SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Amendment No. 1
To Form 10-K on
FORM 10-K/A
(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, 2004
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 per share American Stock Exchange
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. [X]
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, 2004, as reported on the American Stock Exchange, was approximately
$218,751,298. As of February 28, 2005, there were 18,097,191 shares of the
Registrant's Common Stock outstanding.
Documents Incorporated By Reference
Portions of Mission West Properties, Inc.'s Proxy Statement for the 2005 annual
meeting of stockholders, a definitive copy of which will be filed with the SEC
within 120 days after the year end of the year covered by this Form 10-K, are
incorporated by reference herein as portions of Part III of this Form 10-K.
EXPLANATORY NOTE
This amendment to the Form 10-K of Mission West Properties, Inc. is filed solely
to amend the certifications of the Chief Executive Officer, Chief Operating
Officer and Vice President of Finance pursuant to SEC Rule 13a-14(a), which are
filed exhibits 31.1, 31.2 and 31.3 under Item 601(b)(31) of Regulation S-K. No
other portion of the report on Form 10-K as originally filed is being modified
by this amendment.
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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."
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MISSION WEST PROPERTIES, INC.
2004 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 23
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters 24
Item 6. Selected Financial Data 25
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 27
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 48
Item 8. Consolidated Financial Statements and Supplementary Data 49
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 85
Item 9A. Controls and Procedures 85
Item 9B Other Information 85
PART III
Item 10. Directors and Executive Officers of the Registrant 87
Item 11. Executive Compensation 87
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters 87
Item 13. Certain Relationships and Related Transactions 87
Item 14. Principal Accountant Fees and Services 87
PART IV
Item 15. Exhibits, Financial Statements, Schedules and Reports on Form 8-K 88
Signatures 91
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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, 2004, 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
shares of our common stock;
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- 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 in excess of 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. 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 1.4 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 member 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, intended 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, 2004, 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 of our Board of
Directors, 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. 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 (79) 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 AND THEIR IMPACT ON OUR BUSINESS
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 2004 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 22.05% in late 2003 to
22.38% at the end of 2004. Total vacant R&D square footage in Silicon
Valley at the end of the fourth quarter of 2004 amounted to 34.65 million
square feet, of which 26.6%, or 9.2 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 2003 amounted to approximately (4.0) million square feet. For
the year 2004, total negative net absorption declined to approximately
(0.3) 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 12 to 24 months as a result of the increased vacancy in the
market.
For the years ended December 31, 2004 and 2003, average occupancy in our
portfolio was 71.7% and 80.5%, 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 70.7% at December 31, 2004.
Although we scrutinize each prospective tenant's creditworthiness and
continually evaluate the financial capacity of both our prospective and
existing tenants, a downturn in tenants' businesses may weaken tenants'
financial conditions and could result in defaults under their lease
obligations. We believe that the average 2005 renewal rental rates for our
properties will be approximately equal to, or perhaps, below current market
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 501,000 square feet, or 4.7% of our 2005 cash
rent, are scheduled to expire during 2005. 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
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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.
- 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 the 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.
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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 effect 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
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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 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 February 28, 2005, we employed five people, all of whom work at our
executive offices at 10050 Bandley Drive, Cupertino, California, 95014.
FACILITIES
We lease 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 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.
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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 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, the 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 74.2% of the equity interests in the operating
partnerships and approximately 74.2% 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:
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- 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.
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.
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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 the 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.
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, 2004, we had borrowed approximately
$9.6 million under our $20 million line of credit with the Berg Group,
which is collateralized by five of our properties and expires in March
2006. 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 $10.4 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."
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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 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 2006, 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.
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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.
OUR REAL ESTATE ASSETS MAY BE SUBJECT TO IMPAIRMENT CHARGES.
We continually evaluate the recoverability of the carrying value of our
real estate assets for impairment indicators. Factors considered in
evaluating impairment of our existing real estate assets include
significant declines in property operating profits, recurring property
operating losses and other significant adverse changes in general market
conditions that are considered permanent in nature. Generally, a real
estate asset is not considered impaired if the undiscounted, estimated
future cash flows of the asset over its estimated holding period are in
excess of the asset's net book value at the balance sheet date. Assumptions
used to estimate annual and residual cash flow, the estimated holding
period of such assets, the lease up period when properties are vacant and
future rental income require the judgment of management.
In 2004, we recorded an impairment charge to reflect the decline in value
of one of our R&D properties held for sale as of the year end. For further
discussion of this charge please refer to Part II, Item 8, "Consolidated
Financial Statements and Supplementary Data--Note 16, Real Estate Held for
Sale/Discontinued Operations." There can be no assurance that we will not
take additional charges in the future related to the impairment of our
assets. As of the years ended December 31, 2004 and 2003, management
believes it has applied reasonable estimates and judgments in determining
the proper classification of its real estate assets. However, should
external or internal circumstances change requiring the need to shorten the
holding periods or adjust the estimated future cash flows of certain of our
assets, we could be required to record additional impairment charges. If
any real estate asset held for sale is considered impaired, a loss is
provided to reduce the carrying value of the asset to its fair value, less
selling costs. Any future impairment could have a material adverse affect
on the Company's results of operations and funds from operations in the
period in which the charge is taken.
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
- 13 -
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
- 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.
- 14 -
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 our common stock. As of December 31, 2004, 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. Additional common stock reserved under
our 2004 Incentive Plan, including stock options, may also be sold in the
market at some time in the future. Future sales of our common stock in the
market could adversely affect the price of our common stock.
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 slowdown 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 approximately 4,500 to 239,000 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, 2004:
Major
Tenants'
Total Percentage Rentable
No. of Rentable Leased as of Average 2004 Sq. Ft. at 2004 Annual
Location Properties Sq. Ft. Dec. 31, 2004 Occupancy Major Tenants 12/31/04 Base Rents(1)
------------------------------------------------------------------------------------------------------------------------------------
5300-5350 Hellyer Avenue (2) 2 160,000 100% 100% Tyco Electronics Corp. 160,000 $ 3,415,600
10401-10411 Bubb Road (2) 1 20,330 100% 100% Celerity Systems, Inc. 15,830 290,474
45365 Northport Loop West 1 64,218 31% 31% Applied Micro Circuits Corp.19,727 367,858
45700 Northport Loop East 1 47,570 100% 100% Philips Electronics 47,570 823,248
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. 52,232 621,561
3501 W. Warren Avenue & 1 67,864 52% 18% ASM Nutool, Inc. 35,340 96,236
46600 Fremont Blvd.
- 16 -
Major
Tenants'
Total Percentage Rentable
No. of Rentable Leased as of Average 2004 Sq. Ft. at 2004 Annual
Location Properties Sq. Ft. Dec. 31, 2004 Occupancy Major Tenants 12/31/04 Base Rents(1)
------------------------------------------------------------------------------------------------------------------------------------
48800 Milmont Drive 1 53,000 0% 0% Vacant - -
4750 Patrick Henry Drive 1 65,780 53% 31% CHIPS ag, Inc. 35,124 178,850
Triangle Technology Park (2) 7 416,927 62% 63% Intevac Corporation 119,583 5,517,940
JDS Uniphase Corporation 50,212
Xicom Technology, Inc. 47,480
IXYS Technologies, Inc. 19,600
5850-5870 Hellyer Avenue 1 109,715 7% 7% Silver Creek Valley Church 7,675 127,715
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. 46,120 675,658
5400 Hellyer Avenue 1 77,184 71% 30% Tasman Networks, Inc. 32,902 238,139
StorCard, Inc. 21,750
5325-5345 Hellyer Ave. 2 256,500 100% 100% Celestica Asia, Inc. 256,500 4,895,376
5905-5965 Silver Creek 4 346,000 100% 100% CIENA Corporation 346,000 8,993,502
855 Embedded Way 1 67,912 100% 100% Lynuxworks, Inc. 67,912 1,515,690
1065 La Avenida Street 5 515,700 100% 100% Microsoft Corporation 515,700 21,997,381
1750 Automation Parkway 1 80,641 100% 100% JDS Uniphase Corporation 80,641 1,240,738
1756 Automation Parkway 1 80,640 100% 100% JDS Uniphase Corporation 80,640 1,987,164
1762 Automation Parkway 1 61,100 100% 100% JDS Uniphase Corporation 61,100 2,291,464
1768 Automation Parkway 1 110,592 100% 100% JDS Uniphase Corporation 110,592 3,416,737
255 Caspian Drive 1 98,500 0% 0% Vacant - -
245 Caspian Drive (3) 1 - 0% 0% Vacant - -
5970 Optical Court 1 128,520 100% 100% Photon Dynamics, Inc. 128,520 1,710,012
5900 Optical Court 1 165,000 100% 100% Stryker Endoscopy 165,000 4,320,858
2630 Orchard Parkway 1 60,633 64% 5% Maranti, Inc. 38,506 -
2610 Orchard Parkway 1 54,093 0% 25% Vacant - 297,514
55 West Trimble Road 1 91,722 0% 25% Vacant - 504,410
2001 Walsh Avenue 1 80,000 100% 100% NEC Electronics America, 80,000 766,666
Inc.
2880 Scott Boulevard 1 200,000 100% 100% NEC Electronics America, 200,000 3,275,193
Inc.
2890 Scott Boulevard 1 75,000 100% 100% NEC Electronics America, 75,000 2,121,341
Inc.
2800 Scott Boulevard 1 98,430 75% 75% Nvidia Corporation 73,604 477,378
2300 Central Expressway 1 46,338 100% 100% JDS Uniphase Corporation 46,338 3,234,973
2220 Central Expressway 1 62,522 100% 100% BRE/San Tomas LLC 62,522 1,000,000
2330 Central Expressway 1 62,522 0% 0% Vacant - -
2251 Lawson Lane 1 125,000 100% 100% Fujitsu IT Holdings, Inc. 125,000 1,335,703
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. 200,000 812,617
- 17 -
Major
Tenants'
Total Percentage Rentable
No. of Rentable Leased as of Average 2004 Sq. Ft. at 2004 Annual
Location Properties Sq. Ft. Dec. 31, 2004 Occupancy Major Tenants 12/31/04 Base Rents(1)
------------------------------------------------------------------------------------------------------------------------------------
3120 Scott Blvd. (4) 1 75,000 16% 40% DSP Group, Inc. 12,000 430,227
20400 Mariani Avenue 1 105,000 100% 100% Dade Behring, Inc. 105,000 1,514,319
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 3,158,233
10300 Bubb Road 1 23,400 100% 100% Apple Computer, Inc. 23,400 432,900
10440 Bubb Road 1 19,500 100% 83% Lightmaster Systems, Inc. 10,573 201,513
10460 Bubb Road 1 45,460 67% 67% Luminous Networks, Inc. 30,460 563,510
1135 Kern Avenue 1 18,300 50% 50% Broadmedia, Inc. 9,150 90,024
1190 Morse Avenue & 1 28,350 0% 55% Vacant - 189,376
405 Tasman Avenue
450 National Avenue 1 36,100 100% 100% ePeople, Inc. 36,100 1,265,202
3301 Olcott Street 1 64,500 0% 0% Vacant - -
2800 Bayview Avenue 1 59,736 0% 35% Vacant - -
6850 Santa Teresa Blvd. 1 30,000 59% 59% Indala Corporation 17,650 327,408
6810 Santa Teresa Blvd. 1 54,996 100% 100% Polaris Networks, Inc. 54,996 971,574
140-160 Great Oaks Blvd. & 2 105,300 75% 75% Amtech Microelectronics, Inc31,500 1,294,137
6781 Via Del Oro Saint Gobain 21,800
Santa Clara Water District 25,429
6540-6541 Via Del Oro & 2 66,600 74% 74% Exsil, Inc. 20,076 749,418
6385-6387 San Ignacio Ave. Modutek Corporation 17,400
6311-6351 San Ignacio Ave. 5 362,767 44% 63% Saint Gobain 95,953 3,464,662
Avnet, Inc. 32,154
Teledex, LLC 30,000
6320-6360 San Ignacio Ave. 1 157,292 71% 71% Nortel Networks Corp. 92,692 3,701,556
Quantum 3D, Inc. 19,600
75 East Trimble Road & 2 170,810 100% 100% Comerica Bank 93,984 2,754,646
2610 North First Street County of Santa Clara 70,795
2033-2243 Samaritan Drive 3 235,122 36% 36% Texas Instruments, Inc. 48,677 3,594,871
State Farm Insurance 23,801
Good Samaritan Hospital 12,286
1170 Morse Avenue 1 39,231 100% 100% The Parkinson's Institute 39,231 541,392
3236 Scott Blvd. 1 54,672 100% 100% Celeritek, Inc. 54,672 1,176,197
1212 Bordeaux Lane 1 71,800 100% 100% Northrop Grumman Corp. 71,800 1,402,077
McCandless Technology Park 14 705,956 48% 54% Arrow Electronics, Inc. 92,862 7,122,965
Chartered Semiconductor Mfg.45,312
ST Assembly Test
Services, Inc. 33,984
Hermes Microvision, Inc. 25,285
ASM International 22,624
A&D Engineering, Inc 19,332
1600 Memorex Drive 1 107,500 100% 100% Sasco Electric 84,700 824,934
International Network
Services 22,800
1688 Richard Avenue 1 52,800 100% 100% NWE Technology, Inc. 52,800 472,896
- 18 -
Major
Tenants'
Total Percentage Rentable
No. of Rentable Leased as of Average 2004 Sq. Ft. at 2004 Annual
Location Properties Sq. Ft. Dec. 31, 2004 Occupancy Major Tenants 12/31/04 Base Rents(1)
------------------------------------------------------------------------------------------------------------------------------------
1700 Richard Avenue 1 58,783 100% 100% Broadwing Comm Services, 58,783 720,091
Inc.
------------------ -------------
TOTAL 109 7,917,262 $121,630,673
================== =============
(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) Joint venture properties.
(3) 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.
(4) The property at 3120 Scott Boulevard was designated as asset held for sale
at December 31, 2004 and was sold in January 2005.
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 2005, assuming that none of the tenants exercise
existing renewal options or termination rights. The table excludes 2,358,928
rentable square feet that was vacant as of January 1, 2005.
Number of Percentage of Total Annual
Year of Lease Leases Rentable Square Footage 2005 Annual Base Rent Base Rent Represented By
Expiration Expiring Subject to Expiring Leases Under Expiring Leases (1) Expiring Leases (2)
--------------------------------------------------------------------------------------------------------------------
2005 21 501,460 $ 4,760,370 4.7%
2006 15 551,608 15,437,030 15.1%
2007 19 1,126,081 21,327,717 20.9%
2008 7 300,023 3,584,473 3.5%
2009 14 711,305 11,807,241 11.6%
2010 6 452,186 8,123,520 8.0%
2011 3 696,484 14,533,982 14.2%
2012 3 335,187 7,310,028 7.2%
2014 3 649,000 11,692,924 11.4%
Thereafter 1 160,000 3,518,068 3.4%
--------------------------------------------------------------------------------------------------
92 5,483,334 $102,095,353 100%
==================================================================================================
(1) The base rent for leases expiring is based on scheduled 2005 cash rents,
which are different than annual rents determined in accordance with GAAP.
(2) Based upon 2005 cash rents as discussed in Note (1).
If we are unable to lease a significant portion of the available space or space
scheduled to expire in 2005 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 semiconductor
fabrication, underlies a significant portion of northeastern Santa Clara County,
where many of our properties are located.
- 20 -
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 effect on our financial statements.
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 50% 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.
We do not believe that any further court decisions in this case, for or
against us and MWP, will 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. Although to date, we have
consolidated the assets, liabilities and operating results of the Hellyer
LP and allocated 50% of the operating income to the minority interest
holder. 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. On February 4, 2005, the
Maryland Appeals Court heard our appeal. On March 1, 2005, the Maryland
Appeals Court ruled in favor of MWP, finding that the Circuit Court of
Maryland could not assert personal jurisdiction in the RPC suit. The
Maryland Appeals Court will issue its mandate within 30 days, after which
RPC will have 15 days to seek a writ of certiorari to the Maryland Appeals
Court.
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 income 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. In December 2004, we
settled this matter and received a final payment of $276,166, which we
recorded as other income in our consolidated statements of operations.
In January 2004, the GLOBAL CROSSING ESTATE REPRESENTATIVE, FOR ITSELF AND
THE LIQUIDATING TRUSTEE OF THE GLOBAL CROSSING LIQUIDATING TRUST V. MISSION
WEST PROPERTIES L.P. 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. In
addition, the Global debtors and the Creditors' Committee filed an
objection to the unsecured claim filed by Mission West Properties in the
Global cases for $16,710,605. A hearing on the claim objection is set for
March 23, 2005. A trial date has not been set for either the unsecured
claim objection or preference litigation.
- 22 -
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
a) The annual meeting of stockholders of the Company was held on November
24, 2004 in which proxies representing 16,066,957 shares of common
stocks, or 88.9% of the total outstanding shares, voted.
b) At the annual meeting of stockholders, Carl E. Berg, John C. Bolger,
William A. Hasler, Lawrence B. Helzel, and Raymond V. Marino were
elected as directors for the ensuing year, all of whom were serving on
the board of directors at the time of the meeting.
c) The following proposals were voted upon at the meeting:
Proposal No. 1: Election of Directors
Total Vote for Each Total Vote Withheld
Directors Director from Each Director Total Abstentions
---------------------------- ---------------------- ---------------------- ----------------------
Carl E. Berg 15,784,039 82,226 200,692
John C. Bolger 15,766,691 99,574 200,692
William A. Hasler 15,764,941 101,324 200,692
Lawrence B. Helzel 15,767,411 98,854 200,692
Raymond V. Marino 15,614,292 251,973 200,692
Proposal No. 2: Approval of (i) the adoption of the Company's 2004 Equity
Incentive Plan, (ii) the transfer to the 2004 Equity Incentive Plan of up
to 3,991,089 remaining shares available for grant under the 1997 Stock
Option Plan; (iii) the transfer of up to 767,000 shares subject to
outstanding options under the 1997 Stock Option Plan if they expire
unexercised; and (iv) the material terms of the 2004 Equity Incentive Plan
and the performance goals thereunder for purposes of Internal Revenue Code
Section 162(m). There were 6,590,691 votes in favor of the proposal,
3,358,560 votes against the proposal and 212,925 abstentions.
Proposal No. 3: Ratification of the selection of the accounting firm of BDO
Seidman, LLP as the Company's independent registered public accounting firm
for the year ended December 31, 2004. There were 15,979,270 votes in favor
of the proposal, 29,244 votes against the proposal and 58,442 abstentions.
- 23 -
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY 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 2004 and 2003 were as follows:
2004 2003
----------------------------- -----------------------------
High Low High Low
------------- ------------- ------------- -------------
1st Quarter $14.00 $12.81 $10.25 $ 9.02
2nd Quarter $13.44 $11.40 $11.95 $ 9.50
3rd Quarter $12.14 $ 9.95 $12.74 $11.07
4th Quarter $10.95 $ 9.51 $13.45 $12.32
On February 28, 2005, there were 196 registered holders of the Company's
common stock. We declared and paid dividends in each quarter of 2004 and
2003. We expect to pay quarterly dividends during 2005. The following
tables show information for quarterly dividends for 2004 and 2003.
2004
-----------------------------------------------
Record Payment Dividend
Date Date Per Share
------------- ------------- -------------
1st Quarter 03/31/04 04/08/04 $0.24
2nd Quarter 06/30/04 07/08/04 0.24
3rd Quarter 09/30/04 10/07/04 0.24
4th Quarter 12/31/04 01/07/05 0.16
-------------
Total $0.88
=============
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
=============
For federal income tax purposes, we have characterized 98% of the dividends
declared in 2004 and 2003 as taxable ordinary income and 2% as return of
capital.
The closing price of our common stock on December 31, 2004, the last
trading day, was $10.64 per share.
- 24 -
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.
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,
--------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------- -------------- ------------- ------------- -------------
(dollars in thousands, except per share data)
OPERATING DATA:
Revenue:
Rental revenue from real estate $119,523 $129,511 $128,553 $125,002 $96,341
Tenant reimbursements 14,946 18,726 19,957 17,337 14,407
Other income 6,914 4,527 4,248 2,465 1,216
------------- -------------- ------------- ------------- -------------
Total revenues 141,383 152,764 152,758 144,804 111,964
------------- -------------- ------------- ------------- -------------
Expenses:
Property operating, maint. and real estate taxes 20,540 21,220 23,809 18,364 14,798
Interest 17,581 16,446 9,588 8,704 8,290
Interest (related parties) 1,077 1,064 3,422 4,709 4,475
General and administrative 2,011 1,324 1,488 1,284 1,065
Depreciation and amortization of real estate 21,669 20,525 18,064 16,497 14,929
------------- -------------- ------------- ------------- -------------
Total expenses 62,878 60,579 56,371 49,558 43,557
------------- -------------- ------------- ------------- -------------
Income before gain on sales of assets, equity in
earnings of unconsolidated joint venture and
minority interests 78,505 92,185 96,387 95,246 68,407
Gain on sales of assets - - - 11,453 501
Equity in earnings of unconsolidated joint
venture 2,947 3,885 - - -
Minority interests 67,699 80,069 80,548 89,107 56,856
------------- -------------- ------------- ------------- ------------
Income from continuing operations 13,753 16,001 15,839 17,592 12,052
Discontinued operations, net of minority interests:
Gain from disposal of discontinued
operations - - 1,018 - -
(Loss)/income attributable to discontinued
operations (4) (441) 211 258 494 527
------------- -------------- ------------- ------------- -------------
(Loss)/income from discontinued operations (441) 211 1,276 494 527
------------- -------------- ------------- ------------- -------------
Net income to common stockholders $13,312 $16,212 $17,115 $18,086 $12,579
============= ============== ============= ============= =============
Net income to minority interests $66,100 $80,836 $86,641 $91,312 $59,054
============= ============== ============= ============= =============
Basic net income from continuing operations per
share $0.76 $0.90 $0.91 $1.03 $0.71
Diluted net income from continuing operations
per share $0.76 $0.90 $0.89 $1.00 $0.69
Basic net (loss)/income from discontinued
operations per share ($0.02) $0.01 $0.07 $0.03 $0.03
Diluted net (loss)/income from discontinued
operations per share ($0.02) $0.01 $0.07 $0.03 $0.03
Basic net income per share $0.74 $0.91 $0.98 $1.06 $0.74
Diluted net income per share $0.74 $0.91 $0.96 $1.03 $0.72
Dividends per share $0.88 $0.96 $0.96 $0.89 $0.68
PROPERTY AND OTHER DATA:
Total properties, end of period (3) 109 109 101 97 89
Total square feet, end of period (000's) 7,917 7,917 7,164 6,799 6,196
Average monthly rental revenue per square foot (1)$1.80 $1.77 $1.71 $1.59 $1.36
Occupancy at end of period 71% 77% 84% 97% 99%
FUNDS FROM OPERATIONS (2): $103,320 $117,918 $118,444 $115,013 $86,650
Cash flows from operating activities $105,070 $116,493 $117,368 $111,157 $84,580
Cash flows used in investing activities (1,519) (109,983) (20,744) (3,040) (2,736)
Cash flows used in financing activities (106,161) (6,860) (97,455) (107,498) (83,706)
- 25 -
December 31,
--------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------- -------------- ------------- ------------- -------------
(dollars in thousands)
BALANCE SHEET DATA:
Real estate assets,
net of accumulated depr. & amort. $ 960,863 $ 985,751 $886,122 $857,653 $807,456
Total assets 1,005,656 1,032,632 926,783 909,953 826,910
Line of credit - related parties 9,560 6,320 58,792 79,887 50,886
Revolving line of credit 24,208 23,965 23,839 - -
Loan payable - - 20,000 - -
Debt 292,822 299,858 125,062 127,416 132,055
Debt - related parties 10,420 10,762 11,078 11,371 11,643
Total liabilities 380,355 394,324 289,817 286,768 255,505
Minority interests 512,089 524,918 526,580 514,810 469,332
Stockholders' equity 113,212 113,390 110,386 108,375 102,073
Common stock outstanding 18,097,191 17,894,691 17,487,329 17,329,779 17,025,365
O.P. Units issued and outstanding 86,384,695 86,398,064 86,474,032 85,762,541 83,576,027
(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 2004 and 2003 FFO presentation
and to more closely conform to the NAREIT's FFO definition. Additionally,
our 2004 and 2003 FFO calculation includes our portion of the depreciation
and amortization of real estate from our unconsolidated joint venture, but
excludes the above-market 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) As of December 31, 2004, 2003, 2002 and 2001, total properties include a
property at 245 Caspian in Sunnyvale with no building. During 2001, 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.
(4) Upon the implementation of SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," on January 1, 2002, the operating results
of real estate held for sale and sold are reported as discontinued
operations for all years presented. Additionally, all gains and losses on
the sale of assets classified as held for sale subsequent to January 1,
2002 are included in discontinued operations. As the operating results and
gains or losses from the sale of real estate assets prior to January 1,
2002 are included in continuing operations, the presentation of results is
not comparable between years.
- 26 -
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, an independent limited
partner, 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, 2004, we owned a 17.26% 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 4 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. Major property acquisitions made by us from unrelated
sellers include the following:
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.
- 27 -
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We prepare our 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 receivables, 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 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, 2001 were
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. As discussed in Note 16 to the
consolidated financial statements, we recognized an impairment loss in 2004
on one asset held for sale under the application of this standard.
ALLOWANCE FOR DOUBTFUL ACCOUNTS AND DEFERRED RENT. 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 controlling
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 -
INVESTMENT IN UNCONSOLIDATED JOINT VENTURE. 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.
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 Receivable on
the consolidated balance sheets.
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 recognized as other income
when there is a signed termination letter agreement, all of the conditions
of the agreement have been met, and the tenant is no longer occupying the
property. 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.
With regards to critical accounting policies, where applicable, we have
explained and discussed the criteria for identification and selection,
methodology in application and impact on the financial statements with the
Audit Committee of our Board of Directors, which has reviewed these
policies.
- 29 -
RESULTS OF OPERATIONS
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2004 TO THE YEAR ENDED DECEMBER
31, 2003.
RENTAL REVENUE FROM CONTINUING PROPERTY OPERATIONS
As of December 31, 2004 and 2003, through our controlling interests in the
operating partnerships, we owned 109 R&D properties totaling approximately
7.9 million rentable square feet. We did not purchase any new properties in
2004.
The following table depicts the amounts of rental revenue from continuing
operations for the years ended December 31, 2004 and 2003 represented by
our historical properties and the properties acquired in each such year and
the percentage of the total increase in rental revenue over the period that
is represented by each group of properties.
December 31,
----------------------------------
% Change by % of Total Net
2004 2003 $ Change Property Group Change
-------------- -------------- -------------- -------------- --------------
(dollars in thousands)
Same Property (1) $107,851 $121,411 ($13,560) (11.2%) (10.5%)
2003 Acquisitions (2) 11,672 8,100 3,572 44.1% 2.8%
-------------- -------------- -------------- --------------
Total/Overall $119,523 $129,511 ($ 9,988) (7.7%) (7.7%)
============== ============== ============== ==============
(1) "Same Property" is defined as properties owned by us prior to 2003 that we
still owned as of December 31, 2004.
(2) Operating rental revenue for 2003 Acquisitions do not reflect a full 12
months of operations in 2003 because these properties were acquired at
various times during 2003. 2004 and 2003 amounts include approximately $1.9
million and $1.4 million, respectively, 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, 2004, our rental revenue from real estate
decreased by ($10.0) million, or (7.7%) from $129.5 million for the year
ended December 31, 2003 to $119.5 million for the same period in 2004.
Pursuant to SFAS 141, $1.9 million and $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 for the years ended December 31, 2004 and
2003, respectively. The ($10.0) million decrease in rental revenue resulted
from adverse market conditions as "Same Property" rents decreased by
($13.6) since our portfolio physical occupancy rate decreased by (6.6%) and
average market rental rates decreased. However, rents from properties
acquired in 2003 added approximately $3.6 million of rental revenue due to
a full 12 months of operations in 2004. The decline in rental revenue from
the "Same Property" portfolio was a result from the loss of several tenants
due to cessation of operations, tenant relocation or tenant requiring
lesser space.
Our overall physical occupancy rate at December 31, 2004 and 2003 was
approximately 70.7% and 77.3%, respectively. According to BT Commercial
Real Estate, the occupancy rate for R&D property in the Silicon Valley at
December 31, 2004 was approximately 77.6%. Due to an over supply of R&D
properties and competition from other landlords in the Silicon Valley
bidding for tenants, our occupancy rate may drop further in 2005 if the
501,000 rentable square feet scheduled to expire is not renewed or
re-leased. Factors that contributed to our low physical occupancy rate are
primarily the general downturn in the Silicon Valley's economy in recent
years, the softening of our market specifically and the expected weaker
performance of our properties.
EQUITY IN EARNINGS FROM UNCONSOLIDATED JOINT VENTURE
As of December 31, 2004, 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 years ended December 31, 2004 and
2003, equity in earnings from the unconsolidated joint venture was
approximately $2.9 million (including $1 million relating to lease
termination income) and $3.9 million (including $1.4 million relating to a
gain from the sale of real estate which was acquired from a related party
which did not occur in 2004), respectively.
- 30 -
OTHER INCOME FROM CONTINUING PROPERTY OPERATIONS
The following table depicts the amounts of other income from continuing
operations for the years ended December 31, 2004 and 2003.
December 31,
----------------------------------
% Change by
2004 2003 $ Change Group
-------------- -------------- -------------- --------------
(dollars in thousands)
Other income $6,914 $4,527 $2,387 52.7%
Other income of approximately $6.9 million for the year ended December 31,
2004 included approximately $4.3 million from termination fees and $1.2
million from tenant bankruptcy settlements. Other income of approximately
$4.5 million for 2003 included approximately $2.2 million from tenant
bankruptcy settlements.
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, 2004 over property operating and maintenance
expenses and real estate taxes from continuing operations for the year
ended December 31, 2003 and the percentage of total increase in expenses
over the period that is represented by each group of properties.
December 31,
----------------------------------
% Change by % of Total Net
2004 2003 $ Change Property Group Change
-------------- -------------- -------------- -------------- --------------
(dollars in thousands)
Same Property (1) $18,192 $19,638 ($1,446) (7.4%) (6.8%)
2003 Acquisitions (2) 2,348 1,582 766 48.4% 3.6%
-------------- -------------- -------------- --------------
Total/Overall $20,540 $21,220 ($680) (3.2%) (3.2%)
============== ============== ============== ==============
(1) "Same Property" is defined as properties owned by us prior to 2003 that we
still owned as of December 31, 2004.
(2) 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 ($0.7) million, or (3.2%), from $21.2 million
for the year ended December 31, 2003 to $20.5 million for the year ended
December 31, 2004. Tenant reimbursements from continuing operations
decreased by ($3.8) million, or (20.2%), from $18.7 million for the year
ended December 31, 2003 to $14.9 million for the year ended December 31,
2004. The overall decrease in tenant reimbursements, operating expenses and
real estate taxes resulted primarily from 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. Total operating expenses and real estate taxes exceeded
tenant reimbursements because of vacancies, which reached approximately 2.3
million rentable square feet by year-end 2004. 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
December 31, 2004 our vacancy rate was 29%.
General and administrative expenses increased by approximately $0.7
million, 51.9%, from $1.3 million for the year ended December 31, 2003 to
$2.0 million for the year ended December 31, 2004, primarily due to
incurring additional legal and accounting expenses in connection with the
resignation of PricewaterhouseCoopers LLP, our former independent
accountants, the need to re-audit the consolidated financial statements for
years 2001 and 2002 and audit 2003 results, and expenses related to the
compliance with Section 404 of the Sarbanes-Oxley Act of 2002.
The following table depicts the amounts of depreciation and amortization
expense of real estate from continuing operations for the years ended
December 31, 2004 and 2003.
December 31,
----------------------------------
2004 2003 $ Change % Change
-------------- -------------- -------------- --------------
(dollars in thousands)
Depreciation & amortization $21,669 $20,525 $1,144 5.6%
- 31 -
Depreciation and amortization expense of real estate from continuing
operations increased by $1.1 million, or 5.6%, from $20.5 million for the
year ended December 31, 2003 to $21.6 million for the year ended December
31, 2004. The increase was attributable to the recognition of a full year
of depreciation from the acquisition of eight R&D properties in 2003. Of
the $1.1 million increase in depreciation and amortization expense of real
estate, approximately $0.7 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.
The following table depicts the amounts of interest expense from continuing
operations for the years ended December 31, 2004 and 2003.
December 31,
----------------------------------
% Change by
2004 2003 $ Change Group
-------------- -------------- -------------- --------------
(dollars in thousands)
Interest $17,581 $16,446 $1,135 6.9%
Interest (related parties) 1,077 1,064 13 1.2%
-------------- -------------- --------------
Total $18,658 $17,510 $1,148 6.6%
============== ============== ==============
Interest expense increased by $1.1 million, or 6.9%, from $16.5 million for
the year ended December 31, 2003 to $17.6 million for the year ended
December 31, 2004. The increased expense resulted from additional debt that
the Company incurred under a new $80 million collateralized loan obtained
from Citicorp USA, Inc. in 2003 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 in 2003.
Interest expense (related parties) increased by $13,000, or 1.2%, primarily
due to higher interest rates of 4.08% at December 31, 2004 compared to
2.52% at December 31, 2003.
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, 2004
and 2003.
December 31,
-------------------------------------
% Change by
2004 2003 $ Change Group
---------------- --------------- ---------------- ----------------
(dollars in thousands)
Net income to shareholders $13,312 $16,212 ($ 2,900) (17.9%)
Net income to minority interests 66,100 80,836 (14,736) (18.2%)
---------------- --------------- ----------------
Total $79,412 $97,048 ($17,636) (18.2%)
================ =============== ================
As of December 31, 2004 and 2003, we owned a general partnership interest
of 17.16%, 21.63%, 16.14% and 12.38% and 16.95%, 21.61%, 15.98% and 12.37%
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 17.26% and 17.02% general
partnership interest in the operating partnerships, taken as a whole, on a
weighted average basis as of December 31, 2004 and 2003, respectively. Net
income to common stockholders decreased by ($2.9) million, or (17.9%), from
$16.2 million for the year ended December 31, 2003 to $13.3 million for the
year ended December 31, 2004. Our net income attributable to minority
interests decreased by ($14.7) million, or (18.2%), from $80.8 million for
the year ended December 31, 2003 to $66.1 million for the year ended
December 31, 2004. The decrease in net income attributable to common
stockholders and minority interests is primarily due to lower income from
continuing operations as a result of the decrease in revenues and increase
in expenses as previously discussed above. Minority interest represents the
limited partners' ownership interest of 82.74% and 82.98% in the operating
partnerships, on a weighted average basis, as of December 31, 2004 and
2003, 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 stocks by minority interest holders and
the exercise of stock options.
- 32 -
INCOME/(LOSS) FROM DISCONTINUED OPERATIONS
The following table depicts the amounts of income/(loss) from discontinued
operations for the years ended December 31, 2004 and 2003.
December 31, 2004 December 31, 2003
--------------------- --------------------
(dollars in thousands)
Income/(loss) attributable to
discontinued operations ($2,041) $ 979
Minority interest in earnings
attributable to discontinued operations 1,600 (768)
--------------------- --------------------
Total income/(loss) from discontinued
operations ($ 441) $ 211
===================== ====================
In accordance with our adoption of SFAS No. 144, in 2004 we classified a
property consisting of 75,000 rentable square feet separately as an asset
held for sale on the accompanying consolidated balance sheets and reported
the operating results of the asset held for sale as discontinued operations
on the accompanying consolidated statements of operations. As of December
31, 2004, management believed that the asset held for sale was impaired as
the asset's net book value exceeded the expected net sale price of the
asset. We decided to sell that property after an unsolicited offer was made
from an unrelated third party. An impairment charge of approximately ($2.2)
million was recorded to reduce the carrying value of the asset to its fair
value, less selling costs. We sold this property on January 5, 2005 for
$8.5 million. Also see Note 19, "Subsequent Events," to the consolidated
financial statements
SFAS No. 144 requires prior period results of operations for this property
to be restated and presented in discontinued operations in prior
consolidated statements of operations.
We recognized total loss of ($2.0) million from discontinued operations, of
which ($0.4) million and ($1.6) million were attributable to common
stockholders and minority interests, respectively, for the year ended
December 31, 2004. For the year ended December 31, 2003, we recognized
total income from discontinued operations of $1.0 million. The year over
year change resulted primarily from the ($2.2) million impairment charge
discussed above as well as a tenant vacancy that occurred during the second
quarter of 2004. The income to common stockholders and minority interests
attributable to discontinued operation from this property in 2003 was
approximately $0.2 million and $0.8 million, respectively.
- 33 -
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2003 TO THE YEAR ENDED DECEMBER
31, 2002.
RENTAL REVENUE FROM CONTINUING PROPERTY 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 parties or under
the Berg Land Holdings Option Agreement.
Date of Rentable Square
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 revenue 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 revenue over the period that
is represented by each group of properties.
December 31,
----------------------------------
% Change by % of Total Net
2003 2002 $ Change Property Group Change
-------------- -------------- -------------- -------------- --------------
(dollars in thousands)
Same Property (1) $111,201 $120,176 ($8,975) (7.5%) (7.0%)
2002 Acquisitions (2) 10,212 8,377 1,835 21.9% 1.4%
2003 Acquisitions (3) 8,098 - 8,098 100% 6.3%
-------------- -------------- -------------- --------------
Total/Overall $129,511 $128,553 $ 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 revenue 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 revenue 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 revenue from real estate
increased by $0.9 million, or 0.7% from $128.6 million for the year ended
December 31, 2002 to $129.5 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 in 2003. The $0.9 million increase in rental revenue 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. The decline
in rental revenue 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 77.3% and
83.8%, 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.
- 34 -
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 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, 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,
----------------------------------
% Change by % of Total Net
2003 2002 $ Change Property Group Change
-------------- -------------- -------------- -------------- --------------
(dollars in thousands)
Same Property (1) $17,844 $22,482 ($4,638) (20.6%) (19.5%)
2002 Acquisitions (2) 1,794 1,327 467 35.2% 2.0%
2003 Acquisitions (3) 1,582 - 1,582 100.0% 6.6%
-------------- -------------- -------------- --------------
Total/Overall $21,220 $23,809 ($2,589) (10.9%) (10.9%)
============== ============== ============== ==============
(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 (10.9%), from $23.8 million
for the year ended December 31, 2002 to $21.2 million for the year ended
December 31, 2003. Tenant reimbursements from continuing operations
decreased by ($1.2) million, or (6.2%), from $19.9 million for the year
ended December 31, 2002 to $18.7 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 December 31, 2003 our vacancy rate was 23%. General and
administrative expenses decreased by approximately ($0.2) million, or
(11%), 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 $ Change % Change
-------------- -------------- -------------- --------------
(dollars in thousands)
Depreciation & amortization $20,525 $18,064 $2,461 13.6%
- 35 -
Depreciation and amortization expense of real estate from continuing
operations increased by $2.5 million, or 13.6%, from $18 million for the
year ended December 31, 2002 to $20.5 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.
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,
-------------------------------------
% Change by
2003 2002 $ 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.
- 36 -
INCOME FROM DISCONTINUED OPERATIONS
The following table depicts the amounts of income from discontinued
operations for the years ended December 31, 2003 and 2002.
December 31, 2003 December 31, 2002
--------------------- --------------------
(dollars in thousands)
Gain from disposal of discontinued operations - $ 6,103
Income attributable to discontinued operations $ 979 1,266
Minority interest in earnings
attributable to discontinued operations (768) (6,093)
--------------------- --------------------
Total income from discontinued operations $ 211 $ 1,276
===================== ====================
In accordance with our adoption of SFAS No. 144, in 2004 we classified a
75,000 rentable square feet property separately as an asset held for sale
on the accompanying consolidated balance sheets and reported the operating
results of the asset held for sale as a discontinued operation on the
accompanying consolidated statements of operations. Also in accordance with
our adoption of SFAS No. 144, in 2002 we sold one property consisting of
72,426 rentable square feet and classified the gain on sale and operating
results of the disposed property as discontinued operations.
SFAS No. 144 requires prior period results of operations for these
properties to be restated and presented in discontinued operations in prior
consolidated statements of operations.
We recognized total income of $1 million from discontinued operations, of
which $0.2 million and $0.8 million were attributable to common
stockholders and minority interests, respectively, for the year ended
December 31, 2003. For the year ended December 31, 2002, we recognized
total income from discontinued operations of $7.4 million, including $6.1
million gain on sale of real estate. The income to common stockholders and
minority interests attributable to discontinued operations from these
properties in 2002 was approximately $1.3 million and $6.1 million,
respectively.
- 37 -
CHANGES IN FINANCIAL CONDITION
YEAR ENDED DECEMBER 31, 2004.
The most significant changes in our financial condition in 2004 resulted
from the exercise of stock options and the exchange of O.P. Units for
shares of common stock.
Debt outstanding, including amounts due related parties, decreased by
($3.9) million, or (1.1%), from $340.9 million as of December 31, 2003 to
$337.0 million as of December 31, 2004 due to recurring debt service
obligations. Interest rates continued to remain low in 2004.
During the year ended December 31, 2004, stock options were exercised to
purchase a total of 20,000 shares of common stock, consisting of 20,000
shares exercised at $8.25 per share. Total proceeds to the Company were
approximately $165,000.
In 2004, three limited partners exchanged 124,500 O.P. Units for 124,500
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. In 2004, Carl E. Berg gave 58,000 O.P. Units to
charitable institutions that exchanged them for 58,000 shares of the
Company's common stock pursuant to the December 1998 Exchange Rights
Agreement.
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, 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.
- 38 -
LIQUIDITY AND CAPITAL RESOURCES
In 2005 we anticipate a decline in operating cash flows from our operating
property portfolio compared to 2004 because of reduced demand for R&D space
in the Silicon Valley, lower rental rates for new and renewed leases signed
in 2004 and an increase in vacant properties in 2004. In addition, if we
are unable to lease a significant portion of the approximately 501,000
rentable square feet scheduled to expire in 2005 and current available
space, our operating cash flows would be further affected adversely. With
the expectation of lower revenues for the full year of 2005, we expect our
net operating income to continue to decline from 2004. We are also subject
to risks of decreased occupancy through tenant defaults and bankruptcies,
and potential reduction in rental rates upon renewal of properties, which
would result in reduction in cash flows from operations beyond the level we
are anticipating currently. It is reasonably likely that vacancy rates may
continue to increase and effective rental rates on new and renewed leases
may continue to decrease in 2005.
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 2005. 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. As of December 31, 2004 and 2003, the
Company's total debt as a percentage of total market capitalization was
23.3% and 20.1%, respectively. 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. Despite the current weakness in the
economy, we expect our total interest expense to increase as interest rates
rise and through new financing activities. In 2005, we will be obligated to
make payments totaling approximately $8.3 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.
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
4.08% as of December 31, 2004, and matures in March 2006. Debt of $9.6
million under this line of credit was outstanding at December 31, 2004. 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 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 agreed to extend
the loan to May 27, 2004 and again to September 6, 2004. On October 14,
2004, we concluded the extension of the Citicorp Loan for an additional two
years until September 6, 2006. The Citicorp Loan requires monthly principal
payments of $215,000 and carries a variable interest rate of LIBOR plus 2%.
The loan fee and costs incurred in connection with the mortgage loan
extension amounted to approximately $142,000 and will be amortized over the
term of the loan. Under the previous loan terms, Carl E. Berg had
personally guaranteed our repayment obligations and provided a personal
guaranty of our obligation to indemnify the lender for certain potential
environmental liabilities with respect to the pledged properties. Those
guaranties were provided in conjunction with Citicorp's short-term loan of
$80 million for our acquisition of the San Tomas Technology Park and were
released by Citicorp as part of the most recent loan extension. The
Citicorp Loan is secured by eight of our properties. The Citicorp Loan
terms require us to maintain a minimum excess of assets over liabilities of
$400 million, in addition to complying with other customary loan covenants
and conditions. In connection with the extension of the Citicorp Loan, we
retired an 8.75% mortgage loan from Prudential Capital Group with $548,000
of outstanding principal in October 2004, which had been collateralized by
one property located at 20400 Mariani Avenue in Cupertino, California. This
property has been added as additional collateral under the Citicorp Loan.
We have a $40 million line of credit with Cupertino National Bank ("CNB")
that expires on November 2, 2006. We are the borrower under the CNB line of
credit which is guaranteed by Mission West Properties, L.P. and Mission
West Properties, L.P. II.
The CNB line of credit and Citicorp Loan contain certain financial loan and
reporting covenants as defined in the loan agreements. As of December 31,
2004, we were in compliance with these loan covenants.
Since 1999, we have elected to be taxed as a REIT under the Internal
Revenue Code of 1986. We currently intend to continue operating as a REIT
in 2005. As a REIT, we are subject to a number of organizational and
operating requirements, including a
- 39 -
requirement to distribute 90% of our taxable income to our shareholders. As
a REIT, we generally will not be subject to federal income taxes on our
taxable income.
Generally, our objective is to meet our short-term liquidity requirement of
funding the payment of our current level of quarterly common dividends to
shareholders and O.P. Unit holders through our net cash flows provided by
operating activities, less our recurring and nonrecurring property capital
expenditures. These operating capital expenditures are the capital
expenditures necessary to maintain the earnings capacity of our operating
assets over time.
In order to better align with this objective in 2005, we reduced our
quarterly dividend payment rate to common shareholders and O.P. Unit
holders from a rate of $0.24 per share to $0.16 per share effective with
the quarterly dividend paid for the fourth quarter of 2004. The factors
that led to the fourth quarter 2004 dividend reduction were the decline in
economic and market conditions in the Silicon Valley, the reduction in
Microsoft's rent under its new lease and the slower lease-up of vacant
properties resulting in lower cash flow from our operating property
portfolio. For 2005, we expect to maintain our current quarterly dividend
payment rate to common shareholders and O.P. Unit holders of $0.16 per
share. However, distributions are declared at the discretion of our Board
of Directors and are subject to actual cash available for distribution, our
financial condition, capital requirements and such other factors, as our
Board of Directors deems relevant.
On January 7, 2005, we paid dividends of $0.16 per share of common stock to
all common stockholders of record as of December 31, 2004. On the same
date, the operating partnerships paid a distribution of $0.16 per O.P. Unit
to all holders of O.P. Units.
CONTRACTUAL OBLIGATIONS
The following table identifies our contractual obligations as of December
31, 2004 that will impact our liquidity and cash flow in future periods:
------------ ------------ ------------- ------------ ------------ ------------- ------------
2005 2006 2007 2008 2009 Thereafter Total
------------ ------------ ------------- ------------ ------------ ------------- ------------
(dollars in thousands)
Long-Term Debt Obligations (1) $8,284 $115,940 $6,350 $116,674 $4,382 $85,380 $337,010
Operating Lease Obligations (2) 90 90 23 - - - 203
------------ ------------ ------------- ------------ ------------ ------------- ------------
Total $8,374 $116,030 $6,373 $116,674 $4,382 $85,380 $337,213
============ ============ ============= ============ ============ ============= ============
(1) Our long-term debt obligations are set forth in detail in the schedule
below.
(2) Our operating lease obligations relate to a lease of our corporate office
facility from a related party.
At December 31, 2004, we had total indebtedness of approximately $337
million, including approximately $224.5 million of fixed rate mortgage debt
and approximately $112.5 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 $119.4 million
and $94.5 million, respectively.
- 40 -
The following table sets forth certain information regarding debt outstanding as
of December 31, 2004.
At December 31, Maturity Interest
Debt Description Collateral Properties 2004 Date Rate
----------------------------------------- ------------------------------------------- ------------------ ---------- -------------
(dollars in thousands)
Line of Credit:
Berg Group (related parties) 2033-2043 Samaritan Drive, San Jose, CA $ 9,560 3/06 (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 24,208 11/06 (4)
------------------
Mortgage Notes Payable (related parties): 5300-5350 Hellyer Avenue, San Jose, CA 10,420 6/10 7.650%
------------------
Mortgage Notes Payable (2):
Washington Mutual 10460 Bubb Road, Cupertino, CA 154 12/06 9.500%
Prudential Insurance Company of America 10300 Bubb Road, Cupertino, CA 119,441 10/08 6.560%
(3) 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 Ins. Co.(5) 1750 Automation Parkway, San Jose, CA 94,517 1/13 5.640%
1756 Automation Parkway, San Jose, CA
1762 Automation Parkway, San Jose, CA
6320 San Ignacio Avenue, San Jose, CA
6540-6541 Via Del Oro, San Jose, CA
6385-6387 San Ignacio Ave., 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. 2001 Walsh Avenue, Santa Clara, CA 78,710 9/06 (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
20400 Mariani Avenue, Cupertino, CA
------------------
Mortgage Notes Payable 292,822
------------------
Total $337,010
==================
- 41 -
(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
2006. The interest rate was 4.08% at December 31, 2004.
(2) Mortgage notes payable generally require monthly installments of interest
and principal ranging from $8 to $827 over various terms extending through
the year 2013. The weighted average interest rate of mortgage notes payable
was 6.23% at December 31, 2004.
(3) The Prudential Insurance loan is payable in monthly installments of $827,
which includes principal (based upon a 30-year amortization) and interest.
A limited partner, who is not a member of the Berg Group, has guaranteed
approximately $12 million of this debt. Costs and fees incurred with
obtaining this loan aggregated approximately $900, which were deferred and
amortized over the loan period.
(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, 2004 was 4.29% and 4.18%, respectively. As of December 31,
2004, we were in compliance with the financial covenants under each loan
agreement.
(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,
which were deferred and amortized over the loan period.
At December 31, 2004, 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 $10.64 per share on December 31, 2004) on a fully diluted basis,
including the conversion of all O.P. Units into common stock, was
approximately 23.3%. On December 31, 2004, the last trading day for the
year, total market capitalization was approximately $1.45 billion.
At December 31, 2004, the outstanding balance remaining under certain
demand notes that we owed to the operating partnerships was $1.59 million.
The due date of the demand notes has been extended to September 30, 2006.
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.
- 42 -
HISTORICAL CASH FLOWS
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2004 TO THE YEAR ENDED DECEMBER
31, 2003.
Net cash provided by operating activities for the year ended December 31,
2004 was approximately $105.1 million, compared to approximately $116.5
million for the prior year. The decrease in cash provided by operating
activities resulted from lower market rental rates, reductions in tenant
expense reimbursements and the loss of several tenants due to their lease
default, cessation of operations, or relocations resulting in increased
vacancy rates that offset cash savings.
Net cash used in investing activities for improvements to real estate was
approximately ($1.5) million for the year ended December 31, 2004, compared
to approximately ($110) 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 ($106.2) million
for the year ended December 31, 2004, compared to ($6.9) million for the
year ended December 31, 2003. During 2004, 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. During 2003,
financing activities included borrowing $180 million under two new
collateralized mortgage loans, of which $100 million was used to repay
short-term debt and the Berg Group line of credit and $80 million was used
for the acquisition of the San Tomas Technology Park. For the year ended
December 31, 2004, we paid dividends to our stockholders and made
distributions to O.P. Unit holders totaling approximately $101 million,
compared to approximately $100.1 million for the year ended December 31,
2003. Additionally, in 2004 we repaid $3.3 million under our line of credit
with the Berg Group.
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.
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, 2000 through December 31, 2004, the recurring
tenant/building improvement costs and leasing commissions incurred with
respect to new leases and lease renewals of the properties averaged
approximately $2.3 million annually. We will have approximately 501,000
rentable square feet under expiring leases in 2005. 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 2005. We believe we will recover substantially all of these
costs from the tenants under the new or renewed leases through contractual
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."
- 43 -
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.
The FFO for the years ended December 31, 2004, 2003, 2002, 2001 and 2000
are as follows:
For the Year Ended December 31,
------------------------------------------------------------------------
2004 2003 2002 2001 2000
-------------- ------------- -------------- ------------- --------------
(dollars in thousands)
Net income to common stockholders $ 13,312 $ 16,212 $ 17,115 $ 18,086 $12,579
Add:
Minority interests (1) 65,614 80,256 86,053 90,662 58,769
Depreciation and amortization of real estate (2) 24,394 22,850 21,379 17,718 15,803
Less:
Gain on sales of joint venture assets or assets - (1,400) (6,103) (11,453) (501)
-------------- ------------- -------------- ------------- --------------
FFO $103,320 $117,918 $118,444 $115,013 $86,650
============== ============= ============== ============= ==============
(1) The minority interest for third parties totaling $486, $581, $587, $650 and
$284 in 2004, 2003, 2002, 2001 and 2000, respectively, was deducted from
total minority interest in calculating FFO.
(2) Also includes our portion of depreciation and amortization of real estate
from our unconsolidated joint venture totaling $874 in both 2004 and 2003,
and amortization of leasing commissions totaling $1,644, $1,203, $3,020,
$694 and $346 in 2004, 2003, 2002, 2001 and 2000, respectively.
Amortization of leasing commissions is included in the property operating,
maintenance and real estate taxes line item in the Company's consolidated
statements of operations.
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.
- 44 -
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;
- 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
- 45 -
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.
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
From time to time we may dispose of properties in our portfolio, subject to
the required approvals as set forth below. 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.
- 46 -
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 December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment,"
("SFAS No. 123R") which addresses the accounting for employee and director
stock options. Statement 123R requires that the cost of all employee and
director stock options, as well as other equity-based compensation
arrangements, be reflected in the financial statements based on the
estimated fair value of the awards. SFAS No. 123R is an amendment to SFAS
No. 123 and supersedes APB Opinion No. 25 ("APB No. 25"). SFAS No. 123R is
applicable to any award that is settled or measured in stock, including
stock options, restricted stock, stock appreciation rights, stock units,
and employee stock purchase plans. SFAS No. 123R will be effective for
public companies starting with the first interim period commencing after
June 15, 2005. We will adopt the requirements of SFAS No. 123R in the third
quarter of 2005. We expect that the adoption of this standard will reduce
our net income and earnings per share; however, it will have no impact on
cash flow. Although we have not yet determined whether the adoption of SFAS
No. 123R will result in amounts that are similar to the current pro forma
disclosures under SFAS No. 123, we are evaluating the requirements under
SFAS No. 123R including the valuation methods and support for the
assumptions that underlie the valuation of the awards and the transition
methods (modified prospective transition method or the modified
retrospective transition method).
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Non-monetary
Assets" ("SFAS No. 153"). SFAS No. 153 amends the guidance in APB Opinion
No. 29, "Accounting for Non-monetary Transactions" to eliminate certain
exceptions to the principle that exchanges of non-monetary assets be
measured based on the fair value of the assets exchanged. SFAS No. 153
eliminates the exception for non-monetary exchanges of similar productive
assets and replaces it with a general exception for exchanges of
non-monetary assets that do not have commercial substance. This statement
is effective for non-monetary asset exchanges in fiscal years beginning
after June 15, 2005. The adoption of SFAS No. 153 is not expected to have
an impact on our consolidated results of operations, financial position 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, 2004. 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
collateralized notes payable, approximately $119.4 million and $94.5
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, 2004 will be paid upon
maturity.
For fixed rate debt, the table presents the assumption that the outstanding
principal balance at December 31, 2004 will be paid according to scheduled
principal payments and that we will not prepay any of the outstanding
principal balance.
2005 2006 2007 2008 2009 Thereafter Total Fair Value
---- ---- ---- ---- ---- ---------- ----- ----------
(dollars in thousands)
VARIABLE RATE DEBT:
Secured and unsecured debt $2,580 $109,898 $112,478 $112,478
Weighted average interest rate 4.19% 4.19%
FIXED RATE DEBT:
Secured notes payable $5,704 $6,042 $6,350 $116,674 $4,382 $85,380 $224,532 $244,309
Weighted average interest rate 6.23% 6.23% 6.23% 6.23% 6.23% 6.23%
The variable rate debt represented 33.4% and 32.4% and the fixed rate debt
represented 66.6% and 67.6% of all debt outstanding for the years ended
December 31, 2004 and 2003, respectively. All of the debt is denominated in
United States dollars. The weighted average interest rate for variable rate
debt was approximately 4.19% and 3.13% for the years ended December 31,
2004 and 2003, respectively. The difference in spread was due to numerous
increases in interest rates by the Federal Reserve Board during 2004. The
weighted average interest rate for fixed rate debt was approximately 6.23%
for the years ended December 31, 2004 and 2003. The difference in interest
expense attributable to the average interest rate difference between 2003
and 2004 was $1.1 million, which was a result of new debt obtained during
2003 and higher balances of our lines of credit in 2004. We anticipate
interest rate increases from 2004 to 2005 for our variable rate debt.
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 $112.5 million, or 33.4%, of the total $337
million of debt as of December 31, 2004. 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, 2004, 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, 2004, a 1%
increase or decrease in interest rates on our $112.5 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 any
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
---------
Management Report on Internal Control over Financial Reporting 50
Report of Independent Registered Public Accounting Firm 51
Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting 52
Consolidated Balance Sheets at December 31, 2004 and 2003 53
Consolidated Statements of Operations for the years ended December 31, 2004, 2003 and 2002 54
Consolidated Statements of Stockholders' Equity for the years ended December 31, 2004, 2003 and 2002 55
Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002 56
Notes to the Consolidated Financial Statements 57
Supplemental Financial Information 76
Report of Independent Registered Public Accounting Firm 78
Schedule III: Real Estate and Accumulated Depreciation as of December 31, 2004 80
Schedule III: Real Estate and Accumulated Depreciation as of December 31, 2003 82
- 49 -
MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of Mission West Properties, Inc. is responsible for establishing and
maintaining adequate internal control over financial reporting as defined in
Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Mission
West Properties, Inc.'s internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with accounting principles generally accepted in the United States of
America. Internal control over financial reporting includes those written
policies and procedures that:
- pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the
assets of Mission West Properties, Inc.;
- provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with accounting
principles generally accepted in the United States of America;
- provide reasonable assurance that receipts and expenditures of Mission West
Properties, Inc. are being made only in accordance with authorization of
management and directors of Mission West Properties, Inc.; and
- provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of assets that could have a
material effect on the consolidated financial statements.
Internal control over financial reporting includes the controls themselves,
monitoring and internal auditing practices and actions taken to correct
deficiencies as identified.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect the possibility of human error, misstatements and the
circumvention or overriding of controls. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
Management assessed the effectiveness of Mission West Properties, Inc.'s
internal control over financial reporting as of December 31, 2004. Management
based this assessment on the criteria for effective internal control over
financial reporting established in Internal Control - Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO). Management's assessment included an evaluation of the design of Mission
West Properties, Inc.'s internal control over financial reporting and testing of
the operational effectiveness of its internal control over financial reporting.
Management reviewed the results of its assessment with the Audit Committee of
the Board of Directors.
Based on this assessment, management determined that as of December 31, 2004,
Mission West Properties, Inc. maintained effective internal control over
financial reporting.
BDO Seidman, LLP, independent registered public accounting firm, who audited and
reported on the consolidated financial statements of Mission West Properties,
Inc. included in this Annual Report on Form 10-K, has issued an attestation
report on management's assessment of internal control over financial reporting.
- 50 -
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, 2004 and 2003 and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 2004. 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, 2004 and 2003, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2004, in conformity with accounting principles generally accepted
in the United States of America.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of Mission West
Properties, Inc.'s internal control over financial reporting as of December 31,
2004, based on criteria established in Internal Control - Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO) and our report dated January 28, 2005 expressed an unqualified opinion
thereon.
\S\ BDO Seidman, LLP
San Francisco, California
January 28, 2005, except for Note 19
which is as of March 1, 2005
- 51 -
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Board of Directors and Stockholders
Mission West Properties, Inc.
Cupertino, California
We have audited management's assessment, included in the accompanying Management
Report on Internal Control over Financial Reporting, that Mission West
Properties, Inc. maintained effective internal control over financial reporting
as of December 31, 2004, based on criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO criteria). The Company's
management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on
management's assessment and an opinion on the effectiveness of the company's
internal control over financial reporting based on our audit.
We conducted our audit 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 effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that Mission West Properties, Inc.
maintained effective internal control over financial reporting as of December
31, 2004, is fairly stated, in all material respects, based on the COSO
criteria. Also, in our opinion, Mission West Properties, Inc. maintained, in all
material respects, effective internal control over financial reporting as of
December 31, 2004, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets as
of December 31, 2004 and 2003, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 2004, and the financial statement schedule listed
in the accompanying index, of Mission West Properties, Inc. and our reports
dated January 28, 2005, expressed an unqualified opinion thereon.
\S\BDO Seidman, LLP
San Francisco, California
January 28, 2005
- 52 -
MISSION WEST PROPERTIES, INC.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share and per share data)
ASSETS
December 31,
---------------------------------------------
2004 2003
---------------------- ---------------------
Real estate assets:
Land $ 273,663 $ 275,707
Buildings and improvements 770,757 779,636
Real estate related intangible assets 18,284 19,651
---------------------- ---------------------
Total investments in properties 1,062,704 1,074,994
Less accumulated depreciation and amortization (110,062) (89,243)
Assets held for sale, net of accumulated depreciation of $1,578 at 12/31/04 8,221 -
---------------------- ---------------------
Net investments in properties 960,863 985,751
Cash and cash equivalents 1,519 4,129
Restricted cash 1,551 -
Deferred rent receivable, net of $2,000 allowance at
December 31, 2004 and 2003 18,511 18,970
Investment in unconsolidated joint venture 3,559 2,285
Other assets, net of accumulated amortization of
$5,667 and $4,211 at December 31, 2004 and 2003, respectively 19,653 21,497
---------------------- ---------------------
Total assets $1,005,656 $1,032,632
====================== =====================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Line of credit (related parties) $ 9,560 $ 6,320
Revolving line of credit 24,208 23,965
Mortgage notes payable 292,822 299,858
Mortgage note payable (related parties) 10,420 10,762
Interest payable 327 332
Security deposits 8,544 10,248
Deferred rental income 11,038 12,723
Liabilities related to assets held for sale 14 -
Dividend/distribution payable 16,718 25,031
Accounts payable and accrued expenses 6,704 5,085
---------------------- ---------------------
Total liabilities 380,355 394,324
---------------------- ---------------------
Commitments and contingencies
Minority interests 512,089 524,918
Stockholders' equity:
Preferred stock, $.001 par value, 20,000,000 shares authorized,
none issued and outstanding - -
Common stock, $.001 par value at December 31, 2004 and 2003,
200,000,000 shares authorized, 18,097,191 and 17,894,691 shares
issued and outstanding at December 31, 2004 and 2003, respectively 18 18
Paid-in capital 134,539 132,136
Accumulated deficit (21,345) (18,764)
---------------------- ---------------------
Total stockholders' equity 113,212 113,390
---------------------- ---------------------
Total liabilities and stockholders' equity $1,005,656 $1,032,632
====================== =====================
See notes to consolidated financial statements
- 53 -
MISSION WEST PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except share and per share data)
Year Ended December 31,
--------------------------------------------------------------------
2004 2003 2002
--------------------- --------------------- ---------------------
Revenues:
Rental revenue from real estate $119,523 $129,511 $128,553
Tenant reimbursements 14,946 18,726 19,957
Other income, including lease terminations,
settlements and interest 6,914 4,527 4,248
--------------------- --------------------- ---------------------
141,383 152,764 152,758
Expenses:
Property operating, maintenance and real estate taxes 20,540 21,220 23,809
Interest 17,581 16,446 9,588
Interest (related parties) 1,077 1,064 3,422
General and administrative 2,011 1,324 1,488
Depreciation and amortization of real estate 21,669 20,525 18,064
--------------------- --------------------- ---------------------
62,878 60,579 56,371
--------------------- --------------------- ---------------------
Income before equity in earnings of unconsolidated
joint venture and minority interests 78,505 92,185 96,387
Equity in earnings of unconsolidated joint venture,
including $1,400 gain on sale of property acquired from
related party in 2003 2,947 3,885 -
Minority interests 67,699 80,069 80,548
--------------------- --------------------- ---------------------
Income from continuing operations 13,753 16,001 15,839
--------------------- --------------------- ---------------------
Discontinued operations, net of minority interests:
Gain from disposal of discontinued operations - - 1,018
(Loss)/income attributable to discontinued operations (441) 211 258
--------------------- --------------------- ---------------------
(Loss)/income from discontinued operations (441) 211 1,276
--------------------- --------------------- ---------------------
Net income to common stockholders $13,312 $16,212 $17,115
===================== ===================== =====================
Net income to minority interests $66,100 $80,836 $86,641
===================== ===================== =====================
Income per share from continuing operations:
Basic $0.76 $0.90 $0.91
===================== ===================== =====================
Diluted $0.76 $0.90 $0.89
===================== ===================== =====================
(Loss)/income per share from discontinued operations:
Basic ($0.02) $0.01 $0.07
===================== ===================== =====================
Diluted ($0.02) $0.01 $0.07
===================== ===================== =====================
Net income per share to common stockholders:
Basic $0.74 $0.91 $0.98
===================== ===================== =====================
Diluted $0.74 $0.91 $0.96
===================== ===================== =====================
Weighted average shares of common stock (basic) 18,034,873 17,739,609 17,455,799
===================== ===================== =====================
Weighted average shares of common stock (diluted) 18,076,498 17,802,947 17,854,892
===================== ===================== =====================
Weighted average O.P. Units 86,444,773 86,476,217 86,334,548
===================== ===================== =====================
Outstanding common stock 18,097,191 17,894,691 17,487,329
===================== ===================== =====================
Outstanding O.P. Units 86,384,695 86,398,064 86,474,032
===================== ===================== =====================
See notes to consolidated financial statements
- 54 -
MISSION WEST PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(dollars in thousands, except share data)
Shares of Common Common Paid-in- Accumulated Total Stockholders'
Stock Outstanding Stock Capital Deficit Equity
------------------ -------- ------------ --------------- -------------------
Balance, December 31, 2001 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
conversion 124,000 1,518 1,518
Dividends declared (16,773) (16,773)
Net income 17,115 17,115
------------------ -------- ------------ --------------- -------------------
Balance, December 31, 2002 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
conversion 257,000 1 2,827 2,828
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
Issuance of common stock upon option exercise 20,000 165 165
Issuance of common stock upon O.P. Unit
conversion 182,500 2,238 2,238
Dividends declared (15,893) (15,893)
Net income 13,312 13,312
------------------ -------- ------------ --------------- -------------------
Balance, December 31, 2004 18,097,191 $18 $134,539 ($21,345) $113,212
================== ======== ============ =============== ===================
See notes to consolidated financial statements
- 55 -
MISSION WEST PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
Year Ended December 31,
-----------------------------------------------------------
2004 2003 2002
------------------- ------------------ ------------------
Cash flows from operating activities:
Net income from continuing operations $13,753 $16,001 $15,839
Adjustments to reconcile net income to net
cash provided by operating activities:
(Loss)/income from discontinued operations (441) 211 1,276
Minority interest 66,100 80,836 86,641
Depreciation and amortization of real estate and
in-place leases 21,876 20,774 18,360
Amortization of above market lease 1,888 1,416 -
Gain on sale of assets - - (6,103)
Equity in earnings of unconsolidated joint venture (2,947) (3,885) -
Distributions from unconsolidated joint venture 1,673 2,000 -
Asset impairment charge 2,193 - -
Other - - (14)
Change in operating assets and liabilities,
net of liabilities assumed:
Deferred rent receivable 459 (1,969) (78)
Other assets 2,195 (1,453) 389
Interest payable (5) (5) (5)
Security deposits (1,690) (936) 3,847
Deferred rental income (1,685) 2,847 (2,594)
Accounts payable and accrued expenses 1,701 656 (190)
------------------- ------------------ ------------------
Net cash provided by operating activities 105,070 116,493 117,368
------------------- ------------------ ------------------
Cash flows from investing activities:
Improvements to real estate (1,519) (1,370) (1,902)
Refundable option payment utilized for rent payments - - (333)
Proceeds from sales of real estate - - 12,803
Purchase of real estate - (110,013) (31,312)
Net proceeds from sale of TBI unconsolidated joint venture
real estate - 1,400 -
------------------- ------------------ ------------------
Net cash used in investing activities (1,519) (109,983) (20,744)
------------------- ------------------ ------------------
Cash flows from financing activities:
Principal payments on mortgage notes payable (7,036) (5,204) (2,354)
Proceeds from mortgage loan payable - 180,000 -
Principal payments on mortgage notes payable (related parties) (342) (316) (293)
Net proceeds/(payments) under line of credit (related parties) 3,338 (61,471) (39,095)
Proceeds from loan payable - - 20,000
Payment on loan payable - (20,000) -
Proceeds from revolving line of credit 243 126 28,839
Restricted cash (1,551) - -
Payment on line of credit - - (5,000)
Financing costs - (863) (52)
Net proceeds from exercise of stock options 165 1,014 151
Minority interest distributions (83,686) (83,194) (82,916)
Dividends (17,292) (16,952) (16,735)
------------------- ------------------ ------------------
Net cash used in financing activities (106,161) (6,860) (97,455)
------------------- ------------------ ------------------
Net (decrease) in cash and cash equivalents (2,610) (350) (831)
Cash and cash equivalents, beginning of year 4,129 4,479 5,310
------------------- ------------------ ------------------
Cash and cash equivalents, end of year $1,519 $4,129 $4,479
=================== ================== ==================
Refer to Note 14 for supplemental cash flow information.
See notes to consolidated financial statements
- 56 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(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 conducts its business.
As of December 31, 2004, the Company owns a controlling general partnership
interest of 17.16%, 21.63%, 16.14% and 12.38% 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 17.26% general partnership
interest in the operating partnerships, taken as a whole, on a consolidated
weighted average basis.
The Company, through the operating partnerships, owns interests in 109 R&D
properties at December 31, 2004, 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 Statement of Financial Accounting Standards
("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 receivables,
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.
- 57 -
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 acquisitions 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 sheets, 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
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 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. In connection with the January 2005 sale of an asset as more fully
described in Note 19, an impairment loss of approximately ($2,193) was recorded
for the year ended December 31, 2004 and is classified in discontinued
operations, net of minority interests. No impairment losses were recorded for
the years ended December 31, 2003 and 2002.
DISCONTINUED OPERATIONS AND ASSETS HELD FOR SALE:
The Company has adopted 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 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
- 58 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
operations of the property after the disposal transaction. SFAS No. 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.
An asset is generally classified as held for sale once management has committed
to an action to sell the asset, the asset is available for immediate sale in its
present condition (subject to terms that are usual and customary for sales of
such assets), an active program to locate a buyer is initiated, the sale is
probable, the asset is being actively marketed for sale at a price that is
reasonable in relation to its current fair value and actions required to
complete the plan indicate that it is unlikely that significant changes to the
plan will be made or that the plan will be withdrawn. Upon the classification of
a real estate asset as held for sale, the carrying value of the asset is reduced
to the lower of its net book value or its fair value, less costs to sell the
asset. Subsequent to the classification of assets as held for sale, no further
depreciation expense is recorded. Real estate assets held for sale are stated
separately on the accompanying consolidated balance sheets. Effective January 1,
2002 (through the implementation of SFAS No. 144), the operating results of real
estate assets held for sale and sold are reported as discontinued operations in
the accompanying consolidated statements of operations. The income/(loss) from
discontinued operations includes the revenues and expenses, including
depreciation, associated with the assets. This classification of operating
results as discontinued operations applies retroactively for all periods
presented for assets designated as held for sale subsequent to January 1, 2002.
Additionally, gains and losses on assets designated as held for sale subsequent
to January 1, 2002 are classified as part of discontinued 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 obligation receivables 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 sheets. 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
- 59 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
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 recognized in other income when there is a signed
termination letter agreement, all of the conditions of the agreement have been
met, and the tenant is no longer occupying the property. 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
- the collectability 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, 2004, 2003 and 2002,
no provision for federal income taxes has been included in the accompanying
consolidated financial statements.
For the years ended December 31, 2004 and 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 year ended December 31, 2002,
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.
- 60 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
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,
-----------------------------------------------------------
2004 2003 2002
------------------ ------------------- ------------------
(dollars in thousands, except per share data)
Historical net income to common stockholders $13,312 $16,212 $17,115
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 (176) (235) (264)
Allocation of expense to minority interest 145 195 220
------------------ ------------------- ------------------
Pro forma net income to common stockholders $13,281 $16,172 $17,071
------------------ ------------------- ------------------
Earnings per share - basic:
Historical net income to common stockholders $0.74 $0.91 $0.98
Pro forma net income to common stockholders $0.74 $0.91 $0.98
Earnings per share - diluted:
Historical net income to common stockholders $0.74 $0.91 $0.96
Pro forma net income to common stockholders $0.73 $0.91 $0.96
------------------ ------------------- ------------------
There were no stock options granted in 2004, 2003 and 2002.
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, 2004 was
approximately $244,309 as compared to its carrying value of $224,532.
RECLASSIFICATIONS:
Certain amounts from prior year's consolidated financial statements have been
reclassified to conform to the presentation of the current year's consolidated
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 79 tenants at December 31, 2004, default by any major
tenant could significantly impact the results of the consolidated total. One
tenant, Microsoft Corporation, accounted for approximately 18.1%, 16.3% and
15.7% of the Company's cash rental income for the years ended December 31, 2004,
2003 and 2002, respectively, with the next largest tenant accounting for 10.8%,
10.0% and 8.6%, respectively, of total cash rental income. Cash rental income
from Microsoft Corporation was $21,997, $21,151 and $20,338 for the years ended
December 31, 2004, 2003 and 2002, respectively. Future minimum rents from this
tenant are $107,171. During 2004, eleven of the Company's tenants relocated or
ceased operations.
- 61 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
NEW ACCOUNTING PRONOUNCEMENTS:
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment," which
addresses the accounting for employee and director stock options. Statement 123R
requires that the cost of all employee and director stock options, as well as
other equity-based compensation arrangements, be reflected in the financial
statements based on the estimated fair value of the awards. SFAS No. 123R is an
amendment to SFAS No. 123 and supersedes APB Opinion No. 25 ("APB 25"). SFAS No.
123R is applicable to any award that is settled or measured in stock, including
stock options, restricted stock, stock appreciation rights, stock units, and
employee stock purchase plans. SFAS No. 123R will be effective for public
companies starting with the first interim period commencing after June 15, 2005.
The Company will adopt the requirements of SFAS No. 123R in the third quarter of
2005. The Company expects that the adoption of this standard will reduce its net
income and earnings per share; however, it will have no impact on cash flow.
Although the Company has not yet determined whether the adoption of SFAS 123R
will result in amounts that are similar to the current pro forma disclosures
under SFAS No. 123, the Company is evaluating the requirements under SFAS No.
123R including the valuation methods and support for the assumptions that
underlie the valuation of the awards and the transition methods (modified
prospective transition method or the modified retrospective transition method).
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Non-monetary
Assets" ("SFAS No. 153"). SFAS No. 153 amends the guidance in APB Opinion No.
29, "Accounting for Non-monetary Transactions" to eliminate certain exceptions
to the principle that exchanges of non-monetary assets be measured based on the
fair value of the assets exchanged. SFAS No. 153 eliminates the exception for
non-monetary exchanges of similar productive assets and replaces it with a
general exception for exchanges of non-monetary assets that do not have
commercial substance. This statement is effective for non-monetary asset
exchanges in fiscal years beginning after June 15, 2005. The adoption of SFAS
No. 153 is not expected to have an impact on the Company's consolidated results
of operations, financial position or cash flows.
3. DEFERRED RENT ALLOWANCE
The following table represents activity in the deferred rent allowance for the
years ended December 31, 2004, 2003 and 2002.
Provision
Beginning Against Ending
Balance Revenues Charge-off Balance
-------------- ------------ ------------ -------------
(dollars in thousands)
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
Year ended December 31, 2004 $2,000 $1,313 $1,313 $2,000
4. STOCK TRANSACTIONS
As of December 31, 2004 and 2003, $1,588 and $1,471 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. However, the interest income earned by the operating partnerships,
which is interest expense to the Company, in connection with this debt, is
included in the calculation of minority interest as reported on the consolidated
statement of operations, thereby reducing the Company's net income by this same
amount. The Company and the operating partnerships have agreed to extend the due
date of the demand notes to September 30, 2006. 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
- 62 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
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, 2004, stock options at $8.25 per share were
exercised to purchase a total of 20,000 shares of the Company's common stock.
Total proceeds to the Company were approximately $165.
During the year ended December 31, 2003, stock options were exercised to
purchase a total of 150,362 shares of the Company's 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 the Company's common stock.
Total proceeds to the Company were approximately $151.
In 2004 and 2003, 182,500 and 257,000 O.P. Units were exchanged for 182,500 and
257,000 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 82.74% and 82.98%, on a weighted average basis, of
the ownership interests in the real estate operations of the Company as of
December 31, 2004 and 2003, 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 consolidated 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, 2004, 2003 and 2002, income
associated with the minority interests held by the third parties of the three
consolidated joint ventures was $486, $581 and $587, 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.
- 63 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
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 84 additional acres of land
currently controlled by the Berg Group, which could support approximately 1.4
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.
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.
- 64 -
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, 2004 and 2003.
Balance Maturity Interest
Debt Description Collateral Properties At December 31, Date Rate
--------------------------------- --------------------------------- ----------------------------- ---------- ----------
2004 2003
--------------------------------- --------------------------------- ----------------------------- ---------- ----------
(dollars in thousands)
Line of Credit:
Berg Group (related parties) 2033-2043 Samaritan Drive, San Jose, CA $ 9,560 $ 6,320 3/06 (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 24,208 23,965 11/06 (4)
------------- --------------
Mortgage Notes Payable (related 5300-5350 Hellyer Avenue, San Jose, CA 10,420 10,762 6/10 7.650%
parties): ------------- --------------
Mortgage Notes Payable: (2)
Prudential Capital Group (3) - 733 10/06 8.750%
Washington Mutual 10460 Bubb Road, Cupertino, CA 154 225 12/06 9.500%
Prudential Insurance Company of
America (5) 10300 Bubb Road, Cupertino, CA 119,441 121,455 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 E. Arques, Sunnyvale, CA
1250 E. Arques, Sunnyvale, CA
1170 Morse Avenue, Sunnyvale, CA
1600 Memorex Drive, Santa Clara, CA
1688 Richard Avenue, Santa Clara, CA
1700 Richard Avenue, Santa Clara, CA
3540 Bassett Street, Santa Clara, CA
3542 Bassett Street, Santa Clara, CA
3544 Bassett Street, Santa Clara, CA
3550 Bassett Street, Santa Clara, CA
Northwestern Mutual Life
Insurance Company(6) 1750 Automation Parkway, San Jose, CA 94,517 97,445 1/13 5.640%
1756 Automation Parkway, San Jose, CA
1762 Automation Parkway, San Jose, CA
6320 San Ignacio Avenue, San Jose, CA
6540-6541 Via Del Oro, San Jose, CA
6385-6387 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 78,710 80,000 9/06 (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
20400 Mariani Avenue, Cupertino, CA
------------- --------------
Mortgage Notes Payable 292,822 299,858
------------- --------------
Total $337,010 $340,905
============= ==============
(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
2006. The interest rate was 4.08% and 2.52% at December 31, 2004 and 2003,
respectively.
(2) Mortgage notes payable generally require monthly installments of interest
and principal ranging from $8 to $827 over various terms extending through
the year 2013. The weighted average interest rate of mortgage notes payable
was 6.23% at December 31, 2004 and 2003.
(3) The Prudential Capital Group mortgage loan was paid off in its entirety in
October 2004. It was collateralized by one property located at 20400
Mariani Avenue in Cupertino, California. This property was added as
additional collateral to the Citicorp USA, Inc. loan.
- 65 -
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, 2004 and 2003 was 4.29% and
3.17%, respectively. The interest rate for the Citicorp USA, Inc. mortgage
loan at December 31, 2004 and 2003 was 4.18% and 3.17%, respectively. The
Cupertino National Bank line of credit and Citicorp USA, Inc. loan contain
certain financial loan and reporting covenants as defined in the loan
agreements. As of December 31, 2004, the Company was in compliance with
these loan covenants.
(5) The Prudential Insurance loan is payable in monthly installments of $827,
which includes principal (based upon a 30-year amortization) and interest.
A limited partner, who is not a member of the Berg Group, has guaranteed
approximately $12,000 of this debt. Costs and fees incurred with obtaining
this loan aggregated approximately $900, which were deferred and amortized
over the loan period.
(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,
which were deferred and amortized over the loan period.
Scheduled principal payments on debt as of December 31, 2004 are as follows:
Fixed Rate Debt Variable Rate Debt
(Including Related Parties)(Including Related Parties) Total
----------------------- ---------------------- ----------------
December 31, 2005 $ 5,704 $ 2,580 $ 8,284
December 31, 2006 6,042 109,898 115,940
December 31, 2007 6,350 - 6,350
December 31, 2008 116,674 - 116,674
December 31, 2009 4,382 - 4,382
Thereafter 85,380 - 85,380
----------------------- ---------------------- ----------------
$224,532 $112,478 $337,010
======================= ====================== ================
8. OPERATING PARTNERSHIP AND STOCKHOLDER DISTRIBUTIONS
Holders of the Company's common stock and O.P. Units are entitled to dividend
distributions as determined and declared by the Company's Board of Directors.
Under the Exchange Rights Agreement limited partners have the right to tender
O.P. Units to the Company, and, at the Company's 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 the Company's charter document, or the overall 20% Berg
Group ownership limit, as the case may be. O.P. Unit holders are entitled to
vote when their O.P. Units are converted to shares of the Company's common
stock.
During 2004 the Company, as general partner of the operating partnerships,
declared quarterly distributions aggregating $0.88 per common share and O.P.
Unit for total distributions of $91,944, including $16,717 payable in January
2005. During the fourth quarter of 2004, the Company's Board of Directors
reduced the quarterly dividend distribution from $0.24 per common share and O.P.
Unit to $0.16 per common share and O.P. Unit. Total distributions attributable
to O.P. Units owned by various members of the Berg Group were $69,075, which was
treated as a draw on the Berg Group line of credit.
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.
9. EQUITY-BASED COMPENSATION AND RETIREMENT INVESTMENT 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.
- 66 -
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 2004, 2003 and 2002.
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.
Weighted Average
1997 Stock Exercise Price
Option Plan Per Share
--------------- ------------------
Balance, December 31, 2001 983,912 $10.44
Options exercised (33,550) $4.50
---------------
Balance, December 31, 2002 950,362 $10.65
Options exercised (150,362) $6.74
Options cancelled (13,000) $13.00
---------------
Balance, December 31, 2003 787,000 $11.36
Options exercised (20,000) $8.25
---------------
Balance, December 31, 2004 767,000 $11.44
===============
The following table summarizes information regarding options outstanding for the
1997 Stock Option Plan at December 31, 2004:
Options Outstanding Options Exercisable Options Not Exercisable
--------------------------------------------------------------------------------------
Weighted
Average
Remaining Weighted Weighted Weighted
Range of Exercise Prices Contractual Average Average Average
Options Life in Exercise Exercise Exercise
Years (1) Price Options Price Options Price
--------------------------------------------------------------------------------------
$8.25 120,000 1.0 $8.25 120,000 $8.25 - -
$11.33 375,000 4.3 $11.33 229,167 $11.33 145,833 $11.33
$13.00 272,000 1.8 $13.00 269,000 $13.00 3,000 $13.00
------------ ------------ ------------
$8.25 to $13.00 767,000 2.9 $11.44 618,167 $11.46 148,833 $11.36
============ ============ ============
(1) Expiration dates range from July 2005 to April 2009.
None of the options granted are contingent upon the attainment of performance
goals or subject to other restrictions. As of December 31, 2004, outstanding
options to purchase 618,167 shares of common stock were exercisable.
As of December 31, 2004, no additional shares were available for grant under the
1997 Stock Option Plan.
On November 24, 2004, the shareholders of Mission West Properties, Inc. approved
the Company's 2004 Equity Incentive Plan ("2004 Plan"), which replaced the
Company's 1997 Stock Option Plan ("1997 Plan"). The Company's board of directors
approved the 2004 Plan in September 2004. No further options will be granted
under the 1997 Plan.
- 67 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
In replacing the 1997 Plan, the 2004 Plan:
- transferred up to 3,991,089 remaining shares available for issuance under
the Company's 1997 Plan and terminated the 1997 Plan for any new grants;
- transferred up to an additional 767,000 shares subject to outstanding
options under the 1997 Plan if they expire without being exercised;
- and includes the ability to grant restricted stock, restricted stock units,
performance units, dividend equivalent rights, and other stock-based
compensation, including O.P. Units of the Operating Partnerships, as well
as incentive and non-statutory stock options.
Currently, the Company's 1997 Plan authorizes its board of directors to grant
stock options to eligible employees and consultants and provides for the
one-time automatic grant of options to non-employee directors upon joining the
board of directors. The 2004 Plan will allow the Company to grant to employees
and directors a wider range of awards than is permitted under the current stock
option plan, including restricted stock, stock grants, restricted stock units,
performance units, other stock-based compensation, including O.P. Units
exchangeable for shares of common stock, and dividend equivalent rights, which
will help the Company achieve its goal of attracting, retaining and motivating
its personnel which is necessary to build the Company's infrastructure, achieve
the Company's business goals and enhance stockholder value. No options or awards
may be granted under the 2004 Plan after November 24, 2014.
Awards and options granted under the 2004 Plan may be granted to any employees,
non-employee directors or consultants of the Company and any corporation or
other entity affiliated with the Company, including the Operating Partnerships.
Only employees of the Company or a corporate subsidiary may receive incentive
stock options. Options can be granted to non-employee directors and consultants
of the Company and to employees of the Company or a corporate subsidiary. No
individual may receive in any one calendar year awards covering more than
500,000 of the total number of shares of stock.
The options generally are granted at the fair market value of the Company's
common shares at the date of grant, vest over a four to six year period, are
exercisable upon vesting and expire six to eight years from the date of grant.
The exercise price for all incentive stock options under the 2004 Plan shall not
be less than the fair market value of the underlying common shares at the time
the option was granted.
Under the 2004 Plan, each non-employee member of the board of directors who
became or becomes a member of the board of the directors after November 24,
2004, the date on which the Plan was approved by the Company's stockholders,
will receive automatically 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. 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. In addition, the board of
directors may authorize annual option grants or awards to non-employee directors
in the board's discretion as long as the number of shares or equivalent number
of underlying shares of common stock in the case of certain awards, does not
exceed 50,000 per year. A disinterested majority of the board also may authorize
additional options and awards to a director serving as a Committee chair or
providing other extraordinary service to the Board. The 2004 Plan further
provides that upon an acquisition of the Company in which more than 50% of the
total voting power of the Company's outstanding securities is transferred to the
acquirer or acquiring parties, options and awards held by non-employee directors
will vest in full and become exercisable prior to their expiration.
The board of directors may terminate the 2004 Plan at any earlier time or make
modifications of the 2004 Plan as it deems advisable. Awards and options granted
at any time during the term of the 2004 Plan will not expire solely because of
the termination of the 2004 Plan, and no amendment or modification of the 2004
Plan shall affect the terms of any outstanding award unless the board expressly
provides otherwise. Termination or amendment of the 2004 Plan may not adversely
affect the rights of the recipient of an award without his or her consent. The
Compensation Committee of the Board of Directors may amend the terms of any
option or award previously granted, but such amendment may not impair the rights
of the recipient without his or her consent.
A total of 3,991,089 shares of common stock are reserved for issuance under the
2004 Plan. At no time may the number of shares issued pursuant to or subject to
outstanding awards granted under the 2004 Plan exceed this number, subject to
the provisions for increase and adjustment set forth in the 2004 Plan. If any
option or award expires, terminates or is cancelled without being exercised in
full, or any other award is forfeited, the shares forfeited or not purchased
will be available for future grant of awards. As of December 31, 2004, no
options or awards were granted under the 2004 Plan.
- 68 -
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, 2004, 2003 and 2002, the Company recognized $92,
$92 and $95 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, 2004 December 31, 2003 December 31, 2002
-------------------- ------------------- -------------------
Weighted average shares outstanding (basic) 18,034,873 17,739,609 17,455,799
Incremental shares from assumed option exercise 41,625 63,338 399,093
-------------------- ------------------- -------------------
Weighted average shares outstanding (diluted) 18,076,498 17,802,947 17,854,892
==================== =================== ===================
Outstanding options to purchase 272,000, 647,000 and 285,000 shares in 2004,
2003 and 2002, respectively, were excluded from the computation of diluted net
income per share under the treasury stock method because the option exercise
price was greater than the weighted average exercise price of the Company's
common stock during the respective periods. 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, 2004 and 2003 were 86,384,695 and 86,398,064, respectively.
11. OTHER INCOME
Other income, including interest, was approximately $6,914, $4,527 and $4,248
for the years ended December 31, 2004, 2003 and 2002, respectively. For the year
ended December 31, 2004, termination fees and prior tenant bankruptcy
settlements accounted for approximately $4,250 and $1,199, respectively, of
other income. 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, 2004 and 2003, the Berg Group owned 77,577,528 and 78,364,716
O.P. Units, respectively, of the total 86,384,695 and 86,398,064 O.P. Units
issued and outstanding, respectively. The Berg Group's interest in the Company
represents 74.2% and 75.1% of the Company as of December 31, 2004 and 2003,
respectively, assuming conversion of the O.P. Units into common shares of the
Company.
The Company periodically acquires unleased properties, which include land, the
building shell and base building improvements, from the Berg Group under the
Berg Group Land Holdings Options 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 sheets.
The Company did not acquire any properties from the Berg Group in 2004.
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
- 69 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
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.
As of December 31, 2004 and 2003, debt in the amount of $9,560 and $6,320,
respectively, was due the Berg Group under the line of credit. This amount
includes $9,000 of debt assumed in connection with an acquisition of a property
from the Berg Group in 2003. Additionally, in 2004 and 2003, the operating
partnerships declared distributions of $0.88 and $0.96 per O.P. Unit,
respectively. Distributions paid to various members of the Berg Group were
$69,075 and $75,224 in 2004 and 2003, respectively. Interest expense incurred in
connection with the Berg Group line of credit was $266, $227 and $2,562 for the
years ended December 31, 2004, 2003 and 2002, respectively.
As of December 31, 2004 and 2003, debt in the amount of $10,420 and $10,762,
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 $811, $837 and $860 for the years ended December 31,
2004, 2003 and 2002, 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 approximately
160,000 square foot R&D buildings 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 Holdings 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
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.
- 70 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
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 $682, $400 and $303 in 2004, 2003 and
2002, respectively. As of December 31, 2004, accumulated cash flow distributions
from Hellyer LP totaling approximately $2.2 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 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
Agreement because the transaction differed from the standard build-to-suit
development 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 the Company's acquisition of the Berg Group's 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 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 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, 2004, 2003 and 2002, 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 $866, $904 and $748 in rental revenue in
2004, 2003 and 2002, 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.
- 71 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
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, California. 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 Independent Directors Committee.
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 2001 acquisition of 245 Caspian Drive in Sunnyvale, California 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 Independent Directors Committee.
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 amount and overhead
reimbursements paid to Berg & Berg Enterprises, Inc. were $90 for each year
ended December 31, 2004, 2003 and 2002.
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:
Year Minimum Rent
--------------------------------------------
(dollars in thousands)
2005 $102,084
2006 95,389
2007 77,429
2008 62,838
2009 54,297
Thereafter 134,218
---------------------------
Total $526,255
===========================
14. SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest was $18,363, $17,146 and $12,752 for the years ended
December 31, 2004, 2003 and 2002, respectively.
In connection with property acquisitions, the Company assumed $9,000 and $18,000
of related party debt due the Berg Group, assumed other liabilities of $783 and
$387 and issued 350,163 and 835,491 O.P. Units for a total acquisition value of
$12,953 and $30,953 for the years ended December 31, 2003 and 2002,
respectively. The Company did not make any property acquisitions in 2004.
Amounts of $75,326, $75,224 and $75,281 were due the Berg Group for
distributions declared to O.P. Unit holders during the years ended December 31,
2004, 2003 and 2002, 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.
- 72 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
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. 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. See Note 19.
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. In December 2004, the Company settled this matter and received a final
payment of $276 which was recorded as other income in the consolidated
statements of operations.
THE GLOBAL CROSSING ESTATE REPRESENTATIVE, FOR ITSELF AND THE LIQUIDATING
TRUSTEE OF THE GLOBAL CROSSING LIQUIDATING TRUST V. MISSION WEST PROPERTIES,
L.P. 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. In addition, the Global debtors and the Creditor's
Committee filed an objection to the unsecured claim filed by Mission West
Properties in the Global cases for $16,711. See Note 19.
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, 2004.
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 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, 2004.
- 73 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
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. REAL ESTATE ASSET HELD FOR SALE/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 consolidated statements of operations. Prior
period consolidated statements of operations presented in this report have been
reclassified to reflect the income or loss related to properties that were held
for sale or sold and presented as discontinued operations for the years ended
December 31, 2004, 2003 and 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, 2004, there was one property under contract to be sold or
otherwise disposed of which would qualify as assets held for sale. There were no
properties under contract to be sold or otherwise disposed of which would
qualify as assets held for sale as of December 31, 2003.
In November 2004, the Company identified one property as asset held for sale.
That property was sold for $8,500 in January 2005. Based on the expected net
proceeds of the sale, the Company recorded an asset impairment charge of
($2,193) in 2004. Also see Note 19. The Company decided to sell that property
after an unsolicited offer was made from an unrelated third party. In March
2002, the Company sold one property for $18,503 resulting in a gain of $6,103.
Condensed results of operations for these properties for the years ended
December 31, 2004, 2003 and 2002 are as follows:
For the Year Ended December 31,
2004 2003 2002
-------------------- ------------------- --------------------
Revenues (dollars in thousands)
Rental revenue from real estate $ 381 $1,227 $1,561
Tenant reimbursements 92 145 435
Other income 2 - -
-------------------- ------------------- --------------------
Total revenues 475 1,372 1,996
Expenses
Property operating, maintenance and
real estate taxes 116 144 435
Depreciation 207 249 295
Asset impairment charge 2,193 - -
-------------------- ------------------- --------------------
Total expenses 2,516 393 730
Net (loss)/income from discontinued
operations (2,041) 979 1,266
Net gain on disposition of discontinued
operations - - 6,103
Minority interest in earnings attributable to
discontinued operations 1,600 (768) (6,093)
-------------------- ------------------- --------------------
Total (loss)/income from discontinued operations ($ 441) $ 211 $1,276
==================== =================== ====================
- 74 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
For the years ended December 31, 2004 and 2003, income from discontinued
operations included results of operations from one property classified as held
for sale at December 31, 2004. For the year ended December 31, 2002, income from
discontinued operations included results of operations of one property
classified as held for sale at December 31, 2004 and one property sold in 2002
through its sale date.
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.
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 years ended December 31,
2004 and 2003 was $1,888 and $1,416, respectively, and was recorded as a
reduction of rental revenue from real estate. Amortization expense related to
in-place leases of $1,762 and $881 was recorded for the years ended December 31,
2004 and 2003, respectively.
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. Amortization expense
related to in-place leases of $410, $547 and $411 was recorded for the years
ended December 31, 2004, 2003 and 2002, respectively. During 2004, the in-place
lease intangible asset relating to the Orchard-Trimble property became fully
amortized, and the asset cost and related accumulated amortization was removed
from the accounts.
Details of real estate related intangible assets at December 31, 2004 and 2003
are as follows:
Amortizable Intangible Assets 2004 2003
-----------------------------------------------------------------------------
(dollars in thousands)
Above-market lease $11,172 $11,172
In-place leases 7,112 8,479
----------------------------
Gross real estate related intangible assets 18,284 19,651
Less accumulated amortization (5,947) (3,254)
----------------------------
Net real estate related intangible assets $12,337 $16,397
============================
- 75 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except share and per share data)
The estimated aggregate amortization expense for the real estate related
intangible assets for each of the six succeeding fiscal years is as follows:
Estimated
Estimated Above Market Lease
In-place Lease Amortization Estimated
Year Amortization (expense) (revenue off-set) Total Amortization
-----------------------------------------------------------------------------------------
(dollars in thousands)
2005 $1,444 $1,888 $ 3,332
2006 1,285 1,888 3,173
2007 1,205 1,888 3,093
2008 311 1,889 2,200
2009 195 315 510
2010 29 - 29
-----------------------------------------------------------------------
Total $4,469 $7,868 $12,337
=======================================================================
18. SUPPLEMENTAL FINANCIAL INFORMATION (Unaudited)
Quarterly financial information for the year ended December 31, 2004 (1) is as
follows:
For the Three Months Ended
March 31, June 30, September 30, December 31,
(Unaudited)
-----------------------------------------------------------------------------------
Rental revenue from continuing operations $31,270 $29,880 $29,553 $28,820
Income before gain on sales of assets,
equity in earnings of unconsolidated
joint venture and minority interests $19,951 $22,087 $18,315 $18,153
Income from continuing operations $ 3,469 $ 3,812 $3,173 $ 3,299
Income from discontinued operations $ 54 ($ 17) - ($ 478)
Net income $ 3,523 $ 3,795 $3,173 $ 2,821
Per share data:
Basic net income per share $0.20 $0.21 $0.18 $0.16
Diluted net income per share $0.19 $0.21 $0.18 $0.16
Weighted average shares of common stock 17,969,416 18,016,356 18,071,484 18,081,321
(basic)
Weighted average shares of common stock 18,075,262 18,079,139 18,098,174 18,104,454
(diluted)
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,
(Unaudited)
-----------------------------------------------------------------------------------
Rental revenue from continuing operations $31,124 $32,415 $33,003 $32,968
Income before gain on sales of assets,
equity in earnings of unconsolidated
joint venture and minority interests $23,007 $22,577 $22,398 $24,203
Income from continuing operations $ 3,936 $ 4,059 $ 3,841 $ 4,166
Income from discontinued operations $ 52 $ 52 $ 52 $ 53
Net income $ 3,988 $ 4,111 $ 3,893 $ 4,219
Per share data:
Basic net income per share $0.23 $0.23 $0.22 $0.24
Diluted net income per share $0.23 $0.23 $0.22 $0.23
Weighted average shares of common stock 17,637,260 17,701,999 17,747,293 17,869,252
(basic)
Weighted average shares of common stock 17,695,001 17,762,773 17,817,917 17,972,706
(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.
- 76 -
19. SUBSEQUENT EVENTS
On January 5, 2005, the Company completed the sale of a three story 75,000
rentable square foot R&D property at 3120 Scott Boulevard in Santa Clara,
California for $8,500, following the expiration of a long term lease by the
tenant that originally completed construction of the building in March 1984.
During the months leading up to and following the turnover of the building from
the original tenant, management began formulating a marketing strategy to lease
the building to a new tenant. During this evaluation period, management leased a
12,000 square foot portion of the ground floor of the building to a former
subtenant of the original tenant of the building and received an unsolicited
offer to purchase the building from an unrelated party. During the fourth
quarter of 2004, prior to recommending to the Company's Board of Directors to
accept the offer, management took into consideration several factors and
concluded that the property would require additional capital improvements and
likely remain vacant for more than a year under current market conditions. As a
result of the sale, an impairment loss of ($2,193) was recorded in 2004 based on
the fair value of the property being less than its carrying value. That property
was classified as held for sale at December 31, 2004.
On January 7, 2005, the Company paid dividends of $0.16 per share of common
stock to all common stockholders of record as of December 31, 2004. On the same
date, the operating partnerships paid a distribution of $0.16 per O.P. Unit to
all holders of O.P. Units.
On February 9, 2005, after having spent more than one year attempting to resolve
the objection to the Global Crossings claim (as well as the preference lawsuit),
the Court held a hearing to consider objection filed with respect to Mission
West Properties' claim. A continued hearing on the claim objection is set for
March 23, 2005. A trial date has not been set for either the unsecured claim
objection or preference litigation. See Note 15.
On February 22, 2005, the Company acquired an approximately 200,500 rentable
square foot R&D property located at 5521 (formerly 4949) Hellyer Avenue in San
Jose, California from Cisco Systems, Inc. The total acquisition price for this
property was approximately $14,026. The building was purchased vacant.
On February 4, 2005, the Maryland Appeals Court heard the Company's appeal in
the Republic Properties Corporation v. Mission West Properties, L.P suit. On
March 1, 2005, the Maryland Appeals Court ruled in favor of Mission West
Properties, L.P., finding that the Circuit Court of Maryland could not assert
personal jurisdiction. The Maryland Appeals Court will issue its mandate within
30 days, after which Republic Properties Corporation will have 15 days to seek a
writ of certiorari to the Maryland Appeals Court.
- 77 -
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 January 28, 2005 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 schedule listed in the accompanying index. This financial statement
schedule is the responsibility of the Company's management. Our responsibility
is to express an opinion on this financial statement schedule based upon our
audits.
In our opinion such financial statement schedule presents fairly, in all
material respects, the information set forth therein.
\S\ BDO Seidman, LLP
San Francisco, California
January 28, 2005
- 78 -
INTENTIONALLY BLANK
- 79 -
MISSION WEST PROPERTIES, INC.
Schedule III
Real Estate and Accumulated Depreciation & Amortization
December 31, 2004
(dollars in thousands)
Initial Cost Total Cost
---------------------------- Cost ------------------------
Buildings Subsequent to Buildings
December 31, 2004 and Construction/ and
Property Name City Encumbrances Land Improvements Acquisition Land Improvements
---------------------------------------- --------------- -------------- ------------- ------------- ---------- -------------
5300-5350 Hellyer Avenue San Jose E $10,420 $ 5,742 $ 11,442 $ 5,742 $ 11,442
10401-10411 Bubb Road Cupertino A 633 3,078 633 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 1,053 1,866 10,135
Blvd
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 5,007 215 3,238 5,222
5325 Hellyer Avenue San Jose 4,684 10,231 40 4,684 10,271
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 22 2,931 5,885
2610 Orchard Parkway San Jose K 2,615 5,231 2,615 5,231
55 West Trimble Road San Jose K 4,435 8,869 4,435 8,869
2001 Walsh Avenue Santa Clara G,I,J 4,610 5,245 4,610 5,245
2880 Scott Boulevard Santa Clara G,I,J 14,501 25,501 14,501 25,501
2890 Scott Boulevard Santa Clara G,I,J 3,081 10,844 3,081 10,844
2770-2800 Scott Boulevard Santa Clara G,I 7,138 7,075 2 7,138 7,077
2300 Central Expressway Santa Clara G,I,J 2,390 14,418 2,390 14,418
2220 Central Expressway Santa Clara G,I,J 3,304 4,301 162 3,304 4,463
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 M 2,044 7,755 2,044 7,755
20400 Mariani Avenue Cupertino I 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 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 61 434 2,173
10460 Bubb Road Cupertino 154 994 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 $ 1,323 5/00 L
10401-10411 Bubb Road Cupertino A 3,711 502 7/98 L
45365 Northport Loop Fremont 8,169 613 10/00 L
45700 Northport Loop Fremont B 6,951 938 7/98 L
45738 Northport Loop Fremont B 5,234 708 7/98 L
4050 Starboard Drive Fremont B 7,804 1,054 7/98 L
3501 W. Warren Ave/Fremont Fremont 12,001 1,490 7/98 L
Blvd
48800 Milmont Blvd Fremont 5,945 803 7/98 L
4750 Patrick Henry Drive Santa Clara 9,562 1,375 7/98 L
3520 Bassett Street Santa Clara C 6,475 873 7/98 L
3530 Bassett Street Santa Clara C,D 4,982 673 7/98 L
5850-5870 Hellyer Avenue San Jose 9,289 1,005 11/98 L
5750 Hellyer Avenue San Jose 6,620 286 8/01 L
800 Embedded Way San Jose 17,658 1,488 3/00 L
5500 Hellyer Avenue San Jose 17,258 1,223 2/01 L
5550 Hellyer Avenue San Jose 6,739 321 6/01 L
5400 Hellyer Avenue San Jose 8,460 652 7/00 L
5325 Hellyer Avenue San Jose 14,955 1,053 1/01 L
5345 Hellyer Avenue San Jose 10,688 562 1/02 L
5905-5965 Silver Creek San Jose 25,754 1,515 7/01 L
Valley Road
5905-5965 Silver Creek San Jose 6,165 222 10/01 L
Valley Road
855 Embedded Way San Jose 9,878 632 5/01 L
1065-1105 La Avenida Street Mountain View 156,172 15,715 4/99 L
1750 Automation Parkway San Jose H 16,278 1,580 7/99 L
1756 Automation Parkway San Jose H 14,609 1,286 1/00 L
1762 Automation Parkway San Jose H 17,048 1,462 4/00 L
1768 Automation Parkway San Jose 27,330 1,960 12/00 L
255 Caspian Drive Sunnyvale 12,210 1,035 4/00 L
245 Caspian Drive Sunnyvale 5,894 - 4/01 L
5970 Optical Court San Jose 11,153 210 12/03 L
5900 Optical Court San Jose 16,394 818 7/02 L
2630 Orchard Parkway San Jose 8,816 416 3/02 L
2610 Orchard Parkway San Jose K 7,846 371 3/02 L
55 West Trimble Road San Jose K 13,304 629 3/02 L
2001 Walsh Avenue Santa Clara G,I,J 9,855 654 4/03 L
2880 Scott Boulevard Santa Clara G,I,J 40,002 1,979 4/03 L
2890 Scott Boulevard Santa Clara G,I,J 13,925 687 4/03 L
2770-2800 Scott Boulevard Santa Clara G,I 14,215 310 4/03 L
2300 Central Expressway Santa Clara G,I,J 16,808 3,623 4/03 L
2220 Central Expressway Santa Clara G,I,J 7,767 892 4/03 L
2330 Central Expressway Santa Clara G,I 7,605 172 4/03 L
2251 Lawson Lane Santa Clara H 11,450 1,545 7/98 L
1230 East Arques Sunnyvale B 3,207 453 7/98 L
1250 East Arques Sunnyvale B 7,834 1,057 7/98 L
3120 Scott Blvd Santa Clara M 9,799 1,578 7/98 L
20400 Mariani Avenue Cupertino I 9,795 1,323 7/98 L
10500 De Anza Blvd Cupertino B 44,970 6,066 7/98 L
20605-20705 Valley Green Dr.Cupertino H 20,474 2,764 7/98 L
10300 Bubb Road Cupertino B 3,725 503 7/98 L
10440 Bubb Road Cupertino 2,607 353 7/98 L
10460 Bubb Road Cupertino 6,993 944 7/98 L
1135 Kern Avenue Sunnyvale B 2,389 325 7/98 L
405 Tasman Drive Sunnyvale 3,316 452 7/98 L
450 National Avenue Mountain View B 3,584 484 7/98 L
3301 Olcott Street Santa Clara 10,830 1,463 7/98 L
2800 Bayview Avenue Fremont 6,335 858 7/98 L
6850 Santa Teresa Blvd San Jose 3,033 544 7/98 L
6810 Santa Teresa Blvd San Jose 8,570 876 3/99 L
140-160 Great Oaks Blvd San Jose 8,979 1,255 7/98 L
- 80 -
Initial Cost Total Cost
---------------------------- Cost ------------------------
Buildings Subsequent to Buildings
December 31, 2004 and Construction/ and
Property Name City Encumbrances Land Improvements Acquisition Land Improvements
---------------------------------------- --------------- -------------- ------------- ------------- ---------- -------------
6541 Via del Oro/6385 San San Jose H 1,039 5,057 1,039 5,057
Ignacio
6311-6351 San Ignacio Ave. San Jose B 6,246 30,396 170 6,246 30,566
6320-6360 San Ignacio Ave. 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 St
2033-2243 Samaritan Drive San Jose F 9,560 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 1,363 13,994 67,576
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 Ins. Co. of America Loan B 119,441
Northwestern Mutual Life Ins. Co. H 94,517
Citicorp USA, Inc. I 78,710
--------------- -------------- ------------- ------------- ---------- -------------
$312,802 $275,707 $787,352 $9,444 $275,707 $796,796
=============== ============== ============= ============= ========== =============
Accumulated
Depreciation Date of Depreciable
Property Name City Total & Amortization Acquisition Life
---------------------------------------- ------------ -------------- ----------- -----------
6541 Via del Oro/6385 San San Jose H 6,096 823 7/98 L
Ignacio
6311-6351 San Ignacio Ave. San Jose B 36,812 5,025 7/98 L
6320-6360 San Ignacio Ave. San Jose H 15,787 2,149 7/98 L
75 E. Trimble Road/2610 N. San Jose 20,481 2,804 7/98 L
First St
2033-2243 Samaritan Drive San Jose F 29,756 3,923 7/98 L
1170 Morse Avenue Sunnyvale B 3,859 522 7/98 L
3236 Scott Blvd Santa Clara B 7,239 978 7/98 L
1212 Bordeaux Lane Sunnyvale B 13,198 1,782 7/98 L
1325-1810 McCandless Drive Milpitas F,H 81,570 11,059 7/98 L
1600 Memorex Drive Santa Clara B 7,172 946 7/98 L
1688 Richard Avenue Santa Clara B 4,167 476 9/98 L
1700 Richard Avenue Santa Clara B 5,757 549 8/99 L
3506-3510 Bassett Street Santa Clara C 5,650 790 7/98 L
3540-3544 Bassett Street Santa Clara B,C 9,369 1,275 7/98 L
3550 Bassett Street Santa Clara B,C 6,363 876 7/98 L
3560 Bassett Street Santa Clara B,C 6,316 857 7/98 L
3570-3580 Bassett Street Santa Clara B,C 6,308 853 7/98 L
Prudential Ins. Co. of America Loan B
Northwestern Mutual Life Ins. Co. H
Citicorp USA, Inc. I
------------ -----------
$1,072,503 $111,640
============ ===========
(A) 16.67% of this property's ownership is held by unaffiliated parties outside
the operating partnerships of the Company.
(B) Encumbered by the $119,441 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 $9,560 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 $94,517 Northwestern Mutual Life Insurance Company loan -
full amount of loan shown at the bottom of the schedule.
(I) Encumbered by the $78,710 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.
(M) This property was designated as asset held for sale at December 31, 2004.
Upon the classification of real estate asset as held for sale, the carrying
value of the asset is reduced to the lower of its net book value or its
fair value, less selling costs. Accordingly, the carrying value of 3120
Scott Blvd. reflects a write-down of $2,193. In January 2005, this property
was sold for a total sale price of $8,500.
- 81 -
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 633 3,078 633 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 2,615 5,738 2,615 5,738
55 West Trimble Road San Jose K 4,435 9,730 4,435 9,730
2001 Walsh Avenue Santa Clara G,I,J 4,610 5,245 4,610 5,245
2880 Scott Boulevard Santa Clara G,I,J 14,501 25,500 14,501 25,500
2890 Scott Boulevard Santa Clara G,I,J 3,081 10,843 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,J 2,390 14,419 2,390 14,419
2220 Central Expressway Santa Clara G,I,J 3,304 4,301 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 Dr.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 3,711 425 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 8,353 596 3/02 L
55 West Trimble Road San Jose K 14,165 1,009 3/02 L
2001 Walsh Avenue Santa Clara G,I,J 9,855 237 4/03 L
2880 Scott Boulevard Santa Clara G,I,J 40,001 761 4/03 L
2890 Scott Boulevard Santa Clara G,I,J 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,J 16,809 1,534 4/03 L
2220 Central Expressway Santa Clara G,I,J 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 Dr.Cupertino H 20,474 2,339 7/98 L
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
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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 Ins. Co. of America Loan B 121,455
Northwestern Mutual Life Ins. Co. H 97,445
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 L
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 Ins. Co. of America Loan B
Northwestern Mutual Life Ins. Co. H
Citicorp USA, Inc. I
------------ --------------
$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.
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MISSION WEST PROPERTIES, INC.
NOTE TO SCHEDULE III
December 31, 2004 and 2003
(dollars in thousands)
1. Reconciliation of real estate and accumulated depreciation and
amortization:
2004 2003
------------------------ ----------------------
Real estate investments:
Balance at beginning of year $1,074,994 $ 953,175
Additions 1,421 121,819
Reclassification (1,719) -
Impairment charge (2,193) -
------------------------ ----------------------
Balance at end of year $1,072,503 $1,074,994
======================== ======================
Accumulated depreciation and amortization:
Balance at beginning of year $ 89,243 $67,053
Additions 23,765 22,190
Reclassification (1,368) -
------------------------ ----------------------
Balance at end of year $111,640 $89,243
======================== ======================
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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. REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
(a) Disclosure 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.
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.
(b) Changes in Internal Control over Financial Reporting
In October 2004, the Audit Committee of our Board of Directors hired a
third party contractor to assist management in evaluating internal control
over financial reporting using the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) on Internal
Control - Integrated Framework. Under COSO an internal control significant
deficiency is a control deficiency, or combination of control deficiencies,
that adversely affects the company's ability to initiate, authorize,
record, process, or report external financial data reliability in
accordance with generally accepted accounting principles such that there is
more than a remote likelihood that a misstatement of the company's annual
or interim financial statements that is more than inconsequential will not
be prevented or detected. An internal control material weakness is a
significant deficiency, or combination of significant deficiencies, that
results in more than a remote likelihood that a material misstatement of
the annual or interim financial states will not be prevented or detected.
The third party contractor identified certain deficiencies that constituted
significant deficiencies but not material weaknesses. We remediated these
deficiencies by updating and revising certain written policies and
procedures; implementing additional policies and procedures to segregate
duties among our employees for our various accounting cycles; implementing
additional policies and procedures concerning access to and use of our
information technology network; creating checklists to provide a record of
the preparation and review by different members of management for accuracy,
consistency and completeness in our leasing activities and financial
closing procedures; and establishing new dual signature requirements for
disbursements.
Other than the foregoing initiatives, there were no significant changes in
our internal control or, to our knowledge, in other factors that could
significantly affect such internal controls subsequent to the date of their
evaluation. We have determined that our internal control over financial
reporting was effective as of December 31, 2004. Please refer to,
"Management Report on Internal Control over Financial Reporting," above.
Our registered independent public accounting firm has attested to this
report, as set forth in Item 8, above.
ITEM 9B. OTHER INFORMATION
In December 2004, we terminated our lease agreement as amended dated as of
July 25, 1998 with Microsoft Corporation and entered into a new lease for
our R&D properties located at 1045, 1055, 1065, 1075 and 1085 La Avenida
Street in Mountain View, California. Under the new lease Microsoft will
continue to occupy four buildings, which consist of approximately 422,012
rentable square feet, and will vacate the 1075 La Avenida building, which
consists of approximately 93,688 square feet, on or before January 2006.
The new lease term is 116 months commencing January 1, 2005. The new lease
provides for "triple net" rent, which we will accrue on a straight-line
basis of $2.19 per square foot per month. At any time during the term of
the new lease Microsoft has a right of first offer to lease any available
building in the project. The new lease further provides that on December 1,
2008, Microsoft has the right to give notice to vacate either 1055 or 1085
La Avenida effective
- 85 -
September 1, 2009, and if it exercises this contraction right it must pay
us a fee of approximately $400,000. In addition, on December 1, 2010,
Microsoft will have the right to give notice of termination of the lease
effective September 1, 2011, and if it exercises this right, it must pay us
a termination fee of approximately $7.5 million. The termination fee would
be adjusted, however, to take into account the greater or lower rental cost
at the effective date of termination if Microsoft had exercised its earlier
right to add or vacate one additional building. We did not incur any tenant
improvement costs in connection with this new lease, but did incur a
leasing commission of approximately $2.9 million, which we will amortize
over the term of the new lease.
- 86 -
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 is incorporated by reference from the
sections titled "Directors and Executive Officers" and "Section 16(a)
Beneficial Ownership Reporting Compliance" in the Company's definitive
proxy statement for its annual stockholders' meeting.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated by reference from the
section titled "Executive Compensation" in the Company's definitive proxy
statement for its annual stockholders' meeting, excluding, however, the
sections titled "Executive Compensation - Performance Graph" and "Executive
Compensation - Report on Executive Compensation by the Compensation
Committee of the Board of Directors," none of which are incorporated by
reference in response to this item.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information required by Item 12 is incorporated by reference from the
sections titled "Share Ownership" and "Securities Authorized for Issuance
Under Equity Compensation Plans" in the Company's definitive proxy
statement for its annual stockholders' meeting.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated by reference from the
sections titled "Certain Relationships and Related Transactions" in the
Company's definitive proxy statement for its annual stockholders' meeting.
ITEM 14. ACCOUNTANT FEES AND SERVICES
The information required by Item 14 is incorporated by reference from the
sections titled "Principal Accountant Fees and Services" in the Company's
definitive proxy statement for its annual stockholders' meeting.
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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.(1)
3.2.2 Restated Bylaws of Mission West Properties, Inc.(1)
10.1.1 Amended and Restated Agreement of Limited Partnership of Mission West Properties, L.P.(2a)
10.1.2 Amended and Restated Agreement of Limited Partnership of Mission West Properties, L.P. I(2a)
10.1.3 Amended and Restated Agreement of Limited Partnership of Mission West Properties, L.P. II(2a)
10.1.4 Amended and Restated Agreement of Limited Partnership of Mission West Properties, L.P. III(2a)
10.2 Exchange Rights Agreement between Mission West Properties and the Limited Partners(2a)
10.3.1 1997 Stock Option Plan(3)
10.3.2 Form of Incentive Stock Option Agreement(1)
10.3.3 Form of Non-statutory Stock Option Agreement(1)
10.3.4 Form of Directors Stock Option Agreement(1)
10.4.1 Acquisition Agreement, dated as of May 14, 1998, among Mission West Properties, certain partnerships
and the Berg Group (as defined therein)(1)
10.4.2 Amendment of Acquisition Agreement, dated as of July 1, 1998(1)
10.4.3 Form of Partnership Interest Purchase Demand Note (1)
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(1)
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(1)
10.5.3 Form of Registration Rights Agreement for purchasers, who acquired shares of Common Stock under the May 4, 1998 Stock
Purchase Agreements (2b)
10.6 Pending Projects Acquisition Agreement among Mission West Properties, the Operating Partnership and the Berg Group(2a)
10.7 Berg Land Holdings Option Agreement between Mission West Properties and certain members of the Berg Group(2a)
10.8 Berg & Berg Enterprises, Inc. Sublease Agreement(1)
10.9 Not in use
10.10 Not in use
10.11 Not in use
10.12 Lease Agreement with Apple Computer, Inc.(4a)
10.13 Lease Agreement with Cisco Systems, Inc,(4b)
10.14 Lease Agreement with Amdahl Corporation(4c)
10.15 Prudential Promissory Note(5)
10.16 Prudential Deed of Trust(5)
10.17 Prudential Certificate Regarding Distribution(5)
10.18 Prudential Guaranty(5)
10.19 Waiver Agreement(6)
10.20 Ownership Limit Exemption Agreement dated December 29, 1998 between Mission West Properties and Dan and Paul McCarthy(7)
10.21 Lease Agreement with Microsoft Corporation, dated July 25, 1998(8)
10.21.1 Lease Agreement with Microsoft Corporation, dated December 23, 2004
10.22 Contribution Agreement(8)
10.23 Assumption Agreement for Wells Fargo Line of Credit(9)
10.24 Not in use
10.25 Not in use
10.26 Supplemental Agreement among Mission West Properties, Inc., Carl E. Berg and Clyde J. Berg(9)
10.27 Berg Group Revolving Credit - $100,000,000 Secured Promissory Note(10)
10.27.1 Third Amendment to Berg Group $100,000,000 Revolving Line of Credit(11)
10.28 Berg Group Deed of Trust Securing Revolving Promissory Note(12)
- 88 -
10.29 Cupertino National Bank Revolving Credit Loan Agreement(13)
10.29.1 Cupertino National Bank Revolving Credit Loan Agreement Change in Terms Agreement(14)
10.30 Mission West Properties, LP Continuing Guaranty(13)
10.31 Mission West Properties, LP II Continuing Guaranty(13)
10.32 Mission West Properties, L.P. Promissory Note to Northwestern Mutual Life Insurance Company(13)
10.33 Mission West Properties, L.P. I Promissory Note to Northwestern Mutual Life Insurance Company(13)
10.34 Mission West Properties, L.P. II Promissory Note to Northwestern Mutual Life Insurance Company(13)
10.35 Mission West Properties, L.P. Deed of Trust and Security Agreement (First Priority) (13)
10.36 Mission West Properties, L.P. Deed of Trust and Security Agreement (Second Priority) (13)
10.37 Mission West Properties, L.P. I Deed of Trust and Security Agreement (First Priority) (13)
10.38 Mission West Properties, L.P. I Deed of Trust and Security Agreement (Second Priority) (13)
10.39 Mission West Properties, L.P. II Deed of Trust and Security Agreement (First Priority) (13)
10.40 Mission West Properties, L.P. II Deed of Trust and Security Agreement (Second Priority) (13)
10.41 Mission West Properties, L.P. Absolute Assignment of Leases and Rents (First Priority) (13)
10.42 Mission West Properties, L.P. I Absolute Assignment of Leases and Rents (First Priority) (13)
10.43 Mission West Properties, L.P. II Absolute Assignment of Leases and Rents (First Priority) (13)
10.44 Not in use
10.45 Citicorp USA, Inc.$80,000,000 Secured Promissory Note (15)
10.45.1 Citicorp USA, Inc.$80,000,000 First Amendment to Promissory Note (11)
10.45.2 Citicorp USA, Inc.$80,000,000 Second Amendment to Promissory Note (16a)
10.45.3 Citicorp USA, Inc.$80,000,000 Third Amendment to Promissory Note (16b)
10.45.4 Citicorp USA, Inc.$80,000,000 Fourth Amendment to Promissory Note (14)
10.46 2004 Equity Incentive Plan(17)
21.1 Subsidiaries of the Registrant (18)
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 Operating Officer pursuant to Rule 13a-14
31.3 Certificate of Principal Financial Officer pursuant to Rule 13a-14
99.1 Section 1350 Certificate
(1) Incorporated herein by reference to the same-numbered exhibit to the
Company's Registration Statement on Form S-4/A filed on July 20, 1998 and
declared effective on November 23, 1998.
(2a) 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).
(2b) Incorporated herein by reference to Exhibit 10.8 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).
(3) Incorporated herein by reference to Exhibit E to the Company's Schedule 14A
Proxy Statement filed with the Securities and Exchange Commission on
October 21, 1997.
(4a) Incorporated herein by reference to Exhibit 10.15 to the Company's
Registration Statement on Form S-4/A filed on June 17, 1998 and declared
effective on November 23, 1998.
(4b) Incorporated herein by reference to Exhibit 10.16 to the Company's
Registration Statement on Form S-4/A filed on June 17, 1998 and declared
effective on November 23, 1998.
(4c) Incorporated herein by reference to Exhibit 10.17 to the Company's
Registration Statement on Form S-4/A filed on June 17, 1998 and declared
effective on November 23, 1998.
(5) Incorporated herein by reference to the same-numbered exhibit to the
Company's Registration Statement on Form S-4/A filed on October 27, 1998
and declared effective on November 23, 1998.
(6) Incorporated herein by reference to the same-numbered exhibit to the
Registration Statement on Form S-4/A filed on November 16, 1998 and
declared effective on November 23, 1998.
- 89 -
(7) Incorporated herein by reference to the same numbered exhibit to the annual
report on Form 10-K for 1998 filed on March 31, 1999.
(8) 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).
(9) Incorporated herein by reference to the same-numbered exhibit to the
Registration Statement on Form S-11/A filed on June 15, 1999 (Commission
File No. 333-80203).
(10) Incorporated herein by reference to the same-numbered exhibit to the
quarterly report on Form 10-Q filed on November 13, 2001.
(11) Incorporated herein by reference to the same-numbered exhibit to the
quarterly report on Form 10-Q filed on August 12, 2003.
(12) Incorporated herein by reference to the same numbered exhibit to the annual
report on Form 10-K for 1999 filed on March 30, 2000.
(13) Incorporated herein by reference to the same-numbered exhibit to the annual
report on Form 10-K for 2002 filed on March 27, 2003.
(14) Incorporated herein by reference to the same-numbered exhibit to the
quarterly report on Form 10-Q filed on November 2, 2004.
(15) Incorporated herein by reference to the same-numbered exhibit to the
quarterly report on Form 10-Q filed on May 15, 2003.
(16a)Incorporated herein by reference to Exhibit 10.45.1 to the annual report
on Form 10-K for 2003 filed on July 30, 2004.
(16b)Incorporated herein by reference to Exhibit 10.45.2 to the annual report
on Form 10-K for 2003 filed on July 30, 2004.
(17) Incorporated herein by reference to Appendix II to the Company's Schedule
14A Proxy Statement filed with the Securities and Exchange Commission on
October 22, 2004.
(18) Incorporated herein by reference to the same-numbered exhibit to the annual
report on Form 10-K for 1998 filed on March 31, 1999.
(b) Reports on Form 8-K.
The Company filed a Current Report on Form 8-K on October 14, 2004,
regarding its results of operations and financial condition for the third
quarter of 2004.
- 90 -
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: November 4, 2005 By: /s/ CARL E. BERG
----------------------
Carl E. Berg
Chief Executive Officer
Date: November 4, 2005 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 November 4, 2005
Executive Officer, and Director
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