SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For Fiscal Year Ended: December 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 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
Incorporation or organization) Identification Number)
10050 Bandley Drive, Cupertino CA 95014
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (408) 725-0700
---------------
Securities Registered Pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
Common Stock, par value $.001 American Stock Exchange
per share Pacific Exchange, Inc.
Securities Registered Pursuant to Section 12(g) of the Act:
NONE
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 [ ] NO [X]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [X] No [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant, based upon the closing sale price of the Common Stock on June
30, 2003, as reported on the American Stock Exchange, was approximately
$201,700,287. As of July 15, 2004, there were 18,063,691 shares of the
Registrant's Common Stock outstanding.
Documents Incorporated By Reference: None
FORWARD LOOKING INFORMATION
This annual report contains forward-looking statements within the meaning of the
federal securities laws. We intend such forward-looking statements to be covered
by the safe harbor provisions for forward-looking statements contained in the
Private Securities Litigation Reform Act of 1995, and are including this
statement for purposes of complying with these safe harbor provisions.
Forward-looking statements include our discussion of "Quantitative and
Qualitative Disclosures about Market Risks" in Item 7A below. Forward-looking
statements, which are based on certain assumptions and describe future plans,
strategies and expectations of us, are generally identifiable by use of the
words "believe," "expect," "intend," "anticipate," "estimate," "project" or
similar expressions. Our ability to predict results or the actual effect of
future plans or strategies is inherently uncertain. Factors which 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 Real
Estate Investment Trusts ("REITs")), availability of capital, interest rates,
competition, supply of and demand for office and industrial properties in our
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. These risks and uncertainties, together
with the other risks described from time to time in our reports and 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. See Part I, Item 1, "Risk Factors."
i
MISSION WEST PROPERTIES, INC.
2003 FORM 10-K ANNUAL REPORT
Table of Contents
PART I
Page No.
Item 1. Business 1
Item 2. Properties 16
Item 3. Legal Proceedings 22
Item 4. Submission of Matters to a Vote of Security Holders 22
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters 23
Item 6. Selected Financial Data 24
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 26
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 48
Item 8. Financial Statements and Supplementary Data 49
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 84
Item 9A. Controls and Procedures 84
Item 9B Other Information 84
PART III
Item 10. Directors and Executive Officers of the Registrant 85
Item 11. Executive Compensation 88
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters 91
Item 13. Certain Relationships and Related Transactions 94
Item 14. Principal Accountant Fees and Services 96
PART IV
Item 15. Exhibits, Financial Statements, Schedules and Reports
on Form 8-K 98
Signatures 100
Rule 13a-14 Certifications 101
ii
PART I
ITEM 1. BUSINESS
ORGANIZATION AND GENERAL BUSINESS DESCRIPTION
Mission West Properties, Inc. (the "Company") acquires, markets, leases,
and manages Research and Development ("R&D") properties, primarily located
in the Silicon Valley portion of the San Francisco Bay Area. As of December
31, 2003, we owned and managed 109 properties totaling approximately 7.9
million rentable square feet of R&D properties through four limited
partnerships, or operating partnerships, for which we are the sole general
partner. R&D property is designed for research and development and office
uses and, in some cases, includes space for light manufacturing operations
with loading docks. We believe that we have one of the largest portfolios
of R&D properties in the Silicon Valley. There are six tenants who
individually lease in excess of 300,000 rentable square feet from us:
Microsoft Corporation, Fujitsu America (a subsidiary of Fujitsu Limited),
JDS Uniphase Corporation, NEC Electronics America, Inc. (a subsidiary of
NEC Electronics Corporation), Ciena Corporation and Apple Computer, Inc.
For federal income tax purposes we have operated as a self-managed,
self-administered and fully integrated Real Estate Investment Trust
("REIT") since fiscal 1999.
Prior to July 1, 1998, most of our properties were under the ownership or
control of Carl E. Berg, his brother Clyde J. Berg, certain members of
their respective immediate families, and certain entities in which Carl E.
Berg and/or Clyde J. Berg held controlling or other ownership interests
(the "Berg Group"). We acquired these properties as of July 1, 1998 by
becoming the general partner of each of the four operating partnerships in
an UPREIT transaction. At that time, we also acquired ten properties
comprising approximately 560,000 rentable square feet from entities
controlled by third parties in which the Berg Group members were
significant owners.
Through various property acquisition agreements with the Berg Group and
subject to the approval of the Independent Directors Committee of the Board
of Directors, we have the right to purchase, on pre-negotiated terms, R&D
and other types of office and light industrial properties that the Berg
Group develops in the future. With in-house development, architectural and
construction personnel, the Berg Group continues to focus on a full range
of land acquisition, development and construction activities for R&D
properties, often build-to-suit, to meet the demands of Silicon Valley
information technology companies. As the developer, the Berg Group takes on
the risks of purchasing the land, obtaining regulatory approvals and
permits and financing construction. Since September 1998, we have acquired
approximately 3,135,000 additional rentable square feet of R&D properties
from the Berg Group under these agreements.
OUR RELATIONSHIP WITH THE BERG GROUP
Through a series of transactions occurring between May 1997 and December
1998, we became the vehicle for substantially all of the Silicon Valley R&D
property operating activities of the Berg Group. We are the general partner
pursuant to the partnership agreements of the operating partnerships and,
along with members of the Berg Group and other individuals, are party to an
Exchange Rights Agreement and the Berg Land Holdings Option Agreement. Each
agreement defines the material rights and obligations among us, the Berg
Group members, and other parties to those agreements. Among other things,
these agreements give us rights to:
- control the operating partnerships;
- acquire, subject to approval of the Independent Directors Committee of
the Board of Directors, on pre-negotiated terms, all future R&D
properties developed by the Berg Group on land currently owned or
acquired in the future; and
- acquire R&D, office and industrial properties identified by the Berg
Group in California, Oregon and Washington, subject to approval of the
Independent Directors Committee of the Board of Directors.
Under these agreements, our charter or our bylaws, the Berg Group has the
right to:
- designate two of five nominees for director to be elected by our
stockholders, subject to the Berg Group's maintenance of certain
ownership interests;
- participate in our securities offerings;
- exchange their operating partnership interests ("O.P. Units") for our
common stock;
- 1 -
- vote on major transactions, subject to its maintenance of certain
ownership interests; and
- prevent us from selling properties when the sale will have adverse tax
consequences to the Berg Group members.
To comply with REIT requirements that restrict the percentage of the total
value of our stock that may be owned by five or fewer individuals to 50% or
less, our charter generally prohibits the direct or indirect ownership of
more than 9% of our common stock by any stockholder. This limit excludes
the Berg Group, which has an aggregate ownership limit of 20%. Currently,
the Berg Group members collectively own less than 1% of the outstanding
shares of our common stock.
Carl E. Berg, the Company's Chairman of the Board of Directors and Chief
Executive Officer and the controlling member of the Berg Group, has been
engaged in the development and long-term ownership of Silicon Valley real
estate for approximately 35 years, most recently through Berg & Berg
Enterprises ("Berg & Berg"). In 1969, Mr. Berg foresaw the rising demand
for efficient, multi-purpose facilities for the rapidly growing information
technology industry in the Silicon Valley. Since 1972, in addition to his
real estate activities, Mr. Berg also has been actively involved in venture
capital investments in many information technology companies in the Silicon
Valley, including such companies as Amdahl Corporation, Sun Microsystems,
Inc., and Integrated Device Technologies, Inc. He serves on the board of
directors of numerous information technology companies. These activities
have helped Mr. Berg develop a detailed understanding of the real estate
requirements of information technology companies, acquire valuable market
information and increase his name recognition within the venture capital
and entrepreneurial communities. These activities also manifest his
commitment to the growth and success of Silicon Valley companies. We
believe that Mr. Berg's substantial knowledge of and contacts in the
information technology industry provide a significant benefit to the
Company.
BUSINESS STRATEGY
Our 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 properties that provide attractive initial yields and
significant potential for growth in cash-flow;
- focusing on general purpose, single-tenant Silicon Valley R&D
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.
ACQUIRING PROPERTIES DEVELOPED BY THE BERG GROUP
We anticipate that most of our growth, if any, in rentable square footage
in the foreseeable future will come from the acquisition of new R&D
properties that are either currently under development or to be developed
in the future by the Berg Group. For example, in early 2003 we acquired
from the Berg Group a 50% interest in a joint venture, TBI-Mission West
LLC, which consists of four R&D properties totaling approximately 593,000
rentable square feet. In addition to this project, the Berg Land Holdings
Option Agreement gives us the right to acquire future R&D property
developments by the Berg Group on up to 84 additional acres of land
currently controlled by the Berg Group, which could support approximately
1.37 million square feet of new developments. Nevertheless, at this time we
do not anticipate acquiring any additional newly constructed R&D properties
from the Berg Group for several years because of the current market
conditions in the Silicon Valley.
In light of this overcapacity in the market, the Berg Group currently is
seeking local government approval of a proposed rezoning of the 160-acre
Evergreen site to permit residential development on a substantial portion
of the site. The Independent Directors Committee, which is responsible for
reviewing, evaluating and authorizing action with respect to any
transaction between us and any of the Berg Group, has authorized removal of
the Evergreen site from the scope of the Berg Land Holdings Option
Agreement, subject to the completion of the rezoning of the 160-acre
Evergreen site, or portion thereof, for residential development. In making
this determination, the Independent Directors Committee considered a number
of factors, including risks and other potentially adverse consequences that
could be associated with large scale residential development activities.
Any portion of the Evergreen site that is not rezoned as residential
property is not deemed to be removed from the scope of the Berg Land
Holdings Option Agreement and would remain eligible for potential future
acquisition under the Berg Land Holdings Option Agreement.
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BERG LAND HOLDINGS OPTION AGREEMENT. We believe that control of high
quality, developable land is an important strategic factor for continued
success in the Silicon Valley market. In December 1998, we entered into the
Berg Land Holdings Option Agreement under which we have an option to
purchase all land acquired, directly or indirectly, by Carl E. Berg or
Clyde J. Berg that has not been improved with completed buildings and which
is zoned for, intended for or appropriate for R&D, office and/or industrial
development or use in the states of California, Oregon and Washington. In
addition, Carl E. Berg has agreed not to directly or indirectly acquire or
develop any real property zoned for office, industrial or R&D use in the
states of California, Oregon and Washington without first disclosing and
making the acquisition opportunity available to us. Our Independent
Directors Committee decides whether we will pursue each opportunity
presented to us by Mr. Berg. This restriction will expire when there is no
Berg Group nominee on our board of directors and the Berg Group's fully
diluted ownership percentage, which is calculated based on all outstanding
shares of common stock and all shares of common stock that could be
acquired upon the exercise of all outstanding options to acquire our voting
stock, as well as all shares of common stock issuable upon exchange of all
O.P. Units ("Fully Diluted"), falls below 25%.
As of December 31, 2003, we had acquired 20 leased R&D properties totaling
approximately 1,992,000 rentable square feet under this agreement at a cost
of approximately $205.2 million, for which we issued 7,933,849 O.P. Units
and assumed debt of approximately $118 million. The principal terms of the
agreement include the following:
- So long as the Berg Group members and their affiliates own or have the
right to acquire shares representing at least 65% of our common stock
on a Fully Diluted basis, we will have the option to acquire any
building developed by any member of the Berg Group on the land subject
to the Berg Land Holdings Option Agreement at such time as the
building has been leased. Upon our exercise of the option, the option
price will equal the sum of the following or a lesser amount as
approved by the Independent Directors Committee:
1. the full construction cost of the building; plus
2. 10% of the full construction cost of the building; plus
3. interest at LIBOR plus 1.65%, on the amount of the full
construction cost of the building for the period from the date
funds were disbursed by the developer to the close of escrow;
plus
4. the original acquisition cost of the parcel on which the
improvements will be constructed, which range from $8.50 to
$20.00 per square foot for land currently owned or under option;
plus
5. 10% per annum of the amount of the original acquisition cost of
the parcel from the later of January 1, 1998 and the seller's
acquisition date, to the close of escrow; minus
6. the aggregate principal amount of all debt encumbering the
acquired property.
- The acquisition cost, net of any debt, will be payable in cash, or
O.P. Units valued at the average closing price of our common stock
over the 30-trading-day period preceding the acquisition or, in cash,
at the option of the Berg Group.
- We also must assume all property tax assessments.
- If we elect not to exercise the option with respect to any property,
the Berg Group may hold and lease the property for its own account, or
may sell it to a third party.
- All action taken by us under the Berg Land Holdings Option Agreement,
including any variations from stated terms outlined above must be
approved by a majority of the members of the Independent Directors
Committee of our Board of Directors.
As a general policy which has been established by the Independent Directors
Committee, we do not acquire properties under the Berg Land Holdings Option
Agreement until they have been leased. We are responsible for a significant
portion of the leasing process in connection with such acquisitions,
however.
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The following table presents certain information concerning currently
identified land that we have the right to acquire under the Berg Land
Holdings Option Agreement.
Approximate Rentable
Property Net Acres Area (Square Feet)
-------------------------------- -------------------- --------------------------
AVAILABLE LAND:
Piercy & Hellyer 30 490,000
Morgan Hill (1) 18 288,025
King Ranch 12 207,000
Fremont & Cushing 24 387,000
-------------------- --------------------------
TOTAL 84 1,372,025
==================== ==========================
(1) We expect to own an approximate 50% interest in the partnership through one
of our operating partnerships. The property will be operated and managed by
the other joint venture partner in the entity.
Although we expect to acquire new properties or joint ventures available to
us 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 we actually will consummate any of the intended
transactions. Furthermore, we have not yet determined the means by which we
would acquire and pay for any such properties or the impact of any of the
acquisitions on our business, results of operations, financial condition,
Funds From Operation ("FFO") or available cash for distribution. See Item
1. "Risk Factors - Our contractual business relationships with the Berg
Group present additional conflicts of interest which may result in the
realization of economic benefits or the deferral of tax liabilities by the
Berg Group without equivalent benefits to our stockholders."
Given the downturn in the Silicon Valley real estate market for R&D/office
properties, we may not be able to maintain historical levels of growth from
acquisitions of new developments in the future.
OPPORTUNISTIC ACQUISITIONS
In addition to our principal opportunities under the Berg Land Holdings
Option Agreement, we believe our acquisitions experience, established
network of real estate and information technology professionals, and
overall financial condition will continue to provide opportunities for
external growth. Our April 2003 acquisition of approximately 625,000
rentable square feet of R&D properties in the San Tomas Technology Park is
an example of this. In general, we will seek opportunistic acquisitions of
high quality, well located Silicon Valley R&D properties in situations
where illiquidity or inadequate management permit their acquisition at
favorable prices, and where our management skills and knowledge of Silicon
Valley submarkets may facilitate increases in cash flow and asset value.
Furthermore, our use of the operating partnership structure allows us to
offer prospective sellers the opportunity to contribute properties on a
tax-deferred basis in exchange for O.P. Units. Although we have not
consummated any transactions like this since our July 1, 1998 acquisition
of the Berg Group properties, this capacity to complete tax-deferred
transactions with sellers of real property further enhances our ability to
acquire additional properties.
FOCUS ON SINGLE TENANT SILICON VALLEY R&D PROPERTIES
We intend to continue to emphasize the acquisition of single-tenant rather
than multi-tenant properties, a practice that has historically contributed
to the relatively low turnover and high occupancy rates on our properties.
We believe that the relatively small number of tenants (78) occupying our
109 properties, mostly under the triple net lease structure, allows us to
efficiently manage the properties and to serve our tenants' needs without
extensive in-house staff or the assistance of a third-party property
management organization. In addition, this emphasis allows us to incur less
expense for tenant improvements and leasing commissions than multi-tenant,
high turnover property owners. This strategy also reduces the time and
expense associated with obtaining building permits and other governmental
approvals. We believe that the relatively stable, extended relationships
that we have developed with our key tenants are valuable in the expansion
of our business.
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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 during 2001 through 2003 after fast-paced growth
in 1999 and 2000. In the past several years, the Silicon Valley R&D
property market has 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 23%
at the end of 2003 and 23% as of June 30, 2004. Total vacant R&D square
footage in Silicon Valley at the end of the fourth quarter of 2003 amounted
to 35.6 million square feet, of which 33.7%, or 12 million square feet, was
sublease space. Total negative net absorption (which is the computation of
gross square footage leased less gross new square footage vacated for the
period presented) in 2002 amounted to approximately (10.9) million square
feet. For the year 2003, total negative net absorption declined to
approximately (4.0) million square feet as local economic conditions
improved, but the overall R&D property market did not recover. The impact
of vacancies has not been uniform throughout the area, however. The Silicon
Valley R&D property market is characterized by a substantial number of
submarkets, with rent and vacancy rates varying by submarket and location
within each submarket. In addition, the time to complete the marketing and
lease up of vacant space has increased from an average of several months to
as much as an average of 6 to 18 months as a result of the increased
vacancy in the market. For the years ended December 31, 2003 and 2002,
average occupancy in our portfolio was 80.5% and 90%, respectively. Prior
to the first quarter of 2002, we had achieved historical average occupancy
levels of above 98% since 1999. We believe that maintaining average
occupancy levels above 98% will not be sustainable given the current
economic environment, as evidenced by our occupancy level of 77% at
December 31, 2003 and 72% at June 30, 2004. Although we have stringent
lease underwriting standards and continually evaluate the financial
capacity of both our prospective and existing tenants to proactively manage
portfolio credit risk, a downturn in tenants' businesses may weaken
tenants' financial conditions and could result in defaults under their
lease obligations. We believe that the average 2003 renewal rental rates
for our properties will be approximately equal to, or perhaps, below
current rents. In addition, leasing activity for new build-to-suit and
vacated R&D properties has slowed considerably during the past several
years. Leases representing approximately 863,000 square feet, or 11.7% of
our 2004 annualized base rent, are scheduled to expire during 2004. If we
are unable to lease a significant portion of any vacant space or space
scheduled to expire; if we experience significant tenant defaults as a
result of the current economic downturn; or if we are not able to lease
space at or above current market rates, our results of operations and cash
flows will be adversely affected.
OPERATIONS
We operate as a self-administered, self-advised and self-managed REIT with
our own employees. Generally, as the sole general partner of the operating
partnerships, we control the business and assets of the operating
partnerships and have full and complete authority, discretion and
responsibility with respect to the operating partnerships' operations and
transactions, including, without limitation, acquiring additional
properties, borrowing funds, raising new capital, leasing buildings and
selecting and supervising all agents of the operating partnerships.
Although most of our leases are triple net and building maintenance and
tenant improvements are the responsibility of the tenants, from time to
time we may be required to undertake construction and repair work at our
properties. We will bid all major work competitively to subcontractors.
Members of the Berg Group may participate in the competitive bidding for
the work.
We generally will market the properties and negotiate leases with tenants
ourselves. We make the availability of our properties known to the
brokerage community to garner their assistance in locating prospective
tenants. As a result, we expect to retain our policy of paying fixed
commissions to tenants' brokers.
We believe that our business practices provide us with competitive
advantages, including -
- EXTERNAL DEVELOPMENT AFFILIATE. We have the option to purchase all
future R&D, office, industrial property developments of the Berg Group
under the Berg Land Holdings Option Agreement on land currently held
or acquired directly or indirectly by Carl E. Berg or Clyde J. Berg
that is zoned for those purposes and located in California, Oregon and
Washington following completion and lease-up of the property. The
acquisition terms and conditions for the existing and identified
projects have been pre-negotiated and are documented under the Berg
Land Holdings Option Agreement. This relationship provides us with the
economic benefits of development while eliminating development and
initial lease-up risks. It also provides us with access to one of the
most experienced development teams in the Silicon Valley without the
expense of maintaining development personnel.
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- LEAN ORGANIZATION, EXPERIENCED TEAM. In part because of our primary
focus on Silicon Valley, our experience with the special real estate
requirements of information technology tenants and the long-term
triple-net structure of our leases, we are able to conduct and expand
our business with a small management team comprised of highly
qualified and experienced professionals working within a relatively
flat organizational structure. We believe that the leanness of our
organization and our experience will enable us to rapidly assess and
respond to market opportunities and tenant needs, control operating
expenses and develop and maintain excellent relationships with
tenants. We further believe that these advantages translate into
significantly lower costs for operations and give us the ability,
along with the Berg Group, to compete favorably with other R&D
property developers in Silicon Valley, especially for build-to-suit
projects subject to competitive bidding. Furthermore, we believe this
lower cost structure allows us to generate better returns from
properties whose value can be increased through appropriate remodeling
and efficient property management.
- SOUND PROPERTY MANAGEMENT PRACTICES. For each property, the management
team, along with the Berg Group staff, develops a specific marketing
and property management program. We select vendors and subcontractors
on a competitive bid basis from a select group of highly qualified
firms with whom we maintain ongoing relationships and carefully
supervise their work.
OPERATING PARTNERSHIP AGREEMENTS
MANAGEMENT
The operating partnerships consist of four separate limited partnerships
engaged in the combined operation and ownership of all our properties. The
operating partnership agreements are identical in all material respects for
all four of the limited partnerships. Pursuant to operating partnership
agreements, we act as the sole general partner of the operating
partnerships, in which capacity we have exclusive control of the business
and assets of the operating partnerships and generally have full and
complete authority, discretion and responsibility with respect to the
operating partnerships' operations and transactions, including, without
limitation, acquisitions of additional properties, borrowing funds, raising
new capital, leasing buildings, as well as selecting and supervising all
employees and agents of the operating partnerships. Through our authority
to manage our business and affairs, our Board of Directors directs the
business of the operating partnerships.
Notwithstanding our effective control of the operating partnerships, the
Berg Group holds a substantial majority of the outstanding O.P. Units and
the consent of the limited partners holding a majority of the outstanding
O.P. Units is required with respect to certain extraordinary actions
involving the operating partnerships, including:
- the amendment, modification or termination of the operating
partnership agreements;
- a general assignment for the benefit of creditors or the appointment
of a custodian, receiver or trustee for any of the assets of the
operating partnerships;
- the institution of any proceeding for bankruptcy of the operating
partnerships;
- the transfer of any general partnership interests in the operating
partnerships, including, with certain exceptions, transfers attendant
to any merger, consolidation or liquidation of our corporation;
- the admission of any additional or substitute general partner in the
operating partnerships; and
- a change of control of the operating partnerships.
In addition, until the ownership interest of the Berg Group and its
affiliates is less than 15% of the common stock on a Fully Diluted basis,
the consent of the limited partners holding a majority of the outstanding
O.P. Units is also required with respect to:
- the liquidation of the operating partnerships;
- the sale or other transfer of all or substantially all of the assets
of the operating partnerships and certain mergers and business
combinations resulting in the complete disposition of all O.P. Units;
and
- the issuance of limited partnership interests having seniority as to
distributions, assets and voting over the O.P. Units.
- 6 -
TRANSFERABILITY OF O.P. UNITS
The operating partnership agreements provide that the limited partners may
transfer their O.P. Units, subject to certain limitations. Except for
certain transfers by the limited partners to or from certain of their
affiliates, however, all transfers may be made only with our prior written
consent as the sole general partner of the operating partnerships.
In addition, no transfer of O.P. Units by the limited partners may be made
in violation of certain regulatory and other restrictions set forth in the
operating partnership agreements. Except in the case of certain permitted
transfers to or from certain affiliates of the limited partners, the
exchange rights, the put rights, rights to participate in future equity
financings and provisions requiring the approval of certain limited
partners for certain matters will no longer be applicable to O.P. Units so
transferred, and the transferee will not have any rights to nominate
persons to our Board of Directors.
ADDITIONAL CAPITAL CONTRIBUTIONS AND LOANS
Each operating partnership agreement provides that, if the operating
partnership requires additional funds to pursue its investment objectives,
we may fund such investments by raising additional equity capital and
making a capital contribution to the operating partnerships or by borrowing
such funds and lending the net proceeds of such loans to the operating
partnerships. If we intend to provide additional funds through a
contribution to capital and purchase of units of general partnership
interest, the limited partners will have the right to participate in such
funding on a pro rata, pari passu basis and to acquire additional O.P.
Units. If the limited partners do not participate in such financing, we
will acquire additional units of general partnership interest. In either
case, the number of additional units of partnership interest will be
increased based upon the amount of the additional capital contributions and
the value of the operating partnerships as of the date such contributions
are made.
In addition, as general partner of the operating partnerships, we have the
ability to cause the operating partnerships to issue additional O.P. Units.
In the event that the operating partnerships issue new O.P. Units for cash
but not property, the limited partners will have the right to purchase new
O.P. Units at the price we offer in the transaction giving rise to such
participation right in order, and to the extent necessary, to maintain
their respective percentage interests in the operating partnerships.
EXCHANGE RIGHTS, PUT RIGHTS AND REGISTRATION RIGHTS
Under the Exchange Rights Agreement between us and the limited partners,
the limited partners have exchange rights that generally became exercisable
on December 29, 1999. The Exchange Rights Agreement permits every limited
partner to tender O.P. Units to us, and, at our election, to receive common
stock on a one-for-one basis at then-current market value, an equivalent
amount of cash, or a combination of cash and common stock in exchange for
the O.P. Units tendered, subject to the 9% overall ownership limit imposed
on non-Berg Group stockholders under our charter document, or the overall
20% Berg Group ownership limit, as the case may be. For more information,
please refer to this Item 1., "Risk Factors - Failure to satisfy federal
income tax requirements for REITs could reduce our distributions, reduce
our income and cause our stock price to fall." This exchange ratio is
subject to adjustment for stock splits, stock dividends, recapitalizations
of our common stock and similar types of corporate actions. In addition,
once in each 12-month period beginning each December 29, the limited
partners, other than Carl E. Berg and Clyde J. Berg, may exercise a put
right to sell their O.P. Units to the operating partnerships at a price
equal to the average market price of the common stock for the 10-trading
day period immediately preceding the date of tender. Upon any exercise of
the put rights, we will have the opportunity for a period of 15 days to
elect to fund the purchase of the O.P. Units and purchase additional
general partner interests in the operating partnerships for cash, unless
the purchase price exceeds $1 million in the aggregate for all tendering
limited partners, in which case, the operating partnerships or we will be
entitled to reduce proportionally the number of O.P. Units to be acquired
from each tendering limited partner so that the total purchase price is not
more than $1 million.
The shares of our common stock issuable in exchange for the O.P. Units
outstanding at July 1, 1998 and the O.P. Units issued pursuant to the
Pending Projects Acquisition Agreement were registered under the Securities
Act and generally may be sold without restriction if they are acquired by
limited partners that are not affiliates, as defined under SEC Rule 144.
For more information please refer to this Item 1. "Risk Factors - Shares
eligible for future sale could affect the market price of our stock." The
Exchange Rights Agreement gives the holders of O.P. Units the right to
participate in any registered public offering of the common stock initiated
by us to the extent of 25% of the total shares sold in the offering upon
converting O.P. Units to shares of common stock, but subject to the
underwriters' unlimited right to reduce the participation of all selling
stockholders. The holders of O.P. Units will be able to request resale
registrations of shares of common stock acquired on exchange of O.P. Units
on a Form S-3, or any equivalent form of registration statement. We are
obligated to affect no more than two such registrations in any 12-month
period. We are obligated to assist the O.P. Unit holders in obtaining a
firm commitment underwriting agreement for such resale from a qualified
investment-banking firm. If registration on Form S-3, or an equivalent
form, is not available for any reason, we will be obligated to effect a
registration of the shares to be acquired on exercise of the exchange
rights on Form S-11, or an equivalent form, in an underwritten public
offering, upon demand by the holders of no fewer than 500,000 O.P. Units.
All holders of O.P. Units will be entitled to participate in such
registration. We
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will bear all costs of such registrations other than selling expenses,
including commissions and separate counsels' fees of the O.P. Unit holders.
We will not be required to affect any registration for resale on Form S-3,
or equivalent form of common stock shares issuable to the holder of O.P.
Units if the request is for less than 250,000 shares.
OTHER MATTERS
The operating partnership agreements require that the operating
partnerships be operated in a manner that will enable us to satisfy the
requirements for being classified as a REIT and to avoid any federal income
or excise tax liability.
The operating partnership agreements provide that the combined net
operating cash flow from all the operating partnerships, as well as net
sales and refinancing proceeds, will be distributed from time to time as
determined by our Board of Directors, but not less frequently than
quarterly, pro rata in accordance with the partners' percentage interests
in the operating partnerships, taken as a whole. This provision is intended
to cause the periodic distributions per O.P. Unit and per share of our
common stock to be equal. As a consequence of this provision, the capital
interest of a partner in each of the operating partnerships, including our
capital interests, might at times differ significantly from the partner's
percentage interest in the net income and cash flow of that operating
partnership. We do not believe that such differences would have a material
impact on our business, financial condition or funds available for
distributions, however.
Pursuant to the operating partnership agreements, the operating
partnerships will also assume and pay when due, or reimburse us for payment
of, certain costs and expenses relating to our continuity of existence and
operations.
The operating partnership agreements provide that, upon the exercise of an
outstanding option under the 1997 Stock Option Plan, we may purchase
additional general partner interests in the operating partnerships by
contributing the exercise proceeds to the operating partnerships. Our
increased interest shall be equal to the percentage of outstanding shares
of common stock and O.P. Units on an as-converted basis represented by the
shares acquired upon exercise of the option.
TERM
The operating partnerships will continue in full force and effect until
December 31, 2048 or until sooner dissolved pursuant to the terms of the
operating partnership agreements.
EMPLOYEES
As of July 15, 2004, we employed four people, all of whom work at our
executive offices at 10050 Bandley Drive, Cupertino, California, 95014.
FACILITIES
We sublease office space at 10050 Bandley Drive, Cupertino, California from
Berg & Berg Enterprises, Inc. and share clerical staff and other overhead
on what we consider to be very favorable terms. The total monthly rent
payable by us to Berg & Berg Enterprises, Inc. is $7,520.
RISK FACTORS
YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING RISKS, TOGETHER WITH THE OTHER
INFORMATION CONTAINED ELSEWHERE IN THIS FORM 10-K. THE FOLLOWING RISKS
RELATE PRINCIPALLY TO OUR BUSINESS AND THE INDUSTRY IN WHICH WE OPERATE.
THE RISKS AND UNCERTAINTIES CLASSIFIED BELOW ARE NOT THE ONLY ONES WE FACE.
WE ARE DEPENDENT ON CARL E. BERG, AND IF WE LOSE HIS SERVICES OUR BUSINESS
MAY BE HARMED AND OUR STOCK PRICE COULD FALL.
We are substantially dependent upon the leadership of Carl E. Berg, our
Chairman and Chief Executive Officer. Losing Mr. Berg's knowledge and
abilities could have a material adverse effect on our business and the
value of our common stock. Mr. Berg manages our day-to-day operations and
devotes a significant portion of his time to our affairs, but he has a
number of other business interests as well. These other activities reduce
Mr. Berg's attention to our business.
MR. BERG AND HIS AFFILIATES EFFECTIVELY CONTROL OUR CORPORATION AND THE
OPERATING PARTNERSHIPS AND MAY ACT IN WAYS THAT ARE DISADVANTAGEOUS TO
OTHER STOCKHOLDERS.
SPECIAL BOARD VOTING PROVISIONS. Our governing corporate documents, which
are our articles of amendment and restatement, or charter, and our bylaws,
provide substantial control rights for the Berg Group. The Berg Group's
control of our corporation
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means that the value and returns from an investment in the Company's common
stock are subject to the Berg Group's exercise of its rights. These rights
include a requirement that Mr. Berg or his designee as director approve
certain fundamental corporate actions, including amendments to our charter
and bylaws and any merger, consolidation or sale of all or substantially
all of our assets. In addition, our bylaws provide that a quorum necessary
to hold a valid meeting of the Board of Directors must include Mr. Berg or
his designee. The rights described in the two preceding sentences apply
only as long as the Berg Group members and their affiliates, other than us
and the operating partnerships, beneficially own, in the aggregate, at
least 15% of our outstanding shares of common stock on a Fully Diluted
basis. Also, directors representing more than 75% of the entire Board of
Directors must approve other significant transactions, such as incurring
debt above certain amounts and conducting business other than through the
operating partnerships. Without the approval of Mr. Berg or his designee,
Board of Directors' approval that we may need for actions that might result
in a sale of your stock at a premium or raising additional capital when
needed could be difficult or impossible to obtain.
BOARD OF DIRECTORS REPRESENTATION. The Berg Group members have the right to
designate two of the director nominees submitted by our Board of Directors
to stockholders for election, as long as the Berg Group members and their
affiliates, other than us and the operating partnerships, beneficially own,
in the aggregate, at least 15% of our outstanding shares of common stock
calculated on a Fully Diluted basis. If the Fully Diluted ownership of the
Berg Group members and their affiliates, other than us and the operating
partnerships, is less than 15% but is at least 10% of the common stock, the
Berg Group members have the right to designate one of the director nominees
submitted by our Board of Directors to stockholders for election. Its right
to designate director nominees affords the Berg Group substantial control
and influence over the management and direction of our corporation. The
Berg Group's interests could conflict with the interests of our
stockholders, and could adversely affect the price of our common stock.
SUBSTANTIAL OWNERSHIP INTEREST. The Berg Group currently owns O.P. Units
representing approximately 75.1% of the equity interests in the operating
partnerships and approximately 75.1% of our equity interests on a Fully
Diluted basis. The O.P. Units may be converted into shares of common stock,
subject to limitations set forth in our charter and other agreements with
the Berg Group, and upon conversion would represent voting control of our
corporation. The Berg Group's ability to exchange its O.P. Units for common
stock permits it to exert substantial influence over the management and
direction of our corporation. This influence increases our dependence on
the Berg Group.
LIMITED PARTNER APPROVAL RIGHTS. Mr. Berg and other limited partners,
including other members of the Berg Group, may restrict our operations and
activities through rights provided under the terms of the amended and
restated agreement of limited partnership which governs each of the
operating partnerships and our legal relationship to each operating
partnership as its general partner. Matters requiring approval of the
holders of a majority of the O.P. Units, which necessarily would include
the Berg Group, include the following:
- the amendment, modification or termination of any of the operating
partnership agreements;
- the transfer of any general partnership interest in the operating
partnerships, including, with certain exceptions, transfers attendant
to any merger, consolidation or liquidation of our corporation;
- the admission of any additional or substitute general partners in the
operating partnerships;
- any other change of control of the operating partnerships;
- a general assignment for the benefit of creditors or the appointment
of a custodian, receiver or trustee for any of the assets of the
operating partnerships; and
- the institution of any bankruptcy proceeding for any operating
partnership.
In addition, as long as the Berg Group members and their affiliates, other
than us and the operating partnerships, beneficially own, in the aggregate,
at least 15% of the outstanding shares of common stock on a Fully Diluted
basis, the consent of the limited partners holding the right to vote a
majority of the total number of O.P. Units outstanding is also required
with respect to:
- the sale or other transfer of all or substantially all of the assets
of the operating partnerships and certain mergers and business
combinations resulting in the complete disposition of all O.P. Units;
- the issuance of limited partnership interests senior to the O.P. Units
as to distributions, assets and voting; and
- the liquidation of the operating partnerships.
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The liquidity of an investment in the Company's common stock, including our
ability to respond to acquisition offers, will be subject to the exercise
of these rights.
OUR CONTRACTUAL BUSINESS RELATIONSHIPS WITH THE BERG GROUP PRESENT
ADDITIONAL CONFLICTS OF INTEREST, WHICH MAY RESULT IN THE REALIZATION OF
ECONOMIC BENEFITS OR THE DEFERRAL OF TAX LIABILITIES BY THE BERG GROUP
WITHOUT EQUIVALENT BENEFITS TO OUR STOCKHOLDERS.
Our contracts with the Berg Group provide it with interests that could
conflict with those of our other stockholders, including the following:
- our headquarters are leased from an entity owned by the Berg Group, to
whom we pay rent of $7,520 per month;
- the Berg Group is permitted to conduct real estate and business
activities other than our business;
- if we decline an opportunity that has been offered to us, the Berg
Group may pursue it, which would reduce the amount of time that Mr.
Berg could devote to our affairs and could result in the Berg Group's
development of properties that compete with our properties for
tenants;
- in general, we have agreed to limit the liability of the Berg Group to
our corporation and our stockholders arising from the Berg Group's
pursuit of these other opportunities;
- we acquired most of our properties from the Berg Group on terms that
were not negotiated at arm's length and without many customary
representations and warranties that we would have sought in an
acquisition from an unrelated party; and
- we have assumed liability for debt to the Berg Group and debt for
which the Berg Group was liable.
The Berg Group has agreed that the Independent Directors Committee of our
Board of Directors must approve all new transactions between us and any of
its members, or between us and any entity in which it directly or
indirectly owns 5% or more of the equity interests, including the operating
partnerships for this purpose. This committee currently consists of three
directors who are independent of the Berg Group.
EXCLUDED PROPERTIES. With our prior knowledge, the Berg Group retained two
R&D properties in Scotts Valley, Santa Cruz County, California, in which
the operating partnerships and we have no ownership interest. Efforts of
the Berg Group to lease these other properties could interfere with similar
efforts on our behalf.
BERG LAND HOLDINGS. The Berg Group owns several parcels of unimproved land
in the Silicon Valley that the operating partnerships and we have the right
to acquire under the terms of the Berg Land Holdings Option Agreement. We
have agreed to pay an amount based on pre-negotiated terms for any of the
properties that we do acquire. We must pay the acquisition price in cash
unless the Berg Group elects, in its discretion, to receive O.P. Units
valued at the average market price of a share of common stock during the
30-trading-day period preceding the acquisition date. At the time of
acquisition, which is subject to the approval of the Independent Directors
Committee these properties may be encumbered by debt that we or the
operating partnerships will be required to assume or repay. The use of our
cash or an increase in our indebtedness to acquire these properties could
have a material adverse effect on our financial condition, results of
operations and ability to make cash distributions to our stockholders. The
Independent Directors Committee recently authorized the removal of a
160-acre site from the Berg Land Holdings Option Agreement if the Berg
Group is able to obtain residential development zoning for any portion of
this land. The Independent Directors Committee determined that this site is
not likely to be of future development interest to us, and so the Berg
Group is now able to pursue its own residential development opportunities
for this site. Any portions of such site that are rezoned as residential
will no longer be subject to the Berg Land Holdings Option Agreement and
will not provide any future benefit to us.
TAX CONSEQUENCES OF SALE OF PROPERTIES. Because many of our properties have
unrealized taxable gain, a sale of those properties could create adverse
income tax consequences for limited partners of the operating partnerships.
We have agreed with Carl E. Berg, Clyde J. Berg and John Kontrabecki, a
limited partner in two of the operating partnerships, that prior to
December 29, 2008, each of them may prevent us and the operating
partnerships from selling or transferring any of the properties that were
acquired from them in our July 1998 UPREIT acquisition if the proposed sale
or other transfer will be a taxable transaction. As a result, our
opportunities to sell these properties may be limited. If we need to sell
any of these properties to raise cash to service our debt, acquire new
properties, pay cash distributions to stockholders or for other working
capital purposes, we may be unable to do so. These restrictions could harm
our business and cause our stock price to fall.
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TERMS OF TRANSFERS: ENFORCEMENT OF AGREEMENT OF LIMITED PARTNERSHIP. The
terms of the Pending Projects Acquisition Agreement, the Berg Land Holdings
Option Agreement, the partnership agreement of each operating partnership
and other material agreements through which we have acquired our interests
in the operating partnerships and the properties formerly controlled by the
Berg Group were not determined through arm's-length negotiations and could
be less favorable to us than those obtained from an unrelated party. In
addition, Mr. Berg and representatives of the Berg Group sitting on our
Board of Directors may be subject to conflicts of interests with respect to
their obligations as our directors to enforce the terms of the partnership
agreement of each operating partnership when such terms conflict with their
personal interests. The terms of our charter and bylaws also were not
determined through arm's-length negotiations. Some of these terms,
including representations and warranties applicable to acquired properties,
are not as favorable as those that we would have sought through
arm's-length negotiations with unrelated parties. As a result, an
investment in our common stock may involve risks not found in businesses in
which the terms of material agreements have been negotiated at arm's
length.
RELATED PARTY DEBT. As of December 31, 2003, we had borrowed approximately
$6.3 million under our $20 million line of credit with the Berg Group,
which is collateralized by five of our properties and expires in March
2005. The line of credit bears interest at an annual rate of LIBOR plus
1.30%. The Berg Group has no obligation to renew this line of credit when
it expires, and we may be unable to obtain a similar credit facility on
comparable terms. We are also liable under a mortgage loan of $10.8 million
due June 2010 that we assumed in connection with our acquisition of the
5300-5350 Hellyer Avenue R&D properties that we acquired in May 2000 under
the Berg Land Holdings Option Agreement. If we are unable to repay our
debts to the Berg Group when due, the Berg Group could take action to
enforce our payment obligations. Potential actions by the Berg Group to
enforce these obligations could result in the foreclosure in one or more of
our properties and a reduction in the amount of cash distributions to our
stockholders. In turn, if we fail to meet the minimum distributions test
because of a loan default or another reason, we could lose our REIT
classification for federal income tax purposes. For more information please
refer to Item 1., "Risk Factors - Failure to satisfy federal income tax
requirements for REITs could reduce our distributions, reduce our income
and cause our stock price to fall."
OUR OPTION TO ACQUIRE R&D PROPERTIES DEVELOPED ON EXISTING LAND AND LAND
ACQUIRED IN THE FUTURE BY THE BERG GROUP WILL TERMINATE WHEN THE BERG
GROUP'S OWNERSHIP INTEREST HAS BEEN REDUCED.
The Berg Land Holdings Option Agreement, as amended, which provides us with
significant benefits and opportunities to acquire additional R&D properties
from the Berg Group, will expire when the Berg Group and their affiliates
(excluding us and the operating partnerships) own less than 65% of our
common stock on a Fully Diluted basis. Termination of the Berg Land
Holdings Option Agreement could result in limitation of our growth, which
could cause our stock price to fall.
WE MAY CHANGE OUR INVESTMENT AND FINANCING POLICIES AND INCREASE YOUR RISK
WITHOUT STOCKHOLDER APPROVAL.
Our Board of Directors determines the investment and financing policies of
the operating partnerships and our policies with respect to certain other
activities, including our business growth, debt capitalization,
distribution, and operating policies. Our Board of Directors may amend
these policies at any time without a vote of the stockholders. Changes in
these policies could materially adversely affect our financial condition,
results of operations and ability to make cash distributions to our
stockholders, which could harm our business and cause our stock price to
fall. For more information please refer to Item 7. "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Policies
with Respect to Certain Activities."
ANTI-TAKEOVER PROVISIONS IN OUR CHARTER COULD PREVENT ACQUISITIONS OF OUR
STOCK AT A SUBSTANTIAL PREMIUM.
Provisions of our charter and our bylaws could delay, defer or prevent a
transaction or a change in control of our corporation, or a similar
transaction, that might involve a premium price for our shares of common
stock or otherwise be in the best interests of our stockholders. Provisions
of the Maryland general corporation law, which would apply to potential
business combinations with acquirers other than the Berg Group or
stockholders who invested in us in December 1998, also could prevent the
acquisition of our stock for a premium, as discussed in "Certain Provisions
of Maryland Law and of our Charter and Bylaws."
AN INVESTMENT IN OUR STOCK INVOLVES RISKS RELATED TO REAL ESTATE
INVESTMENTS THAT COULD HARM OUR BUSINESS AND CAUSE OUR STOCK PRICE TO FALL.
RENTAL INCOME VARIES. Real property investments are subject to varying
degrees of risk. Investment returns available from equity investments in
real estate depend in large part on the amount of income earned and capital
appreciation, which our properties generate, as well as our related
expenses incurred. If our properties do not generate revenues sufficient to
meet operating expenses, debt service and capital expenditures, our income
and ability to make distributions to our stockholders will be adversely
affected. Income from our properties may also be adversely affected by
general economic conditions, local
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economic conditions such as oversupply of commercial real estate, the
attractiveness of our properties to tenants and prospective tenants,
competition from other available rental property, our ability to provide
adequate maintenance and insurance, the cost of tenant improvements,
leasing commissions and tenant inducements and the potential of increased
operating costs, including real estate taxes.
EXPENDITURES FOR PROPERTY OWNERSHIP ARE FIXED. Income from properties and
real estate values are also affected by a variety of other factors, such as
governmental regulations and applicable laws, including real estate, zoning
and tax laws, interest rate levels and the availability of financing.
Various significant expenditures associated with an investment in real
estate, such as mortgage payments, real estate taxes and maintenance
expenses, generally are not reduced when circumstances cause a reduction in
revenue from the investment. Thus, our operating results and our cash flow
may decline materially if our rental income is reduced.
ILLIQUIDITY. Real estate investments are relatively illiquid, which limits
our ability to restructure our portfolio in response to changes in economic
or other conditions.
GEOGRAPHIC CONCENTRATION. All of our properties are located in the southern
portion of the San Francisco Bay Area commonly referred to as the "Silicon
Valley." The Silicon Valley economy has been weakening for the past few
years, and future increases in values and rents for our properties depend
to a significant extent on the recovery of this region's economy.
LOSS OF KEY TENANTS. Single tenants, many of whom are large, publicly
traded information technology companies, occupy most of our properties. We
may lose tenants when existing leases expire because it may be difficult to
re-lease the same property due to substantial overcapacity of R&D
properties in the Silicon Valley at present. Losing a key tenant could
adversely affect our operating results and our ability to make
distributions to stockholders if we are unable to obtain replacement
tenants promptly. Moreover, to retain key tenants upon the expiration of
existing leases we may need to reduce rents, which also could adversely
affect our operating results and ability to make distributions.
TENANT BANKRUPTCIES. Key tenants could seek the protection of the
bankruptcy laws, which could result in the rejection and termination of
their leases, thereby causing a reduction in our rental income. Under the
bankruptcy laws, these 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
or 15% of the total amount giving under the leases upon default, but not to
exceed three years of 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.
OUR SUBSTANTIAL INDEBTEDNESS. Our properties are subject to substantial
indebtedness. If we are unable to make required mortgage payments, we could
sustain a loss as a result of foreclosure on our properties by the
mortgagor. When the Berg Group line of credit expires in March 2005, we
cannot assure you that we will be able to obtain a replacement line of
credit with terms similar to the Berg Group line of credit, or at all. Our
cost of borrowing funds could increase substantially after the Berg Group
line of credit expires. Under our mortgage loan agreements with
Northwestern Mutual Life Insurance Company, the payment of all $100 million
outstanding could be accelerated upon the sale or certain other transfers
of more than 51% of the total number of O.P. Units and shares of common
stock of the Company held by the members of the Berg Group. We have no
reason to expect such a sale or transfer in the foreseeable future, but the
members of the Berg Group have no obligation to us to refrain from any such
sale or other transfer. We have adopted a policy of maintaining a
consolidated ratio of debt to total market capitalization, which includes
for this purpose the market value of all shares of common stock for which
outstanding O.P. Units are exchangeable, of less than 50%. This ratio may
not be exceeded without the approval of more than 75% of our entire Board
of Directors. Our Board of Directors may vote to change this policy,
however, and we could become more highly leveraged, resulting in an
increased risk of default on our obligations and an increase in debt
service requirements that could adversely affect our financial condition,
our operating results and our ability to make distributions to our
stockholders.
ENVIRONMENTAL CLEAN-UP LIABILITIES. Our properties may expose us to
liabilities under applicable environmental and health and safety laws. If
these liabilities are material, our financial condition and ability to pay
cash distributions may be affected adversely, which would cause our stock
price to fall.
UNINSURED LOSSES. We may sustain uninsured losses with respect to some of
our properties. If these losses are material, our financial condition, our
operating results and our ability to make distributions to our stockholders
may be affected adversely.
EARTHQUAKE DAMAGES ARE UNINSURED. All of our properties are located in
areas that are subject to earthquake activity. Our insurance policies do
not cover damage caused by seismic activity although they do cover losses
from fires after an earthquake. We generally do not consider such insurance
coverage to be economical. If an earthquake occurs and results in
substantial damage to our properties, we could lose our investment in those
properties, which loss could have a material adverse effect on our
financial condition, our operating results and our ability to make
distributions to our stockholders.
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FAILURE TO SATISFY FEDERAL INCOME TAX REQUIREMENTS FOR REITS COULD REDUCE
OUR DISTRIBUTIONS, REDUCE OUR INCOME AND CAUSE OUR STOCK PRICE TO FALL.
FAILURE TO QUALIFY AS A REIT. Although we currently operate in a manner
designed to enable us to qualify and maintain our REIT status, it is
possible that economic, market, legal, tax or other considerations may
cause us to fail to qualify as a REIT or may cause our Board of Directors
either to refrain from making the REIT election or to revoke that election
once made. To maintain REIT status, we must meet certain tests for income,
assets, distributions to stockholders, ownership interests, and other
significant conditions. If we fail to qualify as a REIT in any taxable
year, we will not be allowed a deduction for distributions to our
stockholders in computing our taxable income and would be subject to
federal income tax, including any applicable alternative minimum tax, on
our taxable income at regular corporate rates. Moreover, unless we were
entitled to relief under certain provisions of the tax laws, we would be
disqualified from treatment as a REIT for the four taxable years following
the year in which our qualification was lost. As a result, funds available
for distributions to our stockholders would be reduced for each of the
years involved and, in addition, we would no longer be required to make
distributions to our stockholders.
REIT DISTRIBUTION REQUIREMENTS. To maintain REIT status, we must distribute
as a dividend to our stockholders at least 90% of our otherwise taxable
income, after certain adjustments, with respect to each tax year. We also
may be subject to a 4% non-deductible excise tax in the event our
distributions to stockholders fail to meet certain other requirements.
Failure to comply with these requirements could result in our income being
subject to tax at regular corporate rates and could cause us to be liable
for the excise tax.
OWNERSHIP LIMIT NECESSARY TO MAINTAIN REIT QUALIFICATION. As a REIT, the
federal tax laws restrict the percentage of the total value of our stock
that may be owned by five or fewer individuals to 50% or less. Our charter
generally prohibits the direct or indirect ownership of more than 9% of our
common stock by any stockholder. This limit excludes the Berg Group, which
has an aggregate ownership limit of 20%. In addition, as permitted by our
charter, our Board of Directors has authorized an exception to two other
stockholders that permits them to collectively own, directly or indirectly,
up to 18.5% of our common stock on an aggregate basis, subject to the terms
of an ownership limit exemption agreement. In general, our charter
prohibits the transfer of shares that result in a loss of our REIT
qualification and provides that any such transfer or any other transfer
that causes a stockholder to exceed the ownership limit will result in the
shares being automatically transferred to a trust for the benefit of a
charitable beneficiary. Accordingly, in the event that either the Berg
Group or the two stockholders increase their stock ownership in our
corporation, a stockholder who acquires shares of our common stock, even
though his, her or its aggregate ownership may be less than 9%, may be
required to transfer a portion of that stockholder's shares to such a trust
in order to preserve our status as a REIT.
STOCKHOLDERS ARE NOT ASSURED OF RECEIVING CASH DISTRIBUTIONS FROM US.
Our income consists primarily of our share of the income of the operating
partnerships, and our cash flow consists primarily of our share of
distributions from the operating partnerships. Differences in timing
between the receipt of income and the payment of expenses in arriving at
our taxable income or the taxable income of the operating partnerships and
the effect of required debt amortization payments could require us to
borrow funds, directly or through the operating partnerships, on a
short-term basis to meet our intended distribution policy.
Our Board of Directors will determine the amount and timing of
distributions by the operating partnerships and of distributions to our
stockholders. Our Board of Directors will consider many factors prior to
making any distributions, including the following:
- the amount of cash available for distribution;
- the operating partnerships' financial condition;
- whether to reinvest funds rather than to distribute such funds;
- the operating partnerships' capital expenditures;
- the effects of new property acquisitions, including acquisitions under
our existing agreements with the Berg Group;
- the annual distribution requirements under the REIT provisions of the
federal income tax laws;
- our projected rental rates and revenues; and
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- such other factors as our Board of Directors deems relevant.
We cannot assure you that we will be able to meet or maintain our cash
distribution objectives.
OUR PROPERTIES COULD BE SUBJECT TO PROPERTY TAX REASSESSMENTS.
We do not believe that the acquisition of any of our interests in the
operating partnerships has resulted in a statutory change in ownership that
could give rise to a reassessment of any of our properties for California
property tax purposes. We cannot assure you, however, that county assessors
or other tax administrative agencies in California will not attempt to
assert that such a change occurred as a result of these transactions.
Although we believe that such a challenge would not be successful
ultimately, we cannot assure you regarding the outcome of any related
dispute or proceeding. A reassessment could result in increased real estate
taxes on our properties that, as a practical matter, we may be unable to
pass through to our tenants in full. This could reduce our net income and
our funds available for distributions and cause our stock price to fall.
OUR OBLIGATION TO PURCHASE TENDERED O.P. UNITS COULD REDUCE OUR CASH
DISTRIBUTIONS.
Each of the limited partners of the operating partnerships, other than Carl
E. Berg and Clyde J. Berg, has the annual right to cause the operating
partnerships to purchase the limited partner's O.P. Units at a purchase
price based on the average market value of the common stock for the
ten-trading-day period immediately preceding the date of tender. Upon a
limited partner's exercise of any such right, we will have the option to
purchase the tendered O.P. Units with available cash, borrowed funds or the
proceeds of an offering of newly issued shares of common stock. These put
rights became exercisable on December 29, 1999, and are available once
during a 12-month period. If the total purchase price of the O.P. Units
tendered by all of the eligible limited partners in one year exceeds $1
million, the operating partnerships or we will be entitled to reduce
proportionately the number of O.P. Units to be acquired from each tendering
limited partner so that the total purchase price does not exceed $1
million. The exercise of these put rights may reduce the amount of cash
that we have available to distribute to our stockholders and could cause
our stock price to fall.
In addition, all O.P. Unit holders may tender their O.P. Units to us in
exchange for shares of common stock on a one-for-one basis at then-current
market value or an equivalent amount in cash, at our election. If we elect
to pay cash for the O.P. Units, our liquidity may be reduced and we may
lack sufficient funds to continue paying the amount of our anticipated or
historical cash distributions. This could cause our stock price to fall.
SHARES ELIGIBLE FOR FUTURE SALE COULD AFFECT THE MARKET PRICE OF OUR STOCK.
We cannot predict the effect, if any, that future sales of shares of common
stock, or the availability of shares for future sale, could have on the
market price of the common stock. As of December 31, 2003, all outstanding
shares of our common stock, other than shares controlled by affiliates,
were eligible for sale in the public market without resale restrictions
under the federal securities laws. Sales of substantial amounts of common
stock, including shares issued in connection with the exercise of the
exchange rights held by the limited partners of the operating partnerships,
or the perception that such sales could occur, could adversely affect
prevailing market prices for the common stock. Additional shares of common
stock may be issued to limited partners, subject to the applicable REIT
qualification ownership limit, if they exchange their O.P. Units for shares
of common stock pursuant to their exchange rights, or may be sold by us to
raise funds required to purchase such O.P. Units if eligible limited
partners elect to tender O.P. Units to us using their put rights. Shares of
stock controlled by our affiliates may be sold subject to Rule 144,
including the limitation under Rule 144(e) on the number of shares that may
be sold within a three-month period.
RISKS RELATED TO OUR BUSINESS
If we are unable to strengthen our internal controls, there could be a
material adverse effect on our operations or financial results.
In connection with the audit of our consolidated financial statements for
the years ending December 2003, 2002 and 2001, our independent registered
public accounting firm, BDO Seidman ("BDO"), identified a material weakness
in internal controls which led to certain accounting adjustments for 2003
and certain restatements for 2002 and 2001 as more fully described in Item
9A of this form 10-K. In addition due to our total head count of four, BDO
also identified certain segregation of duties issues without compensating
controls. To address these issues, we will need to continue to improve our
financial and managerial controls and procedures in the future. If we are
unable to maintain an adequate level of financial processes and controls,
we may not be able to accurately report our financial performance on a
timely basis and our business and stock price would be harmed.
- 14 -
In addition, we are in the process of instituting changes to our internal
procedures in order to satisfy the requirements of Section 404 of the
Sarbanes-Oxley Act, which requires annual management assessments of the
effectiveness of our internal controls over financial reporting and a
report by our independent registered public accounting firm addressing
these assessments. If we fail to maintain the adequacy of our internal
controls, as such standards are modified, supplemented or amended from time
to time, we may not be able to ensure compliance with Section 404 of the
Sarbanes-Oxley Act. Failure to achieve such compliance could have a
material adverse effect on our business and stock price.
THE VALUE AND MARKETABILITY OF OUR COMMON STOCK COULD BE ADVERSELY AFFECTED
BY ANY FAILURE TO FILE TIMELY PERIODIC REPORTS UNDER FEDERAL SECURITIES
LAWS.
In January 2004, our former independent accountants, PricewaterhouseCoopers
LLP ("PWC") resigned without issuing their report of independent auditors
for 2003, and subsequent to the date of their resignation, advised us not
to rely on their reports of independent auditors for 2002 and 2001. As a
direct result of PWC's actions, we were unable to timely file this report
on Form 10-K and report on Form 10-Q for the first quarter of 2004. Due to
these filing delinquencies and our inability to promptly retain new
independent accountants, on March 19, 2004, the American Stock Exchange, or
AMEX, notified us that we were not in compliance with its continued listing
standards and required us to submit a compliance form. Through the
appointment of BDO Seidman, LLP ("BDO") as our new independent registered
public accounting firm and filing of this annual report, we have satisfied
certain of the conditions of the AMEX compliance plan. To become compliant
with the AMEX continued listing standards, we must also file our quarterly
reports on Form 10-Q for the first and second quarter of 2004 as soon as
practicable following the filing of the Form 10-K for 2003 but no later
than August 31, 2004. As a result of the resignation of PWC, the Company
estimates that it will incur additional legal, administrative and
accounting expenses of at least approximately $750,000, which will be
recorded as a 2004 expense. We cannot assure you that similar or other
events will not occur in the future, the result of which may be to delay
the filing of required periodic reports under the federal securities laws,
and cause the delisting of our common stock on AMEX without an alternative
stock exchange or market listing. These events could hinder or prevent
trading of our common stock or cause the price of our common stock to
decline materially. In addition, our late SEC filings constituted events of
default under two of our loan arrangements. Both lenders waived our
default, but there can be no assurance that a similar default in the future
would not result in acceleration of one or more of our loan balances, which
could adversely impact our financial condition, cash flows and stock price.
MARKET INTEREST RATES MAY REDUCE THE VALUE OF THE COMMON STOCK.
One of the factors that investors consider important in deciding whether to
buy or sell shares of a REIT is the distribution rate on such shares, as a
percentage of the price of such shares, relative to market interest rates.
If market interest rates go up, prospective purchasers of REIT shares may
expect a higher distribution rate. Higher interest rates would not,
however, increase the funds available for us to distribute, and, in fact,
would likely increase our borrowing costs and decrease funds available for
distributions. Thus, higher market interest rates could cause the price of
our common stock to fall.
- 15 -
ITEM 2. PROPERTIES
GEOGRAPHIC AND TENANT FOCUS
We focus principally on the facility requirements of information technology
companies in the Silicon Valley, which include space for office, R&D, light
manufacturing and assembly. With the Silicon Valley's highly educated and
skilled work force, history of numerous successful start-up companies and
large contingent of venture capital firms, we believe that this region
will, following the current significant slow down in the market, continue
to spawn successful new high-growth industries and entrepreneurial
businesses to an extent matched nowhere else in the United States. We
believe that our focus and thorough understanding of the Silicon Valley
real estate market enables us to:
- anticipate trends in the market;
- identify and concentrate our efforts on the most favorably located
sub-markets;
- take advantage of our experience and extensive contacts and
relationships with local government agencies, real estate brokers and
subcontractors, as well as with tenants and prospective tenants; and
- identify strong tenants.
All of our properties are general-purpose R&D/office type properties
located in desirable sub-markets of the Silicon Valley. Many of our
properties have been developed for or leased to single tenants, many of
whom are large, publicly traded information technology companies. Most of
our major tenants have occupied our properties for many years under
triple-net leases that require the tenant to pay substantially all
operating costs, including property insurance, real estate taxes and
general operating costs.
LEASING
The current leases for the properties have terms ranging from one to eleven
years. Most of the leases provide for fixed periodic rental increases.
Substantially all of the leases are triple-net leases pursuant to which the
tenant is required to pay substantially all of the operating expenses of
the property, property taxes and insurance, including all maintenance and
repairs, and excluding only certain structural repairs to the building
shell. Most of the leases contain renewal options that allow the tenant to
extend the lease based on adjustments to then prevailing market rates, or
based on fixed rental adjustments, which may be at or below market rates.
PROPERTY PORTFOLIO
All of our properties are R&D/office type properties. Generally, these
properties are one- to two-story buildings of tilt-up concrete
construction, have on average 3.5 or more parking spaces per thousand
rentable square feet, clear ceiling heights of less than 18 feet, and range
in size from 18,000 to 211,000 rentable square feet. Most of the office
space is open and suitable for configuration to meet the tenants'
requirements with the use of movable dividers.
The following table sets forth certain information relating to our
properties as of December 31, 2003:
Major
Tenants'
Total Percentage Average Rentable
No. of Rentable Leased as of 2003 Sq. Ft. 2003 Annual
Location Properties Sq. Ft. Dec. 31, 2003 Occupancy Major Tenants at 12/31/03 Base Rents(1)
------------------------------------------------------------------------------------------------------------------------------------
5300-5350 Hellyer Avenue (3) 2 160,000 100% 100% Tyco Electronics 160,000 $ 3,316,116
Corporation
10401-10411 Bubb Road (3) 1 20,330 100% 87% Celerity Systems, Inc. 20,330 311,909
45365 Northport Loop West 1 64,218 31% 42% Applied Micro Circuits 19,727 452,657
Corp.
45700 Northport Loop East 1 47,570 100% 100% Philips Electronics 47,570 789,180
45738 Northport Loop West 1 44,256 100% 100% EIC Corporation 44,256 584,872
4050 Starboard Drive 1 52,232 100% 100% Flash Electronics, Inc. 52,232 564,108
3501 W. Warren Avenue & 1 67,864 24% 36% RIAS Corporation 16,000 480,645
46600 Fremont Blvd.
- 16 -
Major
Tenants'
Total Percentage Average Rentable
No. of Rentable Leased as of 2003 Sq. Ft. 2003 Annual
Location Properties Sq. Ft. Dec. 31, 2003 Occupancy Major Tenants at 12/31/03 Base Rents(1)
------------------------------------------------------------------------------------------------------------------------------------
48800 Milmont Drive 1 53,000 0% 33% Vacant 216,352
4750 Patrick Henry Drive 1 65,780 0% 0% Vacant -
Triangle Technology Park (3) 7 416,927 67% 86% Intevac Corporation 119,583 6,795,064
JDS Uniphase Corporation 50,212
Xicom Technology, Inc. 47,480
Diligent Software 25,350
Systems Corp. 19,600
IXYS Technologies, Inc.
5850-5870 Hellyer Avenue 1 109,715 7% 7% Silver Creek Valley 7,675 123,996
Church
5750 Hellyer Avenue 1 73,312 0% 0% Vacant -
800 Embedded Way 1 239,000 0% 0% Vacant -
5500-5550 Hellyer Avenue 2 196,534 23% 23% ACT Electronics, Inc. 46,120 647,986
5400 Hellyer Avenue 1 77,184 100% 100% Jetstream 77,184 1,231,496
Communications, Inc.
5325-5345 Hellyer Ave. 2 256,500 100% 100% Celestica Asia, Inc. 256,500 4,707,096
5905-5965 Silver Creek 4 346,000 100% 100% CIENA Corporation 346,000 7,839,906
855 Embedded Way 1 67,912 100% 100% Lynuxworks, Inc. 67,912 1,317,168
1065 La Avenida Street 5 515,700 100% 100% Microsoft Corporation 515,700 21,151,328
1750 Automation Parkway 1 80,641 100% 100% JDS Uniphase Corporation 80,641 1,681,274
1756 Automation Parkway 1 80,640 100% 100% JDS Uniphase Corporation 80,640 1,919,964
1762 Automation Parkway 1 61,100 100% 100% JDS Uniphase Corporation 61,100 2,213,980
1768 Automation Parkway 1 110,592 100% 100% JDS Uniphase Corporation 110,592 3,301,200
255 Caspian Drive 1 98,500 0% 0% Vacant -
245 Caspian Drive (5) 1 - 0% 0% Vacant -
5970 Optical Court (2) 1 128,520 100% 0% Photon Dynamics, Inc. 128,520 -
5900 Optical Court 1 165,000 100% 100% Stryker Endoscopy 165,000 4,257,000
2630 Orchard Parkway 1 60,633 0% 0% Vacant -
2610 Orchard Parkway (4) 1 54,093 100% 100% Cadence Design Systems, 54,093 1,165,712
Inc.
55 West Trimble Road (4) 1 91,722 100% 100% Cadence Design Systems, 91,722 1,976,368
Inc.
2001 Walsh Avenue (2) 1 80,000 100% 100% NEC Electronics America, 80,000 530,282
Inc.
2880 Scott Boulevard (2) 1 200,000 100% 100% NEC Electronics America, 200,000 2,183,251
Inc.
2890 Scott Blvd. (2) 1 75,000 100% 100% NEC Electronics America, 75,000 1,549,757
Inc.
2800 Scott Blvd. (2) 1 98,430 75% 98% Nvidia Corporation 73,604 1,159,700
2300 Central Expy. (2) 1 46,338 100% 100% JDS Uniphase Corporation 46,338 2,305,685
2220 Central Expy. (2) 1 62,522 100% 100% BRE/San Tomas LLC 62,522 750,000
2330 Central Expy. (2) 1 62,522 0% 0% Vacant -
2251 Lawson Lane 1 125,000 100% 100% Fujitsu IT Holdings, Inc. 125,000 1,454,279
1230 East Arques 1 60,000 100% 100% Fujitsu IT Holdings, Inc. 60,000 327,069
1250 East Arques 4 200,000 100% 100% Fujitsu IT Holdings, Inc. 200,000 755,923
- 17 -
Major
Tenants'
Total Percentage Average Rentable
No. of Rentable Leased as of 2003 Sq. Ft. 2003 Annual
Location Properties Sq. Ft. Dec. 31, 2003 Occupancy Major Tenants at 12/31/03 Base Rents(1)
------------------------------------------------------------------------------------------------------------------------------------
3120 Scott Blvd. 1 75,000 100% 100% Fujitsu IT Holdings, Inc. 75,000 1,238,081
20400 Mariani Avenue 1 105,000 100% 100% Dade Behring, Inc. 105,000 3,109,050
10500 De Anza Blvd. 1 211,000 100% 100% Apple Computer, Inc. 211,000 5,206,608
20605-705 Valley Green Dr. 2 142,000 100% 100% Apple Computer, Inc. 142,000 3,067,198
10300 Bubb Road 1 23,400 100% 100% Apple Computer, Inc. 23,400 449,280
10440 Bubb Road 1 19,500 54% 46% Lightmaster Systems, Inc. 10,573 127,044
10460 Bubb Road 1 45,460 67% 81% Luminous Networks, Inc. 30,460 626,683
1135 Kern Avenue 1 18,300 50% 62% Broadmedia, Inc. 9,150 133,365
1190 Morse Avenue & 1 28,350 66% 66% Coptech West, Inc. 18,750 217,504
405 Tasman Avenue
450 National Avenue 1 36,100 100% 100% ePeople, Inc. 36,100 1,228,351
3301 Olcott Street 1 64,500 0% 0% Vacant -
2800 Bayview Avenue 1 59,736 0% 35% Vacant 245,958
6850 Santa Teresa Blvd. 1 30,000 59% 59% Indala Corporation 17,650 317,700
6810 Santa Teresa Blvd. 1 54,996 100% 100% Polaris Networks, Inc. 54,996 1,665,601
140-150 Great Oaks Blvd. & 2 105,300 74% 86% Amtech Microelectronics, 31,500 1,482,173
6781 Via Del Oro Inc.
Saint Gobain 21,800
Santa Clara Water 25,000
District
6540-6541 Via Del Oro & 2 66,600 74% 80% Exsil, Inc. 20,076 820,339
6385-6387 San Ignacio Ave. Modutek Corporation 17,400
6311-6351 San Ignacio Ave. 5 362,767 100% 100% On Command Corporation 131,320 6,058,027
Saint Gobain 95,953
Avnet, Inc. 53,494
Photon Dynamics, Inc. 52,000
Teledex, LLC 30,000
6320-6360 San Ignacio Ave. 1 157,292 71% 71% Nortel Networks Corp, 92,692 3,559,188
Quantum 3D, Inc. 19,600
75 East Trimble Road & 2 170,810 100% 100% Comerica Bank 93,984 2,679,835
2610 North First Street County of Santa Clara 70,795
2033-2243 Samaritan Drive 3 235,122 36% 36% Texas Instruments, Inc. 48,677 3,484,925
State Farm Insurance 23,801
Good Samaritan Hospital 12,286
1170 Morse Avenue 1 39,231 100% 100% The Parkinson's Institute 39,231 382,624
3236 Scott Blvd. 1 54,672 100% 100% Celeritek, Inc. 54,672 1,182,789
1212 Bordeaux Lane 1 71,800 100% 100% Northrop Grumman 71,800 1,376,148
Corporation
McCandless Technology Park(4) 14 705,956 69% 82% Larscom, Inc. 118,708
Arrow Electronics, Inc. 92,862 10,846,170
Chartered Semiconductor 45,312
Mfg.
St Assembly Test Services, 33,984
Inc.
USinternetworking, Inc. 27,129
Hermes Microvision, Inc. 25,285
Promise Technology, Inc. 20,331
1600 Memorex Drive 1 107,500 100% 100% Sasco Electric 84,700 802,816
International Network 22,800
Services
- 18 -
Major
Tenants'
Total Percentage Average Rentable
No. of Rentable Leased as of 2003 Sq. Ft. 2003 Annual
Location Properties Sq. Ft. Dec. 31, 2003 Occupancy Major Tenants at 12/31/03 Base Rents(1)
------------------------------------------------------------------------------------------------------------------------------------
1688 Richard Avenue 1 52,800 100% 100% NWE Technology, Inc. 52,800 680,175
1700 Richard Avenue 1 58,783 100% 100% Broadwing Comm Services, 58,783 684,823
Inc.
------------------ --------------
TOTAL 109 7,917,262 $129,733,778
================== ==============
(1) Annual cash rents do not include any effect for recognition of rental
income on the straight-line method of accounting required by generally
accepted accounting principles in the United States of America under which
contractual rent payment increases are recognized evenly over the lease
term.
(2) Properties were purchased in 2003. The 2003 Annual Base Rent reflects rent
received from the date of acquisition through December 31, 2003.
(3) Joint venture properties.
(4) In April and May 2004 we entered into lease termination agreements with two
different tenants, Cadence Design Systems, Inc. and Larscom, Inc., who have
leases expiring in 2004 for the sum total of $2,608,776, which will be
recorded in other revenue in 2004. With the execution of termination
agreements with these two tenants, the Company has an additional 264,523 of
vacant rentable square feet.
(5) Property represents a commitment by the Berg Group to construct an
approximate 75,000 to 90,000 square foot building on land acquired during
2001.
We own 100% of all of the properties, except for one of the buildings in
the Triangle Technology Park, which is owned by a joint venture in which
we, through an operating partnership, own a 75% interest, the property at
10401-10411 Bubb Road, which is owned by a joint venture in which we,
through an operating partnership, own an 83.33% interest, and the
properties at 5300-5350 Hellyer Avenue, which are owned by a joint venture
in which we, through an operating partnership, own a 50% interest, and a
Berg affiliate owns the other 50% venture interest.
- 19 -
LEASE EXPIRATIONS
The following table sets forth a schedule of the lease expirations for the
properties beginning with 2004, assuming that none of the tenants exercise
existing renewal options or termination rights. The table excludes
1,858,180 rentable square feet that was vacant as of December 31, 2003.
Number of Percentage of Total Annual
Year of Lease Leases Rentable Square Footage 2004 Annual Base Rent Base Rent Represented By
Expiration Expiring Subject to Expiring Leases Under Expiring Leases (1) Expiring Leases (2)
--------------------------------------------------------------------------------------------------------------------
2004 (3) 20 862,817 $ 15,327,915 11.7%
2005 21 556,769 11,216,483 8.5%
2006 16 1,244,067 41,109,897 31.3%
2007 18 1,329,355 26,521,018 20.2%
2008 5 274,022 3,421,098 2.6%
2009 8 558,434 9,658,888 7.4%
2010 5 397,514 7,114,110 5.4%
2011 2 602,500 13,048,878 9.9%
2012 1 73,604 477,378 0.4%
Thereafter 1 160,000 3,415,600 2.6%
--------------------------------------------------------------------------------------------------
97 6,059,082 $131,311,265 100%
==================================================================================================
(1) The base rent for leases expiring is based on scheduled 2004 annualized
cash rents, which are different than annual rents determined in accordance
with GAAP.
(2) Based upon 2004 annualized cash rents as discussed in Note (1).
(3) In April and May 2004 we entered into lease termination agreements with two
different tenants, Cadence Design Systems, Inc. and Larscom, Inc., who have
leases expiring in 2004 for the sum total of $2,608,776, which will be
recorded in other revenue in 2004. With the execution of termination
agreements with these two tenants, the Company has an additional 264,523 of
vacant rentable square feet.
If we are unable to lease a significant portion of the available space or
space scheduled to expire in 2004 and thereafter at any of our properties,
if existing tenants do not renew their leases, or if rental rates decrease,
our results of operations, financial condition and cash flows would be
adversely affected.
ENVIRONMENTAL MATTERS
To date, compliance with laws and regulations relating to the protection of
the environment, including those regarding the discharge of materials into
the environment has not had any material effects upon our capital
expenditures, earnings or competitive position.
Under various federal, state and local laws, ordinances and regulations, an
owner or operator of real property may be held liable for the costs of
removal or remediation of certain hazardous or toxic substances located on
or in the property. Such laws often impose liability on the owner and
expose the owner to governmental proceedings without regard to whether the
owner knew of, or was responsible for, the presence of the hazardous or
toxic substances. The cost of any required remediation or removal of such
substances may be substantial. In addition, the owner's liability as to any
specific property is generally not limited and could exceed the value of
the property and/or the aggregate assets of the owner. The presence of such
substances, or the failure to properly remove or remediate such substances,
may also adversely affect the owner's ability to sell or rent the property
or to borrow using the property as collateral. Persons who arrange for
treatment or the disposal of hazardous or toxic substances may also be
liable for the costs of any required remediation or removal of the
hazardous or toxic substances at a disposal facility, regardless of whether
the facility is owned or operated by such owner or entity. In connection
with the ownership of the properties or the treatment or disposal of
hazardous or toxic substances, we may be liable for such costs.
Some of our properties are leased, in part, to businesses, including
manufacturers that use, store or otherwise handle hazardous or toxic
substances in their business operations. These operations create a
potential for the release of hazardous or toxic substances. In addition,
groundwater contaminated by chemicals used in various manufacturing
processes, including
- 20 -
semiconductor fabrication, underlies a significant portion of northeastern
Santa Clara County, where many of our properties are located.
Environmental laws also govern the presence, maintenance and removal of
asbestos. These laws require that owners or operators of buildings
containing asbestos properly manage and maintain the asbestos, that they
adequately inform or train those who may come into contact with asbestos
and that they undertake special precautions, including removal or other
abatement in the event that asbestos is disturbed during renovation or
demolition of a building. These laws may impose fines and penalties on
building owners or operators for failure to comply with these requirements
and may allow third parties to seek recovery from owners or operators for
personal injury associated with exposure to asbestos fibers. We are aware
that there are asbestos-containing materials, or ACMs, present at several
of the properties, primarily in floor coverings. We believe that the ACMs
present at these properties are generally in good condition and that no
ACMs are present at the remaining properties. We believe we are in
compliance in all material respects with all present federal, state and
local laws relating to ACMs and that if we were given limited time to
remove all ACMs present at the properties, the cost of such removal would
not have a material adverse effect on our financial condition, results of
operations and ability to make cash distributions to our stockholders.
Phase I assessments are intended to discover and evaluate information
regarding the environmental condition of the surveyed property and
surrounding properties. Phase I assessments generally include a historical
review, a public records review, an investigation of the surveyed site and
surrounding properties and the preparation and issuance of a written
report, but do not include soil sampling or subsurface investigations and
typically do not include an asbestos survey. Environmental assessments have
been conducted for about half of the properties.
The environmental investigations that have been conducted on our properties
have not revealed any environmental liability that we believe would have a
material adverse effect on our financial condition, results of operations
and assets, and we are not aware of any such liability. Nonetheless, it is
possible that there are material environmental liabilities of which we are
unaware. We cannot assure you that future laws, ordinances, or regulations
will not impose any material environmental liability, or that the current
environmental condition of the properties has not been, or will not be,
affected by tenants and occupants of the properties, by the condition of
properties in the vicinity of the properties, or by third parties unrelated
to us.
- 21 -
ITEM 3. LEGAL PROCEEDINGS
Neither the operating partnerships, the properties nor we are subject to
any material litigation nor, to our knowledge, is any material litigation
threatened against the operating partnerships, the properties or us. From
time to time, we are engaged in legal proceedings arising in the ordinary
course of our business. We do not expect any of such proceedings to have a
material adverse effect on our cash flows, financial condition or results
of operations. We are currently involved in or have recently concluded the
following legal proceedings which we believe the ultimate outcome, will
have no material adverse affect on our financial statements.
In early January 2004 we received $1,836,393 from the Bankruptcy Estate of
Auspex Systems, Inc., pursuant to Notice of Order from the United States
Bankruptcy Court Northern District of California Case No. 03-52596 MM 11
representing our final share of the Estate of Auspex Systems, Inc. as an
unsecured creditor. This amount was recorded in other revenue during the
fourth quarter of 2003.
Republic Properties Corporation ("RPC") v. Mission West Properties, L.P.
("MWP"), in the Circuit Court of Maryland for Baltimore City Case No.
24-C-00-005675. RPC is a former partner with Mission West Properties, L.P.
in the Hellyer Avenue Limited Partnership ("Hellyer LP"). In April 2004 the
Circuit Court for Baltimore City, Maryland issued a Memorandum Opinion in
the case and awarded damages of $933,548 to the RPC plaintiffs, which must
be paid by us or MWP. The court denied all requests by MWP, including a
declaration that all of RPC's interests in Heller L.P. were validly
converted to limited partnership interests and transferred to MWP or its
designee in accordance with the terms of the Hellyer L.P. partnership
agreement. The court also denied RPC's request for an injunction ordering
the reinstatement of RPC's partnership interests in Hellyer L.P. We have
appealed the decision to the Maryland Appeals Court. Under the pre-appeal
hearing procedures, the Maryland Appeals Court requires a mediation hearing
before the parties can appear before the Appeals Court. No date has been
set for such a hearing. We do not believe that any further court decisions
in this case, for or against us and MWP, will not have a material adverse
effect on our business. We have a receivable from a Berg Group affiliate
for the amount of distributions it received as the successor to RPC's
interest in the Hellyer LP which exceeds the amount of the damages awarded
to the RPC parties and would be used to pay for those damages in the event
the decision of the Circuit Court is upheld ultimately. Furthermore, we
have never accounted for the 50% interest of RPC as our asset and if RPC is
deemed to have retained that interest or reacquires that interest our
balance sheet and financial condition would not be impacted. In February
2001, we filed a suit against RPC in Superior Court of the State of
California for the County of Santa Clara Case No. CV 796249 which has been
stayed pending resolution of the Maryland case. In July 2004, RPC attached
our bank account for approximately $1.1 million. Following a July 2004
hearing in Superior Court of the State of California for the County of
Santa Clara, the parties agreed that we will post a $1.5 million bond and
RPC will remove the attachment of our bank account until final resolution
of the appeal in Maryland. In February 2001, we filed a suit against RPC in
Superior Court of the State of California for the County of Santa Clara
Case No. CV 796249 which has been stayed pending resolution of the Maryland
case.
In January 2004, we filed the case of Mission West Properties, L.P. v.
Premisys Communications, Inc. and Zhone Technologies, Inc. in the Superior
Court of the State of California for the County of Alameda Case No.
HG03118906 for breach of lease agreement and claimed damages of $1,399,042.
In April 2004, we settled the matter and received a payment of $1,100,000.
This amount was recorded in other revenue during the second quarter of
2004.
In December 2003, Craig R. Jalbert Liquidating CEO, as representative of
the Estate of the Consolidated Debtors for ACT Manufacturing, Inc. v.
Mission West Properties, L.P. filed an action in United States Bankruptcy
Court District of Massachusetts Case No. 01-47641 (JBR) asserting that
payments of $481,749 made in the ordinary course of business within 90 days
of the ACT bankruptcy filing were preference payments. We have engaged
legal counsel to defend us in this claim and intend to vigorously contest
the matter.
In January 2004, the Global Crossing Estate Representative, for Itself and
the Liquidating Trustee of the Global Crossing Liquidating Trust v. Mission
West Properties filed an action in United States Bankruptcy Court Southern
District of New York Case No. 02-40188 (REG) asserting that payments of
$815,052 made in the ordinary course of business within 90 days of the
Global Crossing bankruptcy filing were preference payments. We have engaged
legal counsel to defend us in this claim and intend to vigorously contest
the matter.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of stockholders during the fourth
quarter of the year ended December 31, 2003.
- 22 -
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Our common stock is listed on the American Stock Exchange ("AMEX") and the
Pacific Exchange, Inc. and trades under the symbol "MSW." The high and low
closing sale prices per share of common stock as reported on AMEX during
each quarter of 2003 and 2002 were as follows:
2003 2002
----------------------------- -----------------------------
High Low High Low
------------- ------------- ------------- -------------
1st Quarter $10.25 $9.02 $13.22 $11.10
2nd Quarter $11.95 $9.50 $13.03 $11.91
3rd Quarter $12.74 $11.07 $11.99 $10.31
4th Quarter $13.45 $12.32 $11.20 $9.72
On July 15, 2004, there were 215 registered holders of the Company's common
stock. We declared and paid dividends in each quarter of 2003 and 2002. We
expect to pay quarterly dividends during 2004. The following tables show
information for quarterly dividends for 2003 and 2002.
2003
-----------------------------------------------
Record Payment Dividend
Date Date Per Share
------------- ------------- -------------
1st Quarter 03/31/03 04/10/03 $0.24
2nd Quarter 06/30/03 07/10/03 0.24
3rd Quarter 09/30/03 10/09/03 0.24
4th Quarter 12/31/03 01/08/04 0.24
-------------
Total $0.96
=============
2002
-----------------------------------------------
Record Payment Dividend
Date Date Per Share
------------- ------------- -------------
1st Quarter 03/29/02 04/11/02 $0.24
2nd Quarter 06/28/02 07/11/02 0.24
3rd Quarter 09/30/02 10/10/02 0.24
4th Quarter 12/31/02 01/09/03 0.24
-------------
Total $0.96
=============
For federal income tax purposes, we have characterized 98% of the dividends
declared in 2003 as taxable ordinary income and 2% as return of capital.
For 2002, we have characterized 100% of the dividends declared as taxable
ordinary income.
The closing price of our common stock on December 31, 2003, the last
trading day, was $12.95 per share.
- 23 -
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected historical financial information
for Mission West Properties, Inc. See Part II - Item 7 "Management's
Discussion and Analysis of Financial Conditions and Results of Operations"
- Overview and Company History for discussion of business combinations and
property dispositions that materially affect the comparability of the
selected financial data.
This Form 10-K includes restatements of previously reported historical
financial data and related descriptions for the years ended December 31,
2002 and 2001. We have identified certain accounting errors applied
historically to the items described in Note 18 to our Consolidated
Financial Statements and concluded that these items have been accounted for
incorrectly. As a result, we have made the appropriate adjustments to our
previously issued consolidated financial statements for the years ended
December 31, 2002 and 2001.
Selected consolidated financial data is derived from the audited financial
statements and notes thereto (see Part II - Item 8 "Consolidated Financial
Statements and Supplementary Data," below) and is as follows:
Year Ended December 31,
--------------------------------------------------------------------------
2003 2002 2001 2000 1999
(As Restated) (As Restated)
(3) (3)
------------- -------------- ------------- ------------- -------------
(dollars in thousands, except per share data)
OPERATING DATA:
Revenue:
Rental revenues $130,739 $129,781 $126,229 $ 97,568 $72,294
Tenant reimbursements 18,871 20,099 17,475 14,548 10,913
Other income, including interest 4,527 4,248 2,465 1,241 1,198
------------- -------------- ------------- ------------- -------------
Total revenues 154,137 154,128 146,169 113,357 84,405
------------- -------------- ------------- ------------- -------------
Expenses:
Property operating, maintenance and real 21,365 23,951 18,502 14,932 11,367
estate taxes
Interest 16,446 9,588 8,704 8,290 11,623
Interest (related parties) 1,064 3,422 4,709 4,475 2,246
General and administrative 1,325 1,488 1,284 1,065 1,185
Depreciation and amortization 20,774 18,313 16,746 15,178 12,878
------------- -------------- ------------- ------------- -------------
Total expenses 60,974 56,762 49,945 43,940 39,299
------------- -------------- ------------- ------------- -------------
Income before gain on sales of assets, equity in
earnings of unconsolidated 93,163 97,366 96,224 69,417 45,106
joint venture and minority interests
Gain on sales of assets - - 11,453 501 -
Equity in earnings of unconsolidated joint 3,885 - - - -
venture
Minority interests 80,836 81,316 89,876 57,650 38,755
------------- -------------- ------------- ------------- -------------
Income from continuing operations 16,212 16,050 17,801 12,268 6,351
Discontinued operations, net of minority interests:
Gain from disposal of discontinued - 1,018 - - -
operations
Income attributable to discontinued - 47 285 311 180
operations
------------- -------------- ------------- ------------- -------------
Income from discontinued operations - 1,065 285 311 180
------------- -------------- ------------- ------------- -------------
Net income to common stockholders $16,212 $17,115 $18,086 $12,579 $ 6,531
============= ============== ============= ============= =============
Net income to minority interests $80,836 $86,641 $91,312 $59,054 $39,785
============= ============== ============= ============= =============
Basic net income from continuing operations $0.91 $0.92 $1.04 $0.72 $0.51
per share
Diluted net income from continuing operations $0.91 $0.90 $1.01 $0.70 $0.50
per share
Basic net income per share $0.91 $0.98 $1.06 $0.74 $0.52
Diluted net income per share $0.91 $0.96 $1.03 $0.72 $0.52
PROPERTY AND OTHER DATA:
Total properties, end of period (4) 109 101 97 89 80
Total square feet, end of period (000's) 7,917 7,164 6,799 6,196 5,307
Average monthly rental revenue per square $1.76 $1.71 $1.59 $1.36 $1.16
foot (1)
Occupancy at end of period 77% 84% 97% 99% 99%
Funds from Operations (2): $117,918 $118,444 $115,013 $86,650 $60,007
Cash flows from operating activities $116,493 $117,368 $111,157 $84,580 $60,298
Cash flows from investing activities (109,983) (20,744) (3,040) (2,736) (12,084)
Cash flows from financing activities (6,860) (97,455) (107,498) (83,706) (41,920)
- 24 -
December 31,
--------------------------------------------------------------------------
2003 2002 2001 2000 1999
(As Restated) (As Restated)
(3) (3)
------------- -------------- ------------- ------------- -------------
(dollars in thousands)
BALANCE SHEET DATA:
Real estate assets, net of accum. $ 985,751 $886,122 $857,653 $807,456 $697,616
depreciation & amort.
Total assets 1,032,632 926,783 909,953 826,910 712,704
Line of credit - related parties 6,320 58,792 79,887 50,886 -
Revolving line of credit 23,965 23,839 - - -
Loan payable - 20,000 - - -
Debt 299,858 125,062 127,416 132,055 133,952
Debt - related parties 10,762 11,078 11,371 11,643 31,193
Total liabilities 394,324 289,817 286,768 255,505 215,212
Minority interests 524,918 526,580 514,810 469,332 396,810
Stockholders' equity $ 113,390 $110,386 $108,375 $102,073 $100,682
Common stock outstanding 17,894,691 17,487,329 17,329,779 17,025,365 16,972,374
O.P. Units issued and outstanding 86,398,064 86,474,032 85,762,541 83,576,027 76,205,789
(1) Average monthly rental revenue per square foot has been determined by
taking the total cash base rent for the period divided by the number of
months in the period, and then divided by the average occupied square feet
in the period.
(2) Funds From Operations ("FFO") is a non-GAAP financial instrument used by
REITs to measure and compare operating performance. As defined by the
National Association of Real Estate Investment Trusts ("NAREIT"), FFO
represents net income (loss) before minority interest of unit holders
(computed in accordance with GAAP), including non-recurring events other
than "extraordinary items" under GAAP and gains and losses from debt
restructuring and sales of discontinued operations, 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. We have
revised our FFO computations for 2002 and 2001 for the inclusion of the
amortization of leasing commissions in depreciation and amortization of
real estate in order to be comparable to our 2003 FFO presentation and to
more closely conform to the NAREIT's FFO definition. Additionally, our 2003
FFO calculation includes our portion of the depreciation and amortization
of real estate from our unconsolidated joint venture, but excludes the
amortization of the favorable lease intangible asset, which was recorded as
a reduction of revenues. 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 our ability to incur and service debt
and make capital expenditures. FFO should not be considered as an
alternative for neither net income as a measure of profitability nor is it
comparable to cash flows provided by operating activities determined in
accordance with GAAP. FFO is not comparable to similarly entitled items
reported by other REITs that do not define them exactly as we define FFO.
See Part II - Item 7 "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Funds from Operations" for
reconciliation of our FFO figures to our net income determined in
accordance with GAAP.
(3) The explanation of these restatement adjustments are described in Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations, and in Note 18 of the Notes to the Consolidated Financial
Statements. See "Item 8. Consolidated Financial Statements and
Supplementary Data -- Notes to the Consolidated Financial Statements."
(4) As of December 31, 2003, 2002, 2001 and 2000, total properties include a
property at 245 Caspian in Sunnyvale with no building. During 2000, the
Company paid the Berg Group approximately $7.5 million for their commitment
to complete an approximate 75,000 to 90,000 square foot building on the
property.
- 25 -
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION INCLUDES FORWARD-LOOKING STATEMENTS, INCLUDING BUT
NOT LIMITED TO STATEMENTS WITH RESPECT TO THE FUTURE FINANCIAL PERFORMANCE,
OPERATING RESULTS, PLANS AND OBJECTIVES OF MISSION WEST PROPERTIES, INC.
ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CURRENTLY ANTICIPATED
DEPENDING UPON A VARIETY OF FACTORS, INCLUDING THOSE DESCRIBED IN PART I -
ITEM 1 "BUSINESS - RISK FACTORS."
OVERVIEW AND BACKGROUND
Our original predecessor was formed in 1969 as Palomar Mortgage Investors,
a California business trust, which operated as a mortgage REIT until 1979
when, under the name of Mission Investment Trust, it terminated its status
as a REIT and began to develop and market its own properties. In 1982,
Mission West Properties was incorporated as a successor to Mission
Investment Trust. In 1997, our predecessor, Mission West Properties, sold
all its real estate assets and paid a special dividend of $9.00 per share
to stockholders, after which it retained only nominal assets. Subsequently,
the Berg Group acquired control of the corporation as a vehicle to acquire
R&D properties, or interests in entities owning such properties in a
transaction completed September 2, 1997. At that time the Berg Group and
the other investors acquired an aggregate 79.6% controlling ownership
position. In May 1998, we, the Berg Group members, John Kontrabecki, and
certain other persons entered into an acquisition agreement providing,
among other things, for our acquisition of interests as the sole general
partner in the operating partnerships. At the time, the operating
partnerships held approximately 4.34 million rentable square feet of R&D
property located in Silicon Valley. The agreement also provided for the
parties to enter into the Pending Projects Acquisition Agreement, the Berg
Land Holdings Option Agreement and the Exchange Rights Agreement, following
stockholder approval. Effective July 1, 1998, we consummated our
acquisition of the general partnership interests in the operating
partnerships through the purchase of the general partnership interests, and
all limited partnership interests in the operating partnerships were
converted into 59,479,633 O.P. Units, which represented ownership of
approximately 87.89% of the operating partnerships. Our general partnership
interests represented the balance of the ownership of the operating
partnerships. At December 31, 2003, we owned a 17.02% general partnership
interest in the operating partnerships, taken as a whole, on a weighted
average basis.
Since the beginning of calendar year 1999, we have been taxed as a
qualified REIT.
Our reincorporation under the laws of the State of Maryland through the
merger of Mission West Properties into Mission West Properties, Inc.
occurred on December 30, 1998, at which time all outstanding shares issued
by our predecessor California corporation were converted into shares of our
common stock on a one-for-one basis.
In July 1999, we completed a public offering of 8,680,000 shares of our
common stock at $8.25 per share. The net proceeds of approximately $66.9
million, after deducting underwriting discounts and other offering costs,
were used primarily to repay indebtedness.
We have grown through property acquisitions. Since September 1998, we have
acquired a total of approximately 3.9 million rentable square feet of R&D
buildings under the Pending Project Acquisition Agreement, the Berg Land
Holdings Option Agreement, and from unrelated third parties. The total cost
of these properties was approximately $619 million. We issued a total of
27,962,025 O.P. Units and assumed debt totaling approximately $308 million
to acquire them.
On March 8, 2002, we acquired the Orchard-Trimble property consisting of
three R&D Properties with a total of approximately 206,500 rentable square
feet for $31.3 million in cash. The acquisition of those properties was
part of a tax-deferred exchange under section 1031 of the Internal Revenue
Code.
On April 9, 2003, we acquired the 36-acre San Tomas Technology Park
consisting of seven R&D properties with a total of approximately 625,000
rentable square feet for $110 million. We financed that acquisition through
new debt and an existing line of credit.
On December 15, 2003, we acquired a 128,520 square foot fully leased two
story office/R&D building at 5970 Optical Court in San Jose from the Berg
Group under the Berg Land Holdings Option Agreement. The total acquisition
price for this property was $11.2 million. We financed this acquisition by
borrowing $9.0 million under an existing line of credit and issuing 169,131
O.P. Units to various members of the Berg Group.
- 26 -
IMPACT OF RESTATEMENTS
We have restated our previously issued consolidated financial statements
for the years ended December 31, 2002 and 2001, as well as for the quarters
ended March 31, June 30 and September 30, 2003 and 2002 and the quarter
ended December 31, 2002 (as set forth in Note 19 of the Notes to the
Consolidated Financial Statements. See "Item 8. Consolidated Financial
Statements and Supplementary Data -- Notes to the Consolidated Financial
Statements.") for the following items:
- We recorded additional amortization expense relating to certain
leasing commissions, which were originally being amortized over a
40-year period. The additional amortization expense resulted from
changing the amortization period of commissions from 40 years to the
term of the lease and the write-off of certain unamortized leasing
commissions in connection with tenant bankruptcies.
- We corrected the purchase accounting originally applied to our 2002
acquisition of the Orchard-Trimble property. In accordance with
Statement of Financial Accounting Standards (SFAS) No. 141, Business
Combinations, which became effective July 1, 2001, we allocated a
portion of the purchase price to in-place lease intangible assets and
recorded additional amortization expense from changing the
amortization period of these intangible assets from 40 years to the
term of the lease.
- We recorded additional depreciation expense relating to the
reclassification of certain real estate assets from a 40- year
depreciable life to a 7 and 25-year depreciable life.
- We reclassified the amortization of the above-market lease intangible
asset relating to the 2003 acquisition of San Thomas Technology Park
from amortization expense to an offset to rental revenues from real
estate.
The aggregate net impact of all restatement items on the consolidated
statements of operations resulted in a decrease in net income to common
stockholders compared to previously reported amounts of $386,000 ($0.02 per
diluted share) and $49,000 ($0.00 per diluted share) for the years ended
December 31, 2002 and 2001, respectively. The aggregate net impact of all
restatement items on the consolidated balance sheet as of December 31, 2002
was a decrease in total assets of $2,623,000, a decrease in minority
interest of $2,188,000 and an increase in the accumulated deficit of
$435,000.
The effects of the restatement items described above on our net income to
common shareholders are as follows:
For the Year Ended December 31,
2002 2001
--------------------- -----------------------
(dollars in thousands)
Net income to common stockholders as previously reported $17,501 $18,135
Impact of adjustments for:
Leasing commission amortization (1,765) (145)
Intangible asset amortization (393) -
Depreciation of real estate assets (163) (157)
--------------------- -----------------------
Total adjustments (2,321) (302)
--------------------- -----------------------
Minority interest portion of adjustments 1,935 253
--------------------- -----------------------
Net income to common stockholders, as restated $17,115 $18,086
===================== =======================
Item 6--Selected Financial Data and Notes 18 and 19 to our Consolidated
Financial Statements further discuss these restatements and their specific
impact on our historical consolidated financial statements.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We prepare the consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
("GAAP"), which requires us 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. Accounting and disclosure decisions with
respect to material transactions that are subject to significant management
judgments or estimates include impairment of long lived assets, deferred
rent reserves, and allocation of purchase price relating to property
acquisitions and the related depreciable lives assigned. 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
- 27 -
statements, and potentially result in materially different results under
different conditions and assumptions. We believe that the following best
describe our 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."
BUSINESS COMBINATIONS. Statement of financial Accounting Standards No. 141
("SFAS No. 141"), Business Combinations, was effective July 1, 2001. The
acquisition costs of each property acquired prior to July 1, 2001were
allocated only to building, land and leasing commissions with building
depreciation being computed based on an estimated weighted average
composite useful life of 40 years and leasing commissions amortization
being computed over the term of the lease. Acquisitions of properties made
subsequent to the effective date of SFAS No. 141 are based on an allocation
of the acquisition cost to land, building, tenant improvements, and
intangibles for at market and above market in place leases, and the
determination of their useful lives are guided by a combination SFAS No.
141 and management's estimates. If we do not appropriately allocate these
components or we incorrectly estimate the useful lives of these components,
our computation of depreciation and amortization expense may not
appropriately reflect the actual impact of these costs over future periods,
which will affect net income.
IMPAIRMENT OF LONG-LIVED ASSETS. We review real estate assets for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable in accordance with
Statement of Financial Accounting Standards No. 144 ("SFAS No. 144"),
Accounting for the Impairment and Disposal of Long-Lived Assets. If the
carrying amount of the asset exceeds its estimated undiscounted net cash
flow, before interest, we will recognize an impairment loss equal to the
difference between its carrying amount and its 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 factors, such as the vacancy rates, future rental rates and
operating costs for R&D facilities in the Silicon Valley area and related
submarkets. 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. To date we have not recognized an
impairment of any long-lived assets.
DISCONTINUED OPERATIONS: SFAS No. 144 addresses the financial accounting
for discontinued operations and the disposal of long lived assets. SFAS No.
144 requires that the results of operations and gains or losses on the sale
of property sold subsequent to December 31, 2001 that were not classified
as held for sale at December 31, 2001 as well as the results of operations
from properties that were classified as held for sale subsequent to
December 31, 2001 be presented in discontinued operations if both the
following criteria are met: (a) the operation and cash flows of the
property have been (or will be) eliminated from the ongoing operations of
the Company as a result of the disposal transaction; and (b) the Company
will not have any significant involvement in the operations of the property
after the disposal transaction. SFAS 144 also requires prior period results
of operations for these properties to be restated and presented in
discontinued operations in prior consolidated statements of operations. The
application of SFAS No. 144 to properties sold during 2002 resulted in
discontinued operations presentation, with the 2001 results of operations
being restated for this 2002 disposition. Properties sold during 2001 have
been reflected as a gain on sale of assets within continuing operations.
ALLOWANCE FOR DOUBTFUL ACCOUNTS AND DEFERRED RENT RESERVE. The preparation
of the consolidated financial statements requires us to make estimates and
assumptions. As such, we must make estimates of the uncollectability of our
accounts receivable based on the evaluation of our tenants' financial
position, analyses of accounts receivable and current economic trends. We
also make estimates for a straight-line adjustment reserve for existing
tenants with the potential of early termination, bankruptcy or ceasing
operations. Our estimates are based on our review of tenants' payment
histories, publicly available financial information and such additional
information about their financial condition as tenants provide to us. The
information available to us might lead us 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 our
estimates.
CONSOLIDATED JOINT VENTURES. We, through an operating partnership, own
three properties that are in joint ventures of which we have interests. We
manage and operate all three properties. The recognition of these
properties and their operating results are 100% reflected on our
consolidated financial statements, with appropriate allocation to minority
interest, because we have operational and financial control of the
investments. We make judgments and assumptions about the estimated monthly
payments made to our minority interest joint venture partners, which are
reported with our periodic results of operations. Actual results may differ
from these estimates under different assumptions or conditions.
- 28 -
INVESTMENTS IN UNCONSOLIDATED JOINT VENTURES. We, through an operating
partnership, have a 50% non-controlling limited partnership interest in one
unconsolidated joint venture. This investment is not consolidated because
the we do not exercise significant control over major operating and
financial decisions. We account for the joint venture using the equity
method of accounting.
FAIR VALUE OF FINANCIAL INSTRUMENTS. Our financial instruments include cash
and cash equivalents, accounts receivable, accounts payable, and debt.
Considerable judgment is required in interpreting market data to develop
estimates of fair value. These estimates presented herein are not
necessarily indicative of the amounts that we could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value
amounts. Cash and cash equivalents, accounts receivable, and accounts
payable are carried at amounts that approximate their fair values due to
their short-term maturities. The carrying amounts of our variable rate debt
approximate fair value since the interest rates on these instruments are
equivalent to rates currently offered to us. For fixed rate debt, we
estimate fair value by using discounted cash flow analyses based on
borrowing rates for similar kinds of borrowing arrangements. The fair value
of our fixed rate debt at December 31, 2003 was approximately $256 million.
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, regardless of when the
rent payments are received by us. The difference between recognized rental
income and rental cash receipts is recorded as Deferred Rent on the
consolidated 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. We try to identify tenants who may be likely to declare bankruptcy
or cease operations. By anticipating these events in advance, we expect to
take steps to minimize their impact on our reported results of operations
through lease renegotiations, reserves against deferred rent, and other
appropriate measures. Our 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 we made different judgments or
estimations.
LEASE TERMINATION. Lease termination fees are included in other revenues.
These fees are paid by tenants who want to terminate their lease
obligations before the end of the contractual term of the lease. There is
no way of predicting or forecasting the timing or amounts of future lease
termination fees.
We recognize income from rent, tenant reimbursements and lease termination
fees and other income once all of the following criteria are met in
accordance with SEC Staff Accounting Bulletin 104:
- the agreement has been fully executed and delivered;
- services have been rendered;
- the amount is fixed and determinable; and
- collectability is reasonably assured.
- 29 -
RESULTS OF OPERATIONS
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2003 TO THE YEAR ENDED DECEMBER
31, 2002.
RENTAL REVENUES FROM CONTINUING OPERATIONS
As of December 31, 2003, through our controlling interests in the operating
partnerships, we owned 109 R&D properties totaling approximately 7.9
million rentable square feet compared to 101 such properties totaling
approximately 7.2 million rentable square feet as of December 31, 2002.
This represented a net increase of approximately 10% in total rentable
square footage from the prior year. During 2003, we made the following
acquisitions by purchase of new properties from unrelated third parties or
under the Berg Land Holdings Option Agreement.
Rentable Square
Date of Acquisition Address Footage
-------------------- ------------------------------------------- -------------------
4/03 2001 Walsh Avenue 80,000
4/03 2880 Scott Boulevard 200,000
4/03 2890 Scott Boulevard 75,000
4/03 2770-2800 Scott Boulevard 98,430
4/03 2300 Central Expressway 46,338
4/03 2220 Central Expressway 62,522
4/03 2330 Central Expressway 62,522
12/03 5970 Optical Court 128,520
-------------------
Total 753,332
===================
The following table depicts the amounts of rental revenues from continuing
operations for the years ended December 31, 2003 and 2002 represented by
our historical properties and the properties acquired in each such year and
the percentage of the total increase in rental revenues over the period
that is represented by each group of properties.
December 31,
----------------------------------
% Change by % of Total
2003 2002 $ Change Property Group Net Change
-------------- -------------- -------------- --------------- --------------
(dollars in thousands)
Same Property (1) $112,429 $121,404 ($8,975) (7.4%) (6.9%)
2002 Acquisitions (2) 10,212 8,377 1,835 21.9% 1.4%
2003 Acquisitions (3) 8,098 - 8,098 100% 6.2%
-------------- -------------- -------------- --------------
Total/Overall $130,739 $129,781 $ 958 0.7% 0.7%
============== ============== ============== ==============
(1) "Same Property" is defined as properties owned by us prior to 2002 that we
still owned as of December 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.
(3) Operating rental revenues for 2003 Acquisitions do not reflect a full 12
months of operations in 2003 because these properties were acquired at
various times during 2003. 2003 amount includes approximately $1.4 million
of above market rent amortization against rental revenue from real estate
in connection with the implementation of SFAS No. 141.
For the year ended December 31, 2003, our rental revenues from real estate
increased by $0.9 million, or 0.7% from $129.8 million for the year ended
December 31, 2002 to $130.7 million for the same period in 2003. Pursuant
to SFAS 141, $1.4 million of amortization expense with respect to
above-market leases included in the San Tomas Technology Park acquisition
was offset against rental revenue and not separately stated as amortization
expense. The $0.9 million increase in rental revenues resulted from new
property acquisitions, as "Same Property" rents decreased by ($9.0), rents
from newly developed properties acquired in 2002 represented an increase of
$1.8 million and rents from newly developed properties acquired in 2003
added approximately $8.1 million of new rental revenue. Approximately $0.3
million in rental revenues were generated from a property whose revenues
and operating results were included in discontinued operations for the year
ended December 31, 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, cessation of operations, or tenant
relocation. Our overall physical occupancy rate at December 31, 2003 and
2002 was approximately 77% and 84%, respectively.
EQUITY IN EARNINGS FROM UNCONSOLIDATED JOINT VENTURE
As of December 31, 2003, we had investments in four R&D buildings, totaling
593,000 rentable square feet in Morgan Hill, California, through an
unconsolidated joint venture with TBI, in which we acquired a 50% interest
from the Berg Group in January 2003. We have a non-controlling limited
partnership interest in this joint venture, which we account for using the
equity method of accounting. For the year ended December 31, 2003, equity
in earnings from the unconsolidated joint venture was approximately $3.9
million, including $1.4 million relating to a gain from the sale of real
estate, which was acquired from a related party.
- 30 -
OTHER INCOME
The following table depicts the amounts of other income from continuing
operations for the years ended December 31, 2003 and 2002.
December 31,
----------------------------------
% Change by
2003 2002 $ Change Group
-------------- -------------- -------------- --------------
(dollars in thousands)
Other income $4,527 $4,248 $279 6.6%
Other income, including interest, was approximately $4.5 million and $4.2
million for the years ended December 31, 2003 and 2002, respectively.
Included in the $4.5 million is approximately $2.2 million from tenant
bankruptcy settlements. Included in the $4.2 million is approximately $2.4
million in termination fees. The $0.3 million increase represented utility
rebate and security deposit forfeitures.
EXPENSES FROM CONTINUING PROPERTY OPERATION
The following table reflects the increase in property operating and
maintenance expenses and real estate taxes from continuing operations for
the year ended December 31, 2003 over property operating and maintenance
expenses and real estate taxes from continuing operations for the year
ended December 31, 2002 and the percentage of total increase in expenses
over the period that is represented by each group of properties.
December 31,
----------------------------------
2003 2002 % Change by % of Total
(As Restated) $ Change Property Group Net Change
-------------- -------------- -------------- -------------- --------------
(dollars in thousands)
Same Property (1) $17,989 $22,624 ($4,635) (20.5%) (19.3%)
2002 Acquisitions (2) 1,794 1,327 467 35.2% 1.9%
2003 Acquisitions (3) 1,582 - 1,582 100.0% 6.6%
-------------- -------------- -------------- --------------
Total/Overall $21,365 $23,951 ($2,586) (10.8%) (10.8%)
============== ============== ============== ==============
(1) "Same Property" is defined as properties owned by us prior to 2002 that we
still owned as of December 31, 2003.
(2) Operating expenses and real estate taxes for 2002 Acquisitions do not
reflect a full 12 months of operations in 2002 because these properties
were acquired at various times during 2002.
(3) Operating expenses and real estate taxes for 2003 Acquisitions do not
reflect a full 12 months of operations in 2003 because these properties
were acquired at various times during 2003.
Operating expenses and real estate taxes from continuing operations, on a
combined basis, decreased by ($2.6) million, or 10.8%, from $24 million for
the year ended December 31, 2002 to $21.4 million for the year ended
December 31, 2003. Tenant reimbursements from continuing operations
decreased by ($1.2) million, or 6.0%, from $20.1 million for the year ended
December 31, 2002 to $18.9 million for the year ended December 31, 2003.
The overall decrease in tenant reimbursements, operating expenses and real
estate taxes is primarily a result of the reductions in assessed property
values on existing properties as a result of property tax appeals that we
filed under California's Proposition 8 and lower occupancy during the
periods presented. Reductions in property tax assessments as a result of
appeals filed under Proposition 8 can be immediately increased to
pre-Proposition 8 assessed values when the County Assessor determines
market conditions have improved. Total operating expenses and real estate
taxes exceeded tenant reimbursements because of vacancies, which reached
approximately 1.8 million rentable square feet by year-end 2003. Certain
expenses such as property insurance, real estate taxes, and other fixed
expenses are not recoverable from vacant properties. We expect tenant
reimbursements to decrease further in the coming year as our vacancy rate
increases. At June 30, 2004 our vacancy rate was 28%. General and
administrative expenses decreased by approximately $0.2 million from $1.5
million for the year ended December 31, 2002 to $1.3 million for the year
ended December 31, 2003, primarily due to the loss of one employee and the
decrease of legal fees in 2003.
The following table depicts the amounts of depreciation and amortization
expense of real estate from continuing operations for the years ended
December 31, 2003 and 2002.
December 31,
----------------------------------
2003 2002
(As Restated) $ Change % Change
-------------- -------------- -------------- --------------
(dollars in thousands)
Depreciation & amortization $20,774 $18,313 $2,461 13.4%
- 31 -
Depreciation and amortization expense of real estate from continuing
operations increased by $2.5 million, or 13.4%, from $18.3 million for the
year ended December 31, 2002 to $20.8 million for the year ended December
31, 2003. The increase was attributable to the acquisition of eight R&D
properties in 2003. Of the $2.5 million increase in depreciation and
amortization expense of real estate, approximately $1 million represented
amortization expense for in place leases comprising a portion of the value
of the assets acquired in the acquisitions of the Orchard-Trimble property
and the San Tomas Technology Park. Depreciation expense attributable to
discontinued operations was approximately $46,000 for the year ended
December 31, 2002.
The following table depicts the amounts of interest expense from continuing
operations for the years ended December 31, 2003 and 2002.
December 31,
----------------------------------
% Change by
2003 2002 $ Change Group
-------------- -------------- -------------- --------------
(dollars in thousands)
Interest $16,446 $ 9,588 $6,858 71.5%
Interest (related parties) 1,064 3,422 (2,358) (68.9%)
-------------- -------------- --------------
Total $17,510 $13,010 $4,500 34.6%
============== ============== ==============
Interest expense increased by $6.8 million, or 71.5%, from $9.6 million for
the year ended December 31, 2002 to $16.4 million for the year ended
December 31, 2003. The increased expense resulted from additional debt that
the Company incurred under a new $100 million collateralized loan obtained
from Northwestern Mutual Life Insurance Company, an $80 million
collateralized loan obtained from Citicorp USA, Inc. and a $40 million line
of credit established with Cupertino National Bank, the proceeds of which
were used primarily for the acquisition of the San Tomas Technology Park.
Interest expense (related parties) decreased by ($2.3) million, or 68.9%,
from $3.4 million for the year ended December 31, 2002 to $1.1 million for
the year ended December 31, 2003 primarily due to the refinancing of a
portion of the related party debt with the new third party financing
discussed above.
The new debt carries a higher interest rate than the Berg Group line of
credit, which it mainly replaced, contributing to the increase in interest
expense for the year. We anticipate additional increases in interest
expense as new debt is incurred in connection with property acquisitions
and we draw on the Cupertino National Bank revolving line of credit.
NET INCOME TO COMMON STOCKHOLDERS AND NET INCOME TO MINORITY INTERESTS
The following table depicts the amounts of earnings attributable to common
stockholders and minority interests for the years ended December 31, 2003
and 2002.
December 31,
-------------------------------------
2003 2002 % Change by
(As Restated) $ Change Group
---------------- --------------- ---------------- ----------------
(dollars in thousands)
Net income to shareholders $16,212 $ 17,115 ($ 903) (5.3%)
Net income to minority interests 80,836 86,641 (5,805) (6.7%)
---------------- --------------- ----------------
Total $97,048 $103,756 ($ 6,708) (6.5%)
================ =============== ================
As of December 31, 2003 and 2002, we owned a general partnership interest
of 16.95%, 21.61%, 15.98% and 12.37% and 16.68%, 21.46%, 15.46% and 12.27%
in the four operating partnerships, Mission West Properties, L.P., Mission
West Properties, L.P. I, Mission West Properties, L.P. II and Mission West
Properties, L.P. III, respectively. We owned a 17.02% and 16.82% general
partnership interest in the operating partnerships, taken as a whole, on a
weighted average basis as of December 31, 2003 and 2002, respectively. Net
income to common stockholders decreased by ($0.9) million, or 5.3%, from
$17.1 million for the year ended December 31, 2002 to $16.2 million for the
year ended December 31, 2003. Our net income attributable to minority
interests decreased by ($5.8) million, or 6.7%, from $86.6 million for the
year ended December 31, 2002 to $80.8 million for the year ended December
31, 2003. Minority interest represents the limited partners' ownership
interest of 82.98% and 83.18% in the operating partnerships, on a weighted
average basis, as of December 31, 2003 and 2002, respectively. The decrease
in the minority interest percentage resulted from the issuance of
additional shares of common stock from the exchange of O.P. Units for
common stock by minority interest holders and the exercise of stock
options.
- 32 -
INCOME FROM DISCONTINUED OPERATIONS
The following table depicts the amounts of income from discontinued
operations for the year ended December 31, 2002.
December 31, 2002
----------------------
(dollars in thousands)
Gain from disposal of discontinued operations $6,103
Income attributable to discontinued operations 287
Minority interest in earnings attributable
to discontinued operations (5,325)
----------------------
Total income from discontinued operations $1,065
======================
In accordance with our adoption of SFAS No. 144, in 2002 we sold and
classified as discontinued operations one property consisting of 72,426
rentable square feet and recognized a net gain of $6.1 million, of which
$1.0 million and $5.1 million were attributable to common stockholders and
minority interests, respectively. The income to common stockholders and
minority interests attributable to discontinued operations from this
property in 2002 was approximately $47,000 and $240,000, respectively.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2002 TO THE YEAR ENDED DECEMBER
31, 2001.
RENTAL REVENUES FROM CONTINUING OPERATIONS
As of December 31, 2002, through our controlling interests in the operating
partnerships, we owned 101 R&D properties totaling approximately 7.2
million square feet compared to 97 such properties totaling approximately
6.78 million square feet as of December 31, 2001. This represented a net
increase of approximately 6% in total rentable square footage from the
prior year. During 2002, we made the following acquisitions by purchase of
new properties under the Berg Land Holdings Option Agreement or as
replacement property in exchange for existing R&D properties that we sold
in 2001 and 2002.
Rentable Square
Date of Acquisition Address Footage
-------------------- ------------------------------------------- -------------------
1/02 5345 Hellyer Avenue 125,000
3/02 2630 Orchard Parkway (1) 60,633
3/02 2610 Orchard Parkway (1) 54,093
3/02 55 West Trimble Road (1) 91,722
7/02 5900 Optical Court 165,000
-------------------
Total 496,448
===================
(1) Acquired in a tax-deferred exchange for R&D properties located at 5713-5729
Fontanoso Way that was sold in year 2001 and 2001 Logic Drive in San Jose,
California that was sold in year 2002.
The following table depicts the amounts of rental revenues from continuing
operations for the years ended December 31, 2002 and 2001 represented by
our historical properties and the properties acquired in each such year and
the percentage of the total increase in rental revenues over the period
that is represented by each group of properties.
December 31,
----------------------------------
% Change by % of Total
2002 2001 $ Change Property Group Net Change
-------------- -------------- -------------- -------------- --------------
(dollars in thousands)
Same Property (1) $103,076 $112,545 ($9,469) (8.4%) (7.5%)
2001 Acquisitions (2) 18,328 13,684 4,644 33.9% 3.7%
2002 Acquisitions (3) 8,377 - 8,377 100.0% 6.6%
-------------- -------------- -------------- --------------
Total/Overall $129,781 $126,229 $3,552 2.8% 2.8%
============== ============== ============== ==============
(1) "Same Property" is defined as properties owned by us prior to 2001 that we
still owned as of December 31, 2002.
(2) Operating rental revenues for 2001 Acquisitions do not reflect a full 12
months of operations in 2001 because these properties were acquired at
various times during 2001.
(3) 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.
For the year ended December 31, 2002, our rental revenues from real estate
increased by $3.5 million, or 2.8% from $126.2 million for the year ended
December 31, 2001 to $129.7 million for the same period in 2002. The $3.5
million increase in rental revenues resulted from new property
acquisitions, as "Same Property" rents decreased by ($9.5) million, rents
from newly developed properties acquired in 2001 represented an increased
of $4.6 million and rents from newly developed properties acquired in 2002
added approximately $8.4 million of new rental revenue. Approximately $0.3
million and $2.0 million in rental revenues were generated from a
discontinued operation for the years ended December 31, 2002 and 2001,
- 33 -
respectively. The decline in rental revenues of ($9.5) million from the
"Same Property" portfolio resulted from adverse market conditions and the
loss of several tenants due to bankruptcy or cessation of operations. Our
overall physical occupancy rate at December 31, 2002 and 2001 was
approximately 84% and 97%, respectively.
OTHER INCOME
The following table depicts the amounts of other income from continuing
operations for the years ended December 31, 2002 and 2001.
December 31,
----------------------------------
% Change by
2002 2001 $ Change Group
-------------- -------------- -------------- --------------
(dollars in thousands)
Other income $4,248 $2,465 $1,783 72.3%
Other income, including interest, was approximately $4.3 million and $2.5
million for the years ended December 31, 2002 and 2001, respectively. The
$1.8 million increase was primarily from lease termination fees.
In 2001, gain from sales of real estate was $11.5 million, effected as
tax-deferred Section 1031 exchanges. Due to the adoption of SFAS No. 144,
"Accounting for the Impairment or Disposal of Long Lived Assets" effective
January 1, 2002, gains from sales of operating properties are classified as
discontinued operations. In 2002, a gain of approximately $6.1 million from
the sale of one property consisting of 72,426 rentable square feet at 2001
Logic Drive in a Section 1031 exchange has been classified as Gain from
Disposal of Discontinued Operations (see below).
EXPENSES FROM CONTINUING PROPERTY OPERATIONS
The following table reflects the increase in property operating and
maintenance expenses and real estate taxes from continuing operations for
the year ended December 31, 2002 over property operating and maintenance
expenses and real estate taxes from continuing operations for the year
ended December 31, 2001 and the percentage of total increase in expenses
over the period that is represented by each group of properties.
December 31,
----------------------------------
2002 2001 % Change by % of Total
(As Restated) (As Restated) $ Change Property Group Net Change
-------------- -------------- -------------- -------------- --------------
(dollars in thousands)
Same Property (1) $19,012 $15,894 $3,118 19.6% 16.9%
2001 Acquisitions (2) 3,612 2,608 1,004 38.5% 5.4%
2002 Acquisitions (3) 1,327 - 1,327 100.0% 7.2%
-------------- -------------- -------------- --------------
Total/Overall $23,951 $18,502 $5,449 29.5% 29.5%
============== ============== ============== ==============
(1) "Same Property" is defined as properties owned by us prior to 2001 that we
still owned as of December 31, 2002.
(2) Operating expenses and real estate taxes for 2001 Acquisitions do not
reflect a full 12 months of operations in 2001 because these properties
were acquired at various times during 2001.
(3) Operating expenses and real estate taxes for 2002 Acquisitions do not
reflect a full 12 months of operations in 2002 because these properties
were acquired at various times during 2002.
Operating expenses and real estate taxes from continuing operations, on a
combined basis, increased by $5.4 million, or 29.5%, from $18.5 million for
the year ended December 31, 2001 to $23.9 million for the year ended
December 31, 2002. Of the $5.4 million increase in operating expenses and
real estate taxes, $3.1 million resulted from the Company's "Same Property"
portfolio, $1 million resulted from properties acquired in 2001 and $1.3
million resulted from properties acquired in 2002. Tenant reimbursements
from continuing operations increased by $2.6 million, or 15%, from $17.5
million for the year ended December 31, 2001 to $20.1 million for the year
ended December 31, 2002. The overall increase in tenant reimbursements,
operating expenses and real estate taxes is primarily a result of the
growth in the total square footage of the Company's portfolio of properties
during the periods presented. Total operating expenses and real estate
taxes exceeded tenant reimbursements because of vacancies, which reached
approximately 1.16 million square feet by year-end 2002. For the same
reason, "Same Property" rental revenues decreased in 2002 over 2001 while
"Same Property" operating expenses increased in 2002 over 2001. General and
administrative expenses increased by $0.2 million from $1.3 million for the
year ended December 31, 2001 to $1.5 million for the year ended December
31, 2002, primarily due to the addition of one new employee in 2001 and the
increase of legal fees in 2002.
- 34 -
The following table depicts the amounts of depreciation and amortization
expense of real estate from continuing operations for the years ended
December 31, 2002 and 2001.
December 31,
----------------------------------
2002 2001
(As Restated) (As Restated) $ Change % Change
-------------- -------------- -------------- --------------
(dollars in thousands)
Depreciation $18,313 $16,746 $1,567 9.4%
Depreciation expense from continuing operations increased by $1.6 million,
or 9.4%, from $16.7 million for the year ended December 31, 2001 to $18.3
million for the year ended December 31, 2002. The increase was attributable
to the acquisition of five R&D properties in 2002. Depreciation expense
attributable to discontinued operations was approximately $46,000 and
$278,000 for the years ended December 31, 2002 and 2001, respectively.
The following table depicts the amounts of interest expense from continuing
operations for the years ended December 31, 2002 and 2001.
December 31,
----------------------------------
% Change by
2002 2001 $ Change Group
-------------- -------------- -------------- --------------
(dollars in thousands)
Interest $ 9,588 $ 8,704 $ 884 10.2%
Interest (related parties) 3,422 4,709 (1,287) (27.3%)
-------------- -------------- --------------
Total $13,010 $13,413 ($ 403) (3.0%)
============== ============== ==============
Interest expense increased by $0.9 million, or 10.2%, from $8.7 million for
the year ended December 31, 2001 to $9.6 million for the year ended
December 31, 2002. The increased expense resulted from additional debt that
the Company incurred under a new $20 million uncollateralized loan obtained
from Citicorp USA, Inc. and a $40 million line of credit established with
Cupertino National Bank. Interest expense (related parties) decreased by
$1.3 million, or 27.3%, from $4.7 million for the year ended December 31,
2001 to $3.4 million for the year ended December 31, 2002. As a result of
five R&D property acquisitions totaling approximately 496,000 rentable
square feet in 2002, debt outstanding, including amounts due related
parties, increased by $20.1 million, or 9%, from $218.7 million as of
December 31, 2001 to $238.8 million as of December 31, 2002. Interest rates
declined in 2002, which lessened the effect of the additional debt on total
interest expense.
NET INCOME TO COMMON STOCKHOLDERS AND NET INCOME TO MINORITY INTERESTS
The following table depicts the amounts of earnings attributable to common
stockholders and minority interests for the years ended December 31, 2002
and 2001.
December 31,
-------------------------------------
2002 2001 % Change by
(As Restated) (As Restated) $ Change Group
---------------- --------------- ---------------- ----------------
(dollars in thousands)
Net income to shareholders $ 17,115 $ 18,086 ($ 971) (5.4%)
Net income to minority interests 86,641 91,312 (4,671) (5.1%)
---------------- --------------- ----------------
Total $103,756 $109,398 ($ 5,642) (5.2%)
================ =============== ================
As of December 31, 2002 and 2001, we owned a general partnership interest
of 16.68%, 21.46%, 15.46% and 12.27% and 16.54%, 21.41%, 15.42% and 12.24%
in the four operating partnerships, Mission West Properties, L.P., Mission
West Properties, L.P. I, Mission West Properties, L.P. II and Mission West
Properties, L.P. III, respectively. We owned a 16.82% and 16.73% general
partnership interest in the operating partnerships, taken as a whole, on a
weighted average basis as of December 31, 2002 and 2001, respectively. Net
income to common stockholders decreased by $1 million, or 5.4%, from $18.1
million for the year ended December 31, 2001 to $17.1 million for the year
ended December 31, 2002. Our income attributable to minority interests
decreased by $4.7 million, or 5.1%, from $91.3 million for the year ended
December 31, 2001 to $86.6 million for the year ended December 31, 2002.
Minority interest represents the limited partners' ownership interest of
83.18% and 83.27% in the operating partnerships, on a weighted average
basis, as of December 31, 2002 and 2001, respectively. The decrease in the
minority interest percentage resulted from the issuance of additional
shares of common stock from the exchange of O.P. Units for shares of common
stock by minority interest holders and the exercise of stock options.
- 35 -
INCOME FROM DISCONTINUED OPERATIONS
The following table depicts the amounts of income from discontinued
operations for the years ended December 31, 2002 and 2001.
December 31,
----------------------------------
% Change by
2002 2001 $ Change Group
-------------- --------------- -------------- ---------------
(dollars in thousands)
Gain from disposal of discontinued operations $6,103 - $6,103 100.0%
Income attributable to discontinued operations 287 $1,721 (1,434) (83.3%)
Minority interest in earnings attributable to
discontinued operations (5,325) (1,436) (3,889) 270.8%
-------------- --------------- --------------
Total income from discontinued operations $1,065 $ 285 $ 780 273.7%
============== =============== ==============
In accordance with our adoption of SFAS No. 144, in 2002 we sold and
classified as discontinued operations one property consisting of 72,426
rentable square feet and recognized a net gain of $6.1 million, of which
$1.0 million and $5.1 million were attributable to common stockholders and
minority interests, respectively. The income to common stockholders and
minority interests attributable to discontinued operations from this
property in 2002 was approximately $47,000 and $240,000, respectively. For
2001, the income to common stockholders and minority interests attributable
to discontinued operations from this property was approximately $285,000
and $1.4 million, respectively. We did not report gains from the disposal
of discontinued operations or from discontinued operations for any
transactions in 2001, since the property sale in 2001 did not qualify for
discontinued operations presentation under old pre-2002 guidance prescribed
by Accounting Principles Board No. 30, Reporting Results of Operations -
Discontinued Events and Extraordinary Items.
CHANGES IN FINANCIAL CONDITION
YEAR ENDED DECEMBER 31, 2003.
The most significant changes in our financial condition in 2003 resulted
from property acquisitions. In addition, stockholders' equity increased
from the exercise of stock options and the exchange of O.P. Units for
common stock.
During 2003, we acquired one R&D property and a 50% interest in the Morgan
Hill joint venture with TBI from the Berg Group. Those acquisitions added
approximately 129,000 square feet of rentable space and were acquired under
the Berg Land Holdings Option Agreement. The total gross acquisition price
was approximately $13.0 million. We financed those acquisitions by
borrowing $9 million under our line of credit from the Berg Group and
issuing 350,163 O.P. Units to various members of the Berg Group. In
addition to those two purchases, we also acquired the San Tomas Technology
Park, which was financed with a combination of an $80 million mortgage note
at LIBOR plus 200 basis points, cash reserves, and cash proceeds from our
line of credit with Cupertino National Bank. This acquisition added
approximately 625,000 rentable square feet to our portfolio.
As a result of those property acquisitions, debt outstanding, including
amounts due related parties, increased by $102.1 million, or 42.8%, from
$238.8 million as of December 31, 2002 to $340.9 million as of December 31,
2003. Interest rates continued to remain low in 2003, which lessened the
effect of the additional debt on total interest expense. We expect interest
expense to increase if we acquire additional properties or interest rates
increase in 2004.
During the year ended December 31, 2003, stock options were exercised to
purchase a total of 150,362 shares of common stock, consisting of 60,362
shares exercised at $4.50 per share and 90,000 shares exercised at $8.25
per share. Total proceeds to the Company were approximately $1 million.
In 2003, three limited partners exchanged 257,000 O.P. Units for 257,000
shares of the Company's common stock under the terms of the December 1998
Exchange Rights Agreement among the Company and the limited partners of the
operating partnerships.
The proceeds from the exercise of stock options and the conversion of O.P.
Units to shares of the Company's common stock were applied to increase our
percentage interest as general partner in the operating partnerships.
- 36 -
YEAR ENDED DECEMBER 31, 2002.
The most significant changes in our financial condition in 2002 resulted
from property acquisitions and exchanges. In addition, stockholders' equity
increased from the exercise of stock options and the exchange of O.P. Units
for common stock.
During 2002, we acquired two R&D properties from the Berg Group, both
located in Silicon Valley. Those acquisitions added approximately 290,000
square feet of rentable space and were acquired under the Berg Land
Holdings Option Agreement. The total gross acquisition price for the two
properties was approximately $31 million. We financed those acquisitions by
borrowing $18 million under our line of credit from the Berg Group and
issuing 835,491 O.P. Units to various members of the Berg Group. In
addition to those two property purchases, we also acquired three R&D
properties representing approximately 206,500 rentable square feet from
Silicon Valley Properties, LLC for approximately $31.3 million in
connection with tax-deferred exchanges involving the property sold to Cisco
Systems, Inc. in late 2001 and property sold to Xilinx, Inc. in early 2002.
Until we obtained those three replacement properties, the sales proceeds
from the properties sold by the Company were designated as restricted cash
for use in tax-deferred property exchanges. No debt or O.P. Units were
issued to acquire those three properties.
In March 2002, we 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. We realized a gain of $6.1 million on the total sale price of
$18.5 million. Prior to our acquisition of the replacement property,
described in the preceding paragraph, the proceeds from the sale of this
property were designated as restricted cash to be used in tax-deferred
property exchanges.
In connection with the restatement of our 2002 consolidated financial
statements, we reclassified approximately $2.5 million recorded originally
as Buildings and Improvements to Other Assets as the amount represents an
ongoing commitment from the Berg Group to construct tenant improvements on
one of our buildings. We also have reclassified $1.4 million recorded
originally as Land, Buildings and Improvements to Real Estate Related
Intangible Assets from the Orchard-Trimble property acquisition in
accordance with SFAS No. 141. Additionally, we reclassified approximately
$3.0 million recorded originally as Buildings and Improvements to Other
Assets, which represents prepaid leasing commissions incurred in connection
with properties acquired from the Berg Group.
During the year ended December 31, 2002, stock options were exercised to
purchase a total of 33,550 shares of common stock at $4.50 per share. Total
proceeds to the Company were approximately $151, 000.
In 2002, three limited partners exchanged 124,000 O.P. Units for 124,000
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. In addition, in 2002, Carl E. Berg gave 155,000
O.P. Units to charitable institutions, which exchanged them for 155,000
shares of the Company's common stock pursuant to the Exchange Rights
Agreement in early January 2003.
The proceeds from the exercise of stock options and the conversion of O.P.
Units to shares of the Company's common stock were applied to increase our
percentage interest as general partner in the operating partnerships.
YEAR ENDED DECEMBER 31, 2001.
The most significant changes in our financial condition in 2001 resulted
from property acquisitions and exchanges. In addition, stockholders' equity
increased from the exercise of stock options and the exchange of O.P. Units
for common stock.
During 2001, we purchased eight R&D properties, all located in Silicon
Valley. Those acquisitions added approximately 748,000 square feet of
rentable space and were acquired from the Berg Group under the Berg Land
Holdings Option Agreement. The total gross acquisition price for these
eight properties was approximately $80.7 million. We financed those
acquisitions by borrowing $45.9 million under our line of credit from the
Berg Group, assuming other liabilities of $2.0 million, and issuing
2,422,837 O.P. Units to various members of the Berg Group. In addition to
those eight property purchases we also acquired two R&D properties
representing approximately 127,000 rentable square feet from the Berg Group
for approximately $23.2 million in connection with a tax-deferred Section
1031 exchange for properties sold to Cisco Systems, Inc. in 2001. Until we
obtained those two replacement properties, the proceeds from the sale of
properties to Cisco Systems, Inc. were classified as restricted cash for
use in tax-deferred property exchanges and on our balance sheet at December
31, 2001. No debt or O.P. Units were issued to acquire those two
properties.
- 37 -
In January 2001, we completed the sale, in a tax-deferred exchange, of a
200,484 square foot R&D property located at 4949 Hellyer Avenue, San Jose,
California to Cisco Systems, Inc., which had exercised an option to
purchase that property in November 2000. We realized a gain of $3.1
million, which is included in gain on sales of assets, on the total sale
price of $23.2 million. In September 2001, we also completed the sale, in a
tax-deferred exchange, of a 77,700 square foot R&D property located at
5713-5729 Fontanoso Way, San Jose, California to Cisco Systems, Inc., which
had also exercised an option to purchase that property in November 2000. We
realized a gain of $8.4 million, which is included in gain on sales of
assets, on the total sale price of $15.4 million.
During the year ended December 31, 2001, stock options were exercised to
purchase a total of 68,088 shares of common stock, consisting of 14,588
shares exercised at $4.50 per share, 47,500 shares exercised at $8.25 per
share, and 6,000 shares exercised at $13.00 per share. Total proceeds to
the Company were approximately $0.5 million.
Two limited partners exchanged 236,323 O.P. Units for 236,323 shares of the
Company's common stock under the terms of the Exchange Rights Agreement.
The proceeds from the exercise of stock options and the conversions of O.P.
Units to shares of the Company's common stock were applied to increase our
percentage interest as general partner in the operating partnerships.
LIQUIDITY AND CAPITAL RESOURCES
We expect our principal source of liquidity for distributions to
stockholders and O.P. Unit holders, debt service, leasing commissions and
recurring capital expenditures to come from cash provided by operations
and/or the borrowings under the lines of credit with the Berg Group and
Cupertino National Bank. We expect these sources of liquidity to be
adequate to meet projected distributions to stockholders and other
presently anticipated liquidity requirements in 2004. We expect to meet our
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 us. We have the ability to meet short-term
obligations or other liquidity needs based on lines of credit with the Berg
Group and Cupertino National Bank, assuming renewal of our existing $40
million line of credit which expires in September 2004. Despite the current
weakness in the economy, we expect our total interest expense to increase
as interest rates rise and as we incur debt through acquisitions of new
properties and financing activities. In 2004, we will be obligated to make
payments totaling approximately $109.6 million of debt principal under
mortgage notes without regard to any debt refinancing or new debt
obligations that we might incur, or optional payments of debt principal. We
anticipate renewing these obligations, primarily Cupertino National Bank
and Citicorp USA, as described below. If we are not able to extend our
loans from Cupertino National Bank and Citicorp, however, we will be
required to finance these loan payments through other sources that may not
be readily avaliable to us on favorable terms. Our operating results and
financial condition could be affected adversely, as a result.
Effective January 1, 2003, the Company and the Berg Group mutually agreed
to reduce the Berg Group $100 million line of credit to $20 million and to
reduce the number of properties securing the line of credit to five. The
Berg Group line of credit bears interest at LIBOR plus 1.30%, which was
2.52% as of December 31, 2003, and matures in March 2005. Debt of $6.3
million under this line of credit was outstanding at December 31, 2003. We
believe that the terms of the Berg Group line of credit were more favorable
than those available from institutional lenders. We are continually
evaluating alternative sources of credit to replace the Berg Group line of
credit. There can be no assurance that we will be able to obtain a line of
credit with terms similar to the Berg Group line of credit, and its cost of
borrowing could increase substantially. See "Item 1 - Business - Risk
Factors - Our contractual business relationships with the Berg Group
presents additional conflicts of interest which may result in the
realization of economic benefits or the deferral of tax liabilities by the
Berg Group without equivalent benefits to our stockholders."
On January 9, 2003, we obtained a $100 million secured mortgage loan from
Northwestern Mutual Life Insurance Company ("Northwestern Loan") that bears
a fixed interest rate at 5.64% and matures in January 2013 with principal
payments amortized over 20 years. The mortgage loan is collateralized by 11
properties. We paid approximately $675,000 in loan fees and financing costs
and used the proceeds to primarily pay down short-term debt and the Berg
Group line of credit.
On April 9, 2003, we obtained an $80 million short-term mortgage loan from
Citicorp USA, Inc. ("Citicorp Loan") that bears interest at LIBOR plus 2%
and originally matured on March 29, 2004. We and Citicorp extended the loan
to May 27, 2004 and again to September 6, 2004. The mortgage loan is
collateralized by seven properties. The extension of this loan is subject
to our providing additional collateral valued at not less than $7.6
million, which we have proposed to Citicorp, and Citicorp is currently
appraising it. We paid $200,000 in financing costs and used the proceeds to
acquire the San Tomas Technology Park property.
- 38 -
In July 2004, the $40 million line of credit with Cupertino National Bank
was scheduled to mature.
Cupertino National Bank and Citicorp USA, Inc., have granted extensions of
the loans to September 2, 2004 and September 6, 2004, respectively, (the
"Loan Extension Period") pending the completion of our Form 10-K filing for
2003. We are in the process of renegotiating the terms and extending these
loans for an additional two-year period. We do not believe that the terms
of the extended loans will differ materially from their current terms. We
are the borrower under the Cupertino National Bank line of credit which is
guaranteed by Mission West Properties, L.P. and Mission West Properties,
L.P. II. Mission West Properties, L.P. is the borrower under the Citicorp
USA mortgage loan which is guaranteed by Carl E. Berg, Mission West
Properties, L.P. I, Mission West Properties L.P. II and Mission West
Properties L.P. III. The Cupertino National Bank line of credit and
Citicorp USA, Inc. mortgage loan contain certain loan covenants. We were
not in compliance with one covenant pertaining to our late filing of the
Form 10-K for the year ending December 31, 2003 and Form 10-Q for the
period ending March 31, 2004 (the "Financial Reporting Covenants"). Each
bank has elected not to enforce the Financial Reporting Covenants during
the Loan Extension Period. Compliance with the Financial Reporting Covenant
is a condition of the renewal for both loans.
On January 8, 2004, we paid dividends of $0.24 per share of common stock to
all common stockholders of record as of December 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.
On March 16, 2004, we declared dividends of $0.24 per common share payable
on April 8, 2004 to all common stockholders of record on March 31, 2004.
On June 16, 2004, we declared dividends of $0.24 per common share payable
on July 8, 2004 to all common stockholders of record on June 30, 2004.
CONTRACTUAL OBLIGATIONS
The following table identifies our contractual obligations as of December
31, 2003 that will impact our liquidity and cash flow in future periods:
2004 2005 2006 2007 2008 Subsequent Total
---------- ----------- ------------- ------------- ------------ ------------- --------------
(dollars in thousands)
Long-Term Debt Obligations (1) $109,577 $12,297 $6,245 $6,350 $6,748 $199,688 $340,905
Operating Lease Obligations(2) 90 90 90 23 - - 293
Total $109,667 $12,387 $6,335 $6,373 $6,748 $199,688 $341,198
(1) Our long-term debt obligations are set forth in detail in the schedule
below. The amount due in 2004 does not reflect the planned two-year
extension of the Citicorp USA, Inc. and Cupertino National Bank loans
described in Liquidity and Capital Resources above.
(2) Our operating lease obligations relate to a lease of our corporate office
facility from a related party.
At December 31, 2003, we had total indebtedness of approximately $340.9
million, including approximately $230.6 million of fixed rate mortgage debt
and approximately $110.3 million under the loan from Citicorp USA, Inc. and
the lines of credit from the Berg Group and Cupertino National Bank, as to
which the interest rate varies with LIBOR. Of total fixed debt, the
Prudential and Northwestern loans represented approximately $121.5 million
and $97.4 million, respectively. The following table sets forth certain
information regarding debt outstanding as of December 31, 2003.
- 39 -
At December 31, Maturity Interest
Debt Description Collateral Properties 2003 Date Rate
------------------------------------------ ---------------------------------------------- ------------------ ---------- -----------
(dollars in thousands)
LINE OF CREDIT
Berg Group (related parties) 2033-2043 Samaritan Drive, San Jose, CA $ 6,320 3/05 (1)
2133 Samaritan Drive, San Jose, CA
2233-2243 Samaritan Drive, San Jose, CA
1310-1450 McCandless Drive, Milpitas, CA
1795-1845 McCandless Drive, Milpitas, CA
Cupertino National Bank Not Applicable 23,965 9/04 (4)
MORTGAGE NOTES PAYABLE (RELATED PARTIES): 5300-5350 Hellyer Avenue, San Jose, CA 10,762 6/10 7.650%
MORTGAGE NOTES PAYABLE (2):
Prudential Capital Group 20400 Mariani Avenue, Cupertino, CA 733 10/06 8.750%
Washington Mutual (Home S&L Association) 10460 Bubb Road, Cupertino, CA 225 12/06 9.500%
Prudential Insurance Company of America(3) 10300 Bubb Road, Cupertino, CA 121,455 10/08 6.560%
10500 North De Anza Blvd, Cupertino, CA
4050 Starboard Drive, Fremont, CA
45700 Northport Loop, Fremont, CA
45738 Northport Loop, Fremont, CA
450 National Ave, Mountain View, CA
6311 San Ignacio Avenue, San Jose, CA
6321 San Ignacio Avenue, San Jose, CA
6325 San Ignacio Avenue, San Jose, CA
6331 San Ignacio Avenue, San Jose, CA
6341 San Ignacio Avenue, San Jose, CA
6351 San Ignacio Avenue, San Jose, CA
3236 Scott 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 East Arques, Sunnyvale, CA
1250 East Arques, Sunnyvale, CA
1170 Morse Avenue, Sunnyvale, CA
1600 Memorex Drive, Santa Clara, CA
1688 Richard Avenue, Santa Clara, CA
1700 Richard Avenue, Santa Clara, CA
3540 Bassett Street, Santa Clara, CA
3542 Bassett Street, Santa Clara, CA
3544 Bassett Street, Santa Clara, CA
3550 Bassett Street, Santa Clara, CA
Northwestern Mutual Life Insurance 1750 Automation Parkway, San Jose, CA 97,445 1/13 5.640%
Company (5) 1756 Automation Parkway, San Jose, CA
1762 Automation Parkway, San Jose, CA
6320 San Ignacio Avenue, San Jose, CA
6540-6541 Via Del Oro, San Jose, CA
6385-6387 San Ignacio Avenue, San Jose, CA
2251 Lawson Lane, Santa Clara, CA
1325 McCandless Drive, Milpitas, CA
1650-1690 McCandless Drive, Milpitas, CA
20605-20705 Valley Green Drive, Cupertino, CA
Citicorp USA, Inc. 2001 Walsh Avenue, Santa Clara, CA 80,000 9/04 (4)
2880 Scott Boulevard, Santa Clara, CA
2890 Scott Boulevard, Santa Clara, CA
2770-2800 Scott Boulevard, Santa Clara, CA
2220 Central Expressway, Santa Clara, CA
2300 Central Expressway, Santa Clara, CA
2330 Central Expressway, Santa Clara, CA
------------------
Mortgage Notes Payable 299,858
------------------
Total $340,905
==================
- 40 -
(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
2005. The interest rate was 2.52% at December 31, 2003.
(2) Mortgage notes payable generally require monthly installments of interest
and principal over various terms extending through the year 2013. The
weighted average interest rate of mortgage notes payable was 6.23% at
December 31, 2003.
(3) The Prudential Insurance loan is payable in monthly installments of $827,
which includes principal (based upon a 30-year amortization) and interest.
John Kontrabecki, one of the limited partners, has guaranteed approximately
$12,000 of this debt. Costs and fees incurred with obtaining this loan
aggregated approximately $900.
(4) Interest rate equal to LIBOR plus 2%. The interest rate for the Cupertino
National Bank line of credit and the Citicorp USA, Inc. mortgage loan at
December 31, 2003 was 3.17%.
(5) The Northwestern loan is payable in monthly installments of $696, which
includes principal (based upon a 20-year amortization) and interest. Costs
and fees incurred with obtaining this loan aggregated approximately $675.
At December 31, 2003, our debt to total market capitalization ratio, which
is computed as our total debt outstanding divided by the sum of total debt
outstanding plus the market value of common stock (based upon the closing
price of $12.95 per share on December 31, 2003) on a fully diluted basis,
including the conversion of all O.P. Units into common stock, was
approximately 20.1%. On December 31, 2003, the last trading day for the
year, total market capitalization was approximately $1.7 billion.
At December 31, 2003, the outstanding balance remaining under certain
demand notes that we owed to the operating partnerships was $1.47 million.
The due date of the demand notes has been extended to September 30, 2005.
The principal of the demand notes, along with the interest expense, which
is interest income to the operating partnerships, is eliminated in
consolidation and is not included in the corresponding line items within
the consolidated financial statements. However, the interest income earned
by the operating partnerships, which is interest expense to us, in
connection with this debt, is included in the calculation of minority
interest as reported on the consolidated statement of operations, thereby
reducing our net income by this same amount. At present, our only means for
repayment of this debt is through distributions that we receive from the
operating partnerships that are in excess of the amount of dividends to be
paid to our stockholders.
- 41 -
HISTORICAL CASH FLOWS
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2003 TO THE YEAR ENDED DECEMBER
31, 2002.
Net cash provided by operating activities for the year ended December 31,
2003 was approximately $116.5 million, compared to approximately $117.4
million for the prior year. The decrease in cash provided by operating
activities resulted from adverse market conditions and loss of several
tenants due to bankruptcy, cessation of operations, or tenant relocation
resulting in increased vacancy rates that offset cash savings.
Net cash used in investing activities was approximately ($110) million for
the year ended December 31, 2003, compared to approximately ($20.7) million
for the prior year. Cash used in investing activities during 2003 related
to financing the acquisition of the San Tomas Technology Park of $110
million as well as new equipment and improvements of $1.4 million.
Net cash used in financing activities was approximately ($6.9) million for
the year ended December 31, 2003, compared to ($97.5) million for the year
ended December 31, 2002. During 2003, we paid debt principal and made
distributions to holders of our common stock and O.P. Units utilizing cash
generated from operating activities and other borrowed funds. Financing
activities in 2003 also consisted of a $100 million collateralized mortgage
loan from Northwestern Mutual Life Insurance Company, an $80 million
collateralized mortgage loan from Citicorp USA, Inc. and a $40 million line
of credit established with Cupertino National Bank in July 2002 of which
$24.0 million had been drawn as of the year end. For the year ended
December 31, 2003, we paid dividends to our stockholders and made
distributions to the O.P. Unit holders totaling approximately $100.1
million, compared to approximately $99.7 million for the year ended
December 31, 2002. Additionally, during 2003, we repaid $61.5 million under
our line of credit with the Berg Group and $20 million under our
uncollateralized loan with Citicorp USA, Inc.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2002 TO THE YEAR ENDED DECEMBER
31, 2001.
Net cash provided by operating activities for the year ended December 31,
2002 was approximately $117.4 million, compared to approximately $111.2
million for the prior year. The increase in cash resulted from increased
rental receipts attributable to newly acquired properties.
Net cash used in investing activities was approximately ($20.7) million for
the year ended December 31, 2002, compared to approximately ($3.0) million
for the prior year. Cash used in investing activities during 2002 related
to the acquisition of three R&D properties through a tax-deferred exchange
transaction involving the property sold to Xilinx, Inc. pursuant to its
purchase option as well as new equipment and improvements.
Net cash used in financing activities was approximately ($97.5) million for
the year ended December 31, 2002, compared to ($107.5) million for the year
ended December 31, 2001. During 2002, we paid debt principal and made
distributions to holders of our common stock and O.P. Units utilizing cash
generated from operating activities and other borrowed funds. Financing
activities in 2002 also consisted of a $20 million uncollateralized loan
from Citicorp USA, Inc. and a $40 million line of credit established with
Cupertino National Bank of which $23.8 million had been drawn as of the
year end. For the year ended December 31, 2002, we paid dividends to our
stockholders and made distributions to the O.P. Unit holders totaling
approximately $99.7 million, compared to approximately $85.0 million for
the year ended December 31, 2001.
CAPITAL EXPENDITURES
The properties require periodic investments of capital for tenant-related
capital expenditures and for general capital improvements. For the years
ended December 31, 1995 through December 31, 2003, the recurring
tenant/building improvement costs and leasing commissions incurred with
respect to new leases and lease renewals of the properties previously owned
or controlled by members of the Berg Group averaged approximately $2.0
million annually. We will have approximately 863,000 rentable square feet
under expiring leases in 2004. We expect that the average annual cost of
recurring tenant/building improvements and leasing commissions, related to
these properties, will be approximately $2.0 million during 2004. We
believe we will recover substantially all of these sums from the tenants
under the new or renewed leases through increases in rental rates. Until we
actually sign the leases, however, we cannot assure you that this will
occur. Capital expenditures may fluctuate in any given period subject to
the nature, extent, and timing of improvements required to be made to the
properties. Tenant/building improvements and leasing costs also may
fluctuate in any given period year depending upon factors such as the
property, the term of the lease, the type of lease and the overall market
conditions. We expect to meet our long-term liquidity requirements for the
funding of 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, but cannot be
assured that we will be able to meet our requirements on favorable terms.
See "Policy with Respect to Certain Activities - Financing Policies."
- 42 -
FUNDS FROM OPERATIONS
FFO is a non-GAAP financial measurement used by real estate investment
trusts to measure and compare operating performance. As defined by NAREIT,
FFO represents net income (loss) before minority interest of O.P. Unit
holders, computed in accordance with GAAP, including non-recurring events
other than "extraordinary items" under GAAP and gains and losses from sales
of depreciable operating properties, 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 our ability to
incur and service debt and make capital expenditures. With the 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
nor is it comparable to cash flows provided by operating activities
determined in accordance with GAAP, nor is FFO necessarily indicative of
funds available to meet our cash needs, including our need to make cash
distributions to satisfy REIT requirements. For example, FFO is not
adjusted for payments of debt principal required under our debt service
obligations.
Our 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. Our 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 FFO exactly as we do.
We have revised our FFO computations for 2002 and 2001 for the inclusion of
the amortization of leasing commissions in depreciation and amortization of
real estate in order to be comparable to our 2003 FFO presentation in
accordance with NAREIT guidelines and to more closely conform to the
NAREIT's FFO definition. Additionally, our 2003 FFO calculation includes
our portion of the depreciation and amortization of real estate from our
unconsolidated TBI-MSW joint venture.
The revised FFO for the years ended December 31, 2003, 2002, 2001, 2000 and
1999 is as follows:
For the Year Ended December 31,
-------------------------------------------------------------------------------
2003 2002 2001 2000 1999
(As Restated) (As Restated)
--------------- --------------- --------------- --------------- ---------------
(dollars in thousands)
Net income to common stockholders (3) $ 16,212 $ 17,115 $ 18,086 $12,579 $ 6,531
Add:
Minority interests (1) 80,256 86,053 90,662 58,769 39,785
Depreciation and amortization of real estate(2) 22,850 21,379 17,718 15,803 13,298
Less:
Gain/(Loss) on sales of joint venture assets 1,400 6,103 11,453 501 (393)
or assets
--------------- --------------- --------------- --------------- ---------------
FFO $117,918 $118,444 $115,013 $86,650 $60,007
=============== =============== =============== =============== ===============
(1) The minority interest for third parties was deducted from total minority
interest in calculating FFO.
(2) Also includes depreciation and amortization of real estate from our
unconsolidated joint venture and amortization of leasing commissions.
(3) Net income to common stockholders is restated for 2002 and 2001
- 43 -
The effect of the revision in the FFO computation described above for the
years ended December 31, 2003, 2002, 2001, 2000 and 1999 is as follows:
For the Year Ended December 31,
2003 2002 2001 2000 1999
(As Revised) (As Restated) (As Restated) (As Reviewed) (As Reviewed)
------------ ------------- ------------- ------------- -------------
(dollars in thousands)
FFO, as previously reported $117,769 $117,360 $114,513 $86,303 $59,079
Less:
Effect of restatements and reclassifications on the consolidated (2,562) (2,321) (302) - -
statement of operations (1)
Add:
Additional depreciation and amortization from restatements 1,146 2,321 302 - -
Amortization of leasing commissions 691 1,084 500 347 142
Depreciation and amortization from unconsolidated joint venture 874 - - - -
------------ ------------- ------------- ------------- -------------
FFO, as revised $117,918 $118,444 $115,013 $86,650 $59,221
============ ============= ============= ============= =============
(1) The reconciliation of consolidated net income as previously reported and as
restated is described above. See "Impact of Restatements."
OVERVIEW OF DISTRIBUTION POLICY
We intend to make regular quarterly distributions to stockholders and O.P.
Unit holders based on our funds available for distributions. Our ability to
make such distributions will be affected by numerous factors including,
most importantly, the receipt of distributions from the operating
partnerships.
Funds available for distributions does not represent cash generated from
operating activities and is not necessarily indicative of cash available to
fund cash needs. The actual return that we will realize and the amount
available for distributions to stockholders will be affected by a number of
factors, including the revenues received from our properties, our operating
expenses, debt service on borrowings, and planned and unanticipated capital
expenditures.
We anticipate that cash available for distribution will exceed earnings and
profits for federal income tax purposes, as the latter figure takes into
account non-cash expenses, such as depreciation and amortization, that we
will incur. Distributions, other than capital gain distributions, by us to
the extent of our current and accumulated earnings and profits for federal
income tax purposes most likely will be taxable to U.S. stockholders as
ordinary dividend income unless a stockholder is a tax-exempt entity.
Distributions in excess of earnings and profits generally will be treated
as a non-taxable reduction of the U.S. stockholder's basis in the common
stock to the extent of such basis, and thereafter as taxable gain. The
percentage of such distributions in excess of earnings and profits, if any,
may vary from period to period.
Distributions are determined by our Board of Directors and depend on actual
cash available for distributions, our financial condition, capital
requirements, the annual distribution requirements under the REIT
provisions of the Code and such other factors as the Board of Directors
deems relevant. For a discussion of the risk that we will not meet our
distribution objectives, see Part I, Item 1., "Business - Risk Factors --
Stockholders are not assured of receiving cash distributions from us."
POLICIES WITH RESPECT TO CERTAIN ACTIVITIES
We have adopted policies with respect to investment, financing, conflicts
of interest and other activities. These policies have been formulated by
our Board of Directors, are set forth in our charter, bylaws, operating
partnership agreements or agreements with the Berg Group, and generally may
be amended or revised from time to time, subject to applicable agreement
terms, at the discretion of the Board of Directors without a vote of the
stockholders. Among other things, these policies provide that:
- so long as the Berg Group members and their affiliates, other than us
and the operating partnerships, beneficially own, in the aggregate, at
least 15% of the outstanding shares of common stock on a Fully Diluted
basis, the approval of a majority of our directors, including Carl E.
Berg or his designee as a director, and of the holders of a majority
of the O.P. Units is required for us to take title to assets, other
than temporarily in connection with an acquisition prior to
contributing such assets to the operating partnerships, or to conduct
business other than through the operating partnerships, or for us or
the operating partnerships to engage in any business other than the
ownership, construction, development and operation of real estate
properties, or for certain fundamental corporate actions, including
amendments to our charter, bylaws or any operating partnership
agreement and any merger, consolidation or sale of all or
substantially all of our assets or the assets of the operating
partnerships;
- 44 -
- changes in certain policies with respect to conflicts of interest must
be consistent with legal requirements;
- certain policies with respect to competition by and acquisitions from
the Berg Group are imposed pursuant to provisions of the acquisition
agreement that cannot be amended or waived without the approval of the
Independent Directors Committee of our Board of Directors;
- we cannot take any action intended to terminate our qualification as a
REIT without the approval of more than 75% of the entire Board of
Directors; and
- we cannot undertake certain other specified transactions, including
the issuance of debt securities, and borrowings in excess of specified
limits, or the amendment of our charter and bylaws, without the
approval of more than 75% of the entire Board of Directors.
INVESTMENT POLICIES
We expect to pursue our business and investment objectives principally
through the direct ownership by the operating partnerships of our
properties and future acquired properties. Development or investment
activities are not limited to any specified percentage of our assets. We
may also participate with other entities in property ownership, through
joint ventures or other types of co-ownership. Equity investments may be
subject to existing mortgage financing and other indebtedness that have
priority over our equity interests.
While we will emphasize equity real estate investments, we may, in our
discretion and subject to the percentage ownership limitations and gross
income tests necessary for REIT qualification, invest in mortgage and other
real estate interests, including securities of other real estate investment
trusts. We have not previously invested in mortgages or securities of other
real estate investment trusts, and we do not have any present intention to
make such investments.
FINANCING POLICIES
To the extent that our Board of Directors determines to seek additional
capital, we may raise such capital through additional equity offerings,
debt financing or retention of cash flow, or through a combination of these
sources, after consideration of provisions of the Code requiring the
distribution by a REIT of a certain percentage of its taxable income and
taking into account taxes that would be imposed on undistributed taxable
income. It is our present intention that any additional borrowings will be
made through the operating partnerships, although we may incur borrowings
that would be re-loaned to the operating partnerships. Borrowings may be
unsecured or may be secured by any or all of our assets, the operating
partnerships or any existing or new property, and may have full or limited
recourse to all or any portion of our assets, the operating partnerships or
any existing or new property.
We have adopted a policy of maintaining a consolidated ratio of debt to
total market capitalization, which includes for this purpose the market
value of all shares of common stock for which outstanding O.P. Units are
exchangeable, of less than 50%. This ratio may not be exceeded without the
approval of more than 75% of our entire Board of Directors. We also may
determine to finance acquisitions through the exchange of properties or the
issuance of additional O.P. Units in the operating partnerships, shares of
common stock or other securities.
In the event that the Board of Directors determines to raise additional
equity capital, it has the authority, without stockholder approval, to
issue additional shares of common stock, preferred stock or other capital
stock, including securities senior to the common stock, in any manner and
on such terms and for such consideration it deems appropriate, including in
exchange for property. In the event that we issue any shares of common
stock or securities convertible into or exchangeable or exercisable for,
shares of common stock, subject to limited exceptions, such as the issuance
of common stock pursuant to any stock incentive plan adopted by us or
pursuant to limited partners' exercise of the exchange rights or the put
rights, the limited partners will have the right to purchase common stock
or such securities in order to maintain their respective percentage
interests in us on a Fully Diluted basis. If the board of directors
determines that we will raise additional equity capital to fund investments
by the operating partnerships, we will contribute such funds to the
operating partnerships as a contribution to capital and purchase of
additional general partnership interest; however, holders of O.P. Units
will have the right to participate in such funding on a pro rata basis. In
the event that holders of O.P. Units sell their O.P. Units to us upon
exercise of their put rights, we are authorized to raise the funds for such
purchase by issuing additional shares of common stock. Alternatively, we
may issue additional shares of common stock in exchange for the tendered
O.P. Units.
- 45 -
Our Board of Directors also has the authority to cause the operating
partnerships to issue additional O.P. Units in any manner and on such terms
and for such consideration, as it deems appropriate, including in exchange
for property. In the event that the operating partnerships issue new O.P.
Units for cash, but not property, the limited partners holding O.P. Units
in an operating partnership will have the right to purchase O.P. Units in
order, and to the extent necessary, to maintain their respective percentage
interests in that operating partnership. The new O.P. Units will be
exchangeable for common stock pursuant to the exchange rights or may be
tendered to us pursuant to the put rights.
DISPOSITION POLICIES
We have no current intention of disposing of any of our properties,
although we reserve the right to do so. The tax basis of the limited
partners in the properties in the operating partnerships is substantially
less than current fair market value. Accordingly, prior to the disposition
of their O.P. Units, upon a disposition of any of the properties, a
disproportionately large share of the gain for federal income tax purposes
would be allocated to the limited partners. Consequently, it may be in the
interests of the limited partners that we continue to hold the properties
in order to defer such taxable gain. In light of this tax effect, the
operating partnership agreements provide that, until December 29, 2008, or
until the Berg Group members and their affiliates, other than us and the
operating partnerships, beneficially own, in the aggregate, less than 15%
of the outstanding shares of common stock on a Fully Diluted basis, if
earlier, Carl E. Berg and Clyde J. Berg may prohibit the operating
partnerships from disposing of properties which they designate in a taxable
transaction. Mr. Kontrabecki has a similar right with respect to seven of
the properties, which right will lapse before the end of the ten-year
period if his beneficial ownership interest falls below 750,000 O.P. Units.
The limited partners may seek to cause us to retain the properties even
when such action may not be in the interests of some, or a majority, of our
stockholders. The operating partnerships will be able to effect
"tax-deferred," like-kind exchanges under Section 1031 of the Code, or in
connection with other non-taxable transactions, such as a contribution of
property to a new partnership, without obtaining the prior written consent
of these individuals. The approval of a majority of our directors,
including Carl E. Berg or his designee, will be required to sell all or
substantially all of our assets. The consent of the holders of a majority
of the O.P. Units will be required to effect a sale or sales of all, or
substantially all, of the assets of any of the operating partnerships.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
We do not believe that recently issued accounting standards will materially
impact our financial position, results of operations, or cash flows.
In November 2002, the FASB issued FASB Interpretation No. (FIN) 45
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others," which elaborates
on the disclosures to be made by a guarantor in its interim and annual
financial statements about its obligations under certain guarantees that it
has issued. It also clarifies that a guarantor is required to recognize, at
the inception of a guarantee, a liability for the fair value of the
obligation undertaken in issuing the guarantee. The initial recognition and
initial measurement provisions of this Interpretation are applicable on a
prospective basis to guarantees issued or modified after December 31, 2002,
irrespective of the guarantor's fiscal year-end. We have not entered into
any new guarantees or modified any existing guarantees subsequent to
December 31, 2002; therefore, adoption of this statement has had no effect
on our financial position, operating results or cash flows.
In December 2003, the FASB issued FIN 46R, "Consolidation of Variable
Interest Entities," a revision to FIN 46, which was issued in January 2003.
Under FIN 46R, a variable interest entity must be consolidated by a company
if that company is subject to a majority of the entity's expected losses or
entitled to receive a majority of the entity's expected residual returns or
both. FIN 46R requires disclosures about variable interest entities that a
company is not required to consolidate, but in which it has a significant
variable interest. The consolidation requirements apply to existing
entities in the first reporting period that ends after March 15, 2004. We
will adopt the consolidation requirements of FIN 46R in the first quarter
of 2004. We expect no significant effect on the consolidated financial
position, results of operations or cash flows as a result of the initial
adoption of this standard in regard to existing variable interest entities;
however, newly formed entities could meet these requirements and will be
recorded as appropriate.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure", which amended SFAS No. 123
"Accounting for Stock-Based Compensation". SFAS No. 148 provides
alternative methods of transition for a voluntary change to the fair value
based method of accounting for stock-based compensation and amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in
both annual and interim financial statements about the method of accounting
for stock-based employee compensation and the effect of the method used on
reported results. On December 31, 2002, we adopted the disclosure
provisions of SFAS No. 148 and continue to account for stock-based
compensation under APB Opinion No. 25 "Accounting for Stock Issued to
Employees". Therefore, the adoption of SFAS No. 148 did not have any effect
on our financial position, operating results or cash flows.
- 46 -
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This
Statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). SFAS
No. 150 was effective beginning in the third quarter of 2003. The FASB
deferred the implementation of SFAS No. 150 as applied to certain minority
interests in finite life entities, however. We adopted the requirements of
SFAS No. 150 in the third quarter of 2003, and considering the
aforementioned deferral, it did not impact our financial position, results
of operations or cash flows.
- 47 -
ITEM 7A. 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. 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
December 31, 2003. The current terms of this debt are described in Item 7.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources." Average interest rates are
based on implied LIBOR for the respective time period. Fair value
approximates book value for fixed rate debt. Of the projected fair value of
secured notes payable, approximately $121.5 million and $97.4 million
represent the Prudential and Northwestern secured loans, respectively.
For variable rate debt, the table presents the assumption that the
outstanding principal balance at December 31, 2003 will be paid upon
maturity.
For fixed rate debt, the table presents the assumption that the outstanding
principal balance at December 31, 2003 will be paid according to scheduled
principal payments and that we will not prepay any of the outstanding
principal balance.
2004 2005 2006 2007 2008 Thereafter Total Fair Value
---- ---- ---- ---- ---- ---------- ----- ----------
VARIABLE RATE DEBT: (dollars in thousands)
Secured and unsecured debt $103,965 $6,320 $110,285 $110,285
Weighted average interest rate 3.13% 3.13%
FIXED RATE DEBT:
Secured notes payable $5,612 $5,977 $6,245 $6,350 $6,748 $199,688 $230,620 $255,980
Weighted average interest rate 6.23% 6.23% 6.23% 6.23% 6.23% 6.23%
The variable rate debt represented 32.4% and 43.0% and the fixed rate debt
represented 67.6% and 57.0% of all debt outstanding for the years ended
December 31, 2003 and 2002, respectively. All of the debt is denominated in
United States dollars. The weighted average interest rate for variable rate
debt was approximately 3.13% and 3.42% for the years ended December 31,
2003 and 2002, respectively. The difference in spread was due to numerous
cuts in interest rates by the Federal Reserve Board during 2002 and 2003.
The weighted average interest rate for fixed rate debt was approximately
6.23% and 6.68% for the years ended December 31, 2003 and 2002,
respectively. The difference in interest expense attributable to the
average interest rate difference between 2002 and 2003 was $4.5 million,
which was also a result of new debt obtained during 2003. We do not
anticipate significant interest rate changes from 2003 to 2004.
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, Inc. loan, which are tied to a LIBOR based interest
rate, were approximately $110.3 million, or 32.4%, of the total $340.9
million of debt as of December 31, 2003. As a result, we pay lower rates of
interest in periods of decreasing interest rates and higher rates of
interest in periods of increasing interest rates. At December 31, 2003, 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 December
31, 2003, a 1% increase or decrease in interest rates on our $110.3 million
of floating rate debt would decrease or increase, respectively, annual
earnings and cash flows by approximately $1.1 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.
- 48 -
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
MISSION WEST PROPERTIES, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
---------
Report of Independent Registered Public Accounting Firm 50
Consolidated Balance Sheets at December 31, 2003 and 2002 (Restated) 51
Consolidated Statements of Operations for the years ended 52
December 31, 2003, 2002 (Restated) and 2001 (Restated)
Consolidated Statements of Stockholders' Equity 53
for the years ended December 31, 2003, 2002 (Restated) and 2001 (Restated)
Consolidated Statements of Cash Flows for the years ended 54
December 31, 2003, 2002 (Restated) and 2001 (Restated)
Notes to the Consolidated Financial Statements 55
Supplemental Financial Information 74
Report of Independent Registered Public Accounting Firm 77
Schedule III: Real Estate and Accumulated Depreciation as of 79
December 31, 2003
Schedule III: Real Estate and Accumulated Depreciation as of 81
December 31, 2002 (Restated)
- 49 -
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Mission West Properties, Inc.
Cupertino, California
We have audited the accompanying consolidated balance sheets of Mission West
Properties, Inc. as of December 31, 2003 and 2002 and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 2003. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Mission West
Properties, Inc. at December 31, 2003 and 2002, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2003, in conformity with accounting principles generally accepted
in the United States of America.
As discussed in Note 18 to the consolidated financial statements, the Company
has restated its consolidated financial statements as of December 31, 2002 and
for the years ended December 31, 2002 and 2001 (which were previously audited by
other independent auditors).
\S\ BDO Seidman, LLP
San Francisco, California
July 27, 2004
- 50 -
MISSION WEST PROPERTIES, INC.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share and per share data)
ASSETS
December 31,
---------------------------------------------
2003 2002
---------------------- ---------------------
(As Restated)
Real estate assets:
Land $ 275,707 $234,251
Buildings and improvements 779,636 717,556
Real estate related intangible assets 19,651 1,368
---------------------- ---------------------
Total investments in properties 1,074,994 953,175
Less accumulated depreciation and amortization (89,243) (67,053)
---------------------- ---------------------
Net investments in properties 985,751 886,122
Cash and cash equivalents 4,129 4,479
Deferred rent receivable, net of $2,000 allowance at December 31, 2003 and 18,970 17,001
2002
Investment in unconsolidated joint venture 2,285 -
Other assets (net of accumulated amortization of
$4,211 and $4,598 at December 31, 2003 and 2002, respectively) 21,497 19,181
---------------------- ---------------------
Total assets $1,032,632 $926,783
====================== =====================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Line of credit (related parties) $ 6,320 $58,792
Revolving line of credit 23,965 23,839
Loan payable - 20,000
Mortgage notes payable 299,858 125,062
Mortgage note payable (related parties) 10,762 11,078
Interest payable 332 337
Security deposits 10,248 11,184
Deferred rental income 12,723 9,876
Dividend/distribution payable 25,031 24,951
Accounts payable and accrued expenses 5,085 4,698
---------------------- ---------------------
Total liabilities 394,324 289,817
---------------------- ---------------------
Commitments and contingencies
Minority interest 524,918 526,580
Stockholders' equity:
Preferred stock, no par value, 200,000 shares authorized,
none issued and outstanding - -
Common stock, $.001 par value at December 31, 2003 and 2002,
200,000,000 shares authorized, 17,894,691 and 17,487,329 shares
issued and outstanding at December 31, 2003 and 2002, respectively 18 17
Paid-in capital 132,136 128,295
Accumulated deficit (18,764) (17,926)
---------------------- ---------------------
Total stockholders' equity 113,390 110,386
---------------------- ---------------------
Total liabilities and stockholders' equity $1,032,632 $926,783
====================== =====================
See notes to consolidated financial statements
- 51 -
MISSION WEST PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except share and per share data)
Year Ended December 31,
--------------------------------------------------------------------
2003 2002 2001
--------------------- --------------------- ---------------------
(As Restated) (As Restated)
Revenues:
Rental revenue from real estate $130,739 $129,781 $126,229
Tenant reimbursements 18,871 20,099 17,475
Other income, including lease terminations, settlements and 4,527 4,248 2,465
interest
--------------------- --------------------- ---------------------
154,137 154,128 146,169
Expenses:
Property operating, maintenance and real estate taxes 21,365 23,951 18,502
Interest 16,446 9,588 8,704
Interest (related parties) 1,064 3,422 4,709
General and administrative 1,325 1,488 1,284
Depreciation and amortization of real estate 20,774 18,313 16,746
--------------------- --------------------- ---------------------
60,974 56,762 49,945
--------------------- --------------------- ---------------------
Income before gain on sales of assets, equity in earnings of
unconsolidated joint venture and minority interests 93,163 97,366 96,224
Gain on sales of assets - - 11,453
Equity in earnings of unconsolidated joint venture, including
$1,400 gain on sale of property acquired from related party 3,885 - -
Minority interests 80,836 81,316 89,876
--------------------- --------------------- ---------------------
Income from continuing operations 16,212 16,050 17,801
--------------------- --------------------- ---------------------
Discontinued operations, net of minority interests:
Gain from disposal of discontinued operations - 1,018 -
Income attributable to discontinued operations - 47 285
--------------------- --------------------- ---------------------
Income from discontinued operations - 1,065 285
--------------------- --------------------- ---------------------
Net income to common stockholders $16,212 $17,115 $18,086
===================== ===================== =====================
Net income to minority interests $80,836 $86,641 $91,312
===================== ===================== =====================
Income per share from continuing operations:
Basic $0.91 $0.92 $1.04
===================== ===================== =====================
Diluted $0.91 $0.90 $1.01
===================== ===================== =====================
Income per share from discontinued operations:
Basic - $0.06 $0.02
===================== ===================== =====================
Diluted - $0.06 $0.02
===================== ===================== =====================
Net income per share to common stockholders:
Basic $0.91 $0.98 $1.06
===================== ===================== =====================
Diluted $0.91 $0.96 $1.03
===================== ===================== =====================
Weighted average shares of common stock (basic) 17,739,609 17,455,799 17,103,714
===================== ===================== =====================
Weighted average shares of common stock (diluted) 17,802,947 17,854,892 17,589,353
===================== ===================== =====================
Weighted average O.P. Units 86,476,217 86,334,548 85,122,715
===================== ===================== =====================
Outstanding common stock 17,894,691 17,487,329 17,329,779
===================== ===================== =====================
Outstanding O.P. Units 86,398,064 86,474,032 85,762,541
===================== ===================== =====================
See notes to consolidated financial statements
- 52 -
MISSION WEST PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(dollars in thousands, except share data)
Total
Shares of Common Common Paid-in- Accumulated Stockholders'
Stock Outstanding Stock Capital Deficit Equity
------------------ -------- ------------ --------------- -------------------
Balance, December 31, 2000 17,025,365 $123,136 $102,073
$17 $(21,080)
Issuance of common stock upon option exercise 68,088 535 535
Issuance of common stock upon O.P. Unit 236,326 2,955 2,955
conversion
Dividends declared (15,274) (15,274)
Net income 18,086 18,086
------------------ -------- ------------ --------------- -------------------
Balance, December 31, 2001 (As Restated) 17,329,779 17 126,626 (18,268) 108,375
Issuance of common stock upon option exercise 33,550 151 151
Issuance of common stock upon O.P. Unit 124,000 1,518 1,518
conversion
Dividends declared (16,773) (16,773)
Net income 17,115 17,115
------------------ -------- ------------ --------------- -------------------
Balance, December 31, 2002 (As Restated) 17,487,329 17 128,295 (17,926) 110,386
Issuance of common stock upon option exercise 150,362 1,014 1,014
Issuance of common stock upon O.P. Unit 257,000 1 2,827 2,828
conversion
Dividends declared (17,050) (17,050)
Net income 16,212 16,212
------------------ -------- ------------ --------------- -------------------
Balance, December 31, 2003 17,894,691 $18 $132,136 $(18,764) $113,390
================== ======== ============ =============== ===================
See notes to consolidated financial statements
- 53 -
MISSION WEST PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
Year Ended December 31,
-----------------------------------------------------------
2003 2002 2001
(As Restated) (As Restated)
------------------- ------------------ ------------------
Cash flows from operating activities:
Net income $16,212 $17,115 $18,086
Adjustments to reconcile net income to net
cash provided by operating activities:
Minority interest 80,836 86,641 91,312
Depreciation and amortization of real estate 23,393 21,379 17,719
Gain on sales of assets - (6,103) (11,453)
Equity in earnings of unconsolidated joint venture (3,885) - -
Distributions from unconsolidated joint venture 2,000 - -
Other - (14) 13
Change in operating assets and liabilities, net of liabilities assumed:
Deferred rent receivable (1,969) (78) (6,054)
Other assets (2,656) (2,630) (664)
Interest payable (5) (5) (5)
Security deposits (936) 3,847 797
Deferred rental income 2,847 (2,594) 1,172
Accounts payable and accrued expenses 656 (190) 234
------------------- ------------------ ------------------
Net cash provided by operating activities 116,493 117,368 111,157
------------------- ------------------ ------------------
Cash flows from investing activities:
Improvements to real estate (1,370) (1,902) (1,041)
Refundable option payment utilized for rent payments - (333) (1,999)
Proceeds from sales of real estate - 12,803 38,489
Purchase of real estate (110,013) (31,312) (38,489)
Net proceeds from sale of TBI unconsolidated joint venture
real estate 1,400 - -
------------------- ------------------ ------------------
Net cash used in investing activities (109,983) (20,744) (3,040)
------------------- ------------------ ------------------
Cash flows from financing activities:
Principal payments on mortgage notes payable (5,204) (2,354) (4,639)
Proceeds from mortgage loan payable 180,000 - -
Principal payments on mortgage notes payable (related parties) (316) (293) (272)
Net payments under line of credit (related parties) (61,471) (39,095) (18,136)
Proceeds from loan payable - 20,000 -
Payment on loan payable (20,000) - -
Proceeds from revolving line of credit 126 28,839 -
Payment on line of credit - (5,000) -
Financing costs (863) (52) -
Net proceeds from exercise of stock options 1,014 151 536
Minority interest distributions (83,194) (82,916) (70,636)
Dividends (16,952) (16,735) (14,351)
------------------- ------------------ ------------------
Net cash used in financing activities (6,860) (97,455) (107,498)
------------------- ------------------ ------------------
Net (decrease) increase in cash and cash equivalents (350) (831) 619
Cash and cash equivalents, beginning of year 4,479 5,310 4,691
------------------- ------------------ ------------------
Cash and cash equivalents, end of year $4,129 $4,479 $5,310
=================== ================== ==================
Refer to Note 14 for supplemental cash flow information.
See notes to consolidated financial statements
- 54 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
1. ORGANIZATIONS AND FORMATION OF THE COMPANY
Mission West Properties, Inc. ("the Company") is a fully integrated,
self-administered and self-managed real estate company that acquires and manages
R&D/office properties in the portion of the San Francisco Bay Area commonly
referred to as Silicon Valley. In July 1998, the Company purchased an
approximate 12.11% of four existing limited partnerships (referred to
collectively as the "operating partnerships") and obtained control of these
partnerships by becoming the sole general partner in each one effective July 1,
1998 for financial accounting and reporting purposes. The Company purchased an
approximate 12.11% interest in each of the operating partnerships. All limited
partnership interests in the operating partnerships were converted into
59,479,633 operating partnership ("O.P.") Units, which represented a limited
partnership ownership interest of approximately 87.89% of the operating
partnerships. The operating partnerships are the vehicles through which the
Company holds its real estate investments, makes real estate acquisitions, and
generally conduct its business.
On December 30, 1998, the Company was reincorporated under the laws of the State
of Maryland through a merger with and into Mission West Properties, Inc.
Accordingly, shares of the former company, Mission West Properties, a California
corporation (no par), which were outstanding at December 30, 1998, were
converted into shares of common stock ($.001 par value per share) on a
one-for-one basis.
As of December 31, 2003, the Company owns a general partnership interest of
16.95%, 21.61%, 15.98% and 12.37% in Mission West Properties, L.P., Mission West
Properties, L.P. I, Mission West Properties, L.P. II and Mission West
Properties, L.P. III, respectively, for a 17.02% general partnership interest in
the operating partnerships, taken as a whole, on a weighted average basis.
The Company, through the operating partnerships, owns interests in 109 R&D
properties, all of which are located in Silicon Valley.
BUSINESS SEGMENT INFORMATION
The Company's primary business is the ownership and management of R&D/office
real estate with a geographic concentration in the Silicon Valley of the San
Francisco Bay Area. Accordingly, the Company has concluded it currently has a
single reportable segment for SFAS No. 131 purposes.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION AND FINANCIAL STATEMENT PRESENTATION:
The accompanying consolidated financial statements include the accounts of the
Company and its controlled subsidiaries, the operating partnerships (the
"Company"). All significant intercompany transactions have been eliminated in
consolidation.
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America ("GAAP") requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the dates of
the financial statements and the reported amounts of revenue and expenses during
the reporting periods. Accounting and disclosure decisions with respect to
material transactions that are subject to significant management judgments or
estimates include impairment of long lived assets, deferred rent reserves, and
allocation of purchase price relating to property acquisitions and the related
depreciable lives assigned. Actual results could differ from those estimates.
REAL ESTATE ASSETS AND RELATED INTANGIBLE ASSETS:
Real estate assets are stated at cost. Cost includes expenditures for
improvements or replacements. Maintenance and repairs are charged to expense as
incurred.
- 55 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
The purchase price allocation for property acquisition subsequent to June 30,
2001 is determined in accordance with the following principles under SFAS No.
141, "Business Combinations":
The fair value of the tangible assets of an acquired property, which includes
land, building and building/tenant improvements, is determined by valuing the
property as if it were vacant, and the "as-if-vacant" value is then allocated to
land, building and tenant improvements based on management's determination of
the relative fair values of these assets. Factors considered by management in
performing these analyses include certain costs during the lease-up periods
considering current market conditions and costs to execute similar leases. These
costs include estimates of lost rental revenue, leasing commissions, and tenant
improvements.
In allocating the fair value of the identified intangible assets of the acquired
property, above-market in-place lease value is recorded based on the present
value, using an interest rate which reflects the risks associated with the lease
acquired, of the difference between (i) the contractual amounts to be paid
pursuant to the in-place lease and (ii) management's estimate of fair market
lease rate for the corresponding in-place lease, measured over a period equal to
the remaining non-cancelable lease term. The capitalized above-market lease
value, included in real estate related intangible assets in the accompanying
December 31, 2003 consolidated balance sheet, is amortized as an offset to
rental revenue from real estate over the remaining non-cancelable lease term.
The value of in-place leases, exclusive of the value of above-market in-place
lease, is amortized to expense over the remaining non-cancelable periods of the
respective leases. If a lease were to be terminated prior to its stated
expiration, all unamortized amounts relating to that lease would be written off
in the period that the lease is terminated.
DEPRECIATION AND AMORTIZATION:
Depreciation and amortization are computed using the straight-line method over
estimated useful lives as follows:
Building shell and base building improvements of newly acquired properties Weighted average composite life of 40 years
Base building improvements made subsequent to initial property acquisition 25 years
Tenant improvements and furniture and fixtures Lesser of life of asset, generally 5-10 years,
or lease term
Above-market and in-place lease value Term of lease
Tenant improvements, including furniture fixtures, and base building
improvements made subsequent to the initial property acquisition, are included
in buildings and improvements in the consolidated balance sheet and total $2,494
and $2,077 at December 31, 2003 and $1,898 and $1,815, respectively, at December
31, 2002.
IMPAIRMENT OF LONG-LIVED ASSETS:
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 in accordance with Statement of Financial Accounting Standards No.
144 ("SFAS No. 144"), "Accounting for the Impairment and Disposal of Long-Lived
Assets". If the carrying amount of the asset, including any intangible assets
associated with that asset, exceeds its estimated undiscounted net cash flow,
before interest, the Company will recognize an impairment loss equal to the
difference between its carrying amount and its 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, such as the vacancy rates, rental rates and operating costs for R&D
facilities in the Silicon Valley area and related submarkets. 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. As of December 31, 2003 management believes that no impairment exists
based upon periodic reviews. No impairment losses were recorded for the years
ended December 31, 2003, 2002 and 2001.
DISCONTINUED OPERATIONS:
The Company adopted the SFAS No. 144, which addresses the financial accounting
for the disposal of long lived assets. SFAS No. 144 requires that the results of
operations and gains or losses on the sale of property sold subsequent to
December 31, 2001 that were not classified as held for sale at December 31, 2001
as well as the results of operations from properties that were classified as
held for sale subsequent to December 31, 2001 be presented in discontinued
operations if both the following
- 56 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
criteria are met: (a) the operation and cash flows of the property have been (or
will be) eliminated from the ongoing operations of the Company as a result of
the disposal transaction; and (b) the Company will not have any significant
involvement in the operations of the property after the disposal transaction.
SFAS 144 also requires prior period results of operations for these properties
to be restated and presented in discontinued operations in prior consolidated
statements of operations.
CASH AND CASH EQUIVALENTS:
The Company considers highly liquid short-term investments with initial
maturities of three months or less to be cash equivalents.
Cash and cash equivalents are primarily held in a single financial institution,
and at times, such balances may be in excess of the Federal Deposit Insurance
Corporation insurance limit.
OTHER ASSETS:
Included in other assets are costs associated with obtaining debt financing and
commissions associated with new leases. Such debt financing costs are being
amortized over the term of the associated debt, by a method that approximates
the effective interest method and such lease commissions are amortized
straight-line over the term of the related lease. If the lease is terminated
prior to the end of the lease term the Company charges any unamortized
capitalized lease commission cost to expense in the period that the lease is
terminated. Also included in other assets are obligations from the Berg Group of
approximately $7,494 to construct a building at 245 Caspian Drive in Sunnyvale,
California and $2,529 in tenant improvements at 5345 Hellyer Avenue in San Jose,
California (see Note 12).
MINORITY INTERESTS:
Minority interests represent the limited partnership interests in the operating
partnerships.
REVENUE RECOGNITION:
Rental income is derived from operating leases and 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 Receivable on the consolidated balance sheet. Certain lease
agreements contain terms that provide for additional rents based on
reimbursement of certain costs including property operating, maintenance and
real estate taxes. These additional rents from tenant reimbursements are
reflected on the accrual basis.
Rental revenue is affected if existing tenants terminate or amend their leases.
The Company tries to identify tenants who may be likely to declare bankruptcy,
cease operations or otherwise terminate leases prior to the end of the lease
term. By anticipating these events in advance, the Company expects to take steps
to minimize their impact on its reported results of operations through lease
renegotiations and other appropriate measures. Reserves against Deferred Rent
Receivable are estimated by management based on known financial conditions of
tenants and management's estimate of net realizeability of such receivables
based on existing or expected negotiations with tenants. The Company's judgments
and estimations about tenants' capacity to continue to meet their lease
obligations will affect the rental revenue recognized. To date, actual
reductions in revenue as a result of early terminations and the tenants'
inability to pay have been within management's estimates. However, material
differences may result in the amount and timing of our rental revenue for any
period if we made different judgments or estimations.
Lease termination fees are included in revenues. These fees are paid by tenants
who want to terminate their lease obligations before the end of the contractual
term of the lease. There is no way of predicting or forecasting the timing or
amounts of future lease termination fees.
The Company recognizes income from rent, tenant reimbursements and lease
termination fees and other income once all of the following criteria are met in
accordance with SEC Staff Accounting Bulletin 104 "Revenue Recognition":
- the agreement has been fully executed and delivered;
- services have been rendered;
- the amount is fixed and determinable; and
- 57 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
- the collect-ability is reasonably assured.
INCOME TAXES:
The Company has been taxed as a real estate investment trust ("REIT") under the
Internal Revenue Code of 1986, as amended, (the "Code") commencing with the
taxable year ended December 31, 1999. In order for the Company to qualify as a
REIT, it must distribute annually at least 90% of its REIT taxable income, as
defined in the Code, to its stockholders and comply with certain other
requirements. Accordingly, for the years ended December 31, 2003, 2002 and 2001,
no provision for federal income taxes has been included in the accompanying
consolidated financial statements.
For the year ended December 31, 2003, the Company's total dividends paid or
payable to the stockholders represent 98% of ordinary income and 2% return of
capital for income tax purposes. For the years ended December 31, 2002 and
December 31, 2001, the Company's total dividends paid or payable to the
stockholders represented 100% ordinary income for income tax purposes.
NET INCOME PER SHARE:
The computation of net income per share is based on the weighted average number
of common shares outstanding during the period. Diluted earnings per share
amounts are based upon the weighted average of common and common equivalent
shares outstanding during the year.
ACCOUNTING FOR STOCK-BASED COMPENSATION:
SFAS No. 123, "Accounting for Stock-Based Compensation," encourages, but does
not require companies to record compensation cost for stock-based employee
compensation plans at fair value. The Company has chosen to continue to account
for stock-based compensation using the intrinsic value method prescribed in
Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued
to Employees" and related interpretations. Accordingly, compensation cost for
stock options is measured as the excess, if any, of the quoted market price of
the Company's stock at the date of the grant over the amount an employee must
pay to acquire the stock.
The following table illustrates the unaudited pro forma effect on consolidated
net income available to common shareholders and consolidated earnings per share
if the fair value method had been applied to all outstanding and unvested stock
options for the last three years.
Year Ended December 31,
-----------------------------------------------------------
2003 2002 2001
(As Restated) (As Restated)
------------------ ------------------- ------------------
(dollars in thousands, except per share data)
Historical net income to common stockholders $16,212 $17,115 $18,086
Add back compensation expense for stock options
included in historical net income to common
stockholders - - -
Deduct compensation expense for stock options
determined under fair value based method (235) (264) (264)
Allocation of expense to minority interest 195 220 220
------------------ ------------------- ------------------
Pro forma net income to common stockholders $16,172 $17,071 $18,042
------------------ ------------------- ------------------
Earnings per share - basic:
Historical net income to common stockholders $0.91 $0.98 $1.06
Pro forma net income to common stockholders $0.91 $0.98 $1.05
Earnings per share - diluted:
Historical net income to common stockholders $0.91 $0.96 $1.03
Pro forma net income to common stockholders $0.91 $0.96 $1.03
------------------ ------------------- ------------------
The estimated fair value of the stock options granted during 2001 was $1.17 per
share on the date of grant using the Black-Scholes option pricing model with the
following weighted average assumptions: dividend yield of 8%, volatility of
23.03%, risk free interest rate of 4.85% and expected life of five years. There
were no stock options granted in 2002 and 2003.
- 58 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
FAIR VALUE OF FINANCIAL INSTRUMENTS:
The Company's financial instruments include cash and cash equivalents, accounts
receivable, accounts payable, and debt. Considerable judgment is required in
interpreting market data to develop estimates of fair value. Accordingly, the
estimates presented herein are not necessarily indicative of the amounts that
the Company could realize in a current market exchange. The use of different
market assumptions and/or estimation methodologies may have a material effect on
the estimated fair value amounts. Cash and cash equivalents, accounts
receivable, and accounts payable are carried at amounts that approximate their
fair values due to their short-term maturities. The carrying amounts of the
Company's variable rate debt approximate fair value since the interest rates on
these instruments are equivalent to rates currently offered to the Company For
fixed rate debt, the Company estimates fair value by using discounted cash flow
analyses based on borrowing rates for similar kinds of borrowing arrangements.
The fair value of the Company's fixed rate debt at December 31, 2003 was
approximately $255,980 as compared to its carrying value of $230,620.
RECLASSIFICATIONS:
Certain amounts from prior year's financial statements have been reclassified to
conform to the presentation of the current year's financial statements.
CONCENTRATION OF CREDIT RISK:
The Company's properties are not geographically diverse, and its tenants operate
primarily in the information technology industry. Additionally, because the
properties are leased to 78 tenants at December 31, 2003, default by any major
tenant could significantly impact the results of the consolidated total. One
tenant, Microsoft Corporation, accounted for approximately 16.3%, 15.7% and
16.0% of the Company's rental income for the years ended December 31, 2003, 2002
and 2001, respectively, with the next largest tenant accounting for 10.0%, 8.6%
and 8.8%, respectively, of total rental income. Rental income from Microsoft
Corporation was $21,151, $20,338 and $19,556 for the years ended December 31,
2003, 2002 and 2001, respectively. Future minimum rents from this tenant are
$50,650. During 2003, fifteen of the Company's tenants relocated, filed
voluntary petitions for bankruptcy protection under Chapter 11 or ceased
operations.
NEW ACCOUNTING PRONOUNCEMENTS
In November 2002, the FASB issued FASB Interpretation No. (FIN) 45 "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others," which elaborates on the disclosures to be
made by a guarantor in its interim and annual financial statements about its
obligations under certain guarantees that it has issued. It also clarifies that
a guarantor is required to recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken in issuing the
guarantee. The initial recognition and initial measurement provisions of this
Interpretation are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002, irrespective of the guarantor's fiscal
year-end. The disclosure provisions are effective for financial statements for
annual or interim periods ending after December 15, 2002. The Company has
provided disclosures of its guarantees in the accompanying footnotes. The
Company has not entered into any new guarantees or modified any existing
guarantees subsequent to December 31, 2002; therefore, adoption of this
statement has had no effect on the Company's financial position, operating
results or cash flows.
In December 2003, the FASB issued FIN 46R, "Consolidation of Variable Interest
Entities," a revision to FIN 46, which was issued in January 2003. Under FIN
46R, a variable interest entity must be consolidated by a company if that
company is subject to a majority of the entity's expected losses or entitled to
receive a majority of the entity's expected residual returns or both. FIN 46R
requires disclosures about variable interest entities that a company is not
required to consolidate, but in which it has a significant variable interest.
The consolidation requirements apply to existing entities in the first reporting
period that ends after March 15, 2004. The Company will adopt the consolidation
and disclosure requirements of FIN 46R in the first quarter of 2004. The Company
expects no significant effect on the consolidated financial position, results of
operations or cash flows as a result of the initial adoption of this standard in
regard to existing variable interest entities; however, newly formed entities
could meet these requirements and will be recorded as appropriate.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure", which amended SFAS No. 123 "Accounting
for Stock-Based Compensation". SFAS No. 148 provides alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based compensation and amends the disclosure requirements of SFAS No.
123 to require prominent disclosures in both annual and interim financial
statements about the method of accounting for stock-based employee compensation
and the effect of the method used on
- 59 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
reported results. On December 31, 2002, the Company adopted the disclosure
provisions of SFAS No. 148 and continued to account for stock-based compensation
under APB Opinion No. 25 "Accounting for Stock Issued to Employees". Therefore,
the adoption of SFAS No. 148 did not have any effect on the Company's financial
position, operating results or cash flows.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This Statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). SFAS No. 150 was effective
beginning in the third quarter of 2003. The FASB deferred the implementation of
SFAS No. 150 as applied to certain minority interests in finite life entities,
however. The Company adopted the requirements of SFAS No. 150 in the third
quarter of 2003, and considering the aforementioned deferral, it did not impact
the Company's financial position, results of operations or cash flows.
3. DEFERRED RENT ALLOWANCE
The following table represents activity in the deferred rent allowance for the
three years ended December 31, 2003, 2002 and 2001:
Provision
Beginning Against Charge- Ending
Balance Revenues off Balance
-------------- ------------ ------------ -------------
(dollars in thousands)
Year ended December 31, 2001 $ - $910 $310 $600
-------------- ------------ ------------ -------------
Year ended December 31, 2002 $600 $4,736 $3,336 $2,000
-------------- ------------ ------------ -------------
Year ended December 31, 2003 $2,000 $2,552 $2,552 $2,000
-------------- ------------ ------------ -------------
4. STOCK TRANSACTIONS
As of December 31, 2003 and 2002, $1,471 and $1,369 remained outstanding under
notes issued in connection with the Company's purchase of its general
partnership interests in 1998 (the "demand notes"), respectively. The demand
notes which accrue interest at 7.25%, along with the interest expense (interest
income to the operating partnerships), are eliminated in consolidation and are
not included in the corresponding line items within the consolidated financial
statements. The Company and the operating partnerships have agreed to extend the
due date of the demand notes to September 30, 2005. At present, the Company's
only means for repayment of this debt is through distributions received from the
operating partnerships in excess of the amount of dividends to be paid to the
Company's stockholders.
The limited partners of the operating partnerships have the right to tender
their O.P. Units to the Company for shares of common stock or, at the Company's
election, for cash. Each of the limited partners of the operating partnerships
(other than Carl E. Berg and Clyde J. Berg) has the annual right to exercise put
rights and cause the operating partnerships to purchase a portion of the limited
partner's O.P. Units at a purchase price based on the average market value of
the common stock for the 10-trading day period immediately preceding the date of
tender, generally limited to one-third of the aggregate number of O.P. Units
owned by each limited partner. Upon the exercise of any such right by a limited
partner, the Company will have the option to purchase the tendered O.P. Units
with available cash, borrowed funds or the proceeds of an offering of newly
issued shares of common stock. These put rights are available once a year. If
the total purchase price of the O.P. Units tendered by all of the eligible
limited partners in one year exceeds $1 million, the Company or the operating
partnerships will be entitled to reduce proportionately the number of O.P. Units
to be acquired from each tendering limited partner so that the total purchase
price does not exceed $1 million.
During the year ended December 31, 2003, stock options were exercised to
purchase a total of 150,362 shares of common stock, consisting of 60,362 shares
exercised at $4.50 per share and 90,000 shares exercised at $8.25 per share.
Total proceeds to the Company were approximately $1,014.
During the year ended December 31, 2002, stock options at $4.50 per share were
exercised to purchase a total of 33,550 shares of common stock. Total proceeds
to the Company were approximately $151.
- 60 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
During the year ended December 31, 2001, stock options were exercised to
purchase a total of 68,088 shares of common stock, consisting of 14,588 shares
exercised at $4.50 per share, 47,500 shares exercised at $8.25 per share, and
6,000 shares exercised at $13.00 per share. Total proceeds to the Company were
approximately $535.
In 2003 and 2002, 257,000 and 124,000 O.P. Units were exchanged for 257,000 and
124,000 shares of the Company's common stock, respectively, under the terms of
the December 1998 Exchange Rights Agreement among the Company and all limited
partners of the operating partnerships.
5. MINORITY INTEREST
Minority interest represents the separate private ownership of the operating
partnerships, by the Berg Group and other non-affiliate interests. In total,
these interests account for 82.98% and 83.18%, on a weighted average basis, of
the ownership interests in the real estate operations of the Company as of
December 31, 2003 and 2002, respectively. 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 operating partnerships have ownership interests of 83.33%, 75% and 50% and
act as the managing member in three separate joint ventures, which were
established to hold properties. The operating partnerships control the joint
ventures, and accordingly, these joint ventures are consolidated in the
COmpany's financial statements. The minority interest in the joint ventures is
reflected as a component of minority interest of the operating partnerships. For
the years ended December 31, 2003, 2002 and 2001, income associated with the
interests held by the third parties of the three joint ventures was $581, $587
and $650, respectively.
6. 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 R&D property
developed by the Berg Group on land currently owned or optioned, or acquired for
these purposes in the future, directly or indirectly, by Carl E. Berg or Clyde
J. Berg. At present, there are approximately 90 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, O.P. Units valued at the
average closing price of the shares of common stock over the 30-trading-day
period preceding the acquisition date. To date, the Company has completed 20
acquisitions under the Berg Land Holdings Option Agreement representing
approximately 1,992,000 rentable square feet. Upon the Company's exercise of an
option to purchase any of the future R&D property developments, the acquisition
price will equal the sum of (a) the full construction cost of the building; plus
(b) 10% of the full construction cost of the building; plus (c) interest at
LIBOR (London Interbank Offer Rate) plus 1.65% on the amount of the full
construction cost of the building for the period from the date funds were
disbursed by the developer to the close of escrow; plus (d) the original
acquisition cost of the parcel on which the improvements will be constructed,
which range from $8.50 to $20.00 per square foot for land currently owned; plus
(e) 10% per annum of the amount of the original acquisition cost of the parcel
from the later of January 1, 1998 or the seller's acquisition date to the close
of escrow; minus (f) the aggregate principal amount of all debt encumbering the
acquired property, or a lesser amount as approved by the members of the
Independent Directors committee of the Company's Board of Directors. Generally,
the Company will not acquire any projects until they are fully completed and
leased.
No estimate can be given at this time as to the total cost to the Company to
acquire future projects under the Berg Land Holdings Option Agreement, or the
timing as to when the Company will acquire such projects. In addition to any
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 ownership 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 R&D, office and/or
industrial development or use in the states of California, Oregon, and
Washington.
- 61 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
Although the Company has the right to acquire the new properties available to it
under the terms of the Berg Land Holdings Option Agreement, 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.
Given the economic downturn in the Silicon Valley, the Company may not be able
to maintain historical levels of growth from acquisitions of new developments in
the future.
- 62 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
7. DEBT
The following table sets forth certain information regarding debt outstanding as
of December 31, 2003 and 2002.
Balance Maturity Interest
Debt Description Collateral Properties At December 31, Date Rate
--------------------------------- --------------------------------------------- ---------------------- -------------- ------------
2003 2002
---------- ----------
Line of Credit:
Berg Group (related parties) 2033-2043 Samaritan Drive, San Jose, CA $ 6,320 $ 58,792 3/05 (1)
2133 Samaritan Drive, San Jose, CA ---------- ----------
2233-2243 Samaritan Drive, San Jose, CA
1310-1450 McCandless Drive, Milpitas, CA
1795-1845 McCandless Drive, Milpitas, CA
Cupertino National Bank(4) Not Applicable 23,965 23,839 9/04 (4)
---------- ----------
Mortgage Notes Payable (related 5300-5350 Hellyer Avenue, San Jose, CA 10,762 11,078 6/10 7.650%
parties): ---------- ----------
Mortgage Notes Payable: (2)
Prudential Capital Group (3) 20400 Mariani Avenue, Cupertino, CA 733 1,423 10/06 8.750%
Washington Mutual (Home S&L Assoc.)10460 Bubb Road, Cupertino, CA 225 297 12/06 9.500%
Prudential Insurance Company of 10300 Bubb Road, Cupertino, CA 121,455 123,342 10/08 6.560%
America (5) 10500 North De Anza Blvd, Cupertino, CA
4050 Starboard Drive, Fremont, CA
45700 Northport Loop, Fremont, CA
45738 Northport Loop, Fremont, CA
450 National Ave, Mountain View, CA
6311 San Ignacio Avenue, San Jose, CA
6321 San Ignacio Avenue, San Jose, CA
6325 San Ignacio Avenue, San Jose, CA
6331 San Ignacio Avenue, San Jose, CA
6341 San Ignacio Avenue, San Jose, CA
6351 San Ignacio Avenue, San Jose, CA
3236 Scott 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
Northwestern Mutual Life 1750 Automation Parkway, San Jose, CA 97,445 - 1/13 5.640%
Insurance Co. (6) 1756 Automation Parkway, San Jose, CA
1762 Automation Parkway, San Jose, CA
6320 San Ignacio Avenue, San Jose, CA
6540-6541 Via Del Oro, San Jose, CA
6385-6387 San Ignacio Avenue, San Jose, CA
2251 Lawson Lane, Santa Clara, CA
1325 McCandless Drive, Milpitas, CA
1650-1690 McCandless Drive, Milpitas, CA
20605-20705 Valley Green Dr., Cupertino, CA
Citicorp USA, Inc. (4) 2001 Walsh Avenue, Santa Clara, CA 80,000 - 9/04 (4)
2880 Scott Boulevard, Santa Clara, CA
2890 Scott Boulevard, Santa Clara, CA
2770-2800 Scott Boulevard, Santa Clara, CA
2220 Central Expressway, Santa Clara, CA
2300 Central Expressway, Santa Clara, CA
2330 Central Expressway, Santa Clara, CA
---------- ----------
Mortgage Notes Payable 299,858 125,062
Uncollateralized Loan:
Citicorp USA, Inc. (7) Not Applicable - 20,000 3/03 (8)
---------- ----------
Total $340,905 $238,771
========== ==========
(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
2005. The interest rate was 2.5% and 2.7% at December 31, 2003 and 2002,
respectively.
(2) Mortgage notes payable generally require monthly installments of interest
and principal over various terms extending through the year 2013. The
weighted average interest rate of mortgage notes payable was 6.23% and
6.68% at December 31, 2003 and 2002, respectively.
(3) The amount of $465 was prepaid and reduced the outstanding principal
balance of the Prudential Capital Group loan in January 2003.
- 63 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
(4) Interest rate equal to LIBOR plus 2%. The interest rate for the Cupertino
National Bank line of credit at December 31, 2003 and 2002 was 3.17% and
3.72%, respectively. The interest rate for the Citicorp USA, Inc. mortgage
loan at December 31, 2003 was 3.17%. In April 2004 and July 2004 the loans
with Citicorp USA, Inc., and Cupertino National Bank, respectively,
matured. Cupertino National Bank and Citicorp USA, Inc. have granted
extensions of the loans to September 2, 2004 and September 6, 2004,
respectively, pending the completion of the Company's Form 10-K filing for
2003. The extension of the Citicorp loan is subject to the Company
providing additional collateral valued at not less than $7.6 million, which
the COmpany has proposed to Citicorp, and Citicorp is currently appraising
it. The Company is in the process of renegotiating the terms and extending
these loans for an additional two year period. The Company does not believe
that the terms of the extended loans will differ materially from their
current terms. Mission West Properties, Inc. is the borrower under the
Cupertino National Bank line of credit which is guaranteed by Mission West
Properties, L.P. and Mission West Properties, L.P. II. Mission West
Properties, L.P. is the borrower under the Citicorp USA., mortgage loan
which is guaranteed by Carl E. Berg, Mission West Properties, L.P. I,
Mission West Properties L.P. II and Mission West Properties L.P. III. The
Cupertino National Bank line of credit and Citicorp USA, Inc., contain
certain loan covenants. The Company was not in compliance with one covenant
pertaining to its late filing of its Form 10-K for the year ending December
31, 2003 and Form 10-Q for the period ending March 31, 2004 (the "Financial
Reporting Covenants"). Both banks have elected not to enforce the Financial
Reporting Covenants during the Loan Extension Period. Compliance with the
Financial Reporting Covenant is a condition of the renewal for both loans.
(5) The Prudential Insurance loan is payable in monthly installments of $827,
which includes principal (based upon a 30-year amortization) and interest.
John Kontrabecki, one of the limited partners, has guaranteed approximately
$12,000 of this debt. Costs and fees incurred with obtaining this loan
aggregated approximately $900.
(6) The Northwestern loan is payable in monthly installments of $696, which
includes principal (based upon a 20-year amortization) and interest. Costs
and fees incurred with obtaining this loan aggregated approximately $675.
(7) The uncollateralized Citicorp USA, Inc. loan was paid off in its entirety
in January 2003.
(8) The uncollateralized loan from Citicorp USA, Inc. carried a fixed LIBOR
interest rate equal to 4.09% for the first six months and LIBOR plus 2.0%
thereafter. The interest rate at December 31, 2002 was 3.81%.
Scheduled principal payments on debt for the years ending are as follows:
Fixed Rate Debt Variable Rate Debt
(Including Related (Including Related
Parties) Parties) Total
----------------------- ---------------------- ----------------
December 31, 2004 $ 5,612 $103,965 $109,577
December 31, 2005 5,977 6,320 12,297
December 31, 2006 6,245 6,245
December 31, 2007 6,350 6,350
December 31, 2008 6,748 6,748
Thereafter 199,688 199,688
----------------------- ---------------------- ----------------
$230,620 $110,285 $340,905
======================= ====================== ================
8. OPERATING PARTNERSHIP AND STOCKHOLDER DISTRIBUTIONS
During 2003 the Company, as general partner of the operating partnerships,
declared quarterly distributions aggregating $0.96 per common share and O.P.
Unit for total distributions of $100,064, including $25,031 payable in January
2004. Total distributions attributable to O.P. Units owned by various members of
the Berg Group were $75,230, which was treated as a draw on the Berg Group line
of credit.
During 2002 the Company, as general partner of the operating partnerships,
declared quarterly distributions aggregating $0.96 per common share and O.P.
Unit for total distributions of $99,643, including $24,951 payable in January
2003. Total distributions attributable to O.P. Units owned by various members of
the Berg Group were $75,076, which was treated as a draw on the Berg Group line
of credit.
During 2001 the Company, as general partner of the operating partnerships,
declared quarterly distributions aggregating $0.89 per common share and O.P.
Unit for total distributions of $91,126, including $24,742 payable in January
2002. Total distributions attributable to O.P. Units owned by various members of
the Berg Group were $70,371, which was treated as a draw on the Berg Group line
of credit.
9. STOCK-BASED COMPENSATION PLANS
The Company's 1997 Stock Option Plan was approved by the Company's shareholders
on November 10, 1997. The 1997 Stock Option Plan was adopted so that the Company
may attract and retain the high quality employees, consultants and directors
necessary to build the Company's infrastructure and to provide ongoing
incentives to the Company's employees in the form of options to purchase the
Company's common stock by enabling them to participate in the Company's success.
- 64 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
The 1997 Stock Option Plan provides for the granting to employees, including
officers (whether or not they are directors) of "incentive stock options" within
the meaning of Section 422 of the Code, and for the granting of non-statutory
options to employees, consultants and directors of the Company. Options to
purchase a maximum of 5,500,000 shares of common stock may be granted under the
1997 Stock Option Plan, subject to equitable adjustments to reflect certain
corporate events.
No options were granted in 2003 and 2002.
During 2001, options were granted to one employee totaling 375,000, which become
exercisable as follows: a) six months from date of grant, 8.33%; and b) each
month thereafter for 66 months, an additional 1.39%. This option has a term of
eight years from the date of grant subject to earlier termination in certain
events related to termination of employment. The options granted during 2001
have an $11.33 per share exercise price.
The remaining contractual lives of unexercised options granted range from July
2005 to April 2009.
The following table shows the activity and detail for the 1997 Stock Option
Plan.
1997 Stock Option Price
Option Plan Per Share
--------------- ------------------
Balance, December 31, 1998 680,000
Options granted 337,000 $8.25
Options exercised (191,920)
Options cancelled (299,722)
---------------
Balance, December 31, 1999 525,358
Options granted 80,000 $8.25
Options granted 352,000 $13.00
Options exercised (52,991)
Options cancelled (113,867)
---------------
Balance, December 31, 2000 790,500
Options granted 375,000 $11.33
Options exercised (68,088)
Options cancelled (113,500)
---------------
Balance, December 31, 2001 983,912
Options exercised (33,550)
---------------
Balance, December 31, 2002 950,362
Options exercised (150,362)
Options cancelled (13,000)
---------------
Balance, December 31, 2003 787,000
The following table summarizes information regarding Options outstanding at
December 31, 2003:
Options Outstanding Options Exercisable Options Not Exercisable
-------------------------------------------------------------------------------------------------------
Weighted
Average
Remaining Weighted Weighted Weighted
Contractual Average Average Average
Options Life in Years(1) Exercise Price Options Exercise Price Options Exercise Price
Range of Exercise Prices -------------------------------------------------------------------------------------------------------
$8.25 140,000 2.0 $8.25 134,000 $8.25 6,000 $8.25
$11.33 375,000 5.3 $11.33 166,667 $11.33 208,333 $11.33
$13.00 272,000 2.8 $13.00 229,000 $13.00 43,000 $13.00
-------------------------------------------------------------------------------------------------------
$8.25 to $13.00 787,000 3.9 $11.36 529,667 $11.28 257,333 $11.54
-------------------------------------------------------------------------------------------------------
(1) Expiration dates range from July 2005 to April 2009.
As of December 31, 2003, 3,991,089 additional shares were available for grant
under the 1997 Stock Option Plan. None of the options granted are contingent
upon the attainment of performance goals or subject to other restrictions. As of
December 31, 2003, outstanding options to purchase 529,667 shares of common
stock were exercisable.
- 65 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
The Company has adopted an employee investment plan (the "Plan"), under Section
401(k) of the Internal Revenue Code. Employees who are at least 21 years old and
who have completed six months of eligibility service may become participants in
the Plan. Each participant may make contributions to the Plan through salary
deferrals in amounts of at least 1% to a maximum of 15% of the participant's
compensation, subject to certain limitations imposed by the Internal Revenue
Code. The Company contributes an amount up to 15% of the participant's
compensation, based upon management's discretion. A participant's contribution
to the Plan is 100% vested and non-forfeitable. A participant will become vested
in 100% of the Company's contributions after two years of eligible service. For
the years ended December 31, 2003, 2002 and 2001, the Company recognized $92,
$95 and $58 of expense for employer contributions made in connection with this
plan, respectively.
10. NET INCOME PER SHARE
Basic net income per share is computed by dividing net income by the
weighted-average number of common shares outstanding for the period. Diluted net
income per share is computed by dividing net income by the sum of
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:
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
2003 2002 2001
------------------ ------------------ -----------------
Weighted average shares outstanding (basic) 17,739,609 17,455,799 17,103,714
Incremental shares from assumed option exercise 63,338 399,093 485,639
------------------ ------------------ -----------------
Weighted average shares outstanding (diluted) 17,802,947 17,854,892 17,589,353
================== ================== =================
The outstanding O.P. Units have been excluded from the diluted net income per
share calculation as there would be no effect on the diluted net income per
share since the minority interests' share of income would also be added back to
net income. O.P. Units outstanding at December 31, 2003 and 2002 were 86,398,064
and 86,474,032, respectively.
11. OTHER INCOME
Other income, including interest, was approximately $4,527, $4,248 and $2,465
for the years ended December 31, 2003, 2002 and 2001, respectively. For the year
ended December 31, 2003, prior tenant bankruptcy settlements accounted for
approximately $2,231 of other income. For the year ended December 31, 2002,
termination fees accounted for approximately $2,529 of other income.
12. RELATED PARTY TRANSACTIONS
As of December 31, 2003 and 2002, the Berg Group owned 78,364,716 and 78,338,684
O.P. Units, respectively, of the total 86,398,064 and 86,474,032 O.P. Units
issued and outstanding, respectively. The Berg Group's interest in the Company
represents 75.1% and 75.4% of the Company as of December 31, 2003 and 2002,
respectively, assuming conversion of the O.P. Units into common shares of the
Company.
The Company periodically acquired unleased properties, which include land, the
building shell and base building improvements, from the Berg Group under the
Berg Group Land Holdings Option Agreement. These acquisitions from the Berg
Group are made for properties where the Company has previously identified a
tenant, and in conjunction with the acquisition, the Company executes a lease
agreement with the tenant. In many of the acquisitions from the Berg Group,
lease commissions relating to these leasing activities conducted by the Company
are paid by the Berg Group and reimbursed by the Company in connection with the
acquisition. These lease commissions are recorded separately in other assets on
the Company's consolidated balance sheet.
During 2003 the Company acquired one R&D property in San Jose and a 50% interest
in a joint venture from the Berg Group. These acquisitions added approximately
129,000 square feet of rentable space and were acquired under the Berg Land
Holdings Option Agreement. The total gross acquisition price was approximately
$12,953. The Company financed these acquisitions by borrowing $9,000 under its
line of credit from the Berg Group and issuing 350,163 O.P. Units to various
members of the Berg Group.
During 2002 the Company acquired two R&D properties, both located in Silicon
Valley. These acquisitions added approximately 290,000 square feet of rentable
space and were acquired from the Berg Group under the Berg Land Holdings
- 66 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
Option Agreement. The total gross acquisition price for these two properties was
approximately $30,953, of which $1,426 related to the reimbursement of leasing
commissions paid by the Berg Group on behalf of the Company. The Company
financed these acquisitions by borrowing $18,000 under the Berg Group line of
credit and issuing 835,491 O.P. Units to various members of the Berg Group.
As of December 31, 2003 and 2002, debt in the amount of $6,320 and $58,792,
respectively, was due the Berg Group under the line of credit. This amount
includes $9,000 and $18,000 of debt assumed in connection with the acquisitions
of properties from the Berg Group in 2003 and 2002, respectively. Additionally,
in 2003 and 2002, the operating partnerships declared distributions of $0.96 per
O.P. Unit. Distributions paid to various members of the Berg Group were $75,224
and $75,281 during 2003 and 2002, respectively. Interest expense incurred in
connection with the Berg Group line of credit was $227, $2,562 and $3,828 for
the years ended December 31, 2003, 2002 and 2001, respectively.
As of December 31, 2003 and 2002, debt in the amount of $10,762 and $11,078,
respectively, was due the Berg Group under a mortgage note established May 15,
2000 in connection with the acquisition of a 50% interest in Hellyer Avenue
Limited Partnership, the obligor under the mortgage note. The mortgage note
bears interest at 7.65%, and is due in ten years with principal payments
amortized over 20 years. Interest expense incurred in connection with the Berg
Group mortgage note was $837, $860 and $881 for the years ended December 31,
2003, 2002 and 2001, respectively.
TRANSFER OF INTEREST TO BERG GROUP IN CONSOLIDATED JOINT VENTURE:
In July 2000, the Hellyer Avenue Limited Partnership ("Hellyer LP") was formally
organized as a California limited partnership between Mission West Properties,
L.P. ("MWP"), of which the Company as the managing general partner, and Republic
Properties Group ("RPC"), an unaffiliated third party, as general partner and
limited partners. MWP was designated as the managing general partner of Hellyer
LP. For a 50% ownership interest in Hellyer LP, RPC agreed to cause Stellex
Microwave Systems, Inc. ("Stellex") to provide a 15-year lease on an approximate
160,000 square foot R&D building to be constructed by Berg & Berg Enterprises,
Inc. ("BBE") on land owned by another Berg Group member.
As part of the transaction, MWP acquired the underlying land pursuant to the
Berg Land Holding Option Agreement for a price of $5.7 million by issuing
659,223 OP units to the Berg Group entity that owned the property. Further,
under the terms of the Hellyer LP partnership agreement MWP then contributed the
land to the partnership at an agreed value of $9.6 million which amount was to
be amortized and paid to MWP in the form of income and cash flow preferences.
The transaction was reviewed and approved by the Independent Directors Committee
of the Company's board of directors.
In connection with the transaction, BBE built and paid for all improvements on
the land. The total cost of the R&D building, exclusive of specified tenant
improvements obligations, was approximately $11.4 million. Hellyer LP issued a
note for the amount of those construction costs to BBE, which note was secured
by the buildings.
Because RPC's interest in Hellyer LP was attributable solely to its commitment
to obtain Stellex as a tenant for the property, the partnership agreement
provided that if a payment default occurred within the first five years of the
Stellex lease, RPC would lose 100% of its interest in the partnership, and if a
payment default occurred during the second five year period under the lease, RPC
would lose 50% of its interest in Hellyer LP.
Pursuant to RPC's commitment to Hellyer LP Stellex executed a lease agreement
obligating Stellex, among other things, to pay monthly rent starting at $1.60
per square foot on a triple net basis for 15 years and to reimburse BBE for the
tenant improvement obligations, which ultimately totaled approximately $10.5
million.
Under the lease terms, Stellex was obligated to reimburse BBE in full for the
tenant improvement costs no later than August 25, 2000. Several days before the
due date, representatives of Stellex met with representatives of MWP and
informed them that Stellex could not pay the balance due BBE. Stellex requested
MWP immediately to draw down the letter of credit as a result of default on the
tenant improvement payment required under the lease.
On September 1, 2000, MWP, as the general partner of Hellyer LP, ceased all
allocations of income and cash flow to RPC and exercised the right under the
partnership agreement to cancel RPC's entire interest in the partnership.
Following discussions with and approval by the Independent Directors Committee,
the Company authorized the transfer of RPC's interest in Hellyer LP to BBE.
Under the Berg Land Holdings Option Agreement and the Acquisition Agreement
dated as of May 14, 1998, the Independent Directors Committee of the Board of
Directors had the right, but not the obligation, to reacquire on behalf of the
- 67 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
Company the property interest and the related distributions related to the
property interest at any time. The transfer was effective as of September 1,
2000.
Stellex filed for bankruptcy protection on September 12, 2000. On November 20,
2000, RPC filed suit in the Circuit Court of Maryland for Baltimore City to
recover past distributions and its interest in the Hellyer LP. The Company
counter-sued on behalf of itself and MWP in California Superior Court. The
Maryland suit went to trial in June 2002. In February 2001
MWP filed suit against RPC in Superior Court of California for the County of
Santa Clara. Following a decision in the Maryland case MWP at the advice of
legal counsel filed an appeal. The California case has been stayed pending final
resolution of the Maryland case. In April 2004 the Circuit Court for Baltimore
City, Maryland issued a Memorandum Opinion in the case and awarded damages of
$934 to the RPC plaintiffs, which must be paid by us or MWP. The court denied
all requests by MWP, including a declaration that all of RPC's interests in
Heller L.P. were validly converted to limited partnership interests and
transferred to MWP or its designee in accordance with the terms of the Hellyer
L.P. partnership agreement. The court also denied RPC's request for an
injunction ordering the reinstatement of RPC's partnership interests in Hellyer
L.P. The Company has appealed the decision to the Maryland Appeals Court. Under
the pre-appeal hearing procedures, the Maryland Appeals Court requires a
mediation hearing before the parties can appear before the Appeals Court. No
date has been set for such a hearing. The Company does not believe that any
further court decisions in this case, for or against us and MWP, will have a
material adverse effect on its financial position.
In January 2002, Stellex was acquired through its bankruptcy proceeding by a
division of Tyco Corporation. In connection with the acquisition of Stellex, the
purchaser assumed the lease with Hellyer LP, agreed to comply with all terms of
lease and reimbursed BBE for the tenant improvements, as required under the
lease agreement and the Bankruptcy Court order.
Since the inception of Hellyer LP, the Company has accounted for the properties
owned by the partnership on a consolidated basis, with reductions for the
minority interest held by the minority partner (first RPC and then BBE). In each
period, the Company has accrued amounts payable by Hellyer LP to the minority
interest partner, including BBE prior to payment. BBE's share of earnings
allocated to its 50% minority interest was $400, $303 and $384 in 2003, 2002 and
2001, respectively. As of December 31, 2003, accumulated cash flow distributions
from Hellyer LP totaling approximately $1.5 million were accrued and distributed
to BBE. If the Company's litigation with RPC is ultimately decided in RPC's
favor, the Company anticipates that BBE may be required to return RPC's former
interest in Hellyer LP and all prior distributions to RPC. As a result of this
uncertainty, in October 2003, the Company recorded such distributions as an
account receivable from BBE, which is included in other assets, with an
offsetting account payable to BBE.
If the Company's litigation with RPC is ultimately decided in RPC's favor, the
Company anticipates that BBE may be required to return RPC's former interest in
Hellyer LP and all prior distributions to RPC. If the litigation is ultimately
decided in favor of the Company, the Independent Directors Committee of the
Board of Directors has the right, but not the obligation, to acquire on behalf
of the Company the former RPC interest and related distributions from BBE under
the terms of the Berg Land Holdings Option Agreement and the Acquisition
Agreement between the Company and the Berg Group.
ACQUISITION OF CARL E. BERG'S INTEREST IN UNCONSOLIDATED JOINT VENTURE: In July
1999 an unrelated party, TBI, advised Carl E. Berg that TBI had an option to
purchase approximately 78.89 acres of unimproved land zoned for R&D development
in Morgan Hill at $2.50 per square foot that would expire in approximately six
months. TBI offered Mr. Berg a 50% interest in the development of this land if
Mr. Berg provided 100% financing for the land at 0% interest for three years.
Mr. Berg advised TBI of his obligation to offer all R&D development
opportunities on the West Coast to the Company and further advised TBI that the
Company's Independent Directors Committee must approve the acquisition of any
properties and that the Company's policy was only to acquire properties that are
leased pursuant to the Berg Land Holdings Option Agreement. The development
joint venture between TBI and the Berg Group proceeded on that basis. Building
construction was financed through loans facilitated by the Berg Group. In early
2003, TBI formed TBI-MSW, a new limited partnership to own all the leased
buildings. The Berg Group offered its 50% non-controlling limited partnership
interest in TBI-MSW to the Company at cost plus an annual interest rate of 7% on
the funds advanced by the Berg Group which amounted to $1.8 million. The
Independent Directors Committee and the Berg Group agreed to use a 7% interest
rate instead of the rate and fees specified in the Berg Land Holdings Option
Agreeement because the transaction differed from the standard build-to-suit
development specified under that agreement. TBI-MSW owned four fully leased
buildings totalling approximately 593,000 rentable square feet. The buildings
were subject to mortgage loans totalling %53.6 million. The Independent
Directors Committee approved the Company's acquisition of the Berg Groups 50%
interest in the joint venture, effective January 1, 2003. The development joint
venture between the Berg Group and TBI retained two vacant shell R&D buildings
and five unimproved
- 68 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
lots. In April 2003, Comcast, Inc. offered to purchase one of the vacant
buildings and two acres of adjoining land from the development joint venture for
net proceeds of $2.8 million, after debt repayment. Prior to the sale of the
property, TBI-MSW acquired this property at no cost under the terms of the Berg
Land Holdings Option Agreement, and the Company received a net distribution of
$1.4 million from the sale. The transaction was approved by the Independent
Directors Committee. The Berg Group continues to own a 50% interest in the
remaining vacant building and five unimproved lots.
BERG CONTROLLED ENTITIES HAVE FINANCIAL INTERESTS IN CERTAIN TENANTS THAT LEASE
SPACE FROM THE COMPANY:
During December 31, 2003, 2002 and 2001, Carl E. Berg or entities controlled by
Mr. Berg have financial interests in several companies that lease space from the
operating partnerships, which include three companies where Mr. Berg has a
greater than 10% ownership interest. These related tenants occupy approximately
48,000 square feet and contributed $904, $748 and $414 in rental revenue in
2003, 2002 and 2001, respectively. Under the Company's Charter, bylaws and
agreements with the Berg Group, the individual members of the Berg Group are
prohibited from acquiring shares of the Company's common stock if such
acquisition would result in their beneficial ownership percentage of the
Company's common stock causing the Company to violate any REIT qualification
requirement.
BERG COMMITMENT TO COMPLETE FUTURE IMPROVEMENTS AND BUILDING IN CONNECTION WITH
CERTAIN ACQUISITIONS FROM THE BERG GROUP UNDER THE BERG LAND HOLDINGS OPTION
AGREEMENT:
The Berg Group has an approximately $2.5 million commitment to complete certain
tenant improvements in connection with the Company's 2002 acquisition of 5345
Hellyer Avenue in San Jose. The Company recorded this portion of its purchase
consideration paid to the Berg Group as an Other Asset on its Consolidated
Balance Sheets. The Berg Group plans to satisfy this commitment to complete
certain tenant improvements when requested by the Company following the approval
of the IDC.
The Berg Group has an approximately $7.5 million commitment to complete an
approximately 75,000 to 90,000 square foot building in connection with the
Company's 2000 acquisition of 245 Caspian in Sunnyvale which is comprised of
approximately three acres of unimproved land. The Company recorded this portion
of its purchase consideration paid to the Berg Group as an Other Asset on its
Consolidated Balance Sheets. The Berg Group plans to satisfy this commitment to
construct a building when requested by the Company following the approval of the
IDC.
LEASING AND OVERHEAD REIMBURSEMENTS PROVIDED BY BERG CONTROLLED ENTITY
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 $90, $90 and
$88 for the years ended December 31, 2003, 2002 and 2001, respectively.
13. FUTURE MINIMUM RENTS
The Company, through the operating partnerships, owns interests in 109 R&D
properties that are leased to tenants under net operating leases with initial
terms extending to the year 2015, and are typically subject to fixed increases.
Generally, the leases grant tenants renewal options. Future minimum rentals
under non-cancelable operating leases, excluding tenant reimbursements of
expenses are as follows:
2004 $126,705
2005 115,853
2006 84,928
2007 59,462
2008 42,047
Thereafter 92,872
-----------
Total 521,867
===========
- 69 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
14. SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest was $17,146, $12,752 and $13,307 for the years ended
December 31, 2003, 2002 and 2001, respectively.
In connection with property acquisitions, the Company assumed $9,000, $18,000
and $45,884 of related party debt due the Berg Group, assumed other liabilities
of $783, $387 and $2,024 and issued 350,163, 835,491 and 2,422,837 O.P. Units
for a total acquisition value of $12,953, $30,953 and $103,881 for the years
ended December 31, 2003, 2002 and 2001, respectively.
Amounts of $75,224, $75,281 and $66,423 were due the Berg Group for
distributions declared to O.P. Unit holders during the years ended December 31,
2003, 2002 and 2001, respectively, and were treated as draws under the Berg
Group line of credit.
15. COMMITMENTS AND CONTINGENCIES
The Company and the operating partnerships, from time to time, are parties to
litigation arising out of the normal course of business. Management is not aware
of any litigation against the Company and believes the ultimate outcome would
not have a material adverse effect on the cash flows, consolidated financial
position or results of operations of the Company.
Republic Properties Corporation (RPC) v. Mission West Properties, L.P., in the
Circuit Court of Maryland for Baltimore City Case No. 24-C-00-005675. RPC is a
former partner with Mission West Properties, L.P. in the Hellyer Avenue Limited
Partnership. In April 2004 the Circuit Court for Baltimore City, Maryland issued
a Memorandum Opinion in the case. Following a review of the Maryland Court's
decision, our legal counsel advised us to request a review of the decision by
the Maryland Appeals Court. Under the pre-appeal hearing procedures the Maryland
Appeals Court requires a mediation hearing before the parties can appear before
the Appeals Court. No such hearing has been scheduled yet. A Maryland Appeals
Court or any further court decision that may not rule in favor of Mission West
Properties L.P. in this matter will not have a material adverse affect on our
financial statements. In July 2004 RPC attached the Company's bank account for
approximately $1.1 million. Following a July 2004 hearing in Superior Court of
the State of California for the County of Santa Clara the parties agreed that
the Company will post a $1.5 million bond and RPC will remove the attachment
from the Company's bank account until final resolution of the appeal in
Maryland. In February 2001 the Company filed a suit against RPC in Superior
Court of the State of California for the County of Santa Clara Case No. CV
796249 which has been stayed pending resolution of the Maryland case.
Mission West Properties, L.P. v. Premisys Communications, Inc. and Zhone
Technologies, Inc. in the Superior Court of the State of California for the
County of Alameda Case No. HG03118906. This was a breach of lease case which the
Company received a $1.1 million settlement for in April 2004.
Craig R. Jalbert Liquidating CEO, as representative of the Estate of the
Consolidated Debtors for ACT Manufacturing, Inc. v. Mission West Properties,
L.P. in United States Bankruptcy Court District of Massachusetts Case No.
01-47641 (JBR). The Company is vigorously opposing this claim which asserts that
certain payments made in the ordinary course of business within 90 days of the
ACT bankruptcy filing were alleged preference payments. The amount of the claim
is $482. The Company has engaged legal counsel to defend itself in this claim.
The Global Crossing Estate Representative, for Itself and the Liquidating
Trustee of the Global Crossing Liquidating Trust v. Mission West Properties in
United States Bankruptcy Court Southern District of New York Case No. 02-40188
(REG). The Company is vigorously opposing this claim which asserts that certain
payments made in the ordinary course of business within 90 days of the Global
Crossing bankruptcy filing were alleged preference payments. The amount of the
claim is $815. The Company has engaged legal counsel to defend itself in this
claim.
GUARANTEES
Under its certificate of incorporation and bylaws, the Company has agreed to
indemnify its officers and directors for certain events or occurrences arising
as a result of the officer or director's serving in such capacity. The maximum
potential amount of future payments the Company could be required to make under
these indemnification agreements is unlimited. The Company believes the
estimated fair value of these indemnification agreements is minimal and has no
liabilities recorded for these agreements as of December 31, 2003.
The Company also enters into indemnification provisions under (i) its agreements
with other companies in its ordinary course of business, typically with lenders,
joint venture partners, contractors, and tenants. Under these provisions the
Company
- 70 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
generally indemnifies and holds harmless the indemnified party for losses
suffered or incurred by the indemnified party as a result of the Company's
activities. These indemnification provisions generally survive termination of
the underlying agreement. The maximum potential amount of future payments the
Company could be required to make under these indemnification provisions is
unlimited. The Company has not incurred material costs to defend lawsuits or
settle claims related to these indemnification agreements. As a result, the
Company believes the estimated fair value of these agreements is minimal.
Accordingly, the Company has no liabilities recorded for these agreements as of
December 31, 2003.
SEISMIC ACTIVITY
The Company's properties are located in an active seismic area of Silicon
Valley. Insurance policies currently maintained by the Company do not cover
seismic activity, although they do cover losses from fires after an earthquake.
ENVIRONMENTAL ISSUES
The environmental investigations that have been conducted on the Company's
properties have not revealed any environmental liability that it believes would
have a material adverse effect on its financial condition, results of operations
and assets, and we are not aware of any such liability. Nonetheless, it is
possible that there are material environmental liabilities of which the Company
are unaware. The Company cannot assure you that future laws, ordinances, or
regulations will not impose any material environmental liability, or that the
current environmental condition of the properties has not been, or will not be,
affected by tenants and occupants of the properties, by the condition of
properties in the vicinity of the properties, or by third parties unrelated to
the Company.
16. DISCONTINUED OPERATIONS
Effective January 1, 2002, the Company adopted SFAS No. 144, 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 year ended December 31, 2002. Additionally, all
periods presented in this report will likely require further reclassification in
future periods if additional properties are held for sale or property sales
occur.
As of December 31, 2003 and 2002, there were no properties under contract to be
sold or otherwise disposed of which would qualify as assets held for sale.
In March 2002, the Company sold one property for a gain of $6,103, upon
receiving sales proceeds of $18,503. Condensed results of operations for this
property for the years ended December 31, 2002 and 2001 are as follows:
For the Year Ended December 31,
2002 2001
--------------------- ----------------------
(dollars in thousands)
Rental revenue from real estate $ 333 $ 1,999
Tenant reimbursements 293 96
--------------------- ----------------------
Total revenues 626 2,095
--------------------- ----------------------
Real estate taxes 293 96
Depreciation 46 278
--------------------- ----------------------
Total expenses 339 374
--------------------- ----------------------
Net income from discontinued operations 287 1,721
Net gain on disposition of discontinued
operations 6,103 -
Minority interest in earnings attributable to
discontinued operations (5,325) (1,436)
--------------------- ----------------------
Total income from discontinued operations $ 1,065 $ 285
===================== ======================
- 71 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
17. PROPERTY ACQUISITIONS
For real estate acquired subsequent to June 30, 2001, the effective date of SFAS
No. 141, Business Combinations, the fair value of the real estate acquired is
allocated to the acquired tangible assets, consisting of land, building and
building/tenant improvements, and identified intangible assets and liabilities,
including the value of the above or below market leases and in-place leases.
The fair value of the tangible assets of an acquired property, which includes
land, building and tenant improvements, is determined by valuing the property as
if it were vacant, and the "as-if-vacant" value is then allocated to land,
building and tenant improvements based on management's determination of the
relative fair values of these assets. Factors considered by management in
performing these analyses include certain costs during the lease-up periods
considering current market conditions and costs to execute similar leases. These
costs include estimates of lost rental revenue, leasing commissions, and tenant
improvements.
In allocating the fair value of the identified intangible assets of the acquired
property, above-market and in-place lease value are recorded based on the
present value, using an interest rate which reflects the risks associated with
the lease acquired, of the difference between (i) the contractual amounts to be
paid pursuant to the in-place lease and (ii) management's estimate of fair
market lease rate for the corresponding in-place lease, measured over a period
equal to the remaining non-cancelable lease term. The capitalized above-market
lease value, included in real estate related intangible assets in the
accompanying consolidated balance sheets, is amortized as an offset to rental
revenues from real estate over the remaining non-cancelable lease term. The
value of in-place leases exclusive of the value of above-market in-place lease
is also amortized to expense over the remaining non-cancelable periods of the
respective leases. If a lease were to be terminated prior to its stated
expiration, all unamortized amounts relating to that lease would be written off
in the period that the lease is terminated.
See note 12 for discussion of property acquisitions from the Berg Group.
On April 9, 2003, the Company acquired San Tomas Technology Park for $110,013,
which was financed through new third party debt and an existing line of credit.
The purchase price was allocated to long-lived assets, one above-market in-place
lease and the value of in-place leases as follows:
Land $41,698
Buildings and improvements 50,031
Above-market in-place lease 11,172
In-place leases 7,112
--------
Total cash purchase price $110,013
========
The results of operations of the San Tomas Technology Park have been included in
the Company's consolidated operating results since the date of acquisition. The
intangible assets are being amortized over the applicable remaining lease terms.
Amortization related to above-market leases for the year ended December 31, 2003
was $1,416 and was recorded as a reduction of rental revenue from real estate.
Amortization expense related to in-place leases of $881 was recorded for the
year ended December 31, 2003.
On March 8, 2002, the Company acquired the Orchard-Trimble property for $31,312
in cash. The purchase price was allocated to long-lived assets and the value of
in-place leases as follows:
Land $10,437
Buildings and improvements 19,507
In-place leases 1,368
-------
Total cash purchase price $31,312
=======
In-place leases were considered at market. The results of operations of the
Orchard-Trimble property have been included in the Company's consolidated
operating results since the date of acquisition. The intangible assets are being
amortized over the applicable remaining lease terms.
- 72 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
Amortization expense related to in-place leases of $547 and $410 was recorded
for the year ended December 31, 2003 and 2002, respectively.
Details of real estate intangible assets are as follows at December 31, 2003 and
2002:
Amortizable Intangibles 2003 2002
-----------------------------------------------------------------------------
Above-market leases $11,172 $ -
In-place leases 8,479 1,368
----------------------------
Gross real estate intangibles 19,651 1,368
Less accumulated amortization (3,254) (410)
----------------------------
Net real estate intangibles $16,397 $ 958
============================
Estimated aggregate amortization expense for each of the six succeeding fiscal
years is as follows:
Estimated
Amortization
Year Expense
-------------------------------------------
2004 $ 4,060
2005 3,332
2006 3,173
2007 3,093
2008 2,199
2009 540
----------------
$16,397
================
The weighted-average amortization period for above intangibles was 43 months at
December 31, 2003.
18. RESTATEMENTS
The Company has restated its previously issued consolidated financial statements
for the years ended December 31, 2002 and 2001, as well as for the quarters
ended March 31, June 30 and September 30, 2003 and 2002 and the quarter ended
December 31, 2002 for the following items:
- The Company recorded additional amortization expense relating to leasing
commissions which were originally being amortized over a 40 year period.
The additional amortization expense resulted from decreasing the
amortization period of commissions from 40 years to the term of the lease
and the write-off of certain unamortized leasing commissions in connection
with tenant bankruptcies.
- The Company corrected the purchase accounting originally applied to its
2002 acquisition of the Orchard-Trimble property. In accordance with
Statement of Financial Accounting Standards (SFAS) No. 141, Business
Combinations, which became effective July 1, 2001, the Company allocated a
portion of the purchase price to in-place lease intangible assets and
recorded additional amortization expense from decreasing the amortization
period of these intangible assets from 40 years to the term of the lease.
- The Company recorded additional depreciation expense relating to the
reclassification of certain real estate assets from a 40 year depreciable
life to a 7 and 25 year depreciable life.
- The Company reclassified the amortization of the above-market lease
intangible asset relating to the 2003 acquisition of San Thomas Technology
Park from amortization expense to an offset to rental revenues from real
estate.
The aggregate impact of all restatement items resulted in a decrease in net
income to common stockholders compared to previously reported amounts of
$386 ($0.02 per diluted share) and $49 ($0.0 per diluted share) for the
years ended December 31, 2002 and 2001, respectively. The aggregate impact of
all restatement items on the consolidated balance sheet as of December 31, 2002
was a decrease in total assets of $2,623, a decrease in minority interest of
$2,188 and an increase in the accumulated deficit of $435.
- 73 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
The effects of the restatement items described above on the Company's net income
to common shareholders are as follows:
For the Year Ended December 31,
2002 2001
--------------------- ---------------------
(dollars in thousands)
Net income to common stockholders as previously reported $17,501 $18,135
Impact of adjustments for:
Leasing commission amortization (1,765) (145)
Intangible asset amortization (393) -
Depreciation of real estate assets (163) (157)
--------------------- ---------------------
Total adjustments (2,321) (302)
--------------------- ---------------------
Minority interest portion of adjustments 1,935 253
--------------------- ---------------------
Net income to common stockholders, as restated $17,115 $18,086
===================== =====================
Note 19 further discusses these restatements and their specific impact on the
Company's historical quarterly consolidated financial statements.
19. SUPPLEMENTAL FINANCIAL INFORMATION (Unaudited)
The Company has restated its (unaudited) consolidated financial statements for
the quarters ended March 31, June 30 and September 30, 2003 and 2002 and the
quarter ended December 31, 2002 to reflect the effects of the adjustments made
in restating our consolidated financial statements for the years ended December
31, 2002 and 2001, and to correct the amortization of certain intangible assets
acquired in 2003 (see Note 18).
Quarterly financial information for the year ended December 31, 2003 (1) is as
follows:
For the Three Months Ended
March 31, June 30, September 30, December 31,
----------- ---------- --------------- --------------
(As Previously (As Previously (As Previously
Reported (As Restated) Reported) (As Restated) Reported) (As Restated)
--------------------------------------------------------------------------------------------
Rental revenue from continuing operations $31,431 $31,431 $33,194 $32,722 $33,782 $33,310 $33,275
Income before gain on sales of assets,
equity in earnings of unconsolidated
joint venture and minority interests $23,526 $23,252 $23,091 $22,822 $22,942 $22,642 $24,448
Income from continuing operations $4,034 $3,988 $4,156 $4,111 $3,943 $3,893 $4,219
Net income $4,034 $3,988 $4,156 $4,111 $3,943 $3,893 $4,219
Per share data:
Basic net income per share $0.23 $0.23 $0.23 $0.23 $0.22 $0.22 $0.24
Diluted net income per share $0.23 $0.23 $0.23 $0.23 $0.22 $0.22 $0.23
Weighted average shares of common stock 17,637,260 17,637,260 17,701,999 17,701,999 17,747,293 17,747,293 17,869,252
(basic)
Weighted average shares of common stock 17,695,001 17,695,001 17,762,773 17,762,773 17,817,917 17,817,917 17,972,706
(diluted)
Quarterly financial information for the year ended December 31, 2002 (1) is as
follows:
For the Three Months Ended
March 31, June 30, September 30,
----------- ---------- ---------------
(As Previously (As Previously (As Previously
Reported (As Restated) Reported) (As Restated) Reported) (As Restated)
----------------------------------------------------------------------------------------
Rental revenue from continuing operations $32,484 $32,484 $32,753 $32,753 $32,165 $32,165
Income before gain on sales of assets,
equity in earnings of unconsolidated
joint venture and minority interests $24,905 $24,793 $24,896 $23,741 $24,594 $23,815
Income from continuing operations $4,136 $4,116 $4,073 $3,880 $4,558 $4,429
Income from discontinued operations $1,065 $1,065 - - - -
Net income $5,201 $5,182 $4,073 $3,880 $4,558 $4,429
Per share data
Basic net income per share $0.30 $0.30 $0.23 $0.22 $0.26 $0.25
Diluted net income per share $0.29 $0.29 $0.23 $0.22 $0.26 $0.25
Weighted average shares of common stock 17,404,568 17,404,568 17,464,692 17,464,692 17,467,329 17,467,329
(basic)
Weighted average shares of common stock 17,853,809 17,853,809 17,902,853 17,902,853 17,856,688 17,856,688
(diluted)
For the Three Months Ended
December 31, 2002
-----------------
(As Previously
Reported (As Restated)
----------------------------
Rental revenue from continuing operations $32,378 $32,378
Income before gain on sales of assets,
equity in earnings of unconsolidated
joint venture and minority interests $25,293 $25,017
Income from continuing operations $3,670 $3,624
Income from discontinued operations - -
Net income $3,670 $3,624
Per share data:
Basic net income per share $0.21 $0.21
Diluted net income per share $0.21 $0.20
Weighted average shares of common stock 17,485,590 17,485,590
(basic)
Weighted average shares of common stock 17,800,971 17,800,971
(diluted)
(1) The summation of the quarterly financial data may not equal the annual
number reported on the consolidated financial statements of operations due
to rounding differences.
- 74 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
20. SUBSEQUENT EVENTS
On January 8, 2004, the Company paid dividends of $0.24 per share of common
stock to all common stockholders of record as of December 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.
On January 26, 2004, the Company's independent accountants,
PricewaterhouseCoopers (PWC) resigned. Following PWC's resignation, the audit
committee which is comprised solely of the Company's three independent directors
engaged independent legal counsel to conduct an investigation into the events
and circumstances leading up to the resignation of PWC. The independent
counsel's report was issued in April 2004 and concluded that there was no
violations of securities laws by management or the Board of Directors. Following
the issuance of the independent counsel's report, the audit committee appointed
BDO Seidman, LLP as the Company's new independent accountants in May 2004.
Following the January 26, 2004 resignation by PWC, the Company has not been in
compliance with certain listing standards of the American Stock Exchange (AMEX).
Upon the appointment of BDO Seidman, LLP as the Company's new independent
accountants, the AMEX granted the Company an extension to comply with their
listing standards by August 1, 2004. To become compliant with the AMEX continued
listing standards, the Company must also file its quarterly reports on Form 10-Q
for the first and second quarter of 2004 as soon as practicable following the
filing of the Form 10-K for 2003 but no later than August 31, 2004.
In early January 2004, the Company received $1,836 from the Bankruptcy Estate of
Auspex Systems, Inc., pursuant to Notice of Order from the United States
Bankruptcy Court Northern District of California Case No. 03-52596 MM 11
representing the Company's final share of the Estate of Auspex Systems, Inc. as
an unsecured creditor. This amount was recorded in 2003 revenue.
On March 16, 2004, the Company declared dividends of $0.24 per common share
payable on April 8, 2004 to all common stockholders of record on March 31, 2004.
On the same date, the operating partnerships paid a distribution of $0.24 per
O.P. Units to all holders of O.P. Units.
In April 2004, the Company settled litigation with a former tenant, Premisys
Communications, Inc., in connection with their breach of lease for the sum of
$1,100 which will be recorded in 2004 revenue.
In April and May 2004, the Company entered into lease termination agreements
with two different tenants who have leases expiring in 2004 for the sum total of
$2,609 which will be recorded in 2004 revenue.
In April 2004, the Circuit Court of Maryland for Baltimore City Case No.
24-C-00-005675 issued a Memorandum Opinion in Republic Properties Corporation
(RPC) v. Mission West Properties, L.P. RPC is a former partner with Mission West
Properties, L.P. in the Hellyer Avenue Limited Partnership. Following a review
of the Maryland Court's decision, the Company's legal counsel advised us to
request a review of the decision by the Maryland Appeals Court. Under the
pre-appeal hearing procedures the Maryland Appeals Court requires a mediation
hearing before the parties can appear before the Appeals Court. The mediation
hearing is in the process of being scheduled. A Maryland Appeals Court or any
further court decision that may not rule in favor of Mission West Properties
L.P. in this matter will not have a material adverse affect on our financial
statements. In July 2004 RPC attached the Company's bank account for
approximately $1,100. Following a July 2004 hearing in Superior Court of the
State of California for the County of Santa Clara, the parties agreed that the
Company will post a $1,500 bond and RPC will remove the attachment of the
Company's bank account until final resolution of the appeal in Maryland.
In April 2004, an $80,000 loan with Citicorp USA, Inc. matured. Citicorp USA,
Inc. has granted an extension until September 6, 2004 pending the completion of
the Company's Form 10-K filing for 2003. The Company is in the process of
renegotiating the terms and extending the $80,000 loan for an additional
two-year period. The Company does not believe that the terms of the extended
loan will differ materially from its current terms.
On June 16, 2004, the Company declared dividends of $0.24 per common share
payable on July 8, 2004 to all common stockholders of record on June 30, 2004.
On the same date, the operating partnerships paid a distribution of $0.24 per
O.P. Units to all holders of O.P. Units.
- 75 -
In July 2004, a $40,000 loan with Cupertino National Bank (CNB) matured. CNB has
granted an extension until September 2, 2004 pending the completion of the
Company's Form 10-K filing for 2003. The Company is in the process of
renegotiating the terms and extending the $40,000 loan for an additional
two-year period. The Company does not believe that the terms of the extended
loan will differ materially from its current terms.
- 76 -
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Mission West Properties, Inc.
Cupertino, California
The audits referred to in our report dated July 27, 2004 relating to the
consolidated financial statements of Mission West Properties, Inc., which is
contained in Item 8 of this Form 10-K included the audit of the financial
statement schedules listed in the accompanying index. These financial statement
schedules are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statement schedules based upon our
audits.
In our opinion such financial statement schedules present fairly, in all
material respects, the information set forth therein.
As a result of the restatement of the Company's consolidated financial
statements as of December 31, 2002 discussed in Note 18 to the Company's
consolidated financial statements, the Company has restated Schedule III: Real
Estate and Accumulated Depreciation of Mission West Properties, Inc. as of
December 31, 2002 (which was previously audited by other independent auditors).
\S\ BDO Seidman, LLP
San Francisco, California
July 27, 2004
- 77 -
INTENTIONALLY BLANK
- 78 -
MISSION WEST PROPERTIES, INC.
Schedule III
Real Estate and Accumulated Depreciation & Amortization
December 31, 2003
(dollars in thousands)
Initial Cost Total Cost
----------------------------- Cost -------------------------
December 31, Buildings Subsequent to Buildings
2003 And Construction/ And
Property Name City Encumbrances Land Improvements Acquisition Land Improvements
---------------------------------------- --------------- -------------- ------------- ------------- ---------- -------------
5300-5350 Hellyer Avenue San Jose E $10,761 $ 5,742 $11,442 $ 5,742 $11,442
10401-10411 Bubb Road Cupertino A 632 3,078 632 3,078
45365 Northport Loop Fremont 2,447 5,711 $ 11 2,447 5,722
45700 Northport Loop Fremont B 1,184 5,760 7 1,184 5,767
45738 Northport Loop Fremont B 891 4,338 5 891 4,343
4050 Starboard Drive Fremont B 1,329 6,467 8 1,329 6,475
3501 W. Warren Ave/Fremont Fremont 1,866 9,082 1,866 9,082
48800 Milmont Blvd Fremont 1,013 4,932 1,013 4,932
4750 Patrick Henry Drive Santa Clara 1,604 7,805 153 1,604 7,958
3520 Bassett Street Santa Clara C 1,104 5,371 1,104 5,371
3530 Bassett Street Santa Clara C,D 849 4,133 849 4,133
5850-5870 Hellyer Avenue San Jose 2,787 6,502 2,787 6,502
5750 Hellyer Avenue San Jose 3,266 3,354 3,266 3,354
800 Embedded Way San Jose 5,508 12,134 16 5,508 12,150
5500 Hellyer Avenue San Jose 4,735 12,484 39 4,735 12,523
5550 Hellyer Avenue San Jose 3,261 3,478 3,261 3,478
5400 Hellyer Avenue San Jose 3,238 5,358 215 3,238 5,573
5325 Hellyer Avenue San Jose 4,684 10,329 40 4,684 10,369
5345 Hellyer Avenue San Jose 4,866 5,822 4,866 5,822
5905-5965 Silver Creek San Jose 8,437 17,317 8,437 17,317
Valley Road
5905-5965 Silver Creek San Jose 3,438 2,727 3,438 2,727
Valley Road
855 Embedded Way San Jose 3,289 6,521 68 3,289 6,589
1065-1105 La Avenida Street Mountain View 46,832 109,275 65 46,832 109,340
1750 Automation Parkway San Jose H 4,789 11,174 315 4,789 11,489
1756 Automation Parkway San Jose H 4,378 10,216 15 4,378 10,231
1762 Automation Parkway San Jose H 4,804 12,224 20 4,804 12,244
1768 Automation Parkway San Jose 8,195 19,121 14 8,195 19,135
255 Caspian Drive Sunnyvale 3,491 7,160 1,559 3,491 8,719
245 Caspian Drive Sunnyvale 5,894 - 5,894 -
5970 Optical Court San Jose 2,758 8,395 2,758 8,395
5900 Optical Court San Jose 3,634 12,677 83 3,634 12,760
2630 Orchard Parkway San Jose 2,931 5,863 2,931 5,863
2610 Orchard Parkway San Jose K 2,616 5,738 2,616 5,738
55 West Trimble Road San Jose K 4,434 9,730 4,434 9,730
2001 Walsh Avenue Santa Clara G,I 4,610 5,245 J 4,610 5,245
2880 Scott Boulevard Santa Clara G,I 14,502 25,500 J 14,502 25,500
2890 Scott Boulevard Santa Clara G,I 3,081 10,843 J 3,081 10,843
2770-2800 Scott Boulevard Santa Clara G,I 7,138 7,075 2 7,138 7,077
2300 Central Expressway Santa Clara G,I 2,390 14,419 J 2,390 14,419
2220 Central Expressway Santa Clara G,I 3,304 4,301 J 88 3,304 4,389
2330 Central Expressway Santa Clara G,I 3,673 3,932 3,673 3,932
2251 Lawson Lane Santa Clara H 1,952 9,498 1,952 9,498
1230 East Arques Sunnyvale B 540 2,628 39 540 2,667
1250 East Arques Sunnyvale B 1,335 6,499 1,335 6,499
3120 Scott Blvd Santa Clara 2,044 9,948 2,044 9,948
20400 Mariani Avenue Cupertino 733 1,670 8,125 1,670 8,125
10500 De Anza Blvd Cupertino B 7,666 37,304 7,666 37,304
20605-20705 Valley Green Cupertino H 3,490 16,984 3,490 16,984
10300 Bubb Road Cupertino B 635 3,090 635 3,090
10440 Bubb Road Cupertino 434 2,112 15 434 2,127
10460 Bubb Road Cupertino 226 994 4,838 1,161 994 5,999
1135 Kern Avenue Sunnyvale B 407 1,982 407 1,982
405 Tasman Drive Sunnyvale 550 2,676 90 550 2,766
450 National Avenue Mountain View B 611 2,973 611 2,973
3301 Olcott Street Santa Clara 1,846 8,984 1,846 8,984
2800 Bayview Avenue Fremont 1,070 5,205 60 1,070 5,265
6850 Santa Teresa Blvd San Jose 377 1,836 820 377 2,656
6810 Santa Teresa Blvd San Jose 2,567 5,991 12 2,567 6,003
140-160 Great Oaks Blvd San Jose 1,402 6,822 755 1,402 7,577
Accumulated
Depreciation Date of Depreciable
Property Name City Total & Amortization Acquisition Life
---------------------------------------- ------------ -------------- ----------- -----------
5300-5350 Hellyer Avenue San Jose E $ 17,184 $ 1,037 5/00 L
10401-10411 Bubb Road Cupertino A 3,710 425 7/98 L
45365 Northport Loop Fremont 8,169 469 10/00 L
45700 Northport Loop Fremont B 6,951 794 7/98 L
45738 Northport Loop Fremont B 5,234 600 7/98 L
4050 Starboard Drive Fremont B 7,804 892 7/98 L
3501 W. Warren Ave/Fremont Fremont 10,948 1,251 7/98 L
Blvd
48800 Milmont Blvd Fremont 5,945 680 7/98 L
4750 Patrick Henry Drive Santa Clara 9,562 1,155 7/98 L
3520 Bassett Street Santa Clara C 6,475 739 7/98 L
3530 Bassett Street Santa Clara C,D 4,982 570 7/98 L
5850-5870 Hellyer Avenue San Jose 9,289 843 11/98 L
5750 Hellyer Avenue San Jose 6,620 203 8/01 L
800 Embedded Way San Jose 17,658 1,234 3/00 L
5500 Hellyer Avenue San Jose 17,258 915 2/01 L
5550 Hellyer Avenue San Jose 6,739 224 6/01 L
5400 Hellyer Avenue San Jose 8,811 527 7/00 L
5325 Hellyer Avenue San Jose 15,053 788 1/01 L
5345 Hellyer Avenue San Jose 10,688 417 1/02 L
5905-5965 Silver Creek San Jose 25,754 1,083 7/01 L
Valley Road
5905-5965 Silver Creek San Jose 6,165 154 10/01 L
Valley Road
855 Embedded Way San Jose 9,878 459 5/01 L
1065-1105 La Avenida Street Mountain View 156,172 12,982 4/99 L
1750 Automation Parkway San Jose H 16,278 1,292 7/99 L
1756 Automation Parkway San Jose H 14,609 1,029 1/00 L
1762 Automation Parkway San Jose H 17,048 1,153 4/00 L
1768 Automation Parkway San Jose 27,330 1,481 12/00 L
255 Caspian Drive Sunnyvale 12,210 738 4/00 L
245 Caspian Drive Sunnyvale 5,894 - 4/01 L
5970 Optical Court San Jose 11,153 - 12/03 L
5900 Optical Court San Jose 16,394 489 7/02 L
2630 Orchard Parkway San Jose 8,794 269 3/02 L
2610 Orchard Parkway San Jose K 8,354 596 3/02 L
55 West Trimble Road San Jose K 14,164 1,009 3/02 L
2001 Walsh Avenue Santa Clara G,I 9,855 237 4/03 L
2880 Scott Boulevard Santa Clara G,I 40,002 761 4/03 L
2890 Scott Boulevard Santa Clara G,I 13,924 272 4/03 L
2770-2800 Scott Boulevard Santa Clara G,I 14,215 133 4/03 L
2300 Central Expressway Santa Clara G,I 16,809 1,534 4/03 L
2220 Central Expressway Santa Clara G,I 7,693 310 4/03 L
2330 Central Expressway Santa Clara G,I 7,605 74 4/03 L
2251 Lawson Lane Santa Clara H 11,450 1,307 7/98 L
1230 East Arques Sunnyvale B 3,207 381 7/98 L
1250 East Arques Sunnyvale B 7,834 894 7/98 L
3120 Scott Blvd Santa Clara 11,992 1,371 7/98 L
20400 Mariani Avenue Cupertino 9,795 1,120 7/98 L
10500 De Anza Blvd Cupertino B 44,970 5,133 7/98 L
20605-20705 Valley Green Cupertino H 20,474 2,339 7/98 L
Drive
10300 Bubb Road Cupertino B 3,725 426 7/98 L
10440 Bubb Road Cupertino 2,561 293 7/98 L
10460 Bubb Road Cupertino 6,993 791 7/98 L
1135 Kern Avenue Sunnyvale B 2,389 276 7/98 L
405 Tasman Drive Sunnyvale 3,316 386 7/98 L
450 National Avenue Mountain View B 3,584 410 7/98 L
3301 Olcott Street Santa Clara 10,830 1,238 7/98 L
2800 Bayview Avenue Fremont 6,335 720 7/98 L
6850 Santa Teresa Blvd San Jose 3,033 440 7/98 L
6810 Santa Teresa Blvd San Jose 8,570 726 3/99 L
140-160 Great Oaks Blvd San Jose 8,979 1,013 7/98 L
- 79 -
Initial Cost Total Cost
------------------------ Cost -------------------------
December 31, Buildings Subsequent to Buildings
2003 And Construction/ And
Property Name City Encumbrances Land Improvements Acquisition Land Improvements
---------------------------------------------- -------------- ---------- ------------- ------------- ---------- -------------
6541 Via del Oro/6385 San Ig. San Jose H 1,039 5,057 1,039 5,057
6311-6351 San Ignacio San Jose B 6,246 30,396 145 6,246 30,541
6320-6360 San Ignacio San Jose H 2,616 12,732 439 2,616 13,171
75 E. Trimble Road/2610 N. San Jose 3,477 16,919 85 3,477 17,004
First Street
2033-2243 Samaritan Drive San Jose F 6,320 5,046 24,556 154 5,046 24,710
1170 Morse Avenue Sunnyvale B 658 3,201 658 3,201
3236 Scott Blvd Santa Clara B 1,234 6,005 1,234 6,005
1212 Bordeaux Lane Sunnyvale B 2,250 10,948 2,250 10,948
1325-1810 McCandless Drive Milpitas F,H 13,994 66,213 1,065 13,994 67,278
1600 Memorex Drive Santa Clara B 1,221 5,940 11 1,221 5,951
1688 Richard Avenue Santa Clara B 1,248 2,913 6 1,248 2,919
1700 Richard Avenue Santa Clara B 1,727 4,030 1,727 4,030
3506-3510 Bassett Street Santa Clara C 943 4,591 116 943 4,707
3540-3544 Bassett Street Santa Clara B,C 1,565 7,615 189 1,565 7,804
3550 Bassett Street Santa Clara B,C 1,079 5,251 33 1,079 5,284
3560 Bassett Street Santa Clara B,C 1,075 5,233 8 1,075 5,241
3570-3580 Bassett Street Santa Clara B,C 1,075 5,233 1,075 5,233
Prudential Insurance Company of B 121,455
America Loan
Northwestern Mutual Life H 97,445
Insurance Company
Citicorp USA, Inc. I 80,000
-------------- ---------- ------------- ------------- ---------- -------------
$316,940 $275,707 $791,361 $7,926 $275,707 $799,287
============== ========== ============= ============= ========== =============
Accumulated
Depreciation Date of Depreciable
Property Name City Total & Amortization Acquisition Life
---------------------------------------------- ------------ -------------- ----------- -----------
6541 Via del Oro/6385 San Ig. San Jose H 6,096 696 7/98 L
6311-6351 San Ignacio San Jose B 36,787 4,241 7/98 L
6320-6360 San Ignacio San Jose H 15,787 1,800 7/98 L
75 E. Trimble Road/2610 N. San Jose 20,481 2,368 7/98 L
First St
2033-2243 Samaritan Drive San Jose F 29,756 3,402 7/98 L
1170 Morse Avenue Sunnyvale B 3,859 442 7/98
3236 Scott Blvd Santa Clara B 7,239 828 7/98 L
1212 Bordeaux Lane Sunnyvale B 13,198 1,508 7/98 L
1325-1810 McCandless Drive Milpitas F,H 81,272 9,300 7/98 L
1600 Memorex Drive Santa Clara B 7,172 797 7/98 L
1688 Richard Avenue Santa Clara B 4,167 403 9/98 L
1700 Richard Avenue Santa Clara B 5,757 447 8/99 L
3506-3510 Bassett Street Santa Clara C 5,650 664 7/98 L
3540-3544 Bassett Street Santa Clara B,C 9,369 1,078 7/98 L
3550 Bassett Street Santa Clara B,C 6,363 740 7/98 L
3560 Bassett Street Santa Clara B,C 6,316 725 7/98 L
3570-3580 Bassett Street Santa Clara B,C 6,308 722 7/98 L
Prudential Insurance Company of B
America Loan 121,455
Northwestern Mutual Life H 97,445
Insurance Company
Citicorp USA, Inc. I 80,000
------------ --------------
$1,074,994 $89,243
============ ==============
(A) 16.67% of this property's ownership is held by unaffiliated parties outside
the operating partnerships of the Company.
(B) Encumbered by the $121,455 Prudential Insurance Company of America loan -
full amount of loan shown at the bottom of the schedule.
(C) Part of the property group referred to as the Triangle Technology Park.
(D) 25% of this property's ownership is held by unaffiliated parties outside
the operating partnerships of the Company.
(E) 50% of this property's ownership is held by an affiliated party since
September 2000.
(F) Three properties at Samaritan Drive and two properties at McCandless Drive
are encumbered by the $6,320 debt due the Berg Group under the line of
credit.
(G) Part of the property group referred to as the San Tomas Technology Park.
(H) Encumbered by the $97,445 Northwestern Mutual Life Insurance Company loan -
full amount of loan shown at the bottom of the schedule.
(I) Encumbered by the $80,000 Citicorp USA, Inc. loan - full amount of loan
shown at the bottom of the schedule.
(J) Purchase price allocated to real estate related intangible assets pursuant
to SFAS No. 141 amounted to $18,284.
(K) Purchase price allocated to real estate related intangible assets pursuant
to SFAS No. 141 amounted to $1,367.
(L) Depreciation is computed based on the following estimated lives:
1. Building shell and base building tenant improvements of newly acquired
properties are being depreciated on a weighted average composite
useful life of 40 years.
2. Real estate intangible assets allocated pursuant to SFAS No. 141 are
being amortized over the remaining life of the underlying leases.
3. Tenant improvements, furniture and fixtures are being depreciated over
their estimated useful lives ranging from 5 to 10 years.
- 80 -
MISSION WEST PROPERTIES, INC.
Schedule III
Real Estate and Accumulated Depreciation
December 31, 2002
(As Restated)
(dollars in thousands)
Initial Cost Total Cost
------------------------ Cost -------------------------
December 31, Buildings Subsequent to Buildings
2002 And Construction/ And
Property Name City Encumbrances Land Improvements Acquisition Land Improvements
---------------------------------------------- -------------- ---------- ------------- ------------- ---------- -------------
5300-5350 Hellyer Avenue San Jose E $11,078 $ 5,742 $11,442 $ 5,742 $11,442
10401-10411 Bubb Road Cupertino A 632 3,078 632 3,078
45365 Northport Loop Fremont 2,447 5,711 $ 11 2,447 5,722
45700 Northport Loop Fremont B 1,184 5,760 7 1,184 5,767
45738 Northport Loop Fremont B 891 4,338 5 891 4,343
4050 Starboard Drive Fremont B 1,329 6,467 8 1,329 6,475
3501 W. Warren Ave/Fremont Fremont 1,866 9,082 1,866 9,082
48800 Milmont Blvd Fremont 1,013 4,932 1,013 4,932
4750 Patrick Henry Drive Santa Clara 1,604 7,805 153 1,604 7,958
3520 Bassett Street Santa Clara C 1,104 5,371 1,104 5,371
3530 Bassett Street Santa Clara C,D 849 4,133 849 4,133
5850-5870 Hellyer Avenue San Jose 2,787 6,502 2,787 6,502
5750 Hellyer Avenue San Jose 3,266 3,354 3,266 3,354
800 Branham Lane East San Jose 5,508 12,851 16 5,508 12,867
5500 Hellyer Avenue San Jose 4,735 12,484 3 4,735 12,487
5550 Hellyer Avenue San Jose 3,261 3,478 3,261 3,478
5400 Hellyer Avenue San Jose 3,238 5,358 215 3,238 5,573
5325 Hellyer Avenue San Jose 4,684 10,329 34 4,684 10,363
5345 Hellyer Avenue San Jose 4,866 5,822 4,866 5,822
5905-5965 Silver Creek San Jose 8,437 17,317 8,437 17,317
Valley Road
5905-5965 Silver Creek San Jose 3,438 2,727 3,438 2,727
Valley Road
855 Branham Lane East San Jose 3,289 6,521 68 3,289 6,589
1065-1105 La Avenida Street Mountain View 46,832 109,275 65 46,832 109,340
1750 Automation Parkway San Jose 4,789 11,174 315 4,789 11,489
1756 Automation Parkway San Jose 4,378 10,216 15 4,378 10,231
1762 Automation Parkway San Jose 4,804 12,224 20 4,804 12,244
1768 Automation Parkway San Jose 8,195 19,121 14 8,195 19,135
255 Caspian Drive Sunnyvale 3,491 7,160 1,047 3,491 8,207
245 Caspian Drive Sunnyvale 5,894 - 5,894 -
5900 Optical Court San Jose 3,634 12,677 52 3,634 12,729
2630 Orchard Parkway San Jose 2,931 5,863 2,931 5,863
2610 Orchard Parkway San Jose G 2,616 5,738 2,616 5,738
55 West Trimble Road San Jose G 4,434 9,730 4,434 9,730
2251 Lawson Lane Santa Clara F 1,952 9,498 1,952 9,498
1230 East Arques Sunnyvale B 540 2,628 39 540 2,667
1250 East Arques Sunnyvale B 1,335 6,499 1,335 6,499
3120 Scott Blvd Santa Clara 2,044 9,948 2,044 9,948
20400 Mariani Avenue Cupertino 1,423 1,670 8,125 1,670 8,125
10500 De Anza Blvd Cupertino B 7,666 37,304 7,666 37,304
20605-20705 Valley Green Dr.Cupertino F 3,490 16,984 3,490 16,984
10300 Bubb Road Cupertino B 635 3,090 635 3,090
10440 Bubb Road Cupertino 434 2,112 434 2,112
10460 Bubb Road Cupertino 297 994 4,838 1,161 994 5,999
1135 Kern Avenue Sunnyvale B 407 1,982 407 1,982
405 Tasman Drive Sunnyvale 550 2,676 90 550 2,766
450 National Avenue Mountain View B 611 2,973 611 2,973
3301 Olcott Street Santa Clara 1,846 8,984 1,846 8,984
2800 Bayview Avenue Fremont 1,070 5,205 1,070 5,205
6850 Santa Teresa Blvd San Jose 377 1,836 820 377 2,656
6810 Santa Teresa Blvd San Jose 2,567 5,991 12 2,567 6,003
140-160 Great Oaks Blvd San Jose 1,402 6,822 205 1,402 7,027
6541 Via del Oro/6385 San San Jose 1,039 5,057 1,039 5,057
Ignacio
6311-6351 San Ignacio San Jose B 6,246 30,396 145 6,246 30,541
Avenue
6320-6360 San Ignacio San Jose 2,616 12,732 353 2,616 13,085
Avenue
75 E. Trimble Road/2610 N. San Jose 3,477 16,919 85 3,477 17,004
First St
2033-2243 Samaritan Drive San Jose F 58,792 5,046 24,556 154 5,046 24,710
1170 Morse Avenue Sunnyvale B 658 3,201 658 3,201
3236 Scott Blvd Santa Clara B 1,234 6,005 1,234 6,005
Accumulated
Depreciation Date of Depreciable
Property Name City Total & Amortization Acquisition Life
---------------------------------------------- ------------ -------------- ----------- -----------
5300-5350 Hellyer Avenue San Jose E $ 17,184 $ 751 5/00 H
10401-10411 Bubb Road Cupertino A 3,710 348 7/98 H
45365 Northport Loop Fremont 8,169 325 10/00 H
45700 Northport Loop Fremont B 6,951 650 7/98 H
45738 Northport Loop Fremont B 5,234 491 7/98 H
4050 Starboard Drive Fremont B 7,804 731 7/98 H
3501 W. Warren Ave/Fremont Fremont 10,948 1,024 7/98 H
Blvd
48800 Milmont Blvd Fremont 5,945 556 7/98 H
4750 Patrick Henry Drive Santa Clara 9,562 935 7/98 H
3520 Bassett Street Santa Clara C 6,475 605 7/98 H
3530 Bassett Street Santa Clara C,D 4,982 466 7/98 H
5850-5870 Hellyer Avenue San Jose 9,289 680 11/98 H
5750 Hellyer Avenue San Jose 6,620 119 8/01 H
800 Branham Lane East San Jose 18,375 915 3/00 H
5500 Hellyer Avenue San Jose 17,222 600 2/01 H
5550 Hellyer Avenue San Jose 6,739 137 6/01 H
5400 Hellyer Avenue San Jose 8,811 362 7/00 H
5325 Hellyer Avenue San Jose 15,047 525 1/01 H
5345 Hellyer Avenue San Jose 10,688 209 1/02 H
5905-5965 Silver Creek San Jose 25,754 650 7/01 H
Valley Road
5905-5965 Silver Creek San Jose 6,165 86 10/01 H
Valley Road
855 Branham Lane East San Jose 9,878 286 5/01 H
1065-1105 La Avenida Street Mountain View 156,172 10,248 4/99 H
1750 Automation Parkway San Jose 16,278 1,005 7/99 H
1756 Automation Parkway San Jose 14,609 771 1/00 H
1762 Automation Parkway San Jose 17,048 845 4/00 H
1768 Automation Parkway San Jose 27,330 1,000 12/00 H
255 Caspian Drive Sunnyvale 11,698 510 4/00 H
245 Caspian Drive Sunnyvale 5,894 - 4/01 H
5900 Optical Court San Jose 16,363 162 7/02 H
2630 Orchard Parkway San Jose 8,794 123 3/02 H
2610 Orchard Parkway San Jose G 8,354 262 3/02 H
55 West Trimble Road San Jose G 14,164 443 3/02 H
2251 Lawson Lane Santa Clara F 11,450 1,070 7/98 H
1230 East Arques Sunnyvale B 3,207 310 7/98 H
1250 East Arques Sunnyvale B 7,834 732 7/98 H
3120 Scott Blvd Santa Clara 11,992 1,122 7/98 H
20400 Mariani Avenue Cupertino 9,795 916 7/98 H
10500 De Anza Blvd Cupertino B 44,970 4,200 7/98 H
20605-20705 Valley Green Cupertino F 20,474 1,914 7/98 H
10300 Bubb Road Cupertino B 3,725 349 7/98 H
10440 Bubb Road Cupertino 2,546 240 7/98 H
10460 Bubb Road Cupertino 6,993 639 7/98 H
1135 Kern Avenue Sunnyvale B 2,389 226 7/98 H
405 Tasman Drive Sunnyvale 3,316 306 7/98 H
450 National Avenue Mountain View B 3,584 335 7/98 H
3301 Olcott Street Santa Clara 10,830 1,013 7/98 H
2800 Bayview Avenue Fremont 6,275 588 7/98 H
6850 Santa Teresa Blvd San Jose 3,033 336 7/98 H
6810 Santa Teresa Blvd San Jose 8,570 576 3/99 H
140-160 Great Oaks Blvd San Jose 8,429 797 7/98 H
6541 Via del Oro/6385 San San Jose 6,096 570 7/98 H
Ignacio
6311-6351 San Ignacio San Jose B 36,787 3,458 7/98 H
Avenue
6320-6360 San Ignacio San Jose 15,701 1,461 7/98 H
Avenue
75 E. Trimble Road/2610 N. San Jose 20,481 1,932 7/98 H
First St
2033-2243 Samaritan Drive San Jose F 29,756 2,777 7/98 H
1170 Morse Avenue Sunnyvale B 3,859 362 7/98 H
3236 Scott Blvd Santa Clara B 7,239 678 7/98 H
- 81 -
December 31, Buildings Subsequent to Buildings
2002 And Construction/ And
Property Name City Encumbrances Land Improvements Acquisition Land Improvements
---------------------------------------------- -------------- ---------- ------------- ------------- ---------- -------------
1212 Bordeaux Lane Sunnyvale B 2,250 10,948 2,250 10,948
1325-1810 McCandless Drive Milpitas F 13,994 66,213 1,056 13,994 67,269
1600 Memorex Drive Santa Clara B 1,221 5,940 36 1,221 5,976
1688 Richard Avenue Santa Clara B 1,248 2,913 6 1,248 2,919
1700 Richard Avenue Santa Clara B 1,727 4,030 1,727 4,030
3506-3510 Bassett Street Santa Clara C 943 4,591 116 943 4,707
3540-3544 Bassett Street Santa Clara C,B 1,565 7,615 189 1,565 7,804
3550 Bassett Street Santa Clara C,B 1,079 5,251 33 1,079 5,284
3560 Bassett Street Santa Clara C,B 1,075 5,233 8 1,075 5,241
3570-3580 Bassett Street Santa Clara C,B 1,075 5,233 1,075 5,233
Prudential Insurance Company of B
America Loan 123,342
-------------- ---------- ------------ ------------- ---------- -------------
$194,932 $234,251 $712,368 $6,556 $234,251 $718,924
============== ========== ============ ============= ========== =============
Accumulated
Depreciation Date of Depreciable
Property Name City Total & Amortization Acquisition Life
---------------------------------------------- ------------ -------------- ----------- -----------
1212 Bordeaux Lane Sunnyvale B 13,198 1,235 7/98 H
1325-1810 McCandless Drive Milpitas F 81,263 7,564 7/98 H
1600 Memorex Drive Santa Clara B 7,197 645 7/98 H
1688 Richard Avenue Santa Clara B 4,167 329 9/98 H
1700 Richard Avenue Santa Clara B 5,757 346 8/99 H
3506-3510 Bassett Street Santa Clara C 5,650 539 7/98 H
3540-3544 Bassett Street Santa Clara C,B 9,369 880 7/98 H
3550 Bassett Street Santa Clara C,B 6,363 604 7/98 H
3560 Bassett Street Santa Clara C,B 6,316 593 7/98 H
3570-3580 Bassett Street Santa Clara C,B 6,308 591 7/98 H
Prudential Insurance Company of
America Loan B
------------ --------------
$953,175 $67,053
============ ==============
(A) 16.67% of this property's ownership is held by unaffiliated parties outside
the operating partnerships of the Company.
(B) Encumbered by the $123,342 Prudential Insurance Company of America loan -
full amount of loan shown at the bottom of the schedule.
(C) Part of the property group referred to as Triangle Technology Park.
(D) 25% of this property's ownership is held by unaffiliated parties outside
the operating partnerships of the Company.
(E) 50% of this property's ownership is held by an affiliated party since
September 2000.
(F) Four properties at McCandless Drive, three properties at Samaritan Drive
and three other various properties are encumbered by the $58,792 debt due
the Berg Group under the line of credit.
(G) Purchase price allocated to real estate related intangible assets pursuant
to SFAS No. 141 was $1,367.
(H) Depreciation is computed based on the following estimated lives:
1. Building shell and base building tenant improvements of newly acquired
properties are being depreciated on a weighted average composite
useful life of 40 years.
2. Real estate intangible assets allocated pursuant to SFAS No. 141 are
being amortized over the remaining life of the underlying leases.
3. Tenant improvements, furniture and fixtures are being depreciated over
their estimated useful lives ranging from 5 to 10 years.
- 82 -
MISSION WEST PROPERTIES, INC.
NOTE TO SCHEDULE III
December 31, 2003 and 2002
(dollars in thousands)
1. Reconciliation of real estate and accumulated depreciation and
amortization:
2003 2002
(As Restated)
------------------------ ------------------------
Real estate investments:
Balance at beginning of year $ 953,175 $ 907,369
Additions 121,819 64,167
Dispositions - (13,421)
Reclassification - (4,940)
------------------------ ------------------------
Balance at end of year $1,074,994 $ 953,175
======================== ========================
Accumulated depreciation and amortization:
Balance at beginning of year $ 67,053 $ 49,716
Additions 22,190 18,359
Dispositions - (1,022)
------------------------ ------------------------
Balance at end of year $ 89,243 $ 67,053
======================== ========================
- 83 -
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
The Company previously disclosed the change in its independent accountants
on Form 8-K, filed February 2, 2004, Form 8-K/A, filed February 18, 2004,
and Form 8-K, filed May 12, 2004.
ITEM 9A. INTERNAL CONTROLS AND PROCEDURES
We strive to maintain disclosure controls and procedures that are designed
to ensure that information required to be disclosed in our Exchange Act
reports is recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms, and that such information
is accumulated and communicated to our management, including our chief
executive officer and chief financial officer, as appropriate, to allow for
timely decisions regarding required disclosure. In designing and evaluating
the disclosure controls and procedures, management recognizes that any
controls and procedures, no matter how well designated and operated, can
provide only reasonable assurance of achieving the desired control
objectives and management necessarily is required to apply its judgment in
evaluating the cost-benefit relationship of possible controls.
Until their resignation on January 26, 2004, our independent accountants
were PricewaterhouseCoopers LLP. In May 2004, we hired new independent
accountants, BDO Seidman, LLP who conducted audits of our financial
statements for 2001, 2002 and 2003. In connection with the issuance of its
report of the independent registered public accounting firm, BDO Seidman,
LLP reported to our audit committee a "material weakness" under standards
established by the Public Company Accounting Oversight Board regarding some
elements of our system of internal controls. They noted a material weakness
with respect to our review and oversight of our application of purchase
accounting relating to the amortization of leasing commissions on acquired
buildings, as a result of which we amortized such commissions over the
40-year term of the acquired building rather than the lease term. In
addition, due to our total head count of four, they have also identified
certain segregation of duties issues without compensating controls.
In the view of BDO Seidman, LLP this material weakness led to certain
accounting adjustments for 2003 and certain restatements for 2002 and 2001,
principally pertaining to purchase accounting errors related to leasing
commissions and to a much smaller extent, to correct depreciable lives for
tenant improvements and base interior improvements. The error in accounting
for lease commission necessitated a significant portion of the restatements
described elsewhere in this report and resulted in adjustments to our 2001,
2002 and 2003 financial statements upon audit. One such commission for one
tenant with a large lease that went bankrupt in 2002 should have been
written off in 2002 and represented approximately $918 or approximately 40%
of the total restatement adjustments for 2002. We have conducted a review
of the errors requiring restatement, including a separate review by our
audit committee to determine what remedial measures were necessary. We
believe our management has taken or is in the process of taking the steps
necessary to correct the errors and avoid similar errors in the future. One
important measure is to have our President also become involved in the
review of our internal controls and procedures.
As required by SEC Rule 13a-15(b) we conducted an evaluation, under the
supervision and with the participation of our management, including our
Chief Executive Officer, President and Vice President of Finance, of the
effectiveness of the design and operation of our disclosure controls and
procedures. Based upon that evaluation, the Chief Executive Officer,
President and Vice President of Finance concluded that our disclosure
controls and procedures are effective in timely alerting them to material
information relating to us (including our subsidiaries) required to be
included in our periodic SEC filings.
Other than the foregoing initiatives, 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.
While we have taken or are in the process of taking the foregoing steps in
order to address the adequacy of our disclosure controls and procedures,
and, in addition, to develop and implement a formal set of internal
controls and procedures for financial reporting in accordance with SEC's
proposed rules to adopt the internal control report requirements included
in Section 404 of the Sarbanes-Oxley Act of 2002, the efficacy of the steps
we have taken to date and the steps we are still in the process of
completing is subject to continued management review supported by
confirmation and testing by our internal and external auditors. As a
result, it is likely that additional changes will be made to our internal
controls and procedures.
ITEM 9B. OTHER INFORMATION
None.
- 84 -
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS AND EXECUTIVE OFFICERS
The names of the company's Directors and Executive Officers as of December
31, 2003 and certain information about them are set forth below:
NAME AGE POSITIONS WITH THE COMPANY
----------------------- --- ---------------------------------------------
Carl E. Berg 66 Chairman of the Board, Chief Executive Officer and Director
Raymond V. Marino 45 President, Chief Operating Officer and Director
Wayne N. Pham 34 Vice President of Finance and Controller
John C. Bolger (1) 57 Director
William A. Hasler (1) 62 Director
Lawrence B. Helzel (1) 56 Director
(1) Member of the Audit Committee, the Compensation Committee and the
Independent Directors Committee.
The following is a biographical summary of the experience of our executive
officers and directors:
Mr. Berg has served as Chairman of the Board and Chief Executive Officer of
the Company since September 1997. Since 1979, Mr. Berg has been a general
partner of Berg & Berg Developers and has been a director and officer of
Berg & Berg Enterprises, Inc. since its inception. Mr. Berg is a private
investor and is also a director of Monolithic System Technology, Inc.,
Focus Enhancements, Inc., and Valence Technology, Inc.
Mr. Marino joined the Company in June 2001 as President and Chief Operating
Officer and was appointed by the board of directors to fill a newly created
board seat in July 2001. From November 1996 to August 2000, he was
President, Chief Executive Officer and a member of the board of directors
of Pacific Gateway Properties, Inc.
Mr. Pham joined the Company in March 2000 as Controller and was promoted to
Vice President of Finance in October 2000. From September 1995 to July
1999, he was Corporate Accountant and Accounting Manager at AvalonBay
Communities, Inc., a multi-family apartment REIT.
Mr. Bolger became a director of the Company on March 30, 1998. Mr. Bolger
is a private investor and certified public accountant. He is the retired
Vice President of Finance and Administration of Cisco Systems, Inc., a
manufacturer of computer networking systems, a position that he held from
May 1989 to December 1992. Mr. Bolger is also a director of Integrated
Device Technology, Inc., Sanmina-SCI Corporation, Wind River Systems, Inc.,
and Micromuse, Inc.
Mr. Hasler became a director of the Company on December 4, 1998. For seven
years, Mr. Hasler was Dean of the Haas School of Business at the University
of California, Berkeley, and is a former vice chairman and director of KPMG
LLP. In 1998, he retired as Dean Emeritus and became Co-CEO of Aphton
Corporation, a public pharmaceutical company. Mr. Hasler recently stepped
down from his position as Co-CEO of Aphton Corporation and assumed the role
of Vice-Chairman of the Board. Mr. Hasler is also the Chairman of the board
of directors of Solectron Corporation and a director of Aphton Corporation,
Technical Olympic USA, Inc., Ditech Communications Network, DMC Stratex
Networks, Inc. and Genitope Corporation. He is a public governor of the
Pacific Stock and Options Exchange and a trustee of the Schwab Funds.
Mr. Helzel became a director of the Company on December 4, 1998. Mr. Helzel
is a private investor and a general partner of Helzel Kirshman, L.P., a
private investment partnership, a position which he has held for more than
five years.
NUMBER TERMS AND ELECTION OF DIRECTORS
Our Bylaws currently provide for a board of directors consisting of five
directors. Each director serves for a term of one year or until the next
annual meeting at which directors are elected and the director's successor
is elected and qualifies. In the election of directors, each stockholder is
entitled to one vote for each share of common stock held by such
stockholder.
- 85 -
MEETINGS OF DIRECTORS
Under our Articles of Amendment and Restatement, or Charter, Bylaws and
contracts with the "Berg Group," which consists of Carl E. Berg, Clyde J.
Berg, the members of their respective immediate families, and affiliated
entities owning limited partnership interests, or O.P. Units, in the
Operating Partnerships, the Berg Group has special rights with respect to
meetings of the board of directors. A quorum for any meeting requires the
presence of Carl E. Berg, or in the event of his death, disability or other
event which results in his ceasing to be director, the presence of someone
who Mr. Berg has designated to replace him ("Berg Designee"). With written
consent from Mr. Berg or the Berg Designee, meetings of the board of
directors may be held without the presence of either of them. Mr. Berg is
obligated to submit a written statement identifying the Berg Designee to us
from time to time and may amend the statement at his sole discretion. In
addition, a majority of the board of directors, which includes Mr. Berg or
the Berg Designee, is required for approval of any amendment to the Charter
or Bylaws and any merger, consolidation or sale of all or substantially all
of our assets or those of the Operating Partnerships. These special
provisions will remain in effect as long as the Berg Group collectively
owns at least 15% of our voting stock computed on a diluted, or "Fully
Diluted", basis taking into account all voting stock issuable upon the
exercise of all outstanding warrants, options, convertible securities and
other rights to acquire voting stock of the Company, and all O.P. Units
exchangeable or redeemable for common stock or other voting stock of ours
without regard to any percentage ownership limit set forth in the Charter
or Bylaws, or by agreement.
COMMITTEES OF THE BOARD OF DIRECTOR AND MEETINGS
Our board of directors has standing Audit and Compensation Committees. The
Audit Committee currently has three members: John C. Bolger, William A.
Hasler and Lawrence B. Helzel. The Compensation Committee currently has the
same three members.
The board of directors has an Independent Directors Committee, which is
also comprised of Messrs. Bolger, Hasler and Helzel. This committee is
responsible for reviewing and acting upon proposed transactions between us
and members of the Berg Group under the terms of certain agreements between
us and such Berg Group members. See "Certain Relationships and Related
Transactions."
During the year ended December 31, 2003, there were four meetings of the
board of directors and five meetings of the Audit Committee. Four of the
five directors attended 100% of the total number of meetings of the board
of directors. One director attended three of the four meetings of the board
of directors. Each of the directors attended 100% of the meetings of the
committees of the board of directors of which he is a member.
The board of directors does not believe that a nominating committee is
necessary because all the independent directors currently serve on the
Audit and Compensation Committees, and any additional committee of
independent directors would consist of the same individuals. The entire
board of directors will review and approve nominations for election to the
board of directors at the next annual meeting of stockholders solely, other
than the two nominees that the Berg Group has the right to designate under
our Charter and Bylaws, by resolution of the independent directors on the
board.
AUDIT COMMITTEE REPORT
The Audit Committee has been established in accordance with section
3(a)-(58)-(A) of the Securities Exchange Act. The Audit Committee reviews,
acts on and reports to the board of directors with respect to various
auditing and accounting matters. The Audit Committee has the authority and
responsibility to select, evaluate, and where appropriate, replace our
independent public accountants. The Audit Committee also reviews the scope
of the annual audit fees to be paid to our independent public accountants,
the performance of the independent public accountants, the audit report of
our consolidated financial statements following completion of the audit and
the accounting practices of the Company with respect to internal accounting
and financial controls. The Audit Committee notes, however, that management
has primary responsibility for our financial statements and the overall
reporting process, including our system of internal controls. The
independent public accountants audit the financial statements prepared by
management, express an opinion on whether those financial statements fairly
present the financial position, results of operations and cash flows in
conformity with accounting principles generally accepted in the United
States of America, and discuss with the Audit Committee any issues they
believe should be raised with us.
The board of directors adopted an Audit Committee Charter on June 9, 2000.
The Audit Committee is currently comprised of Messrs. John C. Bolger,
William A. Hasler, and Lawrence B. Helzel, all of whom are independent
within the meaning of Section 121(A) of the AMEX's listing standards. The
board of directors has determined that Mr. Bolger, the Chairman of the
Audit Committee, and Mr. Hasler are Audit Committee financial expert.
- 86 -
The Audit Committee has reviewed and discussed the audited financial
statements of the Company for fiscal year 2003 with management and the
Company's independent registered public accounting firm, BDO Seidman, LLP
("BDO"). The Committee discussed with BDO matters required to be discussed
by Statement on Auditing Standards No. 61 (Communication with Audit
Committees). The Audit Committee was also provided by BDO the written
disclosures required by Independence Standards Board Standard No. 1
(Independence Discussions with Audit Committees), and the Committee
discussed with BDO that firm's independence.
Based on the discussions with BDO concerning the audit, the independence
discussions and the financial statement review, and such other matters
deemed relevant and appropriate by the Audit Committee, the Audit Committee
recommended to the Board that the Company's financial statements for the
fiscal year ended December 31, 2003 be included in its 2003 Annual Report
on Form 10-K filed with the SEC.
The Audit Committee of the Board of Directors:
John C. Bolger
William A. Hasler
Lawrence B. Helzel
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires
our directors, executive officers and persons who own more than 10% of a
registered class of the Company's equity securities to file with the SEC
initial reports of ownership and reports of changes in ownership of common
stock and other equity securities of ours. Directors, executive officers
and greater than 10% holders are required by SEC regulation to furnish us
with copies of all Section 16(a) reports they file.
To the Company's knowledge, based solely on review of the copies of the
above-mentioned reports furnished to the Company and written
representations regarding all reportable transactions, during the fiscal
year ended December 31, 2003, all Section 16(a) filing requirements
applicable to its directors, officers and greater than ten percent holders
were complied with on time, except that Carl E. Berg and certain members of
the Berg Group did not timely file one or more reports on Form 4 that may
have been due with respect to acquired O.P. Units issued pursuant to the
Berg Land Holdings Option Agreement. The acquisitions of these units were
otherwise disclosed in reports filed by the COmpany on a group Form 4
filing.
CODE OF ETHICS
We have adopted a code of ethics that applies to all of our employees. The
code of ethics is designed to deter wrongdoing and to promote, among other
things, honest and ethical conduct, full, fair, accurate, timely, and
understandable disclosures in reports and documents submitted to the SEC
and other public communications, compliance with all applicable
governmental laws, rules and regulations, the prompt internal reporting of
violations to the code to an appropriate person or persons identified in
the code and accountability for adherence to such code.
The code of ethics is available on our website www.missionwest.com. If we
make any substantive amendments to the code of ethics or grant any waiver,
including any implicit waiver, from a provision of the code to our Chief
Executive Officer, Chief of Operations Officer, Vice President of Finance
or Controller, or persons performing similar functions, where such
amendment or waiver is required to be disclosed under applicable SEC rules,
we intend to disclose the nature of such amendment or waiver on our
website.
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ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following Summary Compensation Table sets forth summary information as
to compensation received by the Company's Chief Executive Officer and all
other executive officers of the Company (collectively the "named executive
officers"), for the years ended December 31, 2003, 2002 and 2001.
Long-Term
Compensation
Annual Compensation Awards
---------------------------------------------- -----------
Securities
Other Annual Underlying All Other
Name and Principal Position Year Salary Bonus Compensation (1) Options Compensation
--------------------------------- -------- ----------- ----------- ------------------- ----------- ----------------
Carl E. Berg 2003 $100,000 $ -- $22,500 -- --
Chairman of the Board and Chief 2002 100,000 -- 22,500 -- --
Executive Officer 2001 100,000 -- 22,500 -- --
Raymond V. Marino (2) 2003 200,000 -- 30,000 375,000 --
President and Chief Operating 2002 200,000 -- 29,000 -- --
Officer 2001 116,667 -- -- -- --
Wayne N. Pham 2003 112,500 -- 16,875 152,000 --
Vice President and Controller 2002 94,000 -- 14,100 -- --
2001 94,000 -- 14,100 -- --
(1) Employer contribution to 401(k) plan.
(2) Mr. Marino joined the Company in June 2001.
OPTION GRANTS IN LAST FISCAL YEAR
The Company did not grant any options to purchase shares of common stock
with respect to the fiscal year ended December 31, 2003.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END VALUES
The following table provides information regarding the aggregate exercises
of options by each of the named executive officers. In addition, this table
includes the number of shares covered by both exercisable and unexercisable
stock options as of December 31, 2003, and the values of "in-the-money"
options, which values represent the positive spread between the exercise
price of any such options and the fiscal year-end value of the Company's
Common Stock.
Number of Securities Value of the Unexercised
Underlying Unexercised In-The-Money Options at
Shares Options at December 31, 2003 December 31, 2003 (1)
Acquired on Value -------------------------- ---------------------------
Name Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
---------------------------- -------------- --------------- ------------- ------------- ------------- -------------
Carl E. Berg -- N/A N/A N/A N/A N/A
Raymond V. Marino -- N/A 166,667 208,333 $270,001 $337,499
Wayne N. Pham -- N/A 128,000 24,000 $345,100 $27,300
(1) The value of unexercised in-the-money options at fiscal year end assumes a
fair market value for the Company's Common Stock of $12.95, the closing
market price per share of the Company's Common Stock as reported on the
American Stock Exchange on December 31, 2003, the last trading day for the
year.
EMPLOYMENT CONTRACTS, TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL
AGREEMENTS
We currently have no employment contracts, termination of employment or
change-in-control agreements in place with any employee of ours.
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COMPENSATION OF DIRECTORS
We pay each director who is not an officer or employee of ours a fee for
serving as director. The annual fee is equal to $15,000 plus $1,000 for
attendance (in person or by telephone) at each meeting of the board of
directors, excluding committee meetings. Officers who are also directors do
not receive any directors' fees.
Each non-employee member of the board of directors who became or becomes a
member of the board of directors after November 10, 1997, the date on which
the 1997 Stock Option Plan (the "Option Plan") was approved by our
stockholders, automatically receives a grant of an option to purchase
50,000 shares of common stock at an exercise price equal to 100% of the
fair market value of the common stock at the date of grant of such option
upon joining the board of directors. Such options become exercisable
cumulatively with respect to 1/48th of the underlying shares on the first
day of each month following the date of grant. Generally, the options must
be exercised while the optionee remains a director.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
the Compensation Committee of the board of directors was formed in December
1998 and currently is comprised of Messrs. John C. Bolger, William A.
Hasler and Lawrence B. Helzel. None of these individuals were at any time
during 2003, or at any other time, an officer or employee of the Company.
No executive officer of ours serves as a member of the Compensation
Committee of any other entity that has one or more executive officers
serving as a member of the Company's board of directors or Compensation
Committee.
REPORT ON EXECUTIVE COMPENSATION BY THE COMPENSATION COMMITTEE OF THE BOARD
OF DIRECTORS
The Compensation Committee (the "Committee") comprises three independent
members of the board of directors. The Company's board of directors has
delegated to the committee responsibility for reviewing, recommending and
approving our compensation policies and benefits programs. The Compensation
Committee also has the principal responsibility for the administration of
Option Plans, including approving stock option grants to executive
officers.
COMPENSATION PHILOSOPHY
The Company's executive compensation policy is designed to attract and
retain qualified executive personnel by providing executives with a
competitive total compensation package based in large part on their
contribution to the financial and operational success of the Company, the
executive's personal performance and increases in stockholder value as
measured by the Company's stock price.
COMPENSATION PROGRAM
The compensation package for the Company's executive officers consists of
the following three components:
BASE SALARY. The Compensation Committee determines the base salary of each
executive based on the executive's scope of responsibility, past
accomplishments and experience and personal performance, internal
comparability considerations and data regarding the prevailing compensation
levels for comparable positions in relevant competing executive labor
markets. The Committee may give different weight to each of these factors
for each executive, as it deems appropriate. In selecting comparable
companies for the purpose of setting competitive compensation for our
executives, the Compensation Committee considers many factors not directly
associated with stock price performance, such as geographic location,
annual revenue and profitability, organizational structure, development
stage and market capitalization.
ANNUAL INCENTIVE COMPENSATION. At the present time, we do not have an
annual incentive compensation program in place. However, the Compensation
Committee may in the future at the Compensation Committee's discretion
institute an annual incentive program.
STOCK OPTIONS. The Compensation Committee believes that granting stock
options to executives and other key employees on an ongoing basis gives
them a strong incentive to maximize stockholder value and aligns their
interests with those of other stockholders. The Compensation Committee
determines stock option grants to executives and has authorized our CEO to
determine stock option grants for all other employees, subject to the
Compensation Committee's approval of total share allocations from the
Option Plan. In determining the size of stock option grants, the
Compensation Committee considers the executive's current position with and
responsibilities to us, potential for increased responsibility and
promotion over the option term, tenure with us and performance in recent
periods, as well as the size of comparable awards made to executives in
- 89 -
similar positions in competing executive labor markets. Generally, each
stock option grant allows the executive to purchase shares of Common Stock
at a price per share equal to the market price on the date the option is
granted, but the Compensation Committee has the power to grant options at a
lower price if considered appropriate under the circumstances. Each stock
option grant generally becomes exercisable, or vests, in installments over
time, or contingent upon the executive's continued employment with us.
Management did not recommend and the Compensation Committee did not
authorize any stock option grants in 2003.
COMPENSATION OF CHIEF EXECUTIVE OFFICER. The annual salary for Mr. Berg was
set in 1997 and first became payable in 1998. The Compensation Committee
has no plan to adjust his compensation.
COMPLIANCE WITH INTERNAL REVENUE CODE SECTION 162(M). Section 162(m) of the
Internal Revenue Code generally disallows a tax deduction to publicly-held
companies for compensation paid to certain executive officers, to the
extent that compensation paid to the officer exceeds $1 million during the
taxable year. the compensation paid to our executive officers for the year
ended December 31, 2003 did not exceed the $1 million limit per officer. In
addition, the Option Plan and executive incentive option grants have been
structured so that any compensation deemed paid to an executive officer in
connection with the exercise of his or her outstanding options with an
exercise price per share equal to the fair market value per share of the
common stock on the grant date will qualify as performance-based
compensation that will not be subject to the $1 million limitation. It is
very unlikely that the cash compensation payable to any of our executive
officers in the foreseeable future will approach the $1 million limit, and
the Compensation Committee does not expect to take any action at this time
to modify cash compensation payable to our executive officers to avoid the
application of Section 162(m).
The Compensation Committee of the Board of Directors:
John C. Bolger
William A. Hasler
Lawrence B. Helzel
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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The following table sets forth certain information as of June 30, 2004,
concerning the ownership of Common Stock by (i) each stockholder of the
Company known by the Company to be the beneficial owner of more than 5% of
the outstanding shares of Common Stock, (ii) each current member of the
board of directors of the Company, (iii) each executive officer and
director of the Company named in the Summary Compensation Table appearing
under "Executive Compensation" below and (iv) all current directors and
executive officers of the Company as a group.
The Company has relied on information supplied by its officers, directors
and certain shareholders and on information contained in filings with the
SEC.
Percent of All
Shares of
Common Stock
Number of Shares Percent of (Assuming Percent of All
Beneficially All Shares of Number of O.P. Exchange of Shares of Common
Name Owned (1) Common Stock Units Holder's O.P. Stock/O.P. Units
Units) (2) (1)(2)
------------------------------------------------------------------------------------------------------------------------------------
Executive Officers and Directors:
Carl E. Berg __ * 44,888,441 71.31% 42.96%
Chairman of the Board, Chief Executive (3)(13)
Officer and Director
Raymond V. Marino 238,463 (4) 1.32% __ 1.32% *
President, Chief Operating Officer and
Director
Wayne N. Pham 143,000 (5) * __ * *
Vice President of Finance and Controller
John C. Bolger, Director 54,222 (6) * __ * *
96 Southerland Drive
Atherton, CA 94027
William A. Hasler, Director 46,000 (7) * __ * *
c/o Aphton Corporation
1 Market Street, Spear Tower, Ste. 1850
San Francisco, CA 94105
Lawrence B. Helzel, Director 219,500 (8) 1.22% __ 1.22% *
c/o Helzel Kirshman, LP
5550 Redwood Road, Suite 4
Oakland, CA 94619
5% Stockholders:
Cohen & Steers Capital Management, Inc. 2,339,500 (9) 12.95% __ 12.95% 2.24%
757 Third Avenue
New York, NY 10017
Neuberger Berman, LLC 2,419,523 13.39% __ 13.39% 2.32%
Neuberger Berman, Inc. (10)
605 Third Avenue
New York, NY 10158
Ingalls & Snyder, LLC 1,906,856 10.56% __ 10.56% 1.83%
61 Broadway (11)
New York, NY 10006
Clyde J. Berg __ * 43,478,470 70.65% 41.61%
c/o Berg & Berg Developers (12)(13)
10050 Bandley Drive
Cupertino, CA 95014
Berg & Berg Enterprises, Inc. (15) __ * 10,789,383 37.39% 10.33%
10050 Bandley Drive
Cupertino, CA 95014
Thelmer G. Aalgaard __ * 1,854,225 9.31% 1.77%
c/o Berg & Berg Developers
10050 Bandley Drive
Cupertino, CA 95014
John T. Kontrabecki __ * 1,755,761 8.86% 1.68%
2755 Campus Drive, Suite 100
San Mateo, CA 94403
All Directors and Officers as a group (6 701,185 (14) 3.88% 44,888,441 (12) 72.42% 43.63%
persons)
* Less than 1%.
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission which generally attribute beneficial
ownership of securities to persons who possess sole or shared voting power
and/or investment power with respect to those securities and includes
securities which such person has the right to acquire beneficial ownership
within 60 days of June 30, 2004.
- 91 -
Unless otherwise indicated, the persons or entities identified in this
table have sole voting and investment power with respect to all shares
shown as beneficially owned by them. Common Stock percentage ownership
interest calculations are based on 18,063,691 shares outstanding as of June
30, 2004 and excluding all shares of Common Stock issuable upon the
exercise of outstanding options other than the shares so issuable within 60
days under options held by the named person. Common Stock/O.P. Units
percentage ownership interest calculations are based on 104,929,219 shares
of Common Stock and O.P. Units exchangeable for Common Stock as of June 30,
2004.
(2) Assumes O.P. Units are exchanged for shares of Common Stock without regard
to (i) whether such O.P. Units may be exchanged for shares of Common Stock
within 60 days of June 30, 2004, and (ii) certain ownership limit
provisions set forth in the Company's Articles of Amendment and
Restatement.
(3) Includes O.P. Units in which Mr. Berg has a pecuniary interest because of
his status as a limited partner in the operating partnerships. Also
includes an additional 10,789,383, 196,428, and 169,131 shares of Common
Stock held by or issuable on exchange of O.P. Units beneficially owned by
Berg & Berg Enterprises, Inc., Berg & Berg Enterprises, LLC, and West Coast
Venture Capital, Inc. respectively. Mr. Berg disclaims beneficial interest
in any shares or O.P. Units deemed beneficially owned by Kara Ann Berg, his
daughter, and the 1981 Kara Ann Berg Trust.
(4) Includes 208,333 shares of Common Stock issuable on exercise of options.
Does not include 166,667 unvested shares of Common Stock issuable on
exercise of options that are not exercisable within 60 days.
(5) Includes 143,000 shares of Common Stock issuable on exercise of options.
Does not include 9,000 unvested shares of Common Stock issuable on exercise
of options that are not exercisable within 60 days.
(6) Includes 32,000 shares of Common Stock issuable on exercise of options.
(7) Includes 32,000 shares of Common Stock issuable on exercise of options.
(8) Includes 32,000 shares of Common Stock issuable on exercise of options.
(9) Cohen & Steers Capital Management, Inc. is the beneficial owner on behalf
of other persons. No such person is known to have an interest in more than
5% of the Common Stock reported. Amount based on the filing of Schedule 13G
on February 17, 2004.
(10) Neuberger Berman, LLC & Neuberger Berman, Inc. is the beneficial owner on
behalf of other persons. One employee, Dan McCarthy, has an interest in
5.7% of the Common Stock reported. No other person is known to have an
interest in more than 5% of the Common Stock reported. Amount based on the
filing of Schedule 13G on February 9, 2004.
(11) Ingalls & Snyder, LLC is the beneficial owner on behalf of other persons.
No such person is known to have an interest in more than 5% of the Common
Stock reported. Amount based on the filing of Schedule 13G on February 5,
2004.
(12) Includes O.P. Units in which Mr. Berg has a pecuniary interest because of
his status as a limited partner in the operating partnerships. Also
includes L.P. Units held by Mr. Berg as trustee of the 1981 Kara Ann Berg
Trust and an additional 10,789,383 shares of Common Stock held by or
issuable on exchange of O.P. Units beneficially owned by Berg & Berg
Enterprises, Inc. This does not include any share deemed beneficially owned
by Sonya L. Berg and Sherri L. Berg, his daughters, as to which he
disclaims beneficial ownership.
(13) Carl E. Berg is an executive officer and director and Clyde J. Berg is a
director of Berg & Berg Enterprises, Inc. With members of their immediate
families, the Messrs. Berg beneficially owns, directly and indirectly, all
of the O.P. Units of Berg & Berg Enterprises, Inc.
(14) Current officers and directors include Carl E. Berg, Raymond V. Marino,
Wayne N. Pham, John C. Bolger, William A. Hasler, and Lawrence B. Helzel.
See Notes 3 through 8.
- 92 -
CONTRACTUAL AND OTHER CONTROL ARRANGEMENTS
SPECIAL BOARD VOTING PROVISIONS. The Charter and Bylaws provide substantial
control rights for the Berg Group. These rights include a requirement that
Mr. Berg or his designee as director approve certain fundamental corporate
actions, including amendments to the Charter and Bylaws and any merger,
consolidation or sale of all or substantially all of our assets. In
addition, the Bylaws provide that a quorum necessary to hold a valid
meeting of the board of directors must include Mr. Berg or his designee.
The rights described in the two preceding sentences apply only as long as
the Berg Group members and their affiliates, other than us and the
Operating Partnerships, beneficially own, in the aggregate, at least 15% of
the outstanding shares of common stock on a Fully Diluted basis. In
addition, directors representing more than 75% of the entire board of
directors must approve other significant transactions, such as incurring
debt above certain amounts, acquiring assets and conducting business other
than through the Operating Partnerships.
BOARD OF DIRECTORS REPRESENTATION.The Berg Group members have the right to
designate two of the director nominees submitted by the board of directors
to stockholders for election, as long as the Berg Group members and their
affiliates, other than the Company and the Operating Partnerships,
beneficially own, in the aggregate, at least 15% of our outstanding shares
of common stock on a Fully Diluted basis. If the Fully Diluted ownership of
the Berg Group members and their affiliates is less than 15% but is at
least 10% of the common stock, the Berg Group members have the right to
designate one of the director nominees submitted by the board of directors
to stockholders for election. Its right to designate director nominees
affords the Berg Group substantial control and influence over the
management and direction of our corporation.
SUBSTANTIAL OWNERSHIP INTEREST. The Berg Group currently owns O.P. Units
representing approximately 75.1% of the equity interests in the operating
partnerships. The O.P. Units may be converted into shares of Common Stock,
subject to limitations set forth in the Charter (including an overall 20%
ownership limitation for the Berg Group), and other agreements with the
Berg Group. Upon conversion these shares would represent voting control of
the Company. The Berg Group's ability to exchange its O.P. Units for common
stock permits it to exert substantial influence over the management and
direction of the Company.
LIMITED PARTNER APPROVAL RIGHTS. Mr. Berg and other limited partners of the
Operating Partnerships, including other members of the Berg Group, may
restrict our operations and activities through rights provided under the
terms of the Amended and Restated Agreement of Limited Partnership which
governs each of the Operating Partnerships and our legal relationship to
each Operating Partnership as its general partner. Matters requiring
approval of the holders of a majority of the O.P. Units, which necessarily
would include the Berg Group, include (i) the amendment, modification or
termination of any of the Operating Partnership Agreements; (ii) the
transfer of any general partnership interest in the Operating Partnerships,
including, with certain exceptions, transfers attendant to any merger,
consolidation or liquidation of our corporation; (iii) the admission of any
additional or substitute general partners in the Operating Partnerships;
(iv) any other change of control of the Operating Partnerships; (v) a
general assignment for the benefit of creditors or the appointment of a
custodian, receiver or trustee of any of the assets of the Operating
Partnerships; and (vi) the institution of any bankruptcy proceeding for any
Operating Partnership.
In addition, as long as the Berg Group members and their affiliates,
beneficially own, in the aggregate, at least 15% of the outstanding shares
of common stock on a Fully Diluted basis, the consent of the limited
partners holding the right to vote a majority of the total number of O.P.
Units outstanding is also required with respect to (i) the sale or other
transfer of all or substantially all of the assets of the Operating
Partnerships and certain mergers and business combinations resulting in the
complete disposition of all O.P. Units; (ii) the issuance of limited
partnership interests senior to the O.P. Units as to distributions, assets
and voting; and (iii) the liquidation of the Operating Partnerships.
- 93 -
EQUITY COMPENSATION PLAN INFORMATION
The following table provides information as of December 31, 2003 regarding
equity compensation plans approved by the Company's security holders.
Number of Shares Number of Shares of Common
of Common Stock Remaining Available
Stock to be Issued Weighted-Average for Future
Upon Exercise of Exercise Price of Issuance Under Equity
Plan Category Outstanding Options Outstanding Options Compensation Plans
----------------------------------------------------------- ------------------- ------------------- --------------------------
Equity Compensation plans approved by security holders 787,000 $11.36 3,991,089
Equity Compensation plans not approved by security holders N/A N/A N/A
Total 787,000 $11.36 3,991,089
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
PROPERTY ACQUISITIONS AND FINANCIAL TRANSACTIONS BETWEEN THE COMPANY AND
THE BERG GROUP
FORMATION OF THE COMPANY: Through a series of transactions in 1997 and
1998, the Company became the vehicle for substantially all of the Silicon
Valley R&D property activities of the Berg Group, which includes Mr. Berg,
his brother Clyde J. Berg, members of their families and a number of
entities in which they have controlling or substantial ownership interests.
The Company owns these former Berg Group properties, as well as the rest of
its properties, through the Operating Partnerships, of which the Company is
the sole general partner. Through various property acquisition agreements
with the Berg Group, the Company has the right to purchase, on
pre-negotiated terms, R&D and other types of office and light industrial
properties that the Berg Group develops in the future in the states of
California, Oregon and Washington the details of which are set forth above.
Since September 1998, we have acquired a total of approximately 3,100,000
million rentable square feet of R&D buildings under the Pending Projects
Acquisition Agreement and the Berg Land Holdings Option Agreement. The
total cost of these properties was approximately $478 million. We issued a
total of 27,962,025 O.P. Units and assumed debt totaling approximately $209
million to acquire them.
ACQUISITIONS FROM THE BERG GROUP: On December 15, 2003, we acquired a
128,520 square foot fully leased two story office/R&D building at 5970
Optical Court in San Jose from the Berg Group under the Berg Land Holdings
Option Agreement. The total acquisition price for this property was $11.2
million. We financed this acquisition by borrowing $9.0 million under an
existing line of credit and issuing 169,131 O.P. Units to various members
of the Berg Group.
ACQUISITION OF CARL E. BERG'S INTEREST IN UNCONSOLIDATED JOINT VENTURE: In
July 1999 an unrelated party, TBI, advised Carl E. Berg that TBI had an
option to purchase approximately 78.89 acres of unimproved land zoned for
R&D development in Morgan Hill at $2.50 per square foot that would expire
in approximately six months. TBI offered Mr. Berg a 50% interest in the
development of this land if Mr. Berg provided 100% financing for the land
at 0% interest for three years. Mr. Berg advised TBI of his obligation to
offer all R&D development opportunities on the West Coast to us and further
advised TBI that our Independent Directors Committee must approve the
acquisition of any properties and that our policy was only to acquire
properties that are leased pursuant to the Berg Land Holdings Option
Agreement. The development joint venture between TBI and the Berg Group
proceeded on that basis. Building construction was financed through loans
facilitated by the Berg Group. In early 2003, TBI formed TBI-MSW, a new
limited partnership, to own all the leased buildings. The Berg Group
offered its 50% non-controlling limited partnership interest in TBI-MSW to
us at cost plus an annual interest rate of 7% on the funds advanced by the
Berg Group which amounted to $1.8 million. The Independent Directors
Committee and the Berg Group agreed to use a 7% interest rate instead of
the rate and fees specified in the Berg Land Holdings Option Agreement
because the transaction differed from the standard build-to-suit
developemnt specified under that agreement. TBI-MSW owned four fully leased
buildings totaling approximately 593,000 rentable square feet. The
buildings were subject to mortgage loans totaling $53.6 million. The
Independent Directors Committee approved our acquisition of the Berg
Group's 50% interest in the joint venture, effective as of January 1, 2003.
The development joint venture between the Berg Group and TBI retained two
vacant shell R&D buildings and five unimproved lots. In April 2003,
Comcast, Inc. offered to purchase one of the vacant buildings and two acres
of adjoining land from the development joint venture for net proceeds of
$2.8 million, after debt repayment. Prior to sale of the property, TBI-MSW
acquired this property at no cost under the terms of the Berg Land Holdings
Option Agreement, and the Company received a net distribution of $1.4
million from the sale. The transaction
- 94 -
was approved by the Independent Directors Committee. The Berg Group
continues to own a 50% interest in the remaining vacant building and five
unimproved lots.
TRANSFER OF INTEREST TO BERG GROUP IN CONSOLIDATED JOINT VENTURE. In July
2000, the Hellyer Avenue Limited Partnership ("Hellyer LP") was formally
organized as a California limited partnership between Mission West
Properties, L.P. ("MWP"), of which we are the managing general partner, and
Republic Properties Group ("RPC"), an unaffiliated third party, as a
general partner and limited partner. MWP was designated as the managing
general partner of Hellyer LP. For a 50% ownership interest in Hellyer LP,
RPC agreed to cause Stellex Microwave Systems, Inc. ("Stellex") to provide
a 15-year lease on an approximate 160,000 square foot R&D building to be
constructed by Berg & Berg Enterprises, Inc. ("BBE") on land owned by
another Berg Group member.
As part of the transaction, MWP acquired the underlying land pursuant to
the Berg Land Holding Option Agreement for a price of $5.7 million by
issuing 659,223 OP units to the Berg Group entity that owned the property.
Further, under the terms of the Hellyer LP partnership agreement MWP then
contributed the land to the partnership at an agreed value of $9.6 million
which amount was to be amortized and paid to MWP in the form of income and
cash flow preferences. The transaction was reviewed and approved by the
Independent Directors Committee.
In connection with the transaction, BBE built and paid for all improvements
on the land. The total cost of the R&D building, exclusive of specified
tenant improvements obligations, was approximately $11.4 million. Hellyer
LP issued a note for the amount of those construction costs to BBE, which
note was secured by the buildings.
Because RPC's interest in Hellyer LP was attributable solely to its
commitment to obtain Stellex as a tenant for the property, the partnership
agreement provided that if a payment default occurred within the first five
years of the Stellex lease, RPC would lose 100% of its interest in the
partnership, and if a payment default occurred during the second five year
period under the lease, RPC would lose 50% of its interest in Hellyer LP.
Pursuant to RPC's commitment to Hellyer LP, Stellex executed a lease
agreement obligating Stellex, among other things, to pay monthly rent
starting at $1.60 per square foot on a triple net basis for 15 years and to
reimburse BBE for the tenant improvement obligations, which ultimately
totaled approximately $10.5 million.
Under the lease terms, Stellex was obligated to reimburse BBE in full for
the tenant improvement costs no later than August 25, 2000. Several days
before the due date, representatives of Stellex met with representatives of
MSW and informed them that Stellex could not pay the balance due BBE.
Stellex requested MSW immediately to draw down the letter of credit as a
result of a default on the tenant improvement payment required under the
lease.
On September 1, 2000, MWP, as the general partner of Hellyer LP, ceased all
allocations of income and cash flow to RPC and exercised the right under
the partnership agreement to cancel RPC's entire interest in the
partnership. Following discussions with and approval by the Independent
Directors Committee, the Company authorized the transfer of RPC's interest
in Hellyer LP to BBE. Under the Berg Land Holdings Option Agreement and the
Acquisition Agreement dated as of May 14, 1998, the Independent Directors
Committee had the right, but not the obligation, to reacquire the property
interest and the related distributions related to the property interest at
any time. The transfer was effective as of September 1, 2000.
Stellex filed for bankruptcy protection on September 12, 2000. On November
20, 2000, RPC filed suit in the Circuit Court of Maryland for Baltimore
City to recover past distributions and its interest in the Hellyer LP., and
we counter-sued on behalf of MWP and ourselves in Superior Court of
California for the County of Santa Clara in February 2001.
In January 2002, Stellex was acquired through its bankruptcy proceeding by
a division of Tyco Corporation. In connection with the acquisition of
Stellex, the purchaser assumed the lease with Hellyer LP, agreed to comply
with all terms of lease and reimbursed BBE for the tenant improvements, as
required under the lease agreement and the Bankruptcy Court order.
Since the inception of Hellyer LP, we have accounted for the properties
owned by the partnership on a consolidated basis, with reductions for the
minority interest held by the minority partner (first RPC and then BBE). In
each period, we have accrued amounts payable by Hellyer LP to the minority
interest partner, including BBE, prior to payment. Through December 31,
2003, accumulated cash flow distributions from Hellyer LP totaling
approximately $1.6 million were accrued, of which $1.5 million was
distributed to BBE, which has been classified on our balance sheet as an
account receivable from BBE with an offsetting account payable to BBE. The
Company did not object to that proposed classification.
In April 2004 the Circuit Court of Maryland for Baltimore City issued its
decision in the Maryland suit, and awarded damages of approximately $1.1
million to RPC. The court denied all requests by MWP, including a
declaration that all of RPC's
- 95 -
interests in Hellyer L.P. were validly converted to limited partnership
interests and transferred to MWP or its designee in accordance with the
terms of the Hellyer L.P. partnership agreement. RPC's request for an
injunction ordering the reinstatement of RPC's partnership interests in
Hellyer L.P. appealed the decision to the Maryland Appeals Court. If the
litigation with RPC is ultimately decided in RPC's favor, we anticipate
that BBE may be required to return RPC's former interest in Hellyer LP and
all prior distributions to RPC. If the litigation is ultimately decided in
our favor, the Independent Directors Committee has the right, but not the
obligation, to acquire the former RPC interest and related distributions
from BBE under the terms of the Berg Land Holdings Option Agreement and the
Acquisition Agreement. In July 2004 RPC attached the Company's bank account
for approximately $1.1 million. Following a July 2004 hearing in Superior
Court of the State of California for the County of Santa Clara the parties
agreed that the Company will post a $1.5 million bond and RPC will remove
the attachment of the Company's bank account until final resolution of the
appeal in Maryland.
If the Company's litigation with RPC is ultimately decided in RPC's favor,
the Company anticipates that BBE may be required to return RPC's former
interest in Hellyer LP and all prior distributions to RPC. If the
litigation is ultimately decided in favor of the Company, the Independent
Directors Committee of the Board of Directors has the right, but not the
obligation, to acquire on behalf of the Company the former RPC interest and
related distributions from BBE under the terms of the Berg Land Holdings
Option Agreement and the Acquisition Agreement between the Company and the
Berg Group.
BERG COMMITMENT TO COMPLETE FUTURE IMPROVEMENTS AND BUILDING IN CONNECTION
WITH CERTAIN ACQUISITIONS FROM THE BERG GROUP UNDER THE BERG LAND HOLDINGS
OPTION AGREEMENT: The Berg Group has an approximately $2.5 million
commitment to complete certain tenant improvements in connection with our
2002 acquisition of 5345 Hellyer Avenue in San Jose. The Berg Group has an
approximately $7.5 million commitment to complete an approximately 75,000
to 90,000 square foot building in connection with our 2000 acquisition of
245 Caspian in Sunnyvale which was comprised of approximately three acres
of unimproved land zoned for commercial development.
BERG CONTROLLED ENTITIES HAVE FINANCIAL INTERESTS IN CERTAIN TENANTS THAT
LEASE SPACE FROM THE COMPANY: During December 31, 2003, 2002 and 2001, Carl
E. Berg or entities controlled by Mr. Berg have financial interests in
several companies that lease space from the operating partnerships, which
include three companies where Mr. Berg has a greater than 10% ownership
interest. These related tenants occupy approximately 48,000 square feet and
contributed $904,000, $748,000 and $414,000 in rental revenue in 2003, 2002
and 2001, respectively.
LEASING AND OVERHEAD REIMBURSEMENTS PROVIDED BY BERG CONTROLLED ENTITY: 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 $90,000,
$90,000 and $88,000 for the years ended December 31, 2003, 2002 and 2001,
respectively.
ITEM 14. ACCOUNTANT FEES AND SERVICES
As previously reported above, on January 26, 2004, our independent
registered public accounting firm, PricewaterhouseCoopers LLP (PWC)
resigned, did not render an audit opinion on the Company's fiscal year 2003
financial statements and withdrew their audit opinions on the Company's
fiscal year 2002 and 2001 financial statements. The Audit Committee
appointed BDO Seidman, LLP ("BDO") as our new independent registered public
accounting firm in May 2004 to complete the audit of the Company's
financial statements for the years ending December 31, 2003, 2002 and 2001.
The aggregate fees accrued by or billed to the Company by our independent
registered public accounting firm for professional services rendered in
connection with fiscal year 2003, 2002 and 2001 are as follows:
BDO 2003 2002 2001
---- ---- ----
Audit Fees (1) $143,500 $143,500 $143,500
Audit Related Fees - - -
Tax Fees - - -
-------- -------- --------
Total $143,500 $143,500 $143,500
(1) Estimated 2003, 2002 and 2001 audit/re-audit and quarterly review fees
accrued by the Company in the second quarter of 2004.
PWC 2003 2002
---- ----
Audit Fees $121,050 $123,450
Audit Related Fees - -
Tax Fees 10,800 -
-------- ---------
Total $131,850 $123,450
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Audit Fees include amounts related to professional services rendered in
connection with audits of our annual financial statements and the reviews
of our quarterly financial statements.
The Audit Committee pre-approves all annual audit engagement services and
fees and all fees for non-audit services (other than non-audit services
that are de minimus within the meaning of section 10A(i)(l)(B) of the
Securities Exchange Act and non-audit services that the independent
accountants are prohibited from providing to us). The Audit Committee
requires the independent accountants to submit a detailed proposal and
budget for each engagement prior to the commencement of the engagement.
Additional services must be pre-approved by the Audit Committee or the
Chairman of the Audit Committee to whom pre-approval authority has been
delegated. All services of the independent accountants relating to review
and attestation of internal controls and procedures pursuant to section 404
of the Sarbanes Oxley Act.
There were no fees paid to independent accountants in the past three fiscal
years that were for non-audit services that the Audit Committee or Chairman
did not pre-approve.
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PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
Exhibits required by Item 601 of Regulation S-K.
EXHIBIT INDEX
3.2.1+ Articles of Amendment and Restatement of Mission West Properties, Inc.
3.2.2+ Restated Bylaws of Mission West Properties, Inc.
10.1.1** Amended and Restated Agreement of Limited Partnership of Mission West Properties, L.P.
10.1.2** Amended and Restated Agreement of Limited Partnership of Mission West Properties, L.P. I
10.1.3** Amended and Restated Agreement of Limited Partnership of Mission West Properties, L.P. II
10.1.4** Amended and Restated Agreement of Limited Partnership of Mission West Properties, L.P. III
10.2** Exchange Rights Agreement between Mission West Properties and the Limited Partners
10.3.1* 1997 Stock Option Plan
10.3.2* Form of Incentive Stock Option Agreement
10.3.3* Form of Non-statutory Stock Option Agreement
10.3.4* Form of Directors Stock Option Agreement
10.4.1* Acquisition Agreement, dated as of May 14, 1998, among
Mission West Properties, certain partnerships and the Berg
Group (as defined therein)
10.4.2* Amendment of Acquisition Agreement, dated as of July 1, 1998
10.4.3* Form of Partnership Interest Purchase Demand Note
10.5.1* Stock Purchase Agreement dated as of May 4, 1998, between
Mission West Properties and the purchasers of Common Stock in
a private placement of 5,800,000 shares and Subscription
Agreement relating to same
10.5.2* Stock Purchase Agreement dated as of May 4, 1998 between
Mission West Properties and the purchasers of Common Stock in
a private placement of 695,058 shares and Subscription
Agreement relating to same
10.5.3** Form of Registration Rights Agreement for purchasers, who
acquired shares of Common Stock under the May 4, 1998 Stock
Purchase Agreements (filed as Exhibits 10.8 to Post-effective
Amendment No. 1 to S-4 Registration Statement filed on Form
S-3 on February 11, 1999. Commission File No. 333-52835-99)
10.6** Pending Projects Acquisition Agreement among Mission West Properties, the Operating Partnership and the
Berg Group
10.7** Berg Land Holdings Option Agreement between Mission West Properties and certain members of the Berg
Group
10.8* Berg & Berg Enterprises, Inc. Sublease Agreement
10.9 Not in use
10.10 Not in use
10.11 Not in use
10.12* Lease Agreement with Apple Computer, Inc.
10.13* Lease Agreement with Cisco Systems, Inc,
10.14* Lease Agreement with Amdahl Corporation
10.15* Prudential Promissory Note
10.16* Prudential Deed of Trust
10.17* Prudential Certificate Regarding Distribution
10.18* Prudential Guaranty
10.19+ Waiver Agreement
10.20** Ownership Limit Exemption Agreement dated December 29, 1999 between Mission West Properties and Dan and
Paul McCarthy
10.21x Lease Agreement with Microsoft Corporation
10.22x Contribution Agreement
10.23xx Assumption Agreement for Wells Fargo Line of Credit
10.24xx Not in use
10.25xx Not in use
10.26xx Supplemental Agreement among Mission West Properties, Inc., Carl E. Berg and Clyde J. Berg
10.27 Berg Group Revolving Credit - $100,000,000 Secured Promissory Note
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10.27.1+++ Amendment to Berg Group $100,000,000 Revolving Line of Credit
10.28 Berg Group Deed of Trust Securing Revolving Promissory Note
10.29*** Cupertino National Bank Revolving Credit Loan Agreement
10.29.1 Cupertino National Bank Revolving Credit Loan Agreement Change in Terms Agreement
10.30 Mission West Properties, LP Continuing Guaranty
10.31 Mission West Properties, LP II Continuing Guaranty
10.32 Mission West Properties, L.P. Promissory Note to Northwestern Mutual Life Insurance Company
10.33 Mission West Properties, L.P. I Promissory Note to Northwestern Mutual Life Insurance Company
10.34 Mission West Properties, L.P. II Promissory Note to Northwestern Mutual Life Insurance Company
10.35 Mission West Properties, L.P. Deed of Trust and Security Agreement (First Priority)
10.36 Mission West Properties, L.P. Deed of Trust and Security Agreement (Second Priority)
10.37 Mission West Properties, L.P. I Deed of Trust and Security Agreement (First Priority)
10.38 Mission West Properties, L.P. I Deed of Trust and Security Agreement (Second Priority)
10.39 Mission West Properties, L.P. II Deed of Trust and Security Agreement (First Priority)
10.40 Mission West Properties, L.P. II Deed of Trust and Security Agreement (Second Priority)
10.41 Mission West Properties, L.P. Absolute Assignment of Leases and Rents (First Priority)
10.42 Mission West Properties, L.P. I Absolute Assignment of Leases and Rents (First Priority)
10.43 Mission West Properties, L.P. II Absolute Assignment of Leases and Rents (First Priority)
10.44 Not in use
10.45 Citicorp USA, Inc.$80,000,000 Secured Promissory Note
10.45.1 Citicorp USA, Inc.$80,000,000 Second Amendment to Promissory Note
10.45.2 Citicorp USA, Inc.$80,000,000 Third Amendment to Promissory Note
10.45.3 Citicorp USA, Inc.$80,000,000 Secured Promissory Note Extension
21.1++ Subsidiaries of the Registrant
23.1 Consent of Independent Registered Public Accounting Firm
24.1 Powers of Attorney (included on the signature page hereto)
31.1 Certificate of Principal Executive Officer pursuant to Rule 13a-14
31.2 Certificate of Principal Financial Officer pursuant to Rule 13a-14
99.1 Section 1350 Certificate
* Incorporated herein by reference to the same-numbered exhibit to the Company's
Registration Statement on Form S-4 filed on May 15, 1998 and declared effective
on November 23, 1998.
** Incorporated herein by reference to the same-numbered exhibit to the
Company's Post-effective Amendment No. 1 to Registration Statement on Form S-4
filed on Form S-3 on February 11, 1999. (Commission File No. 333-52835-99).
*** Incorporated herein by reference to the same-numbered exhibit to the annual
report on Form 10-K 2002 filed on March 27, 2003
+ Incorporated herein by reference to the same-numbered exhibit to Amendment No.
4 to the Registration Statement on Form S-4 filed on November 16, 1998 and
declared effective on November 23, 1998.
++ Incorporated herein by reference to the same-numbered exhibit to the annual
report on Form 10-K for 1998 filed on March 31, 1999.
+++ Incorporated herein by reference to the same-numbered exhibit to the annual
report on FOrm 10-K 2001 filed on March 29, 2002
x Incorporated herein by reference to the same-numbered exhibit to current
report on Form 8-K filed on May 14, 1999 (Commission File No. 000-25235).
xx Incorporated herein by reference to the same-numbered exhibit to the
Registration Statement on Form S-11 filed on June 8, 1999 (Commission File No.
333-80203).
(b) Reports on Form 8-K.
The Company filed a Current Report on Form 8-K on October 17, 2003,
regarding its results of operations and financial condition for the third
quarter of 2003.
- 99 -
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Report to be
signed on its behalf by the undersigned, thereunto duly authorized.
MISSION WEST PROPERTIES, INC.
Date: July 29, 2004 By: /s/ CARL E. BERG
--------------------------------
Carl E. Berg
Chief Executive Officer
Date: July 29, 2004 By: /s/ WAYNE N. PHAM
--------------------------------
Wayne N. Pham
Vice President of Finance and
Controller
(Principal Accounting Officer)
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Carl E. Berg his true and lawful
attorney-in-fact with the power of substitution, to sign any amendments to
this Report on Form 10-K and to file the same, with exhibits thereto and
other documents in connection therewith, with the Securities and Exchange
Commission, hereby ratifying and confirming all that each of said
attorney-in-fact, or his or her substitute, may do or choose to be done by
virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ CARL E. BERG
-------------------------
Carl E. Berg Chairman of the Board, Chief July 29, 2004
Executive Officer, and Director
/s/ RAYMOND V. MARINO
-------------------------
Raymond V. Marino President, Chief Operating Officer July 29, 2004
and Director
/s/ JOHN C. BOLGER
-------------------------
John C. Bolger Director July 29, 2004
/s/ WILLIAM A. HASLER
-------------------------
William A. Hasler Director July 29, 2004
/s/ LAWRENCE B. HELZEL
-------------------------
Lawrence B. Helzel Director July 29, 2004
- 100 -
CERTIFICATE PURSUANT TO
RULE 13a-14 THE SECURITIES EXCHANGE ACT OF 1934
I, Carl E. Berg, certify that:
1. I have reviewed this Annual Report on Form 10-K of Mission West Properties,
Inc. (the "Company") for the year ended December 31, 2003;
2. Based on my knowledge, this annual 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 annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
Company as of, and for, the periods presented in this annual report;
4. The Company's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-14(e)) for the Company and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
Company, including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the period in
which this annual report is being prepared;
b) evaluated the effectiveness of the Company's disclosure controls and
procedures and presented in this annual report our conclusions about
the effectiveness of the disclosure controls and procedures, as of the
end of the period covered by this annual report based on such
evaluation; and
c) disclosed in this annual report any change in the Company's internal
control over financial reporting that occurred during the Company's
most recent fiscal quarter (the Company's fourth fiscal quarter in the
case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the Company's internal control
over financial reporting; and
5. The Company's other certifying officer(s) and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
Company's auditors and the audit committee of the Company's board of directors
(or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the Company's ability to record,
process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the Company's internal
control over financial reporting.
Carl E. Berg
Chairman and CEO
July 29, 2004
- 101 -
CERTIFICATE PURSUANT TO
RULE 13a-14 THE SECURITIES EXCHANGE ACT OF 1934
I, Raymond V. Marino, certify that:
1. I have reviewed this Annual Report on Form 10-K of Mission West Properties,
Inc. (the "Company") for the year ended December 31, 2003;
2. Based on my knowledge, this annual 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 annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
Company as of, and for, the periods presented in this annual report;
4. The Company's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-14(e)) for the Company and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
Company, including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the period in
which this annual report is being prepared;
b) evaluated the effectiveness of the Company's disclosure controls and
procedures and presented in this annual report our conclusions about
the effectiveness of the disclosure controls and procedures, as of the
end of the period covered by this annual report based on such
evaluation; and
c) disclosed in this annual report any change in the Company's internal
control over financial reporting that occurred during the Company's
most recent fiscal quarter (the Company's fourth fiscal quarter in the
case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the Company's internal control
over financial reporting; and
5. The Company's other certifying officer(s) and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
Company's auditors and the audit committee of the Company's board of directors
(or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the Company's ability to record,
process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the Company's internal
control over financial reporting.
Raymond V. Marino
President and Chief Operating Officer
July 29, 2004
- 102 -
CERTIFICATE PURSUANT TO
RULE 13a-14 THE SECURITIES EXCHANGE ACT OF 1934
I, Wayne N. Pham, certify that:
1. I have reviewed this Annual Report on Form 10-K of Mission West Properties,
Inc. (the "Company") for the year ended December 31, 2003;
2. Based on my knowledge, this annual 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 annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
Company as of, and for, the periods presented in this annual report;
4. The Company's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-14(e)) for the Company and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
Company, including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the period in
which this annual report is being prepared;
b) evaluated the effectiveness of the Company's disclosure controls and
procedures and presented in this annual report our conclusions about
the effectiveness of the disclosure controls and procedures, as of the
end of the period covered by this annual report based on such
evaluation; and
c) disclosed in this annual report any change in the Company's internal
control over financial reporting that occurred during the Company's
most recent fiscal quarter (the Company's fourth fiscal quarter in the
case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the Company's internal control
over financial reporting; and
5. The Company's other certifying officer(s) and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
Company's auditors and the audit committee of the Company's board of directors
(or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the Company's ability to record,
process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the Company's internal
control over financial reporting.
Wayne N. Pham
Vice President of Finance and Controller
July 29, 2004
- 103 -
Exhibit 99.1
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 Annual Report on Form 10-K of Mission West Properties,
Inc. (the "Company") for the year ended December 31, 2003 as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), each of
Carl E. Berg, Chairman of the Board and Chief Executive Officer of the Company,
and Wayne N. Pham, Vice President of Finance and Controller of the Company,
hereby certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906
of the Sarbanes-Oxley Act of 2002, to the best of his knowledge, that:
(1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934, as amended; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and result of operations of the
Company.
--------------------------------------------------------------------------------
Carl E. Berg
Chairman of the Board and Chief Executive Officer
July 29, 2004
--------------------------------------------------------------------------------
Wayne N. Pham
Vice President of Finance and Controller
July 29, 2004
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.
A signed original of this written statement required by section 906 has been
provided to the Company and will be retained by the Company and furnished to the
Securities and Exchange Commission or its staff upon request.
EXHIBIT 23.1
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Mission West Properties, Inc.
Cupertino, California
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 No. 333-80369 of our reports dated July 27, 2004, relating
to the consolidated financial statements and schedules of Mission West
Properties, Inc. appearing in the Company's Annual Report on Form 10-K for the
year ended December 31, 2003.
/s/ BDO Seidman, LLP
San Francisco, California
July 27, 2004