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, 2002
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 [ ]
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:
17,487,329 shares outstanding as of November 12, 2002
- 1 -
Mission West Properties, Inc.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2002
INDEX
Page
PART I FINANCIAL INFORMATION ----
Item 1. Financial Statements (unaudited):
Consolidated Balance Sheets as of September 30, 2002
and December 31, 2001...................................................................................3
Consolidated Statements of Operations for the three
and nine months ended September 30, 2002 and 2001.......................................................4
Consolidated Statements of Cash Flows for the
nine months ended September 30, 2002 and 2001...........................................................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.............................................20
Item 4. Controls and Procedures................................................................................20
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K......................................................................21
SIGNATURES...........................................................................................................21
- 2 -
PART I - FINANCIAL INFORMATION
ITEM 1 CONSOLIDATED FINANCIAL STATEMENTS
MISSION WEST PROPERTIES, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share amounts)
(Unaudited)
---------
September 30, 2002 December 31, 2001
---------------------- ----------------------
ASSETS
Real estate assets, at cost
Land $235,046 $218,058
Buildings 726,007 692,485
---------------------- ----------------------
961,053 910,543
Less accumulated depreciation (61,995) (49,608)
---------------------- ----------------------
Net real estate assets 899,058 860,935
Cash and cash equivalents 7,055 5,310
Restricted cash - 15,435
Deferred rent 15,835 16,923
Other assets 13,984 11,652
---------------------- ----------------------
Total assets $935,932 $910,255
====================== ======================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Line of credit (related parties) $ 51,465 $ 79,887
Line of credit 27,739 -
Unsecured loan 20,000 -
Mortgage notes payable 125,898 127,416
Mortgage notes payable (related parties) 11,153 11,371
Interest payable 340 342
Security deposits 7,065 7,337
Prepaid rental income 20,730 12,470
Dividends/distributions payable 24,951 24,742
Refundable option payment - 18,836
Accounts payable and accrued expenses 7,167 4,367
---------------------- ----------------------
Total liabilities 296,508 286,768
Commitments and contingencies (Note 7)
Minority interest 528,275 515,063
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, 17,467,329 and 17,329,779 shares issued and
outstanding at September 30, 2002 and December 31, 2001,
respectively 17 17
Paid-in-capital 128,095 126,626
Accumulated deficit (16,963) (18,219)
---------------------- ----------------------
Total stockholders' equity 111,149 108,424
---------------------- ----------------------
Total liabilities and stockholders' equity $935,932 $910,255
====================== ======================
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,
2002 2001 2002 2001
-------------------- -------------------- -------------------- --------------------
Revenues:
Rental income from real estate $ 32,165 $ 32,728 $ 97,403 $ 93,061
Tenant reimbursements 5,219 5,284 15,420 12,482
Other income, including interest 487 658 1,261 1,999
Gain on sales of assets - 8,452 - 11,553
-------------------- -------------------- -------------------- --------------------
Total revenues 37,871 47,122 114,084 119,095
-------------------- -------------------- -------------------- --------------------
Expenses:
Operating expenses 1,974 2,470 6,170 5,412
Real estate taxes 3,091 2,469 9,152 7,319
Depreciation of real estate 4,552 4,256 13,363 12,384
General and administrative 386 150 1,190 951
Interest 2,413 2,144 7,045 6,570
Interest (related parties) 861 1,272 2,770 3,735
-------------------- -------------------- -------------------- --------------------
Total expenses 13,277 12,761 39,690 36,371
-------------------- -------------------- -------------------- --------------------
Income before minority interest 24,594 34,361 74,394 82,724
Minority interest 20,036 28,703 61,629 69,007
-------------------- -------------------- -------------------- --------------------
Income from continuing operations 4,558 5,658 12,765 13,717
-------------------- -------------------- -------------------- --------------------
Discontinued operations:
Gain from disposal of assets - - 6,103 -
Gain from operations - 430 287 1,291
Less minority interest share - (358) (5,323) (1,076)
-------------------- -------------------- -------------------- --------------------
Net gain from discontinued operations - 72 1,067 215
-------------------- -------------------- -------------------- --------------------
Net income to common stockholders $ 4,558 $ 5,730 $ 13,832 $ 13,932
==================== ==================== ==================== ====================
Total minority interest $ 20,036 $ 29,061 $ 66,952 $ 70,083
==================== ==================== ==================== ====================
Income per share from continuing operation:
Basic $ 0.26 $ 0.33 $ 0.73 $ 0.81
==================== ==================== ==================== ====================
Diluted $ 0.26 $ 0.33 $ 0.71 $ 0.80
==================== ==================== ==================== ====================
Income per share from discontinued operations:
Basic - - $ 0.06 $ 0.01
==================== ==================== ==================== ====================
Diluted - - $ 0.06 $ 0.01
==================== ==================== ==================== ====================
Net income per share to common stockholders:
Basic $ 0.26 $ 0.33 $ 0.79 $ 0.82
==================== ==================== ==================== ====================
Diluted $ 0.26 $ 0.33 $ 0.77 $ 0.81
==================== ==================== ==================== ====================
Weighted average number of shares of
common stock outstanding (basic) 17,467,329 17,120,279 17,445,759 17,084,034
==================== ==================== ==================== ====================
Weighted average number of shares of
common stock outstanding (diluted) 17,856,688 17,320,462 17,872,108 17,302,594
==================== ==================== ==================== ====================
The accompanying notes are an integral part of these
consolidated financial statements.
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MISSION WEST PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
---------
Nine months ended September 30,
-------------------------------------
2002 2001
------------------ ------------------
Cash flows from operating activities:
Net income $13,832 $13,932
Adjustments to reconcile net income to net cash provided by
operating activities:
Minority interest 66,952 70,083
Depreciation 13,409 12,592
Gain on sales of real estate from continued operations - (11,553)
Gain on sales of real estate from discontinued operations (6,103) -
Other (20) 92
Changes in assets and liabilities:
Deferred rent 1,088 (5,352)
Other assets (2,332) (976)
Interest payable (2) (2)
Security deposits (272) 1,199
Prepaid rental income 8,260 (1,015)
Accounts payable and accrued expenses 2,410 2,388
------------------ ------------------
Net cash provided by operating activities 97,222 81,388
------------------ ------------------
Cash flows from investing activities:
Improvements to real estate assets/new equipment (1,668) (411)
Refundable option payment (18,836) (1,500)
Real estate purchase (31,311) (38,489)
Proceeds from sales of real estate 18,591 38,489
Restricted cash 12,714 -
------------------ ------------------
Net cash used in investing activities (20,510) (1,911)
------------------ ------------------
Cash flows from financing activities:
Principal payments on mortgage notes payable (1,518) (4,151)
Principal payments on mortgage notes payable (related parties) (218) (202)
Net payments under line of credit (related parties) (46,422) (14,557)
Proceeds from unsecured loan 20,000 -
Proceeds from line of credit 32,739 -
Payment on line of credit (5,000) -
Financing costs (52) -
Proceeds from stock options exercised 151 457
Minority interest distributions (62,104) (50,038)
Dividends paid (12,543) (10,242)
------------------ ------------------
Net cash used in financing activities (74,967) (78,733)
------------------ ------------------
Net increase in cash and cash equivalents 1,745 744
Cash and cash equivalents, beginning 5,310 4,691
------------------ ------------------
Cash and cash equivalents, ending $ 7,055 $ 5,435
================== ==================
Supplemental information:
Cash paid for interest $ 9,606 $10,227
================== ==================
Supplemental schedule of non-cash investing and financing activities:
Debt incurred in connection with property acquisitions (related parties) $18,000 $43,884
================== ==================
Assumption of other liabilities in connection with property acquisitions $ 387 $ 2,024
================== ==================
Issuance of operating partnership units in connection with property acquisitions $10,223 $28,118
================== ==================
The accompanying notes are an integral part of these
consolidated financial statements.
- 5 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)
(Unaudited)
---------
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.
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, 2002.
Minority interest in earnings 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, 2002 are not necessarily
indicative of the results to be expected for the entire year.
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 8).
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, 2002.
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 273 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. The owners of the
future R&D property developments may obtain cash or, at their option,
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. As of September 30, 2002, the Company had
completed 18 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.
- 6 -
No estimate can be given at this time as to the total cost to the Company
to acquire projects under the Berg land holdings option agreement, or the
timing of the Company's acquisition of any of such projects. However, the
Berg Group currently has three properties under development with a total of
approximately 311,000 rentable square feet of R&D properties that the
Company has the right to acquire under this agreement. All three properties
are joint ventures in which the Berg Group holds approximately a 50%
interest. As of September 30, 2002, the estimated acquisition price to the
operating partnerships for these three projects would be approximately
$33,700. The final acquisition price of these three properties could differ
significantly from this estimate. In addition to projects currently under
development, the Company has the right to acquire future developments by
the Berg Group on up to 250 additional acres of land currently controlled
by the Berg Group, which could support approximately 3.9 million square
feet of new developments. 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.
PROPERTY DISPOSITION
On March 6, 2002, the Company completed the sale, in a tax-deferred
exchange, of a 72,400 square foot R&D property located at 2001 Logic Drive,
San Jose, California to Xilinx, Inc., which had exercised a purchase option
in the same month. The Company realized a gain of $6,103 on the total sale
price of approximately $18,503. At March 31, 2002, the proceeds from the
sale of this property were classified as restricted cash to be used in
tax-deferred property exchanges.
PROPERTY ACQUISITIONS
Effective January 1, 2002, the Company acquired an approximately 125,000
rentable square foot newly constructed R&D building located at 5345 Hellyer
Avenue in San Jose, California from the Berg Group under the Berg land
holdings option agreement. The total acquisition price for this property
was $13,652. The Company acquired this property by borrowing $7,500 under
the Berg Group line of credit and issuing 502,805 O.P. Units to various
members of the Berg Group.
Effective March 8, 2002, the Company acquired three R&D buildings totaling
approximately 206,500 rentable square foot located at 2610 and 2630 Orchard
Parkway and 55 West Trimble Road in San Jose, California from Silicon
Valley Properties, LLC in a tax-deferred exchange transaction involving the
Company's former R&D properties located at 2001 Logic Drive and 5713-5729
Fontanoso Way, San Jose, California. The total acquisition price for the
properties acquired from Silicon Valley Properties, LLC was approximately
$31,250.
During the third quarter of 2002, the Company acquired an approximately
165,000 rentable square foot newly constructed R&D building located at 5900
Optical Court in San Jose, California from the Berg Group under the Berg
land holdings option agreement. The total acquisition price for this
property was $17,301. The Company acquired this property in the
tax-deferred exchange with Xilinx, Inc. of the R&D property located at 2001
Logic Drive, San Jose, California. The recorded purchase price consisted of
restricted cash of $2,730 provided by Xilinx, Inc., $10,500 borrowed under
the Berg Group line of credit, and 332,686 issued O.P. Units to various
members of the Berg Group.
3. STOCK TRANSACTIONS
During the nine months ended September 30, 2002, stock options to purchase
33,550 shares of common stock were exercised at $4.50 per share. Total
proceeds to the Company were $151. Two limited partners of one of the
operating partnerships exchanged 104,000 O.P. Units for 104,000 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.
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.
The computation for weighted average shares is detailed below:
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------- -------------------------------
2002 2001 2002 2001
-------------- ------------- -------------- -------------
Weighted average shares outstanding (basic) 17,467,329 17,120,278 17,445,759 17,084,034
Incremental shares from assumed option exercise 389,359 200,184 426,349 218,560
-------------- ------------- -------------- -------------
Weighted average shares outstanding (diluted) 17,856,688 17,320,462 17,872,108 17,302,594
============== ============= ============== =============
- 7 -
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 amounts because the
minority interests' share of income would also be added back to net income.
The total number of O.P. Units outstanding at September 30, 2002 and 2001
was 86,494,032 and 85,599,628, respectively.
5. RELATED PARTY TRANSACTIONS
As of September 30, 2002, the Berg Group owned 78,338,684 O.P. Units.
Combined with shares of the Company's common stock owned by the Berg Group,
the Berg Group's ownership as of September 30, 2002 represented
approximately 75% of the equity interests of the Company, assuming
conversion of the 86,494,032 O.P. Units outstanding into the Company's
common stock.
As of September 30, 2002, debt in the amount of $51,465 was due the Berg
Group under the line of credit established March 1, 2000. The Berg Group
$100 million line of credit is currently collateralized by nine properties,
bears interest at LIBOR plus 1.30%, and matures in March 2003. 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, 2002,
debt in the amount of $11,153 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 10
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 $2.30 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 2003.
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
the three months ended September 30, 2002 and 2001, and $68 and $65 for the
nine months ended September 30, 2002 and 2001, respectively.
6. SUBSEQUENT EVENTS
On October 10, 2002, the Company paid dividends of $0.24 per share of
common stock to all common stockholders of record as of September 30, 2002.
On the same date, the operating partnerships paid a distribution of $0.24
per O.P. Unit to all holders of O.P. Units.
7. 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.
8. 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. Prior period
statements of operations presented in this report have been reclassified to
reflect the income or loss related to properties that were sold and
presented as discontinued operations for the three and nine month-periods
ended September 30, 2002. Additionally, all periods presented in this
report will likely require further reclassification in future periods if
additional property sales occur.
As of September 30, 2002, there were no properties under contract to be
sold or disposed of which would qualify as discontinued operations.
In March 2002, the Company sold one property for a gain of $6,103.
Condensed results of operations for this property for the three and nine
months ended September 30, 2002 and 2001 are as follows:
- 8 -
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------------ ------------------------------------------
2002 2001 2002 2001
------------------- ------------------ ------------------ -------------------
(Dollars in thousands) (Dollars in thousands)
Rental income from real estate - $500 $333 $1,500
Tenant reimbursements - 25 293 71
------------------- ------------------ ------------------ -------------------
Total revenues - 525 626 1,571
Real estate taxes - 25 293 71
Depreciation - 70 46 209
------------------- ------------------ ------------------ -------------------
Total expenses - 95 339 280
------------------- ------------------ ------------------ -------------------
Net income - $430 $287 $1,291
=================== ================== ================== ===================
- 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, 2001. The
results for the three and nine months ended September 30, 2002 are not
necessarily indicative of the results to be expected for the entire fiscal year
ending December 31, 2002. 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 below 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, 2002, the Company
owned and managed 101 properties totaling approximately 7.2 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. The
four tenants who lease the most square footage from the Company are Microsoft
Corporation, JDS Uniphase Corporation, Amdahl Corporation (a subsidiary of
Fujitsu Limited), and Apple Computer, 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 we have 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.
- 10 -
RESULTS OF OPERATIONS
COMPARISON OF THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 TO THE THREE
AND NINE MONTHS ENDED SEPTEMBER 30, 2001.
As of September 30, 2002, the Company, through its controlling interests in the
operating partnerships, owned 101 properties totaling approximately 7.2 million
square feet compared to 96 properties totaling approximately 6.7 million square
feet owned by the Company as of September 30, 2001. This represents a net
increase of approximately 7% in total rentable square footage from one year ago.
Since September 30, 2001, the Company has acquired the properties listed below
and disposed of 77,700 rentable square feet at 5713-5729 Fontanoso Way and
72,400 rentable square feet at 2001 Logic Drive in San Jose, California.
Rentable Square
Date of Acquisition Address Footage
--------------------- -------------------------------------- ---------------------
10/01 5905-65 Silver Creek Valley Rd. II 98,500
01/02 5345 Hellyer Avenue 125,000
03/02 2630 Orchard Parkway (1) 60,633
03/02 2610 Orchard Parkway (1) 54,093
03/02 55 West Trimble (1) 91,722
07/02 5900 Optical Court 165,000
---------------------
594,948
=====================
(1) Acquired in a tax-deferred exchange from the sale of R&D properties at
5713-5729 Fontanoso Way and 2001 Logic Drive, San Jose, California.
The following tables reflect the increase in the Company's rental revenues,
excluding rental revenues from discontinued operations, for the three and nine
months ended September 30, 2002 over rental revenues for the comparable three
and nine months in 2001:
Three Months Ended September 30,
---------------------------------
% Change by % of Total Net
2002 2001 $ Change Property Group Change
-------------- -------------- ---------------- --------------- -----------------
(Dollars in thousands)
Same Property (1) $25,371 $28,018 ($2,647) (9.4%) (8.1%)
2001 Acquisitions (2) 3,880 4,710 (830) (17.6%) (2.5%)
2002 Acquisitions 2,914 - 2,914 100.0% 8.9%
-------------- -------------- ---------------- -----------------
$32,165 $32,728 ($ 563) (1.7%) (1.7%)
============== ============== ================ =================
Nine Months Ended September 30,
---------------------------------
% Change by % of Total Net
2002 2001 $ Change Property Group Change
-------------- -------------- ---------------- --------------- -----------------
(Dollars in thousands)
Same Property (1) $77,031 $84,738 ($7,707) (9.1%) (8.3%)
2001 Acquisitions (2) 14,578 8,323 6,255 75.2% 6.7%
2002 Acquisitions 5,794 - 5,794 100.0% 6.2%
-------------- -------------- ---------------- -----------------
$97,403 $93,061 $4,342 4.6% 4.6%
============== ============== ================ =================
(1) "Same Property" is defined as properties owned as of July 1, 1998 and
acquired in 1998, 1999 and 2000 and still owned as of September 30, 2002.
(2) The figures for "2001 Acquisitions" in year 2001 for some properties do not
reflect a full three and nine months of rent due to the timing of the
acquisition of the properties during 2001.
RENTAL REVENUE FROM CONTINUING OPERATIONS
For the quarter ended September 30, 2002, rental revenues decreased by $0.5
million from $32.7 million for the three months ended September 30, 2001 to
$32.2 million for the same period of 2002. Of the $0.5 million decrease in
rental revenues, ($2.6) million resulted from the Company's "Same Property"
portfolio, ($0.8) million resulted from properties acquired in 2001, and $2.9
million resulted from properties acquired in 2002. Rental revenues increased by
$4.3 million from $93.1 million for the nine months ended September 30, 2001 to
$97.4 million for the same period of 2002, which included a deduction of $1.4
million straight-line rent adjustment. Of the $4.3 million increase in rental
revenues, ($7.7) million resulted from the Company's "Same Property" portfolio,
$6.2 million were generated by properties acquired in 2001, and $5.8 million
were generated by properties acquired in 2002. Approximately $0.3 million in
rental revenues were generated from a discontinued operation for the nine months
ended September 30, 2002. The decline in rental revenues from the "same
property" portfolio was a result from adverse market conditions and loss of
several tenants due to bankruptcy or cessation of operations. The net increase
in rental revenues was primarily attributable to new acquisitions.
- 11 -
OTHER INCOME FROM CONTINUING OPERATIONS
Other income, including interest, was approximately $0.5 million and $0.7
million for the three months ended September 30, 2002 and 2001, respectively.
Other income, including interest, was approximately $1.3 million and $2.0
million for the nine months ended September 30, 2002 and 2001, respectively.
EXPENSES FROM CONTINUING OPERATIONS
Tenant reimbursements from continuing operations decreased by $0.1 million, or
2%, from $5.3 million for the three months ended September 30, 2001 to $5.2
million for the three months ended September 30, 2002. Operating expenses and
real estate taxes from continuing operations, on a combined basis, increased by
$0.1 million, or 2%, from $4.9 million to $5.0 million for the three months
ended September 30, 2001 and 2002, respectively. Both tenant reimbursements and
operating expenses combined with real estate taxes from a discontinued operation
were approximately $0.3 million each for the nine months ended September 30,
2002. The increases in operating expenses and real estate taxes resulted
primarily from the increase in the total rentable square footage since September
30, 2001.
Depreciation expense from continuing operations increased by $0.3 million from
$4.3 million to $4.6 million for the three months ended September 30, 2001 and
2002, respectively. Depreciation expense from continuing operations increased by
$1.0 million from $12.4 million to $13.4 million for the nine months ended
September 30, 2001 and 2002, respectively. Depreciation expense from a
discontinued operation was approximately $46,000 for the nine months ended
September 30, 2002. The increase was attributable to the acquisition of six R&D
properties since September 30, 2001.
Interest expense increased by $0.27 million, or 12.6%, from $2.14 million for
the three months ended September 30, 2001 to $2.41 million for the three months
ended September 30, 2002. The increased expense resulted from additional debt
that the Company incurred under a new $20 million unsecured loan obtained from
Citicorp during the first quarter 2002 and a new unsecured line of credit
obtained from Cupertino National Bank during the third quarter 2002. Interest
expense (related parties) decreased by $0.41 million, or 32.3%, from $1.27
million for the three months ended September 30, 2001 to $0.86 million for the
three months ended September 30, 2002 due to lower interest rates and repayments
of debt under the Berg Group line of credit. As a result, overall interest
expense (including amounts paid to related parties) for the quarter ended
September 30, 2002 decreased by $0.14 million compared to the same quarter a
year ago. Interest expense increased by $0.47 million, or 7.2%, from $6.57
million for the nine months ended September 30, 2001 to $7.04 million for the
nine months ended September 30, 2002. Interest expense (related parties)
decreased by $0.96 million, or 25.7%, from $3.73 million for the nine months
ended September 30, 2001 to $2.77 million for the nine months ended September
30, 2002. Overall interest expense for the nine months ended September 30, 2002
decreased by $0.49 million compared to the nine months ended September 30, 2001
due primarily to lower interest rates and repayments of debt under the Berg
Group line of credit. The six R&D property acquisitions and additional debt the
Company obtained increased total debt outstanding, including amounts due related
parties, by $15.44 million, or 7.0%, from $220.81 million as of September 30,
2001 to $236.25 million as of September 30, 2002. Management expects interest
expense to increase as new debt is incurred in connection with property
acquisitions, as the Company draws on the Berg Group line of credit, and as it
seeks alternative sources of credit.
NET INCOME TO MINORITY INTEREST AND NET INCOME TO COMMON STOCKHOLDERS
The minority interest portion of income decreased by $9.02 million, or 31.0%,
from $29.06 million for the three months ended September 30, 2001 to $20.04
million for the three months ended September 30, 2002. This difference was
represented principally by the gain from asset sales of $8.45 million in the
third quarter of 2001. Net income to stockholders decreased by $1.17 million, or
20.4%, from $5.73 million for the three months ended September 30, 2001 to $4.56
million for the same period in 2002. For the nine months ended September 30,
2002 and 2001, the minority interest portion of income was $66.95 million and
$70.08 million, respectively, resulting in net income to stockholders of $13.83
million and $13.93 million, respectively. 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, 2002 and 2001.
RECENT RENTAL MARKET DEVELOPMENTS
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 slowed
markedly in 2001 and in the first nine months of 2002 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 14.8% in late 2001 to 20.8% at the end of the third quarter 2002.
Total vacant R&D square footage in Silicon Valley at the end of the third
quarter of 2002 amounted to 31.8 million square feet, of which 40%, or 12.7
million square feet, was being offered under subleases. Total negative net
absorption in 2001 amounted to approximately 15.6 million square feet. During
the first nine months of 2002, there was total negative net absorption of
approximately 9.3 million square feet. The impact of this 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 considerably by submarket and location within each submarket. The
Company's actual occupancy rate at September 30, 2002 was 86%, which is a
significant decline from the occupancy rate of 98% at September
- 12 -
30, 2001, but higher than the area's occupancy rate. The Company believes that
its occupancy rate could decline going forward if more key tenants seek the
protection of the bankruptcy laws. For example, during the last twelve months,
ten tenants accounting for approximately 744,000 net rentable square feet of R&D
properties have either filed petitions under Chapter 11 of the Bankruptcy Code
or have discontinued operations. Under the bankruptcy laws, tenants may have the
right to reject their leases with us and our claim for rent will be limited to
the greater of one year's rent or 15% of the total amount of rent under the
leases upon default, but not to exceed three years of rent on the remaining term
of the lease following the earlier of the petition filing date or the date on
which we gained repossession of the property, as well as any rent that was
unpaid on the earlier of those dates. In addition, leases with respect to
approximately 476,000 rentable square feet are expiring prior to the end of
2002. These properties may take anywhere from six to 12 months or longer to
re-lease. The Company anticipates its vacancy rate to range between 14-16% by
the end of 2002 and renewal rental rates to be the same as or, perhaps, lower
than current rental rates. 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.
CHANGES IN FINANCIAL CONDITION
The most significant changes during the nine months ended September 30, 2002
resulted from property acquisitions and exchanges. In addition, debt increased
from new acquisitions and borrowings and stockholders' equity increased from the
exercise of stock options and the exchange of O.P. Units for common stock.
At September 30, 2002, real estate assets increased by approximately $50.5
million from December 31, 2001 taking into account new acquisitions, one
disposition, and some tenant improvements. During the first nine months of 2002,
the Company acquired two additional properties representing approximately
290,000 rentable square feet of R&D property located in Silicon Valley from the
Berg Group under the Berg land holdings option agreement. The aggregate
acquisition price for these properties was approximately $31.0 million. The
Company financed these acquisitions by borrowing $18.0 million under the Berg
Group line of credit and issuing 835,491 O.P. Units. In addition, in March 2002,
the Company acquired three R&D properties representing approximately 206,500
rentable square feet for approximately $31.3 million as replacement properties
in a tax-deferred exchange in which the Company disposed of former R&D
properties at 5713-5729 Fontanoso Way and 2001 Logic Drive in San Jose,
California. No debt or O.P. Units were issued for these acquisitions. The
Company also realized a gain of $6.1 million on the transaction.
At September 30, 2002, total liabilities increased by approximately $9.7 million
from December 31, 2001 as a result of obtaining a new line of credit and
incurring debt from acquisitions.
At September 30, 2002, total stockholders' equity increased by approximately
$2.7 million from December 31, 2001 from the reduction of accumulated deficit,
stock option exercises and the exchange of O.P. Units for the Company's common
stock. During the nine months ended September 30, 2002, stock options to
purchase 33,550 shares of common stock were exercised at $4.50 per share. Total
proceeds to the Company were approximately $0.15 million. During the first nine
months of 2002, two limited partners of an operating partnership exchanged
104,000 O.P. Units for 104,000 shares of the Company's common stock under the
exchange rights agreement among the Company and the limited partners in the
operating partnerships, which represented additional paid in capital of
approximately $1.3 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 Funds From Operations ("FFO") and/or the Berg
Group line of credit and other credit facilities 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 in 2002. 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 the
Berg Group and Cupertino National Bank line 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.
The Company is continually evaluating alternative sources of credit to replace
the Berg Group $100 million line of credit, which expires in March 2003. The
Company believes that the terms of the Berg Group line of credit are more
favorable than those available from institutional lenders. There can be no
assurance, however, that the Berg Group will continue to rollover and extend
this line of credit, as it has been doing since 1999, or that the Company will
be able to obtain a line of credit with terms similar to the Berg Group line of
credit. Thus, the Company's cost of borrowing could increase substantially in
2003 and thereafter.
On March 1, 2002, the Company obtained a $20 million unsecured loan from
Citicorp USA, Inc. with an interest rate based on LIBOR. The loan, which matures
on March 1, 2003, bears a fixed LIBOR interest rate of 4.09% for the first six
months and LIBOR plus 2.0% thereafter. The Company paid a loan fee of $50,000
and expects to use the loan for acquiring new R&D properties.
- 13 -
At September 30, 2002, the Company had total indebtedness of $236.3 million,
including $125.9 million of fixed rate mortgage debt, $11.2 million under the
Berg Group mortgage note (related parties), $51.5 million under the Berg Group
line of credit (related parties), $20.0 million under the Citicorp loan, and
$27.7 million under the Cupertino National Bank line of credit.
As of September 30, 2002, the Company's Debt to Total Market Capitalization
ratio was approximately 17.0%, based upon a Total Market Capitalization of
approximately $1.4 billion. The Company computed this ratio by dividing the
Company's total debt outstanding as of September 30, 2002 by the sum of this
debt plus the market value of common stock (based upon the closing price of
$11.08 per share on September 30, 2002) on a fully diluted basis, taking into
account the conversion of all O.P. Units into common stock.
On October 10, 2002, the Company paid dividends of $0.24 per share of common
stock to all common stockholders of record as of September 30, 2002. On the same
date, the operating partnerships paid a distribution of $0.24 per O.P. Unit to
all holders of O.P. Units.
On July 12, 2002, the Company established a $40 million unsecured revolving line
of credit (the "Revolving Line of Credit") with Cupertino National Bank,
Cupertino, California (the "Bank"). The Revolving Line of Credit is guaranteed
by the Company and two operating partnerships, which pledged four properties,
bears interest at LIBOR plus 2%, and matures July 12, 2004. The Company pays an
annual loan fee of $33,000. The Company will use the proceeds from the Revolving
Line of Credit to repay debt, complete acquisitions and finance other working
capital requirements.
- 14 -
MORTGAGE DEBT
The following table sets forth information regarding debt outstanding
as of September 30, 2002:
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 $51,465 3/03 (1)
2133 Samaritan Drive, San Jose, CA -----------------
2233-2243 Samaritan Drive, San Jose, CA
1310-1450 McCandless Drive, Milpitas, CA
1315-1375 McCandless Drive, Milpitas, CA
1650-1690 McCandless Drive, Milpitas, CA
1795-1845 McCandless Drive, Milpitas, CA
2251 Lawson Lane, Santa Clara, CA (4)
20605-20705 Valley Green Dr, Cupertino, CA (4)
Mortgage Notes Payable (related parties): 5300 & 5350 Hellyer Avenue, San Jose, CA 11,153 6/10 7.650%
-----------------
Mortgage Notes Payable:
Prudential Capital Group 20400 Mariani Avenue, Cupertino, CA 1,468 4/09 8.750%
New York Life Insurance Company 10440 Bubb Road, Cupertino, CA 322 9/09 9.625%
Home Savings & Loan Association 10460 Bubb Road, Cupertino, CA 314 12/06 9.500%
Prudential Insurance Company of America (2) 10300 Bubb Road, Cupertino, CA 123,794 10/08 6.560%
10500 N. DeAnza Blvd, Cupertino, CA
4050 Starboard Drive, Fremont, CA
45700 Northport Loop, Fremont, CA
45738 Northport Loop, Fremont, CA
450-460 National Avenue, Mt 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 Blvd, 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
-----------------
Mortgage Notes Payable Subtotal 125,898
-----------------
Unsecured Loan:
Citicorp USA, Inc. Not Applicable 20,000 3/03 (3)
-----------------
Revolving Line of Credit:
Cupertino National Bank Not Applicable 27,739 7/04 (5)
-----------------
Total $236,255
=================
(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
2003. The interest rate at September 30, 2002 was 3.051%.
(2) John Kontrabecki, one of the limited partners, has guaranteed approximately
$12.0 million of this debt.
(3) The unsecured loan from Citicorp USA, Inc. carries a fixed LIBOR interest
rate equal to 4.09% for the first six months and LIBOR plus 2.0% thereafter
and is payable in full in March 2003. The interest rate at September 30,
2002 was 3.81%.
(4) Substituted collateral properties for the Berg Group line of credit.
(5) The unsecured revolving line of credit from Cupertino National Bank carries
a variable interest rate equal to LIBOR plus 2.0% and is payable in full in
July 2004. The interest rate at September 30, 2002 was 3.82%.
- 15 -
CURRENT PROPERTIES SUBJECT TO OUR ACQUISITION AGREEMENT WITH THE BERG GROUP
The following table presents certain projected information at September 30, 2002
concerning projects for which the Company, through its interests in the
operating partnerships, has the right to acquire under the Berg land holdings
option agreement.
Approximate
Number of Rentable Area Anticipated Total Estimated
Property Buildings (Square Feet) Acquisition Date Acquisition Value (1)
------------------------------ ------------ -------------------- ------------------------- -------------------------
Berg Land Holdings Option
Under Development (Dollars in thousands)
Morgan Hill (JV I) (2) 2 160,000 4th Q 2002/1st Q 2003 $17,500
Morgan Hill (JV II) (2) 1 151,242 4th Q 2002/1st Q 2003 16,200
- ------- ------
Subtotal 3 311,242 33,700
Available Land
Piercy & Hellyer 490,000
Morgan Hill (2) 368,025
King Ranch 207,000
Fremont & Cushing 387,000
Evergreen 2,480,000
---------
Subtotal 3,932,025
-------- -------
TOTAL 3 4,243,267 $33,700
= ========= =======
(1) The estimated acquisition value represents the estimated cash price for
acquiring the projects under the terms of the Berg land holdings option
agreement, which may differ from the actual acquisition cost as determined
under GAAP, if O.P. Units or any other securities based on the market value
of the Company's common stock are issued in the transaction.
(2) The Company expects to own an approximate 50% interest in the partnership
through one of its operating partnerships. The property will be operated
and managed by the other partner in the entity. The rentable area and
estimated acquisition value shown above reflect both the Company's and the
other partner's combined interest in these properties.
Pursuant to the Berg land holdings option agreement between the Company and the
Berg Group, the Company currently has the option to acquire any future R&D,
office and industrial property developed by the Berg Group on land it currently
owns or has under option, or acquires for these purposes in the future, directly
or indirectly by certain members of the Berg Group.
The time required to complete the leasing of developments varies from project to
project. The acquisition dates and acquisition costs set forth in the table are
only estimates by management. Generally, the Company will not acquire any of the
above projects until they are fully completed and leased. There can be no
assurance that the acquisition date and final cost to the Company as indicated
above would be realized. No estimate can be given at this time as to the
Company's total cost to acquire projects under the Berg land holdings option
agreement, nor can we be certain of the period in which we will acquire any of
the projects.
Although the Company expects to acquire the new properties available to it under
the terms of the Berg land holdings option agreement, subsequent to the approval
by the independent directors committee, there can be no assurance that the
Company actually will consummate any intended transactions, including all of
those discussed above. Furthermore, the Company has not yet determined the means
by which it would acquire and pay for any such properties or the impact of any
of the acquisitions on its business, results of operations, financial condition,
FFO or available cash for distribution.
Leasing activity for new build-to-suit and vacated R&D properties has slowed
considerably during the past year and the first nine months of 2002.
Consequently, the Company believes that the projected acquisition dates for
other development properties subject to the Berg land holdings option agreement
may be delayed for the foreseeable future. Such delays limit future growth in
revenues, operating income and Funds Available for Distribution ("FAD").
- 16 -
HISTORICAL CASH FLOWS
Net cash provided by operating activities for the nine months ended September
30, 2002 was $97.2 million compared to $81.4 million for the same period in
2001, a 19% increase. The change was a direct result of increased rent from
newly acquired properties.
Net cash used in investing activities was approximately $20.5 million and $1.9
million for the nine months ended September 30, 2002 and 2001, respectively. Of
the $20.5 million net cash used in investing activities, $18.5 million
represented the return of a deposit furnished by Xilinx, Inc. relating to a
purchase option agreement between Xilinx and the Company, $1.7 million was used
to acquire new equipment and tenant improvements, and $0.3 million was applied
to Xilinx's monthly rent obligation prior to the execution of the purchase
option agreement.
Net cash used in financing activities was $75.0 million for the nine months
ended September 30, 2002 compared to $78.7 million for the same period in 2001,
a 5% decrease. Of the $75.0 million net cash used in financing activities, $48.2
million was used to pay outstanding debt, $62.1 million for minority interest
distributions, and $12.5 million for dividends. The Company obtained $47.8
million from financing activities, including borrowings under the Citicorp
unsecured loan and the Cupertino National Bank line of credit, as well as
proceeds from the exercise of stock options. During the nine months ended
September 30, 2002, the Company made payments on outstanding debt and
distributions to holders of its common stock and O.P. Units by utilizing cash
generated from operating activities and other borrowed funds.
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, 2001, 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 $1.3 million during 2002. The Company believes it will recover
substantially all of these sums from the tenants under new or renewed leases
through increases in rental rates. 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
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 and
depreciation of non-real estate assets) and after adjustments for unconsolidated
partnerships and joint ventures. Management considers 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. With the recent emphasis on the disclosure of
operating earnings per share, we will still continue to use FFO as a measure of
the Company's performance. 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.
The minority interest in earnings for unrelated parties are deducted from total
minority interest in earnings in calculating FFO.
- 17 -
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, 2002 and 2001 are summarized in the
tables below:
Three Months Ended September 30, Nine Months Ended September 30,
----------------------------------------- ------------------------------------------
2002 2001 2002 2001
------------------ ------------------ ------------------- -------------------
(Dollars in thousands) (Dollars in thousands)
Net income $ 4,558 $ 5,730 $13,832 $13,932
Add:
Minority interest (1) 19,941 28,897 66,546 69,593
Depreciation (2) 4,552 4,326 13,409 12,592
Less:
Gain on sale of assets - 8,452 6,103 11,553
------------------ ------------------ ------------------- -------------------
FFO $29,051 $30,501 $87,684 $84,564
================== ================== =================== ===================
(1) Excludes minority interest for unrelated parties.
(2) Includes depreciation from discontinued operations.
DISTRIBUTION POLICY
The Company intends to pay distributions to stockholders and O.P. unit holders
based upon total Funds Available for Distribution ("FAD"), which is calculated
as FFO less adjustment for straight-line rents included in net income, leasing
commissions paid and capital expenditures made during the respective period. The
calculations of FAD for the three and nine months ended September 30, 2002 and
2001 are as follows:
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------------ ------------------------------------------
2002 2001 2002 2001
------------------- ------------------- ------------------- -------------------
(Dollars in thousands) (Dollars in thousands)
FFO $29,051 $30,501 $87,684 $84,564
Less:
Straight-line rents (484) 1,025 (1,088) 5,352
Leasing commissions 33 71 277 653
Capital expenditures 586 87 699 411
------------------- ------------------- ------------------- -------------------
FAD $28,916 $29,318 $87,796 $78,148
=================== =================== =================== ===================
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 effects of new property acquisitions, including acquisitions under
existing agreements with the Berg Group;
- 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.
We cannot assure you that the Company will be able to meet or maintain
management's cash distribution objectives.
- 18 -
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
The Company does not believe recently issued accounting standards will
materially impact the Company's financial statements.
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, changes in:
- 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, and
- general accounting principles, policies and guidelines applicable to REITs.
In addition, the actual timing of development, construction, and leasing on the
projects that the Company believes it may acquire in the future under the Berg
land holdings option agreement is unknown presently, and reliance should not be
placed on the estimates concerning these projects set forth under the caption,
"Current Properties Subject to Our Acquisition Agreement with the Berg Group,"
above. 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.
- 19 -
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. By attempting to match
anticipated cash inflow from our operating and financing activities with
anticipated cash outflow to fund debt payments, distributions to shareholders
and O.P. Unit holders, capital expenditures and other cash requirements, we
expect to minimize the effects on our future earnings and cash flow where
interest rate risk is most sensitive. 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 primary market risk we face is the risk of interest rate fluctuations. The
Berg Group line of credit, the Cupertino National Bank line of credit and the
Citicorp USA unsecured loan, which are tied to a LIBOR based interest rate, were
approximately $51.5 million, $27.7 million, and $20.0 million, or 22%, 12% and
8%, respectively, of the total $236.3 million of outstanding debt as of
September 30, 2002. 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. At September 30, 2002, we had no interest rate caps or interest
rate swap contracts.
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" 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, 2002, a 1% increase or decrease in
interest rates on our $99.2 million of floating rate debt would decrease or
increase, respectively, nine months earnings and cash flows by approximately
$0.74 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 on our financial
structure.
ITEM 4
CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. Within the 90 days prior to
the date of this report, 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 and Chief Financial Officer, 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 and Chief Financial Officer 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.
- 20 -
================================================================================
PART II - OTHER INFORMATION
ITEM 6
EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
None
b. Reports on Form 8-K
None
================================================================================
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 12, 2002 By:/s/ Wayne N. Pham
----------------------------------------------
Wayne N. Pham
Vice President of Finance and Controller
(Principal Accounting Officer and Duly
Authorized Officer)
- 21 -
CERTIFICATE PURSUANT TO
RULE 13a-14 THE SECURITIES EXCHANGE ACT OF 1934
I, Carl E. Berg, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of Mission West
Properties, Inc. (the "Company") for the quarterly period ended September 30,
2002;
2. Based on my knowledge, this quarterly 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 quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure the
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 quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying offices and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Carl E. Berg
Chairman and CEO
November 12, 2002
CERTIFICATE PURSUANT TO
RULE 13a-14 THE SECURITIES EXCHANGE ACT OF 1934
I, Wayne N. Pham, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of Mission West
Properties, Inc. (the "Company") for the quarterly period ended September 30,
2002;
2. Based on my knowledge, this quarterly 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 quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure the
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 quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying offices and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Wayne N. Pham
Vice President of Finance and Controller
November 12, 2002
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,
2002 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 12, 2002
================================
Wayne N. Pham
Vice President of Finance and Controller
November 12, 2002
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.