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 MARCH 31, 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:
17,704,691 shares outstanding as of May 14, 2003
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Mission West Properties, Inc.
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2003
INDEX
PAGE
PART I FINANCIAL INFORMATION ----
Item 1. Financial Statements (unaudited):
Consolidated Balance Sheets as of March 31, 2003
and December 31, 2002...................................................................................3
Consolidated Statements of Operations for the three
months ended March 31, 2003 and 2002....................................................................4
Consolidated Statements of Cash Flows for the
three months ended March 31, 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.............................................19
Item 4. Controls and Procedures................................................................................19
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K......................................................................20
SIGNATURES...........................................................................................................20
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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)
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March 31, 2003 December 31, 2002
---------------------- ----------------------
ASSETS
Real estate assets, at cost
Land $ 234,707 $ 234,707
Buildings and improvements 727,135 726,581
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Total investments in properties 961,842 961,288
Less accumulated depreciation (71,123) (66,560)
---------------------- ----------------------
Net investments in properties 890,719 894,728
Investments in unconsolidated joint venture 2,037 -
---------------------- ----------------------
Net investments in real estate assets 892,756 894,728
Cash and cash equivalents 2,721 4,479
Deferred rent 17,245 17,001
Other assets 16,855 13,198
---------------------- ----------------------
Total assets $ 929,577 $ 929,406
====================== ======================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Line of credit (related parties) $ 26 $ 58,792
Revolving line of credit - 23,839
Loan payable - 20,000
Mortgage notes payable 223,586 125,062
Mortgage notes payable (related parties) 11,001 11,078
Interest payable 337 337
Security deposits 10,398 11,184
Prepaid rental income 13,892 9,876
Dividend/distribution payable 24,996 24,951
Accounts payable and accrued expenses 4,819 4,698
---------------------- ----------------------
Total liabilities 289,055 289,817
Commitments and contingencies (Note 6)
Minority interests 528,288 528,768
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, 17,653,691 and 17,487,329 shares issued and
outstanding at March 31, 2003 and December 31, 2002,
respectively 18 17
Paid-in-capital 129,911 128,295
Accumulated deficit (17,695) (17,491)
---------------------- ----------------------
Total stockholders' equity 112,234 110,821
---------------------- ----------------------
Total liabilities and stockholders' equity $ 929,577 $ 929,406
====================== ======================
The accompanying notes are an integral part of these
consolidated financial statements.
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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 March 31,
2003 2002
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Revenues:
Rental revenues from real estate $ 31,431 $ 32,484
Tenant reimbursements 4,575 5,326
Other income, including interest 735 497
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Total revenues 36,741 38,307
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Expenses:
Operating expenses 1,519 2,275
Real estate taxes 3,075 3,057
Depreciation of real estate 4,563 4,356
General and administrative 358 434
Interest 3,406 2,270
Interest (related parties) 294 1,010
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Total expenses 13,215 13,402
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Income before minority interests and equity in
earnings of unconsolidated joint venture 23,526 24,905
Equity in earnings of unconsolidated
joint venture 737 -
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Income before minority interests 24,263 24,905
Minority interests 20,229 20,769
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Income from continuing operations 4,034 4,136
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Discontinued operations, net minority interests:
Gain from disposal of discontinued operations - 1,017
Income attributable to discontinued operations - 48
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Income from discontinued operations - 1,065
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Net income to common stockholders $ 4,034 $ 5,201
==================== ====================
Net income to minority interests $ 20,229 $ 26,094
==================== ====================
Income per share from continuing operations:
Basic $0.23 $0.24
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Diluted $0.23 $0.23
==================== ====================
Income per share from discontinued operations:
Basic - $0.06
==================== ====================
Diluted - $0.06
==================== ====================
Net income per share to common stockholders:
Basic $0.23 $0.30
==================== ====================
Diluted $0.23 $0.29
==================== ====================
Weighted average number of shares of
common stock outstanding (basic) 17,637,260 17,404,568
==================== ====================
Weighted average number of shares of
common stock outstanding (diluted) 17,695,001 17,853,809
==================== ====================
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)
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Three months ended March 31,
--------------------------------------
2003 2002
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Cash flows from operating activities:
Net income $ 4,034 $ 5,201
Adjustments to reconcile net income to net cash provided by
operating activities:
Minority interests 20,229 26,094
Depreciation 4,563 4,402
Gain on sales of assets - (6,103)
Equity in earnings of unconsolidated joint venture (737) -
Other 7 (18)
Changes in assets and liabilities:
Distributions from unconsolidated joint venture 500 -
Deferred rent (244) 780
Other assets (3,657) (3,972)
Security deposits (786) 263
Prepaid rental income 4,016 1,470
Accounts payable and accrued expenses (9) 471
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Net cash provided by operating activities 27,916 28,588
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Cash flows from investing activities:
Improvements to real estate assets/new equipment (554) -
Refundable option payment - (18,836)
Real estate purchase - (31,311)
Proceeds from sales of real estate - 18,591
Restricted cash - 15,435
Restricted cash available - (2,715)
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Net cash used in investing activities (554) (18,836)
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Cash flows from financing activities:
Principal payments on mortgage notes payable (1,476) (498)
Proceeds from mortgage note payable 100,000 -
Principal payments on mortgage notes payable (related parties) (77) (71)
Net payments under line of credit (related parties) (58,765) (2,298)
Proceeds from loan payable - 20,000
Payment on loan payable (20,000) -
Payment on revolving line of credit (23,839) -
Financing Costs - (52)
Proceeds from stock options exercised 42 151
Minority interests distributions (20,808) (20,637)
Dividends paid (4,197) (4,159)
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Net cash used in financing activities (29,120) (7,564)
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Net (decrease)/increase in cash and cash equivalents (1,758) 2,188
Cash and cash equivalents, beginning 4,479 5,310
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Cash and cash equivalents, ending $ 2,721 $ 7,498
================== ===================
Supplemental information:
Cash paid for interest $ 3,648 $ 3,168
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Supplemental schedule of non-cash investing and financing activities:
Debt incurred in connection with property acquisitions (related parties) $ - $ 7,500
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Assumption of other liabilities in connection with property acquisitions $ - $ 12
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Issuance of operating partnership units in connection with property acquisitions $ - $ 6,152
================== ===================
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 March 31, 2003. 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 months ended March 31, 2003 are not necessarily indicative of
the results to be expected for the entire year.
Investments in Unconsolidated Joint Ventures. The Company accounts for its
investments in properties 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. On a regular basis, the value of the
Company's investments in unconsolidated joint ventures is assessed for
impairment. An investment is impaired only if the Company's estimate of the
value of the investment is less than the carrying value of the investment.
The impairment amount shall be measured as the excess of the carrying
amount of the investment over the value of the investment.
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).
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 months ended
March 31, 2003.
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. 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 March 31, 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
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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.
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. Generally, the Company will not acquire any projects until
they are fully completed and leased. Currently the Berg Group is not
developing any new projects. The Berg Group is currently seeking government
approval of a proposed rezoning of the 160-acre Evergreen site to permit
residential development on a substantial portion of the site. If the Berg
Group obtains the requested rezoning, it will ask the independent directors
committee to approve the removal of the rezoned portions of this property
from the Berg Land Holdings Option Agreement. 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.
Although the Company expects to acquire any new properties available to it
under the terms of the Berg Land Holdings Option Agreement, after approval
by the independent directors committee, there can be no assurance that the
Company actually will consummate any intended transactions. 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, or available cash for
distribution.
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. TBI initially financed the
properties by obtaining mortgage loans. At December 31, 2002, TBI's total
mortgage debt on the four properties was approximately $53,600. The
Company's pro rata share of debt on March 31, 2003 was approximately
$26,700. This investment is not consolidated because the management and
control over significant day to day operating activities are with TBI.
3. STOCK TRANSACTIONS
During the three months ended March 31, 2003, stock options to purchase
9,362 shares of common stock were exercised at $4.50 per share. Total
proceeds to the Company were $42. 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.
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 March 31,
-------------------------------
2003 2002
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Weighted average shares outstanding (basic) 17,637,260 17,404,568
Incremental shares from assumed option exercise 57,741 449,241
-------------- -------------
Weighted average shares outstanding (diluted) 17,695,001 17,853,809
============== =============
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 March 31, 2003 and 2002 was
86,498,064 and 86,165,346, respectively.
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5. RELATED PARTY TRANSACTIONS
As of March 31, 2003, the Berg Group owned 78,364,716 O.P. Units. Combined
with shares of the Company's common stock owned by the Berg Group, the Berg
Group's ownership as of March 31, 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.
The Company and the Berg Group have mutually agreed to reduce the Berg
Group $100,000 line of credit to $20,000 and to reduce collateralized
properties to five properties. The Berg Group line of credit will still
bear interest at LIBOR plus 1.30%, 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 March 31, 2003, debt in
the amount of $26 was due the Berg Group under the line of credit. As of
March 31, 2003, debt in the amount of $11,001 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 $2.34 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 believes that it will
negotiate a short-term renewal at lease term expiration.
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 March 31, 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 will likely require further reclassification in
future periods if additional property sales occur.
As of March 31, 2003, 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 total gain of $6,103.
Condensed results of operations for this property for the three months
ended March 31, 2003 and 2002 are as follows:
Three Months Ended March 31,
------------------------------------------
2003 2002
------------------- ------------------
(Dollars in thousands)
Rental income from real estate - $333
Tenant reimbursements - 293
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Total revenues - 626
Real estate taxes - 293
Depreciation - 46
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Total expenses - 339
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Income before minority interests - 287
Minority interests - 239
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Net income - $ 48
=================== ==================
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8. SUBSEQUENT EVENTS
On April 1, 2003, the Company obtained a 50% interest in a joint venture
with TBI 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 shell building. The shell building was sold on April 2, 2003 for cash.
The Company will recognize a gain of approximately $1,400 in the second
quarter 2003 from its share of the joint venture's profit.
On 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
$110,000 from an unrelated third party and financed with a combination of
debt and cash reserves. The debt component is comprised of a new short term
$80,000 mortgage note with a commercial bank collateralized by the acquired
assets. This note bears interest at a rate equal to LIBOR plus 200 basis
points and matures in 120 days. The Company paid a financing fee of $150.
The Company is in the process of securing long term mortgage debt to retire
this short term credit facility. In addition, the Company utilized
approximately $19,200 of its operating line of credit with Cupertino
National Bank to pay part of the purchase price.
On April 10, 2003, the Company paid dividends of $0.24 per share of common
stock to all common stockholders of record as of March 31, 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.
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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 months ended March 31, 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 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 March 31, 2003, 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. As of
March 31, 2003, the four tenants who leased the most square footage from the
Company were 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 the Company 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.
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 Standard ("SFAS")
No. 66, "Accounting for Sales of Real Estate."
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.
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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 of which it has interests. It
manages and operates all three properties. The recognition of these properties
and their operating results are reflected on the Company's consolidated
financial statements and minority interest because it has operational and
financial control of the investments. The Company makes judgments and
assumptions about the estimated monthly payments 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.
REVENUE RECOGNITION. Rental revenue is recognized on the straight-line method of
accounting required by GAAP under which contractual rent payment increases are
recognized evenly over the lease term. The difference between recognized rental
income and rental cash receipts is recorded as deferred rent on the balance
sheet. Certain lease agreements contain terms that provide for additional rents
based on reimbursement of certain costs. These additional rents are reflected on
the accrual basis.
Rental revenue is affected if existing tenants terminate or amend their leases.
Thus, if tenants lengthen their lease term, additional rental revenue is
recognized. On the other hand, if tenants terminate their lease agreements or
shorten their lease terms, rental revenue decreases because of reduced future
cash flows and a one-time straight-line adjustment to deferred rent, which is
the difference between recognized rental income and rental cash receipts. The
Company tries to identify tenants who have the potential of bankruptcy or of
ceasing operations. By anticipating these events in advance, the Company expects
to take actions to minimize the effect on the results of its operations. The
Company's judgments and estimations about tenants' capacity to continue to meet
their lease obligations will affect the 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.
- 11 -
RESULTS OF OPERATIONS
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2003 TO THE THREE MONTHS ENDED
MARCH 31, 2002.
As of March 31, 2003, the Company, through its controlling interests in the
operating partnerships, owned 101 properties totaling approximately 7.2 million
square feet compared to 100 properties totaling approximately 7.0 million square
feet owned by the Company as of March 31, 2002. This represents a net increase
of approximately 3% in total rentable square footage, which is attributable to
the Company's acquisition of one property at 5900 Optical Court, San Jose,
California consisting of approximately 165,000 net rentable square feet in July
2002.
Rental revenues from continuing operations for the three months ended March 31,
2003 declined from the comparable three-month period in 2002, as illustrated in
the following table:
Three Months Ended March 31,
---------------------------------
% Change by % of Total Net
2003 2002 $ Change Property Group Change
-------------- -------------- -------------- --------------- -----------------
(Dollars in thousands)
Same Property (1) $28,849 $31,444 ($2,595) (8.3%) (7.9%)
2002 Acquisitions (2) 2,582 1,040 1,542 148.3% 4.7%
-------------- -------------- -------------- -----------------
$31,431 $32,484 ($1,053) (3.2%) (3.2%)
============== ============== ============== =================
(1) "Same Property" is defined as properties owned by the Company prior to 2002
that the Company still owned as of March 31, 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 March 31, 2003, rental revenues decreased by $1.1 million,
or 3.2%, from $32.5 million for the three months ended March 31, 2002 to $31.4
million for the same period of 2003. Of the $1.1 million decrease in rental
revenues, ($2.6) million resulted from the Company's "Same Property" portfolio
and $1.5 million resulted from properties acquired in 2002. The overall decline
in rental revenues was a result of adverse market conditions and loss of several
tenants due to their bankruptcy or cessation of operations since March 31, 2002.
The Company's occupancy rate at March 31, 2003 was approximately 83%, compared
to 92% at March 31, 2002.
EQUITY IN EARNINGS FROM UNCONSOLIDATED JOINT VENTURE
As of March 31, 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 interests in this venture, which it accounts
for using the equity method of accounting. For the three months ended March 31,
2003, the Company recorded approximately $0.7 million in equity in earnings from
an unconsolidated joint venture.
OTHER INCOME
Other income, including interest, increased to $0.7 million for the three months
ended March 31, 2003 from $0.5 million for the first quarter of 2002. Utility
rebates represented most of the increase. The Company does not consider these
rebates to be a recurring item.
EXPENSES FROM CONTINUING OPERATIONS
Operating expenses and real estate taxes from continuing operations, on a
combined basis, decreased by $0.7 million, or 13.2%, from $5.3 million to $4.6
million for the three months ended March 31, 2002 and 2003, respectively, due to
lower occupancy during the first quarter of 2003. Tenant reimbursements from
continuing operations also consistently decreased by $0.8 million, or 15.1%,
from $5.3 million for the three months ended March 31, 2002 to $4.5 million for
the three months ended March 31, 2003.
Depreciation expense from continuing operations was approximately the same in
the first quarter of 2002 and 2003, as the Company acquired just one new
property between March 31, 2002 and March 31, 2003.
Interest expense increased by $1.1 million, or 47.8%, from $2.3 million for the
three months ended March 31, 2002 to $3.4 million for the three months ended
March 31, 2003. The increased 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 and a new $100 million
mortgage loan from Northwestern Mutual Life Insurance Company in early January
2003. Interest expense (related parties) decreased by $0.7 million, or 70%, from
$1.0 million for the three months ended March 31, 2002 to $0.3 million for the
three months ended March 31, 2003 due to lower interest rates and the repayment
of the remaining balance on the Berg Group line of credit. Total debt
outstanding, including amounts due related parties, decreased by $8.7 million,
or 3.6%, from $243.3 million as of March 31, 2002 to $234.6 million as of March
31, 2003. As a result of the new debt outstanding, interest expense (including
amounts paid to related parties) for the quarter ended March 31, 2003 increased
by $0.4 million compared to the same quarter a year ago because the new debt
carries a higher interest rate than the Berg Group line of credit. Management
expects interest expense to increase as new debt is incurred in connection with
property acquisitions, as the Company draws on the Cupertino National Bank
revolving line of credit, and as it seeks alternative sources of credit.
- 12 -
NET INCOME TO MINORITY INTEREST AND NET INCOME TO COMMON STOCKHOLDERS
The minority interest portion of income decreased by $5.9 million, or 22.6%,
from $26.1 million for the three months ended March 31, 2002 to $20.2 million
for the three months ended March 31, 2003. Net income to stockholders decreased
by $1.2 million, or 23.1%, from $5.2 million for the three months ended March
31, 2002 to $4.0 million for the same period in 2003. The decline in net income
was primarily due to reduced rental revenues and the absence of 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 March 31, 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 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 22.5% at the end of the first quarter 2003. Total vacant R&D
square footage in Silicon Valley at the end of the first quarter of 2003
amounted to 35.0 million square feet, of which 38%, or 13.2 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 three
months of 2003, there was total negative net absorption of approximately (2.0)
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 March 31, 2003 was 83%, which is a
significant decline from the occupancy rate of 92% at March 31, 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 527,000 rentable
square feet are expiring prior to the end of 2003. These properties 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 scheduled to expire; 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.
RECENT PROPERTY ACQUISITIONS. Effective January 1, 2003, the Company acquired a
50% interest in a joint venture with TBI in Morgan Hill, California for $1.8
million 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.
On 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 San Tomas Technology Park is currently
approximately 90% leased, but one tenant, which leases approximately 98,000
rentable square feet, has filed a petition under Chapter 11 of the Bankruptcy
Code subsequent to the acquisition date. The project was acquired for $110
million from BRE/San Tomas I LLC and BRE/San Tomas II LLC and financed with a
combination of debt and cash reserves. The debt component is comprised of a new
$80 million short term mortgage note with a commercial bank collateralized with
the acquired assets which bears interest at LIBOR plus 200 basis points and
matures in 120 days. The Company paid a financing fee of $150,000. The Company
is in the process of securing long term mortgage debt to retire this short term
credit facility. In addition, the Company utilized approximately $19.2 million
of its operating line of credit with Cupertino National Bank in connection with
this acquisition. Pro forma financial information of the Company pertaining to
this acquisition will be filed by amendment to the Company's Current Report on
Form 8-K, dated April 23, 2003.
On April 1, 2003, the Company obtained a 50% interest in a joint venture with
TBI 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 shell
building. The shell building was sold on April 2, 2003 for cash. The Company
will recognize a gain of approximately $1.4 million in the second quarter 2003
from its share of the joint venture's profit.
- 13 -
CHANGES IN FINANCIAL CONDITION
The most significant changes during the three months ended March 31, 2003
resulted from the acquisition of a 50% joint venture interest and additional
borrowings. Stockholders' equity increased from the exercise of stock options
and the exchange of O.P. Units for common stock.
At March 31, 2003, real estate assets increased by approximately $0.6 million
from December 31, 2002 due to tenant improvements. During the first three months
of 2003, the Company acquired a 50% interest in a joint venture from the Berg
Group under the Berg Land Holdings Option Agreement for $1.8 million. The
Company financed this acquisition by issuing 181,032 O.P. Units. The joint
venture consists of four buildings with approximately 593,000 square feet, which
are operated and managed by TBI, the other partner in the joint venture.
At March 31, 2003, total stockholders' equity increased by approximately $1.4
million from December 31, 2002 from the increase of accumulated deficit, stock
option exercises and the exchange of O.P. Units for the Company's common stock.
During the three months ended March 31, 2003, stock options to purchase 9,362
shares of common stock were exercised at $4.50 per share. Total proceeds to the
Company were approximately $42,000. During the first three 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 $1.6 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 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 2003. 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 revolving 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.
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 ten years 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 10, 2003, the Company paid dividends of $0.24 per share of common stock
to all common stockholders of record as of March 31, 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.
At March 31, 2003, the Company had total indebtedness of $234.6 million,
including $223.6 million of fixed rate mortgage debt and $11.0 million under the
Berg Group mortgage note (related parties), as detailed in the table below:
- 14 -
MORTGAGE DEBT
The following table sets forth information regarding debt outstanding as of
March 31, 2003:
Maturity Interest
Debt Description Collateral Properties Balance Date Rate
---------------------------------------------- -------------------------------------- ----------------- ------------ ------------
(Dollars in thousands)
Line of Credit:
Berg Group (related parties) 2033-2043 Samaritan Dr., San Jose, CA $ 26 3/04 (1)
2133 Samaritan Dr., San Jose, CA -----------------
2233-2243 Samaritan Dr., San Jose, CA
1310-1450 McCandless Dr., Milpitas, CA
1795-1845 McCandless Dr., Milpitas, CA
Mortgage Notes Payable (related parties): 5300 & 5350 Hellyer Ave., San Jose, CA 11,001 6/10 7.650%
-----------------
Mortgage Notes Payable:
Prudential Capital Group 20400 Mariani Ave., Cupertino, CA 905 10/06 8.750%
Washington Mutual (Home Savings & Loan Assoc.) 10460 Bubb Road, Cupertino, CA 280 12/06 9.500%
Prudential Insurance Company of America (2) 10300 Bubb Road, Cupertino, CA 122,882 10/08 6.560%
10500 N. DeAnza Blvd., Cupertino, CA
4050 Starboard Dr., Fremont, CA
45700 Northport Loop, Fremont, CA
45738 Northport Loop, Fremont, CA
450-460 National Ave., Mt. View, CA
6311 San Ignacio Ave., San Jose, CA
6321 San Ignacio Ave., San Jose, CA
6325 San IgnaciO Ave., San Jose, CA
6331 San Ignacio Ave., San Jose, CA
6341 San Ignacio Ave., San Jose, CA
6351 San Ignacio Ave., San Jose, CA
3236 Scott Blvd., Santa Clara, CA
3560 Bassett St., Santa Clara, CA
3570 Bassett St., Santa Clara, CA
3580 Bassett St., Santa Clara, CA
1135 Kern Ave., Sunnyvale, CA
1212 Bordeaux Lane, Sunnyvale, CA
1230 E. Arques, Sunnyvale, CA
1250 E. Arques, Sunnyvale, CA
1170 Morse Ave., Sunnyvale, CA
1600 Memorex Dr., Santa Clara, CA
1688 Richard Ave., Santa Clara, CA
1700 Richard Ave., Santa Clara, CA
3540 Bassett St., Santa Clara, CA
3542 Bassett St., Santa Clara, CA
3544 Bassett St., Santa Clara, CA
3550 Bassett St., Santa Clara, CA
Northwestern Mutual Life Insurance Company 1750 Automation Pkwy., San Jose, CA 99,519 1/13 5.640%
1756 Automation Pkwy., San Jose, CA
1762 Automation Pkwy., San Jose, CA
6320 San Ignacio Ave., 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 Dr., Milpitas, CA
1650-1690 McCandless Dr., Milpitas, CA
20605-20705 Valley Green Dr., Cupertino, CA
-----------------
Mortgage Notes Payable Subtotal 223,586
-----------------
TOTAL $ 234,613
=================
(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 March 31, 2003 was 2.56%.
(2) John Kontrabecki, one of the limited partners, has guaranteed approximately
$12,000 of this debt.
- 15 -
As of March 31, 2003, the Company's debt to total market capitalization ratio
was approximately 19.3%, based upon a total market capitalization of
approximately $1.2 billion. The Company computed this ratio by dividing the
Company's total debt outstanding as of March 31, 2003 by the sum of this debt
plus the market value of common stock (based upon the closing price of $9.40 per
share on March 31, 2003) on a fully diluted basis, taking into account the
conversion of all O.P. Units into common stock. Had the Company factored in the
$80 million loan obtained from Citicorp USA, Inc. and the $19.2 million drawn
down on the Cupertino National Bank line of credit in April 2003 for the San
Tomas Technology Park acquisition, the debt to total market capitalization ratio
would have been 24.5%.
HISTORICAL CASH FLOWS
Net cash provided by operating activities for the three months ended March 31,
2003 was $27.9 million compared to $28.6 million for the same period in 2002.
The decline resulted from the decrease in rental income from the Company's
current portfolio of property due to tenant lease obligation defaults during
2002.
Net cash used in investing activities was approximately ($0.6) million and
($18.8) million for the three months ended March 31, 2003 and 2002,
respectively, as there were minimal cash transactions related to purchases and
sales during the first quarter of 2003.
Net cash used in financing activities was ($29.1) million for the three months
ended March 31, 2003 compared to ($7.6) million for the same period in 2002. Of
the ($29.1) million net cash used in financing activities, ($104.2) million was
used to pay outstanding debt, ($20.8) million for minority interest
distributions, and ($4.2) million for dividends. The Company obtained
approximately $100 million from financing activity, which included the
Northwestern Loan, as well as 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 $1.5 million during 2003. 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
The Company's principal performance measurements are net income to common
stockholders and earnings per share computed in accordance with GAAP. 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. 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. 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 months ended March 31, 2003 and 2002, as reconciled to
net income to common stockholders, are summarized in the tables below:
- 16 -
Three Months Ended March 31,
-----------------------------------------
2003 2002
------------------ ------------------
(Dollars in thousands)
Net income to common
stockholders $ 4,034 $ 5,201
Add:
Minority interests (1) 20,057 25,933
Depreciation (2) 4,564 4,402
Less:
Gain on sale of assets - 6,103
------------------ ------------------
FFO $ 28,655 $ 29,433
================== ==================
(1) Excludes minority interest for unrelated parties.
(2) Includes depreciation from discontinued operations.
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.
- 17 -
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
The Company does not believe recently issued accounting standards will
materially impact its 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, 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 unknown presently, 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.
- 18 -
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
March 31, 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 March 31, 2003 will be paid upon maturity.
For fixed rate debt, the table presents the assumption that the outstanding
principal balance at March 31, 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 $26 $26 $26
Weighted average interest rate 2.56%
Fixed Rate Debt:
Secured notes payable $3,967 $5,612 $5,977 $6,245 $6,350 $206,436 $234,587 $242,890
Weighted average interest rate 6.23% 6.23% 6.23% 6.23% 6.23% 6.23%
The variable rate debt represented less than 1%, and the fixed rate debt
represented almost 100% of all debt outstanding for the three months ended March
31, 2003. All of the debt is denominated in United States dollars. Fair value of
fixed rate debt is affected by changes in market interest rates.
The primary market risk we face is the risk of interest rate fluctuations. 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 March
31, 2003, we do not have any substantial variable rate debt that exposes us to
this risk. We also had no interest rate caps or interest rate swap contracts at
March 31, 2003.
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, 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.
- 19 -
================================================================================
PART II - OTHER INFORMATION
ITEM 6
EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
10.45 Citicorp USA, Inc. Promissory Note
99.1 Section 1350 Certificate of CEO
99.2 Section 1350 Certificate of principal financial officer
99.3 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 April 23, 2003, regarding
its results of operations and financial condition for the first quarter
2003 and its acquisition of the San Tomas Technology Park on April 9, 2003.
================================================================================
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.
Mission West Properties, Inc.
(Registrant)
Date: May 14, 2003 By: /s/ Carl E. Berg
----------------------------------
Carl E. Berg
Chief Executive Officer
Date: May 14, 2003 By: /s/ Wayne N. Pham
----------------------------------
Wayne N. Pham
Vice President of Finance and Controller
(Principal Accounting Officer and Duly
Authorized Officer)
- 20 -