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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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Form 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
COMMISSION FILE NUMBER 1-8383
Mission West Properties, Inc.
(Exact name of registrant as specified in its charter)
Maryland 95-2635431
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(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
10050 Bandley Drive
Cupertino, California 95014-2188
(Address of principal executive offices)
Registrant's telephone number, including area code is (408) 725-0700
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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 Exchange Act Rule 12b-2). Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date:
17,754,691 shares outstanding as of November 11, 2003
- 1 -
MISSION WEST PROPERTIES, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2003
INDEX
PAGE
PART I FINANCIAL INFORMATION ----
Item 1. Financial Statements (unaudited):
Consolidated Balance Sheets as of September 30, 2003
and December 31, 2002...................................................................................3
Consolidated Statements of Operations for the three
and nine months ended September 30, 2003 and 2002.......................................................4
Consolidated Statements of Cash Flows for the
nine months ended September 30, 2003 and 2002...........................................................5
Notes to Consolidated Financial Statements..............................................................6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................................................................10
Item 3. Quantitative and Qualitative Disclosures About Market Risk.............................................21
Item 4. Controls and Procedures................................................................................21
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.......................................................................22
SIGNATURES...........................................................................................................23
- 2 -
PART I - FINANCIAL INFORMATION
ITEM 1 CONSOLIDATED FINANCIAL STATEMENTS
MISSION WEST PROPERTIES, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share and per share amounts)
(Unaudited)
---------
September 30, 2003 December 31, 2002
---------------------- ----------------------
ASSETS
Real estate assets, at cost
Land $ 276,405 $ 234,707
Buildings and improvements 777,156 726,581
Real estate related intangible assets 18,284 -
---------------------- ----------------------
Total investments in properties 1,071,845 961,288
Less accumulated depreciation and amortization (82,318) (66,560)
---------------------- ----------------------
Net investments in properties 989,527 894,728
Investment in unconsolidated joint venture 2,258 -
---------------------- ----------------------
Net investments in real estate assets 991,785 894,728
Cash and cash equivalents 5,096 4,479
Deferred rent 18,047 17,001
Other assets 15,463 13,198
---------------------- ----------------------
Total assets $1,030,391 $ 929,406
====================== ======================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Line of credit (related parties) $ 769 $ 58,792
Revolving line of credit 19,966 23,839
Loan payable - 20,000
Mortgage notes payable 301,115 125,062
Mortgage notes payable (related parties) 10,843 11,078
Interest payable 335 337
Security deposits 10,389 11,184
Prepaid rental income 15,003 9,876
Dividend/distribution payable 25,021 24,951
Accounts payable and accrued expenses 7,471 4,698
---------------------- ----------------------
Total liabilities 390,912 289,817
Commitments and contingencies (Note 6)
Minority interests 527,023 528,768
Stockholders' equity:
Preferred stock, $.001 par value, 20,000,000 shares
authorized, none issued and outstanding - -
Common stock, $.001 par value, 200,000,000 shares
authorized, 17,754,691 and 17,487,329 shares issued and
outstanding at September 30, 2003 and December 31, 2002,
respectively 18 17
Paid-in-capital 130,552 128,295
Accumulated deficit (18,114) (17,491)
---------------------- ----------------------
Total stockholders' equity 112,456 110,821
---------------------- ----------------------
Total liabilities and stockholders' equity $1,030,391 $ 929,406
====================== ======================
The accompanying notes are an integral part of these
consolidated financial statements.
- 3 -
MISSION WEST PROPERTIES, INC
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except share and per share amounts)
(Unaudited)
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Three months ended September 30, Nine months ended September 30,
2003 2002 2003 2002
-------------------- -------------------- -------------------- -------------------
Revenues:
Rental revenues from real estate $33,782 $32,165 $ 98,408 $ 97,403
Tenant reimbursements 4,796 5,219 14,360 15,420
Other income, including interest 567 487 1,871 1,261
-------------------- -------------------- -------------------- -------------------
Total revenues 39,145 37,871 114,639 114,084
-------------------- -------------------- -------------------- -------------------
Expenses:
Operating expenses 2,555 1,974 5,965 6,170
Real estate taxes 2,876 3,091 9,391 9,152
Depreciation and amortization 5,797 4,552 15,758 13,363
General and administrative 360 386 1,039 1,190
Interest 4,335 2,413 12,097 7,045
Interest (related parties) 280 861 830 2,770
-------------------- -------------------- -------------------- -------------------
Total expenses 16,203 13,277 45,080 39,690
-------------------- -------------------- -------------------- -------------------
Income before equity in earnings of
unconsolidated joint venture & minority interests 22,942 24,594 69,559 74,394
Equity in earnings of unconsolidated joint
venture 599 - 3,358 -
Minority interests 19,598 20,036 60,785 61,629
-------------------- -------------------- -------------------- -------------------
Income from continuing operations 3,943 4,558 12,132 12,765
-------------------- -------------------- -------------------- -------------------
Discontinued operations, net minority interests:
Gain from disposal of discontinued operations - - - 1,018
Income attributable to discontinued operations - - - 49
-------------------- -------------------- -------------------- -------------------
Income from discontinued operations - - - 1,067
-------------------- -------------------- -------------------- -------------------
Net income to common stockholders $ 3,943 $ 4,558 $12,132 $13,832
==================== ==================== ==================== ===================
Net income to minority interests $19,598 $20,036 $60,785 $66,952
==================== ==================== ==================== ===================
Income per share from continuing operations:
Basic $0.22 $0.26 $0.68 $0.73
==================== ==================== ==================== ===================
Diluted $0.22 $0.26 $0.68 $0.71
==================== ==================== ==================== ===================
Income per share from discontinued operations:
Basic - - - $0.06
==================== ==================== ==================== ===================
Diluted - - - $0.06
==================== ==================== ==================== ===================
Net income per share to common stockholders:
Basic $0.22 $0.26 $0.68 $0.79
==================== ==================== ==================== ===================
Diluted $0.22 $0.26 $0.68 $0.77
==================== ==================== ==================== ===================
Weighted average number of shares of
common stock outstanding (basic) 17,747,293 17,467,329 17,695,920 17,445,759
==================== ==================== ==================== ===================
Weighted average number of shares of
common stock outstanding (diluted) 17,817,917 17,856,688 17,757,461 17,872,108
==================== ==================== ==================== ===================
The accompanying notes are an integral part of these
consolidated financial statements.
- 4 -
MISSION WEST PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
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Nine months ended September 30,
--------------------------------------
2003 2002
------------------ -------------------
Cash flows from operating activities:
Net income $ 12,132 $ 13,832
Adjustments to reconcile net income to net cash provided by
operating activities:
Minority interests 60,785 66,952
Depreciation and amortization 15,758 13,409
Gain on sales of assets - (6,103)
Equity in earnings of unconsolidated joint venture (3,358) -
Distributions from unconsolidated joint venture 1,500 -
Other - (20)
Changes in assets and liabilities:
Deferred rent (1,046) 1,088
Other assets (1,402) (2,332)
Interest payable (2) (2)
Security deposits (795) (272)
Prepaid rental income 5,127 8,260
Accounts payable and accrued expenses 3,124 2,410
------------------ -------------------
Net cash provided by operating activities 91,823 97,222
------------------ -------------------
Cash flows from investing activities:
Improvements to real estate assets/new equipment (1,262) (1,668)
Refundable option payment - (18,836)
Real estate purchase (110,013) (31,311)
Proceeds from sales of real estate - 18,591
Restricted cash - 12,714
Proceeds from sale of joint venture real estate 1,400 -
------------------ -------------------
Net cash used in investing activities (109,875) (20,510)
------------------ -------------------
Cash flows from financing activities:
Principal payments on mortgage notes payable (3,946) (1,518)
Proceeds from mortgage note payable 180,000 -
Principal payments on mortgage notes payable (related parties) (235) (218)
Net payments under line of credit (related parties) (58,022) (46,422)
Proceeds from loan payable - 20,000
Payment on loan payable (20,000) -
Proceeds from revolving line of credit - 27,739
Payment on revolving line of credit (3,873) -
Financing costs (863) (52)
Proceeds from stock options exercised 683 151
Minority interests distributions (62,384) (62,104)
Dividends paid (12,691) (12,543)
------------------ -------------------
Net cash provided by (used in) financing activities 18,669 (74,967)
------------------ -------------------
Net increase in cash and cash equivalents 617 1,745
Cash and cash equivalents, beginning 4,479 5,310
------------------ -------------------
Cash and cash equivalents, ending $ 5,096 $ 7,055
================== ===================
Supplemental information:
Cash paid for interest $ 12,672 $ 9,606
================== ===================
Supplemental schedule of non-cash investing and financing activities:
Debt incurred in connection with property acquisitions (related parties) $ - $ 18,000
================== ===================
Assumption of other liabilities in connection with property acquisitions $ 783 $ 387
================== ===================
Issuance of operating partnership units in connection with property acquisitions $ - $ 10,223
================== ===================
Issuance of operating partnership units in connection with joint venture acquisition $ 1,800 $ -
================== ===================
The accompanying notes are an integral part of these
consolidated financial statements.
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MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share data and per square footage)
(Unaudited)
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1. PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts of
Mission West Properties, Inc. and its controlled subsidiaries, including
the operating partnerships (the "Company"). All significant intercompany
balances have been eliminated in consolidation.
Certain prior year amounts have been reclassified to conform to the current
year's presentation. There is no impact on net income or stockholders'
equity.
Minority interest represents the separate private ownership of the
operating partnerships by the Berg Group (defined as Carl E. Berg, his
brother Clyde J. Berg, members of their respective immediate families, and
certain entities they control) and other non-affiliate interests. In total,
these interests account for approximately 83% of the ownership interests in
the real estate operations of the Company as of September 30, 2003.
Minority interest in net income has been calculated by taking the net
income of the operating partnerships (on a stand-alone basis) multiplied by
the respective minority interest ownership percentage.
The financial statements have been prepared in accordance with accounting
principles generally accepted in the United States of America ("GAAP")
applicable to interim financial information and pursuant to the rules and
regulations of the Securities and Exchange Commission. Accordingly, certain
information and footnote disclosures normally included in financial
statements prepared in accordance with GAAP have been condensed or omitted
pursuant to such rules and regulations. However, in the opinion of
management, all adjustments, consisting only of normal recurring
adjustments, necessary for a fair presentation have been included. The
Company presumes that users of the interim financial information have read
or have access to the audited financial statements for the preceding fiscal
year and that the adequacy of additional disclosure needed for a fair
presentation may be determined in that context. The results of operations
for the three and nine months ended September 30, 2003 are not necessarily
indicative of the results to be expected for the entire year.
The Company accounts for its investments in unconsolidated joint ventures
under the equity method of accounting as the Company exercises some
influence, but does not operate, manage or control the properties. These
investments are recorded at cost and subsequently adjusted for equity in
earnings and cash contributions and distributions.
The Company adopted Statement of Financial Accounting Standards No. 144,
"Accounting for the Impairment or Disposal of Long Lived Assets," effective
January 1, 2002 (see note 7).
In January 2003, the released FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities - an interpretation of ARB No. 15" ("FIN 46").
FIN 46 requires that any entity meeting certain rules and relation to a
company's equity investment risk and level of financial control be
considered as a variable interest entity. The statement (as amended) is
applicable to all variable interest entities created or acquired after
January 31, 2003, and the first interim period beginning after December 15,
2003, for variable interest entities in which the Company holds a variable
interest that is acquired before February 1, 2003. The Company plans on
adopting FIN 46 in the time frames as required by the statement. Management
expects no significant effect on the consolidated financial position,
results of operations or cash flows of the Company as a result of the
initial adoption of this standard in regard to existing variable interest
entities; however, newly formed entities could meet these requirements and
will be recorded as appropriate.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity ("SFAS
150"). This Statement establishes standards for how an issuer classifies
and measures certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances). SFAS 150 was effective beginning in the third quarter of
2003. The FASB deferred the implementation of SFAS 150 as applied to
certain minority interests in finite-lived entities, however. The Company
adopted the requirements of SFAS 150 in the third quarter of 2003, and
considering the aforementioned deferral, it did not impact the Company's
financial position, results of operations or cash flows.
The Company has elected to be taxed as a real estate investment trust
("REIT") under the Internal Revenue Code of 1986, as amended. Accordingly,
no provision has been made for income taxes for the three and nine months
ended September 30, 2003.
- 6 -
2. REAL ESTATE
BERG LAND HOLDINGS OPTION AGREEMENT
Under the terms of the Berg Land Holdings Option Agreement, the Company,
through the operating partnerships, has the option to acquire any future
Research & Development ("R&D"), office and industrial buildings developed
by the Berg Group on land currently owned, optioned, or acquired for these
purposes in the future, directly or indirectly, by certain members of the
Berg Group. At present, there are approximately 250 acres of Silicon Valley
land, including land under development, owned directly or under 50% joint
venture entities, by certain members of the Berg Group that are subject to
the terms of the Berg Land Holdings Option Agreement. As of September 30,
2003, the Company had completed 19 acquisitions under the Berg Land
Holdings Option Agreement representing approximately 1,864,000 rentable
square feet. Upon the Company's exercise of an option to purchase any of
the future R&D property developments under the terms of the Berg Land
Holdings Option Agreement, the acquisition price will equal the sum of (a)
the full construction cost of the building; (b) 10% of the full
construction cost of the building; (c) the acquisition value of the parcel
as defined in the agreement upon which the improvements are constructed
(currently ranging from $7.50 to $20.00 per square foot); (d) 10% per annum
of the acquisition value of the parcel for the period from January 1, 1998
to the close of escrow; and (e) interest at LIBOR (London Interbank Offer
Rate) plus 1.65% per annum on the full construction costs of the building
for the period from the date funds were disbursed by the developer to the
close of escrow; less (f) any debt encumbering the property, or a lesser
amount as approved by the members of the independent directors committee of
the Company's board of directors. At the option of the owners of the land
so purchased by the Company, the purchase may be paid in cash or operating
partnership interests ("O.P. units") valued at the average closing price of
shares of common stock over the 30-trading-day period preceding the
acquisition date.
Under the Berg Land Holdings Option Agreement, as long as the Berg Group's
percentage ownership interest in the Company and the operating partnerships
taken as a whole is at least 65%, the Company also has an option to
purchase all land acquired, directly or indirectly, by Carl E. Berg or
Clyde J. Berg in the future which has not been improved with completed
buildings and which is zoned for, intended for or appropriate for research
and development, office and/or industrial development or use in the states
of California, Oregon and Washington.
INVESTMENT IN UNCONSOLIDATED JOINT VENTURE
Effective January 1, 2003, the Company acquired a 50% interest in a joint
venture with TBI in Morgan Hill, California for $1,800 from the Berg Group
under the Berg Land Holdings Option Agreement. The Company financed the
acquisition of its 50% interest with the issuance of 181,032 O.P. units to
the Berg Group. The joint venture consists of four R&D buildings with
approximately 593,000 rentable square feet, which are operated and managed
by TBI, the other partner in the joint venture. The Company's investment in
this joint venture is reflected as an investment in unconsolidated joint
venture on the accompanying consolidated balance sheets. This investment is
not consolidated because TBI has management and control over significant
day-to-day operating activities.
On April 1, 2003, the joint venture with TBI acquired a 60,000 rentable
square foot shell building in Morgan Hill, California from the Berg Group
under the Berg Land Holdings Option Agreement. The joint venture financed
100% of the cost of the building. The building was sold on April 2, 2003.
The Company received a cash distribution and recognized a gain of $1,400,
its proportionate share, on the sale.
PROPERTY ACQUISITIONS
Effective April 9, 2003, the Company acquired a 36-acre seven-building
campus style office/R&D project comprised of approximately 625,000 rentable
square feet at San Tomas and Central Expressway in Santa Clara, California,
also known as the San Tomas Technology Park. The project was acquired for
approximately $110,000 from an unrelated third party and financed with a
combination of debt and cash reserves. The debt component is comprised of
an $80,000 short term loan from Citicorp USA, Inc., which is collateralized
by the acquired properties. This loan bears interest at an annual rate
equal to LIBOR plus 2% and matures in April 2004. In addition, the Company
utilized approximately $19,200 of its operating line of credit with
Cupertino National Bank in connection with this acquisition. The
Consolidated Statements of Operations for the three and nine months ended
September 30, 2003 include revenues and expenses from the acquired
properties at the San Tomas Technology Park from the date of acquisition.
See related discussion under Note 8.
3. STOCK TRANSACTIONS
During the nine months ended September 30, 2003, stock options to purchase
60,362 shares of common stock and 50,000 shares of common stock were
exercised at $4.50 and $8.25 per share, respectively. Total proceeds to the
Company were approximately $683. Two limited partners exchanged 157,000
O.P. units for 157,000 shares of the Company's common stock under the terms
of the December 1998 Exchange Rights Agreement among the Company and all
limited partners of the operating partnerships.
- 7 -
4. NET INCOME PER SHARE
Basic operating net income per share is computed by dividing net income by
the weighted average number of common shares outstanding for the period.
Diluted operating net income per share is computed by dividing net income
by the sum of the weighted-average number of common shares outstanding for
the period plus the assumed exercise of all dilutive securities using the
treasury stock method.
The computation for weighted average shares is detailed below:
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------- -------------------------------
2003 2002 2003 2002
-------------- ------------- -------------- -------------
Weighted average shares outstanding (basic) 17,747,293 17,467,329 17,695,920 17,445,759
Incremental shares from assumed option exercise 70,624 389,359 61,541 426,349
-------------- ------------- -------------- -------------
Weighted average shares outstanding (diluted) 17,817,917 17,856,688 17,757,461 17,872,108
============== ============= ============== =============
The outstanding O.P. units, which are exchangeable at the unit holder's
option, subject to certain conditions, for shares of common stock on a
one-for-one basis have been excluded from the diluted net income per share
calculation, as there would be no effect on the calculation after adding
the minority interests' share of income back to net income. The total
number of O.P. units outstanding at September 30, 2003 and 2002 was
86,498,064 and 86,494,032, respectively.
5. RELATED PARTY TRANSACTIONS
As of September 30, 2003, the Berg Group owned 78,364,716 O.P. units. The
Berg Group's ownership as of September 30, 2003 represented approximately
75% of the equity interests of the Company, assuming conversion of the
86,498,064 O.P. units outstanding into the Company's common stock.
Effective January 1, 2003, the Company and the Berg Group mutually agreed
to reduce the Berg Group $100,000 line of credit to $20,000 and to reduce
the number of properties securing the line of credit to five. The Berg
Group line of credit bears interest at LIBOR plus 1.30%, which was 2.48% as
of September 30, 2003, and matures in March 2004. The Company believes that
the terms of the Berg Group line of credit are more favorable than those
available from commercial lenders. As of September 30, 2003, debt in the
amount of $769 was due the Berg Group under the line of credit, and debt in
the amount of $10,843 was due the Berg Group under a mortgage note
established May 15, 2000 in connection with the acquisition of a 50%
interest in Hellyer Avenue Limited Partnership, the obligor under the
mortgage note. The mortgage note bears interest at 7.65% and is due in ten
years with principal payments amortized over 20 years.
Carl E. Berg has a substantial financial interest in one company that
leases space from the operating partnerships. This company occupies 5,862
square feet at $1.00 per square foot per month. This lease was in effect
prior to the Company's acquisition of its general partnership interests in
July 1998. The lease expires in May 2004.
The Company currently leases office space owned by Berg & Berg Enterprises,
Inc., an affiliate of Carl E. Berg and Clyde J. Berg. Rental amounts and
overhead reimbursements paid to Berg & Berg Enterprises, Inc. were $23 for
each of the three-month periods ended September 30, 2003 and 2002 and $68
for each of the nine-month periods ended September 30, 2003 and 2002.
6. COMMITMENTS AND CONTINGENCIES
The Company and the operating partnerships are or may become, from time to
time, parties to litigation arising out of the normal course of business.
Management is not aware of any litigation against the Company that would
have a material adverse effect on the consolidated financial position,
results of operations or cash flows of the Company.
Insurance policies currently maintained by the Company do not cover losses
from the consequence of terrorism or seismic activity, although they do
cover losses from fires after an earthquake.
7. DISCONTINUED OPERATIONS
Effective January 1, 2002, the Company adopted Statement of Financial
Accounting Standards No. 144, "Accounting for the Impairment or Disposal of
Long Lived Assets," which addresses financial accounting and reporting for
the impairment and disposal of long-lived assets. In general, income or
loss attributable to the operations and sale of property, and the
operations related to property held for sale, are classified as
discontinued operations in the statements of operations. All periods
presented in this report could require further reclassification in future
periods if additional property sales occur.
As of September 30, 2003, there were no properties under contract to be
sold or disposed of which would qualify as discontinued operations.
- 8 -
In March 2002, the Company sold one property for a total gain of $6,103,
including minority interest share of $5,085. Condensed results of
operations for this property for the nine months ended September 30, 2002
are as follows:
Nine Months Ended
September 30, 2002
-------------------
(Dollars in thousands)
Rental income from real estate $333
Tenant reimbursements 293
-------------------
Total revenues 626
Real estate taxes 293
Depreciation 46
-------------------
Total expenses 339
-------------------
Income before minority interests 287
Minority interests 238
-------------------
Net income $ 49
===================
8. BUSINESS COMBINATIONS
For real estate acquired subsequent to June 30, 2001, the effective date of
Statement of Financial Accounting Standards ("SFAS") No. 141, Business
Combinations, the fair value of the real estate acquired is allocated to
the acquired tangible assets, consisting of land, building and tenant
improvements, and identified intangible assets and liabilities, including
the value of the above or below market leases and in-place leases.
On April 9, 2003, the Company acquired San Tomas Technology Park for
$110,000 in cash. The purchase price was allocated to long-lived assets,
one above-market in-place lease and the value of in-place leases. The
Company recorded $18,284 of the purchase price as real estate related
intangible assets in the accompanying consolidated balance sheets for the
above-market in-place lease and the value of in-place leases. The
intangible assets will be amortized over the applicable remaining lease
terms. Amortization expense of $912 and $1,385 was recorded for the three
and nine months ended September 30, 2003, respectively.
The purchase price allocation for this acquisition was determined in
accordance with the following principles under SFAS No. 141:
The fair value of the tangible assets of an acquired property, which
includes land, building and tenant improvements, is determined by valuing
the property as if it were vacant, and the "as-if-vacant" value is then
allocated to land, building and tenant improvements based on management's
determination of the relative fair values of these assets. Factors
considered by management in performing these analyses include certain costs
during the lease-up periods considering current market conditions and costs
to execute similar leases. These costs include estimates of lost rental
revenue, leasing commissions, and tenant improvements.
In allocating the fair value of the identified intangible assets of the
acquired property, above-market in-place lease value is recorded based on
the present value, using an interest rate which reflects the risks
associated with the lease acquired, of the difference between (i) the
contractual amounts to be paid pursuant to the in-place lease and (ii)
management's estimate of fair market lease rate for the corresponding
in-place lease, measured over a period equal to the remaining
non-cancelable lease term. The capitalized above-market lease value,
included in real estate related intangible assets in the accompanying
consolidated balance sheets, is amortized to expense as amortization of
real estate over the remaining non-cancelable lease term. The value of
in-place leases exclusive of the value of above-market in-place lease is
also amortized to expense over the remaining non-cancelable periods of the
respective leases. If a lease were to be terminated prior to its stated
expiration, all unamortized amounts relating to that lease would be written
off in the period that the lease is terminated.
9. SUBSEQUENT EVENTS
On October 9, 2003, the Company paid dividends of $0.24 per share of common
stock to all common stockholders of record as of September 30, 2003. On the
same date, the operating partnerships paid a distribution of $0.24 per O.P.
unit to all holders of O.P. units.
- 9 -
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
This Management's Discussion and Analysis of Financial Condition and Results of
Operations should be read in conjunction with the accompanying consolidated
financial statements and notes thereto contained herein and the Company's
consolidated financial statements and notes thereto contained in the Company's
Annual Report on Form 10-K as of and for the year ended December 31, 2002. The
results for the three and nine months ended September 30, 2003 are not
necessarily indicative of the results to be expected for the entire fiscal year
ending December 31, 2003. The following discussion includes forward-looking
statements, including but not limited to, statements with respect to the
Company's future financial performance, operating results, plans and objectives.
Actual results may differ materially from those currently anticipated depending
upon a variety of factors, including those described under the sub-heading,
"Forward-Looking Information."
OVERVIEW
Mission West Properties, Inc. (the "Company") acquires, markets, leases, and
manages R&D and office properties, primarily located in the Silicon Valley
portion of the San Francisco Bay Area. As of September 30, 2003, the Company
owned and managed 108 properties totaling approximately 7.8 million rentable
square feet through four limited partnerships, or operating partnerships, for
which it is the sole general partner. This class of property is designed for
research and development and office uses and, in some cases, includes space for
light manufacturing operations with loading docks. The Company believes that it
has one of the largest portfolios of R&D properties in the Silicon Valley. As of
September 30, 2003, the five tenants who leased the most square footage from the
Company were Microsoft Corporation, JDS Uniphase Corporation, Amdahl Corporation
(a subsidiary of Fujitsu Limited), Apple Computer, Inc., and NEC Electronics
America, Inc. For federal income tax purposes, the Company has operated as a
self-managed, self-administered and fully integrated real estate investment
trust ("REIT") since fiscal 1999.
The Company's acquisition, growth and operating strategy incorporates the
following elements:
- - working with the Berg Group to take advantage of their abilities and
resources to pursue development opportunities which the Company has an
option to acquire, on pre-negotiated terms, upon completion and leasing;
- - capitalizing on opportunistic acquisitions from third parties of
high-quality R&D and office properties that provide attractive initial
yields and significant potential for growth in cash-flow;
- - focusing on general purpose, single-tenant Silicon Valley R&D and office
properties for information technology companies in order to maintain low
operating costs, reduce tenant turnover and capitalize on our relationships
with these companies and our extensive knowledge of their real estate
needs; and
- - maintaining prudent financial management principles that emphasize current
cash flow while building long-term value, the acquisition of pre-leased
properties to reduce development and leasing risks and the maintenance of
sufficient liquidity to acquire and finance properties on desirable terms.
On April 9, 2003, the Company acquired seven R&D and office properties located
at the San Tomas Technology Park in Santa Clara, California. The acquisition
added approximately 625,000 net rentable square feet, or approximately 9%, to
the Company's existing portfolio of properties.
CRITICAL ACCOUNTING POLICIES
The Company prepares the consolidated financial statements in conformity with
GAAP, which requires it to make certain estimates, judgments and assumptions
that affect the reported amounts in the accompanying consolidated financial
statements, disclosure of contingent assets and liabilities and related
footnotes. Actual results may differ from these estimates under different
assumptions or conditions.
Critical accounting policies are defined as those that require management to
make estimates, judgments and assumptions, giving due consideration to
materiality, in certain circumstances that affect amounts reported in the
consolidated financial statements, and potentially result in materially
different results under different conditions and assumptions. The Company
believes that the following best describe its critical accounting policies:
REAL ESTATE ASSETS. Real estate assets are stated at cost. Cost includes
expenditures for improvements or replacements. Maintenance and repairs are
charged to expense as incurred. Gains and losses from sales are included in
income in accordance with Statement of Financial Accounting Standards ("SFAS")
No. 66, "Accounting for Sales of Real Estate."
- 10 -
The Company reviews real estate assets for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. If the carrying amount of the asset exceeds its estimated
undiscounted net cash flow, before interest, it will recognize an impairment
loss equal to the difference between the carrying amount and the estimated fair
value. If impairment is recognized, the reduced carrying amount of the asset
will be accounted for as its new cost. For a depreciable asset, the new cost
will be depreciated over the asset's remaining useful life. Generally, fair
values are estimated using discounted cash flow, replacement cost or market
comparison analyses. The process of evaluating for impairment requires estimates
as to future events and conditions, which are subject to varying market and
economic factors, however. Therefore, it is reasonably possible that a change in
estimate resulting from judgments as to future events could occur which would
affect the recorded amounts of the property.
The purchase price allocation for property acquisition subsequent to June 30,
2001 is determined in accordance with the following principles under SFAS No.
141:
The fair value of the tangible assets of an acquired property, which includes
land, building and tenant improvements, is determined by valuing the property as
if it were vacant, and the "as-if-vacant" value is then allocated to land,
building and tenant improvements based on management's determination of the
relative fair values of these assets. Factors considered by management in
performing these analyses include certain costs during the lease-up periods
considering current market conditions and costs to execute similar leases. These
costs include estimates of lost rental revenue, leasing commissions, and tenant
improvements.
In allocating the fair value of the identified intangible assets of the acquired
property, above-market in-place lease value is recorded based on the present
value, using an interest rate which reflects the risks associated with the lease
acquired, of the difference between (i) the contractual amounts to be paid
pursuant to the in-place lease and (ii) management's estimate of fair market
lease rate for the corresponding in-place lease, measured over a period equal to
the remaining non-cancelable lease term. The capitalized above-market lease
value, included in real estate related intangible assets in the accompanying
consolidated balance sheets, is amortized to expense as amortization of real
estate over the remaining non-cancelable lease term. The value of in-place
leases exclusive of the value of above-market in-place lease is also amortized
to expense over the remaining non-cancelable periods of the respective leases.
If a lease were to be terminated prior to its stated expiration, all unamortized
amounts relating to that lease would be written off in the period that the lease
is terminated.
ALLOWANCE FOR DOUBTFUL ACCOUNTS AND RESERVE. The preparation of the consolidated
financial statements requires the Company to make estimates and assumptions. As
such, it must make estimates of the uncollectability of its accounts receivable
based on the evaluation of its tenants' financial position, analyses of accounts
receivable and current economic trends. The Company also makes estimates for a
straight-line adjustment reserve for existing tenants with the potential of
bankruptcy or ceasing operations. Its estimates are based on the review of
tenants' payment histories, publicly available financial information and such
additional information about their financial condition as tenants provide them.
The information available to the Company might lead it to overstate or
understate these reserve amounts. The use of different estimates or assumptions
could produce different results. Moreover, actual future collections of accounts
receivable or reductions in future reported rental income due to tenant
bankruptcies or other business failures could differ materially from the
Company's estimates.
CONSOLIDATED JOINT VENTURES. The Company, through an operating partnership, owns
three properties that are in joint ventures in which the Company holds ownership
interests. The Company manages and operates all three properties. The Company's
ownership of these properties and its portion of their operating results are
reflected on the Company's consolidated financial statements because the Company
owns a majority interest, exercises significant control over major operating
decisions, and has operational and financial control of the investments. The
Company makes judgments and assumptions about the estimated monthly payments to
be made to its joint venture partners, which are reported with its periodic
results of operations. Actual results may differ from these estimates under
different assumptions or conditions.
INVESTMENTS IN UNCONSOLIDATED JOINT VENTURES. The Company, through an operating
partnership, has a non-controlling limited partnership interest in one
unconsolidated joint venture. This investment is not consolidated because the
Company does not exercise significant control over major operating and financial
decisions. The Company accounts for the joint venture using the equity method of
accounting.
REVENUE RECOGNITION. The Company recognizes rental revenue on the straight-line
method of accounting required by GAAP under which contractual rent payment
increases are recognized evenly over the lease term, regardless of when the rent
payments are received by the Company. The difference between recognized rental
income and rental cash receipts is recorded as deferred rent on the consolidated
balance sheets.
Certain lease agreements contain terms that provide for additional rents based
on reimbursement of certain costs. These additional rents are recognized on the
accrual basis.
Rental revenue is affected if existing tenants terminate or amend their leases.
The Company tries to identify tenants who may be likely to declare bankruptcy or
cease operations. By anticipating these events in advance, the Company expects
to take steps to minimize their impact on its reported results of operations
through lease renegotiations, adjustments to deferred rent, and other
appropriate measures. The Company's judgments and estimations about tenants'
capacity to continue to meet their lease obligations will affect the
- 11 -
rental revenue recognized. Material differences may result in the amount and
timing of our rental revenue for any period if the Company made different
judgments or estimations.
- 12 -
RESULTS OF OPERATIONS
COMPARISON OF THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 TO THE THREE
AND NINE MONTHS ENDED SEPTEMBER 30, 2002.
As of September 30, 2003, the Company, through its controlling interests in the
operating partnerships, owned 108 properties totaling approximately 7.8 million
rentable square feet compared to 101 properties totaling approximately 7.2
million rentable square feet owned by the Company as of September 30, 2002. This
represents a net increase of approximately 8% in total rentable square footage,
which is primarily attributable to the Company's acquisition of seven properties
at the San Tomas Technology Park in Santa Clara, California consisting of
approximately 625,000 net rentable square feet in April 2003.
Rental revenues from continuing operations for the three and nine months ended
September 30, 2003 compared to the three and nine-month periods in 2002 are as
follows:
Three Months Ended September 30,
---------------------------------
% Change by % of Total Net
2003 2002 $ Change Property Group Change
-------------- -------------- -------------- --------------- -----------------
(Dollars in thousands)
Same Property (1) $27,984 $29,251 ($1,267) (4.3%) (3.9%)
2002 Acquisitions (2) 2,553 2,914 (361) (12.4%) (1.1%)
2003 Acquisitions 3,245 - 3,245 100% 10.0%
-------------- -------------- -------------- -----------------
$33,782 $32,165 $1,617 5.0% 5.0%
============== ============== ============== =================
Nine Months Ended September 30,
--------------------------------
% Change by % of Total Net
2003 2002 $ Change Property Group Change
-------------- -------------- -------------- --------------- -----------------
(Dollars in thousands)
Same Property (1) $84,568 $91,609 ($7,041) (7.7%) (7.2%)
2002 Acquisitions (2) 7,659 5,794 1,865 32.2% 1.9%
2003 Acquisitions 6,181 - 6,181 100% 6.3%
-------------- -------------- -------------- -----------------
$98,408 $97,403 $1,005 1.0% 1.0%
============== ============== ============== =================
(1) "Same Property" is defined as properties owned by the Company prior to 2002
that the Company still owned as of September 30, 2003.
(2) Operating rental revenues for 2002 Acquisitions do not reflect a full 12
months of operations in 2002 because these properties were acquired at
various times during 2002.
RENTAL REVENUE FROM CONTINUING OPERATIONS
For the quarter ended September 30, 2003, rental revenues increased by $1.6
million, or 5%, from $32.2 million for the three months ended September 30, 2002
to $33.8 million for the same period of 2003. The net increase resulted from a
decline of ($1.3) million in the Company's "Same Property" portfolio, a decrease
of ($0.3) million from properties acquired in 2002, and an increase of $3.2
million from properties acquired in 2003. Rental revenues increased by $1.0
million from $97.4 million for the nine months ended September 30, 2002 to $98.4
million for the same period of 2003. Of the $1.0 million increase in rental
revenues, ($7.0) million resulted from the Company's "Same Property" portfolio,
$1.8 million were generated by properties acquired in 2002, and $6.2 million
were generated by properties acquired in 2003. The overall increase in rental
revenues was mainly a result of the San Tomas Technology Park acquisition in
April 2003. The decline in rents from the "Same Property" and "2002
Acquisitions" portfolios resulted from property vacancies. The Company's
occupancy rate at September 30, 2003 was approximately 78%, compared to
approximately 86% at September 30, 2002.
EQUITY IN EARNINGS FROM UNCONSOLIDATED JOINT VENTURE
As of September 30, 2003, the Company had investments in four R&D buildings,
totaling 593,000 rentable square feet, through an unconsolidated joint venture,
in which the Company acquired a 50% interest in January 2003. The Company has a
non-controlling limited partnership interest in this joint venture, which it
accounts for using the equity method of accounting. For the three months ended
September 30, 2003, the Company recorded equity in earnings from the
unconsolidated joint venture of approximately $0.6 million. For the nine-month
period ended September 30, 2003, equity in earnings from the unconsolidated
joint venture was approximately $3.4 million, including $1.4 million relating to
a gain from the sale of real estate by the unconsolidated joint venture.
OTHER INCOME
Other income, including interest, increased to $0.6 million for the three months
ended September 30, 2003 from $0.5 million for the third quarter of 2002. For
the nine months ended September 30, 2003 and 2002, other income, including
interest, was $1.9 million and $1.3 million, respectively. Utility rebate and
security deposit forfeitures represented most of the increase. The Company does
not consider these transactions to be recurring items.
EXPENSES FROM CONTINUING OPERATIONS
Operating expenses and real estate taxes from continuing operations, on a
combined basis, increased by $0.4 million, or 8.0%, from $5.0 million to $5.4
million for the three months ended September 30, 2002 and 2003, respectively,
due to the combined effects of reductions in assessed property values on
existing properties, increase in repairs and maintenance expenses, and the
acquisition of the
- 13 -
San Tomas Technology Park in April 2003. Tenant reimbursements from continuing
operations decreased by $0.4 million, or 7.7%, from $5.2 million for the three
months ended September 30, 2002 to $4.8 million for the three months ended
September 30, 2003. The decrease in tenant reimbursements was due to lower
occupancy. Certain expenses such as property insurance, real estate taxes, and
other fixed expenses are not recoverable from vacant properties.
Depreciation and amortization expense of real estate from continuing operations
increased by $1.2 million from $4.6 million to $5.8 million for the three months
ended September 30, 2002 and 2003, respectively. Of the $1.2 million increase in
depreciation and amortization expense of real estate, approximately $0.9 million
represented amortization expense of intangible assets resulting from the
acquisition of the San Tomas Technology Park (see note 8). Depreciation expense
from continuing operations increased by $2.4 million from $13.4 million to $15.8
million for the nine months ended September 30, 2002 and 2003, respectively,
reflecting the newly acquired San Tomas Technology Park.
Interest expense increased by $1.9 million, or 79.2%, from $2.4 million for the
three months ended September 30, 2002 to $4.3 million for the three months ended
September 30, 2003. The increase in interest expense resulted from additional
debt obtained by the Company, consisting of a new revolving line of credit from
Cupertino National Bank put in place during the third quarter 2002, a new $100
million mortgage loan from Northwestern Mutual Life Insurance Company obtained
in early January 2003, and a new $80 million mortgage loan from Citicorp USA,
Inc. obtained in early April 2003. Interest expense (related parties) decreased
by $0.6 million, or 66.7%, from $0.9 million for the three months ended
September 30, 2002 to $0.3 million for the three months ended September 30, 2003
due to lower interest rates and the repayments of the Berg Group line of credit.
Total debt outstanding, including amounts due related parties, increased by
$96.4 million, or 40.8%, from $236.3 million as of September 30, 2002 to $332.7
million as of September 30, 2003. Overall interest expense, including amounts
paid to related parties, for the quarter ended September 30, 2003 increased by
$1.3 million compared to the same quarter a year ago.
Interest expense increased by $5.1 million, or 72.9%, from $7.0 million for the
nine months ended September 30, 2002 to $12.1 million for the nine months ended
September 30, 2003. Interest expense (related parties) decreased by $2.0
million, or 71.4%, from $2.8 million for the nine months ended September 30,
2002 to $0.8 million for the nine months ended September 30, 2003. Overall
interest expense for the nine months ended September 30, 2003 increased by $3.1
million compared to the nine months ended September 30, 2002 with the
substitution of new debt for the loan under the Berg Group line of credit.
Interest expense for the three and nine month periods in 2003 increased as a
result of new debt. In addition to the higher amount of debt, the new debt
carries a higher interest rate than the Berg Group line of credit which it
mainly replaced. Management expects additional increases in interest expense as
new debt is incurred in connection with property acquisitions, the Company draws
on the Cupertino National Bank revolving line of credit, and the Company seeks
alternative sources of credit.
NET INCOME TO MINORITY INTEREST AND NET INCOME TO COMMON STOCKHOLDERS
The minority interest portion of income decreased by $0.4 million, or 2.0%, from
$20.0 million for the three months ended September 30, 2002 to $19.6 million for
the three months ended September 30, 2003. Net income to common stockholders
decreased by $0.6 million, or 13.3%, from $4.5 million for the three months
ended September 30, 2002 to $3.9 million for the same period in 2003. For the
nine months ended September 30, 2003 and 2002, the minority interest portion of
income was $60.8 million and $67.0 million, respectively, resulting in net
income to stockholders of $12.1 million and $13.8 million, respectively. The
decline in net income was primarily due to reduced rental revenues and because
net income for the prior year's comparable period included gain from a sale of
discontinued operations. Minority interest represents the ownership interest of
all limited partners in the operating partnerships taken as a whole, which was
approximately 83% as of September 30, 2003 and 2002.
RECENT DEVELOPMENTS
RENTAL MARKET CONDITIONS. All of the Company's properties are located in the
Northern California area known as Silicon Valley, which generally consists of
portions of Santa Clara County, Southwestern Alameda County, Southeastern San
Mateo County and Eastern Santa Cruz County. The Silicon Valley economy and
business activity have slowed markedly since 2001 after fast-paced growth in
1999 and 2000. The Silicon Valley R&D property market has historically
fluctuated with the local economy. According to a recent report by BT Commercial
Real Estate, vacancy rates for Silicon Valley R&D property increased from
approximately 21.9% in late 2002 to 24.0% at the end of the third quarter 2003.
Total vacant R&D square footage in Silicon Valley at the end of the third
quarter of 2003 amounted to 37.1 million square feet, of which 33.7%, or 12.5
million square feet, was being offered under subleases. Total negative net
absorption in 2002 amounted to approximately (10.9) million square feet. During
the first nine months of 2003, there was total negative net absorption of
approximately (5.3) million square feet. The impact of the rental market decline
has not been uniform throughout the area, however. The Silicon Valley R&D
property market has been characterized by a substantial number of submarkets,
with rent and vacancy rates varying by submarket and location within each
submarket.
The Company's actual occupancy rate at September 30, 2003 was 78.3%, which is a
significant decline from the occupancy rate of 85.8% at September 30, 2002. The
Company believes that its occupancy rate could decline further going forward if
key tenants seek the protection of the bankruptcy laws or discontinue
operations. In addition, leases with respect to approximately 76,000 rentable
square feet are expiring in the fourth quarter 2003. The properties subject to
these leases may take anywhere from six to 12 months or longer to re-lease. The
Company expects the average 2003 renewal rental rates for these properties to be
approximately equal to or, perhaps, below current rents. If the Company is
unable to lease a significant portion of any vacant space or space subject to
expiring
- 14 -
leases; if the Company experiences significant tenant defaults as a result of
the current economic downturn; or if the Company is not able to lease space at
or above current market rates, its results of operations and cash flows will be
adversely affected. The Company's operating results and ability to pay dividends
at current levels remain subject to a number of material risks, as indicated
under the caption "Forward-Looking Information" below and in the section
entitled "Risk Factors" in the Company's most recent annual report on Form 10-K.
- 15 -
CHANGES IN FINANCIAL CONDITION
For the nine months ended September 30, 2003, net investments in real estate
assets increased by approximately $97.1 million from December 31, 2002 due to
the San Tomas Technology Park acquisition, new tenant improvements, and the
acquisition of a 50% interest in a joint venture from the Berg Group under the
Berg Land Holdings Option Agreement for $1.8 million. The Company increased
total loan indebtedness by approximately $99.2 million in connection with the
San Tomas Technology Park acquisition and issued 181,032 O.P. units for the
joint venture interest.
At September 30, 2003, total stockholders' equity, net, increased by
approximately $1.6 million from December 31, 2002 as the Company obtained
additional capital from stock option exercises and the exchange of O.P. units
for the Company's common stock while incurring a deficit of ($0.6) million.
During the nine months ended September 30, 2003, stock options to purchase
60,362 shares of common stock were exercised at $4.50 per share, and stock
options to purchase 50,000 shares of common stock were exercised at $8.25 per
share. Total proceeds to the Company were approximately $0.7 million. During the
first nine months of 2003, two limited partners exchanged 157,000 O.P. units for
157,000 shares of the Company's common stock under the Exchange Rights Agreement
among the Company and the limited partners in the operating partnerships. The
newly issued shares increased additional paid in capital by approximately $2.3
million.
LIQUIDITY AND CAPITAL RESOURCES
The Company expects its principal sources of liquidity for distributions to
stockholders and unit holders, debt service, leasing commissions and recurring
capital expenditures to come from operations and/or other credit facilities that
currently exists or that may be established by the Company with third party
financial institutions. The Company expects these sources of liquidity to be
adequate to meet projected distributions to stockholders and other presently
anticipated liquidity requirements during the next 12 months. The Company
expects to meet its long-term liquidity requirements for the funding of property
development, property acquisitions and other material non-recurring capital
improvements through long-term secured and unsecured indebtedness and the
issuance of additional equity securities by the Company. The Company has the
ability to meet short-term obligations or other liquidity needs based on its
existing lines of credit. Despite the current weakness in the economy, the
Company expects interest expense to increase, but not significantly, as it
incurs debt through acquisitions of new properties and as interest rates
increase.
On January 9, 2003, the Company obtained a $100 million secured mortgage loan
from Northwestern Mutual Life Insurance Company ("Northwestern Loan") that bears
a fixed interest rate at 5.64% and matures in January 2013 with principal
payments amortized over 20 years. The mortgage loan is secured by 11 properties.
The Company paid approximately $675,000 in loan fees and financing costs and
used the proceeds to primarily pay down short-term debt and the Berg Group line
of credit.
On April 9, 2003, the Company obtained an $80 million short-term mortgage loan
from Citicorp USA, Inc. ("Citicorp Loan") that bears interest at LIBOR plus 2%
and matures in April 2004. The Company paid $200,000 in financing costs and used
the proceeds to acquire the San Tomas Technology Park property. The original
loan term was 120 days, but the Company and Citicorp USA, Inc. agreed to a
nine-month loan term extension in June 2003.
On October 9, 2003, the Company paid dividends of $0.24 per share of common
stock to all common stockholders of record as of September 30, 2003. On the same
date, the operating partnerships paid a distribution of $0.24 per O.P. unit to
all holders of O.P. units.
DEBT
At September 30, 2003, the Company had total indebtedness of $332.7 million,
including $301.1 million of fixed rate mortgage debt, $10.8 million under the
Berg Group mortgage note (related parties), $20.0 million under the Cupertino
National Bank line of credit, and $0.8 million under the Berg Group line of
credit (related parties), as detailed in the table below:
- 16 -
The following table sets forth information regarding debt outstanding as of
September 30, 2003:
Maturity Interest
Debt Description Collateral Properties Balance Date Rate
- --------------------------------------------- ---------------------------------------- ------------------ ------------ ---------
(Dollars in thousands)
Line of Credit:
Berg Group (related parties) 2033-2043 Samaritan Drive, San Jose, CA $ 769 3/04 (1)
------------------
2133 Samaritan Drive, San Jose, CA
2233-2243 Samaritan Drive, San Jose, CA
1310-1450 McCandless Drive, Milpitas, CA
1795-1845 McCandless Drive, Milpitas, CA
Cupertino National Bank Not Applicable 19,966 7/04 (3)
------------------
Mortgage Notes Payable (related parties): 5300 & 5350 Hellyer Avenue, San Jose, CA 10,843 6/10 7.650%
------------------
Mortgage Notes Payable:
Prudential Capital Group 20400 Mariani Avenue, Cupertino, CA 791 10/06 8.750%
Washington Mutual (Home Savings & Loan Assoc.) 10460 Bubb Road, Cupertino, CA 244 12/06 9.500%
Prudential Insurance Company of America (2) 10300 Bubb Road, Cupertino, CA 121,938 10/08 6.560%
10500 N. De Anza Boulevard, Cupertino, CA
4050 Starboard Drive, Fremont, CA
45700 Northport Loop, Fremont, CA
45738 Northport Loop, Fremont, CA
450-460 National Avenue, Mountain View, CA
6311 San Ignacio Avenue, San Jose, CA
6321 San Ignacio Avenue, San Jose, CA
6325 San Ignacio Avenue, San Jose, CA
6331 San Ignacio Avenue, San Jose, CA
6341 San Ignacio Avenue, San Jose, CA
6351 San Ignacio Avenue, San Jose, CA
3236 Scott Boulevard, Santa Clara, CA
3560 Bassett Street, Santa Clara, CA
3570 Bassett Street, Santa Clara, CA
3580 Bassett Street, Santa Clara, CA
1135 Kern Avenue, Sunnyvale, CA
1212 Bordeaux Lane, Sunnyvale, CA
1230 E. Arques, Sunnyvale, CA
1250 E. Arques, Sunnyvale, CA
1170 Morse Avenue, Sunnyvale, CA
1600 Memorex Drive, Santa Clara, CA
1688 Richard Avenue, Santa Clara, CA
1700 Richard Avenue, Santa Clara, CA
3540 Bassett Street, Santa Clara, CA
3542 Bassett Street, Santa Clara, CA
3544 Bassett Street, Santa Clara, CA
3550 Bassett Street, Santa Clara, CA
Northwestern Mutual Life Insurance Company 1750 Automation Parkway, San Jose, CA 98,142 1/13 5.640%
1756 Automation Parkway, San Jose, CA
1762 Automation Parkway, San Jose, CA
6320 San Ignacio Avenue, San Jose, CA
6540-6541 Via Del Oro, San Jose, CA
6385-6387 Via Del Oro, San Jose, CA
2251 Lawson Lane, Santa Clara, CA
1325 McCandless Drive, Milpitas, CA
1650-1690 McCandless Drive, Milpitas, CA
20605-20705 Valley Green Drive, Cupertino, CA
Citicorp USA, Inc. 2001 Walsh Avenue, Santa Clara, CA 80,000 4/04 (3)
2880 Scott Boulevard, Santa Clara, CA
2890 Scott Boulevard, Santa Clara, CA
2770-2800 Scott Boulevard, Santa Clara, CA
2300 Central Expressway, Santa Clara, CA
2220 Central Expressway, Santa Clara, CA
2330 Central Expressway, Santa Clara, CA
------------------
Mortgage Notes Payable Subtotal 301,115
------------------
TOTAL $ 332,693
==================
(1) The debt owed to the Berg Group under the line of credit carries a variable
interest rate equal to LIBOR plus 1.30% and is payable in full in March
2004. The interest rate at September 30, 2003 was 2.48%.
(2) John Kontrabecki, one of the limited partners, has guaranteed approximately
$12,000 of this debt.
(3) Interest rate equal to LIBOR plus 2%. The interest rates for the Cupertino
National Bank line of credit and the Citicorp USA, Inc. mortgage loan at
September 30, 2003 were 3.10% and 3.14%, respectively.
- 17 -
As of September 30, 2003, the Company's debt to total market capitalization
ratio was approximately 20.5%, based upon a total market capitalization of
approximately $1.6 billion. The Company computed this ratio by dividing the
Company's total debt outstanding as of September 30, 2003 by the sum of this
debt plus the market value of common stock (based upon the closing price of
$12.36 per share on September 30, 2003) on a fully diluted basis, taking into
account the conversion of all O.P. units into common stock.
HISTORICAL CASH FLOWS
Net cash provided by operating activities for the nine months ended September
30, 2003 was $91.8 million compared to $97.2 million for the same period in
2002. The decline resulted primarily from the decrease in rental revenue from
the Company's current portfolio of property due to tenant lease obligation
defaults during 2002 and 2003.
Net cash used in investing activities was approximately ($109.9) million and
($20.5) million for the nine months ended September 30, 2003 and 2002,
respectively. Of the ($109.9) million net cash used in investing activities,
($110) million was used to acquire the San Tomas Technology Park property, $1.4
million was received from the sale of joint venture real estate, and ($1.3)
million was used for tenant improvements and new equipment.
Net cash provided by financing activities was $18.7 million for the nine months
ended September 30, 2003 compared to ($75.0) million used in financing
activities for the same period in 2002. Of the $18.7 million net cash from
financing activities, ($86.1) million was used to pay outstanding debt, ($62.4)
million for minority interest distributions, and ($12.7) million for dividends.
The Company obtained approximately $180 million from financing activity, which
included the Northwestern Loan, the Citicorp Loan, net of related financing
costs, and proceeds from the exercise of stock options.
CAPITAL EXPENDITURES
The Company's existing R&D properties require periodic investments of capital
for tenant-related capital expenditures and for general capital improvements.
For the years ended December 31, 1997 through December 31, 2002, the recurring
tenant improvement costs and leasing commissions incurred with respect to new
leases and lease renewals of the properties that were owned or controlled by
members of the Berg Group prior to July 1, 1998 averaged approximately $1.75
million annually. The Company expects that the average annual cost of recurring
tenant improvements and leasing commissions, related to the properties, will be
approximately $2.0 million during 2003. The Company believes it will recover
substantially all of these sums from the tenants under new or renewed leases.
The Company expects to meet its long-term liquidity requirements for the funding
of property development, property acquisitions and other material non-recurring
capital improvements through long-term secured and unsecured indebtedness and
the issuance of additional equity securities by the Company.
FUNDS FROM OPERATIONS
The Company's principal performance measurements are net income to common
stockholders and earnings per share computed in accordance with GAAP. Management
considers Funds From Operations ("FFO") an appropriate measure of performance of
an equity REIT because, along with cash flows from operating activities,
financing activities and investing activities, it provides investors with an
understanding of the Company's ability to incur and service debt, and make
capital expenditures. FFO is a non-GAAP financial measurement used by real
estate investment trusts to measure and compare operating performance. As
defined by the National Association of Real Estate Investment Trusts ("NAREIT"),
FFO represents net income (loss) before minority interest of unit holders
(computed in accordance with GAAP), excluding gains (or losses) from debt
restructuring and sales of property, plus real estate related depreciation and
amortization (excluding amortization of deferred financing costs, amortization
of commission and depreciation of non-real estate assets) and after adjustments
for unconsolidated partnerships and joint ventures. FFO should not be considered
as an alternative for net income as a measure of profitability and it is not
comparable to cash flows provided by operating activities determined in
accordance with GAAP, nor is FFO necessarily indicative of funds available to
meet the Company's cash needs, including its need to make cash distributions to
satisfy REIT requirements.
The Company's definition of FFO also assumes conversion at the beginning of the
period of all convertible securities, including minority interests that might be
exchanged for common stock. FFO does not represent the amount available for
management's discretionary use as such funds may be needed for capital
replacement or expansion, debt service obligations or other commitments and
uncertainties. Furthermore, FFO is not comparable to similarly entitled items
reported by other REITs that do not define them exactly as the Company defines
FFO. FFO for the three and nine months ended September 30, 2003 and 2002, as
reconciled to net income to common stockholders, are summarized in the following
tables:
- 18 -
Three Months Ended September 30, Nine Months Ended September 30,
----------------------------------------- -----------------------------------------
2003 2002 2003 2002
------------------ ------------------ ------------------ ------------------
(Dollars in thousands) (Dollars in thousands)
Net income to common stockholders $ 3,943 $ 4,558 $12,132 $13,832
Add:
Minority interests (1) 19,474 19,941 60,331 66,546
Depreciation and amortization (2) 5,797 4,552 15,758 13,409
Less:
Gain on sale of JV assets / assets - - (1,400) (6,103)
------------------ ------------------ ------------------ ------------------
Funds From Operations $29,214 $29,051 $86,821 $87,684
================== ================== ================== ==================
(1) Excludes minority interest for unrelated parties.
(2) Includes depreciation of real estate from discontinued operations and
amortization expense of costs allocated to intangible assets in property
acquisitions.
DISTRIBUTION POLICY
The Company's board of directors will determine the amount and timing of
distributions to our stockholders. The board of directors will consider many
factors prior to making any distributions, including the following:
- - the amount of cash available for distribution;
- - the Company's financial condition;
- - whether to reinvest funds rather than to distribute such funds;
- - the Company's committed and projected capital expenditures;
- - the amount of cash required for new property acquisitions, including
acquisitions under existing agreements with the Berg Group;
- - prospects of tenant renewals and re-leases of properties subject to
expiring leases;
- - cash required for re-leasing activities;
- - the annual distribution requirements under the REIT provisions of the
federal income tax laws; and
- - such other factors as the board of directors deems relevant.
The Company cannot assure you that it will be able to meet or maintain
management's cash distribution objectives.
- 19 -
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
The Company does not believe recently issued accounting standards will
materially impact its financial statements.
In January 2003, the released FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities - an interpretation of ARB No. 15" ("FIN 46"). FIN 46
requires that any entity meeting certain rules and relation to a company's
equity investment risk and level of financial control be considered as a
variable interest entity. The statement (as amended) is applicable to all
variable interest entities created or acquired after January 31, 2003, and the
first interim period beginning after December 15, 2003, for variable interest
entities in which the Company holds a variable interest that is acquired before
February 1, 2003. The Company plans on adopting FIN 46 in the time frames as
required by the statement. Management expects no significant effect on the
consolidated financial position, results of operations or cash flows of the
Company as a result of the initial adoption of this standard in regard to
existing variable interest entities; however, newly formed entities could meet
these requirements and will be recorded as appropriate.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity ("SFAS 150").
This Statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). SFAS 150
was effective beginning in the third quarter of 2003. The FASB deferred the
implementation of SFAS 150 as applied to certain minority interests in
finite-lived entities, however. The Company adopted the requirements of SFAS 150
in the third quarter of 2003, and considering the aforementioned deferral, it
did not impact the Company's financial position, results of operations or cash
flows.
FORWARD-LOOKING INFORMATION
This quarterly report contains forward-looking statements within the meaning of
the federal securities laws. The Company intends such forward-looking statements
to be covered by the safe harbor provisions for forward-looking statements
contained in the Private Securities Reform Act of 1995, and is including this
statement for purposes of complying with these safe harbor provisions.
Forward-looking statements, which are based on certain assumptions and describe
future plans, strategies and expectations of the Company, are generally
identifiable by use of the words "believe," "expect," "intend," "anticipate,"
"estimate," "project" or similar expressions. Additionally, all disclosures
under Part I., Item 3 constitute forward-looking statements. The Company's
ability to predict results or the actual effect of future plans or strategies is
inherently uncertain.
Factors that could have a material adverse effect on the operations and future
prospects of the Company include, but are not limited to, the following:
- - economic conditions generally and the real estate market specifically,
- - legislative or regulatory provisions affecting the Company (including
changes to laws governing the taxation of REITs),
- - availability of capital,
- - interest rates,
- - competition,
- - supply of and demand for R&D, office and industrial properties in the
Company's current and proposed market areas,
- - tenant defaults and bankruptcies,
- - lease term expirations and renewals, and
- - general accounting principles, policies and guidelines applicable to REITs.
In addition, the actual timing of development, construction, and leasing on any
projects that the Company believes it may acquire in the future under the Berg
Land Holdings Option Agreement is presently unknown, and reliance should not be
placed on the estimates concerning these projects. These risks and
uncertainties, together with the other risks described from time to time in the
Company's reports and other documents filed with the Securities and Exchange
Commission, should be considered in evaluating forward-looking statements and
undue reliance should not be placed on such statements.
- 20 -
ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not generally hold market risk sensitive instruments for trading purposes.
We use fixed and variable rate debt to finance our operations. Our exposure to
market risk for changes in interest rates relates primarily to our current and
future debt obligations. We are vulnerable to significant fluctuations of
interest rates on our floating rate debt and pricing on our future debt. We
manage our market risk by monitoring interest rates where we try to recognize
the unpredictability of the financial markets and seek to reduce potentially
adverse effect on the results of our operations. This takes frequent evaluation
of available lending rates and examination of opportunities to reduce interest
expense through new sources of debt financing. Several factors affecting the
interest rate risk include governmental monetary and tax policies, domestic and
international economics and other factors that are beyond our control. The
following table provides information about the principal cash flows, weighted
average interest rates, and expected maturity dates for debt outstanding as of
September 30, 2003. The current terms of this debt are described in Item 2,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources."
For variable rate debt, the table presents the assumption that the outstanding
principal balance at September 30, 2003 will be paid upon maturity.
For fixed rate debt, the table presents the assumption that the outstanding
principal balance at September 30, 2003 will be paid according to scheduled
principal payments and that we will not prepay any of the outstanding principal
balance.
2003 2004 2005 2006 2007 Thereafter Total Fair Value
---- ---- ---- ---- ---- ---------- ----- ----------
VARIABLE RATE DEBT: (Dollars in thousands)
Secured debt $100,735 $100,735 $100,735
Weighted average interest rate 3.13%
FIXED RATE DEBT:
Secured notes payable $1,338 $5,612 $5,977 $6,245 $6,350 $206,436 $231,958 $257,319
Weighted average interest rate 6.23% 6.23% 6.23% 6.23% 6.23% 6.23%
The primary market risk we face is the risk of interest rate fluctuations.
Principal amounts outstanding under the Berg Group line of credit, the Cupertino
National Bank line of credit and the Citicorp USA, Inc. mortgage loan, which are
tied to a LIBOR based interest rate, were approximately $0.8 million, $20.0
million, and $80.0 million, or 0.2%, 6.0% and 24.0%, respectively, of the total
$332.7 million of outstanding debt as of September 30, 2003. As a result, we pay
lower rates of interest in periods of decreasing interest rates and higher rates
of interest in periods of increasing interest rates. All of the debt is
denominated in United States dollars. We had no interest rate caps or interest
rate swap contracts at September 30, 2003.
The following discussion of market risk is based solely on a possible
hypothetical change in future market conditions related to our variable-rate
debt. It includes "forward-looking statements," as previously defined, regarding
market risk, but we are not forecasting the occurrence of these market changes.
Based on the amount of variable debt outstanding as of September 30, 2003, a 1%
increase or decrease in interest rates on our $100.7 million of floating rate
debt would decrease or increase, respectively, nine months earnings and cash
flows by approximately $0.76 million, as a result of the increased or decreased
interest expense associated with the change in rate, and would not have an
impact on the fair value of the floating rate debt. This amount is determined by
considering the impact of hypothetical interest rates on our borrowing cost. Due
to the uncertainty of fluctuations in interest rates and the specific actions
that might be taken by us to mitigate of such fluctuations and their possible
effects, the foregoing sensitivity analysis assumes no changes to our financial
structure.
ITEM 4
CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. The Company has conducted an
evaluation, under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer, President and Vice
President of Finance, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures pursuant to Exchange Act Rule
13a-14c. Base upon that evaluation, the Chief Executive Officer, President and
Vice President of Finance concluded that the Company's disclosure controls and
procedures are effective in timely alerting them to material information
relating to the Company (including its subsidiaries) required to be included in
the Company's periodic SEC filings.
CHANGES IN INTERNAL CONTROLS. There were no significant changes in our internal
controls or to our knowledge, in other factors that could significantly affect
such internal controls subsequent to the date of their evaluation.
- 21 -
ITEM 6
EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
31.1 Section 1350 Certificate of CEO
31.2 Section 1350 Certificate of principal financial officer
32 Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
b. Reports on Form 8-K
The Company filed a Current Report on Form 8-K on July 14,
2003, regarding its results of operations and financial
condition for the second quarter of 2003.
- 22 -
================================================================================
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 thereto duly authorized.
MISSION WEST PROPERTIES, INC.
(Registrant)
Date: November 11, 2003 By: /s/ Carl E. Berg
------------------------------------
Carl E. Berg
Chief Executive Officer
Date: November 11, 2003 By: /s/ Wayne N. Pham
------------------------------------
Wayne N. Pham
Vice President of Finance and Controller
(Principal Accounting Officer and Duly
Authorized Officer)
- 23 -
Exhibit 31.1
CERTIFICATE PURSUANT TO
RULE 13a-14 THE SECURITIES EXCHANGE ACT OF 1934
I, Carl E. Berg, certify that:
1. I have reviewed this Form 10-Q of Mission West Properties, Inc. for the
quarterly period ended September 30, 2003;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our conclusions
about the effectiveness of the disclosure controls and procedures, as
of the end of the period covered by this report based on such
evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Carl E. Berg
Chairman and CEO
November 11, 2003
Exhibit 31.2
CERTIFICATE PURSUANT TO
RULE 13a-14 THE SECURITIES EXCHANGE ACT OF 1934
I, Wayne N. Pham, certify that:
1. I have reviewed this Form 10-Q of Mission West Properties, Inc. for the
quarterly period ended September 30, 2003;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our conclusions
about the effectiveness of the disclosure controls and procedures, as
of the end of the period covered by this report based on such
evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Wayne N. Pham
Vice President of Finance and Controller
November 11, 2003
Exhibit 32
CERTIFICATION OF CEO AND CFO PURSUANT TO
18 U.S.C. ss. 1350,
AS ADOPTED PURSUANT TO
ss. 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report on Form 10-Q of Mission West
Properties, Inc. (the "Company") for the quarterly period ended September 30,
2003 as filed with the Securities and Exchange Commission on the date hereof
(the "Report"), each of Carl E. Berg, Chairman of the Board and Chief Executive
Officer of the Company, and Wayne N. Pham, Vice President of Finance and
Controller of the Company, hereby certify, pursuant to 18 U.S.C. ss. 1350, as
adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, to the best of
his knowledge, that:
(1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934, as amended; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and result of operations of the
Company.
======================================================
Carl E. Berg
Chairman of the Board and Chief Executive Officer
November 11, 2003
======================================================
Wayne N. Pham
Vice President of Finance and Controller
November 11, 2003
This certification accompanies this Report pursuant to ss. 906 of the
Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the
Sarbanes-Oxley Act of 2002, or otherwise required, be deemed filed by the
Company for purposes of ss. 18 of the Securities Exchange Act of 1934, as
amended.