, we may not be aware of all potential liabilities and problems associated with a property. We may have limited contractual recourse, or no contractual recourse, against the sellers of a property. In the future, we expect the majority of our properties and portfolios of properties to be acquired on an “as is” basis, with limited recourse against the sellers. In addition, our investments may fail to perform in accordance with our expectations. Further, estimates of the costs of improvements to bring an acquired property up to standards established for the market position intended for that property might prove inaccurate. To the extent that we acquire properties with substantial vacancies, as we have in the past, we may be unable to lease vacant space in a timely manner or at all, and the costs of obtaining tenants, including tenant improvements, lease concessions, and brokerage commissions, could prove more costly than anticipated.


Real estate development is subject to other risks, including the following:


-

the risks of difficult and complicated construction projects;

-

the risks related to the use of contractors and subcontractors to perform all or substantially all construction activities;

-

the risk of development delays, unanticipated increases in construction costs, environmental issues, and regulatory approvals; and

-

financial risks relating to financing and construction loan difficulties.


Additionally, the time frame required for development, construction, and lease-up of these properties means that we may have to wait a few years or more for a significant cash return to be realized.


29


We may abandon development opportunities resulting in direct expenses to us.


From time to time, we may invest significant time and resources exploring development opportunities that we subsequently decide are not in our best interest. The costs of investigating these opportunities will still be considered a direct expense and may harm our financial condition.


Our uninsured or underinsured losses could result in a loss in value of our properties.


We currently maintain general liability coverage with primary limits of $1 million per occurrence and $2 million in the aggregate, as well as $40 million of umbrella/excess liability coverage. This coverage protects us against liability claims as well as the cost of legal defense. We carry property “All Risks” insurance of $200 million on a replacement value basis covering both the cost of direct physical damage and the loss of rental income. Separate flood and earthquake insurance is provided with an annual aggregate limit of $20 million, subject to a deductible of the greater of $100,000 or 5% of total insurable value per building and respective rent loss with respect to earthquake coverage. Additional excess earthquake coverage with an aggregate limit of $10 million is provided for properties located in California, which represent approximately 54% of our portfolio’s annualized base rent. Some losses, including those due to acts of war, nuclear accidents, pollution, mold, or terrorism, may be either uninsurable or not economically insurable. However, we do presently carry insurance for terrorism losses as defined under the Terrorism Risk Insurance Act of 2002 under our “All Risks” property policies, liability policies, primary and umbrella/excess policies. In addition, “non-certified” terrorism coverage is provided under our property policy for losses in excess of $10 million up to the $200 million limit.


Some losses could exceed the limits of our insurance policies or could cause us to bear a substantial portion of those losses due to deductibles under those policies. If we suffer an uninsured loss, we could lose both our invested capital in and anticipated cash flow from the property while being obligated to repay any outstanding indebtedness incurred to acquire the property. In addition, a majority of our properties are located in areas that are subject to earthquake activity. Although we have obtained earthquake insurance policies for all of our properties, if one or more properties sustain damage as a result of an earthquake, we may incur substantial losses up to the amount of the deductible under the earthquake insurance policy and, additionally, to the extent that the damage exceeds the policy’s maximum coverage, we would not have insurance compensation for that portion of the losses. Although we have obtained owner’s title insurance policies for each of our properties, the title insurance may be in an amount less than the current market value of some of the properties. If a title defect results in a loss that exceeds insured limits, we could lose all or part of our investment in, and anticipated gains, if any, from, the property. Furthermore, the current insurance market is characterized by rising premium rates, increasing deductibles, and more restrictive coverage language. Continued increases in the costs of insurance coverage or increased limits or exclusions in insurance policy coverage could negatively affect our financial results.


If we fail to maintain our qualification as a real estate investment trust, we could experience adverse tax and other consequences, including the loss of deductibility of dividends in calculating our taxable income and the imposition of federal income tax at regular corporate rates.


We have elected to qualify as a real estate investment trust (REIT) under Sections 856 to 860 of the Internal Revenue Code of 1986, as amended. We believe that we have been organized and have operated in a manner so as to have satisfied the REIT qualification requirements since 1985. However, the IRS could challenge our qualification as a REIT for taxable years still subject to audit, and we may fail to qualify as a REIT in the future.



30


Qualification as a REIT involves the application of highly technical and complex tax provisions, and the determination of various factual matters and circumstances not entirely within our control may have an impact on our ability to maintain our qualification as a REIT. For example, in order to qualify as a REIT, at least 95% of our gross income in any year must be derived from qualifying sources and we must make distributions to stockholders aggregating annually at least 90% of our REIT taxable income, excluding net capital gains. In addition, we cannot assure you that new legislation, Treasury Regulations, administrative interpretations, or court decisions will not significantly change the tax laws with respect to our qualification as a REIT or the federal income tax consequences of such qualification. We are not aware of any proposal to amend the tax laws that would significantly and negatively affect our ability to continue to operate as a REIT.


If we fail to maintain our qualification as a REIT, or are found not to have qualified as a REIT for any prior year, we would not be entitled to deduct dividends paid to our stockholders and would be subject to federal income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates. In addition, unless entitled to statutory relief, we would also be disqualified from treatment as a REIT for the four taxable years following the year during which qualification was lost. This treatment would reduce amounts available for investment or distribution to stockholders because of any additional tax liability for the year or years involved. In addition, we would no longer be required by the Internal Revenue Code to make any distributions. As a result, disqualification as a REIT would harm us and our ability to make distributions to our stockholders. To the extent that distributions to stockholders have been made in anticipation of our qualification as a REIT, we might be required to borrow funds or to liquidate investments to pay the applicable tax.


We must comply with strict income distribution requirements to maintain favorable tax treatment as a REIT. If our cash flow is insufficient to meet our operating expenses and the distribution requirements, we may need to incur additional borrowings or otherwise obtain funds to satisfy these requirements.


To maintain REIT status, we are required each year to distribute to our stockholders at least 90% of our REIT taxable income, excluding net capital gains. In addition, we are subject to a 4% nondeductible excise tax on the amount, if any, by which distributions paid by us in any calendar year are less than the sum of 85% of our ordinary income and 95% of our capital gain net income for the calendar year plus any amount of such income not distributed in prior years. Although we anticipate that cash flow from operations will be sufficient to pay our operating expenses and meet the distribution requirements, we cannot assure you that this will occur, and we may need to incur borrowings or otherwise obtain funds to satisfy the distribution requirements associated with maintaining the REIT qualification. In addition, differences in timing between the receipt of income and payment of expenses in arriving at our taxable income could require us to incur borrowings or otherwise obtain funds to meet the distribution requirements necessary to maintain our qualification as a REIT. We cannot assure you that we will be able to borrow funds or otherwise obtain funds if and when necessary to satisfy these requirements.


As a REIT, we are subject to complex constructive ownership rules that limit any holder to 9.8% in value of our outstanding common and preferred stock, taken together. Any shares transferred in violation of this rule are subject to redemption by us and any such transaction is voidable.


To maintain REIT qualification, our charter provides that no holder is permitted to own more than 9.8% in value of our outstanding common and preferred stock, taken together, or more than 9.8% (in value or number) of our outstanding common stock. In addition, no holder is permitted to own any shares of any class of our stock if that ownership would cause more than 50% in value of our outstanding common and preferred stock, taken together, to be owned by five or fewer individuals, would result in our stock being beneficially owned by less than 100 persons or would otherwise result in our failure to qualify as a REIT. Acquisition or ownership of our common or preferred stock in violation of these restrictions results in automatic transfer of the stock to a trust for the benefit of a charitable beneficiary or, under specified circumstances, the violative transfer may be deemed void or we may choose to redeem the violative shares. Peter B. Bedford is subject to higher ownership limitations than our other stockholders. Specifically, Mr. Bedford is not permitted to own more than 15% of the lesser of the number or value of the outstanding shares of our common stock.



31


The ownership limitations described above are applied using the constructive ownership rules of the Internal Revenue Code. These rules are complex and may cause common or preferred stock owned beneficially or constructively by a group of related individuals and/or entities to be constructively owned by one individual or entity. As a result, the acquisition of less than 9.8% of our outstanding common or preferred stock or the acquisition of an interest in an entity that owns our common or preferred stock by an individual or entity could cause that individual or entity or another individual or entity to constructively own stock in excess of the limits and subject that stock to the ownership restrictions in our charter.


We rely on the services of our key personnel, and their expertise and knowledge of our business would be difficult to replace.


We are highly dependent on the efforts of our senior officers. While we believe that we could find suitable replacements for these key personnel, the loss of their services could harm our business. Peter Bedford, our chief executive officer and chairman of the board, has announced his intention to step down as our CEO. James Moore, our president and chief operating officer, has announced his intention to retire in July 2005.  If we cannot find suitable replacements for these officers, our business would be harmed. In addition, we cannot assure you that the replacements will not wish to change aspects of how we conduct our business or that any such change will be successful. We have retained a third-party search firm to identify potential successor CEO candidates.  Mr. Bedford will continue to serve as our CEO until the successor has been chosen.  After relinquishing the CEO position, Mr. Bedford intends to remain on our board of directors and to continue to serve as its chairman.  Our credit facility provides that it is an event of default if Mr. Bedford ceases for any reason to be our chairman or CEO, and a replacement reasonably satisfactory to the lenders has not been appointed by our board of directors within six months.  Although we expect to select a replacement that will meet our lenders' requirements, we cannot assure you that the candidate that is ultimately selected will be satisfactory to our lenders. If we are unable to find a replacement that is satisfactory to our lenders, they may accelerate our obligations under the credit facility, which would adversely affect our liquidity and our ability to pay dividends to our stockholders.


The commercial real estate industry is highly competitive, and we compete with companies, including REITs, that may be able to purchase properties at lower capitalization rates than would be accretive for us.


We seek to grow our asset base through the acquisition of industrial and suburban office properties and portfolios of these properties, as well as through the development of new industrial and suburban office properties. Many real estate companies, including other REITs, compete with us in making bids to acquire new properties. The level of competition to acquire income-producing properties is largely measured by the capitalization rates at which properties are trading. The capitalization rate is the annual yield that property produces on the investment. Currently, capitalization rates are low due to the amount of capital available for investment and attractive debt financing terms. As a result, we may not be able to compete effectively with companies, including REITs, that may be able to purchase properties at lower capitalization rates than would be accretive for us.


Many of our properties are located in markets with an oversupply of space, and our ability to compete effectively with other properties to attract tenants may be limited to the extent that competing properties may be newer, better capitalized or in more desirable locations than our properties.


Numerous industrial and suburban office properties compete with our properties in attracting tenants. Some of these competing properties are newer, better located, or better capitalized than our properties. Many of our investments are located in markets that have a significant supply of available space, resulting in intense competition for tenants and lower rents. We believe the oversupply of available space relative to demand has increased in recent years due to the softened U.S. economy. The number of competitive properties in a particular area could negatively impact our ability to lease space in the properties or at newly acquired or developed properties.



32


We could incur costs from environmental liabilities even though we did not cause, contribute to, or know about them.


Under various federal, state, and local laws, ordinances and regulations, an owner or operator of real estate may be held liable for the costs of removal or remediation of hazardous or toxic substances released on, above, under or in a property. These laws often impose liability regardless of whether the owner knew of, or was responsible for, the presence of the hazardous or toxic substances. In addition, environmental laws often impose liability on a previous owner of property for hazardous or toxic substances present during the prior ownership period. A transfer of the property may not relieve an owner of all liability. Accordingly, we could be liable for properties previously sold or otherwise divested. The costs of removal or remediation could be substantial. Additionally, the presence of the substances, or the failure to properly remove them, may harm our ability to borrow using the real estate as collateral.


All of our properties have had Phase I environmental site assessments, which involve inspection without soil sampling or groundwater analysis, by independent environmental consultants and have been inspected for hazardous materials as part of our acquisition inspections. None of the Phase I assessments has revealed any environmental problems requiring material costs for clean up. The Phase I assessment for Milpitas Town Center, however, indicates that the groundwater under that property either has been or may in the future be, impacted by the migration of contaminants originating off-site. According to information available to us, the responsible party for this offsite source has been identified and has begun clean up. We do not believe that this environmental matter will impair the future value of Milpitas Town Center in any significant respect or that we will be required to fund any portion of the cost of remediation. We cannot assure you, however, that these Phase I assessments or our inspections have revealed all environmental liabilities and problems relating to our properties.


We believe that we are in compliance in all material respects with all federal, state, and local laws regarding hazardous or toxic substances. To date, compliance with federal, state, and local environmental protection regulations has not had a material effect on us. However, we cannot assure you that costs relating to the investigation and remediation of environmental issues for properties currently or previously owned by us, or properties that we may acquire in the future, or other expenditures or liabilities, including claims by private parties, resulting from hazardous substances present in, on, under, or above the properties or resulting from circumstances or other actions or claims relating to environmental matters, will not harm us and our ability to pay dividends to our stockholders.


Costs associated with moisture infiltration and resulting mold remediation may be significant.


Concern about indoor exposure to mold, fungi, and mycotoxins has been increasing because this exposure is allegedly linked to various adverse effects on health. Increasingly, insurance companies are excluding mold-related risks from their policy coverage, and it is now excluded from our coverage. Costs and potential liability stemming from tenant exposure to mold and the increased costs of renovating and remodeling buildings with exposure to mold could harm our financial position and results.


We could incur unanticipated costs to comply with the Americans with Disabilities Act, and any non-compliance could result in fines.


Under the Americans with Disabilities Act (the ADA), all public accommodations and commercial facilities are required to meet federal requirements related to access and use by disabled persons. Compliance with the ADA requires removal of access barriers, and any non-compliance may result in the imposition of fines by the U.S. government or an award of damages to private litigants. Although we believe that our properties are substantially in compliance with these requirements, in the future we may incur costs to comply with the ADA with respect to both existing properties and properties acquired in the future, which could limit our ability to make distributions to stockholders.



33


We are subject to numerous federal, state, and local regulatory requirements, and any changes to existing regulations or new laws may result in significant, unanticipated costs.


Our properties are, and any properties we may acquire in the future will be, subject to various other federal, state, and local regulatory requirements, including local building codes. Failure to comply with these requirements could result in the imposition of fines by governmental authorities or awards of damages to private litigants. We believe that our properties are currently in substantial compliance with all applicable regulatory requirements, although expenditures at properties owned by us may be necessary to comply with changes in these laws. Although no material expenditures are contemplated at this time to comply with any laws or regulations, we cannot assure you that these requirements will not be changed or that new requirements will not be imposed that would require significant unanticipated expenditures by us, which could harm us and our ability to make distributions to our stockholders. Similarly, changes in laws increasing the potential liability for environmental conditions existing on our properties could result in significant unanticipated expenditures.


Our $150 million credit agreement and our mortgage loans are collateralized by approximately 94% of our total real estate assets, and in the event of default under any of these debt instruments, our lenders could foreclose on the collateral securing this indebtedness.


As of March 31, 2004, our $150 million credit facility was collateralized by mortgages on 21 properties that accounted for approximately 23% of our annualized base rent and approximately 23% of our total real estate assets. All of our mortgage loans were collateralized by 69 properties that accounted for approximately 74% of our annualized base rent and approximately 71% of our total real estate assets. If we fail to meet our obligations under the credit facility, the mortgage loans, or any other debt instruments we may enter into from time to time, including failure to comply with financial covenants, the holders of this indebtedness generally would be entitled to demand immediate repayment of the principal and to foreclose upon any collateral securing this indebtedness. In addition, default under or acceleration of any debt instrument could, pursuant to cross-default clauses, cause or permit the acceleration of other indebtedness. Any default or acceleration would harm us, jeopardizing our qualification as a REIT and threatening our continued viability.


Our $150 million credit agreement and some of our mortgage loans carry floating interest rates, and increases in market interest rates could harm our results of operations.


As of March 31, 2004, our $150 million credit facility had an outstanding balance of $72.2 million, and we had other floating rate loans of $37.2 million. Borrowings under our credit facility bear interest at a floating rate, and we may from time to time incur or assume other indebtedness also bearing interest at a floating rate. In that regard, our results of operations for 2003 and the first quarter of 2004 have benefited from low levels of interest rates that are currently near historic lows. Should this trend in interest rates reverse itself, our operating results could be harmed.


We use borrowings to finance the acquisition, development and operation of properties and to repurchase our common stock, and we cannot assure you that financing will be available on commercially reasonable terms, or at all, in the future.


We borrow money to pay for the acquisition, development, and operation of our properties, to repurchase our common stock, and for other general corporate purposes. Our credit facility currently expires on March 31, 2007, when the principal amount of all outstanding borrowings must be paid. Since the term of our credit facility is limited, our ability to fund acquisitions and provide funds for working capital and other cash needs following the expiration or utilization of the credit facility will depend primarily on our ability to obtain additional private or public equity or debt financing.



34


A downturn in the economy could make it difficult for us to borrow money on favorable terms. If we are unable to borrow money on favorable terms, we may need to sell some of our assets at unfavorable prices in order to pay our loans. We could encounter several problems, including:


-

insufficient cash flow to meet required payments of principal and interest;

-

an increase on variable interest rates on indebtedness; and

-

an inability to refinance existing indebtedness on favorable terms or at all.


Our leverage could harm our ability to operate our business and fulfill our debt obligations.


We have significant debt service obligations. As of March 31, 2004, we had total liabilities of approximately $470.6 million, excluding unused commitments under our credit facility, and total stockholders’ equity of approximately $301.2 million. Payments to service this debt totaled approximately $8.0 million during the three months ended March 31, 2004. Our debt level increases the possibility that we could be unable to generate cash sufficient to pay the principal of, interest on, or other amounts due in respect of our indebtedness. In addition, we may incur additional debt from time to time to fund our stock buy back program, finance strategic acquisitions, investments, or for other purposes, subject to the restrictions contained in our debt instruments.


We have not used derivatives extensively to mitigate our interest rate risks.


Historically, we have not used interest rate swaps, caps and floors, or other derivative transactions extensively to help us mitigate our interest rate risks because we have determined that the cost of these transactions outweighed their potential benefits and could have, in some cases, jeopardized our status as a REIT. Generally, income from derivative transactions qualifies for purposes of the 95% gross income test but not for purposes of the 75% gross income test. We have entered into swap agreements to hedge our exposure to variable interest rates on two mortgages with remaining principal balances of approximately $24.6 million as of March 31, 2004. Even if we were to use derivative transactions more extensively, we would not be fully insulated from the prepayment and interest rate risks to which we are exposed. However, we do not have any policy that prohibits us from using derivative transactions or other hedging strategies more extensively in the future. If we do engage in additional derivative transactions in the future, we cannot assure you that a liquid secondary market will exist for any instruments purchased or sold in those transactions, and we may be required to maintain a position until exercise or expiration, which could result in losses.


We may change our policies without stockholder approval.


Our major policies, including those concerning our qualification as a REIT and with respect to dividends, acquisitions, debt, and investments, are established by our board of directors. Although it has no present intention to do so, the board of directors may amend or revise these and other policies from time to time without a vote of or advance notice to our stockholders. Accordingly, holders of our capital stock will have no control over changes in our policies, including any policies relating to the payment of dividends or to maintaining qualification as a REIT. In addition, policy changes could harm our financial condition, results of operations, the price of our securities, or our ability to pay dividends.




35


Recently enacted U.S. federal income tax legislation reduces the maximum tax rates applicable to corporate dividends from 38.6% to 15%, which may make investments in corporations relatively more attractive than investments in REITs and negatively affect our stock price as a result.


The Jobs and Growth Tax Relief Reconciliation Act of 2003 reduces the tax rates applicable to corporate dividends, in the case of individual taxpayers, from as high as 38.6% to 15% through December 31, 2008. The reduced maximum 15% rate imposed on some corporate dividends implemented by the Jobs and Growth Tax Relief Reconciliation Act of 2003 does not, however, generally apply to ordinary dividends paid by REITs. We do not presently expect that ordinary dividends paid by us will be eligible for the reduced tax rate on dividends. This change in the maximum tax rate on qualifying dividends may make investments in corporate stock relatively more attractive than investments in REITs, which could harm our stock price.


An increase in market interest rates could cause the respective prices of our common stock and preferred stock to decrease.


One of the factors that may influence the respective market prices of our shares of common stock and preferred stock will be the annual dividend yield on the price paid for shares of our common stock or preferred stock as compared to yields on other financial instruments. An increase in market interest rates may lead prospective purchasers of our stock to seek a higher annual yield from their investments, which may adversely affect the respective market prices of our common stock and preferred stock. As of March 31, 2004, interest rates in the U.S. remained near their historic lows.


We may incur additional indebtedness, which may harm our financial position and cash flow and potentially impact our ability to pay dividends.


Our governing documents and existing debt instruments do not limit us from incurring additional indebtedness and other liabilities. As of March 31, 2004, we had approximately $439.0 million of indebtedness outstanding. We may incur additional indebtedness and become more highly leveraged, which could harm our financial position and potentially limit our cash available to pay dividends. As a result, we may not have sufficient funds to satisfy our dividend obligations relating to our preferred stock or pay dividends on our common stock, if we assume additional indebtedness.


We cannot assure you that we will be able to pay dividends regularly although we have done so in the past.


Our ability to pay dividends in the future is dependent on our ability to operate profitably and to generate cash from our operations. Although we have done so in the past, we cannot guarantee that we will be able to pay dividends on a regular quarterly basis in the future. Furthermore, any new shares of common stock issued will substantially increase the cash required to continue to pay cash dividends at current levels. Any common stock or preferred stock that may in the future be issued to finance acquisitions, upon exercise of stock options or otherwise would have a similar effect. In addition, our existing credit facility limits our ability to pay quarterly dividends to stockholders.


Our ability to pay dividends is further limited by the requirements of Maryland law.


Our ability to pay dividends on our common stock and preferred stock is further limited by the laws of Maryland. Under the Maryland General Corporation Law, a Maryland corporation may not make a distribution if, after giving effect to the distribution, either the corporation would not be able to pay indebtedness of the corporation as the indebtedness becomes due in the usual course of business or the corporation’s total assets would be less than the sum of the corporation’s total liabilities plus the amount that would be needed, if the corporation were to be dissolved at the time of distribution, to satisfy the preferential rights upon dissolution of stockholders whose preferential rights are superior to those receiving the distribution. Accordingly, we cannot make a distribution, except by dividend, on our common stock or preferred stock if, after giving effect to the distribution, our total assets would be less than the sum of our liabilities plus the amount that would be needed to satisfy the preferential rights upon dissolution of the holders of any shares of preferred stock then outstanding, or if we would not be able to pay our indebtedness as it became due.


 

36




FINANCIAL PERFORMANCE


Our funds from operations (FFO) during the three months ended March 31, 2004 was $11,644,000. During the same period in 2003, our FFO was $12,582,000. Although FFO is not a financial measure calculated in accordance with accounting principles generally accepted in the United States of America (GAAP), we believe that FFO may be an appropriate alternative measure of the performance of an equity REIT. Presentation of this information provides the reader with an additional measure to compare the performance of equity REITs. FFO is generally defined by the National Association of Real Estate Investment Trusts as net income (loss) (computed in accordance with GAAP), excluding extraordinary items and gains (losses) from sales of property, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. We computed our FFO in accordance with this definition. FFO does not represent cash generated by operating activities in accordance with GAAP; it is not necessarily indicative of cash available to fund cash needs and should not be considered as an alternative to net income (loss) as an indicator of our operating performance or as an alternative to cash flow as a measure of liquidity. Furthermore, FFO as disclosed by other REITs may not be comparable to our presentation. The most directly comparable financial measure calculated in accordance with GAAP to FFO is net income (loss). The following table sets forth a reconciliation of the differences between our FFO and our net income available to common stockholders for each of the three months ended March 31, 2004 and 2003.



 

Three Months Ended

March 31,

 

2004

2003


Funds From Operations

    (in thousands, except share amounts):

  

              Net income available to common stockholders

$  4,736

$  7,672

               Adjustments:

                   Depreciation and amortization


6,908


4,910


               Funds From Operations


$11,644


$12,582


               Weighted average number of

                       shares – diluted



16,273,156



16,370,146


37


Item 3. Qualitative and Quantitative Disclosures about Market Risk


We are exposed to interest rate changes primarily as a result of our line of credit 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 these objectives, we balance our borrowings between fixed and variable rate debt. During 2003, we significantly increased our level of fixed rate debt to take advantage of historically low interest rates. While we have entered into interest swap agreements to minimize our exposure to interest rate fluctuations, we do not enter into derivative or interest rate transactions for speculative purposes.


We monitor our interest rate risk using a variety of techniques. The table below presents the principal amounts and related weighted average annual interest rates by year of expected maturity to evaluate the expected cash flows and sensitivity to interest rate changes (dollars in thousands):


 

Twelve Month Period Ending March 31,

 


2005


2006


2007


2008


2009


Thereafter


Total

Fair

Value


Variable rate debt


$21,217


$    712


$72,915


$    769


$    799


$  12,958


$109,370


$109,370

Weighted average

  interest rate


3.07%


4.84%


3.63%


4.84%


4.84%


4.84%


3.69%


3.69%


Fixed rate debt


$  5,890


$73,978


$47,957


$34,630


$14,843


$152,321


$329,619


$335,502

Weighted average

  interest rate


6.17%


5.08%


7.61%


7.08%


4.94%


5.87%


6.03%


5.50%


As the table incorporates only those exposures that existed as of March 31, 2004, it 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 ultimate realized gain or loss with respect to interest rate fluctuations will depend on the exposures that arise during the period, our hedging strategies at that time, and interest rates. If interest rates were to increase by 10%, or an average of 38 basis points, interest expense on our outstanding variable rate debt would increase by approximately $369,000 annually.


Item 4. Controls and Procedures


Our management, with the participation of our chief executive officer and chief financial officer, has conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of March 31, 2004. Based on that evaluation, the chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective in ensuring that all material information required to be filed in this quarterly report has been made known to them in a timely fashion. There have been no significant changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) during the quarter ended March 31, 2004 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

38


PART II. OTHER INFORMATION


Item 1. Legal Proceedings


We are not presently subject to material litigation. Moreover, to our knowledge, we are not aware of any threatened litigation against us, other than routine actions for negligence or other claims and proceedings arising in the ordinary course of business, some of which are expected to be covered by liability insurance and all of which collectively are not expected to have a material adverse impact on our liquidity, results of operations, business or financial position.


Item 2. Changes in Securities





Period



Total number of

shares purchased (1)



Average price

paid per share

Total number of

shares purchased as

part of publicly

announced program

Maximum number

of shares that may

yet be purchased

under the program (2)


January 1-31, 2004


36,175


$28.82


-


1,931,573


February 1-29, 2004


2,112


$30.02


-


1,929,461


March 1-31, 2004


598


$31.56


-


1,928,863


Total


38,885


$28.92


-


1,928,863


(1)

During the first quarter of 2004, we acquired 38,885 shares of our common stock from our employees (a) in consideration for satisfying their payroll tax obligations and (b) in connection with their stock option exercises. The acquisitions were not made pursuant to a publicly announced repurchase program.


(2)

On July 7, 1998, we announced that our board of directors had authorized management to repurchase up to 3 million shares of our common stock through open market transactions. The board of directors subsequently approved increases in the number of share repurchases to 4.5 million shares in September 1999, then to 8 million shares in September 2000 and later to 10 million shares in January 2002.  The share repurchase program does not have an expiration date. We did not repurchase any shares of our common stock pursuant to this program during the quarter ended March 31, 2004.


Item 3. Defaults upon Senior Securities


None


Item 4. Submission of Matters to Vote of Security Holders


None


Item 5. Other Information


None


39


Item 6. Exhibits and Reports on Form 8-K


A.

Exhibits

Exhibit No.

Exhibit



3.1(d)

Articles of Amendment and Restatement of Bedford Property Investors, Inc., filed on May 27, 2003, is incorporated herein by reference to Exhibit 3.1(d) to our Form 10-Q for the quarter ending June 30, 2003.


3.1(e)

Articles Supplementary relating to the Series A Cumulative Redeemable Preferred Stock of Bedford Property Investors, Inc., filed on August 4, 2003, is incorporated herein by reference to Exhibit 3.1(e) to our Form 10-Q for the quarter ending June 30, 2003.


3.1(f)

Articles Supplementary relating to the Series B Cumulative Redeemable Preferred Stock of Bedford Property Investors, Inc., filed on April 5, 2004, is incorporated herein by reference to Exhibit 4.2 to our Registration Statement on Form 8-A filed with the SEC on April 5, 2004.


3.2(b)

Second Amended and Restated Bylaws of Bedford Property Investors, Inc. are incorporated herein by reference to Exhibit 3.2(b) to our Form 10-Q for the quarter ending June 30, 2003.


4.4

Series A Cumulative Redeemable Preferred Stock Registration Rights Agreement, dated August 5, 2003, between Bedford Property Investors, Inc. and RBC Dain Rauscher Inc. is incorporated herein by reference to Exhibit 4.4 to our Form 10-Q for the quarter ending June 30, 2003.


10.71*

Sixth Amended and Restated Credit Agreement, dated March 31, 2004, by and among Bedford Property Investors, Inc., Bank of America, N.A., as Administrative Agent for the Banks, Swing Line Lender and L/C Issuer, and Union Bank of California, N.A., as Syndication Agent.


31.1*

Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.


31.2*

Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.


32.1*

Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to 906 of the Sarbanes-Oxley Act of 2002.


32.2*

Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to 906 of the Sarbanes-Oxley Act of 2002.


*

Filed herewith


40


B.

Reports on Form 8-K


On February 10, 2004, we filed a report on Form 8-K to furnish to the Securities and Exchange Commission our press release issued on February 9, 2004, which reported our financial results for the year ended December 31, 2003.


On February 24, 2004, we filed a report on Form 8-K/A to furnish to the Securities and Exchange Commission the required financial information for our acquisitions, which were originally reported on a Form 8-K filed on December 23, 2003.


SIGNATURES


Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


Dated:  May 7, 2004                                


BEDFORD PROPERTY INVESTORS, INC.

(Registrant)



By:

/s/ HANH KIHARA

Hanh Kihara

Senior Vice President and

Chief Financial Officer



By:

/s/ KRISTA K. ROWLAND

Krista K. Rowland

Vice President and Controller



41


EXHIBIT INDEX

Exhibit No.

Exhibit


3.1(d)

Articles of Amendment and Restatement of Bedford Property Investors, Inc., filed on May 27, 2003, is incorporated herein by reference to Exhibit 3.1(d) to our Form 10-Q for the quarter ending June 30, 2003.


3.1(e)

Articles Supplementary relating to the Series A Cumulative Redeemable Preferred Stock of Bedford Property Investors, Inc., filed on August 4, 2003, is incorporated herein by reference to Exhibit 3.1(e) to our Form 10-Q for the quarter ending June 30, 2003.


3.1(f)

Articles Supplementary relating to the Series B Cumulative Redeemable Preferred Stock of Bedford Property Investors, Inc., filed on April 5, 2004, is incorporated herein by reference to Exhibit 4.2 to our Registration Statement on Form 8-A filed with the SEC on April 5, 2004.


3.2(b)

Second Amended and Restated Bylaws of Bedford Property Investors, Inc. are incorporated herein by reference to Exhibit 3.2(b) to our Form 10-Q for the quarter ending June 30, 2003.


4.4

Series A Cumulative Redeemable Preferred Stock Registration Rights Agreement, dated August 5, 2003, between Bedford Property Investors, Inc. and RBC Dain Rauscher Inc. is incorporated herein by reference to Exhibit 4.4 to our Form 10-Q for the quarter ending June 30, 2003.


10.71*

Sixth Amended and Restated Credit Agreement, dated March 31, 2004, by and among Bedford Property Investors, Inc., Bank of America, N.A., as Administrative Agent for the Banks, Swing Line Lender and L/C Issuer, and Union Bank of California, N.A., as Syndication Agent.


31.1*

Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.


31.2*

Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.


32.1*

Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to 906 of the Sarbanes-Oxley Act of 2002.


32.2*

Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to 906 of the Sarbanes-Oxley Act of 2002.



*

Filed herewith



42