UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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Form 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006
COMMISSION FILE NUMBER 1-8383
Mission West Properties, Inc.
(Exact name of registrant as specified in its charter)
Maryland 95-2635431
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(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
10050 Bandley Drive
Cupertino, California 95014-2188
(Address of principal executive offices)
Registrant's telephone number, including area code is (408) 725-0700
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Exchange Act Rule 12b-2). Yes [ ] No [X]
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's
classes of common stock as of the latest practicable date:
18,511,291 shares outstanding as of April 30, 2006
MISSION WEST PROPERTIES, INC.
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2006
INDEX
PAGE
PART I FINANCIAL INFORMATION ----
Item 1. Financial Statements:
Consolidated Balance Sheets as of March 31, 2006 (unaudited)
and December 31, 2005 ..................................................................................2
Consolidated Statements of Operations for the
three months ended March 31, 2006 and 2005 (unaudited)..................................................3
Consolidated Statements of Cash Flows for the
three months ended March 31, 2006 and 2005 (unaudited)..................................................4
Notes to Consolidated Financial Statements (unaudited)..................................................5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................................................................12
Item 3. Quantitative and Qualitative Disclosures about Market Risk.............................................23
Item 4. Controls and Procedures................................................................................24
PART II OTHER INFORMATION
Item 1. Legal Proceedings......................................................................................25
Item 1A. Risk Factors...........................................................................................25
Item 6. Exhibits...............................................................................................25
SIGNATURES........................................................................................................26
EXHIBITS
Exhibit 31.1 - Certification Pursuant to Rule 13a-14(a) of the Securities
Exchange Act of 1934
Exhibit 31.2 - Certification Pursuant to Rule 13a-14(a) of the Securities
Exchange Act of 1934
Exhibit 31.3 - Certification Pursuant to Rule 13a-14(a) of the Securities
Exchange Act of 1934
Exhibit 32 - Certification of CEO and CFO Pursuant to 18 U.S.C. ss. 1350,
as Adopted Pursuant to ss. 906 of the Sarbanes-Oxley Act of
2002
- 1 -
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
MISSION WEST PROPERTIES, INC.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share and per share amounts)
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March 31, 2006 December 31, 2005
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ASSETS (unaudited) (audited)
Real estate assets, at cost:
Land $ 277,269 $ 273,933
Buildings and improvements 775,237 766,457
Real estate related intangible assets 18,784 17,410
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Total investments in properties 1,071,290 1,057,800
Less accumulated depreciation and amortization (136,370) (130,419)
--------------------- ----------------------
Net investments in properties 934,920 927,381
Cash and cash equivalents 39,937 31,441
Restricted cash 12,698 16,712
Deferred rent receivable, net 18,540 19,218
Investment in unconsolidated joint venture 3,340 3,263
Other assets, net 28,212 25,362
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Total assets $1,037,647 $1,023,377
===================== ======================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Mortgage notes payable $ 355,009 $ 357,481
Mortgage notes payable (related parties) 9,955 10,051
Interest payable 321 321
Security deposits 6,608 8,047
Deferred rental income 10,585 6,103
Dividends and distributions payable 16,729 16,725
Accounts payable and accrued expenses 10,939 8,952
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Total liabilities 410,146 407,680
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Commitments and contingencies (Note 10)
Minority interests 509,522 500,682
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Stockholders' equity:
Preferred stock, $.001 par value, 20,000,000 shares authorized,
none issued and outstanding - -
Common stock, $.001 par value, 200,000,000 shares authorized,
18,511,291 and 18,448,791 shares issued and outstanding
at March 31, 2006 and December 31, 2005 18 18
Paid-in-capital 138,811 138,038
Accumulated deficit (20,850) (23,041)
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Total stockholders' equity 117,979 115,015
--------------------- ----------------------
Total liabilities and stockholders' equity $1,037,647 $1,023,377
===================== ======================
The accompanying notes are an integral part of these
consolidated financial statements.
- 2 -
MISSION WEST PROPERTIES, INC
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except share and per share amounts)
(unaudited)
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Three months ended March 31,
2006 2005
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Revenues:
Rental revenue from real estate $24,316 $26,247
Tenant reimbursements 3,309 3,628
Lease termination fees 16,056 -
Other income, including interest 732 303
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Total revenues 44,413 30,178
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Expenses:
Property operating, maintenance and real estate taxes 4,681 4,889
Interest 5,215 4,647
Interest (related parties) 192 307
General and administrative 635 675
Depreciation and amortization of real estate 5,479 5,574
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Total expenses 16,202 16,092
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Income before equity in earnings of unconsolidated
joint venture and minority interests 28,211 14,086
Equity in earnings/(loss) of unconsolidated joint venture 331 (6)
Minority interests (23,390) (11,677)
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Income from continuing operations 5,152 2,403
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Discontinued operations, net minority interests:
Gain from disposal of discontinued operations - 14
Loss attributable to discontinued operations - (9)
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Income from discontinued operations - 5
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Net income available to common stockholders $ 5,152 $ 2,408
================== ===================
Net income available to minority interests $23,390 $11,695
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Income per common share from continuing operations:
Basic $0.28 $0.13
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Diluted $0.28 $0.13
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Income per common share from discontinued operations:
Basic - -
================== ===================
Diluted - -
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Net income per common share:
Basic $0.28 $0.13
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Diluted $0.28 $0.13
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Weighted average shares of
common stock outstanding (basic) 18,455,897 18,110,524
================== ===================
Weighted average shares of
common stock outstanding (diluted) 18,520,297 18,136,797
================== ===================
The accompanying notes are an integral part of these
consolidated financial statements.
- 3 -
MISSION WEST PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(unaudited)
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Three months ended March 31,
2006 2005
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Cash flows from operating activities:
Income from continuing operations $ 5,152 $ 2,403
Income from discontinued operations - 5
Adjustments to reconcile income from continuing operations to net cash provided by
operating activities:
Minority interest income from continuing operations 23,390 11,677
Minority interest income from discontinued operations - 18
Minority interest distributions (13,967) (11,695)
Depreciation and amortization of real estate and in-place leases 5,479 5,573
Depreciation and amortization from discontinued operations - 33
Amortization of above market lease 472 472
Gain on sale of real estate - (63)
Equity in (earnings)/loss of unconsolidated joint venture (331) 6
Distributions from unconsolidated joint venture 255 255
Interest earned on restricted cash (121) -
Lease termination fee income related to restricted cash (11,147) -
Stock-based compensation expense 59 -
Other 7 -
Changes in operating assets and liabilities:
Deferred rent receivable 678 (615)
Other assets (2,823) (4,477)
Security deposits (1,439) (443)
Deferred rental income 4,482 1,622
Accounts payable and accrued expenses 1,987 2,966
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Net cash provided by operating activities 12,133 7,737
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Cash flows from investing activities:
Improvements to real estate assets (79) (285)
Proceeds from sale of real estate - 8,387
Purchase of real estate (13,447) (14,184)
Restricted cash used for purchase of real estate 13,447 -
Excess restricted cash 1,835 -
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Net cash provided by/(used in) investing activities 1,756 (6,082)
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Cash flows from financing activities:
Principal payments on mortgage notes payable (2,472) (1,967)
Principal payments on mortgage notes payable (related parties) (96) (90)
Net payments under line of credit (related parties) - (1,651)
Proceeds from revolving line of credit - 8,296
Proceeds from exercised stock options 125 -
Distributions paid to minority interests in excess of earnings - (2,306)
Dividends paid (2,950) (2,895)
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Net cash used in financing activities (5,393) (613)
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Net increase in cash and cash equivalents 8,496 1,042
Cash and cash equivalents, beginning of period 31,441 1,519
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Cash and cash equivalents, end of period $ 39,937 $ 2,561
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Supplemental information:
Cash paid for interest $ 5,338 $ 4,864
=================== ==================
Supplemental schedule of non-cash investing and financing activities:
Issuance of common stock upon conversion of O.P. units $ 589 $ 535
=================== ==================
The accompanying notes are an integral part of these
consolidated financial statements.
- 4 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share, per share, O.P. units and
per square footage amounts)
(unaudited)
1. ORGANIZATION 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.
On December 30, 1998, the Company was reincorporated under the laws of the
State of Maryland through a merger with and into Mission West Properties,
Inc. Accordingly, shares of the former company, Mission West Properties, a
California corporation (no par), which were outstanding at December 30,
1998, were converted into shares of common stock ($.001 par value per
share) on a one-for-one basis.
As of March 31, 2006, the Company owns a controlling general partnership
interest of 17.83%, 21.68%, 16.18% and 12.42% 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, which represents a 17.66%
general partnership interest in the operating partnerships, taken as a
whole, on a consolidated weighted average basis.
Through the operating partnerships, the Company owns interests in 109 R&D
properties, all of which are located in Silicon Valley.
The Company has elected to be taxed as a real estate investment trust
("REIT") under the Internal Revenue Code of 1986, as amended. Accordingly,
no provision has been made for income taxes for the three months ended
March 31, 2006.
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, "Disclosures about
Segments of an Enterprise and Related Information," purposes.
2. BASIS OF PRESENTATION
PRINCIPLES OF CONSOLIDATION AND FINANCIAL STATEMENT PRESENTATION
The accompanying unaudited interim consolidated financial statements of the
Company have been prepared in accordance with Rule 10-01 of Regulation S-X
promulgated by the Securities and Exchange Commission and, therefore, do
not include all information and footnotes necessary for a fair presentation
of financial position, results of operations and cash flows in conformity
with accounting principles generally accepted in the United States of
America. In the opinion of the Company, however, the accompanying unaudited
interim consolidated financial statements contain all adjustments,
consisting only of normal recurring adjustments, necessary to present
fairly the Company's consolidated financial position as of March 31, 2006,
and its consolidated results of operations for the three months ended March
31, 2006 and 2005, and its cash flows for the three months ended March 31,
2006 and 2005. All significant intercompany balances have been eliminated
in consolidation. The consolidated financial statements as of March 31,
2006 and for the three months ended March 31, 2006 and 2005 and related
footnote disclosures are unaudited. The results of operations for the three
months ended March 31, 2006 are not necessarily indicative of the results
to be expected for the entire year.
The Company also consolidates all variable interest entities ("VIE") in
which it is deemed to be the primary beneficiary in accordance with FASB
Interpretation No. 46R ("FIN 46R"). As of March 31, 2006, the Company
consolidated one VIE in the accompanying consolidated balance sheets in
connection with an assignment of lease agreement with an unrelated party,
M&M Real Estate Control & Restructuring, LLC (see Note 5 for further
discussion of this transaction). Under the terms of the agreement, the
Company, who is the primary beneficiary of that entity, will receive
monthly rent payments of approximately $733 from April 2006 through
December 2006, $545 from January 2007 through August 2007 and $330 from
September 2007 through November 2007.
- 5 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(dollars in thousands, except share, per share, O.P. units
and per square footage amounts)
(unaudited)
STOCK-BASED OPTION COMPENSATION ACCOUNTING
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 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. At March 31, 2006, the Company had one
stock-based option compensation plan. The Company has adopted the
requirements of SFAS No. 123R effective January 1, 2006 using the modified
prospective method of transition. Accordingly, prior periods have not been
restated. The adoption of this standard did not have a material effect on
the Company's consolidated statements of operations or financial position.
The Company measures compensation cost for its stock options at fair value
on the date of grant and recognizes compensation expense ratably over the
vesting period, generally four years. The fair value of the Company's stock
options is determined using the Black-Scholes option pricing model.
Compensation expense related to the Company's share-based awards is
included in general and administrative expense within the Company's
consolidated statements of operations.
MINORITY INTERESTS
Minority interest represents the separate private ownership of the
operating partnerships by the Berg Group (defined as Carl E. Berg, his
brother Clyde J. Berg, members of their respective immediate families, and
certain entities they control) and other non-affiliate interests. In total,
these interests account for approximately 82.34% of the ownership interests
in the real estate operations of the Company as of March 31, 2006. Minority
interest in net income is calculated by taking the net income of the
operating partnerships (on a stand-alone basis) multiplied by the
respective minority interest ownership percentage.
Allocation of corporate general and administrative expenses to the
operating partnerships is performed based upon shares and operating
partnership units outstanding for each operating partnership in relation to
the total for all four operating partnerships.
RECLASSIFICATIONS
Certain reclassifications have been made to the previously reported 2005
consolidated financial statements in order to conform to the 2006
presentation.
The following notes, which present interim disclosures as required by the
SEC, highlight significant changes to the notes to the Company's December
31, 2005 audited consolidated financial statements and should be read
together with the consolidated financial statements and notes thereto
included in the Company's 2005 Form 10-K filed on March 16, 2006.
3. REAL ESTATE
On March 9, 2006, the Company acquired a fully leased office/R&D property
with approximately 95,700 rentable square feet located at 233 South
Hillview Drive in Milpitas, California from Sipex Corporation in a
tax-deferred exchange under section 1031 of the Internal Revenue Code of
1986. The total acquisition price for this property was approximately
$13,450 and was funded from the proceeds received from the 800 Embedded Way
property sale, which were held by a third party and classified as
restricted cash as of December 31, 2005.
The purchase price of the 233 South Hillview Drive acquisition was
allocated to long-lived assets and the value of an in-place lease. The
in-place lease was valued at fair market so there was no intangible asset
allocated to above-or-below market lease value. The Company recorded $1,374
of the purchase price as real estate related intangible assets in the
accompanying consolidated balance sheets for the value of an in-place
lease. The intangible assets will be amortized over the applicable
remaining lease terms. Amortization expense of $18 was recorded for the
three months ended March 31, 2006.
The purchase price allocation for this acquisition was determined in
accordance with the following principles under SFAS No. 141:
The fair value of the tangible assets of an acquired property, which
includes land, building and tenant improvements, is determined by valuing
the property as if it were vacant, and the "as-if-vacant" value is then
allocated to land, building and tenant improvements based on management's
determination of the relative fair values of these assets. Factors
considered by management in performing these analyses include certain costs
during the lease-up periods considering current market conditions and costs
to execute similar leases. These costs include estimates of lost rental
revenue, leasing commissions and tenant improvements.
The capitalized in-place lease value, included in real estate related
intangible assets in the accompanying consolidated balance sheets, is
amortized to expense as amortization of real estate over the remaining
non-cancelable lease term. If a lease were to be
- 6 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(dollars in thousands, except share, per share, O.P. units
and per square footage amounts)
(unaudited)
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.
4. RESTRICTED CASH
Restricted cash totaled $12,698 as of March 31, 2006. Of this amount,
$11,147 represents a balance we consolidated due to the Company's adoption
of FIN 46R, "Consolidation of Variable Interest Entities." The Company does
not have possession or control over these funds or any right to receive
them except in accordance with the payment terms of the lease agreement
that has been assigned to the VIE. See Note 5 below for further discussion.
The remaining $1,551 represents a bond the Company posted in the Republic
Properties Corporation v. Mission West Properties, L.P. litigation (see
Note 10).
5. VARIABLE INTEREST ENTITY
In December 2003, the FASB issued FIN 46R, a revision to FIN 46, which was
issued in January 2003. Under FIN 46R, a variable interest entity must be
consolidated by a company if that company is subject to a majority of the
entity's expected losses or entitled to receive a majority of the entity's
expected residual returns or both. FIN 46R requires disclosures about
variable interest entities that a company is not required to consolidate,
but in which it has a significant variable interest.
In March 2006, one of the Company's tenants, JDS Uniphase ("JDS"), entered
into an assignment of lease agreement with an unrelated party, M&M Real
Estate Control & Restructuring, LLC ("M&M"), in connection with leases for
approximately 252,000 rentable square feet located in San Jose, California.
M&M assumed all of JDS's remaining obligations under these leases, acquired
certain personal property of JDS located on the premises and received a
payment of approximately $11,147. At the same time, the Company entered
into a consent for assignment of lease with both parties and a mutual
release agreement with JDS, pursuant to which all of the JDS's obligations
under these leases have been effectively transferred to M&M. M&M must
continue to perform all of the obligations under the assumed JDS leases and
has the right to sublease any or all of the 252,000 rentable square feet
vacated by JDS for the remainder of the current lease terms, which expire
in 2006 and 2007. Based upon the provisions of FIN 46R, the Company
determined that M&M is a variable interest entity. The Company further
determined that the Company is the primary beneficiary of this variable
interest entity and therefore consolidated this entity for financial
reporting purposes. Upon consolidation, the Company recognized a lease
termination fee of $11,147 in March 2006.
6. STOCK TRANSACTIONS
During the three months ended March 31, 2006, stock options to purchase
12,500 shares of common stock were exercised at $10.00 per share. Total
proceeds to the Company were $125. During the same period, one limited
partner exchanged 50,000 O.P. units for 50,000 shares of the Company's
common stock under the terms of the Exchange Rights Agreement among the
Company and all limited partners of the operating partnerships resulting in
a reclassification of $589 from minority interest to paid-in-capital.
Neither the Company nor the operating partnership received any proceeds
from the issuance of the common stock in exchange for O.P. units.
7. DISCONTINUED OPERATIONS
Effective January 1, 2002, the Company adopted SFAS No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets," which addresses
financial accounting and reporting for the impairment and disposal of long
lived assets. In general, income or loss attributable to the operations and
sale of property and the operations related to property held for sale is
classified as discontinued operations in the consolidated statements of
operations. All periods presented in this report will likely require
further reclassification in future periods if there are properties held for
sale or property sales occur.
As of March 31, 2006, there were no properties under contract to be sold or
otherwise disposed of which would qualify as assets held for sale or
discontinued operations. During the first quarter of 2005, the Company sold
two properties for a combined sales price of $12,750. Condensed results of
operations for these properties for the three months ended March 31, 2005
are as follows:
- 7 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(dollars in thousands, except share, per share, O.P. units
and per square footage amounts)
(unaudited)
Three Months Ended March 31,
2006 2005
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(dollars in thousands)
(unaudited)
Revenues
Rental revenue from real estate - $ 14
Tenant reimbursements - 1
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Total revenues - 15
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Expenses
Property operating, maintenance and real estate
taxes - 22
Depreciation - 33
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Total expenses - 55
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Loss from discontinued operations - (40)
Gain from disposal of discontinued operations - 63
Minority interest in earnings attributable to
discontinued operations - (18)
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Income from discontinued operations - $ 5
=========== ============
A deferred gain of approximately $1,408 was recorded on one of the disposed
properties in 2005. The gain was recognized as revenue based on the
installment method of profit recognition because the purchaser of the
property did not make a sufficiently large down payment under SFAS No. 66,
"Accounting for Sales of Real Estate" ("SFAS No. 66"). SFAS No. 66
establishes accounting standards for recognizing profit or loss on sales of
real estate. Gain on the sale is recognized proportionately as the seller
receives payments from the purchaser. Interest income is recognized on an
accrual basis, when appropriate. The Company recorded a $63 gain in the
first quarter of 2005, and the balance of the expected gain was deferred
until the Company received the remaining balance of the sales price from
the purchaser.
8. NET INCOME PER SHARE
Basic operating net income per share is computed by dividing net income by
the weighted average number of common shares outstanding for the period.
Diluted operating net income per share is computed by dividing net income
by the sum of the weighted-average number of common shares outstanding for
the period plus the assumed exercise of all dilutive securities using the
treasury stock method.
The computation for weighted average shares is detailed below:
Three Months Ended March 31,
2006 2005
--------------- --------------
Weighted average shares outstanding (basic) 18,455,897 18,110,524
Incremental shares from assumed option exercise 64,400 26,273
--------------- --------------
Weighted average shares outstanding (diluted) 18,520,297 18,136,797
=============== ==============
Outstanding options to purchase 647,000 shares in 2006 and 2005 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, which are exchangeable
at the unit holder's option, subject to certain conditions, for shares of
common stock on a one-for-one basis have been excluded from the diluted net
income per share calculation, as there would be no effect on the
calculation after adding the minority interests' share of income back to
net income. The total number of O.P. units outstanding at March 31, 2006
and 2005 was 86,038,095 and 86,334,695, respectively.
9. RELATED PARTY TRANSACTIONS
As of March 31, 2006, the Berg Group owned 77,490,528 O.P. units. The Berg
Group's combined ownership of O.P. units and shares of common stock as of
March 31, 2006 represented approximately 74% of the total equity interests,
assuming conversion of the 86,038,095 O.P. units outstanding into the
Company's common stock.
As of March 31, 2006, debt in the amount of $9,955 was due the Berg Group
under a mortgage note established on 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 June 2010 with principal payments amortized over 20 years.
Interest expense incurred in connection with the Berg Group line of credit,
which was terminated in October 2005, and mortgage note was $192 and $307
for the three months ended March 31, 2006 and 2005, respectively.
- 8 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(dollars in thousands, except share, per share, O.P. units
and per square footage amounts)
(unaudited)
During the first three months of 2006 and 2005, Carl E. Berg or entities
controlled by Mr. Berg held financial interests in several companies that
lease space from the operating partnerships, which include three companies
in which Mr. Berg has a greater than 10% ownership interest. These related
tenants occupy approximately 48,000 square feet and contributed $132 and
$217 in rental revenue during the three months ended March 31, 2006 and
2005, respectively. Under the Company's charter, bylaws and agreements with
the Berg Group, the individual members of the Berg Group are prohibited
from acquiring or holding 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.
In March 2006, the Company and Fujitsu Limited, or Fujitsu, agreed to the
termination of a lease for one building consisting of approximately 125,000
rentable square feet. Fujitsu is responsible for repairing damage to the
building and with the Company's Independent Directors Committee approval
has hired Berg & Berg Enterprises, LLC to perform the restoration work for
a total of approximately $4,500.
The Berg Group has an approximately $2,500 commitment to complete certain
tenant improvements in connection with the Company's 2002 acquisition of
5345 Hellyer Avenue in San Jose. The Company recorded this portion of the
purchase price 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 of
the Company's Board of Directors (the "Independent Directors Committee").
The Berg Group has an approximately $7,500 commitment to complete an
approximately 75,000 to 90,000 square foot building in connection with the
Company's 2001 acquisition of 245 Caspian in Sunnyvale which is comprised
of approximately three acres of unimproved land. The Company recorded this
portion of the purchase price 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.
The Company currently leases office space owned by Berg & Berg Enterprises,
Inc., an affiliate of Carl E. Berg and Clyde J. Berg. Rental amounts and
overhead reimbursements paid to Berg & Berg Enterprises, Inc. were $23 for
each of the three-month periods ended March 31, 2006 and 2005.
10. COMMITMENTS AND CONTINGENCIES
Neither the operating partnerships, the Company's properties nor the
Company are subject to any material litigation nor, to the Company's
knowledge, is any material litigation threatened against the operating
partnerships, the properties or the Company. From time to time, the Company
is engaged in legal proceedings arising in the ordinary course of business.
The Company does not expect any of such proceedings to have a material
adverse effect on its cash flows, financial condition or results of
operations. The Company is currently involved in the following legal
proceedings, and does not believe the ultimate outcome of any of these
proceedings will have a material adverse effect on its financial condition
or operating results.
Republic Properties Corporation ("RPC") v. Mission West Properties, L.P.
("MWP"), in the Circuit Court of Maryland for Baltimore City Case No.
24-C-00-005675. RPC is a former partner with Mission West Properties, L.P.
in the Hellyer Avenue Limited Partnership ("Hellyer LP"). In April 2004,
the Circuit Court for Baltimore City, Maryland issued a Memorandum Opinion
in the case and awarded damages of approximately $934 to the RPC
plaintiffs, which represented a liability of the Company or MWP. The
Company has 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 those damages in the event the decision of the Circuit
Court is upheld ultimately. The Company has never accounted for the 50%
interest in Hellyer LP that is claimed by RPC as an asset of the Company.
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 was stayed pending resolution of the Maryland case. In March 2005,
the Company voluntarily dismissed its California 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 lacked personal jurisdiction
over MWP. In April 2005, the decision of the Maryland Appeals Court became
final, and the Company obtained a court order for the release of a $1,551
bond, which it posted to remove an attachment order issued to RPC. In April
2005, RPC submitted a motion to the Superior Court of the State of
California effectively asking the court to prevent MWP from dismissing the
previously dismissed California suit. In July 2005, the Maryland Supreme
Court agreed to hear an appeal filed by RPC. In April 2006 the Maryland
Supreme Court upheld an earlier Maryland Appeals Court ruling in favor of
MWP, finding that the Circuit Court of Maryland could not assert personal
jurisdiction in the RPC suit. All litigation in the Maryland portion of
this dispute over the Hellyer Avenue limited partnership is now concluded
in our favor. The lawsuit in the Santa Clara County, California Superior
Court is still unresolved.
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MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(dollars in thousands, except share, per share, O.P. units
and per square footage amounts)
(unaudited)
In January 2004, the Global Crossing Estate Representative, for itself and
the Liquidating Trustee of the Global Crossing Liquidating Trust v. Mission
West Properties filed an action in United States Bankruptcy Court Southern
District of New York Case No. 02-40188 (REG) asserting that payments of
approximately $815 made in the ordinary course of business within 90 days
of the Global Crossing bankruptcy filing were preference payments. The
Company has engaged legal counsel to defend itself in this claim and intend
to vigorously contest the matter. On February 9, 2005, the Court held a
hearing to consider the objection filed with respect to Mission West
Properties' claim. In April 2005, the Company filed a motion for summary
judgment in the United States Bankruptcy Court Southern District of New
York requesting the Court to dismiss the preference claim. The motion for
summary judgment was denied. Discovery continues by both parties and no
trial date has been set.
GUARANTEES AND INDEMNITIES
Under its articles 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 recorded no liabilities for these agreements
as of March 31, 2006.
The Company also enters into indemnification provisions under its
agreements with other companies in the ordinary course of business,
typically with lenders, joint venture partners, contractors, and tenants.
Under these provisions the Company typically agrees to indemnify and hold
harmless the indemnified party for losses suffered or incurred by the
indemnified party as a result of certain kinds of activities or inactions
of the Company. 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. To date, 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 recorded no liabilities for these agreements as of March 31,
2006.
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 the Company
believes would have a material adverse effect on its financial condition,
results of operations and assets, and the Company is not aware of any such
liability. Nonetheless, it is possible that there are material
environmental liabilities of which the Company is unaware. In addition, the
Company cannot assure 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.
BERG LAND HOLDINGS OPTION AGREEMENT
In April 2005, the Berg Group disclosed the receipt of an offer from an
unrelated party to purchase a portion of the Piercy & Hellyer land
comprised of approximately 10 acres in San Jose, California that is subject
to the Berg Land Holdings Option Agreement with the Company. The
prospective purchaser has disclosed its intention to develop "for sale"
industrial type buildings. In light of the overcapacity in the Silicon
Valley R&D properties market and the Company's current inventory of
available buildings for lease in this submarket, 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 this approximately 10-acre parcel of
land from the scope of the Berg Land Holdings Option Agreement, subject to
the completion of the sale to the unrelated party. 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 acquiring undeveloped land for future development.
In the event this parcel of land is not sold to this prospective purchaser,
the parcel would not be deemed to be removed from the scope of the Berg
Land Holdings Option Agreement and would remain eligible for potential
future acquisition by the Company under the Berg Land Holdings Option
Agreement.
In light of the overcapacity in the Silicon Valley R&D properties 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 the Company and any member of the Berg
Group, 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
- 10 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(dollars in thousands, except share, per share, O.P. units
and per square footage amounts)
(unaudited)
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 by the Company under the Berg Land Holdings Option
Agreement.
11. SUBSEQUENT EVENTS
On April 6, 2006, the Company paid dividends of $0.16 per share of common
stock to all common stockholders of record as of March 31, 2006. On the
same date, the operating partnerships paid a distribution of $0.16 per O.P.
unit to all holders of O.P. units. Aggregate dividends and distributions
amounted to approximately $16,728.
In May 2006, one limited partner exchanged 789,796 O.P. units for 789,796
shares of the Company's common stock under the terms of the Exchange Rights
Agreement among the Company and all limited partners of the operating
partnerships. Neither the Company nor the operating partnership received
any proceeds from the issuance of the common stock in exchange for O.P.
units.
- 11 -
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and Results of
Operations should be read in conjunction with the accompanying consolidated
financial statements and notes thereto contained herein and our consolidated
financial statements and notes thereto contained in our Annual Report on Form
10-K as of and for the year ended December 31, 2005. The results for the three
months ended March 31, 2006 are not necessarily indicative of the results to be
expected for the entire fiscal year ending December 31, 2006. The following
discussion includes forward-looking statements, including but not limited to,
statements with respect to our future financial performance, operating results,
plans and objectives. Actual results may differ materially from those currently
anticipated depending upon a variety of factors, including those described under
the sub-heading, "Forward-Looking Information."
FORWARD-LOOKING INFORMATION
This quarterly 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 Reform Act of 1995, and are including this statement
for purposes of complying with these safe harbor provisions. Forward-looking
statements, which are based on certain assumptions and describe future plans,
strategies and expectations of the Company, are generally identifiable by use of
the words "believe," "expect," "intend," "anticipate," "estimate," "project" or
similar expressions. Additionally, all disclosures under Part I, Item 3
constitute forward-looking statements. Our ability to predict results or the
actual effect of future plans or strategies is inherently uncertain.
Factors that could have a material adverse effect on our operations and future
prospects include, but are not limited to, the following:
- economic conditions generally and the real estate market specifically,
- legislative or regulatory provisions (including changes to laws
governing the taxation of REITs),
- availability of capital,
- interest rates,
- competition,
- supply of and demand for R&D, office and industrial properties in our
current and proposed market areas,
- tenant defaults and bankruptcies,
- lease term expirations and renewals, and
- changes in general accounting principles, policies and guidelines
applicable to REITs.
In addition, the actual timing of development, construction, and leasing on any
projects that we believe we may acquire in the future under the Berg Land
Holdings Option Agreement is presently unknown, and reliance should not be
placed on estimates concerning these projects. These risks and uncertainties,
together with the other risks described from time to time in our reports and
other documents filed with the Securities and Exchange Commission, should be
considered in evaluating forward-looking statements and undue reliance should
not be placed on such statements.
OVERVIEW
We acquire, market, lease, and manage R&D/office properties, primarily located
in the Silicon Valley portion of the San Francisco Bay Area. As of March 31,
2006, we owned and managed 109 properties totaling approximately 7.9 million
rentable square feet through four limited partnerships, or operating
partnerships, for which we are the sole general partner. This class of property
is designed for research and development and office uses and, in some cases,
includes space for light manufacturing operations with loading docks. We believe
that we have one of the largest portfolios of R&D/office properties in the
Silicon Valley. As of March 31, 2006, the four tenants who each leased in excess
of 300,000 rentable square feet from us were Microsoft 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.
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/office properties that provide attractive initial
yields and significant potential for growth in cash-flow;
- focusing on general purpose, single-tenant Silicon Valley R&D/office
properties for information technology companies in order to maintain
low operating costs, reduce tenant turnover and capitalize on our
relationships with these companies and our extensive knowledge of
their real estate needs; and
- 12 -
- 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.
CURRENT ECONOMIC ENVIRONMENT
All of our 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 R&D property market has historically fluctuated
with the local economy. The Silicon Valley economy and business activity have
slowed markedly since 2001 after fast-paced growth in 1999 and 2000. According
to a recent report by NAI BT Commercial Real Estate, the vacancy rate for
Silicon Valley R&D property was approximately 19.6% in late 2005 and 20.1% at
the end of the first quarter of 2006. Total vacant R&D square footage in Silicon
Valley at the end of the first quarter of 2006 amounted to 31.0 million square
feet, of which 22.4%, or 7.0 million square feet, was being offered under
subleases. Total positive net absorption (which is the computation of gross
square footage leased less gross new square footage vacated for the period
presented) in 2005 amounted to approximately 3.6 million square feet. During the
first three months of 2006, there was total negative net absorption of
approximately (0.97) million square feet. Average asking market rent per square
foot at the end of the first quarter of 2006 was $0.89 compared to $0.88 in late
2005, although individual properties within any particular submarket presently
may be leased above or below the current average asking market rental rates
within that submarket. The Silicon Valley R&D property market has been
characterized by a substantial number of submarkets, with rent and vacancy rates
varying by submarket and location within each submarket.
Our occupancy rate at March 31, 2006 was 67.3% compared to 67.7% at March 31,
2005. We believe that our occupancy rate could decline further going forward if
key tenants seek the protection of bankruptcy laws, consolidate operations or
discontinue operations. In addition, leases with respect to approximately
245,000 rentable square feet are expiring prior to the end of 2006. The
properties subject to these leases may take anywhere from 24 to 36 months or
longer to re-lease. We believe that the average 2006 renewal rental rates for
our properties will be approximately equal to, or perhaps below, current market
rents, but we cannot give any assurance that leases will be renewed or that
available space will be re-leased at rental rates equal to or above the current
quoted market rates.
Despite our strategic focus on single tenant properties and leases, in order to
meet market conditions, we have been, and expect to continue leasing less than
the entire premises of some of our R&D properties to a single tenant from time
to time. Leasing our R&D properties, which generally have been built for single
tenant occupancy, to multiple tenants can increase our leasing costs and
operating expenses and reduce the profitability of our leasing activities.
If we are unable to lease a significant portion of any vacant space or space
subject to expiring leases; if we experience significant tenant defaults as a
result of the current economic downturn; if we are not able to lease space at or
above current market rates; if we restructure existing leases and lower existing
rents in order to retain tenants for an extended term; or if we increase our
lease costs and operating expenses substantially to accommodate multiple tenants
in our R&D properties, our results of operations and cash flows will be
adversely affected. Furthermore, in this event it is probable that our board of
directors will reduce the quarterly dividend on the common stock and the
outstanding O.P. units. Our operating results and ability to pay dividends at
current levels remain subject to a number of material risks, as indicated under
the caption "Forward-Looking Information" above and in the section entitled
"Risk Factors" in our most recent annual report on Form 10-K.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We prepare the consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America ("GAAP"), which
requires us to make certain estimates, judgments and assumptions that affect the
reported amounts in the accompanying consolidated financial statements,
disclosure of contingent assets and liabilities and related footnotes.
Accounting and disclosure decisions with respect to material transactions that
are subject to significant management judgments or estimates include impairment
of long lived assets, deferred rent reserves, and allocation of purchase price
relating to property acquisitions and the related depreciable lives assigned.
Actual results may differ from these estimates under different assumptions or
conditions.
Critical accounting policies are defined as those that require management to
make estimates, judgments and assumptions, giving due consideration to
materiality, in certain circumstances that affect amounts reported in the
consolidated financial statements, and potentially result in materially
different results under different conditions and assumptions. We believe that
the following best describe our critical accounting policies:
BUSINESS COMBINATIONS. Statement of Financial Accounting Standards ("SFAS") No.
141, "Business Combinations" ("SFAS No. 141"), 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 commission 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, including lease origination
and lease up period costs, and above and below market in place leases, and the
determination of their useful lives are guided by a combination of SFAS No. 141
and management's estimates. If we do not appropriately allocate these
- 13 -
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 SFAS No. 144, "Accounting for
the Impairment and Disposal of Long-Lived Assets" ("SFAS No. 144"). 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, lease periods, deferred maintenance 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.
ALLOWANCE FOR DOUBTFUL ACCOUNTS AND DEFERRED RENT. We must estimate the
uncollectibility 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 reserves against our deferred rent
receivable for existing tenants with the potential of early termination,
bankruptcy or ceasing operations. We charge or credit rental income for
increases or decreases to our deferred rent reserves. Our estimates are based on
our review of tenants' payment histories, the remaining lease term, whether or
not the tenant is currently occupying our building, 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.
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 we do
not exercise significant control over major operating and financial decisions.
We account for this joint venture interest using the equity method of
accounting.
FAIR VALUE OF FINANCIAL INSTRUMENTS. Our financial instruments include cash and
cash equivalents, accounts receivable, accounts payable, and debt. Considerable
judgment is required in interpreting market data to develop estimates of fair
value. Our estimates of fair value are not necessarily indicative of the amounts
that we could realize in a current market exchange. The use of different market
assumptions and/or estimation methodologies may have a material effect on the
estimated fair value amounts. Cash and cash equivalents, accounts receivable,
and accounts payable are carried at amounts that approximate their fair values
due to their short-term maturities. The carrying amounts of our variable rate
debt approximate fair value since the interest rates on these instruments are
equivalent to rates currently offered to us. For fixed rate debt, we estimate
fair value by using discounted cash flow analyses based on borrowing rates for
similar kinds of borrowing arrangements.
STOCK-BASED COMPENSATION. 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 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. We have adopted the requirements of SFAS No. 123R effective January 1,
2006 using the modified prospective method of transition. Accordingly, prior
periods have not been restated. The adoption of this standard did not have a
material effect on our consolidated statements of operations or financial
position. Compensation cost under SFAS No. 123R may differ due to different
assumptions and treatment of forfeitures.
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, cease
operations or are likely to seek a negotiated settlement of their obligation. 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
- 14 -
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.
SFAS No. 66, "Accounting for Sales of Real Estate" ("SFAS No. 66"), establishes
accounting standards for recognizing profit or loss on sales of real estate. The
gain on the sale is only recognized proportionately as the seller receives
payments from the purchaser. Interest income is recognized on an accrual basis,
when appropriate.
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 when the tenant no longer has the right to occupy 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. We cannot predict or forecast 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
- collectibility 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. The Audit Committee has reviewed the
critical accounting policies we identified.
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RESULTS OF OPERATIONS
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2006 TO THE THREE MONTHS ENDED
MARCH 31, 2005
As of March 31, 2006, through our controlling interests in the operating
partnerships, we owned 109 properties totaling approximately 7.9 million
rentable square feet compared to 108 properties totaling approximately 8.0
million rentable square feet owned by us as of March 31, 2005. This represents a
net decrease of approximately 1% in total rentable square footage, as we
acquired one property consisting of approximately 95,700 rentable square feet
and disposed of one property consisting of approximately 239,000 rentable square
feet since the first quarter of 2005.
RENTAL REVENUE FROM REAL ESTATE FROM CONTINUING OPERATIONS
For the quarter ended March 31, 2006, rental revenue from real estate decreased
by approximately ($1.9) million, or 7.4%, from $26.2 million for the three
months ended March 31, 2005 to $24.3 million for the same period of 2006. Rental
revenue includes approximately ($0.5) million in amortization for the three
months ended March 31, 2006 and 2005 for the amortization of an above-market
lease intangible asset pursuant to SFAS No. 141. The decline in rental revenue
was primarily a result of lower rental rates on new leases and renewals and the
loss of several tenants due to bankruptcy, relocation or cessation of their
operations since March 31, 2005, all of which resulted from current adverse
market conditions. Our occupancy rate at March 31, 2006 was approximately 67.3%,
compared to approximately 67.7% at March 31, 2005. Due to an over supply of R&D
properties and competition from other landlords in the Silicon Valley, our
occupancy rate may drop further if the 245,000 rentable square feet scheduled to
expire during the remainder of 2006 is not renewed or re-leased.
EQUITY IN EARNINGS FROM UNCONSOLIDATED JOINT VENTURE
As of March 31, 2006, we had investments in four R&D buildings, totaling 593,000
rentable square feet, through an unconsolidated joint venture, TBI-MSW, in which
we acquired a 50% interest in January 2003 from the Berg Group under the Berg
Land Holdings Option Agreement. We have a non-controlling limited partnership
interest in this joint venture, which we account for using the equity method of
accounting. For the three months ended March 31, 2006, we recorded equity in
earnings from the unconsolidated joint venture of approximately $0.33 million
compared to equity in loss of ($6,000) for the same period in 2005. Our equity
in earnings from this unconsolidated joint venture increased in the first
quarter of 2006 resulted from the write-offs of leasing commission and tenant
improvements in the first quarter of 2005 for a tenant that terminated its lease
agreement in December 2004 that did not recur in 2006. The occupancy rate for
the properties owned by this joint venture at March 31, 2006 and 2005 was
approximately 78.7%.
LEASE TERMINATION INCOME FROM CONTINUING OPERATIONS
Lease termination fees for the three months ended March 31, 2006 were
approximately $16.1 million. These fees were paid by four tenants who terminated
their lease obligations before the end of the contractual term of the lease.
There was no lease termination income in the first quarter of 2005. We do not
consider those transactions to be recurring items.
OTHER INCOME FROM CONTINUING OPERATIONS
Other income of approximately $0.7 million for the three months ended March 31,
2006 included approximately $0.4 million from interest income and $0.3 million
from management fee income. Other income for the three months ended March 31,
2005 consisted primarily of management fee income and miscellaneous income.
EXPENSES FROM CONTINUING OPERATIONS
Property operating expenses and real estate taxes during the first quarter of
2006 decreased by approximately ($0.2) million, or 4.3%, from $4.9 million to
$4.7 million for the three months ended March 31, 2005 and 2006, respectively,
due primarily to property tax refunds totaling approximately $0.2 million in the
first quarter of 2006 and two R&D property dispositions in the first quarter of
2005. Tenant reimbursements decreased by approximately ($0.3) million, or 8.8%,
from $3.6 million for the three months ended March 31, 2005 to $3.3 million for
the three months ended March 31, 2006 due to lower occupancy. Certain expenses
such as property insurance, real estate taxes, and other fixed operating
expenses are not recoverable from vacant properties. General and administrative
expenses remained relatively the same for the three months ended March 31, 2006
and 2005.
Depreciation and amortization expense of real estate decreased by approximately
($0.1) million, or 1.7%, from $5.6 million to $5.5 million for the three months
ended March 31, 2005 and 2006, respectively. The decrease was attributable
primarily to the disposition of two R&D properties during the first quarter of
2005.
Interest expense increased by approximately $0.6 million, or 12.2%, from $4.6
million for the three months ended March 31, 2005 to $5.2 million for the three
months ended March 31, 2006. Interest expense (related parties) decreased by
approximately ($0.1) million, or 37.5%, from $0.3 million for the three months
ended March 31, 2005 to $0.2 million for the three months ended March 31, 2006
due to the termination of the Berg Group line of credit in October 2005. Total
debt outstanding, including amounts due related parties, increased by
approximately $23.4 million, or 6.9%, from $341.6 million as of March 31, 2005
to $365.0 million as of March 31, 2006. Overall interest expense, including
amounts paid to related parties, for the quarter ended March 31, 2006 increased
by approximately $0.5 million compared to the same quarter a year ago primarily
due to two new fixed rate secured mortgage loans of $25.8 million and $125
million from Allianz Life Insurance Company obtained in April 2005 and July
2005, respectively.
- 16 -
INCOME FROM DISCONTINUED OPERATIONS
The following table depicts the amounts of income from discontinued operations
for the three months ended March 31, 2005.
Three Months Ended March 31,
2006 2005
----------- ------------
(dollars in thousands)
(unaudited)
Gain from disposal of discontinued operations - $ 63
Loss attributable to discontinued operations - (40)
Minority interest in earnings attributable to
discontinued operations - (18)
----------- ------------
Income from discontinued operations - $ 5
=========== ============
In accordance with our adoption of SFAS No. 144, in the first quarter of 2005 we
sold and classified as discontinued operations two properties consisting of
103,350 rentable square feet and recorded a gain of $63,000, of which $14,000
and $49,000 were attributable to common stockholders and minority interests,
respectively.
The income to common stockholders and minority interests attributable to
discontinued operations from these two properties for the three months ended
March 31, 2005 was approximately $5,000 and $18,000, respectively.
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS AND NET INCOME AVAILABLE TO MINORITY
INTERESTS
Minority interest in net income has been calculated by taking the net income of
the operating partnerships (on a stand-alone basis) multiplied by the respective
minority interest ownership percentage. Minority interest represents the
ownership interest of all limited partners in the operating partnerships taken
as a whole, which was approximately 82% and 83% as of March 31, 2006 and 2005,
respectively.
Net income available to common stockholders increased by approximately $2.7
million, or 114.0%, from $2.4 million for the three months ended March 31, 2005
to $5.1 million for the same period in 2006. The minority interest portion of
income increased by approximately $11.7 million, or 100%, from $11.7 million for
the three months ended March 31, 2005 to $23.4 million for the three months
ended March 31, 2006. The increase in net income for both common stockholders
and minority interests was primarily due to the realization of lease termination
fees and lower operating expenses and property taxes in 2006, partially offset
with increases in interest expense.
- 17 -
CHANGES IN FINANCIAL CONDITION
The most significant changes in our financial condition during the three months
ended March 31, 2006 resulted from the acquisition of one R&D property. In
addition, total stockholders' equity increased from the issuance of common stock
for the exchange of O.P. units and stock option exercises.
At March 31, 2006, total investments in properties had a net increase of
approximately $13.5 million from December 31, 2005 due to one R&D property
acquisition. During the first three months of 2006, we acquired one R&D property
consisting approximately 95,700 rentable square feet located in the Silicon
Valley. The purchase price for this property was approximately $13.5 million.
Total stockholders' equity, net, increased by approximately $3.0 million from
December 31, 2005 as we obtained additional capital from the issuance of 50,000
shares of our common stock for the exchange of O.P. units and 12,500 shares of
our common stock from stock option exercises and incurred a surplus of
approximately $2.2 million due to the realization of higher lease termination
fees for the period. During the first three months of 2006, one limited partner
exchanged 50,000 O.P. units for 50,000 shares of our common stock under the
Exchange Rights Agreement among us and the limited partners in the operating
partnerships. In addition, stock options to purchase 12,500 shares of common
stock were exercised. The newly issued shares increased additional paid in
capital by approximately $0.7 million.
LIQUIDITY AND CAPITAL RESOURCES
We expect a continued decline in operating cash flows from our operating
property portfolio in 2006 as compared to 2005. The reduction in cash flows
reflects the overall reduced demand for R&D properties, lower rental rates for
new and renewed leases, and an increase in vacant properties in 2006. In
addition, if we are unable to lease a significant portion of the approximately
245,000 rentable square feet scheduled to expire during the remainder of 2006 or
an equivalent amount of our currently available space of approximately 2.9
million rentable square feet, our operating cash flows may be affected
adversely. With the expectation of lower rental revenues for the remainder of
2006, we expect the properties' net operating income to continue to show year
over year declines when compared to 2005. As noted above, we expect cash flows
from operating activities to continue to show declines primarily driven by the
general downturn in the Silicon Valley's economy in recent years, the softening
of the Company's market specifically, and the expected weaker performance of our
properties. 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 reduced cash flow from operations. It is
reasonably likely that vacancy rates may continue to increase and effective
rental rates on new and renewed leases may continue to decrease.
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 line of credit with Cupertino National Bank ("CNB"). We expect these
sources of liquidity to be adequate to meet projected distributions to
stockholders and other presently anticipated liquidity requirements in 2006. 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 cash and investments, long-term secured and unsecured
indebtedness and the issuance of additional equity securities by us. We have the
ability to meet short-term obligations or other liquidity needs based on a line
of credit with CNB. We expect our total interest expense to increase through new
financing activities. In the remainder of 2006, we will be obligated to make
payments totaling approximately $7.8 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.
Cash and cash equivalents increased by approximately $8.5 million from $31.4
million as of December 31, 2005 to $39.9 million as of March 31, 2006 primarily
from cash flow from operations and excess remaining restricted cash from a 1031
tax-deferred exchange transaction.
Restricted cash totaled $12.7 million as of March 31, 2006. Of this amount,
$11.1 million represents a balance we consolidated due to our adoption of FIN
46R, "Consolidation of Variable Interest Entities" (see Note 5). The remaining
$1.6 million represents a bond we posted in the Republic Properties Corporation
v. Mission West Properties, L.P. litigation (see Note 10). We do not possess or
control these funds or have any rights to receive them except as provided in the
applicable agreements. Therefore, restricted cash is not available for
distribution to stockholders.
DISTRIBUTIONS
On April 6, 2005, we paid dividends of $0.16 per share of common stock to all
common stockholders of record as of March 31, 2006. On the same date, the
operating partnerships paid a distribution of $0.16 per O.P. unit to all holders
of O.P. units. Aggregate dividends and distributions amounted to approximately
$16.7 million. For the remainder of 2006, 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.
- 18 -
DEBT
At March 31, 2006, we had total indebtedness of $365.0 million, including $355.0
million of fixed rate mortgage debt and $10.0 million under the Berg Group
mortgage note (related parties), as detailed in the table below. The CNB loan
contains certain financial loan and reporting covenants as defined in the loan
agreements. As of March 31, 2006, we were in compliance with these loan
covenants.
CONTRACTUAL OBLIGATIONS
The following table identifies our contractual obligations as of March 31, 2006
that will impact our liquidity and cash flow in future periods:
2006 2007 2008 2009 2010 Thereafter Total
--------------------------------------------------------------------------------------------
(dollars in thousands)
Long-Term Debt Obligations(1) $7,847 $11,029 $121,605 $9,580 $10,125 $204,778 $364,964
Operating Lease Obligations(2) 68 23 - - - - 91
------------ ------------- ------------ ------------ ------------- ------------ ------------
Total $7,915 $11,052 $121,605 $9,580 $10,125 $204,778 $365,055
============ ============= ============ ============ ============= ============ ============
(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.
- 19 -
The following table sets forth information regarding debt outstanding as of
March 31, 2006:
Maturity Interest
Debt Description Collateral Properties Balance Date Rate
------------------------------------------------ -------------------------------------- ----------------- ------------- -----------
(dollars in thousands)
Line of Credit:
Cupertino National Bank Not Applicable - 11/06 (3)
-----------------
Mortgage Notes Payable (related parties): 5300 & 5350 Hellyer Avenue, San Jose, CA $ 9,955 6/10 7.65%
-----------------
Mortgage Notes Payable (1):
Prudential Insurance Company of America (2) 10300 Bubb Road, Cupertino, CA 116,730 10/08 6.56%
10500 N. De Anza Boulevard, Cupertino, CA
4050 Starboard Drive, Fremont, CA
45700 Northport Loop, Fremont, CA
45738 Northport Loop, Fremont, CA
450 National Avenue, Mountain View, CA
6311 San Ignacio Avenue, San Jose, CA
6321 San Ignacio Avenue, San Jose, CA
6325 San Ignacio Avenue, San Jose, CA
6331 San Ignacio Avenue, San Jose, CA
6341 San Ignacio Avenue, San Jose, CA
6351 San Ignacio Avenue, San Jose, CA
3236 Scott Boulevard, Santa Clara, CA
3560 Bassett Street, Santa Clara, CA
3570 Bassett Street, Santa Clara, CA
3580 Bassett Street, Santa Clara, CA
1135 Kern Avenue, Sunnyvale, CA
1212 Bordeaux Lane, Sunnyvale, CA
1230 E. Arques, Sunnyvale, CA
1250 E. Arques, Sunnyvale, CA
1170 Morse Avenue, Sunnyvale, CA
1600 Memorex Drive, Santa Clara, CA
1688 Richard Avenue, Santa Clara, CA
1700 Richard Avenue, Santa Clara, CA
3540 Bassett Street, Santa Clara, CA
3542 Bassett Street, Santa Clara, CA
3544 Bassett Street, Santa Clara, CA
3550 Bassett Street, Santa Clara, CA
Northwestern Mutual Life Insurance Company (4) 1750 Automation Parkway, San Jose, CA 90,598 1/13 5.64%
1756 Automation Parkway, San Jose, CA
1762 Automation Parkway, San Jose, CA
6320 San Ignacio Avenue, San Jose, CA
6540-6541 Via Del Oro, San Jose, CA
6385-6387 San Ignacio Avenue, San Jose, CA
2251 Lawson Lane, Santa Clara, CA
1325 McCandless Drive, Milpitas, CA
1650-1690 McCandless Drive, Milpitas, CA
20605-20705 Valley Green Drive, Cupertino, CA
Allianz Life Insurance Co. (Allianz Loan I)(5) 5900 Optical Court, San Jose, CA 25,089 8/25 5.56%
Allianz Life Insurance Co. (Allianz Loan II)(5) 5325-5345 Hellyer Avenue, San Jose, CA 122,592 8/25 5.22%
1768 Automation Parkway, San Jose, CA
2880 Scott Boulevard, Santa Clara, CA
2890 Scott Boulevard, Santa Clara, CA
2800 Scott Boulevard, Santa Clara, CA
20400 Mariani Avenue, Cupertino, CA
10450-10460 Bubb Road, Cupertino, CA
-----------------
355,009
-----------------
TOTAL $364,964
=================
(1) Mortgage notes payable generally require monthly installments of interest
and principal ranging from $177,000 to $840,000 over various terms
extending through the year 2025. The weighted average interest rate of
mortgage notes payable was 5.84% at March 31, 2006.
(2) The Prudential Insurance loan is payable in monthly installments of
$827,000, 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 $12.0 million of this debt. Costs and fees
incurred with obtaining this loan aggregated approximately $900,000, which
were deferred and amortized over the loan period.
(3) Interest rate equal to LIBOR plus 1.75%. The Cupertino National Bank line
of credit contains certain financial loan and reporting covenants as
defined in the loan agreements, including minimum tangible net worth and
debt service coverage ratio. As of March 31, 2006, the Company was in
compliance with these loan covenants.
(4) The Northwestern loan is payable in monthly installments of $696,000, which
includes principal (based upon a 20-year amortization) and interest. Costs
and fees incurred with obtaining this loan aggregated approximately
$675,000, which were deferred and amortized over the loan period.
(5) The Allianz loans are payable in monthly aggregate installments of
$1,017,000, which includes principal (based upon a 20-year amortization)
and interest. Costs and fees incurred with obtaining these loans aggregated
approximately $1,089,000, which were deferred and amortized over the loan
periods. The Allianz loans contain certain customary covenants as defined
in the loan agreements. As of March 31, 2006, the Company was in compliance
with these loan covenants.
At March 31, 2006, 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 $11.75 per share on March 31, 2006) on a fully diluted basis, including the
conversion of all O.P. units into common stock, was approximately 22.9%. On
March 31, 2006, the last trading day for the quarter, total market
capitalization was approximately $1.6 billion.
- 20 -
At March 31, 2006, the outstanding balance remaining under certain notes that we
owed to the operating partnerships was $1.7 million. The due date of these notes
has been extended to September 30, 2007. The principal amount of these 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 or by raising additional equity capital.
HISTORICAL CASH FLOWS
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2006 TO THE THREE MONTHS ENDED
MARCH 31, 2005
Net cash provided by operating activities for the three months ended March 31,
2006 was $12.1 million compared to $7.7 million for the same period in 2005. The
increase resulted primarily from the increase in deferred rental income. The
increase in cash flow from operating activities was also caused by payments of
higher leasing commissions (included in other assets) in 2005, which amounted to
approximately $3.6 million compared to $0.3 million in 2006.
Net cash provided by/(used in) investing activities was approximately $1.8
million and ($6.1) million for the three months ended March 31, 2006 and 2005,
respectively. Cash used in investing activities during the three months ended
March 31, 2006 related principally to the acquisition of the property at 233
South Hillview Drive for approximately $13.5 million. That property acquisition
was completed as a tax-deferred exchange transaction involving our former R&D
property at 800 Embedded Way, San Jose, California. The remaining excess
restricted cash of approximately $1.8 million was transferred to our general
cash account. Capital expenditures relating to real estate improvements were
approximately $79,000 and $0.3 million for the three months ended March 31, 2006
and 2005, respectively.
Net cash used in financing activities was ($5.4) million for the three months
ended March 31, 2006 compared to ($0.6) million for the three months ended March
31, 2005. During the first three months of 2006, we received $0.1 million from
stock option exercises, used $2.6 million to pay outstanding debt, and paid $2.9
million to common stockholders for dividends. During the same period in 2005, we
used $3.7 million to pay outstanding debt, drew an additional $8.3 million from
the Cupertino National Bank line of credit, and paid $2.3 million to minority
interests for distributions in excess of earnings and $2.9 million to common
stockholders for dividends.
FUNDS FROM OPERATIONS ("FFO")
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, plus non-recurring events other than "extraordinary items"
under GAAP, excluding 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. FFO does include impairment losses for properties held for sale and
held for use. Management considers FFO to be an appropriate supplemental measure
of the Company's operating and financial performance because when compared year
over year, it reflects the impact to operations from trends in occupancy rates,
rental rates, operating costs, general and administrative expenses and interest
costs, providing a perspective not immediately apparent from net income. In
addition, management believes that FFO provides useful information about the
Company's financial performance when compared to other REITs since FFO is
generally recognized as the industry standard for reporting the operations of
REITs. In addition to the disclosure of operating earnings per share, we will
continue to use FFO as a measure of our 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 the 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. 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.
- 21 -
FFO for the three months ended March 31, 2006 and 2005, as reconciled to net
income available to common stockholders, are summarized in the following tables:
Three Months Ended March 31,
2006 2005
------------------ ------------------
(dollars in thousands)
Net income available to common stockholders $ 5,152 $ 2,408
Add:
Minority interests (1) 23,256 11,574
Depreciation & amortization of real estate (2) 6,118 6,389
Less:
Gain on sale of asset - (63)
------------------ ------------------
FFO $34,526 $20,308
================== ==================
(1) The minority interest for third parties totaling $135 and $121 for the
three months ended March 31, 2006 and 2005, respectively, was deducted from
total minority interest in calculating FFO.
(2) Includes our portion of depreciation and amortization of real estate and
leasing commissions from our unconsolidated joint venture totaling $211 and
$354 for the three months ended March 31, 2006 and 2005, respectively. Also
includes amortization of leasing commissions of $428 for the three months
ended March 31, 2006 and 2005. 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.
DISTRIBUTION POLICY
Our board of directors determines the amount and timing of distributions to our
stockholders. The board of directors will consider many factors prior to making
any distributions, including the following:
- the amount of cash available for distribution;
- our financial condition;
- whether to reinvest funds rather than to distribute such funds;
- our committed and projected capital expenditures;
- the amount of cash required for new property acquisitions, including
acquisitions under existing agreements with the Berg Group;
- the amount of our annual debt service requirements;
- prospects of tenant renewals and re-leases of properties subject to
expiring leases;
- cash required for re-leasing activities;
- the annual distribution requirements under the REIT provisions of the
federal income tax laws; and
- such other factors as the board of directors deems relevant.
We cannot assure you that we will be able to meet or maintain our cash
distribution objectives.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
We do not believe recently issued accounting standards will materially impact
our financial position, results of operations, or cash flows.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections" ("SFAS No. 154"), to replace APB Opinion 20, "Reporting Accounting
Changes in Interim Financial Statements" ("APB 20"). SFAS No. 154 changes the
requirements for the accounting for and reporting of a change in accounting
principle and requires retrospective application to prior periods' financial
statements, unless it is impracticable to determine period specific effects or
the cumulative effect of the change. SFAS No. 154 will be effective for
accounting changes and corrections of errors made in fiscal years beginning
after December 15, 2005. The adoption of this statement is not expected to have
a material effect on our consolidated results of operations or financial
condition.
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. We have
adopted the requirements of SFAS No. 123R effective January 1, 2006 using the
modified prospective method of transition. Accordingly, prior periods have not
been restated. The adoption of this standard did not have a material effect on
our consolidated statements of operations or financial position.
- 22 -
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not generally hold market risk sensitive instruments for trading purposes.
We use fixed and variable rate debt to finance our operations. Our exposure to
market risk for changes in interest rates relates primarily to our current
variable rate debt and future debt obligations. We are vulnerable to significant
fluctuations of interest rates on our floating rate debt and pricing on our
future debt. We manage our market risk by monitoring interest rates where we try
to recognize the unpredictability of the financial markets and seek to reduce
potentially adverse effect on the results of our operations. This takes frequent
evaluation of available lending rates and examination of opportunities to reduce
interest expense through new sources of debt financing. Several factors
affecting the interest rate risk include governmental monetary and tax policies,
domestic and international economics and other factors that are beyond our
control. The following table provides information about the principal cash
flows, weighted average interest rates, and expected maturity dates for debt
outstanding as of March 31, 2006. The current terms of this debt are described
in Item 2, "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Liquidity and Capital Resources."
For fixed rate debt, the table presents the assumption that the outstanding
principal balance at March 31, 2006 will be paid according to scheduled
principal payments and that we will not prepay any of the outstanding principal
balance.
Nine
Months Year Ending December 31,
Remaining ----------------------------------------------
2006 2007 2008 2009 2010 Thereafter Total Fair Value
-----------------------------------------------------------------------------------------------
(dollars in thousands)
Fixed Rate Debt:
Secured notes payable $7,847 $11,029 $121,605 $9,580 $10,125 $204,778 $364,964 $432,689
Weighted average interest rate 5.84% 5.84% 5.84% 5.84% 5.84% 5.84%
The primary market risks we face are interest rate fluctuations. Principal
amounts outstanding under the CNB line of credit, which had a balance of zero at
March 31, 2006, is tied to a LIBOR based interest rate. As a result, we pay
lower rates of interest in periods of decreasing interest rates and higher rates
of interest in periods of increasing interest rates. All of our debt is
denominated in United States dollars. We had no interest rate caps or interest
rate swap contracts at March 31, 2006.
As of March 31, 2006, we had no interest rate risk since there was no variable
rate debt outstanding.
- 23 -
ITEM 4. CONTROLS AND PROCEDURES
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 designed 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 and procedures.
As required by SEC Rule 13a-15(b) we conducted an evaluation, under the
supervision and with the participation of our management, including our Chief
Executive Officer, President and Vice President of Finance, of the effectiveness
of the design and operation of our disclosure controls and procedures. Based
upon that evaluation, the Chief Executive Officer, President and Vice President
of Finance concluded that our disclosure controls and procedures (as defined in
Rule 13a-15(e) or Rule 15d-15(e)) were effective as of March 31, 2006.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There was no material change in our internal control over financial reporting
during the last fiscal quarter that has materially affected, or is reasonably
likely to materially affect our internal control over financial reporting.
- 24 -
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Legal proceedings are incorporated herein by reference from Part 1 "Item 1. -
Financial Statements - Note 10 - Commitments and Contingencies."
ITEM 1A. RISK FACTORS
While we attempt to identify, manage and mitigate risks and uncertainties
associated with our business to the extent practical under the circumstances,
some level of risk and uncertainty will always be present. In addition to the
other information contained in this report, you should carefully review the
factors discussed under Item 1A of our 2005 Form 10-K which describes some of
the risks and uncertainties associated with our business. These risks and
uncertainties have the potential to materially affect our business, financial
condition, results of operations, cash flows, and future prospects. Additional
risks and uncertainties not presently known to us or that we currently deem
immaterial also may impair our business operations.
ITEM 6. EXHIBITS
31.1 Section 1350 Certificate of CEO
31.2 Section 1350 Certificate of President & COO
31.3 Section 1350 Certificate of Principal Financial Officer
32 Certification pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
- 25 -
================================================================================
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.
Mission West Properties, Inc.
(Registrant)
Date: May 9, 2006 By: /s/ Carl E. Berg
---------------------------------------
Carl E. Berg
Chief Executive Officer
Date: May 9, 2006 By: /s/ Wayne N. Pham
---------------------------------------
Wayne N. Pham
Vice President of Finance and Controller
(Principal Accounting Officer and Duly
Authorized Officer)
- 26 -