UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For Fiscal Year Ended: December 31, 2008
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from______________ to______________
Commission File No. 1-8383
MISSION WEST PROPERTIES, INC.
(Exact name of registrant as specified in its charter)
Maryland 95-2635431
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
10050 Bandley Drive, Cupertino, CA 95014
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (408) 725-0700
---------------
Securities Registered Pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered Common Stock,
$.001 par value per share The Nasdaq Stock Market LLC
Securities Registered Pursuant to Section 12(g) of the Act: NONE
Indicate by check mark if the Registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the Registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes [ ] No [X]
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the Registrant is 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 Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of June 30, 2008, the aggregate market value of the Registrant's common
stock held by non-affiliates of the registrant was $213,611,025 based on the
closing price as reported on the NASDAQ Stock Market LLC.
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of the latest practicable date.
Class Outstanding at February 28, 2009
--------------------------------------- --------------------------------
Common Stock, $.001 par value per share 21,748,211 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's proxy statement to be delivered to stockholders in
connection with the Registrant's 2009 Annual Meeting of Stockholders to be held
May 20, 2009 are incorporated by reference into Part III of this Form 10-K. The
Registrant intends to file its proxy statement within 120 days after its fiscal
year end.
FORWARD LOOKING INFORMATION
This annual report contains forward-looking statements within the meaning of the
federal securities laws. We intend such forward-looking statements to be covered
by the safe harbor provisions for forward-looking statements contained in the
Private Securities Litigation Reform Act of 1995, and are including this
statement for purposes of complying with these safe harbor provisions.
Forward-looking statements include our discussion of "Quantitative and
Qualitative Disclosures about Market Risks" in Item 7A below. Forward-looking
statements, which are based on certain assumptions and describe future plans,
strategies and expectations of us, are generally identifiable by use of the
words "believe," "expect," "intend," "anticipate," "estimate," "project" or
similar expressions. Our ability to predict results or the actual effect of
future plans or strategies is inherently uncertain. Factors which could have a
material adverse effect on the operations and future prospects or would cause
actual results in the future to differ materially from any of our
forward-looking statements of the Company include, but are not limited to,
changes in: the credit markets and the overall availability and cost of credit,
economic conditions generally and the real estate market specifically,
legislative or regulatory provisions affecting the Company (including changes to
laws governing the taxation of Real Estate Investment Trusts ("REITs")),
availability of capital, interest rates, competition, supply of and demand for
office and industrial properties in our current and proposed market areas,
tenant defaults and bankruptcies, and general accounting principles, policies
and guidelines applicable to REITs. In addition, the actual timing of
development, construction, and leasing on the projects that the Company believes
it may acquire in the future is unknown presently. These risks and
uncertainties, together with the other risks described from time to time in our
reports and documents filed with the Securities and Exchange Commission, should
be considered in evaluating forward-looking statements and undue reliance should
not be placed on such statements (see Item 1A, "Risk Factors").
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MISSION WEST PROPERTIES, INC.
2008 FORM 10-K ANNUAL REPORT
Table of Contents
PART I
Page No.
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Item 1. Business 1
Item 1A. Risk Factors 9
Item 1B. Unresolved Staff Comments 15
Item 2. Properties 16
Item 3. Legal Proceedings 21
Item 4. Submission of Matters to a Vote of Security Holders 21
PART II
Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities 22
Item 6. Selected Financial Data 24
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 26
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 42
Item 8. Financial Statements and Supplementary Data 43
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 80
Item 9A. Controls and Procedures 80
Item 9B. Other Information 80
PART III
Item 10. Directors, Executive Officers and Corporate Governance 81
Item 11. Executive Compensation 81
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters 81
Item 13. Certain Relationships and Related Transactions, and Director Independence 81
Item 14. Principal Accountant Fees and Services 81
PART IV
Item 15. Exhibits and Financial Statement Schedules 82
Signatures 83
Rule 13a-14(a) Certifications 88
Section 1350 Certifications 91
- ii -
PART I
ITEM 1. BUSINESS
ORGANIZATION AND GENERAL BUSINESS DESCRIPTION
Mission West Properties, Inc. (the "Company") acquires, markets, leases, and
manages research and development ("R&D") properties, primarily located in the
Silicon Valley portion of the San Francisco Bay Area. As of December 31, 2008,
we owned and managed 111 properties totaling approximately 8.0 million rentable
square feet of R&D properties through four limited partnerships, or operating
partnerships, for which we are the sole general partner. R&D property is
designed for research and development and office uses and, in some cases,
includes space for light manufacturing operations with loading docks. We believe
that we have one of the largest portfolios of R&D properties in the Silicon
Valley. There are two tenants who individually lease in excess of 300,000
rentable square feet from us: Microsoft Corporation and Apple Computer, Inc. For
federal income tax purposes we have operated as a self-managed,
self-administered and fully integrated Real Estate Investment Trust ("REIT")
since fiscal 1999.
Prior to July 1, 1998, most of our properties were under the ownership or
control of Carl E. Berg, his brother Clyde J. Berg, certain members of their
respective immediate families, and certain entities in which Carl E. Berg and/or
Clyde J. Berg held controlling or other ownership interests, including Berg &
Berg Developers, Berg & Berg Enterprises, Inc. and Berg & Berg Enterprises, LLC
(the "Berg Group"). We acquired these properties as of July 1, 1998 by becoming
the general partner of each of the four operating partnerships in an UPREIT
transaction. At that time, we also acquired ten properties comprising
approximately 560,000 rentable square feet from entities controlled by third
parties in which the Berg Group members were significant owners.
Through various property acquisition agreements with the Berg Group and subject
to the approval of the Independent Directors Committee of the Board of
Directors, we have the right to purchase, on pre-negotiated terms, R&D and other
types of office and light industrial properties that the Berg Group develops in
the future. With in-house development, architectural and construction personnel,
the Berg Group continues to focus on a full range of land acquisition,
development and construction activities for R&D properties, often build-to-suit,
to meet the demands of Silicon Valley information technology companies. As the
developer, the Berg Group takes on the risks of purchasing the land, obtaining
regulatory approvals and permits and financing construction. Since September
1998, we have acquired approximately 3,386,000 additional rentable square feet
of R&D properties from the Berg Group under these agreements.
Our executive offices are located at 10050 Bandley Drive, Cupertino, California
95014, and our telephone number is (408) 725-0700. Our website is located at
http://www.missionwest.com. On our website, you can access, free of charge, our
annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K and amendments to those reports filed or furnished pursuant to Section
13(a) or 15(d) of the Exchange Act of 1934, as amended, as soon as reasonably
practicable after such material is electronically filed with, or furnished to,
the Securities and Exchange Commission (the "SEC"). A copy of these filings is
available to all interested parties upon written request to "Investor Relations"
at our corporate offices.
We file annual, quarterly and special reports, proxy statements and other
information with the SEC. You may read and copy any document we file with the
SEC at the SEC's Public Reference Room at 100 F Street, N.W., Washington, D.C.
20549. You may obtain information about the operation of the SEC's Public
Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a
website that contains reports, proxy and information statements, and other
information regarding registrants that file electronically with the SEC
(http://www.sec.gov).
OUR RELATIONSHIP WITH THE BERG GROUP
Through a series of transactions occurring between May 1997 and December 1998,
we became the vehicle for substantially all of the Silicon Valley R&D property
operating activities of the Berg Group. We are the general partner pursuant to
the partnership agreements of the operating partnerships and, along with members
of the Berg Group and other individuals, are party to an acquisition agreement
dated as of May 14, 1998 and amended, as of July 1, 1998, exchange rights
agreement and the Berg Land Holdings Option Agreement. Each agreement defines
the material rights and obligations among us, the Berg Group members, and other
parties to those agreements. Among other things, these agreements give us rights
to:
- control the operating partnerships;
- until December 31, 2010, acquire, subject to approval of the Independent
Directors Committee of the Board of Directors, on pre-negotiated terms, all
future R&D properties developed by the Berg Group on land currently owned
or acquired in the future; and
- acquire R&D, office and industrial properties identified by the Berg Group
in California, Oregon and Washington, subject to approval of the
Independent Directors Committee of the Board of Directors.
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Under these agreements, our charter or our bylaws, the Berg Group has the right
to:
- designate two of five nominees for director to be elected by our
stockholders, subject to the Berg Group's maintenance of certain ownership
interests;
- participate in our securities offerings;
- exchange their operating partnership interests ("O.P. Units") for shares of
our common stock;
- vote on major transactions, subject to maintenance of certain ownership
thresholds; and
- prevent us from selling properties when the sale will have adverse tax
consequences to the Berg Group members.
To comply with REIT requirements that restrict the percentage of the total value
of our stock that may be owned by five or fewer individuals to 50% or less, our
charter generally prohibits the direct or indirect ownership of more than 9% of
our common stock by any stockholder. This limit excludes the Berg Group, which
has an aggregate ownership limit of 20%. Currently, the Berg Group members
collectively own approximately 9.2% of the outstanding shares of our common
stock.
Carl E. Berg, the Company's Chairman of the Board of Directors and Chief
Executive Officer and the controlling member of the Berg Group, has been engaged
in the development and long-term ownership of Silicon Valley real estate for
almost 40 years. In 1969, Mr. Berg foresaw the rising demand for efficient,
multi-purpose facilities for the rapidly growing information technology industry
in the Silicon Valley. Since 1972, in addition to his real estate activities,
Mr. Berg also has been actively involved in venture capital investments in many
information technology companies in the Silicon Valley, including such companies
as Amdahl Corporation, Sun Microsystems, Inc., and Integrated Device
Technologies, Inc. He serves on the board of directors of numerous electronics
and energy technology companies. These activities have helped Mr. Berg develop a
detailed understanding of the real estate requirements of technology companies,
acquire valuable market information and increase his name recognition within the
venture capital and entrepreneurial communities. These activities also manifest
his commitment to the growth and success of Silicon Valley companies. We believe
that Mr. Berg's substantial knowledge of and contacts in various technology
industries provide a significant benefit to the Company.
BUSINESS STRATEGY
Our acquisition, growth and operating strategy incorporates the following
elements:
- working with the Berg Group to take advantage of their abilities and
resources to pursue development opportunities which we have an option to
acquire until December 31, 2010, on pre-negotiated terms, upon completion
and leasing;
- capitalizing on opportunistic acquisitions from third parties of
high-quality R&D properties that provide attractive initial yields and
significant potential for growth in cash-flow;
- focusing on general purpose, single-tenant Silicon Valley R&D properties
for technology companies in order to maintain low operating costs, reduce
tenant turnover and capitalize on our relationships with these companies
and our extensive knowledge of their real estate needs; and
- maintaining prudent financial management principles that emphasize current
cash flow while building long-term value, the acquisition of pre-leased
properties to reduce development and leasing risks and the maintenance of
sufficient liquidity to acquire and finance properties on desirable terms.
ACQUIRING PROPERTIES DEVELOPED BY THE BERG GROUP
We entered into the Berg Land Holdings Option Agreement in December 1998 under
which we have an option to purchase all land acquired, directly or indirectly,
by Carl E. Berg or Clyde J. Berg that has not been improved with completed
buildings and which is zoned, intended or appropriate for R&D, office and/or
industrial development or use in the states of California, Oregon and
Washington. Currently, the Berg Land Holdings Option Agreement gives us the
right to acquire future R&D property developments by the Berg Group on up to 84
additional acres of land currently controlled by the Berg Group, which could
support approximately 1.4 million square feet of new development. In light of
the continued overcapacity in the Silicon Valley R&D properties market, however,
at this time we do not anticipate acquiring any additional newly constructed R&D
properties from the Berg Group for several years because of the current market
conditions in the Silicon Valley.
For example, the Berg Group currently is seeking local government approval of a
proposed rezoning of the 160-acre Evergreen site to permit residential
development on a substantial portion of the site. The Independent Directors
Committee, which is responsible for reviewing, evaluating and authorizing action
with respect to any transaction between us and any member of the Berg Group, has
authorized removal of the Evergreen site from the scope of the Berg Land
Holdings Option Agreement, subject to the completion of the rezoning of the
160-acre Evergreen site, or portion thereof, for residential development. In
making this determination, the Independent Directors Committee considered a
number of factors, including the lack of benefit to be derived from future R&D
property development on this site and the risks and other potentially adverse
consequences that could be associated with large scale
- 2 -
residential development activities. Any portion of the Evergreen site that is
not rezoned as residential property is not deemed to be removed from the scope
of the agreement and would remain eligible for potential future acquisition by
the Company under the Berg Land Holdings Option Agreement.
As of December 31, 2008, we have acquired 23 leased R&D properties totaling
approximately 2,243,000 rentable square feet under the Berg Land Holdings Option
Agreement at a cost of approximately $237.8 million, for which we have issued
8,482,085 O.P. Units and assumed debt of approximately $141.4 million. The
principal terms of the agreement include the following:
- So long as the Berg Group members and their affiliates own or have the
right to acquire shares representing at least 65% of our common stock on a
Fully Diluted basis, or until December 31, 2010, whichever occurs first, we
will have the option to acquire any building developed by any member of the
Berg Group on the land subject to the Berg Land Holdings Option Agreement
at such time as the building has been leased. Upon our exercise of the
option, the option price will equal the sum of the following or a lesser
amount as approved by the Independent Directors Committee:
1. the full construction cost of the building; plus
2. 10% of the full construction cost of the building; plus
3. interest at LIBOR plus 1.65%, on the amount of the full construction
cost of the building for the period from the date funds were disbursed
by the developer to the close of escrow; plus
4. the original acquisition cost of the parcel on which the improvements
will be constructed, which range from $8.50 to $20.00 per square foot
for land currently owned or under option; plus
5. 10% per annum of the amount of the original acquisition cost of the
parcel from the later of January 1, 1998 and the seller's acquisition
date, to the close of escrow; minus
6. the aggregate principal amount of all debt encumbering the acquired
property.
- The acquisition cost, net of any debt, will be payable in cash, or O.P.
Units valued at the average closing price of our common stock over the
30-trading-day period preceding the acquisition or, in cash, at the option
of the Berg Group .
- We also must assume all property tax assessments.
- If we elect not to exercise the option with respect to any property, the
Berg Group may hold and lease the property for its own account, or may sell
it to a third party.
- All action taken by us under the Berg Land Holdings Option Agreement,
including any variations from stated terms outlined above must be approved
by a majority of the members of the Independent Directors Committee.
In addition, under the Acquisition Agreement, Carl E. Berg has agreed not to
directly or indirectly acquire or develop any real property zoned for office,
industrial or R&D use in the states of California, Oregon and Washington without
first disclosing and making the acquisition opportunity available to us. The
Independent Directors Committee decides whether we will pursue each opportunity
presented to us by Mr. Berg. This restriction will expire when there is no Berg
Group nominee on our board of directors and the Berg Group's fully diluted
ownership percentage, which is calculated based on all outstanding shares of
common stock and all shares of common stock that could be acquired upon the
exercise of all outstanding options to acquire our voting stock, as well as all
shares of common stock issuable upon exchange of all O.P. Units ("Fully
Diluted"), falls below 25%.
As a general policy which has been established by the Independent Directors
Committee, we do not acquire properties under the Berg Land Holdings Option
Agreement until they have been leased. We are responsible for a significant
portion of the leasing process in connection with such acquisitions, however.
The following table presents certain information concerning currently identified
land that we have the right to acquire under the Berg Land Holdings Option
Agreement.
Approximate Rentable Area
Available Land: Net Acres (Square Feet)
----------------------------------- ---------------------- ------------------------------
Piercy & Hellyer 30 490,000
Morgan Hill (1) 18 288,000
King Ranch 12 207,000
Fremont & Cushing 24 387,000
---------------------- ------------------------------
Total 84 1,372,000
====================== ==============================
(1) This land is owned by the TBI joint ventures partnership. We expect to own
an approximate 50% interest in the partnership through one of our operating
partnerships. The property will be operated and managed by the other joint
venture partner in the entity.
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Although we may acquire new properties or joint ventures available to us under
the terms of the Berg Land Holdings Option Agreement, subject to approval by the
Independent Directors Committee, there can be no assurance that we actually will
consummate any additional transactions. Furthermore, we have not yet determined
the means by which we would acquire and pay for any such properties or the
impact of any of the acquisitions on our business, results of operations,
financial condition, Funds from Operation ("FFO") or available cash for
distribution (see Item 1A, "Risk Factors - Our contractual business
relationships with the Berg Group present additional conflicts of interest which
may result in the realization of economic benefits or the deferral of tax
liabilities by the Berg Group without equivalent benefits to our stockholders").
OPPORTUNISTIC ACQUISITIONS
In addition to our potential acquisition opportunities under the Berg Land
Holdings Option Agreement, we believe our acquisitions experience, established
network of real estate and information technology professionals, and overall
financial condition will continue to provide opportunities for external growth.
In general, we will seek opportunistic acquisitions of high quality, well
located Silicon Valley R&D properties in situations where illiquidity or
inadequate management permit their acquisition at favorable prices, and where
our management skills and knowledge of Silicon Valley submarkets may facilitate
increases in cash flow and asset value.
Furthermore, our use of the operating partnership structure allows us to offer
prospective sellers the opportunity to contribute properties on a tax-deferred
basis in exchange for O.P. Units. Although we have not consummated any
transactions on this basis since our July 1, 1998 acquisition of the Berg Group
properties, this capacity to complete tax-deferred transactions with sellers of
real property further enhances our ability to acquire additional properties.
FOCUS ON SINGLE TENANT SILICON VALLEY R&D PROPERTIES
We intend to continue to emphasize the acquisition of single-tenant rather than
multi-tenant properties, a practice that has historically contributed to the
relatively low turnover and higher occupancy rates on our properties. We believe
that the relatively small number of tenants (75 total) leasing our properties,
mostly under the triple net lease structure, allows us to efficiently manage the
properties and to serve our tenants' needs without extensive in-house staff or
the assistance of a third-party property management organization. In addition,
this emphasis allows us to incur less expense for tenant improvements and
leasing commissions than multi-tenant, high turnover property owners. This
strategy also reduces the time and expense associated with obtaining building
permits and other governmental approvals. We believe that the relatively stable,
extended relationships that we have developed with our key tenants are valuable
in the expansion of our business.
RECENT RENTAL MARKET DEVELOPMENTS AND THEIR IMPACT ON OUR BUSINESS
All of the Company's properties are located in the Northern California area
known as Silicon Valley, which generally consists of portions of Santa Clara
County, Southwestern Alameda County, Southeastern San Mateo County and Eastern
Santa Cruz County. In the past several years, the Silicon Valley R&D property
market has fluctuated with the local economy. According to a recent report by
NAI BT Commercial Real Estate (the "BT Report"), vacancy rates for Silicon
Valley R&D property decreased from approximately 16.6% in late 2007 to 16.3% at
the end of 2008. Total vacant R&D square footage in Silicon Valley at the end of
the fourth quarter of 2008 amounted to approximately 25.1 million rentable
square feet, of which 17.7%, or 4.5 million rentable square feet, was sublease
space. According to the BT Report, in 2007, total positive net absorption (which
is the computation of gross square footage leased less gross new square footage
vacated for the period presented) amounted to approximately 2.9 million rentable
square feet, and in 2008, there was total negative net absorption of
approximately 33 thousand rentable square feet as local economic conditions
deteriorated due to a weakened economy, dysfunctional financial markets,
depressed housing, a falling stock market and rising unemployment rates.
According to the BT Report, the average asking market rent per square foot was
$1.26 at year-end for 2008 and 2007, although individual properties within any
particular submarket presently may be leased above or below the current average
asking market rental rates within that submarket and the region as a whole.
Moreover, the impact of vacancies has not been uniform throughout the area. The
Silicon Valley R&D property market is characterized by a substantial number of
submarkets, with rent and vacancy rates varying by submarket and location within
each submarket.
In addition, leasing activity for new build-to-suit and vacated R&D properties
has slowed considerably during the past several years. The time to complete the
marketing and lease up of vacant space has increased from an average of several
months to as much as an average of 18 to 40 months as a result of the
over-supply of R&D properties in the market.
For the years ended December 31, 2008 and 2007, the occupancy rates for leased
properties in our portfolio were 66.4% and 61.7%, respectively.
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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 tends to increase our leasing costs and
operating expenses and reduce the profitability of our leasing activities.
Although we scrutinize each prospective tenant's creditworthiness and
continually evaluate the financial capacity of both our prospective and existing
tenants, a downturn in tenants' businesses may weaken their financial condition
and could result in defaults under their lease obligations.
We believe that the average 2009 renewal rental rates for our properties will be
approximately equal to, or perhaps, below current market rents. Leases
representing approximately 370,000 rentable square feet, or 2.2% of our 2009
cash rent, are scheduled to expire during 2009. If we are unable to lease a
significant portion of any vacant space or space scheduled to expire; if we
experience significant tenant defaults as a result of the current economic
downturn; if we restructure existing leases and lower existing rents in order to
retain tenants for an extended term; if we increase our lease costs and
operating expenses substantially to accommodate multiple tenants in our R&D
properties; or if we are not able to lease space at or above current market
rates, our results of operations and cash flows will be affected adversely.
OPERATIONS
We operate as a self-administered, self-advised and self-managed REIT with our
own employees. As the sole general partner of the operating partnerships, we
control the business and assets of the operating partnerships and have full and
complete authority, discretion and responsibility with respect to the operating
partnerships' operations and transactions, including, without limitation,
acquiring additional properties, borrowing funds, raising new capital, leasing
buildings and selecting and supervising all agents of the operating
partnerships.
Although most of our leases are triple net and building maintenance and tenant
improvements are the responsibility of the tenants, from time to time we may be
required to undertake construction and repair work at our properties. We bid all
major work competitively to subcontractors. Members of the Berg Group may
participate in the competitive bidding for the work, but all contracts with the
Berg Group are subject to review and approval by the Independent Directors
Committee.
We generally market our properties and negotiate leases ourselves. We make the
availability of our properties known to the brokerage community to garner their
assistance in locating prospective tenants, however. As a result, we expect to
retain our policy of paying fixed commissions to tenants' brokers.
We believe that our business practices provide us with competitive advantages,
including -
- EXTERNAL DEVELOPMENT AFFILIATE. Until December 31, 2010, we have the option
to purchase all future R&D, office, industrial property developments of the
Berg Group under the Berg Land Holdings Option Agreement on land currently
held or acquired directly or indirectly by Carl E. Berg or Clyde J. Berg
that is zoned for those purposes and located in California, Oregon and
Washington following completion and lease-up of the property. The
acquisition terms and conditions for the existing and identified projects
have been pre-negotiated and are documented under the Berg Land Holdings
Option Agreement. This relationship provides us with the economic benefits
of development while eliminating development and initial lease-up risks. It
also provides us with access to one of the most experienced development
teams in the Silicon Valley without the expense of maintaining development
personnel.
- LEAN ORGANIZATION, EXPERIENCED TEAM. In part because of our primary focus
on Silicon Valley, our experience with the special real estate requirements
of information technology tenants and the long-term triple-net structure of
our leases, we are able to conduct and expand our business with a small
management team comprised of highly qualified and experienced professionals
working within a relatively flat organizational structure. We believe that
the leanness of our organization and our experience will enable us to
rapidly assess and respond to market opportunities and tenant needs,
control operating expenses and develop and maintain excellent relationships
with tenants. We further believe that these advantages translate into
significantly lower costs for operations and give us the ability, along
with the Berg Group, to compete favorably with other R&D property
developers in Silicon Valley, especially for build-to-suit projects subject
to competitive bidding. Furthermore, we believe this lower cost structure
allows us to generate better returns from properties whose value can be
increased through appropriate remodeling and efficient property management.
- SOUND PROPERTY MANAGEMENT PRACTICES. For each property, the management
team, along with the Berg Group staff, develops a specific marketing and
property management program. We select vendors and subcontractors on a
competitive bid basis from a select group of highly qualified firms with
whom we maintain ongoing relationships and carefully supervise their work.
- 5 -
OPERATING PARTNERSHIP AGREEMENTS
MANAGEMENT
The operating partnerships consist of four separate limited partnerships engaged
in the combined operation and ownership of all our properties. The operating
partnership agreements are identical in all material respects for all four of
the limited partnerships. Pursuant to the operating partnership agreements, we
act as the sole general partner of the operating partnerships, in which capacity
we have exclusive control of the business and assets of the operating
partnerships and generally have full and complete authority, discretion and
responsibility with respect to the operating partnerships' operations and
transactions, including, without limitation, acquisitions of additional
properties, borrowing funds, raising new capital, leasing buildings, as well as
selecting and supervising all employees and agents of the operating
partnerships. Through our authority to manage our business and affairs, our
Board of Directors directs the business of the operating partnerships.
Notwithstanding our effective control of the operating partnerships, the Berg
Group holds a substantial majority of the outstanding O.P. Units and the consent
of the limited partners holding a majority of the outstanding O.P. Units is
required with respect to certain extraordinary actions involving the operating
partnerships, including:
- the amendment, modification or termination of the operating partnership
agreements;
- a general assignment for the benefit of creditors or the appointment of a
custodian, receiver or trustee for any of the assets of the operating
partnerships;
- the institution of any proceeding for bankruptcy of the operating
partnerships;
- the transfer of any general partner interests in the operating
partnerships, including, with certain exceptions, transfers attendant to
any merger, consolidation or liquidation of our corporation;
- the admission of any additional or substitute general partner in the
operating partnerships; and
- a change of control of the operating partnerships.
In addition, until the ownership interest of the Berg Group and its affiliates
is less than 15% of the common stock on a Fully Diluted basis, the consent of
the limited partners holding a majority of the outstanding O.P. Units is also
required with respect to:
- the liquidation of the operating partnerships;
- the sale or other transfer of all or substantially all of the assets of the
operating partnerships and certain mergers and business combinations
resulting in the complete disposition of all O.P. Units; and
- the issuance of limited partnership interests having seniority as to
distributions, assets and voting over the O.P. Units.
TRANSFERABILITY OF O.P. UNITS
The operating partnership agreements provide that the limited partners may
transfer their O.P. Units, subject to certain limitations. Except for certain
transfers by the limited partners to or from certain of their affiliates,
however, all transfers may be made only with our prior written consent as the
sole general partner of the operating partnerships.
In addition, no transfer of O.P. Units by the limited partners may be made in
violation of certain regulatory and other restrictions set forth in the
operating partnership agreements. Except in the case of certain permitted
transfers to or from certain affiliates of the limited partners, the exchange
rights, the put rights, rights to participate in future equity financings and
provisions requiring the approval of certain limited partners for certain
matters will no longer be applicable to O.P. Units so transferred, and the
transferee will not have any rights to nominate persons to our Board of
Directors.
ADDITIONAL CAPITAL CONTRIBUTIONS AND LOANS
Each operating partnership agreement provides that, if the operating partnership
requires additional funds to pursue its investment objectives, we may fund such
investments by raising additional equity capital and making a capital
contribution to the operating partnerships or by borrowing such funds and
lending the net proceeds of such loans to the operating partnerships. If we
intend to provide additional funds through a contribution to capital and
purchase of units of general partner interest, the limited partners will have
the right to participate in such funding on a pro rata, pari passu basis and to
acquire additional O.P. Units. If the limited partners do not participate in
such financing, we will acquire additional units of general partner interest. In
either case, the number of additional units of partnership interest will be
increased based upon the amount of the additional capital contributions and the
value of the operating partnerships as of the date such contributions are made.
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In addition, as general partner of the operating partnerships, we have the
ability to cause the operating partnerships to issue additional O.P. Units. In
the event that the operating partnerships issue new O.P. Units for cash but not
property, the limited partners will have the right to purchase new O.P. Units at
the price we offer in the transaction giving rise to such participation right in
order, and to the extent necessary, to maintain their respective percentage
interests in the operating partnerships.
EXCHANGE RIGHTS, PUT RIGHTS AND REGISTRATION RIGHTS
Under the Exchange Rights Agreement between us and the limited partners, the
limited partners have exchange rights that generally became exercisable on
December 29, 1999. The Exchange Rights Agreement permits every limited partner
to tender O.P. Units to us, and, at our election, to receive common stock on a
one-for-one basis at then-current market value, an equivalent amount of cash, or
a combination of cash and common stock in exchange for the O.P. Units tendered,
subject to the 9% overall ownership limit imposed on non-Berg Group stockholders
under our charter document, or the overall 20% Berg Group ownership limit, as
the case may be. For more information, please refer to Item 1A, "Risk Factors -
Failure to satisfy federal income tax requirements for REITs could reduce our
distributions, reduce our income and cause our stock price to fall." This
exchange ratio is subject to adjustment for stock splits, stock dividends,
recapitalizations of our common stock and similar types of corporate actions. In
addition, once in each 12-month period beginning each December 29, the limited
partners, other than Carl E. Berg and Clyde J. Berg, may exercise a put right to
sell their O.P. Units to the operating partnerships at a price equal to the
average market price of the common stock for the 10-trading day period
immediately preceding the date of tender. Upon any exercise of the put rights,
we will have the opportunity for a period of 15 days to elect to fund the
purchase of the O.P. Units and purchase additional general partner interests in
the operating partnerships for cash, unless the purchase price exceeds $1
million in the aggregate for all tendering limited partners, in which case, the
operating partnerships or we will be entitled, but not required, to reduce
proportionally the number of O.P. Units to be acquired from each tendering
limited partner so that the total purchase price is not more than $1 million.
Through December 31, 2008 no limited partner ever has exercised this put right.
The number of shares of our common stock issuable in exchange for the total
number of O.P. Units outstanding at July 1, 1998 and the O.P. Units issued
pursuant to the Pending Projects Acquisition Agreement were registered under the
Securities Act and generally may be sold without restriction if they are
acquired by limited partners that are not affiliates, as defined under SEC Rule
144. For more information please refer to Item 1A, "Risk Factors - Shares
eligible for future sale could affect the market price of our stock." The
Exchange Rights Agreement gives the holders of O.P. Units the right to
participate in any registered public offering of the common stock initiated by
us to the extent of 25% of the total shares sold in the offering upon converting
O.P. Units to shares of common stock, but subject to the underwriters' unlimited
right to reduce the participation of all selling stockholders. The holders of
O.P. Units will be able to request resale registrations of shares of common
stock acquired on exchange of O.P. Units on a Form S-3, or any equivalent form
of registration statement, subject to limitations and restrictions contained in
the Exchange Rights Agreement. In April 2006, we registered up to 86,088,095
shares of common stock issuable on exchange of O.P. Units for resale pursuant to
the prospectus included in a registration statement on Form S-3 that the SEC
declared effective on April 28, 2006. We intend to maintain the effectiveness of
this registration statement in order to facilitate re-sales of shares of common
stock acquired by O.P. Unit holders from time to time without volume limitations
or other resale restrictions under SEC Rule 144.
OTHER MATTERS
The operating partnership agreements require that the operating partnerships be
operated in a manner that will enable us to satisfy the requirements for being
classified as a REIT and to avoid any federal income or excise tax liability.
The operating partnership agreements provide that the combined net operating
cash flow from all the operating partnerships, as well as net sales and
refinancing proceeds, will be distributed from time to time as determined by our
Board of Directors, but not less frequently than quarterly, pro rata in
accordance with the partners' percentage interests in the operating
partnerships, taken as a whole. This provision is intended to cause the periodic
distributions per O.P. Unit and per share of our common stock to be equal. As a
consequence of this provision, the capital interest of a partner in each of the
operating partnerships, including our capital interests, might at times differ
significantly from the partner's percentage interest in the net income and cash
flow of that operating partnership. We do not believe that such differences
would have a material impact on our business, financial condition or funds
available for distributions, however.
Pursuant to the operating partnership agreements, the operating partnerships
will also assume and pay when due, or reimburse us for payment of, certain costs
and expenses relating to our continuity of existence and operations.
The operating partnership agreements provide that, upon the exercise of an
outstanding option under the 2004 Equity Incentive Plan (including options
granted originally under the 1997 Stock Option Plan), we may purchase additional
general partner interests in the operating partnerships by contributing the
exercise proceeds to the operating partnerships. Our increased interest will be
equal to the percentage of outstanding shares of common stock and O.P. Units on
an as-converted basis represented by the shares acquired upon exercise of the
option.
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TERM
The operating partnerships will continue in full force and effect until December
31, 2048 or until sooner dissolved pursuant to the terms of the operating
partnership agreements.
EMPLOYEES
As of February 28, 2009, we employed six people, all of whom work at our
executive offices at 10050 Bandley Drive, Cupertino, California, 95014.
FACILITIES
We lease office space at 10050 Bandley Drive, Cupertino, California from Berg &
Berg Enterprises, Inc. and share clerical staff and other overhead on what we
consider to be favorable terms. The total monthly rent payable by us to Berg &
Berg Enterprises, Inc. is $10,000.
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ITEM 1A. RISK FACTORS
YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING RISKS, TOGETHER WITH THE OTHER
INFORMATION CONTAINED ELSEWHERE IN THIS FORM 10-K. THE FOLLOWING RISKS RELATE
PRINCIPALLY TO OUR BUSINESS AND THE INDUSTRY IN WHICH WE OPERATE. THE RISKS AND
UNCERTAINTIES CLASSIFIED BELOW ARE NOT THE ONLY ONES WE FACE.
SILICON VALLEY MARKET AND ECONOMIC CONDITIONS.
In the Silicon Valley, recent market and economic conditions have been
unprecedented and challenging with tighter credit conditions and slower growth
through the fourth quarter of 2008. For the year ended December 31, 2008,
continued concerns about the systemic impact of inflation, energy costs, the
availability and cost of credit and a declining real estate market have
contributed to increased market volatility and diminished expectations for the
Silicon Valley economy. These conditions, combined with declining business and
consumer confidence and increased unemployment have contributed to volatility of
unprecedented levels.
As a result of these market conditions, the cost and availability of credit has
been and may continue to be adversely affected by illiquid credit markets and
wider credit spreads. Concern about the stability of the markets generally and
the strength of counterparties specifically has led many lenders and
institutional investors to reduce, and in some cases, cease to provide funding
to borrowers. Continued turbulence in the Silicon Valley economy may adversely
affect the financial condition and the liquidity and financial condition of our
tenants and result in a significantly higher level of defaults. If these market
conditions continue, they may limit our ability and the ability of our tenants,
to timely refinance maturing liabilities and access the capital markets to meet
liquidity needs, resulting in adverse effects on our financial condition and
results of operations.
WE MAY NOT BE ABLE TO OBTAIN ADDITIONAL CAPITAL TO FURTHER OUR BUSINESS
OBJECTIVES.
Our ability to acquire properties depends upon our ability to obtain capital.
The real estate industry is currently experiencing a volatile capital market.
The lack of capital is expected to cause a decrease in the level of new
investment activity. An inability to obtain debt capital on acceptable terms
could delay or prevent us from acquiring desirable investments.
WE ARE DEPENDENT ON CARL E. BERG, AND IF WE LOSE HIS SERVICES OUR BUSINESS MAY
BE HARMED AND OUR STOCK PRICE COULD FALL.
We are substantially dependent upon the leadership of Carl E. Berg, our Chairman
and Chief Executive Officer. Losing Mr. Berg's knowledge and abilities could
have a material adverse effect on our business and the value of our common
stock. Mr. Berg manages our day-to-day operations and devotes a significant
portion of his time to our affairs, but he has a number of other business
interests as well. These other activities reduce Mr. Berg's attention to our
business.
MR. BERG AND HIS AFFILIATES EFFECTIVELY CONTROL OUR CORPORATION AND THE
OPERATING PARTNERSHIPS AND MAY ACT IN WAYS THAT ARE DISADVANTAGEOUS TO OTHER
STOCKHOLDERS.
SPECIAL BOARD VOTING PROVISIONS
Our governing corporate documents, which are our articles of amendment and
restatement, or charter, and our bylaws, provide substantial control rights for
the Berg Group. The Berg Group's control of our corporation means that the value
and returns from an investment in the Company's common stock are subject to the
Berg Group's exercise of its rights. These rights include a requirement that Mr.
Berg or his designee as director approve certain fundamental corporate actions,
including amendments to our charter and bylaws and any merger, consolidation or
sale of all or substantially all of our assets. In addition, our bylaws provide
that a quorum necessary to hold a valid meeting of the Board of Directors must
include Mr. Berg or his designee. The rights described in the two preceding
sentences apply only as long as the Berg Group members and their affiliates,
other than us and the operating partnerships, beneficially own, in the
aggregate, at least 15% of our outstanding shares of common stock on a Fully
Diluted basis. Also, directors representing more than 75% of the entire Board of
Directors must approve other significant transactions, such as incurring debt
above certain amounts and conducting business other than through the operating
partnerships. Without the approval of Mr. Berg or his designee, the Board of
Directors' approval that we may need for actions that might result in a sale of
your stock at a premium or raising additional capital when needed could be
difficult or impossible to obtain.
BOARD OF DIRECTORS REPRESENTATION
The Berg Group members have the right to designate two of the director nominees
submitted by our Board of Directors to stockholders for election, as long as the
Berg Group members and their affiliates, other than us and the operating
partnerships, beneficially own, in the aggregate, at least 15% of our
outstanding shares of common stock calculated on a Fully Diluted basis. If the
Fully Diluted ownership of the Berg Group members and their affiliates, other
than us and the operating partnerships, is less than 15% but is at least 10% of
the common stock, the Berg Group members have the right to designate one of the
director nominees submitted by our Board of Directors to stockholders for
election. Its right to designate director nominees affords the Berg Group
substantial control and influence over the management and direction of our
corporation. The Berg Group's interests could conflict with the interests of our
stockholders and could adversely affect the price of our common stock.
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SUBSTANTIAL OWNERSHIP INTEREST
The Berg Group currently owns O.P. Units representing approximately 74.1% of the
equity interests in the operating partnerships and approximately 73.7% of our
equity interests on a Fully Diluted basis as of December 31, 2008. The O.P.
Units may be converted into shares of common stock, subject to limitations set
forth in our charter and other agreements with the Berg Group, and upon
conversion would represent voting control of our corporation. The Berg Group's
ability to exchange its O.P. Units for common stock permits it to exert
substantial influence over the management and direction of our corporation. This
influence increases our dependence on the Berg Group.
LIMITED PARTNER APPROVAL RIGHTS
Mr. Berg and other limited partners, including other members of the Berg Group,
may restrict our operations and activities through rights provided under the
terms of the amended and restated agreement of limited partnership which governs
each of the operating partnerships and our legal relationship to each operating
partnership as its general partner. Matters requiring approval of the holders of
a majority of the O.P. Units, which necessarily would include the Berg Group,
include the following:
- the amendment, modification or termination of any of the operating
partnership agreements;
- the transfer of any general partner interest in the operating partnerships,
including, with certain exceptions, transfers attendant to any merger,
consolidation or liquidation of our corporation;
- the admission of any additional or substitute general partners in the
operating partnerships;
- any other change of control of the operating partnerships;
- a general assignment for the benefit of creditors or the appointment of a
custodian, receiver or trustee for any of the assets of the operating
partnerships; and
- the institution of any bankruptcy proceeding for any operating partnership.
In addition, as long as the Berg Group members and their affiliates, other than
us and the operating partnerships, beneficially own, in the aggregate, at least
15% of the outstanding shares of common stock on a Fully Diluted basis, the
consent of the limited partners holding the right to vote a majority of the
total number of O.P. Units outstanding is also required with respect to:
- the sale or other transfer of all or substantially all of the assets of the
operating partnerships and certain mergers and business combinations
resulting in the complete disposition of all O.P. Units;
- the issuance of limited partnership interests senior to the O.P. Units as
to distributions, assets and voting; and
- the liquidation of the operating partnerships.
The liquidity of an investment in the Company's common stock, including our
ability to respond to acquisition offers, will be subject to the exercise of
these rights.
OUR CONTRACTUAL BUSINESS RELATIONSHIPS WITH THE BERG GROUP PRESENT ADDITIONAL
CONFLICTS OF INTEREST, WHICH MAY RESULT IN THE REALIZATION OF ECONOMIC BENEFITS
OR THE DEFERRAL OF TAX LIABILITIES BY THE BERG GROUP WITHOUT EQUIVALENT BENEFITS
TO OUR STOCKHOLDERS.
Our contracts with the Berg Group provide it with interests that could conflict
with those of our other stockholders, including the following:
- our headquarters are leased from an entity owned by the Berg Group, to whom
we pay rent of $10,000 per month;
- the Berg Group is permitted to conduct real estate and business activities
other than our business;
- if we decline an opportunity that has been offered to us, the Berg Group
may pursue it, which would reduce the amount of time that Mr. Berg could
devote to our affairs and could result in the Berg Group's development of
properties that compete with our properties for tenants;
- in general, we have agreed to limit the liability of the Berg Group to our
corporation and our stockholders arising from the Berg Group's pursuit of
these other opportunities;
- we acquired most of our properties from the Berg Group on terms that were
not negotiated at arm's length and without many customary representations
and warranties that we would have sought in an acquisition from an
unrelated party; and
- we have assumed liability for debt to the Berg Group and debt for which the
Berg Group was liable.
The Berg Group has agreed that the Independent Directors Committee of our Board
of Directors must approve all new transactions between us and any of its
members, or between us and any entity in which it directly or indirectly owns 5%
or more of the equity interests, including the operating partnerships for this
purpose. This committee currently consists of three directors who are
independent of the Berg Group.
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BERG LAND HOLDINGS
The Berg Group owns several parcels of unimproved land in the Silicon Valley
that the operating partnerships and we have the right to acquire under the terms
of the Berg Land Holdings Option Agreement. We have agreed to pay an amount
based on pre-negotiated terms for any of the properties that we do acquire. We
must pay the acquisition price in cash unless the Berg Group elects, in its
discretion, to receive O.P. Units valued at the average market price of a share
of common stock during the 30-trading-day period preceding the acquisition date.
At the time of acquisition, which is subject to the approval of the Independent
Directors Committee, these properties may be encumbered by debt that we or the
operating partnerships will be required to assume or repay. The use of our cash
or an increase in our indebtedness to acquire these properties could have a
material adverse effect on our financial condition, results of operations and
ability to make cash distributions to our stockholders. This agreement will
expire on December 31, 2010, after which we will no longer have the right to
acquire properties from the Berg Group or the pre-determined terms provided in
that agreement.
TERMS OF TRANSFERS: ENFORCEMENT OF AGREEMENT OF LIMITED PARTNERSHIP
The terms of the Pending Projects Acquisition Agreement, the Berg Land Holdings
Option Agreement, the partnership agreement of each operating partnership and
other material agreements through which we have acquired our interests in the
operating partnerships and the properties formerly controlled by the Berg Group
were not determined through arm's-length negotiations and could be less
favorable to us than those obtained from an unrelated party. In addition, Mr.
Berg and representatives of the Berg Group sitting on our Board of Directors may
be subject to conflicts of interests with respect to their obligations as our
directors to enforce the terms of the partnership agreement of each operating
partnership when such terms conflict with their personal interests. The terms of
our charter and bylaws also were not determined through arm's-length
negotiations. Some of these terms, including representations and warranties
applicable to acquired properties, are not as favorable as those that we would
have sought through arm's-length negotiations with unrelated parties. As a
result, an investment in our common stock may involve risks not found in
businesses in which the terms of material agreements have been negotiated at
arm's length.
RELATED PARTY DEBT
We are liable under a mortgage loan of approximately $8.8 million due June 2013,
which was extended from the original maturity date of June 2010, in connection
with our acquisition of the 5300-5350 Hellyer Avenue R&D properties that we
acquired in May 2000 under the Berg Land Holdings Option Agreement. If we are
unable to repay our debt to the Berg Group when due, the Berg Group could take
action to enforce our payment obligations. Potential actions by the Berg Group
to enforce these obligations could result in the foreclosure in one or more of
our properties and a reduction in the amount of cash distributions to our
stockholders. In turn, if we fail to meet the minimum distributions test because
of a loan default or another reason, we could lose our REIT classification for
federal income tax purposes. For more information please refer to Item 1A, "Risk
Factors - Failure to satisfy federal income tax requirements for REITs could
reduce our distributions, reduce our income and cause our stock price to fall."
OUR OPTION TO ACQUIRE R&D PROPERTIES DEVELOPED ON EXISTING LAND AND LAND
ACQUIRED IN THE FUTURE BY THE BERG GROUP WILL TERMINATE WHEN THE BERG GROUP'S
OWNERSHIP INTEREST HAS BEEN REDUCED, OR IF EARLIER, ON DECEMBER 31, 2010.
The Berg Land Holdings Option Agreement, as amended, which provides us with
significant benefits and opportunities to acquire additional R&D properties from
the Berg Group, will expire on the earlier of December 31, 2010 and the date on
which the Berg Group and their affiliates (excluding us and the operating
partnerships) own less than 65% of our common stock on a Fully Diluted basis.
Although we do not currently perceive growth opportunities from the land that is
subject to the Berg Land Holdings Option Agreement, it is possible that the
termination of that agreement will result in limitation of our growth, which
could cause our stock price to fall.
WE MAY CHANGE OUR INVESTMENT AND FINANCING POLICIES AND INCREASE YOUR RISK
WITHOUT STOCKHOLDER APPROVAL.
Our Board of Directors determines the investment and financing policies of the
operating partnerships and our policies with respect to certain other
activities, including our business growth, debt capitalization, distribution,
and operating policies. Our Board of Directors may amend these policies at any
time without a vote of the stockholders. Changes in these policies could
materially adversely affect our financial condition, results of operations and
ability to make cash distributions to our stockholders, which could harm our
business and cause our stock price to fall. For more information please refer to
Item 7, "Management's Discussion and Analysis of Financial Condition and Results
of Operations - Policies with Respect to Certain Activities."
ANTI-TAKEOVER PROVISIONS IN OUR CHARTER COULD PREVENT ACQUISITIONS OF OUR STOCK
AT A SUBSTANTIAL PREMIUM.
Provisions of our charter and our bylaws could delay, defer or prevent a
transaction or a change in control of our corporation, or a similar transaction,
that might involve a premium price for our shares of common stock or otherwise
be in the best interests of our stockholders. Provisions of the Maryland general
corporation law, which would apply to potential business combinations with
acquirers other than the Berg Group or stockholders who invested in us in
December 1998, also could prevent the acquisition of our stock for a premium, as
discussed in "Certain Provisions of Maryland Law and of our Charter and Bylaws."
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AN INVESTMENT IN OUR STOCK INVOLVES RISKS RELATED TO REAL ESTATE INVESTMENTS
THAT COULD HARM OUR BUSINESS AND CAUSE OUR STOCK PRICE TO FALL.
RENTAL INCOME VARIES
Real property investments are subject to varying degrees of risk. Investment
returns available from equity investments in real estate depend in large part on
the amount of income earned and capital appreciation, which our properties
generate, as well as our related expenses incurred. If our properties do not
generate revenues sufficient to meet operating expenses, debt service and
capital expenditures, our income and ability to make distributions to our
stockholders will be adversely affected. Income from our properties may also be
adversely affected by general economic conditions, local economic conditions
such as oversupply of commercial real estate, the attractiveness of our
properties to tenants and prospective tenants, competition from other available
rental property, our ability to provide adequate maintenance and insurance, the
cost of tenant improvements, leasing commissions and tenant inducements and the
potential of increased operating costs, including real estate taxes.
EXPENDITURES FOR PROPERTY OWNERSHIP ARE FIXED
Income from properties and real estate values also are affected by a variety of
other factors, such as governmental regulations and applicable laws, including
real estate, zoning and tax laws, interest rate levels and the availability of
financing. Various significant expenditures associated with an investment in
real estate, such as mortgage payments, real estate taxes and maintenance
expenses, generally are not reduced when circumstances cause a reduction in
revenue from the investment. Thus, our operating results and our cash flow may
decline materially if our rental income is reduced.
ILLIQUIDITY
Real estate investments are relatively illiquid, which limits our ability to
restructure our portfolio in response to changes in economic or other
conditions.
GEOGRAPHIC CONCENTRATION
All of our properties are located in the southern portion of the San Francisco
Bay Area commonly referred to as the "Silicon Valley." The Silicon Valley
economy has weakened after relatively recent years and there remains significant
excess capacity for R&D properties in the Silicon Valley. At present, future
increases in values and rents for our properties depend to a significant extent
on a strong recovery of this region's economy, which we do not currently
foresee.
LOSS OF KEY TENANTS
Single tenants, many of whom are large, publicly traded information technology
companies, occupy most of our properties. We may lose tenants when existing
leases expire because it may be difficult to re-lease the same property due to
substantial overcapacity of R&D properties in the Silicon Valley at present.
Losing a key tenant could adversely affect our operating results and our ability
to make distributions to stockholders if we are unable to obtain replacement
tenants promptly. Moreover, to retain key tenants upon the expiration of
existing leases we may need to reduce rents, which also could adversely affect
our operating results and ability to make distributions.
TENANT BANKRUPTCIES
Key tenants could seek the protection of the bankruptcy laws, which could result
in the rejection and termination of their leases, thereby causing a reduction in
our rental income. Under the bankruptcy laws, these tenants may have the right
to reject their leases with us and our claim for rent will be limited to the
greater of one year or 15% of the total amount owing under the leases upon
default, but not to exceed three years of the remaining term of the lease
following the earlier of the petition filing date or the date on which we gained
repossession of the property, as well as any rent that was unpaid on the earlier
of those dates.
OUR SUBSTANTIAL INDEBTEDNESS
Our properties are subject to substantial indebtedness. If we are unable to make
required mortgage payments, we could sustain a loss as a result of foreclosure
on our properties by the mortgagor. Furthermore, our mortgage loans may be
subject to covenants that we are obligated to satisfy. For example, under our
mortgage loan agreements with Northwestern Mutual Life Insurance Company, the
payment of all $100 million outstanding could be accelerated upon the sale or
certain other transfers of more than 51% of the total number of O.P. Units and
shares of common stock of the Company held by the members of the Berg Group. We
have no reason to expect such a sale or transfer in the foreseeable future, but
the members of the Berg Group have no obligation to us to refrain from any such
sale or other transfer. We have adopted a policy of maintaining a consolidated
ratio of debt to total market capitalization, which includes for this purpose
the market value of all shares of common stock for which outstanding O.P. Units
are exchangeable, of less than 50%. This ratio may not be exceeded without the
approval of more than 75% of our entire Board of Directors. Our Board of
Directors may vote to change this policy, however, and we could become more
highly leveraged, resulting in an increased risk of default on our obligations
and an increase in debt service requirements that could adversely affect our
financial condition, our operating results and our ability to make distributions
to our stockholders.
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ENVIRONMENTAL CLEAN-UP LIABILITIES
Our properties may expose us to liabilities under applicable environmental and
health and safety laws. If these liabilities are material, our financial
condition and ability to pay cash distributions may be affected adversely, which
would cause our stock price to fall.
UNINSURED LOSSES
We may sustain uninsured losses with respect to some of our properties. If these
losses are material, our financial condition, our operating results and our
ability to make distributions to our stockholders may be affected adversely.
EARTHQUAKE DAMAGES ARE UNINSURED
All of our properties are located in areas that are subject to earthquake
activity. Our insurance policies do not cover damage caused by seismic activity
although they do cover losses from fires after an earthquake. We generally do
not consider such insurance coverage to be economical. If an earthquake occurs
and results in substantial damage to our properties, we could lose our
investment in those properties, which loss could have a material adverse effect
on our financial condition, our operating results and our ability to make
distributions to our stockholders.
OUR REAL ESTATE ASSETS MAY BE SUBJECT TO IMPAIRMENT CHARGES.
We continually evaluate the recoverability of the carrying value of our real
estate assets for impairment indicators. Factors considered in evaluating
impairment of our existing real estate assets include significant declines in
property operating profits, recurring property operating losses and other
significant adverse changes in general market conditions that are considered
permanent in nature. Generally, a real estate asset is not considered impaired
if the undiscounted, estimated future cash flows of the asset over its estimated
holding period are in excess of the asset's net book value at the balance sheet
date. Assumptions used to estimate annual and residual cash flow, the estimated
holding period of such assets, the lease up period when properties are vacant
and future rental income require the judgment of management. Actual results
could be different than our estimates.
There can be no assurance that we will not take impairment charges in the future
related to the impairment of our assets. As of the years ended December 31, 2008
and 2007, management believed it had applied reasonable estimates and judgments
in determining the proper classification of its real estate assets. However,
should external or internal circumstances change requiring the need to shorten
the holding periods or adjust the estimated future cash flows of certain of our
assets, we could be required to record additional impairment charges. If any
real estate asset held for sale is considered impaired, a loss is provided to
reduce the carrying value of the asset to its fair value, less selling costs.
Any future impairment could have a material adverse affect on the Company's
results of operations and funds from operations in the period in which the
charge is taken.
FAILURE TO SATISFY FEDERAL INCOME TAX REQUIREMENTS FOR REITS COULD REDUCE OUR
DISTRIBUTIONS, REDUCE OUR INCOME AND CAUSE OUR STOCK PRICE TO FALL.
FAILURE TO QUALIFY AS A REIT
Although we currently operate in a manner designed to enable us to qualify and
maintain our REIT status, it is possible that economic, market, legal, tax or
other considerations may cause us to fail to qualify as a REIT or may cause our
Board of Directors either to refrain from making the REIT election or to revoke
that election once made. To maintain REIT status, we must meet certain tests for
income, assets, distributions to stockholders, ownership interests, and other
significant conditions. If we fail to qualify as a REIT in any taxable year, we
will not be allowed a deduction for distributions to our stockholders in
computing our taxable income and would be subject to federal income tax,
including any applicable alternative minimum tax, on our taxable income at
regular corporate rates. Moreover, unless we were entitled to relief under
certain provisions of the tax laws, we would be disqualified from treatment as a
REIT for the four taxable years following the year in which our qualification
was lost. As a result, funds available for distributions to our stockholders
would be reduced for each of the years involved and, in addition, we would no
longer be required to make distributions to our stockholders.
REIT DISTRIBUTION REQUIREMENTS
To maintain REIT status, we must distribute as a dividend to our stockholders at
least 90% of our otherwise net taxable income, after certain adjustments, with
respect to each tax year. We also may be subject to a 4% non-deductible excise
tax in the event our distributions to stockholders fail to meet certain other
requirements. Failure to comply with these requirements could result in our
income being subject to tax at regular corporate rates and could cause us to be
liable for the excise tax.
OWNERSHIP LIMIT NECESSARY TO MAINTAIN REIT QUALIFICATION
As a REIT, the federal tax laws restrict the percentage of the total value of
our stock that may be owned by five or fewer individuals to 50% or less. Our
charter generally prohibits the direct or indirect ownership of more than 9% of
our common stock by any stockholder. This limit excludes the Berg Group, which
has an aggregate ownership limit of 20%. In addition, as permitted by our
charter, our Board of Directors has authorized an exception applicable to two
other stockholders that permits them to collectively own, directly or
indirectly, up to 18.5% of our common stock on an aggregate basis, subject to
the terms of an ownership limit exemption agreement. In general, our charter
prohibits the transfer of shares that result in a loss of our REIT qualification
and provides that any
- 13 -
such transfer or any other transfer that causes a stockholder to exceed the
ownership limit will result in the shares being automatically transferred to a
trust for the benefit of a charitable beneficiary. Accordingly, in the event
that either the Berg Group or the two stockholders increase their stock
ownership in our corporation, a stockholder who acquires shares of our common
stock, even though his, her or its aggregate ownership may be less than 9%, may
be required to transfer a portion of that stockholder's shares to such a trust
in order to preserve our status as a REIT.
STOCKHOLDERS ARE NOT ASSURED OF RECEIVING CASH DISTRIBUTIONS FROM US.
Our income consists primarily of our share of the income of the operating
partnerships, and our cash flow consists primarily of our share of distributions
from the operating partnerships. Differences in timing between the receipt of
income and the payment of expenses in arriving at our taxable income or the
taxable income of the operating partnerships and the effect of required debt
amortization payments could require us to borrow funds, directly or through the
operating partnerships, on a short-term basis to meet our intended distribution
policy.
Our Board of Directors will determine the amount and timing of distributions by
the operating partnerships and of distributions to our stockholders. Our Board
of Directors will consider many factors prior to making any distributions,
including the following:
- the amount of cash available for distribution;
- availability of financing;
- 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 our existing agreements with the Berg Group;
- the amount of our annual debt service requirements;
- the annual distribution requirements under the REIT provisions of the
federal income tax laws;
- our projected rental rates and revenues;
- our ability to collect rent payments;
- prospects of tenant renewals and re-leases of properties subject to
expiring leases;
- cash required for re-leasing activities; and o such other factors as our
Board of Directors deem relevant.
We cannot assure you that we will be able to meet or maintain our cash
distribution objectives.
OUR PROPERTIES COULD BE SUBJECT TO PROPERTY TAX REASSESSMENTS.
We do not believe that the acquisition of any of our interests in the operating
partnerships has resulted in a statutory change in ownership that could give
rise to a reassessment of any of our properties for California property tax
purposes. We cannot assure you, however, that county assessors or other tax
administrative agencies in California will not attempt to assert that such a
change occurred as a result of these transactions. Although we believe that such
a challenge would not be successful ultimately, we cannot assure you regarding
the outcome of any related dispute or proceeding. A reassessment could result in
increased real estate taxes on our properties that, as a practical matter, we
may be unable to pass through to our tenants in full. This could reduce our net
income and our funds available for distributions and cause our stock price to
fall.
OUR OBLIGATION TO PURCHASE TENDERED O.P. UNITS COULD REDUCE OUR CASH
DISTRIBUTIONS.
Each of the limited partners of the operating partnerships, other than Carl E.
Berg and Clyde J. Berg, has the annual right to cause the operating partnerships
to purchase the limited partner's O.P. Units at a purchase price based on the
average market value of the common stock for the ten-trading-day period
immediately preceding the date of tender. Upon a limited partner's exercise of
any such right, we will have the option to purchase the tendered O.P. Units with
available cash, borrowed funds or the proceeds of an offering of newly issued
shares of common stock. These put rights became exercisable on December 29,
1999, and are available once during a 12-month period. If the total purchase
price of the O.P. Units tendered by all of the eligible limited partners in one
year exceeds $1 million, the operating partnerships or we will be entitled, but
not required, to reduce proportionately the number of O.P. Units to be acquired
from each tendering limited partner so that the total purchase price does not
exceed $1 million. Thus, we might repurchase O.P. Units for a total purchase
price of more than $1 million in one year. The exercise of these put rights may
reduce the amount of cash that we have available to distribute to our
stockholders and could cause our stock price to fall.
In addition, all O.P. Unit holders may tender their O.P. Units to us in exchange
for shares of common stock on a one-for-one basis at then-current market value
or an equivalent amount in cash, at our election. If we elect to pay cash for
the O.P. Units, our liquidity may
- 14 -
be reduced and we may lack sufficient funds to continue paying the amount of our
anticipated or historical cash distributions. This could cause our stock price
to fall.
SHARES ELIGIBLE FOR FUTURE SALE COULD AFFECT THE MARKET PRICE OF OUR STOCK.
We cannot predict the effect, if any, that future sales of shares of common
stock, or the availability of shares for future sale, could have on the market
price of our common stock. As of December 31, 2008, all outstanding shares of
our common stock, other than shares controlled by affiliates, were eligible for
sale in the public market without resale restrictions under the federal
securities laws. Sales of substantial amounts of common stock, including shares
issued in connection with the exercise of the exchange rights held by the
limited partners of the operating partnerships, or the perception that such
sales could occur, could adversely affect prevailing market prices for the
common stock. Additional shares of common stock may be issued to limited
partners, subject to the applicable REIT qualification ownership limit, if they
exchange their O.P. Units for shares of common stock pursuant to their exchange
rights, or may be sold by us to raise funds required to purchase such O.P. Units
if eligible limited partners elect to tender O.P. Units to us using their put
rights. Shares of stock controlled by our affiliates may be sold subject to Rule
144, including the limitation under Rule 144(e) on the number of shares that may
be sold within a three-month period. In addition, pursuant to a registration
statement on Form S-3 declared effective by the SEC in April 2006, all shares of
common stock acquired upon exchange of currently outstanding O.P. Units may be
resold without any such restrictions. Additional common stock reserved under our
2004 Equity Incentive Plan, including stock options, also may be sold in the
market at some time in the future. Future sales of our common stock in the
market could adversely affect the price of our common stock.
MARKET INTEREST RATES MAY REDUCE THE VALUE OF THE COMMON STOCK.
One of the factors that investors consider important in deciding whether to buy
or sell shares of a REIT is the distribution rate on such shares, as a
percentage of the price of such shares, relative to market interest rates. If
market interest rates go up, prospective purchasers of REIT shares may expect a
higher distribution rate. Higher interest rates would not, however, increase the
funds available for us to distribute, and, in fact, would likely increase our
borrowing costs and decrease funds available for distributions. Thus, higher
market interest rates could cause the price of our common stock to fall.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
- 15 -
ITEM 2. PROPERTIES
GEOGRAPHIC AND TENANT FOCUS
We focus principally on the facility requirements of information technology
companies in the Silicon Valley, which include space for office, R&D, light
manufacturing and assembly. With the Silicon Valley's highly educated and
skilled work force, history of numerous successful start-up companies and large
contingent of venture capital firms, we believe that this region will, following
the current significant slowdown in the market, continue to spawn successful new
high-growth industries and entrepreneurial businesses to an extent matched
nowhere else in the United States. We believe that our focus and thorough
understanding of the Silicon Valley real estate market enables us to:
- anticipate trends in the market;
- identify and concentrate our efforts on the most favorably located
sub-markets;
- take advantage of our experience and extensive contacts and relationships
with local government agencies, real estate brokers and subcontractors, as
well as with tenants and prospective tenants; and
- identify strong tenants.
All of our properties are general-purpose R&D/office type properties located in
desirable sub-markets of the Silicon Valley. Many of our properties have been
developed for or leased to single tenants, many of whom are large, publicly
traded information technology companies. Most of our major tenants have occupied
our properties for many years under triple-net leases that require the tenant to
pay substantially all operating costs, including property insurance, real estate
taxes and general operating costs.
LEASING
The current leases for our properties have terms ranging from month-to-month to
12 years. Most of the leases provide for fixed periodic rental increases.
Substantially all of the leases are triple-net leases pursuant to which the
tenant is required to pay substantially all of the property operating expenses,
including all maintenance and repairs, property taxes and insurance, and
excluding only certain structural repairs to the building shell. Most of the
leases contain renewal options that allow the tenant to extend the lease based
on adjustments to then prevailing market rates, or based on fixed rental
adjustments, which may be at or below market rates.
PROPERTY PORTFOLIO
All of our properties are R&D/office type properties. Generally, these
properties are one- to two-story buildings of tilt-up concrete construction,
have on average 3.5 or more parking spaces per thousand rentable square feet,
clear ceiling heights of less than 18 feet, and range in size from approximately
4,500 to 211,000 rentable square feet. Most of the office space is open and
suitable for configuration to meet the tenants' requirements with the use of
movable dividers.
The following table sets forth certain information relating to our properties as
of December 31, 2008:
Major
Tenants'
Total Percentage Average Rentable
No. of Rentable Occupied as of 2008 Sq. Ft. 2008 Annual
Location Properties Sq. Ft. Dec. 31, 2008 Occupancy Major Tenants at 12/31/08 Base Rents(1)
------------------------------------------------------------------------------------------------------------------------------------
5300-5350 Hellyer Avenue (2) 2 160,000 100% 100% Tyco Electronics Corporation 160,000 $3,844,283
10401-10411 Bubb Road (2) 1 20,330 78% 78% Aeroflex, Inc. 15,830 216,080
45365 Northport Loop West 1 64,218 0% 0% Vacant - -
45738 Northport Loop West 1 44,256 100% 100% Quicksil, Inc. 44,256 606,307
4050 Starboard Drive 1 52,232 100% 100% Flash Electronics, Inc. 52,232 531,726
3501 West Warren Avenue & 1 67,864 24% 63% Oakland Fluid System Tech, Inc. 16,524 697,869
46600 Fremont Boulevard
48800 Milmont Drive 1 53,000 0% 0% Vacant - -
4750 Patrick Henry Drive 1 63,105 100% 100% Infoblox, Inc. 63,105 513,675
Triangle Technology Park (2) 7 416,927 73% 77% Intevac Corporation 169,795 3,308,177
Xicom Technology, Inc. 72,336
LSA Cleanpart, LLC 28,300
SASCO 25,350
- 16 -
Major
Tenants'
Total Percentage Average Rentable
No. of Rentable Occupied as of 2008 Sq. Ft. 2008 Annual
Location Properties Sq. Ft. Dec. 31, 2008 Occupancy Major Tenants at 12/31/08 Base Rents(1)
------------------------------------------------------------------------------------------------------------------------------------
5830-5870 Hellyer Avenue 1 109,715 24% 24% MeiVac, Inc. 26,557 261,321
5750 Hellyer Avenue 1 73,312 100% 100% NDS Surgical Imaging, LLC 73,312 691,270
5500-5550 Hellyer Avenue 2 196,534 66% 20% CTS Corporation 78,794 450,646
Snap-on, Inc. 50,643
5400 Hellyer Avenue 1 77,184 73% 69% Nortel Networks, Inc. 34,702 578,072
Capella, Inc. 21,750
5325-5345 Hellyer Avenue 2 256,500 100% 100% Celestica Asia, Inc. 256,500 5,726,892
5905-5965 Silver Crk Valley Rd. 4 346,000 0% 0% Vacant - -
5845 Hellyer Avenue 1 98,500 0% 0% Vacant - -
855 Embedded Way 1 67,912 100% 47% Celestica Asia, Inc. 39,039 666,473
Lynuxworks, Inc. 28,873
1065-1105 La Avenida Street 5 515,700 100% 100% Microsoft Corporation 515,700 12,576,156
1875 Charleston Road 1 42,126 100% 100% Netlogic Microsystems, Inc. 42,126 872,004
1750 Automation Parkway 1 80,641 100% 100% JDS Uniphase Corporation 80,641 1,466,533
1756 Automation Parkway 1 80,640 36% 36% A&D Engineering, Inc. 28,739 317,364
1762 Automation Parkway 1 61,100 100% 100% Hermes Microvision, Inc. 61,100 642,620
1768 Automation Parkway 1 110,592 67% 86% 2Wire, Inc. 74,584 1,306,014
255 Caspian Drive 1 119,756 100% 100% Equinix Operating Company, Inc.119,756 2,532,839
245 Caspian Drive (3) 1 - - - - - -
5981 Optical Court 1 110,542 100% 100% SoloPower, Inc. 110,542 1,563,751
5970 Optical Court 1 128,520 100% 100% Photon Dynamics, Inc. 128,520 2,018,460
5900 Optical Court 1 165,000 100% 100% Stryker Corporation 165,000 3,515,430
2630 Orchard Parkway 1 60,633 0% 0% Vacant - -
2610 Orchard Parkway 1 54,093 0% 0% Vacant - -
55 West Trimble Road 1 91,722 0% 0% Vacant - -
2001 Walsh Avenue 1 80,000 100% 100% Nvidia Corporation 80,000 952,830
2880 Scott Boulevard 1 200,000 100% 100% NEC Electronics America, Inc. 200,000 2,522,730
2890 Scott Boulevard 1 75,000 100% 50% Nvidia Corporation 75,000 787,500
2770-2800 Scott Boulevard 1 99,800 100% 100% Nvidia Corporation 99,800 1,292,914
2300 Central Expressway 1 46,338 100% 100% Juniper Networks, Inc. 46,338 660,204
2220 Central Expressway 1 62,522 100% 100% Tellabs, Inc. 62,522 705,874
2330 Central Expressway 1 62,522 100% 100% Tellabs, Inc. 62,522 705,873
233 South Hillview Drive 2 95,690 100% 100% Exar Corporation 95,690 1,330,272
2251 Lawson Lane 1 125,000 51% 7% Synaptics, Inc. 64,270 154,249
1230 East Arques 1 60,000 100% 100% Fujitsu 60,000 349,964
1250 East Arques 4 200,000 100% 100% Fujitsu 200,000 869,311
- 17 -
Major
Tenants'
Total Percentage Average Rentable
No. of Rentable Occupied as of 2008 Sq. Ft. 2008 Annual
Location Properties Sq. Ft. Dec. 31, 2008 Occupancy Major Tenants at 12/31/08 Base Rents(1)
------------------------------------------------------------------------------------------------------------------------------------
20400 Mariani Avenue 1 105,000 100% 75% Apple, Inc. 105,000 723,006
10500 De Anza Boulevard 1 211,000 100% 100% Apple, Inc. 211,000 4,070,567
20605-705 Valley Green Drive 2 142,000 100% 100% Apple, Inc. 142,000 2,487,840
10300 Bubb Road 1 23,400 100% 100% Apple, Inc. 23,400 267,462
10440 Bubb Road 1 19,500 100% 100% Novare Surgical Systems, Inc. 10,833 271,302
10450-10460 Bubb Road 1 45,460 100% 100% Ricoh Corporation 30,460 656,800
VMWare, Inc. 15,000
1135 Kern Avenue 1 18,300 0% 0% Vacant - -
450 National Avenue 1 36,100 0% 20% Vacant - 105,820
3301 Olcott Street 1 64,500 0% 0% Vacant - -
2800 Bayview Avenue 1 59,736 0% 0% Vacant - -
5521 Hellyer Avenue 1 203,800 44% 44% Nanosolar, Inc. 89,040 587,664
6850 Santa Teresa Boulevard 1 30,000 41% 41% Bio-Medical Applications of CA 12,350 123,341
6810 Santa Teresa Boulevard & 1 54,996 87% 87% ZiLOG, Inc. 40,527 587,340
180 Great Oaks Boulevard
140-160 Great Oaks Boulevard 2 105,300 75% 75% Semiconductor Tooling Services 53,300 809,616
& 6781 Via Del Oro Santa Clara Valley Water Dist. 25,429
6540-6541 Via Del Oro & 2 66,600 71% 73% Modutek Corporation 21,376 466,635
6385-6387 San Ignacio Avenue
6311-6351 San Ignacio Avenue 5 362,767 55% 48% Saint Gobain 95,953 2,917,008
Stion Corporation 64,435
Teledex, LLC 30,000
6320-6360 San Ignacio Avenue 1 157,292 12% 12% Quantum 3D, Inc. 19,600 368,190
75 East Trimble Road & 2 170,810 59% 59% Comerica, Inc. 93,984 1,149,828
2610 North First Street
2904 Orchard Parkway 1 75,335 100% 100% BAE Systems Land & Armaments 75,335 1,020,529
3236 Scott Boulevard 1 54,672 100% 100% Mimix Broadband, Inc. 54,672 726,462
1212 Bordeaux Lane 1 71,800 100% 100% Loral Space & 71,800 722,334
Communications, Inc.
McCandless Technology Park 14 705,958 22% 24% ST Assembly Test Services, Inc. 33,984 1,261,013
Consentry Networks, Inc. 33,821
1600 Memorex Drive 1 107,500 21% 21% International Network 22,800 223,326
Services, Inc.
1688 Richard Avenue 1 52,800 100% 100% NWE Technology, Inc. 52,800 393,444
1700 Richard Avenue 1 58,783 100% 100% Cincinnati Bell, Inc. 58,783 861,175
Morgan Hill Land (4) - - - - - - -
300 Montague Expressway 1 49,457 0% 1% Vacant - 30,767
337 Trade Zone Boulevard 1 42,912 0% 0% Vacant - -
324-368 Montague Expressway 1 56,265 0% 0% Vacant - -
-------------------- ---------------
TOTAL 111 8,047,569 66% $76,067,152
==================== ===============
- 18 -
(1) Annual cash rents do not include the recognition of rental income on the
straight-line method of accounting required by accounting principles
generally accepted in the United States of America ("GAAP") under which
contractual rent payment increases are recognized evenly over the lease
term.
(2) Joint venture properties.
(3) Property represents a commitment by the Berg Group to construct an
approximate 75,000 to 90,000 square foot building on land acquired during
2001.
(4) This property comprises of 55 acres of vacant land, which could support
approximately 800,000 rentable square feet of space. The vacant land is
currently zoned for industrial use and a portion has the potential to be
rezoned for residential use.
We own 100% of all of the properties listed in the table, except: one of the
buildings in the Triangle Technology Park, which is owned by a joint venture in
which we, through an operating partnership, own a 75% interest; the property at
10401-10411 Bubb Road, which is owned by a joint venture in which we, through an
operating partnership, own an 83.33% interest; and the properties at 5300-5350
Hellyer Avenue, which are owned by a joint venture in which we, through an
operating partnership, own a 50% interest, and a Berg affiliate owns the other
50% venture interest.
SCHEDULE OF LEASE EXPIRATIONS
The following table sets forth a schedule of the lease expirations for the
properties beginning with 2009, assuming that none of the tenants exercise
existing renewal options or termination rights. The table excludes 2,701,554
rentable square feet that were vacant as of December 31, 2008.
Number of Percentage of Total Annual
Year of Lease Expiring Rentable Square Footage 2009 Annual Base Rent Base Rent Represented By
Expiration Leases Subject to Expiring Leases Under Expiring Leases (1) Expiring Leases (2)
--------------------------------------------------------------------------------------------------------------------
2009 22 369,613 $1,777,373 2.2%
2010 12 572,000 9,298,560 11.3%
2011 15 827,605 12,225,746 14.9%
2012 13 1,001,452 14,883,768 18.1%
2013 6 459,737 5,801,817 7.1%
2014 11 1,281,952 23,158,141 28.2%
2015 4 328,211 6,313,276 7.7%
2016 2 144,600 2,959,748 3.6%
2017 3 241,089 3,050,940 3.7%
Thereafter 1 119,756 2,608,286 3.2%
--------------------------------------------------------------------------------------------------
89 5,346,015 $82,077,655 100%
==================================================================================================
(1) The base rent for expiring leases is based on 2009 scheduled cash rent,
which is different than annual rent determined in accordance with GAAP.
(2) Based upon 2009 cash rent as discussed in Note (1).
If we are unable to lease a significant portion of the available space or space
scheduled to expire in 2009 and thereafter at any of our properties; if existing
tenants do not renew their leases; or if rental rates decrease, our results of
operations, financial condition and cash flows would be affected adversely.
ENVIRONMENTAL MATTERS
To date, compliance with laws and regulations relating to the protection of the
environment, including those regarding the discharge of materials into the
environment has not had any material effects upon our capital expenditures,
earnings or competitive position.
Under various federal, state and local laws, ordinances and regulations, an
owner or operator of real property may be held liable for the costs of removal
or remediation of certain hazardous or toxic substances located on or in the
property. Such laws often impose liability on the owner and expose the owner to
governmental proceedings without regard to whether the owner knew of, or was
responsible for, the presence of the hazardous or toxic substances. The cost of
any required remediation or removal of such substances may be substantial. In
addition, the owner's liability as to any specific property is generally not
limited and could exceed the value of the property and/or the aggregate assets
of the owner. The presence of such substances, or the failure to properly remove
or remediate such substances, may also adversely affect the owner's ability to
sell or rent the property or to borrow using the property as collateral. Persons
who arrange for treatment or the disposal of hazardous or toxic substances may
also be liable for the costs of any required
- 19 -
remediation or removal of the hazardous or toxic substances at a disposal
facility, regardless of whether the facility is owned or operated by such owner
or entity. In connection with the ownership of the properties or the treatment
or disposal of hazardous or toxic substances, we may be liable for such costs.
Some of our properties are leased, in part, to businesses, including
manufacturers that use, store or otherwise handle hazardous or toxic substances
in their business operations. These operations create a potential for the
release of hazardous or toxic substances. In addition, groundwater contaminated
by chemicals used in various manufacturing processes, including semiconductor
fabrication, underlies a significant portion of northeastern Santa Clara County,
where many of our properties are located.
Environmental laws also govern the presence, maintenance and removal of
asbestos. These laws require that owners or operators of buildings containing
asbestos properly manage and maintain the asbestos, that they adequately inform
or train those who may come into contact with asbestos and that they undertake
special precautions, including removal or other abatement in the event that
asbestos is disturbed during renovation or demolition of a building. These laws
may impose fines and penalties on building owners or operators for failure to
comply with these requirements and may allow third parties to seek recovery from
owners or operators for personal injury associated with exposure to asbestos
fibers. We are aware that there are asbestos-containing materials, or ACMs,
present at several of the properties, primarily in floor coverings. We believe
that the ACMs present at these properties are generally in good condition and
that no ACMs are present at the remaining properties. We believe we are in
compliance in all material respects with all present federal, state and local
laws relating to ACMs and that if we were given limited time to remove all ACMs
present at the properties, the cost of such removal would not have a material
adverse effect on our financial condition, results of operations and ability to
make cash distributions to our stockholders.
Phase I assessments are intended to discover and evaluate information regarding
the environmental condition of the surveyed property and surrounding properties.
Phase I assessments generally include a historical review, a public records
review, an investigation of the surveyed site and surrounding properties and the
preparation and issuance of a written report, but do not include soil sampling
or subsurface investigations and typically do not include an asbestos survey.
Environmental assessments have been conducted for about half of the properties.
The environmental investigations that have been conducted on our properties have
not revealed any environmental liability that we believe would have a material
adverse effect on our financial condition, results of operations and assets, and
we are not aware of any such liability. Nonetheless, it is possible that there
are material environmental liabilities of which we are unaware. We cannot assure
you that future laws, ordinances, or regulations will not impose any material
environmental liability, or that the current environmental condition of the
properties has not been, or will not be, affected by tenants and occupants of
the properties, by the condition of properties in the vicinity of the
properties, or by third parties unrelated to us.
- 20 -
ITEM 3. LEGAL PROCEEDINGS
Neither the operating partnerships, our properties nor we are subject to any
material litigation nor, to our knowledge, is any material litigation threatened
against the operating partnerships, our properties or us. From time to time, we
are engaged in legal proceedings arising in the ordinary course of our business.
We do not expect any of such proceedings to have a material adverse effect on
our cash flows, financial condition or results of operations. We are currently
involved in the following legal proceedings and we believe that the ultimate
outcome of these proceedings will not have a material adverse effect on our
operating results, cash flows or financial condition.
Mission West Properties, L.P. v. Republic Properties Corporation, et al. Santa
Clara County Superior Court, Case No. CV 796249. In February 2001, while the
Maryland case was pending, we filed a suit against RPC in the Superior Court of
the State of California for the County of Santa Clara, Case No. CV 796249. The
case was stayed pending resolution of the Maryland case, and we dismissed our
suit on March 4, 2005. In April 2005, RPC submitted a motion asking the Superior
Court to reinstate the case, which the Court granted on May 25, 2005. On July 5,
2006, RPC filed a cross-complaint in the case seeking partnership distributions
to which we demurred. The Court sustained our demurrer with leave to amend.
Subsequently, RPC filed an amended complaint, and we submitted another demurrer
seeking dismissal of the claims on statute of limitations grounds. On February
20, 2007, the Court overruled our demurrer. We sought a writ from the California
State Court of Appeal for the Sixth District to direct the lower court to
reverse its decision, but the petition for the writ was denied. In April 2008,
we filed a motion for summary judgment in the California Superior Court which
was denied. In October 2008, a motion filed by RPC for summary judgment in the
California Superior Court was denied. A trial in the California Superior Court
commenced in February 2009.
The Independent Directors Committee of the Board of Directors has exercised the
right to acquire on behalf of the Company the former RPC interest and related
distributions from Berg & Berg Enterprises, Inc. under the terms of the Berg
Land Holdings Option Agreement between the Company and the Berg Group if the
litigation is ultimately decided in favor of the Company, as more fully
explained under Item 8, "Financial Statements and Supplementary Data - Note 13."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of stockholders during the fourth quarter of
the year ended December 31, 2008.
- 21 -
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
HISTORICAL PERFORMANCE COMPARISON
The following graph compares the change in the Company's cumulative stockholder
return on its shares of common stock to the cumulative total return of the
NAREIT Equity REIT Total Return Index ("NAREIT Equity Index") and the Standard &
Poor's 500 Stock Index ("S&P 500 Index") from December 31, 2003 to December 31,
2008. The line graph starts December 31, 2003. The graph assumes that the value
of the investment in the Company's common stock was $100 at December 31, 2003
and that all dividends were reinvested. The common stock's price on December 31,
2003 was $12.95. The Company obtained the information about the NAREIT Equity
Index and S&P 500 Index from each entity respectively, and has assumed that the
information is reliable, but cannot assume its accuracy.
[OBJECT OMITTED]
The stock price performance shown in the graph is not necessarily
indicative of future performance of the Company's common stock.
Our common stock is listed on the Nasdaq Stock Market, LLC ("NASDAQ") and trades
under the symbol "MSW." The closing price of our common stock on December 31,
2008, the last trading day of the year, was $7.65 per share. The high and low
closing price per share of common stock as reported on NASDAQ during each
quarter of 2008 and 2007 were as follows:
2008 2007
----------------------------- -----------------------------
High Low High Low
------------- ------------- ------------- -------------
1st Quarter $10.13 $8.36 $14.60 $11.89
2nd Quarter $12.39 $9.45 $14.85 $13.00
3rd Quarter $11.36 $8.58 $14.01 $11.30
4th Quarter $9.27 $6.11 $12.50 $9.23
- 22 -
On February 28, 2009, there were 171 registered holders of the Company's common
stock.
DIVIDEND POLICY
We declared and paid dividends in each quarter of 2008 and 2007. We expect to
pay quarterly dividends during 2009. The following tables show information for
quarterly dividends for 2008 and 2007.
2008
-----------------------------------------------
Dividend
Record Date Payment Date Per Share
------------- ------------- -------------
1st Quarter 03/31/08 04/03/08 $0.20
2nd Quarter 06/30/08 07/03/08 0.20
3rd Quarter 09/30/08 10/09/08 0.20
4th Quarter 12/31/08 01/08/09 0.20
-------------
Total $0.80
=============
2007
-----------------------------------------------
Dividend
Record Date Payment Date Per Share
------------- ------------- -------------
1st Quarter 03/30/07 04/05/07 $0.16
2nd Quarter 06/30/07 07/05/07 0.16
3rd Quarter 09/28/07 10/04/07 0.16
4th Quarter 12/31/07 01/03/08 0.16
-------------
Total $0.64
=============
The declaration and payment of dividends and distributions will continue to be
determined by the Board of Directors in light of conditions then existing,
including the Company's earnings, financial condition, capital requirements,
debt service requirements and other factors.
For federal income tax purposes, we have characterized the dividends declared in
2008 as follows: 73.3% taxable ordinary income, 22.2% capital gain and 4.5%
unrecaptured section 1250 gain (unaudited). For 2007, we have characterized 97%
taxable ordinary income, 2% capital gain and 1% unrecaptured section 1250 gain
(unaudited).
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
See Item 12 of Part III of this Report regarding information about securities
authorized for issuance under our equity compensation plans.
- 23 -
Item 6. Selected Financial Data
The following table sets forth selected historical financial information for
Mission West Properties, Inc. (see Item 7, "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Overview and Background" for
discussion of business combinations and property dispositions that materially
affect the comparability of the selected financial data).
Selected consolidated financial data is derived from the audited financial
statements and notes thereto (see Item 8, "Financial Statements and
Supplementary Data") and is as follows:
Year Ended December 31,
--------------------------------------------------------------------------
2008 2007 2006 2005 2004
------------- ------------- ------------- -------------- -------------
(dollars in thousands, except per share data)
OPERATING INFORMATION: (1)
Operating revenues:
Rental revenue from real estate $79,075 $80,337 $91,457 $99,082 $116,410
Above market lease intangible asset
amortization - (4,091) (1,888) (1,888) (1,888)
Tenant reimbursements 16,406 13,355 13,061 14,030 14,054
Other income, including lease terminations and
settlements 4,223 61,982 18,222 4,023 6,861
------------- ------------- ------------- -------------- -------------
Total operating revenues 99,704 151,583 120,852 115,247 135,437
------------- ------------- ------------- -------------- -------------
Operating expenses:
Property operating, maintenance and real
estate taxes 23,460 20,371 18,505 18,613 18,952
General and administrative 2,635 3,035 2,248 1,910 2,011
Depreciation and amortization of real estate 23,224 22,588 21,579 20,329 20,602
------------- ------------- ------------- -------------- -------------
Total operating expenses 49,319 45,994 42,332 40,852 41,565
------------- ------------- ------------- -------------- -------------
Operating income 50,385 105,589 78,520 74,395 93,872
Other income (expenses):
Equity in earnings of unconsolidated joint
venture 19,617 1,408 1,985 724 2,947
Interest and dividend income 1,735 3,086 2,344 567 -
Unrealized loss from investment in marketable
securities (278) - - - -
Interest expense (19,787) (20,131) (20,708) (21,294) (17,581)
Interest expense - related parties (1,332) (724) (755) (972) (1,077)
------------- ------------- ------------- -------------- -------------
Income from continuing operations before
minority interests 50,340 89,228 61,386 53,420 78,161
Minority interests from continuing operations (40,206) (71,471) (49,928) (44,136) (64,936)
------------- ------------- ------------- -------------- -------------
Income from continuing operations 10,134 17,757 11,458 9,284 13,225
Discontinued operations, net of minority interests:
Gain from disposal of discontinued operations(2) - 1,126 2,935 445 -
Income attributable to discontinued operations (2) - 5 237 298 87
------------- ------------- ------------- -------------- -------------
Income from discontinued operations - 1,131 3,172 743 87
------------- ------------- ------------- -------------- -------------
Net income to common stockholders $10,134 $18,888 $14,630 $10,027 $13,312
============= ============= ============= ============== =============
Net income to minority interests $40,206 $76,960 $66,358 $47,524 $66,100
============= ============= ============= ============== =============
Basic net income per share from continuing $0.51 $0.90 $0.60 $0.51 $0.73
operations
============= ============= ============= ============== =============
Diluted net income per share from continuing $0.51 $0.89 $0.59 $0.51 $0.73
operations
============= ============= ============= ============== =============
Basic net income per share from discontinued - $0.06 $0.17 $0.04 $0.01
operations
============= ============= ============= ============== =============
Diluted net income per share from discontinued - $0.06 $0.17 $0.04 $0.01
operations
============= ============= ============= ============== =============
Basic net income per share to common stockholders $0.51 $0.96 $0.77 $0.55 $0.74
============= ============= ============= ============== =============
Diluted net income per share to common $0.51 $0.95 $0.76 $0.55 $0.74
stockholders
============= ============= ============= ============== =============
PROPERTY AND OTHER INFORMATION:
Total properties, end of period (3) 111 109 107 107 109
Total rentable square feet, end of period(000's) 8,048 7,862 7,701 7,780 7,917
Average monthly rental revenue per square foot(4) $1.25 $1.42 $1.57 $1.58 $1.80
Occupancy for leased properties, end of period 66% 62% 69% 69% 71%
Dividends per share to common stockholders $0.80 $0.64 $0.64 $0.64 $0.88
Funds from operations (5) $55,334 $114,867 $86,585 $79,152 $103,320
Funds from operations per share (5)(6) $0.52 $1.09 $0.83 $0.76 $0.99
CASH FLOW INFORMATION:
Cash flows provided by operating activities $39,775 $23,501 $27,012 $21,898 $38,970
Cash flows used in investing activities ($29,605) ($8,548) ($5,369) ($2,875) ($1,519)
Cash flows (used in) provided by financing
activities ($33,861) ($25,047) ($19,299) $10,899 ($40,061)
- 24 -
December 31,
--------------------------------------------------------------------------
2008 2007 2006 2005 2004
------------- ------------- ------------- -------------- -------------
(dollars in thousands)
BALANCE SHEET INFORMATION:
Real estate assets, net of accumulated depr.
& amort. $943,579 $922,117 $898,889 $927,381 $960,863
Total assets $1,034,285 $1,053,885 $1,027,487 $1,023,377 $1,005,656
Mortgage notes payable $330,908 $337,520 $348,101 $357,481 $292,822
Mortgage notes payable - related parties $8,761 $9,224 $9,654 $10,051 $10,420
Revolving line of credit $13,079 - - - $24,208
Line of credit - related parties - - - - $9,560
Total liabilities $402,382 $388,581 $397,327 $407,680 $380,355
Minority interests $497,485 $526,626 $501,282 $500,682 $512,089
Stockholders' equity $134,418 $138,678 $128,878 $115,015 $113,212
Common stock outstanding 19,748,211 19,664,087 19,443,587 18,448,791 18,097,191
O.P. Units issued and outstanding 85,526,965 85,533,935 85,206,199 86,088,095 86,384,695
(1) Certain reclassifications have been made to prior period amounts in order
to conform to current period presentation.
(2) Upon the implementation of SFAS 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," on January 1, 2002, the operating results
of real estate held for sale and sold are reported as discontinued
operations for all years presented. Additionally, all gains and losses on
the sale of assets classified as held for sale subsequent to January 1,
2002 are included in discontinued operations.
(3) As of December 31, 2008, 2007, 2006, 2005 and 2004, total properties
include a property at 245 Caspian in Sunnyvale with no building. In 2001,
we paid the Berg Group approximately $7.5 million for their commitment to
complete an approximate 75,000 to 90,000 square foot building on the
property.
(4) Average monthly rental revenue per square foot has been determined by
taking the total cash base rent for the period divided by the number of
months in the period, and then divided by the average occupied square feet
in the period.
(5) Funds from Operations ("FFO") is a non-GAAP financial term used by REITs to
measure and compare operating performance. As defined by the National
Association of Real Estate Investment Trusts ("NAREIT"), FFO represents net
income (loss) before minority interest of unit holders (computed in
accordance with GAAP), including non-recurring events other than
"extraordinary items" under GAAP and excluding gains and losses from sales
of discontinued operations or 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. Additionally, our 2008, 2007, 2006, 2005 and 2004 FFO calculation
includes our portion of the depreciation and amortization of real estate
from our unconsolidated joint venture, but excludes the above-market lease
intangible asset, which was recorded as a reduction of revenues. Management
considers FFO to be an appropriate supplemental measure of our 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
our financial performance when compared to other REITs because FFO is
generally recognized as the industry standard for reporting the operations
of REITs. FFO should neither be considered as an alternative for neither
net income as a measure of profitability nor is it comparable to cash flows
provided by operating activities determined in accordance with GAAP. FFO is
not comparable to similarly entitled items reported by other REITs that do
not define them exactly as we define FFO.
(6) Considering the potential effect of all O.P. Units being exchanged for
shares of the Company's common stock.
Our definition of FFO also assumes conversion at the beginning of the period of
all convertible securities, including O.P. Units represented by O.P. Units that
may be exchanged for shares of common stock. Our FFO does not represent the
amount available for management's discretionary use; as such funds may be needed
for capital replacement or expansion, debt service obligations or other
commitments and uncertainties. Furthermore, FFO is not comparable to similarly
entitled items reported by other REITs that do not define FFO exactly as we do.
A reconciliation of net income to common stockholders to FFO for the years ended
December 31, 2008, 2007, 2006, 2005 and 2004 follows:
Year Ended December 31,
------------------------------------------------------------------------
2008 2007 2006 2005 2004
-------------- ------------- -------------- ------------- --------------
(dollars in thousands, except per share data)
Net income to common stockholders $10,134 $18,888 $14,630 $10,027 $13,312
Add:
Minority interests (1) 39,838 76,458 65,859 47,045 65,614
Depreciation and amortization of real estate (2) 25,833 26,050 24,636 24,286 24,394
Less:
Gain on sales of assets or joint venture assets (20,471) (6,529) (18,540) (2,206) -
-------------- ------------- -------------- ------------- --------------
FFO $55,334 $114,867 $86,585 $79,152 $103,320
============== ============= ============== ============= ==============
Weighted average common shares and
O.P. Units-diluted 105,524,677 105,016,651 104,809,155 104,545,776 104,521,271
FFO per common share and O.P. Unit-diluted $0.52 $1.09 $0.83 $0.76 $0.99
(1) Minority interests in net income is calculated by taking the net income of
the operating partnerships (on a stand-alone basis) multiplied by the
respective weighted average minority interests' ownership percentage.
Minority interests for third parties totaling approximately $368, $502,
$499, $479 and $486 in 2008, 2007, 2006, 2005 and 2004, respectively, was
deducted from total minority interest in calculating FFO. (dollars in
thousands)
(2) Also includes our portion of depreciation and amortization of real estate
from our unconsolidated joint venture totaling approximately $900, $757,
$849, $984 and $874 in 2008, 2007, 2006, 2005 and 2004, respectively, and
amortization of leasing commissions totaling approximately $1,709, $2,558,
$1,513, $1,703 and $1,644 in 2008, 2007, 2006, 2005 and 2004, respectively.
Amortization of leasing commissions is included in the property operating,
maintenance and real estate taxes line item in our consolidated statements
of operations. (dollars in thousands)
- 25 -
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION INCLUDES FORWARD-LOOKING STATEMENTS, INCLUDING, BUT NOT
LIMITED TO, STATEMENTS WITH RESPECT TO THE FUTURE FINANCIAL PERFORMANCE,
OPERATING RESULTS, PLANS AND OBJECTIVES OF MISSION WEST PROPERTIES, INC. ACTUAL
RESULTS MAY DIFFER MATERIALLY FROM THOSE CURRENTLY ANTICIPATED DEPENDING UPON A
VARIETY OF FACTORS, INCLUDING THOSE DESCRIBED IN PART I - ITEM 1A, RISK FACTORS.
OVERVIEW AND BACKGROUND
Our original predecessor was formed in 1969 as Palomar Mortgage Investors, a
California business trust, which operated as a mortgage REIT until 1979 when,
under the name of Mission Investment Trust, it terminated its status as a REIT
and began to develop and market its own properties. In 1982, Mission West
Properties was incorporated as a successor to Mission Investment Trust. In 1997,
our predecessor, Mission West Properties, sold all of its real estate assets and
paid a special dividend of $9.00 per share to stockholders, after which it
retained only nominal assets. Subsequently, the Berg Group acquired control of
the corporation as a vehicle to acquire R&D properties, or interests in entities
owning such properties, in a transaction completed on September 2, 1997. At that
time the Berg Group and other investors acquired an aggregate 79.6% controlling
ownership position. In May 1998, we, the Berg Group members, an independent
limited partner, and certain other persons entered into an acquisition agreement
providing, among other things, for our acquisition of interests as the sole
general partner in the operating partnerships. At the time, the operating
partnerships held approximately 4.34 million rentable square feet of R&D
property located in Silicon Valley. The agreement also provided for the parties
to enter into the Pending Projects Acquisition Agreement, the Berg Land Holdings
Option Agreement and the Exchange Rights Agreement, following stockholder
approval. Effective July 1, 1998, we consummated our acquisition of the general
partner interests in the operating partnerships through the purchase of the
general partner interests, and all limited partnership interests in the
operating partnerships were converted into 59,479,633 O.P. Units, which
represented ownership of approximately 87.89% of the operating partnerships. Our
general partner interests represented the balance of the ownership of the
operating partnerships. At December 31, 2008, we owned an 18.73% general partner
interest in the operating partnerships, taken as a whole, on a weighted average
basis.
Since the beginning of calendar year 1999, we have been taxed as a qualified
REIT.
Our reincorporation under the laws of the State of Maryland through the merger
of Mission West Properties into Mission West Properties, Inc. occurred on
December 30, 1998, at which time all outstanding shares issued by our
predecessor California corporation were converted into shares of our common
stock on a one-for-one basis.
In July 1999, we completed a public offering of 8,680,000 shares of our common
stock at $8.25 per share. The net proceeds of approximately $66.9 million, after
deducting underwriting discounts and other offering costs, were used primarily
to repay indebtedness.
We have grown through property acquisitions. Since September 1998, we have
acquired a total of approximately 7.14 million rentable square feet of R&D
buildings and vacant land under the Pending Project Acquisition Agreement, the
Berg Land Holdings Option Agreement, and from unrelated third parties. The total
cost of these properties was approximately $739.3 million. To acquire these
properties, we paid cash or exchanged existing properties, issued a total of
28,510,261 O.P. Units and assumed debt totaling approximately $331.3 million.
Since 1998, we have sold a total of approximately 1.0 million rentable square
feet of R&D buildings. The total sales price of these properties was
approximately $144.2 million.
Almost all of our earnings and cash flow is derived from rental revenue received
pursuant to leased R&D space at our properties. Key factors that affect our
business and financial results include the following:
- the current turmoil in the credit markets;
- economic conditions generally and the real estate market specifically;
- the occupancy rates of the properties;
- rental rates on new and renewed leases;
- tenant improvement and leasing costs incurred to obtain and retain tenants;
- operating expenses;
- cost and availability of capital;
- interest rates;
- the extent of acquisitions and sales of real estate;
- legislative or regulatory provisions (including changes to laws governing
the taxation of REITs);
- competition;
- 26 -
- 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;
- changes in general accounting principles, policies and guidelines
applicable to REITs; and
- ability to timely refinance maturing debt obligations and the terms of any
such refinancing.
Negative effects from any of these factors could cause a deterioration in our
operating results, cash flows and financial condition.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We prepare our consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America ("GAAP"), which
requires us to make certain estimates, judgments and assumptions that affect the
reported amounts in the accompanying consolidated financial statements,
disclosure of contingent assets and liabilities and related footnotes.
Accounting and disclosure decisions with respect to material transactions that
are subject to significant management judgments or estimates include impairment
of long lived assets, deferred rent receivables, and allocation of purchase
price relating to property acquisitions and the related depreciable lives
assigned. Actual results may differ from these estimates under different
assumptions or conditions.
Critical accounting policies are defined as those that require management to
make estimates, judgments and assumptions, giving due consideration to
materiality, in certain circumstances that affect amounts reported in the
consolidated financial statements, and potentially result in materially
different results under different conditions and assumptions. We believe that
the following best describe our critical accounting policies:
REAL ESTATE ASSETS
Real estate assets are stated at cost. Cost includes expenditures for
improvements or replacements. Maintenance and repairs are charged to expense as
incurred. Gains and losses from sales are included in income in accordance with
Statement of Financial Accounting Standard ("SFAS") 66, "Accounting for 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.
BUSINESS COMBINATIONS
Statement of Financial Accounting Standards 141, "Business Combinations" ("SFAS
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
commission 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 141 are based on an
allocation of the acquisition cost to land, building, tenant improvements, and
intangibles for at market and above market in place leases, and the
determination of their useful lives are guided by a combination SFAS 141 and
management's estimates. Amortization expense of above and below market lease
intangible asset is offset against rental revenue in the revenue section while
amortization of in-place lease value intangible asset is included in
depreciation and amortization of real estate in the expense section of our
consolidated statements of operations. If we do not appropriately allocate these
components or we incorrectly estimate the useful lives of these components, our
computation of depreciation and amortization expense may not appropriately
reflect the actual impact of these costs over future periods, which will affect
net income.
IMPAIRMENT OF LONG-LIVED ASSETS
We review real estate assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable in accordance with Statement of Financial Accounting Standards 144,
"Accounting for the Impairment and Disposal of Long-Lived Assets" ("SFAS 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 and operating costs for R&D facilities
in the Silicon Valley area and related submarkets. The analysis that we prepare
in connection with determining if there may be any asset impairment loss under
SFAS 144 considers several assumptions: holding period of ten years, 36 months
lease up period and cap rate ranging from 8% to 9%. 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 DEFERRED RENT AND DOUBTFUL ACCOUNTS
The preparation of the consolidated financial statements requires us to make
estimates and assumptions. As such, we must make estimates of the
uncollectability of our accounts receivable based on the evaluation of our
tenants' financial position, analyses of accounts receivable and current
economic trends. We also make estimates for a straight-line adjustment reserve
for existing tenants with the potential of early termination, bankruptcy or
ceasing operations. Our estimates are based on our review of tenants' payment
- 27 -
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.
CONSOLIDATION OF 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 the joint venture using the equity
method of accounting.
CONSOLIDATION OF VARIABLE INTEREST ENTITIES
We consolidate all variable interest entities ("VIE") in which we are deemed to
be the primary beneficiary in accordance with FASB Interpretation No. 46
(Revised December 2003), "Consolidation of Variable Interest Entities" ("FIN
46R"). As of December 31, 2008, we consolidated one VIE in the accompanying
consolidated financial statements in connection with an assignment of a lease
agreement with an unrelated party, M&M Real Estate Control & Restructuring, LLC
(see Item 8, "Financial Statements and Supplementary Data - Note 7" for further
discussion of this transaction).
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 rent receivable, and other appropriate measures. Our
judgments and estimations about tenants' capacity to continue to meet their
lease obligations will affect the rental revenue recognized. Material
differences may result in the amount and timing of our rental revenue for any
period if we made different judgments or estimations.
Lease termination 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 by agreement with us. 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
- collectability is reasonably assured.
With regard to critical accounting policies, where applicable, we have explained
and discussed the criteria for identification and selection, methodology in
application and impact on the financial statements with the Audit Committee of
our Board of Directors, which has reviewed these policies.
- 28 -
RESULTS OF OPERATIONS
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2008 TO THE YEAR ENDED DECEMBER 31,
2007
RENTAL REVENUE FROM CONTINUING PROPERTY OPERATIONS
As of December 31, 2008 and 2007, through our controlling interests in the
operating partnerships, we owned 111 and 109 R&D properties totaling
approximately 8.0 and 7.9 million rentable square feet, respectively. We
acquired two R&D properties during 2008.
The following table depicts the amounts of rental revenue from continuing
operations for the years ended December 31, 2008 and 2007 represented by our
historical properties and the percentage of the total decrease in rental revenue
over the period that is represented by each group of properties.
Year Ended December 31,
----------------------------------
2008 2007 $ Change % Change
-------------- --------------- -------------- ---------------
(dollars in thousands)
Same Property (1) $76,375 $80,282 ($3,907) (4.9%)
2007 Acquisitions (2) 33 55 (22) (40.0%)
2008 Acquisitions (3) 3,389 - 3,389 100.0%
-------------- --------------- --------------
Total $79,797 $80,337 ($540) (0.7%)
============== =============== ==============
(1) "Same Property" is defined as properties owned by us prior to 2007 that we
still owned as of December 31, 2008.
(2) Operating rental revenue for 2007 Acquisitions do not reflect a full 12
months of operations in 2007 because these properties were acquired at
various times during the year.
(3) Operating rental revenue for 2008 Acquisitions do not reflect a full 12
months of operations in 2008 because these properties were acquired at
various times during the year.
For the year ended December 31, 2008, our rental revenue from real estate
decreased by approximately ($0.5) million, or (0.7%). Pursuant to SFAS 141,
approximately $4.1 million of amortization expense with respect to above-market
leases that we obtained through property acquisitions was offset against revenue
for the year ended December 31, 2007. The ($0.5) million decrease in rental
revenue resulted from current adverse market conditions as "Same Property" rents
decreased due to lease terminations, cessation of tenant operations and tenant
relocations since December 31, 2007.
Our overall occupancy rate for leased properties at December 31, 2008 and 2007
was approximately 66.4% and 61.7%, respectively. According to the BT Report, the
leased occupancy rate for R&D property in the Silicon Valley at December 31,
2008 was approximately 83.7%. Due to an over supply of R&D properties and
competitive bidding for tenants by other landlords in the Silicon Valley bidding
for tenants, our occupancy rate may drop further in 2009 if the approximately
370,000 rentable square feet scheduled to expire is not renewed or re-leased.
Factors that contributed to our low occupancy rate were primarily the general
downturn in the Silicon Valley's economy in recent years, the softening of the
R&D property market specifically, as well as the weaker relative performance of
certain properties due to their location and the weak demand in those
submarkets.
OTHER INCOME FROM CONTINUING PROPERTY OPERATIONS
The following table depicts the amounts of other income, including lease
terminations and settlements, from continuing operations for the years ended
December 31, 2008 and 2007.
Year Ended December 31,
----------------------------------
2008 2007 $ Change % Change
-------------- --------------- -------------- ---------------
(dollars in thousands)
Other income $4,223 $61,982 ($57,759) (93.2%)
Other income, including lease terminations and settlements, of approximately
$4.2 million for the year ended December 31, 2008 included approximately $3.0
million from lease termination fees, $1.0 million from management fees, and $0.2
million from miscellaneous income. Other income, including lease terminations
and settlements, of approximately $62.0 million for the year ended December 31,
2007 included approximately $57.5 million from lease termination fees, $1.8
million from security deposit forfeitures, $1.0 million from management fees,
$0.3 million from tenant bankruptcy settlements and $1.4 million from
miscellaneous income. In 2007, of the $57.5 million in lease termination fees,
approximately $46 million was from the Ciena Corporation lease termination.
Management fees are paid by the tenants to the landlord for the administration
and supervision of the property. We do not consider termination fees and tenant
bankruptcy settlements to be recurring items.
EXPENSES FROM CONTINUING PROPERTY OPERATIONS
The following table reflects the amounts of property operating and maintenance
expenses and real estate taxes ("operating expenses") from continuing operations
for the years ended December 31, 2008 and 2007 and the percentage of total
increase in expenses over the period that is represented by each group of
properties.
- 29 -
Year Ended December 31,
----------------------------------
2008 2007 $ Change % Change
-------------- --------------- -------------- ---------------
(dollars in thousands)
Same Property (1) $22,657 $20,107 $2,550 12.7%
2007 Acquisitions (2) 403 264 139 52.7%
2008 Acquisitions (3) 400 - 400 100.0%
-------------- --------------- --------------
Total $23,460 $20,371 $3,089 15.2%
============== =============== ==============
(1) "Same Property" is defined as properties owned by us prior to 2007 that we
still owned as of December 31, 2008.
(2) Operating expenses for 2007 Acquisitions do not reflect a full 12 months of
operations in 2007 because these properties were acquired at various times
during the year.
(3) Operating expenses for 2008 Acquisitions do not reflect a full 12 months of
operations in 2008 because these properties were acquired at various times
during the year.
Operating expenses from continuing operations increased by approximately $3.1
million, or 15.2%, from $20.4 million for the year ended December 31, 2007 to
$23.5 million for the year ended December 31, 2008 primarily due to higher real
estate taxes, maintenance and repair costs and utility rates. Tenant
reimbursements from continuing operations increased by approximately $3.0
million, or 22.8%, from $13.4 million for the year ended December 31, 2007 to
$16.4 million for the year ended December 31, 2008. The increase in tenant
reimbursements resulted primarily from the increase in operating expenses. Total
operating expenses exceeded tenant reimbursements because of vacancies which
reached approximately 2.7 million rentable square feet by year-end 2008. Certain
operating expenses such as property insurance, real estate taxes, and other
fixed expenses are not recoverable from vacant properties. At December 31, 2008
our vacancy rate was approximately 34%.
The following table depicts the amounts of general and administrative expenses
from operations for the years ended December 31, 2008 and 2007.
Year Ended December 31,
----------------------------------
2008 2007 $ Change % Change
-------------- --------------- -------------- ---------------
(dollars in thousands)
General and administrative $2,635 $3,035 $400 (13.2%)
General and administrative expenses decreased by approximately ($0.4) million,
or (13.2%), from $3.0 million for the year ended December 31, 2007 to $2.6
million for the year ended December 31, 2008. The decrease in general and
administrative expenses was primarily a result of higher legal fees associated
with a potential acquisition of the Company in 2007 that did not recur in 2008.
The following table depicts the amounts of depreciation and amortization expense
of real estate from continuing operations for the years ended December 31, 2008
and 2007.
Year Ended December 31,
----------------------------------
2008 2007 $ Change % Change
-------------- --------------- -------------- ---------------
(dollars in thousands)
Depreciation and amortization $23,224 $22,588 $636 2.8%
Depreciation and amortization expense of real estate from continuing operations
increased by approximately $0.6 million, or 2.8%, primarily due to two property
acquisitions, new construction of tenant improvements and the write-off of
tenant improvements in connection with a lease termination.
EQUITY IN EARNINGS FROM UNCONSOLIDATED JOINT VENTURE
The following table depicts the amounts of equity in earnings of unconsolidated
joint venture from operations for the years ended December 31, 2008 and 2007.
Year Ended December 31,
----------------------------------
2008 2007 $ Change % Change
-------------- --------------- -------------- ---------------
(dollars in thousands)
Equity in earnings of
unconsolidated joint venture $19,617 $1,408 $18,209 1,293.3%
As of December 31, 2008, we had investments in one R&D building, totaling
approximately 155,500 rentable square feet in Morgan Hill, California, through
an unconsolidated joint venture with TBI, in which we acquired a 50% interest
from the Berg Group in January 2003. We have a non-controlling limited
partnership interest in this joint venture, which we account for using the
equity method of accounting. For the years ended December 31, 2008 and 2007,
equity in earnings from the unconsolidated joint venture was approximately $19.6
million and $1.4 million, respectively. Our equity in earnings from this
unconsolidated joint venture increased primarily due to a gain on sale of two
R&D properties in 2008. The occupancy rate for the properties owned by this
joint venture at December 31, 2008 and 2007 was 100%.
- 30 -
The following table depicts the amounts of interest and dividend income from
operations for the years ended December 31, 2008 and 2007.
Year Ended December 31,
----------------------------------
2008 2007 $ Change % Change
-------------- --------------- -------------- ---------------
(dollars in thousands)
Interest and dividend income $1,735 $3,086 ($1,351) (43.8%)
Interest and dividend income decreased by approximately ($1.4) million, or
(43.8%), from $3.1 million for the year ended December 31, 2007 to $1.7 million
for the year ended December 31, 2008. The decrease in interest and dividend
income was primarily a result of lower cash balance and interest rates. For the
year ended December 31, 2008, interest and dividend income totaled approximately
$1.1 million and $0.6 million, respectively. For the year ended December 31,
2007, interest income totaled approximately $3.1 million.
In 2008, we recorded an unrealized loss from investment in marketable securities
of approximately ($0.3) million. As of December 31, 2008, the fair value of the
investment totaled approximately $3.3 million and the cost thereof was
approximately $3.6 million.
The following table depicts the amounts of interest expense from operations for
the years ended December 31, 2008 and 2007.
Year Ended December 31,
----------------------------------
2008 2007 $ Change % Change
-------------- --------------- -------------- ---------------
(dollars in thousands)
Interest $19,787 $20,131 ($344) (1.7%)
Interest (related parties) 1,332 724 608 84.0%
-------------- --------------- --------------
Total $21,119 $20,855 $264 1.3%
============== =============== ==============
Interest expense decreased by approximately ($0.3) million, or (1.7%). Interest
expense (related parties) increased by approximately $0.6 million, or 84.0%, due
to short-term notes payable issued to the Berg Group in connection with
quarterly dividend distributions. As of December 31, 2008, the short-term notes
payable were paid off in full.
NET INCOME TO COMMON STOCKHOLDERS AND NET INCOME TO MINORITY INTERESTS
The following table depicts the amounts of earnings attributable to common
stockholders and minority interests for the years ended December 31, 2008 and
2007.
Year Ended December 31,
-------------------------------
2008 2007 $ Change % Change
------------- ------------- ------------- -------------
(dollars in thousands)
Net income to common stockholders $10,134 $18,888 ($8,754) (46.3%)
Net income to minority interests 40,206 76,960 (36,754) (47.8%)
------------- ------------- -------------
Total $50,340 $95,848 ($45,508) (47.5%)
============= ============= =============
As of December 31, 2008 and 2007, we owned a controlling general partner
interest of 20.02%, 21.85%, 16.31% and 12.52% and 19.94%, 21.78%, 16.26% and
12.48% in the four operating partnerships, Mission West Properties, L.P.,
Mission West Properties, L.P. I, Mission West Properties, L.P. II and Mission
West Properties, L.P. III, respectively. We owned an 18.73% general partner
interest in the operating partnerships, taken as a whole, on a consolidated
weighted average basis as of December 31, 2008 and 2007. Net income to common
stockholders in 2008 decreased by approximately ($8.8) million, or (46.3%), from
2007. Our net income attributable to minority interests in 2008 decreased by
approximately ($36.8) million, or (47.8%), from December 31, 2007. The decrease
in net income attributable to common stockholders and minority interests
resulted primarily due to lower lease termination income and higher operating
expenses described above.
Minority interests represent the limited partners' ownership interest of 81.27%
in the operating partnerships, on a weighted average basis, as of December 31,
2008 and 2007.
INCOME FROM DISCONTINUED OPERATIONS
The following table depicts the amounts of income from discontinued operations
for the years ended December 31, 2008 and 2007.
Year Ended December 31,
--------------------------------------------------------------
2008 2007
----------------------------- ----------------------------
(dollars in thousands)
Income attributable to discontinued operations - $6,620
Minority interests in earnings attributable to discontinued operations - (5,489)
----------------------------- ----------------------------
Income from discontinued operations - $1,131
============================= ============================
- 31 -
In 2007, we sold two R&D properties and in accordance with our adoption of SFAS
144, classified the net gains on sale and operating results of the disposed
properties as discontinued operations. SFAS 144 requires prior period results of
operations for these properties to be retrospectively adjusted and presented in
discontinued operations in prior consolidated statements of operations.
We recognized total income of approximately $6.6 million from discontinued
operations, of which $1.1 million and $5.5 million were attributable to common
stockholders and minority interests, respectively, for the year ended December
31, 2007.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2007 TO THE YEAR ENDED DECEMBER 31,
2006
RENTAL REVENUE FROM CONTINUING PROPERTY OPERATIONS
As of December 31, 2007 and 2006, through our controlling interests in the
operating partnerships, we owned 109 and 107 R&D properties totaling
approximately 7.9 and 7.7 million rentable square feet, respectively. We sold
two R&D properties and acquired four R&D properties and 55 acres of vacant land
during 2007.
The following table depicts the amounts of rental revenue from continuing
operations for the years ended December 31, 2007 and 2006 represented by our
historical properties and the percentage of the total decrease in rental revenue
over the period that is represented by each group of properties.
Year Ended December 31,
----------------------------------
2007 2006 $ Change % Change
-------------- --------------- -------------- ---------------
(dollars in thousands)
Same Property (1) $78,067 $89,685 ($11,618) (13.0%)
2006 Acquisitions (2) 2,215 1,772 443 25.0%
2007 Acquisitions (3) 55 - 55 100.0%
-------------- --------------- --------------
Total $80,337 $91,457 ($11,120) (12.2%)
============== =============== ==============
(1) "Same Property" is defined as properties owned by us prior to 2006 that we
still owned as of December 31, 2007. (
2) Operating rental revenue for 2006 Acquisitions do not reflect a full 12
months of operations in 2006 because these properties were acquired at
various times during the year.
(3) Operating rental revenue for 2007 Acquisitions do not reflect a full 12
months of operations in 2007 because these properties were acquired at
various times during the year.
For the year ended December 31, 2007, our rental revenue from real estate
decreased by approximately ($11.1) million, or (12.2%). Pursuant to SFAS 141,
approximately $4.1 million and $1.9 million of amortization expense with respect
to above-market leases that we obtained through property acquisitions was offset
against revenue for the years ended December 31, 2007 and 2006, respectively.
The ($11.1) million decrease in rental revenue resulted from current adverse
market conditions as "Same Property" rents decreased due to lease terminations,
cessation of tenant operations and tenant relocations since December 31, 2006.
Our overall occupancy rate for leased properties at December 31, 2007 and 2006
was approximately 61.7% and 69.5%, respectively. According to the BT Report, the
leased occupancy rate for R&D property in the Silicon Valley at December 31,
2007 was approximately 83.4%. Factors that contributed to our low occupancy rate
were primarily the general downturn in the Silicon Valley's economy in recent
years, the softening of the R&D property market specifically, as well as the
weaker relative performance of certain properties due to their location and the
weak demand in those submarkets.
OTHER INCOME FROM CONTINUING PROPERTY OPERATIONS
The following table depicts the amounts of other income, including lease
terminations and settlements, from continuing operations for the years ended
December 31, 2007 and 2006.
Year Ended December 31,
----------------------------------
2007 2006 $ Change % Change
-------------- --------------- -------------- ---------------
(dollars in thousands)
Other income $61,982 $18,222 $43,760 240.1%
Other income, including lease terminations and settlements, of approximately
$62.0 million for the year ended December 31, 2007 included approximately $57.5
million from lease termination fees, $1.8 million from security deposit
forfeitures, $1.0 million from management fees, $0.3 million from tenant
bankruptcy settlements and $1.4 million from miscellaneous income. In 2007, of
the $57.5 million in lease termination fees, approximately $46 million was from
the Ciena Corporation lease termination. Other income, including lease
terminations and settlements, of approximately $18.2 million for the year ended
December 31, 2006 included approximately $16.0 million from lease termination
fees, $1.1 million from management fees, $0.5 million from a property tax
accrual, $0.2 million from tenant bankruptcy settlements, $0.1 million from
security deposit forfeitures and $0.3 million from miscellaneous income. In
2006, of the $16.0 million in lease termination fees, approximately $11.1
million was from the JDS Uniphase lease termination. Management fees are paid by
the tenants to the landlord for the administration and supervision of the
property. We do not consider termination fees and tenant bankruptcy settlements
to be recurring items.
- 32 -
EXPENSES FROM CONTINUING PROPERTY OPERATIONS
The following table reflects the amounts of property operating and maintenance
expenses and real estate taxes ("operating expenses") from continuing operations
for the years ended December 31, 2007 and 2006 and the percentage of total
increase in expenses over the period that is represented by each group of
properties.
Year Ended December 31,
----------------------------------
2007 2006 $ Change % Change
-------------- --------------- -------------- ---------------
(dollars in thousands)
Same Property (1) $19,393 $18,001 $1,392 7.7%
2006 Acquisitions (2) 714 504 210 41.7%
2007 Acquisitions (3) 264 - 264 100.0%
-------------- --------------- --------------
Total $20,371 $18,505 $1,866 10.1%
============== =============== ==============
(1) "Same Property" is defined as properties owned by us prior to 2006 that we
still owned as of December 31, 2007.
(2) Operating expenses for 2006 Acquisitions do not reflect a full 12 months of
operations in 2006 because these properties were acquired at various times
during the year.
(3) Operating expenses for 2007 Acquisitions do not reflect a full 12 months of
operations in 2007 because these properties were acquired at various times
during the year.
Operating expenses from continuing operations increased by approximately $1.9
million, or 10.1%, from $18.5 million for the year ended December 31, 2006 to
$20.4 million for the year ended December 31, 2007 primarily due to increase in
real estate taxes, higher maintenance and repair costs and lease commission
write-offs associated with lease terminations. Tenant reimbursements from
continuing operations increased by approximately $0.3 million, or 2.3%, from
$13.1 million for the year ended December 31, 2006 to $13.4 million for the year
ended December 31, 2007. The increase in tenant reimbursements resulted
primarily from the increase in operating expenses. Total operating expenses
exceeded tenant reimbursements because of vacancies, which reached approximately
3.0 million rentable square feet by year-end 2007. Certain operating expenses
such as property insurance, real estate taxes, and other fixed expenses are not
recoverable from vacant properties. At December 31, 2007 our vacancy rate was
approximately 38%.
The following table depicts the amounts of general and administrative expenses
from operations for the years ended December 31, 2007 and 2006.
Year Ended December 31,
----------------------------------
2007 2006 $ Change % Change
-------------- --------------- -------------- ---------------
(dollars in thousands)
General and administrative $3,035 $2,248 $787 35.0%
General and administrative expenses increased by approximately $0.8 million, or
35.0%, from $2.2 million for the year ended December 31, 2006 to $3.0 million
for the year ended December 31, 2007. The increase in general and administrative
expenses was primarily a result of higher legal fees associated with a potential
acquisition of the Company, salaries and wages and share-based compensation
expense.
The following table depicts the amounts of depreciation and amortization expense
of real estate from continuing operations for the years ended December 31, 2007
and 2006.
Year Ended December 31,
----------------------------------
2007 2006 $ Change % Change
-------------- --------------- -------------- ---------------
(dollars in thousands)
Depreciation and amortization $22,588 $21,579 $1,009 4.7%
Depreciation and amortization expense of real estate from continuing operations
increased by approximately $1.0 million, or 4.7%, primarily due to new
construction of tenant improvements and the write-offs of additional
amortization expense relating to in-place lease value intangible assets pursuant
to SFAS 141 in connection with two lease terminations.
EQUITY IN EARNINGS FROM UNCONSOLIDATED JOINT VENTURE
The following table depicts the amounts of equity in earnings of unconsolidated
joint venture from operations for the years ended December 31, 2007 and 2006.
Year Ended December 31,
----------------------------------
2007 2006 $ Change % Change
-------------- --------------- -------------- ---------------
(dollars in thousands)
Equity in earnings of
unconsolidated joint venture $1,408 $1,985 ($577) (29.1%)
As of December 31, 2007, we had investments in three R&D buildings, totaling
approximately 466,600 rentable square feet in Morgan Hill, California, through
an unconsolidated joint venture with TBI, in which we acquired a 50% interest
from the Berg Group in
- 33 -
January 2003. We have a non-controlling limited partnership interest in this
joint venture, which we account for using the equity method of accounting. For
the years ended December 31, 2007 and 2006, equity in earnings from the
unconsolidated joint venture was approximately $1.4 million and $2.0 million,
respectively. Our equity in earnings from this unconsolidated joint venture
decreased primarily due to a gain on sale of one R&D property in 2006 that did
not recur in 2007. The occupancy rate for the properties owned by this joint
venture at December 31, 2007 and 2006 was 100%.
The following table depicts the amounts of interest and dividend income from
operations for the years ended December 31, 2007 and 2006.
Year Ended December 31,
----------------------------------
2007 2006 $ Change % Change
-------------- --------------- -------------- ---------------
(dollars in thousands)
Interest and dividend income $3,086 $2,344 $742 31.7%
Interest and dividend income increased by approximately $0.7 million, or 31.7%,
from $2.3 million for the year ended December 31, 2006 to $3.0 million for the
year ended December 31, 2007. The increase in interest and dividend income was
primarily a result of higher interest rates. For the year ended December 31,
2007, interest income totaled approximately $3.0 million. For the year ended
December 31, 2006, interest income totaled approximately $2.3 million.
The following table depicts the amounts of interest expense from operations for
the years ended December 31, 2007 and 2006.
Year Ended December 31,
----------------------------------
2007 2006 $ Change % Change
-------------- --------------- -------------- ---------------
(dollars in thousands)
Interest $20,131 $20,708 ($577) (2.8%)
Interest (related parties) 724 755 (31) (4.1%)
-------------- --------------- --------------
Total $20,855 $21,463 ($608) (2.8%)
============== =============== ==============
Interest expense decreased by approximately ($0.6) million, or (2.8%). Interest
expense (related parties) decreased by ($0.03) million, or (4.1%).
NET INCOME TO COMMON STOCKHOLDERS AND NET INCOME TO MINORITY INTERESTS
The following table depicts the amounts of earnings attributable to common
stockholders and minority interests for the years ended December 31, 2007 and
2006.
Year Ended December 31,
-------------------------------
2007 2006 $ Change % Change
------------- ------------- ------------- -------------
(dollars in thousands)
Net income to common stockholders $18,888 $14,630 $4,258 29.1%
Net income to minority interests 76,960 66,358 10,602 16.0%
------------- ------------- -------------
Total $95,848 $80,988 $14,860 18.3%
============= ============= =============
As of December 31, 2007 and 2006, we owned a controlling general partner
interest of 19.94%, 21.78%, 16.26% and 12.48% and 19.71%, 21.78%, 16.26% and
12.48% in the four operating partnerships, Mission West Properties, L.P.,
Mission West Properties, L.P. I, Mission West Properties, L.P. II and Mission
West Properties, L.P. III, respectively. We owned an 18.73% and 18.23% general
partner interest in the operating partnerships, taken as a whole, on a
consolidated weighted average basis as of December 31, 2007 and 2006,
respectively. Net income to common stockholders in 2007 increased by
approximately $4.3 million, or 29.1%, from December 31, 2006. Our net income
attributable to minority interests in 2007 increased by approximately $10.6
million, or 16.0%, from December 31, 2006. The increase in net income
attributable to common stockholders and minority interests resulted primarily
due to higher lease termination fee income described above.
Minority interests represent the limited partners' ownership interest of 81.27%
and 81.77% in the operating partnerships, on a weighted average basis, as of
December 31, 2007 and 2006, respectively. The decrease in the minority interest
ownership percentage resulted from the exchange of O.P. Units for shares of the
Company's common stock.
INCOME FROM DISCONTINUED OPERATIONS
The following table depicts the amounts of income from discontinued operations
for the years ended December 31, 2007 and 2006.
Year Ended December 31,
--------------------------------------------------------------
2007 2006
----------------------------- ----------------------------
(dollars in thousands)
Income attributable to discontinued operations $6,620 $19,603
Minority interests in earnings attributable to discontinued operations (5,489) (16,431)
----------------------------- ----------------------------
Income from discontinued operations $1,131 $3,172
============================= ============================
- 34 -
In 2007, we sold two R&D properties and in accordance with our adoption of SFAS
144, classified the net gains on sale and operating results of the disposed
properties as discontinued operations, and in 2006, we sold three R&D properties
and classified the net gains on sale and operating results of the disposed
properties as discontinued operations. SFAS 144 requires prior period results of
operations for these properties to be retrospectively adjusted and presented in
discontinued operations in prior consolidated statements of operations.
We recognized total income of approximately $6.6 million from discontinued
operations, of which $1.1 million and $5.5 million were attributable to common
stockholders and minority interests, respectively, for the year ended December
31, 2007. For the year ended December 31, 2006, we recognized total income from
discontinued operations of approximately $19.6 million. The income to common
stockholders and minority interests attributable to discontinued operations from
these properties in 2006 was approximately $3.2 million and $16.4 million,
respectively.
CHANGES IN FINANCIAL CONDITION
YEAR ENDED DECEMBER 31, 2008
The most significant changes in our financial condition in 2008 resulted from
the acquisition of two R&D properties, the exercise of stock options and the
exchange of O.P. Units for shares of the Company's common stock.
During 2008, we acquired two R&D properties representing approximately 186,000
rentable square feet for an aggregate gross purchase price of approximately
$35.8 million. We acquired one R&D property in a tax-deferred exchange
transaction plus cash and paid cash to members of the Berg Group to acquire the
second R&D property.
Debt outstanding, including amounts due related parties, increased by
approximately $6.0 million, or 1.7%, from $346.7 million as of December 31, 2007
to $352.7 million as of December 31, 2008. In 2008, we repaid the remaining
balance on the Prudential loan with proceeds from the $115 million Hartford
loan, borrowed from our revolving line of credit and made recurring scheduled
debt payments.
During the year ended December 31, 2008, stock options to purchase 70,487 shares
of the Company's common stock were exercised at $10.00 per share and stock
options to purchase 6,667 shares of the Company's common stock were exercised at
$9.51 per share. The total proceeds to the Company of approximately $0.8 million
increased additional paid-in-capital.
In 2008, three limited partners exchanged a total of 6,970 O.P. Units for 6,970
shares of the Company's common stock pursuant to the Exchange Rights Agreement
resulting in a reclassification of approximately $0.07 million from minority
interests to additional paid-in-capital.
The conversion of O.P. Units to shares of the Company's common stock was applied
to increase our percentage interest as general partner in the operating
partnerships.
YEAR ENDED DECEMBER 31, 2007
The most significant changes in our financial condition in 2007 resulted from
the acquisition of four R&D properties, the acquisition of 55 acres of vacant
land, the disposition of two R&D properties and the exchange of O.P. Units for
shares of the Company's common stock.
During 2007, we acquired four R&D properties representing approximately 247,000
rentable square feet for an aggregate gross purchase price of approximately
$26.3 million. We acquired three of the R&D properties in tax-deferred exchange
transactions and paid cash and issued O.P. Units to members of the Berg Group to
acquire the fourth property. We also acquired 55 acres of vacant land for
approximately $27.8 million in a tax-deferred exchange transaction. In addition
to those property acquisitions, we sold two R&D properties to unrelated third
parties for a total gross sales price of approximately $16.0 million. Those
property dispositions reduced approximately 87,000 rentable square feet. The
proceeds were classified as restricted cash for use in tax-deferred property
exchanges and were reflected on our consolidated balance sheet as restricted
cash at December 31, 2007 (see Item 8, "Financial Statements and Supplementary
Data - Note 6" for further discussion of this transaction).
Debt outstanding, including amounts due related parties, decreased by
approximately ($11.1) million, or (3.1%), from $357.8 million as of December 31,
2006 to $346.7 million as of December 31, 2007 due to normal scheduled debt
payments.
In 2007, two limited partners exchanged a total of 220,500 O.P. Units for
220,500 shares of common stock pursuant to the Exchange Rights Agreement
resulting in a reclassification of approximately $2.9 million from minority
interests to additional paid-in-capital.
- 35 -
The conversion of O.P. Units to shares of the Company's common stock was applied
to increase our percentage interest as general partner in the operating
partnerships.
LIQUIDITY AND CAPITAL RESOURCES
In 2009, we anticipate operating cash flows from our property portfolio to be
lower compared to 2008. We are still experiencing weak demand for our R&D
properties in certain areas of the Silicon Valley, principally the south San
Jose area. If we are unable to lease a significant portion of the approximately
370,000 rentable square feet scheduled to expire in 2009, as well as our
currently available space, our operating cash flows will be affected adversely.
We are also subject to risks of decreased occupancy through tenant defaults and
bankruptcies, and potential reduction in rental rates upon renewal of
properties, which would result in reduction in cash flows from operations beyond
the level we are anticipating currently.
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 future borrowings
under our $17.5 million line of credit with the Heritage Bank of Commerce, which
we obtained in early 2008. We expect these sources of liquidity to be adequate
to meet projected distributions to stockholders and other presently anticipated
liquidity requirements in 2009. 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 our existing cash reserves. In 2009, we will be
obligated to make payments totaling approximately $25.7 million of debt
principal under our existing mortgage notes and line of credit without regard to
any debt refinancing or new debt obligations that we might incur, or optional
payments of debt principal.
On March 4, 2008, we established a $10 million uncollateralized revolving line
of credit with Heritage Bank of Commerce ("HBC"). We paid approximately $26,000
in loan and legal fees. On April 17, 2008, we entered into a "Change in Terms
Agreement" with HBC that increased the facility from $10 million to $17.5
million. The line of credit bears an interest rate of LIBOR plus 1.75% and
matures June 15, 2009. The HBC line of credit contains certain financial loan
and reporting covenants as defined in the loan agreements. As of December 31,
2008, we were in compliance with these loan covenants. The proceeds from the HBC
line of credit may be used to repay debt, complete acquisitions and finance
other working capital requirements.
We expect to renew the HBC line of credit in June 2009 when it matures.
On October 1, 2008, we entered into a fixed rate term agreement and related
contracts and instruments for a secured mortgage loan totaling $115 million from
Hartford Life Insurance Company, Hartford Life and Accident Insurance Company
and Hartford Life and Annuity Insurance Company (the "Hartford Loan"). The
proceeds were used primarily to repay the remaining balance of an existing
mortgage loan with Prudential Mortgage Capital Company and to provide other
working capital needs. The Hartford Loan bears a fixed interest rate of 6.21%,
with a 20-year amortization, and matures October 1, 2018, at which time any
outstanding principal and interest will be due. Pursuant to the loan agreement,
monthly principal and interest installment payments of approximately $0.84
million are due on the first day of each month. The Hartford Loan is secured by
20 properties consisting of approximately 1.6 million rentable square feet. In
connection with the loan, we paid approximately $1.0 million in loan fees and
financing costs, which are amortized over the ten year loan period. We have the
option to prepay the Hartford Loan, subject to certain yield maintenance
provisions, though generally no prepayment is permitted during the first 24
months of the loan term.
As of December 31, 2008, we were in compliance with loan covenants relating to
the Allianz, Hartford, Northwestern mortgage loans and the HBC line of credit
loan.
Cash and cash equivalents decreased by approximately ($23.7) million from $23.7
million as of December 31, 2007 to zero as of December 31, 2008.
Restricted cash totaled approximately $39.5 million as of December 31, 2008. The
entire amount represents a balance we have consolidated due to our adoption of
FIN 46R (see Item 8, "Financial Statements and Supplementary Data - Note 7" for
further discussion of this transaction). 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.
Since 1999, we have elected to be taxed as a REIT under the Internal Revenue
Code of 1986. We intend to continue operating as a REIT in 2009. As a REIT, we
are subject to a number of organizational and operating requirements, including
a requirement to distribute 90% of our taxable income to our stockholders. Also
as a REIT, we generally will not be subject to federal income taxes on our
taxable income.
- 36 -
Generally, our objective is to meet our short-term liquidity requirement of
funding the payment of our current level of quarterly common dividends to
stockholders and O.P. Unit holders through our net cash flows provided by
operating activities, less our recurring and nonrecurring property capital
expenditures. These operating capital expenditures are the capital expenditures
necessary to maintain the earnings capacity of our operating assets over time.
For 2009, we expect to maintain our quarterly dividend payment at the current
rate of $0.20 per share to common stockholders and O.P. Unit holders. 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 (see Item 1A, "Risk Factors - Stockholders are not assured of receiving
cash distributions from us").
On January 8, 2009, we paid dividends of $0.20 per share of common stock to all
common stockholders of record as of December 31, 2008. On the same date, the
operating partnerships paid a distribution of $0.20 per O.P. Unit to all holders
of O.P. Units, with the exception of the Berg Group. A short-term note payable,
which bears interest at LIBOR plus 2%, in the amount of approximately $10.8
million was issued to the Berg Group and fully paid in February 2009. Aggregate
dividends and distributions for the quarter ended December 31, 2008 amounted to
approximately $21.1 million.
Funds available for distributions does not represent cash generated from
operating activities and is not necessarily indicative of cash available to fund
cash needs. The actual return that we will realize and the amount available for
distributions to stockholders will be affected by a number of factors, including
the revenues received from our properties, our operating expenses, debt service
on borrowings, and planned and unanticipated capital expenditures.
We anticipate that cash available for distribution will exceed earnings and
profits for federal income tax purposes, as the latter figure takes into account
non-cash expenses such as depreciation and amortization that we will incur.
Distributions other than capital gain distributions by us to the extent of our
current and accumulated earnings and profits for federal income tax purposes
most likely will be taxable to U.S. stockholders as ordinary dividend income
unless a stockholder is a tax-exempt entity. Distributions in excess of earnings
and profits generally will be treated as a non-taxable reduction of the U.S.
stockholder's basis in the common stock to the extent of such basis, and
thereafter as taxable gain. The percentage of such distributions in excess of
earnings and profits, if any, may vary from period to period.
CONTRACTUAL OBLIGATIONS
The following table identifies the contractual obligations with respect to the
maturities and scheduled principal repayments of our secured debt, Note, Credit
Facility and scheduled interest payments of our fixed-rate and variable-rate
debt at December 31, 2008 and provides information about our operating lease
obligations that will impact our liquidity and cash flow in future periods.
------------- ------------- ------------- -------------- ------------- ------------- ------------
2009 2010 2011 2012 2013 Thereafter Total
------------- ------------- ------------- -------------- ------------- ------------- ------------
Principal payments(1) $25,669 $13,328 $14,109 $14,935 $81,269 $203,438 $352,748
Interest payments-fixed rate debt(2) 19,170 18,433 17,651 16,825 12,820 62,288 147,187
Interest payments-variable rate debt(3) 166 - - - - - 166
Operating lease obligations(4) 120 30 - - - - 150
------------- ------------- ------------- -------------- ------------- ------------- ------------
Total $45,125 $31,791 $31,760 $31,760 $94,089 $265,726 $500,251
============= ============= ============= ============== ============= ============= ============
(1) As of December 31, 2008, 96.3% of our debt was contractually fixed and 3.7%
of our debt bore interest at variable rates. Our debt obligations are set
forth in detail in the table below.
(2) The information in the table above reflects our projected interest rate
obligations for the fixed-rate payments based on the contractual interest
rates, interest payment dates and scheduled maturity dates.
(3) The information in the table above reflects our projected interest rate
obligations for the variable-rate payments based on LIBOR plus a 1.75%
spread at December 31, 2008, the scheduled interest payment dates and
maturity dates .
(4) Our operating lease obligations relate to a lease of our corporate office
facility from a related party.
At December 31, 2008, we had total indebtedness of approximately $352.7 million.
A table listing our indebtedness as of December 31, 2008 is set forth in Item 8,
"Financial Statements and Supplementary Data - Note 8."
At December 31, 2008, 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 $7.65 per share on December 31, 2008) on a fully diluted basis, including the
conversion of all O.P. Units into common stock, was approximately 30.4%. On
December 31, 2008, the last trading day for the year, total market
capitalization was approximately $1.16 billion. By comparison, on December 31,
2007 total debt as a percentage of market capitalization was 25.7% and total
market capitalization was approximately $1.35 billion.
- 37 -
At December 31, 2008, the outstanding balance remaining under certain demand
notes that we owed to the operating partnerships was approximately $2.1 million.
The due date of the demand notes has been extended to September 30, 2010. The
principal of the demand notes, along with the interest expense, which is
interest income to the operating partnerships, is eliminated in consolidation
and is not included in the corresponding line items within the consolidated
financial statements. However, the interest income earned by the operating
partnerships, which is interest expense to us, in connection with this debt, is
included in the calculation of minority interest as reported on the consolidated
statements 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
The Company's cash flow activities are summarized as follows:
Year Ended December 31,
-----------------------------------------------------------
2008 2007 2006
----------------- ---------------- ----------------
(dollars in thousands)
Cash flow provided by operating activities $39,775 $23,501 $27,012
Cash flow used in investing activities ($29,605) ($8,548) ($5,369)
Cash flow (used in) provided by financing activities($33,861) ($25,047) ($19,299)
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2008 TO THE YEAR ENDED DECEMBER 31,
2007
Cash and cash equivalents were approximately zero at December 31, 2008 compared
with $23.7 million at December 31, 2007.
Net cash provided by operating activities for the year ended December 31, 2008
was approximately $39.8 million, compared with approximately $23.5 million for
the year ended December 31, 2007. The increase in cash provided by operating
activities resulted primarily from a $16.9 million cash distribution received
from our unconsolidated joint venture, TBI-MWP, from the sale of two R&D
buildings.
Cash used in investing primarily consists of property acquisitions, improvements
to our properties and investment in marketable securities. Net cash used in
investing activities was approximately ($29.6) million for the year ended
December 31, 2008 compared with approximately ($8.5) million for the prior year.
In 2008, we acquired two properties for approximately $35.8 million, incurred
capital expenditures relating to real estate improvements of approximately $6.5
million, invested approximately $3.1 million in marketable securities and
transferred excess restricted cash of approximately $7.7 million to our general
cash account. We used restricted cash totaling approximately $8.1 million for
the acquisition of one R&D property in a tax-deferred exchange transaction
involving our former R&D property at Morse Avenue in Sunnyvale, California. In
2007, we acquired six properties for approximately $47.5 million, incurred
capital expenditures relating to real estate improvements of approximately $4.9
million and transferred excess restricted cash of approximately $0.6 million to
our general cash account. We used restricted cash totaling approximately $43.2
million for the acquisition of three R&D properties and 55 acres of vacant land
in tax-deferred exchange transactions involving our former R&D properties at
Samaritan Drive in San Jose, California. We sold two R&D properties for
approximately $15.4 million, net, as described above, the proceeds of which were
reflected on our consolidated balance sheet as restricted cash at December 31,
2007.
Net cash used in financing activities was approximately ($33.9) million for the
year ended December 31, 2008, compared with approximately ($25.0) million for
the year ended December 31, 2007. During 2008, financing activities included
borrowing $115 million under a new collateralized mortgage loan, borrowing
approximately $13.1 million under our line of credit, payments of approximately
$122.1 million for outstanding debt, borrowing and payment of approximately
$19.4 million for the purchase of an R&D building, borrowing and payment of $3
million for a short-term loan, payment of approximately $1.2 million in
financing costs related to a new mortgage loan, refund of $1.5 million from a
certificate of deposit related to a former loan escrow, receipt of approximately
$0.8 million from stock option exercises, payments of approximately $15.0
million to common stockholders as dividends and paid approximately $25.9 million
to O.P. Unit holders for distributions in excess of their share of earnings.
During 2007, financing activities included payments of approximately $11.0
million for outstanding debt, payment of approximately $1.5 million for a
certificate of deposit related to a current loan escrow and payments of
approximately $12.5 million to common stockholders as dividends.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2007 TO THE YEAR ENDED DECEMBER 31,
2006
Cash and cash equivalents were approximately $23.7 million at December 31, 2007,
a decrease of ($10.1) million from $33.8 million at December 31, 2006.
Net cash provided by operating activities for the year ended December 31, 2007
was approximately $23.5 million, compared with approximately $27.0 million for
the prior year. The decrease in cash provided by operating activities resulted
primarily from lower lease termination fee payment, lower deferred rental income
and higher leasing commission payments (included in other assets) in 2007.
- 38 -
Cash used in investing primarily consists of property acquisitions, property
sales and improvements to our properties. Net cash used in investing activities
was approximately ($8.5) million for the year ended December 31, 2007 compared
with approximately ($5.4) million for the prior year. In 2007, we acquired six
properties for approximately $47.5 million, incurred capital expenditures
relating to real estate improvements of approximately $4.9 million and
transferred excess restricted cash of approximately $0.6 million to our general
cash account. We used restricted cash totaling approximately $43.2 million for
the acquisition of three R&D properties and 55 acres of vacant land in
tax-deferred exchange transactions involving our former R&D properties at
Samaritan Drive in San Jose, California. We sold two R&D properties for
approximately $15.4 million, net, as described above, the proceeds of which are
reflected on our consolidated balance sheet as restricted cash at December 31,
2007. In 2006, we sold three vacant R&D properties for approximately $42.6
million, net. We acquired three R&D properties for approximately $16.0 million,
incurred capital expenditures relating to real estate improvements of
approximately $4.3 million and transferred approximately $1.8 million of excess
restricted cash to our general cash account. We used restricted cash totaling
approximately $13.5 million to complete the acquisition of two R&D properties in
a tax-deferred exchange transaction involving our former R&D property at
Embedded Way in San Jose, California. Proceeds of approximately $43.0 million,
which included earned interest, from the three vacant R&D property dispositions
were classified as restricted cash for use in tax-deferred property exchanges
and were reflected on our consolidated balance sheet as restricted cash at
December 31, 2006.
Net cash used in financing activities was approximately ($25.0) million for the
year ended December 31, 2007, compared with approximately ($19.3) million for
the year ended December 31, 2006. During 2007, financing activities included
payments of approximately $11.0 million for outstanding debt, payment of
approximately $1.5 million for a certificate of deposit related to a loan escrow
and payments of approximately $12.5 million to common stockholders as dividends.
During 2006, financing activities included payments of approximately $9.8
million for outstanding debt, receipt of approximately $1.6 million from the
refund of an appeal bond, receipt of approximately $1.0 million from stock
option exercises and payments of approximately $12.1 million to common
stockholders as dividends.
CAPITAL EXPENDITURES
Our properties require periodic investments of capital for tenant-related
capital expenditures and for general capital improvements. For the years ended
December 31, 2003 through December 31, 2007, the recurring tenant/building
improvement costs and leasing commissions incurred with respect to new leases
and lease renewals of the properties averaged approximately $6.2 million
annually. We will have approximately 370,000 rentable square feet under expiring
leases in 2009. We expect that the average annual cost of recurring
tenant/building improvements and leasing commissions related to these properties
will be approximately $5.0 million during 2009. We believe we will recover
substantially all of these costs from the tenants under the new or renewed
leases through contractual increases in rental rates. Until we actually sign the
leases, however, we cannot assure you that this will occur. Capital expenditures
may fluctuate in any given period subject to the nature, extent, and timing of
improvements required to be made to the properties. Tenant/building improvements
and leasing costs also may fluctuate in any given period year depending upon
factors such as the property, the term of the lease, the type of lease and the
overall market conditions. We expect to meet our long-term liquidity
requirements for the funding of property acquisitions and other material
non-recurring capital improvements through our currently available sources of
capital, including operating cash flows, cash on hand, and our credit
facility(see "Policies with Respect to Certain Activities - Financing Policies"
below).
DISTRIBUTION POLICY
Distributions are determined by our Board of Directors and depend on actual cash
available for distributions, our financial condition, capital requirements, the
annual distribution requirements under the REIT provisions of the Code and such
other factors as the Board of Directors deems relevant. For a discussion of the
risk that we will not meet our distribution objectives, see Item 1A, "Risk
Factors - Stockholders are not assured of receiving cash distributions from us."
POLICIES WITH RESPECT TO CERTAIN ACTIVITIES
We have adopted policies with respect to investment, financing, conflicts of
interest and other activities. These policies have been formulated by our Board
of Directors, are set forth in our charter, bylaws, operating partnership
agreements or agreements with the Berg Group, and generally may be amended or
revised from time to time, subject to applicable agreement terms, at the
discretion of the Board of Directors without a vote of the stockholders. Among
other things, these policies provide that:
- so long as the Berg Group members and their affiliates, other than us and
the operating partnerships, beneficially own, in the aggregate, at least
15% of the outstanding shares of common stock on a Fully Diluted basis, the
approval of a majority of our directors, including Carl E. Berg or his
designee as a director, and of the holders of a majority of the O.P. Units
is required for us to take title to assets, other than temporarily in
connection with an acquisition prior to contributing such assets to the
operating partnerships, or to conduct business other than through the
operating partnerships, or for us or the operating partnerships to engage
in any business other than the ownership, construction, development and
operation of real estate properties, or for certain fundamental corporate
actions, including amendments to our charter, bylaws or any operating
- 39 -
partnership agreement and any merger, consolidation or sale of all or
substantially all of our assets or the assets of the operating
partnerships;
- changes in certain policies with respect to conflicts of interest must be
consistent with legal requirements;
- certain policies with respect to competition by and acquisitions from the
Berg Group are imposed pursuant to provisions of the acquisition agreement
that cannot be amended or waived without the approval of the Independent
Directors Committee of our Board of Directors;
- we cannot take any action intended to terminate our qualification as a REIT
without the approval of more than 75% of the entire Board of Directors; and
- we cannot undertake certain other specified transactions, including the
issuance of debt securities, and borrowings in excess of specified limits,
or the amendment of our charter and bylaws, without the approval of more
than 75% of the entire Board of Directors.
INVESTMENT POLICIES
We expect to pursue our business and investment objectives principally through
the direct ownership by the operating partnerships of our properties and future
acquired properties. Development or investment activities are not limited to any
specified percentage of our assets. We may also participate with other entities
in property ownership, through joint ventures or other types of co-ownership.
Equity investments may be subject to existing mortgage financing and other
indebtedness that have priority over our equity interests.
While we will emphasize equity real estate investments, we may, in our
discretion and subject to the percentage ownership limitations and gross income
tests necessary for REIT qualification, invest in mortgage and other real estate
interests, including securities of other real estate investment trusts. We have
not previously invested in mortgages of other real estate investment trusts. In
the fourth quarter of 2008, we invested approximately $3.6 million in securities
of another real estate investment trust.
FINANCING POLICIES
To the extent that our Board of Directors determines to seek additional capital,
we may raise such capital through additional equity offerings, debt financing or
retention of cash flow, or through a combination of these sources, after
consideration of provisions of the Code requiring the distribution by a REIT of
a certain percentage of its taxable income and taking into account taxes that
would be imposed on undistributed taxable income. It is our present intention
that any additional borrowings will be made through the operating partnerships,
although we may incur borrowings that would be re-loaned to the operating
partnerships. Borrowings may be unsecured or may be secured by any or all of our
assets, the operating partnerships or any existing or new property, and may have
full or limited recourse to all or any portion of our assets, the operating
partnerships or any existing or new property.
We have adopted a policy of maintaining a consolidated ratio of debt to total
market capitalization, which includes for this purpose the market value of all
shares of common stock for which outstanding O.P. Units are exchangeable, of
less than 50%. This ratio may not be exceeded without the approval of more than
75% of our entire Board of Directors. We also may determine to finance
acquisitions through the exchange of properties or the issuance of additional
O.P. Units in the operating partnerships, shares of common stock or other
securities.
In the event that the Board of Directors determines to raise additional equity
capital, it has the authority, without stockholder approval, to issue additional
shares of common stock, preferred stock or other capital stock, including
securities senior to the common stock, in any manner and on such terms and for
such consideration it deems appropriate, including in exchange for property. In
the event that we issue any shares of common stock or securities convertible
into or exchangeable or exercisable for, shares of common stock, subject to
limited exceptions, such as the issuance of common stock pursuant to any stock
incentive plan adopted by us or pursuant to limited partners' exercise of the
exchange rights or the put rights, the limited partners will have the right to
purchase common stock or such securities in order to maintain their respective
percentage interests in us on a Fully Diluted basis. If the Board of Directors
determines that we will raise additional equity capital to fund investments by
the operating partnerships, we will contribute such funds to the operating
partnerships as a contribution to capital and purchase of additional units of
general partner interest; however, holders of O.P. Units will have the right to
participate in such funding on a pro rata basis. In the event that holders of
O.P. Units sell their O.P. Units to us upon exercise of their put rights, we are
authorized to raise the funds for such purchase by issuing additional shares of
common stock. Alternatively, we may issue additional shares of common stock in
exchange for the tendered O.P. Units.
Our Board of Directors also has the authority to cause the operating
partnerships to issue additional O.P. Units in any manner and on such terms and
for such consideration, as it deems appropriate, including in exchange for
property. In the event that the operating partnerships issue new O.P. Units for
cash, but not property, the limited partners holding O.P. Units in an operating
partnership will have the right to purchase O.P. Units in order, and to the
extent necessary, to maintain their respective percentage interests in that
operating partnership. The new O.P. Units will be exchangeable for common stock
pursuant to the exchange rights or may be tendered to us pursuant to the put
rights.
- 40 -
DISPOSITION POLICIES
From time to time we may dispose of properties in our portfolio, subject to the
required approvals as set forth below. During the past two years we have sold
vacant R&D properties that we did not believe were likely to earn the type of
return on assets that we seek. We will continue to dispose of under-performing
properties when we consider it appropriate.
A significant factor influencing our disposition policy is that the tax basis of
the limited partners in the properties in the operating partnerships is
substantially less than current fair market value. Accordingly, prior to the
disposition of their O.P. Units, upon a disposition of any of the properties, a
disproportionately large share of the gain for federal income tax purposes would
be allocated to the limited partners.
In addition, the approval of a majority of our directors, including Carl E. Berg
or his designee, will be required to sell all or substantially all of our
assets. The consent of the holders of a majority of the O.P. Units will be
required to effect a sale or sales of all, or substantially all, of the assets
of any of the operating partnerships.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
For discussion of recent accounting pronouncements, see Item 8, "Financial
Statements and Supplementary Data - Note 2" to our consolidated financial
statements included in this report.
- 41 -
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not generally hold market risk sensitive instruments for trading purposes.
We use fixed and variable rate debt to finance our operations. Our exposure to
market risk for changes in interest rates relates primarily to our current
variable rate debt and our future debt obligations. We are vulnerable to
significant fluctuations of interest rates on our floating rate debt.
We manage our market risk by monitoring interest rates where we try to recognize
the unpredictability of the financial markets and seek to reduce potentially
adverse effects on the results of our operations. This takes frequent evaluation
of available lending rates and examination of opportunities to reduce interest
expense through new sources of debt financing. Several factors affecting the
interest rate risk include governmental monetary and tax policies, domestic and
international economics and other factors that are beyond our control. The
following table provides information about the principal cash flows, weighted
average interest rates, and expected maturity dates for debt outstanding as of
December 31, 2008. The current terms of our outstanding debt are described in
Item 8, "Financial Statements and Supplementary Data - Note 8." For fixed rate
debt, we estimate fair value by using discounted cash flow analyses based on
borrowing rates for similar kinds of borrowing arrangements. We estimated that
the fair value of fixed rate debt at December 31, 2008 was approximately $496.3
million.
For fixed rate debt, the table presents the assumption that the outstanding
principal balance at December 31, 2008 will be paid according to scheduled
principal payments and that we will not prepay any of the outstanding principal
balance.
For variable rate debt, the table presents the assumption that the outstanding
principal balance at December 31, 2008 will be paid upon maturity.
2009 2010 2011 2012 2013 Thereafter Total Fair Value
----------------------------------------------------------------------------------------------
(dollars in thousands)
FIXED RATE DEBT:
Secured notes payable $12,591 $13,327 $14,109 $14,935 $81,269 $203,438 $339,669 $496,320
Weighted average interest rate 5.86% 5.86% 5.86% 5.86% 5.86% 5.86%
VARIABLE RATE DEBT:
Unsecured debt $13,079 - - - - - $13,079 $13,079
Weighted average interest rate 3.17% - - - - -
The fixed rate debt represented 96.3% and 100% and the variable rate debt
represented 3.7% and 0% of all debt outstanding for the years ended December 31,
2008 and 2007, respectively.
All of our debt is denominated in United States dollars. The weighted average
interest rate for the fixed rate debt was approximately 5.86% and 5.85% for the
years ended December 31, 2008 and 2007, respectively. The increase in interest
expense attributable to the average interest rate difference between 2007 and
2008 was approximately $0.3 million, which was a result of new debt obtained in
2008.
The primary market risk we face is the risk of interest rate fluctuations. The
Heritage Bank of Commerce line of credit, which is tied to a LIBOR based
interest rate, was approximately $13.1 million, or 3.7%, of the total $352.7
million of debt as of December 31, 2008. With a floating interest rate we could
pay lower rates of interest in periods of decreasing interest rates and higher
rates of interest in periods of increasing interest rates. As of December 31,
2008 and 2007, we did not have any derivative instruments.
The following discussion of market risk is based solely on a possible
hypothetical change in future market conditions related to our variable rate
debt. It includes "forward-looking statements" regarding market risk, but we are
not forecasting the occurrence of these market changes. Based on the amount of
variable debt outstanding as of December 31, 2008, a 1% increase or decrease in
interest rates on our $13.1 million of floating rate debt would decrease or
increase, respectively, annual earnings and cash flows by approximately $0.1
million, as a result of the increased or decreased interest expense associated
with the change in rate, and would not have an impact on the fair value of the
floating rate debt. This amount is determined by considering the impact of
hypothetical interest rates on our borrowing cost. Due to the uncertainty of
fluctuations in interest rates and the specific actions that might be taken by
us to mitigate any such fluctuations and their possible effects, the foregoing
sensitivity analysis assumes no changes on our financial structure.
- 42 -
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
MISSION WEST PROPERTIES, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
---------
Report of Independent Registered Public Accounting Firm 44
Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting 45
Consolidated Balance Sheets as of December 31, 2008 and 2007 46
Consolidated Statements of Operations for the years ended December 31, 2008, 2007 and 2006 47
Consolidated Statements of Stockholders' Equity for the years ended December 31, 2008, 2007 and 2006 48
Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007 and 2006 49
Notes to Consolidated Financial Statements 50
Supplemental Financial Information 72
Report of Independent Registered Public Accounting Firm on Financial Statement Schedule 73
Schedule III: Real Estate and Accumulated Depreciation as of December 31, 2008 75
Schedule III: Real Estate and Accumulated Depreciation as of December 31, 2007 77
- 43 -
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Mission West Properties, Inc.
Cupertino, California
We have audited the accompanying consolidated balance sheets of Mission West
Properties, Inc. (the "Company") as of December 31, 2008 and 2007, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2008. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Mission West
Properties, Inc. at December 31, 2008 and 2007, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2008, in conformity with accounting principles generally
accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the Company's internal control over
financial reporting as of December 31, 2008, based on the criteria established
in Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission and our report dated March 13, 2009
expressed an unqualified opinion thereon.
\S\ Burr, Pilger & Mayer, LLP
San Francisco, California
March 13, 2009
- 44 -
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON
INTERNAL CONTROL OVER FINANCIAL REPORTING
Board of Directors and Stockholders
Mission West Properties, Inc.
Cupertino, California
We have audited Mission West Properties, Inc.'s (the Company) internal control
over financial reporting as of December 31, 2008, based on criteria established
in Internal Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the "COSO criteria"). The Company's
management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting included in the accompanying Management's
Report on Internal Control over Financial Reporting. Our responsibility is to
express an opinion on the Company's internal control over financial reporting
based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, testing
and evaluating the design and operating effectiveness of internal control based
on the assessed risk, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect that transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, Mission West Properties, Inc. maintained, in all material
respects, effective internal control over financial reporting as of December 31,
2008, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
Mission West Properties, Inc. as of December 31, 2008 and 2007, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended December 31, 2008, and the related
financial statement schedules listed in the Index at Item 15(a), and our reports
dated March 13, 2009 expressed an unqualified opinion thereon.
\S\ Burr, Pilger & Mayer, LLP
San Francisco, California
March 13, 2009
- 45 -
MISSION WEST PROPERTIES, INC.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except per share data)
ASSETS
December 31,
---------------------------------------------
2008 2007
---------------------- ---------------------
Investments in real estate:
Land $320,911 $312,152
Buildings and improvements 799,471 764,665
Real estate related intangible assets 3,240 2,119
---------------------- ---------------------
Total investments in properties 1,123,622 1,078,936
Accumulated depreciation and amortization (180,043) (156,819)
---------------------- ---------------------
Net investments in properties 943,579 922,117
Investment in unconsolidated joint venture 3,768 2,735
---------------------- ---------------------
Net investments in real estate 947,347 924,852
Cash and cash equivalents - 23,691
Restricted cash 39,478 65,509
Investment in marketable securities 3,368 -
Deferred rent receivables 17,841 14,833
Other assets, net 26,251 25,000
---------------------- ---------------------
Total assets $1,034,285 $1,053,885
====================== =====================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Mortgage notes payable $330,908 $337,520
Mortgage note payable (related parties) 8,761 9,224
Revolving line of credit 13,079 -
Interest payable 1,596 1,331
Security deposits 5,272 4,754
Deferred rental income 3,964 3,302
Dividends and distributions payable 21,055 16,832
Accounts payable and accrued expenses 17,747 15,618
---------------------- ---------------------
Total liabilities 402,382 388,581
---------------------- ---------------------
Commitments and contingencies (Note 16)
Minority interests in operating partnerships 497,485 526,626
---------------------- ---------------------
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, 19,748,211
and 19,664,087 shares issued and outstanding at December 31, 2008 and 2007 20 20
Additional paid-in capital 154,412 153,024
Distributions in excess of accumulated earnings (20,014) (14,366)
---------------------- ---------------------
Total stockholders' equity 134,418 138,678
---------------------- ---------------------
Total liabilities and stockholders' equity $1,034,285 $1,053,885
====================== =====================
See notes to consolidated financial statements.
- 46 -
MISSION WEST PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share data)
Year Ended December 31,
------------------------------------------------------------------------
2008 2007 2006
---------------------- ----------------------- -----------------------
Operating revenues:
Rental revenue from real estate $79,075 $80,337 $91,457
Above market lease intangible asset amortization - (4,091) (1,888)
Tenant reimbursements 16,406 13,355 13,061
Other income, including lease terminations and settlements 4,223 61,982 18,222
---------------------- ----------------------- -----------------------
Total operating revenues 99,704 151,583 120,852
---------------------- ----------------------- -----------------------
Operating expenses:
Property operating, maintenance and real estate taxes 23,460 20,371 18,505
General and administrative 2,635 3,035 2,248
Depreciation and amortization of real estate 23,224 22,588 21,579
---------------------- ----------------------- -----------------------
Total operating expenses 49,319 45,994 42,332
---------------------- ----------------------- -----------------------
Operating income 50,385 105,589 78,520
Other income (expenses):
Equity in earnings of unconsolidated joint venture 19,617 1,408 1,985
Interest and dividend income 1,735 3,086 2,344
Unrealized loss from investment (278) - -
Interest expense (19,787) (20,131) (20,708)
Interest expense - related parties (1,332) (724) (755)
---------------------- ----------------------- -----------------------
Income from continuing operations before minority interests 50,340 89,228 61,386
Minority interests from continuing operations (40,206) (71,471) (49,928)
---------------------- ----------------------- -----------------------
Income from continuing operations 10,134 17,757 11,458
Discontinued operations, net of minority interests:
Gain from disposal of properties classified as discontinued operations - 1,126 2,935
Income attributable to discontinued operations - 5 237
---------------------- ----------------------- -----------------------
Income from discontinued operations - 1,131 3,172
---------------------- ----------------------- -----------------------
Net income to common stockholders $10,134 $18,888 $14,630
====================== ======================= =======================
Net income to minority interests $40,206 $76,960 $66,358
====================== ======================= =======================
Income per share from continuing operations:
Basic $0.51 $0.90 $0.60
====================== ======================= =======================
Diluted $0.51 $0.89 $0.59
====================== ======================= =======================
Income per share from discontinued operations:
Basic - $0.06 $0.17
====================== ======================= =======================
Diluted - $0.06 $0.17
====================== ======================= =======================
Net income per share to common stockholders:
Basic $0.51 $0.96 $0.77
====================== ======================= =======================
Diluted $0.51 $0.95 $0.76
====================== ======================= =======================
Weighted average shares of common stock (basic) 19,714,414 19,627,234 19,066,581
====================== ======================= =======================
Weighted average shares of common stock (diluted) 19,996,349 19,854,411 19,298,664
====================== ======================= =======================
Weighted average O.P. Units 85,528,329 85,162,240 85,510,491
====================== ======================= =======================
Outstanding common stock 19,748,211 19,664,087 19,443,587
====================== ======================= =======================
Outstanding O.P. Units 85,526,965 85,533,935 85,206,199
====================== ======================= =======================
See notes to consolidated financial statements.
- 47 -
MISSION WEST PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(dollars in thousands, except per share data)
Distributions in
Additional Excess of Total
Shares of Common Common Paid-in Accumulated Stockholders'
Stock Outstanding Stock Capital Earnings Equity
------------------- -------- ------------- ----------------- --------------
Balance, December 31, 2005 18,448,791 $18 $138,038 ($23,041) $115,015
Net income 14,630 14,630
Dividends declared at $0.64 per share (12,271) (12,271)
Issuance of common stock upon O.P. Unit conversion 881,896 1 10,279 10,280
Issuance of common stock upon option exercise 112,900 1,014 1,014
Stock-based compensation 210 210
------------------- ---------- ------------- ----------------- ------------
Balance, December 31, 2006 19,443,587 19 149,541 (20,682) 128,878
Net income 18,888 18,888
Dividends declared at $0.64 per share (12,572) (12,572)
Issuance of common stock upon O.P. Unit conversion 220,500 1 2,854 2,855
Stock-based compensation 629 629
------------------- ---------- ------------- ----------------- ------------
Balance, December 31, 2007 19,664,087 20 153,024 (14,366) 138,678
Net income 10,134 10,134
Dividends declared at $0.80 per share (15,782) (15,782)
Issuance of common stock upon O.P. Unit conversion 6,970 66 66
Issuance of common stock upon option exercise 77,154 852 852
Stock-based compensation 470 470
------------------- ---------- ------------- ----------------- ------------
Balance, December 31, 2008 19,748,211 $20 $154,412 ($20,014) $134,418
=================== ========== ============= ================= ============
See notes to consolidated financial statements.
- 48 -
MISSION WEST PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
Year Ended December 31,
---------------------------------------------------------------
2008 2007 2006
-------------------- -------------------- -------------------
Cash flows from operating activities (including discontinued operations):
Net income $10,134 $18,888 $14,630
Adjustments to reconcile net income to net cash provided by
operating activities:
Minority interests in operating partnerships and discontinued 40,206 76,960 66,358
operations
Minority interests distributions (40,206) (55,313) (55,618)
Depreciation and amortization of real estate and in-place leases 23,224 22,735 22,274
Amortization of above market lease - 4,091 1,888
Gain from disposal of properties classified as discontinued operations - (6,529) (18,102)
Equity in earnings of unconsolidated joint venture (19,617) (1,408) (1,985)
Distributions from unconsolidated joint venture 18,584 2,141 1,780
Interest earned on restricted cash (977) (1,631) (821)
Lease termination fee income related to restricted cash 9,741 (35,636) (4,549)
Stock-based compensation expense 553 629 236
Other 142 147 37
Change in operating assets and liabilities, net of liabilities assumed:
Deferred rent receivable (3,008) 3,656 729
Other assets (2,575) (389) 751
Interest payable 265 (44) 1,054
Security deposits 518 (2,230) (1,070)
Deferred rental income 662 (3,572) 771
Accounts payable and accrued expenses 2,129 1,006 (1,351)
-------------------- -------------------- -------------------
Net cash provided by operating activities 39,775 23,501 27,012
-------------------- -------------------- -------------------
Cash flows from investing activities:
Improvements to investments in real estate (6,468) (4,878) (4,277)
Net proceeds from sale of properties - 15,431 42,628
Acquisition of properties (35,764) (47,491) (15,959)
Restricted cash held in escrow - (15,431) (43,043)
Restricted cash released for purchase of properties 8,082 43,191 13,447
Proceeds from release of restricted cash 7,654 630 1,835
Investment in marketable securities (3,109) - -
-------------------- -------------------- -------------------
Net cash used in investing activities (29,605) (8,548) (5,369)
-------------------- -------------------- -------------------
Cash flows from financing activities:
Proceeds from mortgage loan payable 115,000 - -
Principal payments on mortgage notes payable (121,612) (10,581) (9,380)
Principal payments on mortgage notes payable (related parties) (463) (430) (397)
Real estate purchase financing (related parties) 19,429 - -
Payment on real estate purchase financing (related parties) (19,429) - -
Proceeds from note payable (related parties) 3,000 - -
Payment on note payable (related parties) (3,000) - -
Net borrowings on revolving line of credit 13,079 - -
Debt issuance costs (1,231) - -
Loan escrow refund (deposit) 1,500 (1,500) -
Refund of appeal bond - - 1,599
Net proceeds from exercise of stock options 768 - 989
Minority interests distributions in excess of earnings (25,923) - -
Dividends paid (14,979) (12,536) (12,110)
-------------------- -------------------- -------------------
Net cash used in financing activities (33,861) (25,047) (19,299)
-------------------- -------------------- -------------------
Net (decrease)/increase in cash and cash equivalents (23,691) (10,094) 2,344
Cash and cash equivalents, beginning of year 23,691 33,785 31,441
-------------------- -------------------- -------------------
Cash and cash equivalents, end of year $ - $23,691 $33,785
==================== ==================== ===================
See notes to consolidated financial statements.
- 49 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)
1. ORGANIZATIONS AND FORMATION OF THE COMPANY
Mission West Properties, Inc. ("the Company") is a fully integrated,
self-administered and self-managed real estate company that acquires and manages
research and development ("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% interest in each 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. At that time, all limited partnership interests in the operating
partnerships were converted into 59,479,633 Operating Partnership Units ("O.P.
Units"), which represented a limited partnership ownership interest of
approximately 87.89% of the operating partnerships. The operating partnerships
are the vehicles through which the Company holds its real estate investments,
makes real estate acquisitions, and generally conducts its business.
As of December 31, 2008, the Company owns a controlling general partner interest
of 20.02%, 21.85%, 16.31% and 12.52% in Mission West Properties, L.P., Mission
West Properties, L.P. I, Mission West Properties, L.P. II and Mission West
Properties, L.P. III, respectively, for an 18.73% general partner interest in
the operating partnerships, taken as a whole, on a consolidated weighted average
basis.
The Company, through the operating partnerships, owns interests in 111 R&D
properties at December 31, 2008, all of which are located in the Silicon Valley.
BUSINESS SEGMENT INFORMATION
The Company's primary business is the ownership and management of R&D/office
real estate with a geographic concentration in the Silicon Valley of the San
Francisco Bay Area. Accordingly, the Company has concluded that it currently has
a single reportable segment for Statement of Financial Accounting Standards
("SFAS") 131 purposes.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION AND FINANCIAL STATEMENT PRESENTATION
The accompanying consolidated financial statements include the accounts of the
Company and its controlled subsidiaries, the operating partnerships (the
"Company"). All significant intercompany transactions have been eliminated in
consolidation.
The Company consolidates all variable interest entities in which it is deemed to
be the primary beneficiary in accordance with Financial Accounting Standard
Board ("FASB") Interpretation No. 46 (Revised December 2003), "Consolidation of
Variable Interest Entities" ("FIN 46R").
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America ("GAAP") requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the dates of
the financial statements and the reported amounts of revenue and expenses during
the reporting periods. Accounting and disclosure decisions with respect to
material transactions that are subject to significant management judgments or
estimates include impairment of long lived assets, realizability of deferred
rent receivables, and allocation of purchase price relating to property
acquisitions and the related depreciable lives assigned. Actual results could
differ materially from those estimates.
REAL ESTATE ASSETS AND RELATED INTANGIBLE ASSETS
Real estate assets are stated at cost. Cost includes expenditures for
improvements or replacements. Maintenance and repairs are charged to expense as
incurred.
According to SFAS 141, "Business Combinations," the fair value of the real
estate acquired is allocated to the acquired tangible assets, consisting of
land, building and tenant improvements, and identified intangible assets and
liabilities, consisting of the value of above-market and below-market leases,
other value of in-place leases and value of tenant relationships, based in each
case on their relative fair values. SFAS 141 was revised in December 2007. 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.
- 50 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
In allocating the fair value of the identified intangible assets of the acquired
property, above-market in-place lease value is recorded based on the present
value, using an interest rate which reflects the risks associated with the lease
acquired, of the difference between (i) the contractual amounts to be paid
pursuant to the in-place lease and (ii) management's estimate of fair market
lease rate for the corresponding in-place lease, measured over a period equal to
the remaining non-cancelable lease term. The capitalized above-market lease
value, included in real estate related intangible assets, is amortized as an
offset to rental revenue from real estate over the remaining non-cancelable
lease term. The value of in-place leases, exclusive of the value of above-market
in-place lease, is amortized to expense over the remaining non-cancelable
periods of the respective leases. If a lease were to be terminated prior to its
stated expiration, all unamortized amounts relating to that lease would be
written off in the period that the lease is terminated.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization are computed using the straight-line method over
estimated useful lives as follows:
Building shell and base building improvements of newly acquired properties - Weighted average composite life of 40 years
Base building improvements made subsequent to initial property acquisition - 25 years
Tenant improvements and furniture and fixtures - Lesser of life of asset, generally 5-10 years,
or term of lease
Above-market and in-place lease value - Term of lease
IMPAIRMENT OF LONG-LIVED ASSETS
The Company reviews real estate assets for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable in accordance with SFAS 144, "Accounting for the Impairment and
Disposal of Long-Lived Assets." If the carrying amount of the asset, including
any intangible assets associated with that asset, exceeds its estimated
undiscounted net cash flow, before interest, the Company will recognize an
impairment loss equal to the difference between its carrying amount and its
estimated fair value. If impairment is recognized, the reduced carrying amount
of the asset will be accounted for as its new cost. For a depreciable asset, the
new cost will be depreciated over the asset's remaining useful life. Generally,
fair values are estimated using discounted cash flow, replacement cost or market
comparison analyses. The analysis that the Company prepares in connection with
determining if there may be any asset impairment loss under SFAS 144 considers
several assumptions: holding period of ten years, 36 months lease up period and
cap rate ranging from 8% to 9%. The process of evaluating for impairment
requires estimates as to future events and conditions, which are subject to
varying market and economic factors, such as the vacancy rates, rental rates and
operating costs for R&D facilities in the Silicon Valley area and related
submarkets. Therefore, it is reasonably possible that a change in estimate
resulting from judgments as to future events could occur which would affect the
recorded amounts of the property. No impairment losses were recorded for the
years ended December 31, 2008 and 2007.
ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS
In accordance with SFAS 144, the results of operations and gains or losses on
the sale of property are presented as discontinued operations if both the
following criteria are met: (a) the operation and cash flows of the property
have been (or will be) eliminated from the ongoing operations of the Company as
a result of the disposal transaction; and (b) the Company will not have any
significant involvement in the operations of the property after the disposal
transaction. SFAS 144 also requires prior period results of operations for these
properties to be retrospectively adjusted and presented in discontinued
operations in prior consolidated statements of operations.
An asset is generally classified as held for sale once management has committed
to an action to sell the asset, the asset is available for immediate sale in its
present condition (subject to terms that are usual and customary for sales of
such assets), an active program to locate a buyer is initiated, the sale is
probable, the asset is being actively marketed for sale at a price that is
reasonable in relation to its current fair value and actions required to
complete the plan indicate that it is unlikely that significant changes to the
plan will be made or that the plan will be withdrawn. Properties for sale with
significant contingencies that may prevent their sale, such as obtaining
rezoning approval from the city, are not classified as assets held for sale.
Upon the classification of a real estate asset as held for sale, the carrying
value of the asset is reduced to the lower of its net book value or its fair
value, less costs to sell the asset. Subsequent to the classification of assets
as held for sale, no further depreciation expense is recorded. Real estate
assets held for sale are stated separately on the accompanying consolidated
balance sheets. The operating results of real estate assets held for sale and
sold are reported as discontinued operations in the accompanying consolidated
statements of operations. The income/(loss) from discontinued operations
includes the revenues and expenses, including depreciation, associated with the
assets. This classification of operating results as discontinued operations
applies retroactively for all periods presented for assets designated as held
for sale. Additionally, gains and losses on assets designated as held for sale
are classified as part of discontinued operations.
CASH AND CASH EQUIVALENTS
The Company considers highly liquid short-term investments with initial
maturities of three months or less to be cash equivalents. Cash and cash
equivalents are primarily held in one or more financial institutions, and at
times, such balances may be in excess of the Federal Deposit Insurance
Corporation insurance limit.
- 51 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
RESTRICTED CASH
Restricted cash totaled approximately $39,478 as of December 31, 2008. The
entire amount represents a balance the Company has consolidated due to its
adoption of FIN 46R, The Company does 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.
FUNDS HELD AT QUALIFIED INTERMEDIARY FOR 1031 EXCHANGE
Periodically, the Company enters into exchange agreements with qualified
intermediaries to facilitate the exchange of real property pursuant to Section
1031 of the Code ("Section 1031 Exchange"). A Section 1031 Exchange generally
allows for the deferral of income taxes related to the gain attributable to the
sale of property if qualified replacement properties are identified within 45
days and such qualified replacement properties are acquired within 180 days from
the initial sale. During the replacement period, the Company may direct the
proceeds from a disposition to be held at a qualified intermediary for the sole
purpose of completing a Section 1031 Exchange. The proceeds are generally
classified as restricted cash.
INVESTMENT IN MARKETABLE SECURITIES
Marketable securities reported in the Company's consolidated balance sheet
represent investments traded in the open market. The marketable securities are
adjusted to fair value at the end of each accounting period, with the
corresponding losses and gains recorded in unrealized losses or gains from
investment. For the year ended December 31, 2008, the Company recorded net
unrealized losses of approximately $278 related to the decrease in fair value of
the marketable securities, which was reported in unrealized loss from investment
in the Company's consolidated statement of operations.
OTHER ASSETS
Included in other assets are costs associated with obtaining debt financing and
commissions associated with new leases. Such debt financing costs are being
amortized over the term of the associated debt, by a method that approximates
the effective interest method and such lease commissions are amortized
straight-line over the term of the related lease. If the lease is terminated
prior to the end of the lease term, the Company charges any unamortized
capitalized lease commission cost to expense in the period that the lease is
terminated. Also included in other assets are commitments from the Berg Group of
approximately $7,494 to construct a building at 245 Caspian Drive in Sunnyvale,
California (see Note 13 below).
MINORITY INTERESTS
Minority interests in the operating partnerships represent the proportionate
share of the equity in the operating partnerships of the limited partners.
Minority interests in net income is calculated by taking the net income of the
operating partnerships (on a stand-alone basis) multiplied by the respective
minority interests' ownership percentage.
REVENUE RECOGNITION
Rental income is derived from operating leases and recognized on the
straight-line method of accounting required by GAAP under which contractual rent
payment increases are recognized evenly over the lease term. The difference
between recognized rental income and rental cash receipts is recorded as
"Deferred rent receivable" on the consolidated balance sheets. Certain lease
agreements contain terms that provide for additional rents based on
reimbursement of certain costs including property operating expenses,
maintenance and real estate taxes. These additional rents from tenant
reimbursements are reflected on the accrual basis.
Rental revenue is affected if existing tenants terminate or amend their leases.
The Company tries to identify tenants who may be likely to declare bankruptcy,
cease operations or otherwise terminate leases prior to the end of the lease
term, such as tenants who do not occupy all or a large portion of the property
being leased. By anticipating these events in advance, the Company expects to
take steps to minimize their impact on its reported results of operations
through lease renegotiations and other appropriate measures. Reserves against
"Deferred rent receivable" are estimated by management based on known financial
conditions of tenants and management's estimate of net realizability of such
receivables based on existing or expected negotiations with tenants. The
Company's judgments and estimations about tenants' capacity to continue to meet
their lease obligations will affect the rental revenue recognized. To date,
actual reductions in revenue as a result of early terminations and the tenants'
inability to pay have been within management's estimates. However, material
differences may result in the amount and timing of the Company's rental revenue
for any period if it made different judgments or estimations.
Lease termination fees are recognized in operating revenues when there is a
signed termination letter agreement, all of the conditions of the agreement have
been met, the tenant is no longer occupying the property and the termination
consideration is probable of collection. These fees are paid by tenants who want
to terminate their lease obligations before the end of the contractual term of
the lease by agreement with us. There is no way of predicting or forecasting the
timing or amounts of future lease termination fees.
- 52 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
The Company recognizes income from rent, tenant reimbursements and lease
termination fees and other income once all of the following criteria are met in
accordance with SEC Staff Accounting Bulletin 104, "Revenue Recognition":
- the agreement has been fully executed and delivered;
- services have been rendered;
- the amount is fixed and determinable; and
- the collectability is reasonably assured.
INCOME TAXES
The Company has been taxed as a real estate investment trust ("REIT") under the
Internal Revenue Code of 1986, as amended, (the "Code") commencing with the
taxable year ended December 31, 1999. In order for the Company to qualify as a
REIT, it must distribute annually at least 90% of its REIT taxable income, as
defined in the Code, to its stockholders and comply with certain other
requirements. Accordingly, for the years ended December 31, 2008, 2007 and 2006,
no provision for federal income taxes has been included in the accompanying
consolidated financial statements.
For the year ended December 31, 2008, the Company's total dividends paid or
payable to the stockholders represented approximately 73.3% ordinary income,
22.2% capital gain and 4.5% unrecaptured section 1250 gain for income tax
purposes (unaudited). For the year ended December 31, 2007, the Company's total
dividends paid or payable to the stockholders represented approximately 97%
ordinary income, 2% capital gain and 1% unrecaptured section 1250 gain for
income tax purposes (unaudited). For the year ended December 31, 2006, the
Company's total dividends paid or payable to the stockholders represented 100%
ordinary income for income tax purposes (unaudited).
NET INCOME PER SHARE
The computation of net income per share is based on the weighted average number
of common shares outstanding during the period. Diluted earnings per share
amounts are based upon the weighted average of common and common equivalent
shares outstanding during the year.
ACCOUNTING FOR STOCK-BASED COMPENSATION
SFAS 123 (Revised 2004), "Share-Based Payment" ("SFAS 123R"), addresses the
accounting for employee, director and consultant stock options. SFAS 123R
requires that the cost of stock options, as well as other equity-based
compensation arrangements, be reflected in the consolidated financial statements
based on the estimated fair value of the awards. SFAS 123R is an amendment to
SFAS 123 and supersedes Accounting Principles Board Opinion 25, "Accounting for
Stock Issued to Employees" ("APB 25"). SFAS 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. As of
December 31, 2008, the Company had one stock-based compensation plan.
The Company measures compensation cost for its stock options at fair value on
the date of grant and recognizes compensation expense relating to the remaining
unvested portion of outstanding stock options at the time of adoption 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 expenses in the Company's accompanying consolidated
statements of operations. For the year ended December 31, 2008, under SFAS 123R,
the Company recorded approximately $553 of expense for share-based compensation
relating to stock options.
As of December 31, 2008, there was approximately $564 of total unrecognized
compensation cost related to unvested share-based compensation arrangements
granted under the compensation plan. That cost is expected to be recognized over
a weighted-average period of approximately four years.
In January 2008, stock options to purchase 1,025,000 shares of common stock were
granted to employees, non-employee directors and consultants. The options vest
monthly for 48 months from date of grant, subject to continued employment or
other service to the Company. Each option grant has a term of six years from the
date of grant subject to earlier termination in certain events related to
termination of employment or service. The options were granted at an exercise
price of $9.51 per share. The estimated fair value of the options granted was
$0.57 per share on the date of grant using the Black-Scholes option pricing
model with the following assumptions: dividend yield of 8.41%, volatility of
20.43%, risk free rates of 3.45% and an expected life of six years. All options
were granted at fair market value on the date of grant.
In July 2008, stock options to purchase 52,500 shares of common stock were
granted to an employee and a non-employee director. The options vest monthly for
48 months from date of grant, subject to continued employment or other service
to the Company. Each option grant has a term of six years from the date of grant
subject to earlier termination in certain events related to termination of
- 53 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
employment or service. The options were granted at an exercise price of $11.36
per share. The estimated fair value of the options granted was $0.99 per share
on the date of grant using the Black-Scholes option pricing model with the
following assumptions: dividend yield of 7.04%, volatility of 22.07%, risk free
rates of 3.20% and an expected life of six years. All options were granted at
fair market value on the date of grant.
In November 2008, stock options to purchase 705,000 shares of common stock were
granted to employees, non-employee directors and consultants. The options vest
monthly ranging from 36-48 months from date of grant, subject to continued
employment or other service to the Company. Each option grant has a term of six
years from the date of grant subject to earlier termination in certain events
related to termination of employment or service. The options were granted at an
exercise price of $6.14 per share. The estimated fair value of the options
granted was $0.12 per share on the date of grant using the Black-Scholes option
pricing model with the following assumptions: dividend yield of 13.03%,
volatility of 22.39%, risk free rates of 2.08% and an expected life of six
years. All options were granted at fair market value on the date of grant.
In 2007, stock options to purchase 710,000 shares of common stock were granted
to employees, non-employee directors and consultants. The options vest monthly
for 48 months from date of grant, subject to continued employment or other
service to the Company. Each option grant has a term of six years from the date
of grant subject to earlier termination in certain events related to termination
of employment or service. The options were granted at an exercise price of
$12.09 per share. The estimated fair value of the options granted in 2007 was
$1.45 per share on the date of grant using the Black-Scholes option pricing
model with the following assumptions: dividend yield of 5.29%, volatility of
18.94%, risk free rates of 4.53% and an expected life of six years. All options
were granted at fair market value on the date of grant.
There were no stock options granted in 2006.
In April 2005, the Company's Compensation Committee of the Board of Directors,
in accordance with the provisions of the 2004 Equity Incentive Plan, unanimously
approved the following awards of dividend equivalent rights ("DERs"), each such
DER representing the current right to receive the dividend paid on one share of
the Company's common stock, when paid by the Company:
- The three non-employee outside directors each received 45,000 DERs
effective as of the second quarter of 2005, which will remain in effect as
long as the individual continues to serve on the Board of Directors; and
- Key employees of the Company received a total of 155,000 DERs effective as
of the second quarter of 2005, which will remain in effect for each key
employee as long as they continue to be employed by the Company.
In April 2005, a total of 290,000 DERs were awarded by the Company's Board of
Directors. In 2008, one director and one employee forfeited 45,000 and 15,000
DERs, respectively, when they resigned from the Company. A new non-employee
outside director was awarded 45,000 DERs when he joined the Company's Board of
Directors. As of December 31, 2008, there was a total of 275,000 DERs. The
Company recorded DER compensation expense of approximately $217, $186 and $186
in 2008, 2007 and 2006, respectively.
FAIR VALUE
On January 1, 2008, the Company adopted the provisions of SFAS 157, "Fair Value
Measurements" ("SFAS 157") for its financial assets and liabilities measured at
fair value on a recurring basis. SFAS 157 defines fair value as the price that
would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants. SFAS 157 also specifies a three-level
hierarchy of valuation techniques based upon whether the inputs reflect
assumptions other market participants would use based upon market data obtained
from independent sources (observable inputs) or reflect its own assumptions of
market participant valuation (unobservable inputs) and requires the use of
observable inputs if such data is available without undue cost and effort. At
December 31, 2008, the Company had approximately $3.4 million of financial
assets classified as Level 1 and thus measured at fair value using quoted market
prices for identical instruments in active markets from an independent third
party source.
The only financial asset or liability recorded at fair value in the Company's
consolidated financial statements is the marketable securities. The Company
determined the fair value for the marketable securities using quoted prices in
active markets for identical securities.
In February 2007, the FASB issued SFAS 159, "The Fair Value Option for Financial
Assets and Financial Liabilities" ("SFAS 159"). SFAS 159 provides companies with
an option to report selected financial assets and liabilities at fair value and
establishes presentation and disclosure requirements designed to facilitate
comparisons between companies that choose different measurement attributes for
similar types of assets and liabilities. SFAS 159 was effective January 1, 2008.
On January 1, 2008, the Company did not elect to apply the fair value option to
any specific financial assets or liabilities.
- 54 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
The Company's financial instruments include cash and cash equivalents, accounts
receivable, accounts payable, and debt. Considerable judgment is required in
interpreting market data to develop estimates of fair value. Accordingly, the
estimates presented herein are not necessarily indicative of the amounts that
the Company could realize in a current market exchange. The use of different
market assumptions and/or estimation methodologies may have a material effect on
the estimated fair value amounts. Cash and cash equivalents, accounts
receivable, and accounts payable are carried at amounts that approximate their
fair values due to their short-term maturities. For fixed rate debt, the Company
estimates fair value by using discounted cash flow analyses based on borrowing
rates for similar kinds of borrowing arrangements. The fair value of the
Company's fixed rate debt at December 31, 2008 was approximately $496,320
compared with its carrying value of approximately $339,669.
RECLASSIFICATIONS
Certain amounts from prior year's consolidated financial statements have been
reclassified to conform to the presentation of the current year's consolidated
financial statements.
CONCENTRATION OF CREDIT RISK
The Company's properties are not geographically diverse, and its tenants operate
primarily in the information technology industry. Additionally, because the
properties are leased to 75 tenants at December 31, 2008, default by any major
tenant could significantly impact the results of the consolidated total. One
tenant, Microsoft Corporation, accounted for approximately 16.5%, 15.1% and
12.5% of the Company's total cash rental income for the years ended December 31,
2008, 2007 and 2006, respectively. Cash rental income from Microsoft Corporation
was approximately $12,576, $12,288 and $11,728 for the years ended December 31,
2008, 2007 and 2006, respectively. Future minimum rents from this tenant are
approximately $76,467. One other tenant accounted for approximately 9.8%, 10.8%
and 10.0% of the Company's total cash rental income for the years ended December
31, 2008, 2007 and 2006, respectively. During 2008, 11 of the Company's tenants
relocated or ceased operations.
NEW ACCOUNTING PRONOUNCEMENTS
In September 2006, the FASB issued SFAS 157, "Fair Value Measurements" ("SFAS
157"). SFAS 157 defines fair value, establishes a framework for measuring fair
value and expands disclosures about fair value measurements. SFAS 157 applies
under other accounting pronouncements that require or permit fair value
measurements. Accordingly, this statement does not require any new fair value
measurements. This guidance was issued to increase consistency and comparability
in fair value measurements and to expand disclosures about fair value
measurements. SFAS establishes and requires disclosure of fair value hierarchy
that distinguishes between data obtained from sources independent of the
reporting entity and the reporting entity's own assumptions about market
participant assumptions. The three levels of hierarchy are 1) using quoted
prices in active markets for identical assets and liabilities, 2) "significant
other observable inputs" and 3) "significant unobservable inputs". "Significant
other observable inputs" can include quoted prices for similar assets or
liabilities in active markets, as well as inputs that are observable for the
asset or liability, such as interest rates, foreign exchange rates and yield
curves that are observable at commonly quoted intervals. "Significant
unobservable inputs" are typically based on an entity's own assumptions, as
there is little, if any, related market activity. SFAS 157 is effective for
financial statements issued for fiscal years beginning after November 15, 2007.
Adoption of SFAS 157 by the Company on January 1, 2008 did not have a material
effect on the Company's consolidated financial statements. The FASB has approved
a one-year deferral for the implementation of the statement for non-financial
assets and non-financial liabilities that are recognized or disclosed at fair
value in the financial statements on a nonrecurring basis. The Company believes
that the impact of these items will not be material to its consolidated
financial statements.
In February 2007, the FASB issued SFAS 159, "The Fair Value Option for Financial
Assets and Financial Liabilities" ("SFAS 159"). SFAS 159 provides companies with
an option to report selected financial assets and liabilities at fair value.
SFAS 159's objective is to reduce both complexity in accounting for financial
instruments and the volatility in earnings caused by measuring related assets
and liabilities differently. SFAS 159 is effective for financial statements
issued for fiscal years beginning after November 15, 2007. The adoption of SFAS
159 did not have a material impact on the Company's consolidated financial
statements since the Company elected not to apply the fair value option for any
of its eligible financial instruments or other items.
In December 2007, the FASB issued SFAS 141 (Revised 2007), "Business
Combinations" ("SFAS 141R"). SFAS 141R will change the accounting for business
combinations. Under SFAS 141R, an acquiring entity will be required to recognize
all the assets acquired and liabilities assumed in a transaction at the
acquisition date fair value with limited exceptions. SFAS 141R will change the
accounting treatment and disclosure for certain specific items in a business
combination. Under SFAS 141R, certain transaction costs that have historically
been capitalized as acquisition costs will be expensed. SFAS 141R applies
prospectively to business combinations for which the acquisition date is on or
after the beginning of the first annual reporting period beginning on or after
December 15, 2008. Early adoption is prohibited. Based on historical acquisition
costs and activity levels, the adoption of SFAS 141R will not have a significant
impact on the Company's results of operations and financial position.
- 55 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
In December 2007, the FASB issued SFAS 160, "Noncontrolling Interests in
Consolidated Financial Statements" ("SFAS 160"). SFAS 160 requires that
noncontrolling interests be presented as a component of consolidated
stockholders' equity, eliminates "minority interest accounting" such that the
amount of net income attributable to the noncontrolling interests will be
presented as part of consolidated net income on the consolidated statement of
operations and not as a separate component of income and expenses. SFAS 160 is
effective for fiscal years beginning on or after December 15, 2008. Early
adoption is prohibited. The adoption of SFAS 160 will have a significant impact
on the Company's computation of net income and its presentation of the balance
sheet and statement of stockholders' equity.
3. DEFERRED RENT RECEIVABLE, NET
The following table represents activity in the allowance against deferred rent
receivable, net for the years ended December 31, 2008, 2007 and 2006.
Provision
Beginning Against Ending
Balance Revenue Charge-off Balance
------------------------------------------------------
(dollars in thousands)
Year ended December 31, 2006 $2,000 $1,216 $1,216 $2,000
Year ended December 31, 2007 $2,000 $4,457 $2,707 $250
Year ended December 31, 2008 $250 $259 $259 $250
4. STOCK TRANSACTIONS
As of December 31, 2008 and 2007, approximately $2,117 and $1,970 remained
outstanding under notes issued in connection with the Company's purchase of its
general partner interests in 1998 (the "demand notes"), respectively. The demand
notes which accrue interest at 7.25%, along with the interest expense (interest
income to the operating partnerships), are eliminated in consolidation and are
not included in the corresponding line items within the consolidated financial
statements. However, the interest income earned by the operating partnerships,
which is interest expense to the Company, in connection with this debt, is
included in the calculation of minority interest as reported on the consolidated
statements of operations, thereby reducing the Company's net income by this same
amount. The Company and the operating partnerships have agreed to extend the due
date of the demand notes to September 30, 2010. At present, the Company's only
means for repayment of this debt is through distributions received from the
operating partnerships in excess of the amount of dividends to be paid to the
Company's stockholders or by raising additional equity capital.
The limited partners of the operating partnerships have the right to tender
their O.P. Units to the Company for shares of common stock or, at the Company's
election, for cash. Each of the limited partners of the operating partnerships
(other than Carl E. Berg and Clyde J. Berg) has the annual right to exercise put
rights and cause the operating partnerships to purchase a portion of the limited
partner's O.P. Units at a purchase price based on the average market value of
the common stock for the 10-trading day period immediately preceding the date of
tender, generally limited to one-third of the aggregate number of O.P. Units
owned by each limited partner. Upon the exercise of any such right by a limited
partner, the Company will have the option to purchase the tendered O.P. Units
with available cash, borrowed funds or the proceeds of an offering of newly
issued shares of common stock. These put rights are available once a year. If
the total purchase price of the O.P. Units tendered by all of the eligible
limited partners in one year exceeds $1 million, the Company or the operating
partnerships is entitled in its discretion to reduce proportionately the number
of O.P. Units to be acquired from each tendering limited partner so that the
total purchase price does not exceed $1 million.
During the year ended December 31, 2008, stock options to purchase 70,487 shares
of the Company's common stock were exercised at $10.00 per share and stock
options to purchase 6,667 shares of the Company's common stock were exercised at
$9.51 per share. Total proceeds to the Company were approximately $768.
There were no stock option exercises in 2007.
During the year ended December 31, 2006, stock options to purchase 80,000 shares
of the Company's common stock were exercised at $8.25 per share and stock
options to purchase 32,900 shares of the Company's common stock were exercised
at $10.00 per share. Total proceeds to the Company were approximately $989.
In 2008, 2007 and 2006, 6,970, 220,500 and 881,896 O.P. Units were exchanged for
6,970, 220,500 and 881,896 shares of the Company's common stock, respectively,
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 partnerships received any proceeds from the issuance of the common
stock in exchange for O.P. Units.
- 56 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
5. MINORITY INTERESTS
Minority interests represent the separate private ownership of the operating
partnerships, by the Berg Group and other non-affiliate interests. In total,
these interests account for 81.27%, on a weighted average basis, of the
ownership interests in the real estate operations of the Company as of December
31, 2008 and 2007. Minority interests in earnings have been calculated by taking
the net income of the operating partnerships (on a stand-alone basis) multiplied
by the respective minority interests' ownership percentage.
The operating partnerships have ownership interests of 83.33%, 75% and 50% and
act as the managing member in three separate joint ventures, which were
established to hold properties. The operating partnerships control the joint
ventures, and accordingly, these joint ventures are consolidated in the
Company's consolidated financial statements. The minority interests in the joint
ventures are reflected as a component of minority interests of the operating
partnerships. For the years ended December 31, 2008, 2007 and 2006, income
associated with the minority interests held by third parties of the three
consolidated joint ventures was approximately $368, $502 and $499, respectively.
6. REAL ESTATE
PROPERTY ACQUISITIONS
On January 1, 2008, the Company acquired an approximately 110,500 rentable
square foot newly constructed R&D building located at 5981 Optical Court in San
Jose, California from the Berg Group under the Berg Land Holdings Option
Agreement. The total acquisition price for this property was approximately
$19,068. The Company acquired this property by issuing a short-term note payable
to the Berg Group, which was fully paid off in July 2008. The Company allocated
the purchase price to land and building based upon the estimated relative fair
values of such assets. Because the acquired property was vacant, there was no
purchase price allocation to lease intangible assets. The property was leased
within several days after the acquisition date.
On February 29, 2008, the Company acquired a fully leased office/R&D building
comprised of approximately 75,300 rentable square feet at 2904 Orchard Parkway
in San Jose, California from an unrelated party for approximately $16,696. The
acquisition was partially funded from the proceeds received from the 1170 Morse
Avenue property sale (see below under "Property Dispositions"), which were held
by a third party and classified as restricted cash as of December 31, 2007. The
purchase price of 2904 Orchard Parkway 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 approximately $1,121 of the purchase price as real estate
related intangible asset in the accompanying consolidated balance sheet for the
value of an in-place lease. The intangible asset is amortized over the
applicable remaining lease term. Amortization expense of approximately $187 was
recorded for the year ended December 31, 2008.
In March 2007, the Company acquired approximately 50 acres of vacant land in
Morgan Hill, California, which could support approximately 725,000 rentable
square feet of space. The land is currently zoned for industrial use and a
portion has the potential to be rezoned for residential use. The acquisition
price for this property was approximately $25,543 and was funded from a portion
of the proceeds received from the Samaritan property sale, which were held by a
third party and classified as restricted cash as of December 31, 2006.
In April 2007, the Company acquired three office/R&D buildings comprised of
approximately 149,000 rentable square feet at Montague Expressway in Milpitas,
California for approximately $15,351. The acquisition was funded from a portion
of the proceeds received from the Samaritan property sale, which were held by a
third party. With the exception of one lease, the property was purchased without
any long-term tenants. The Company allocated the purchase price to land and
building based upon the estimated relative fair values of such assets. There was
no purchase price allocation to lease intangible assets.
In April 2007, the Company acquired approximately five acres of vacant land in
Morgan Hill, California, which could support approximately 73,000 rentable
square feet of space. The land is currently zoned for industrial use. The
acquisition price for this property was approximately $2,297 and was funded from
the remaining proceeds received from the Samaritan property sale, which were
held by a third party.
In September 2007, the Company acquired an approximately 98,500 rentable square
foot newly constructed R&D building located at 5845 Hellyer Avenue in San Jose,
California from the Berg Group under the Berg Land Holdings Option Agreement.
The total acquisition price for this property was approximately $10,903. The
Company acquired this property by issuing 548,236 O.P. Units to the Berg Group
and $4,300 in cash, which was paid in the fourth quarter of 2007. The Company
allocated the purchase price to land
- 57 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
and building based upon the estimated relative fair values of such assets. Since
the property was vacant when acquired, there was no purchase price allocation to
lease intangible assets.
The purchase price allocation for these property acquisitions was determined in
accordance with the following principles under SFAS 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 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.
PROPERTY DISPOSITIONS
In August 2007, the Company disposed of one R&D property located at 45700
Northport Loop in Fremont, California consisting of approximately 39,000
rentable square feet. A total net gain of approximately $1,699 was recognized
and classified as discontinued operations, net of minority interests, on the
total sales price of approximately $7,742. Proceeds from the sale were
classified as restricted cash to be used in tax-deferred property exchanges as
of December 31, 2007. In 2008, the entire proceeds from the sale were
transferred to the Company's general cash account since it was unable to
complete a tax-deferred property exchange.
In September 2007, the Company disposed of one R&D property located at 1170
Morse Avenue in Sunnyvale, California consisting of approximately 48,000
rentable square feet. A total net gain of approximately $4,830 was recognized
and classified as discontinued operations, net of minority interests, on the
total sales price of approximately $8,301. Proceeds from the sale were
classified as restricted cash to be used in tax-deferred property exchanges as
of December 31, 2007.
BERG LAND HOLDINGS OPTION AGREEMENT
Under the terms of the Berg Land Holdings Option Agreement, the Company, through
the operating partnerships, has the option to acquire any future R&D property
developed by the Berg Group on land currently owned or optioned, or acquired for
these purposes in the future, directly or indirectly, by Carl E. Berg or Clyde
J. Berg. This agreement will expire on December 31, 2010, after which the
Company will no longer have the right to acquire properties from the Berg Group
on the pre-determined terms provided in that agreement. At present, there are
approximately 84 acres of Silicon Valley land, including land under development,
owned directly or under 50% joint venture entities by certain members of the
Berg Group that are subject to the terms of the Berg Land Holdings Option
Agreement. The owners of the future R&D property developments may obtain cash
or, at their option, O.P. Units valued at the average closing price of the
shares of common stock over the 30-trading-day period preceding the acquisition
date. To date, the Company has completed 23 acquisitions under the Berg Land
Holdings Option Agreement representing approximately 2,243,000 rentable square
feet. The acquired properties cost approximately $237,775, for which the Company
issued 8,482,085 O.P Units and assumed debt of approximately $141,410. Upon the
Company's exercise of an option to purchase any of the future R&D property
developments, the acquisition price will equal the sum of (a) the full
construction cost of the building; plus (b) 10% of the full construction cost of
the building; plus (c) interest at LIBOR (London Interbank Offered Rate) plus
1.65% on the amount of the full construction cost of the building for the period
from the date funds were disbursed by the developer to the close of escrow; plus
(d) the original acquisition cost of the parcel on which the improvements will
be constructed, which range from $8.50 to $20.00 per square foot for land
currently owned; plus (e) 10% per annum of the amount of the original
acquisition cost of the parcel from the later of January 1, 1998 or the seller's
acquisition date to the close of escrow; minus (f) the aggregate principal
amount of all debt encumbering the acquired property, or a lesser amount as
approved by the members of the Independent Directors committee of the Company's
Board of Directors. Generally, the Company will not acquire any projects until
they are fully completed and leased.
No estimate can be given at this time as to the total cost to the Company to
acquire future projects under the Berg Land Holdings Option Agreement, or the
timing as to when the Company will acquire such projects. In addition to any
projects currently under development, the Company has the right to acquire
future developments by the Berg Group on up to 84 additional acres of land
currently controlled by the Berg Group, which could support approximately 1.4
million square feet of new developments. Under the Berg Land Holdings Option
Agreement, as long as the Berg Group ownership in the Company and the operating
partnerships taken as a whole is at least 65%, or until December 31, 2010,
whichever occurs first, the Company also has an option to purchase all land
- 58 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
acquired, directly or indirectly, by Carl E. Berg or Clyde J. Berg in the future
which has not been improved with completed buildings and which is zoned for,
intended for or appropriate for R&D, office and/or industrial development or use
in the states of California, Oregon, and Washington.
Although the Company has the right to acquire the new properties available to it
under the terms of the Berg Land Holdings Option Agreement, there can be no
assurance that the Company actually will consummate any intended transactions.
Furthermore, the Company has not yet determined the means by which it would
acquire and pay for any such properties or the impact of any of the acquisitions
on its business, results of operations, financial condition or available cash
for distribution.
7. VARIABLE INTEREST ENTITY
Under FIN 46R, a variable interest entity ("VIE") 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.
Under FIN 46R, for an entity to qualify as a VIE one or more of the following
three characteristics must exist:
1. The equity investment at risk is not sufficient to permit the entity to
finance its activities without additional subordinated financial support by
any parties, including the equity holders.
2. The equity investors lack one or more of the following essential
characteristics of a controlling financial interest: a. the direct or
indirect ability to make decisions about the entity's activities through
voting or similar rights; b. the obligation to absorb the expected loss of
the entity; c. the right to receive the expected residual returns of the
entity; or
3. The equity investors have voting rights that are not proportionate to their
economic interests, and the activities of the entity involve or are
conducted on behalf of an investor with a disproportionately small voting
interest.
In August 2007, one of the Company's tenants, Ciena Corporation, 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 445,000
rentable square feet located in San Jose, California. As a result of the
assignment, M&M assumed all of Ciena's remaining obligations under these leases
and received a payment from Ciena of $53,000, of which $7,000 was reserved for
tenant improvements. At the same time, the Company entered into a consent for
assignment of lease with both parties and a mutual release agreement with Ciena,
pursuant to which all of Ciena's obligations under these leases were effectively
transferred to M&M. M&M is obligated to continue to perform all of the
obligations under the assumed Ciena leases and has the right to sublease any or
all of the 444,500 rentable square feet vacated by Ciena for the remainder of
the current lease term, which expires in 2011. Under the terms of the assignment
of lease agreement, the Company received monthly rent payments of approximately
$789 from July 2007 through June 2008, and will receive $818 from July 2008
through June 2009, $849 from July 2009 through June 2010, $881 from July 2010
through June 2011 and $915 from July 2011 through December 2011. Based upon FIN
46R, the Company determined that M&M is a VIE. The Company further determined
that it is the primary beneficiary of this VIE and therefore has consolidated
this entity for financial reporting purposes. Upon consolidation, the Company
recognized a gross lease termination fee of $46,000 in August 2007.
Factors considered by the Company in determining whether M&M should be
considered a VIE for financial reporting purposes included the following:
- No equity was contributed by the partners in the formation of M&M.
- At present, the assigned leases are the only properties under management by
M&M.
- Because M&M does not have an operating history that demonstrates its
ability to finance its activities without additional subordinated financial
support.
- All revenues, other than interest income, are generated by M&M from the
Company in the form of fees or commissions.
The Company remains at risk with respect to the assigned leases because if M&M's
operating expenses exceed its interest income, fees and commissions there would
be insufficient funds to meet the assigned lease obligation without additional
financial support from equity holders or other parties. The Company, which had
released the original tenant from its obligations under the lease, would have to
absorb the majority of any loss, making it the primary beneficiary of M&M's
activities.
- 59 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
8. DEBT
The following table sets forth certain information regarding debt outstanding as
of December 31, 2008 and 2007.
Balance at Maturity Interest
Debt Description Collateral Properties December 31, Date Rate
------------------------------------------ ---------------------------------- --------------------------- ---------- ----------
2008 2007
------------- -------------
(dollars in thousands)
Line of Credit:
Heritage Bank of Commerce(1) Not Applicable $13,079 - June 2009 (1)
------------- -------------
Mortgage Notes Payable (related parties): 5300-5350 Hellyer Avenue, San Jose, CA 8,761 $9,224 June 2013 7.650%
------------- -------------
Mortgage Notes Payable:(2)
Hartford Life Insurance Company(3) 5981 Optical Court, San Jose, CA 114,513 - October 2018 6.210%
Hartford Life and Accident Ins. Co. 5500 Hellyer Avenue, San Jose, CA
Hartford Life and Annuity Ins. Co. 5550 Hellyer Avenue, San Jose, CA
(collectively known as the "Hartford Loan") 4050 Starboard Drive, Fremont, CA
45738 Northport Loop, Fremont, CA
233 South Hillview Drive, Milpitas, CA
10300 Bubb Road, Cupertino, CA
1230 E. Arques, Sunnyvale, CA
1250-1280 E. Arques, Sunnyvale, CA
1212 Bordeaux Lane, Sunnyvale, CA
2904 Orchard Parkway, San Jose, CA
3236 Scott Blvd, Santa Clara, CA
6311 San Ignacio Avenue, San Jose, CA
6321-6325 San Ignacio Avenue, San Jose, CA
6331 San Ignacio Avenue, San Jose, CA
6341-6351 San Ignacio Avenue, San Jose, CA
3540-3580 Bassett Street, Santa Clara, CA
Prudential Mortgage Capital Company(4) Not Applicable - 112,543 October 2008 6.560%
Northwestern Mutual Life Insurance Co.(5) 1750 Automation Parkway, San Jose, CA 81,308 84,959 January 2013 5.640%
1756 Automation Parkway, San Jose, CA
1762 Automation Parkway, San Jose, CA
6320 San Ignacio Avenue, San Jose, CA
6540-6541 Via Del Oro, San Jose, CA
6385-6387 San Ignacio Avenue, San Jose, CA
20605-20705 Valley Green Drive, Cupertino, CA
2001 Walsh Avenue, Santa Clara, CA
2220 Central Expressway, Santa Clara, CA
2300 Central Expressway, Santa Clara, CA
2330 Central Expressway, Santa Clara, CA
Allianz Life Insurance Company(I)(6) 5900 Optical Court, San Jose, CA 23,009 23,825 August 2025 5.560%
Allianz Life Insurance Company(II)(6) 5325-5345 Hellyer Avenue, San Jose, CA 112,078 116,193 August 2025 5.220%
1768 Automation Parkway, San Jose, CA
2880 Scott Boulevard, Santa Clara, CA
2890 Scott Boulevard, Santa Clara, CA
2800 Scott Boulevard, Santa Clara, CA
10450-10460 Bubb Road, Cupertino, CA
6800-6810 Santa Teresa Blvd., San Jose, CA
6850 Santa Teresa Blvd., San Jose, CA
4750 Patrick Henry Drive, Santa Clara, CA
------------- -------------
330,908 337,520
------------- -------------
Total $352,748 $346,744
============= =============
(1) The Heritage Bank of Commerce ("HBC") line of credit was obtained in March
2008. Interest rate for the HBC line of credit is LIBOR plus 1.75%. The
interest rate for the HBC line of credit at December 31, 2008 was 3.17%. In
April 2008, the Company entered into a "Change in Terms Agreement" with HBC
that increased the facility from $10 million to $17.5 million. The HBC line
of credit contains certain financial loan and reporting covenants as
defined in the loan agreement. As of December 31, 2008, the Company was in
compliance with these loan covenants.
(2) Mortgage notes payable generally require monthly installments of interest
and principal ranging from approximately $177 to $840 over various terms
extending through the year 2025. The weighted average interest rate of
mortgage notes payable was 5.86% and 5.85% at December 31, 2008 and 2007,
respectively.
(3) The Hartford loan is payable in monthly installments of approximately $838,
which includes principal (based upon a 20-year amortization) and interest.
Costs and fees incurred with obtaining this loan aggregated approximately
$1,058, which were deferred and amortized over the loan period. The
Hartford loan contains certain customary covenants as defined in the loan
agreement. As of December 31, 2008, the Company was in compliance with
these loan covenants.
(4) Proceeds from the Hartford loan were used to repay the remaining balance of
the Prudential loan in October 2008.
(5) The Northwestern loan is payable in monthly installments of approximately
$696, which includes principal (based upon a 20-year amortization) and
interest. Costs and fees incurred with obtaining this loan aggregated
approximately $664, which were deferred and amortized over the loan period.
The Northwestern loan contains certain customary covenants as defined in
the loan agreement. As of December 31, 2008, the Company was in compliance
with these loan covenants.
- 60 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
(6) The Allianz loans are payable in monthly installments of approximately
$1,017, which includes principal (based upon a 20-year amortization) and
interest. Costs and fees incurred with obtaining these loans aggregated
approximately $1,125, which were deferred and amortized over the loan
periods. The Allianz loans contain certain customary covenants as defined
in the loan agreements. As of December 31, 2008, the Company was in
compliance with these loan covenants.
On March 4, 2008, the Company established a $10,000 uncollateralized revolving
line of credit with Heritage Bank of Commerce ("HBC"). The Company paid
approximately $26 in loan and legal fees. On April 17, 2008, the Company entered
into a "Change in Terms Agreement" with HBC that increased the facility from
$10,000 to $17,500. The line of credit bears an interest rate of LIBOR plus
1.75% and matures June 15, 2009. The HBC line of credit contains certain
financial loan and reporting covenants as defined in the loan agreements. As of
December 31, 2008, the Company was in compliance with these loan covenants. The
proceeds from the HBC line of credit may be used to repay debt, complete
acquisitions and finance other working capital requirements.
On October 1, 2008, the Company entered into a fixed rate term agreement and
related contracts and instruments for a secured mortgage loan totaling $115,000
from Hartford Life Insurance Company, Hartford Life and Accident Insurance
Company and Hartford Life and Annuity Insurance Company (the "Hartford Loan").
The proceeds were used primarily to repay the remaining balance of an existing
mortgage loan with Prudential Mortgage Capital Company and to provide other
working capital needs. The Hartford Loan bears a fixed interest rate of 6.21%,
with a 20-year amortization, and matures October 1, 2018, at which time any
outstanding principal and interest will be due. Pursuant to the loan agreement,
monthly principal and interest installment payments of approximately $838 are
due on the first day of each month. The Hartford Loan is secured by 20properties
consisting of approximately 1.6 million rentable square feet. The Company paid
approximately $1,058 in loan fees and financing costs, which are amortized over
the ten year loan period. The Company has the option to prepay the Hartford
Loan, subject to certain yield maintenance provisions, though generally no
prepayment is permitted during the first 24 months of the loan term.
During 2008, the Company issued multiple short-term notes payable to the Berg
Group in connection with a property acquisition, quarterly dividend
distributions and a cash loan. The interest rates on these notes were LIBOR plus
2%. The aggregate loan amount totaled approximately $50,588 and was fully repaid
as of December 31, 2008.
Scheduled principal payments on debt as of December 31, 2008 are as follows:
Total Debt
(Including Related
Parties)
-------------------------
December 31, 2009 $25,670
December 31, 2010 13,327
December 31, 2011 14,109
December 31, 2012 14,935
December 31, 2013 81,269
Thereafter 203,438
-------------------------
Total $352,748
=========================
9. OPERATING PARTNERSHIP AND STOCKHOLDER DISTRIBUTIONS
Holders of the Company's common stock and O.P. Units are entitled to dividend
distributions as determined and declared by the Company's Board of Directors.
Under the Exchange Rights Agreement limited partners have the right to tender
O.P. Units to the Company, and, at the Company's election, to receive common
stock on a one-for-one basis at then-current market value, an equivalent amount
of cash, or a combination of cash and common stock in exchange for the O.P.
Units tendered, subject to the 9% overall ownership limit imposed on non-Berg
Group stockholders under the Company's charter document, or the overall 20% Berg
Group ownership limit, as the case may be. O.P. Unit holders are entitled to
vote when their O.P. Units are converted to shares of the Company's common
stock. Once in each 12-month period beginning each December 29, the limited
partners, other than Carl E. Berg and Clyde J. Berg, may exercise a put right to
sell their O.P. Units to the operating partnerships at a price equal to the
average market price of the common stock for the 10-trading day period
immediately preceding the date of tender. Upon any exercise of the put rights,
the Company will have the opportunity for a period of 15 days to elect to fund
the purchase of the O.P. Units and purchase additional general partner interests
in the operating partnerships for cash, unless the purchase price exceeds $1
million in the aggregate for all tendering limited partners, in which case, the
operating partnerships or the Company will be entitled, but not required, to
reduce proportionally the number of O.P. Units to be acquired from each
tendering limited partner so that the total purchase price is not more than $1
million.
- 61 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
During 2008, the Company, as general partner of the operating partnerships,
declared quarterly dividends/distributions aggregating $0.80 per common share
and O.P. Unit for total dividends/distributions of approximately $84,204,
including $21,055 payable in January 2009. Total distributions attributable to
O.P. Units owned by various members of the Berg Group were approximately
$63,040.
During 2007, the Company, as general partner of the operating partnerships,
declared quarterly dividends/distributions aggregating $0.64 per common share
and O.P. Unit for total dividends/distributions of approximately $67,152,
including $16,832 payable in January 2008. Total distributions attributable to
O.P. Units owned by various members of the Berg Group were approximately
$50,271.
During 2006, the Company, as general partner of the operating partnerships,
declared quarterly dividends/distributions aggregating $0.64 per common share
and O.P. Unit for total dividends/distributions of approximately $66,948,
including $16,745 payable in January 2007. Total distributions attributable to
O.P. Units owned by various members of the Berg Group were approximately
$50,151.
10. EQUITY-BASED COMPENSATION AND RETIREMENT INVESTMENT PLANS
The Company's 1997 Stock Option Plan ("1997 Plan") was approved by the Company's
stockholders on November 10, 1997. On November 24, 2004, the 2004 Equity
Incentive Plan ("2004 Plan") was approved by the Company's stockholders and
replaced the 1997 Plan. The Company's board of directors approved the 2004 Plan
in September 2004. No further options are available or will be granted under the
1997 Plan. In replacing the 1997 Plan, the 2004 Plan:
- transferred up to 3,991,089 remaining shares available for issuance under
the Company's 1997 Plan and terminated the 1997 Plan for any new grants;
- transferred up to an additional 767,000 shares subject to outstanding
options under the 1997 Plan if they expire without being exercised, of
which 272,000 shares had been transferred as of December 31, 2008; and
- includes the ability to grant restricted stock, restricted stock units,
performance units, dividend equivalent rights, and other stock-based
compensation, including O.P. Units of the Operating Partnerships, as well
as incentive and non-statutory stock options.
The 2004 Plan was adopted so that the Company may attract and retain the high
quality employees, directors and consultants necessary to build the Company's
infrastructure and to provide ongoing incentives to the Company's employees in
the form of options to purchase the Company's common stock by enabling them to
participate in the Company's success.
The 2004 Plan provides for the granting to employees, including officers
(whether or not they are directors) of "incentive stock options" within the
meaning of Section 422 of the Code, and for the granting of non-statutory
options to employees, directors and consultants of the Company. 1,180,535 and
2,843,089 shares of common stock were available for future option or award
grants under the 2004 Plan as of December 31, 2008 and 2007, respectively.
In January 2008, stock options to purchase 1,025,000 shares of common stock were
granted to employees, non-employee directors and consultants. The options vest
monthly for 48 months from date of grant, subject to continued employment or
other service to the Company. Each option grant has a term of six years from the
date of grant subject to earlier termination in certain events related to
termination of employment or service. The options were granted at an exercise
price of $9.51 per share. The estimated fair value of the options granted was
$0.57 per share on the date of grant using the Black-Scholes option pricing
model with the following assumptions: dividend yield of 8.41%, volatility of
20.43%, risk free rates of 3.45% and an expected life of six years. All options
were granted at fair market value on the date of grant.
In July 2008, stock options to purchase 52,500 shares of common stock were
granted to an employee and a non-employee director. The options vest monthly for
48 months from date of grant, subject to continued employment or other service
to the Company. Each option grant has a term of six years from the date of grant
subject to earlier termination in certain events related to termination of
employment or service. The options were granted at an exercise price of $11.36
per share. The estimated fair value of the options granted was $0.99 per share
on the date of grant using the Black-Scholes option pricing model with the
following assumptions: dividend yield of 7.04%, volatility of 22.07%, risk free
rates of 3.20% and an expected life of six years. All options were granted at
fair market value on the date of grant.
In November 2008, stock options to purchase 705,000 shares of common stock were
granted to employees, non-employee directors and consultants. The options vest
monthly ranging from 36-48 months from date of grant, subject to continued
employment or other
- 62 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
service to the Company. Each option grant has a term of six years from the date
of grant subject to earlier termination in certain events related to termination
of employment or service. The options were granted at an exercise price of $6.14
per share. The estimated fair value of the options granted was $0.12 per share
on the date of grant using the Black-Scholes option pricing model with the
following assumptions: dividend yield of 13.03%, volatility of 22.39%, risk free
rates of 2.08% and an expected life of six years. All options were granted at
fair market value on the date of grant.
In 2007, stock options to purchase 710,000 shares of common stock were granted
to employees, non-employee directors and consultants, which options vest monthly
for 48 months from date of grant, subject to continued employment or other
service to the Company. Each option grant has a term of six years from the date
of grant subject to earlier termination in certain events related to termination
of employment or service. The options were granted at an exercise price of
$12.09 per share. The estimated fair value of the options was $1.45 per share on
the date of grant using the Black-Scholes option pricing model with the
following assumptions: dividend yield of 5.29%, volatility of 18.94%, risk free
rates of 4.53% and an expected life of six years. All options were granted at
fair market value on the date of grant.
No options were granted in year 2006.
The remaining contractual lives of unexercised option grants range from April
2009 to November 2014.
The following table shows the activity and detail for the 2004 Plan for each of
the three years in the period ended December 31, 2008.
Weighted Average
Options Exercise Price
Outstanding Per Share
-------------------- ---------------------
Balance, December 31, 2005 1,422,000 $10.83
Options exercised (112,900) $8.76
Options forfeited (272,000) $13.00
--------------------
Balance, December 31, 2006 1,037,100 $10.48
Options granted 710,000 $12.09
--------------------
Balance, December 31, 2007 1,747,100 $11.13
Options granted 1,782,500 $8.23
Options exercised (77,154) $9.96
Options forfeited (119,946) $10.81
--------------------
Balance, December 31, 2008 3,332,500 $9.62
====================
Available for grant at December 31, 2008 1,180,535
====================
Available for grant at December 31, 2007 2,843,089
====================
The following table summarizes information regarding options outstanding for the
2004 Plan at December 31, 2008:
Options Outstanding Options Exercisable Options Not Exercisable
----------------------------------------------------------------------------------------
Weighted
Average Weighted Weighted Weighted
Remaining Average Average Average
Contractual Exercise Exercise Exercise
Range of Exercise Prices Options Life in Years Price Options Price Options Price
------------------------------------------------------------------------------------------------------------------
$6.14 705,000 5.92 $6.14 148,438 $6.14 556,562 $6.14
$9.51 960,000 5.00 $9.51 265,833 $9.51 694,167 $9.51
$10.00 590,000 2.33 $10.00 590,000 $10.00 - -
$11.33 375,000 0.33 $11.33 375,000 $11.33 - -
$11.36 52,500 5.50 $11.36 5,469 $11.36 47,031 $11.36
$12.09 650,000 4.00 $12.09 311,458 $12.09 338,542 $12.09
------------ ------------- ------------
$6.14 to $12.09 3,332,500 4.01 $9.62 1,696,198 $10.27 1,636,302 $8.95
============ ============= ============
None of the options granted are contingent upon the attainment of performance
goals or subject to other restrictions. As of December 31, 2008 and 2007,
"in-the-money" outstanding options to purchase 148,438 and zero shares of common
stock, respectively, were exercisable.
The 2004 Plan allows the Company to grant to employees and directors a wider
range of awards than is permitted under the 1997 Plan, including restricted
stock, stock grants, restricted stock units, performance units, other
stock-based compensation, including O.P. Units exchangeable for shares of common
stock, and dividend equivalent rights, which will help the Company achieve its
goal of attracting,
- 63 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
retaining and motivating its personnel which is necessary to build the Company's
infrastructure, achieve the Company's business goals and enhance stockholder
value. No options or awards may be granted under the 2004 Plan after November
24, 2014.
Awards and options granted under the 2004 Plan may be granted to any employees,
non-employee directors or consultants of the Company and any corporation or
other entity affiliated with the Company, including the Operating Partnerships.
Only employees of the Company or a corporate subsidiary may receive incentive
stock options. Options can be granted to non-employee directors and consultants
of the Company and to employees of the Company or a corporate subsidiary. No
individual may receive in any one calendar year options for more than 500,000 of
the total number of shares of stock.
The options generally are granted at the fair market value of the Company's
common shares at the date of grant, vest over a four-to-six year period, are
exercisable upon vesting and expire six-to-eight years from the date of grant.
The exercise price for all incentive stock options under the 2004 Plan shall not
be less than the fair market value of the underlying common shares at the time
the option was granted.
Under the 2004 Plan, each non-employee member of the board of directors who
became or becomes a member of the board of the directors after November 24,
2004, the date on which the Plan was approved by the Company's stockholders,
will receive automatically a grant of an option to purchase 50,000 shares of
common stock at an exercise price equal to 100% of the fair market value of the
common stock at the date of grant of such option. Such options become
exercisable cumulatively with respect to 1/48th of the underlying shares on the
first day of each month following the date of grant. Generally, the options must
be exercised while the optionee remains a director. In addition, the board of
directors may authorize annual option grants or awards to non-employee directors
in the board's discretion as long as the number of shares or equivalent number
of underlying shares of common stock in the case of certain awards, does not
exceed 50,000 per year. A disinterested majority of the board also may authorize
additional options and awards to a director serving as a Committee chair or
providing other extraordinary service to the Board. The 2004 Plan further
provides that upon an acquisition of the Company in which more than 50% of the
total voting power of the Company's outstanding securities is transferred to the
acquirer or acquiring parties, options and awards held by non-employee directors
will vest in full and become exercisable prior to their expiration.
The board of directors may terminate the 2004 Plan at any earlier time or make
modifications of the 2004 Plan as it deems advisable. Awards and options granted
at any time during the term of the 2004 Plan will not expire solely because of
the termination of the 2004 Plan, and no amendment or modification of the 2004
Plan shall affect the terms of any outstanding award unless the board expressly
provides otherwise. Termination or amendment of the 2004 Plan may not adversely
affect the rights of the recipient of an award without his or her consent. The
Compensation Committee of the Board of Directors may amend the terms of any
option or award previously granted, but such amendment may not impair the rights
of the recipient without his or her consent.
A total of 4,263,089 shares of common stock are reserved for issuance under the
2004 Plan, in addition to 375,000 shares subject to outstanding options under
the 1997 Plan if they expire unexercised. At no time may the number of shares
issued pursuant to or subject to outstanding awards granted under the 2004 Plan
exceed this number, subject to the provisions for increase and adjustment set
forth in the 2004 Plan. If any option or award expires, terminates or is
cancelled without being exercised in full, or any other award is forfeited, the
shares forfeited or not purchased will be available for future grant of awards.
The Company has adopted an employee investment plan (the "Plan"), under Section
401(k) of the Internal Revenue Code. Employees who are at least 21 years old and
who have completed six months of eligibility service may become participants in
the Plan. Each participant may make contributions to the Plan through salary
deferrals in amounts of at least 1% to a maximum of 15% of the participant's
compensation, subject to certain limitations imposed by the Internal Revenue
Code. The Company contributes an amount up to 15% of the participant's
compensation, based upon management's discretion. A participant's contribution
to the Plan is 100% vested and non-forfeitable. A participant will become vested
in 100% of the Company's contributions after two years of eligible service. For
the years ended December 31, 2008, 2007 and 2006, the Company recognized
approximately $118, $123 and $103 of expense for employer contributions made in
connection with this Plan, respectively.
11. NET INCOME PER SHARE
Basic net income per share is computed by dividing net income by the
weighted-average number of common shares outstanding for the period. Diluted net
income per share is computed by dividing net income by the sum of
weighted-average number of common shares outstanding for the period plus the
assumed exercise of all dilutive securities.
The following table provides a reconciliation of net income to common
stockholders and the number of shares used in the computations of "basic" net
income per share to common stockholders and "diluted" net income per share to
common stockholders.
- 64 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
Year Ended Year Ended Year Ended
December 31, 2008 December 31, 2007 December 31, 2006
-------------------- -------------------- -------------------
(dollars in thousands, except per share data)
Numerator:
Income from continuing operations $10,134 $17,757 $11,458
Income from discontinued operations - 1,131 3,172
-------------------- -------------------- -------------------
Net income to common stockholders $10,134 $18,888 $14,630
==================== ==================== ===================
Denominator:
Weighted average shares of common stock (basic) 19,714,414 19,627,234 19,066,581
Effect of dilutive securities:
Incremental shares from assumed stock options exercise 281,935 227,177 232,083
-------------------- -------------------- -------------------
Weighted average shares of common stock (diluted) 19,996,349 19,854,411 19,298,664
==================== ==================== ===================
Per share data:
Basic net income per share:
Net income to common stockholders before
discontinued operations $0.51 $0.90 $0.60
Discontinued operations - 0.06 0.17
-------------------- -------------------- -------------------
Net income to common stockholders $0.51 $0.96 $0.77
==================== ==================== ===================
Diluted net income per share:
Net income to common stockholders before
discontinued operations $0.51 $0.89 $0.59
Discontinued operations - 0.06 0.17
-------------------- -------------------- -------------------
Net income to common stockholders $0.51 $0.95 $0.76
==================== ==================== ===================
Outstanding options to purchase 2,627,500 shares in 2008 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 period. The outstanding O.P.
Units have been excluded from the diluted net income per share calculation as
there would be no effect on the diluted net income per share since the minority
interests' share of income would also be added back to net income. O.P. Units
outstanding at December 31, 2008, 2007 and 2006 were 85,526,965, 85,533,935 and
85,206,199, respectively.
12. OTHER INCOME
Other income from continuing operations was approximately $4,223, $61,982 and
$18,222 for the years ended December 31, 2008, 2007 and 2006, respectively. For
the year ended December 31, 2008, termination fees, management fee income and
miscellaneous income accounted for approximately $3,007, $967 and $249,
respectively, of other income. For the year ended December 31, 2007, termination
fees, prior tenant bankruptcy settlements, management fee income, security
deposit forfeitures and miscellaneous income accounted for approximately
$57,515, $300, $982, $1,799 and $1,386, respectively, of other income. For the
year ended December 31, 2006, termination fees, prior tenant bankruptcy
settlements, management fee income, security deposit forfeitures and
miscellaneous income accounted for approximately $16,068, $183, $1,070, $104 and
$797, respectively, of other income. Management fee is paid by the tenant to the
landlord for the administration and supervision of the property.
13. RELATED PARTY TRANSACTIONS
As of December 31, 2008 and 2007, the Berg Group owned 77,902,384 O.P. Units of
the total 85,526,965 and 85,533,935 O.P. Units issued and outstanding,
respectively. The Berg Group's interest in the Company represents 74.0% and
74.1% of the Company as of December 31, 2008 and 2007, respectively, assuming
conversion of the O.P. Units into common shares of the Company.
The Company periodically acquires non-leased properties, which include land, the
building shell and base building improvements, from the Berg Group under the
Berg Group Land Holdings Options Agreement. These acquisitions from the Berg
Group are made for properties where the Company has previously identified a
tenant, and in conjunction with the acquisition, the Company executes a lease
agreement with the tenant. In many of the acquisitions from the Berg Group,
lease commissions relating to these leasing activities conducted by the Company
are paid by the Berg Group and reimbursed by the Company in connection with the
acquisition. These lease commissions are recorded separately in "Other assets"
on the Company's consolidated balance sheets.
PROPERTY ACQUISITION
In January 2008, the Company acquired an approximately 111,500 rentable square
foot newly constructed R&D building located at 5981 Optical Court in San Jose,
California from the Berg Group under the Berg Land Holdings Option Agreement.
The total acquisition price for this property was approximately $19,068. The
Company acquired this property by issuing a short-term note
- 65 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
payable to the Berg Group, which was fully repaid in July 2008. The transaction
was approved by the Independent Directors Committee of the Company's Board of
Directors.
In September 2007, the Company acquired an approximately 98,500 rentable square
foot newly constructed R&D building located at 5845 Hellyer Avenue in San Jose,
California from the Berg Group under the Berg Land Holdings Option Agreement.
The total acquisition price for this property was approximately $10,903. The
Company acquired this property by issuing 548,236 O.P. Units and paying $4,300
in cash to the selling members of the Berg Group. The transaction was approved
by the Independent Directors Committee of the Company's Board of Directors.
DEBT WITH THE BERG GROUP
As of December 31, 2008 and 2007, debt in the amount of approximately $8,761 and
$9,224, respectively, was due the Berg Group under a mortgage note established
May 15, 2000 in connection with the acquisition of a 50% interest in Hellyer
Avenue Limited Partnership, the obligor under the mortgage note. The mortgage
note bears interest at 7.65%, and is due in ten years with principal payments
amortized over 20 years. In the fourth quarter of 2008, the Company and the Berg
Group agreed to extend the loan maturity date to June 2013. Interest expense
incurred in connection with the Berg Group mortgage note was approximately $690,
$724 and $755 for the years ended December 31, 2008, 2007 and 2006,
respectively.
During 2008, the Company issued multiple short-term notes payable to the Berg
Group in connection with a property acquisition, quarterly dividend
distributions and a cash loan. The interest rates on these notes were LIBOR plus
2%. The aggregate loan amount totaled approximately $50,588 and was fully repaid
as of December 31, 2008. For the year ended December 31, 2008, interest expense
incurred in connection with those short-term notes payable was approximately
$643.
TRANSFER OF INTEREST TO BERG GROUP IN CONSOLIDATED JOINT VENTURE
In July 2000, the Hellyer Avenue Limited Partnership ("Hellyer LP") was formally
organized as a California limited partnership between Mission West Properties,
L.P. ("MWP"), of which the Company as the managing general partner, and Republic
Properties Corporation ("RPC"), an unaffiliated third party, as general partner
and limited partners. MWP was designated as the managing general partner of
Hellyer LP. For a 50% ownership interest in Hellyer LP, RPC agreed to cause
Stellex Microwave Systems, Inc. ("Stellex") to provide a 15-year lease on
approximately 160,000 square foot R&D buildings to be constructed by Berg & Berg
Enterprises, Inc. ("BBE") on land owned by another Berg Group member.
As part of the transaction, MWP acquired the underlying land pursuant to the
Berg Land Holdings Option Agreement for a price of $5.7 million by issuing
659,223 O.P. Units to the Berg Group entity that owned the property. Further,
under the terms of the Hellyer LP partnership agreement MWP then contributed the
land to the partnership at an agreed value of $9.6 million, which amount was to
be amortized and paid to MWP in the form of income and cash flow preferences.
The transaction was reviewed and approved by the Independent Directors Committee
of the Company's Board of Directors.
In connection with the transaction, BBE built and paid for all improvements on
the land. The total cost of the R&D buildings, exclusive of specified tenant
improvements obligations, was approximately $11.4 million. Hellyer LP issued a
note for the amount of those construction costs to BBE, which note was secured
by the buildings.
Because RPC's interest in Hellyer LP was attributable solely to its commitment
to obtain Stellex as a tenant for the property, the partnership agreement
provided that if a payment default occurred within the first five years of the
Stellex lease, RPC would lose 100% of its interest in the partnership, and if a
payment default occurred during the second five year period under the lease, RPC
would lose 50% of its interest in Hellyer LP.
Pursuant to RPC's commitment to Hellyer LP, Stellex executed a lease agreement
obligating Stellex, among other things, to pay monthly rent starting at $1.60
per square foot on a triple net basis for 15 years and to reimburse BBE for the
tenant improvement obligations, which ultimately totaled approximately $10.5
million.
Under the lease terms, Stellex was obligated to reimburse BBE in full for the
tenant improvement costs no later than August 25, 2000. Several days before the
due date, representatives of Stellex met with representatives of MWP and
informed them that Stellex could not pay the balance due BBE. Stellex requested
MWP immediately to draw down the letter of credit as a result of default on the
tenant improvement payment required under the lease.
On September 1, 2000, MWP, as the general partner of Hellyer LP, ceased all
allocations of income and cash flow to RPC and exercised the right under the
partnership agreement to cancel RPC's entire interest in the partnership.
Following discussions with and approval by the Independent Directors Committee,
the Company authorized the transfer of RPC's interest in Hellyer LP to BBE.
- 66 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
Under the Berg Land Holdings Option Agreement and the Acquisition Agreement
dated as of May 14, 1998, the Independent Directors Committee of the Board of
Directors had the right, but not the obligation, to reacquire on behalf of the
Company the property interest and the related distributions related to the
property interest at any time. The transfer was effective as of September 1,
2000.
In January 2002, Stellex was acquired through its bankruptcy proceeding by a
division of Tyco Corporation. In connection with the acquisition of Stellex, the
purchaser assumed the lease with Hellyer LP, agreed to comply with all terms of
lease and reimbursed BBE for the tenant improvements, as required under the
lease agreement and the Bankruptcy Court order.
Since the inception of Hellyer LP, the Company has accounted for the properties
owned by the partnership on a consolidated basis, with reductions for the
minority interest held by the minority partner (first RPC and then BBE). In each
period, the Company has accrued amounts payable by Hellyer LP to the minority
interest partner, including BBE prior to payment. BBE's share of earnings
allocated to its 50% minority interest was approximately $0.8 million, $0.7
million and $0.8 million in 2008, 2007 and 2006, respectively. As of December
31, 2008, accumulated cash flow distributions from Hellyer LP totaling
approximately $5.3 million were accrued and distributed to BBE. If the Company's
litigation with RPC (as described under Note 16 below) is ultimately decided in
RPC's favor, the Company anticipates that BBE may be required to return RPC's
former interest in Hellyer LP and all prior distributions to RPC. As a result of
this uncertainty, in October 2003, the Company recorded such distributions as an
account receivable from BBE, which is included in "Other assets" on the
Company's consolidated balance sheets, with an offsetting account payable to
BBE.
The Independent Directors Committee of the Board of Directors has exercised the
right to acquire on behalf of the Company the former RPC interest and related
distributions from BBE under the terms of the Berg Land Holdings Option
Agreement between the Company and the Berg Group if the litigation is ultimately
decided in favor of the Company.
ACQUISITION OF CARL E. BERG'S INTEREST IN UNCONSOLIDATED JOINT VENTURE
In July 1999, TBI, an unrelated party, advised Carl E. Berg that TBI had an
option to purchase approximately 78.89 acres of unimproved land zoned for R&D
development in Morgan Hill at $2.50 per square foot that would expire in
approximately six months. TBI offered Mr. Berg a 50% interest in the development
of this land if Mr. Berg provided 100% financing for the land at 0% interest for
three years. Mr. Berg advised TBI of his obligation to offer all R&D development
opportunities on the West Coast to the Company and further advised TBI that the
Company's Independent Directors Committee must approve the acquisition of any
properties and that the Company's policy was only to acquire properties that are
leased pursuant to the Berg Land Holdings Option Agreement. The development
joint venture between TBI and the Berg Group proceeded on that basis. Building
construction was financed through loans facilitated by the Berg Group. In early
2003, TBI formed TBI-MWP, a new limited partnership, to own all the leased
buildings. The Berg Group offered its 50% non-controlling limited partnership
interest in TBI-MWP to the Company at cost plus an annual interest rate of 7% on
the funds advanced by the Berg Group which amounted to $1.8 million. The
Independent Directors Committee and the Berg Group agreed to use a 7% interest
rate instead of the rate and fees specified in the Berg Land Holdings Option
Agreement because the transaction differed from the standard build-to-suit
development specified under that agreement. TBI-MWP owned four fully leased
buildings totaling approximately 593,000 rentable square feet. The buildings
were subject to mortgage loans totaling approximately $53.6 million. The
Independent Directors Committee approved the Company's acquisition of the Berg
Group's 50% interest in the joint venture effective January 1, 2003. The
development joint venture between the Berg Group and TBI retained two vacant
shell R&D buildings and five unimproved lots. In April 2003, Comcast, Inc.
offered to purchase one of the vacant buildings and two acres of adjoining land
from the development joint venture for net proceeds of $2.8 million, after debt
repayment. Prior to sale of the property, TBI-MWP acquired this property at no
cost under the terms of the Berg Land Holdings Option Agreement, and the Company
received a net distribution of $1.4 million from the sale. The transaction was
approved by the Independent Directors Committee. The Berg Group continues to own
a 50% interest in the remaining vacant building and five unimproved lots. In
July 2006, TBI-MWP sold one R&D property with approximately 126,400 rentable
square feet for approximately $8.5 million. The total gain on the sale was
approximately $0.9 million of which $0.45 million was the Company's share. In
November 2008, TBI-MWP sold two R&D properties with approximately 311,200
rentable square feet for approximately $65 million. The total gain on the sale
was approximately $40.9 million of which approximately $20.5 million was the
Company's share. TBI-MWP currently owns one fully leased R&D building totaling
approximately 155,500 rentable square feet.
BERG CONTROLLED ENTITIES HAVE FINANCIAL INTERESTS IN CERTAIN TENANTS THAT LEASE
SPACE FROM THE COMPANY
During the years ended December 31, 2008, 2007 and 2006, Carl E. Berg or
entities controlled by Mr. Berg held financial interests in several companies
that lease space from the operating partnerships, which include companies where
Mr. Berg has a greater than 10% ownership interest. These related party tenants
contributed approximately $1,218, $1,227 and $1,875 in rental revenue in 2008,
2007 and 2006, respectively. Under the Company's Charter, bylaws and agreements
with the Berg Group, the individual members of the Berg Group are prohibited
from acquiring shares of the Company's common stock if such acquisition would
result in their beneficial
- 67 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
ownership percentage of the Company's common stock causing the Company to
violate any REIT qualification requirement, and currently their share ownership
is below a level at which rent from related party tenants would be excluded in
determining compliance with REIT qualification tests.
BERG GROUP COMMITMENT TO COMPLETE FUTURE IMPROVEMENTS AND BUILDING IN CONNECTION
WITH CERTAIN ACQUISITIONS FROM THE BERG GROUP UNDER THE BERG LAND HOLDINGS
Option Agreement In connection with the Company's 2002 acquisition of 5345
Hellyer Avenue in San Jose, California the Berg Group made an approximately
$2,529 commitment to the Company to complete certain tenant improvements. The
Company recorded this portion of its purchase consideration paid to the Berg
Group in "Other assets" on its consolidated balance sheets. The Berg Group
satisfied this commitment in late 2008. The Company reclassified approximately
$2,529 from "Other assets" to tenant improvements and will start depreciation of
the asset over the remaining lease term effective January 1, 2009.
The Berg Group has an approximately $7,494 commitment to complete an
approximately 75,000 to 90,000 square foot building in connection with the
Company's 2001 acquisition of 245 Caspian Drive in Sunnyvale, California which
is comprised of approximately three acres of unimproved land. The Company
recorded this portion of its purchase consideration paid to the Berg Group in
"Other assets" 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.
LAND LEASE RENT REIMBURSEMENT TO CARL E. BERG
In 2007, one tenant was leasing four R&D buildings from the Company and was also
leasing raw land from Carl E. Berg. Total rent from the tenant was paid directly
to the Company, which included the land rent. The Company reimbursed Carl E.
Berg $85 per month for the land rent. That tenant terminated its lease
obligations with the Company effective July 1, 2007, and the Company acquired
the land in connection with a completed 98,500 rentable square feet shell
building (see "Property Acquisitions" above under Note 6) and after July 1, 2007
no further rent was paid to Carl E. Berg.
LEASING AND OVERHEAD REIMBURSEMENTS PROVIDED BY BERG CONTROLLED ENTITY
The Company currently leases office space owned by Berg & Berg Enterprises for
the Company's headquarters. Rental amount and overhead reimbursements paid to
Berg & Berg Enterprises, Inc. were approximately $114, $95 and $90 for the years
ended December 31, 2008, 2007 and 2006.
14. FUTURE MINIMUM RENTS
The Company, through the operating partnerships, owns interests in 111 R&D
properties that are leased to tenants under net operating leases with initial
terms extending to the year 2020, and are typically subject to fixed increases.
Generally, the leases grant tenants renewal options. Future minimum rentals
under non-cancelable operating leases as of December 31, 2008, excluding tenant
reimbursements of expenses, are as follows:
Year Minimum Rent
--------------------------------------------
(dollars in thousands)
2009 $ 81,905
2010 80,862
2011 71,499
2012 55,548
2013 45,028
Thereafter 71,800
----------------------------
Total $406,642
============================
15. SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest was approximately $20,712, $20,617 and $20,137 for the
years ended December 31, 2008, 2007 and 2006, respectively.
In connection with a property acquisition from the Berg Group, the Company
issued a short-term note payable for approximately $19,068 for the year ended
December 31, 2008. The Company fully repaid the balance as of December 31, 2008.
In connection with a property acquisition from the Berg Group, the Company
issued 548,236 O.P. Units for a total acquisition value of approximately $6,603
for the year ended December 31, 2007.
- 68 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
Amounts of approximately $59,888, $50,189 and $50,166 were paid to the Berg
Group for distributions declared to O.P. Unit holders during the years ended
December 31, 2008, 2007 and 2006, respectively.
For the years ended December 31, 2008, 2007 and 2006, 6,970, 220,500 and 881,896
O.P. Units were exchanged for 6,970, 220,500 and 881,896 shares of the Company's
common stock, respectively, under the terms of the Exchange Rights Agreement
among the Company and all limited partners of the operating partnerships. These
non-cash transactions were valued at approximately $66, $2,855 and $10,280 for
the years ended December 31, 2008, 2007 and 2006, respectively, based on the
market closing price on the day of the transactions.
16. COMMITMENTS AND CONTINGENCIES
The Company and the operating partnerships, from time to time, are parties to
litigation arising out of the normal course of business. 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.
Mission West Properties, L.P. v. Republic Properties Corporation, et al. Santa
Clara County Superior Court, Case No. CV 796249. In February 2001, while a
related case in Maryland was pending, the Company filed a suit against Republic
Properties Corporation ("RPC") in the Superior Court of the State of California
for the County of Santa Clara, Case No. CV 796249. The case was stayed pending
resolution of the Maryland case, and the Company dismissed its suit on March 4,
2005. In April 2005, RPC submitted a motion asking the Superior Court to
reinstate the case, which the Court granted on May 25, 2005. In April 2006, the
Maryland case was dismissed by the highest court in Maryland for lack of
personal jurisdiction. On July 5, 2006, RPC filed a cross-complaint in the case
seeking partnership distributions to which the Company demurred. The Court
sustained the Company's demurrer with leave to amend. Subsequently, RPC filed an
amended complaint and the Company submitted another demurrer seeking dismissal
of the claims on statute of limitations grounds. On February 20, 2007, the Court
overruled the Company's demurrer. The Company sought a writ from the California
State Court of Appeal for the Sixth District to direct the lower court to
reverse its decision, but the petition for the writ was denied. In April 2008,
the Company filed a motion for summary judgment in the California Superior Court
which was denied. In October 2008, a motion filed by RPC for summary judgment in
the California Superior Court was denied. A trial in the California Superior
Court commenced in February 2009.
GUARANTEES
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 December 31, 2008.
The Company also enters into indemnification provisions under its agreements
with other companies in its ordinary course of business, typically with lenders,
joint venture partners, contractors, and tenants. Under these provisions the
Company 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. 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 December 31, 2008.
SEISMIC ACTIVITY
The Company's properties are located in an active seismic area of Silicon
Valley. Insurance policies currently maintained by the Company do not cover
seismic activity, although they do cover losses from fires after an earthquake.
ENVIRONMENTAL ISSUES
The environmental investigations that have been conducted on the Company's
properties have not revealed any environmental liability that it believes would
have a material adverse effect on its financial condition, results of operations
and assets, and 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. The Company cannot assure you that future laws, ordinances,
or regulations will not impose any material environmental liability, or that the
current environmental condition of the properties has not been, or will not be,
affected by tenants and occupants of the properties, by the condition of
properties in the vicinity of the properties, or by third parties unrelated to
the Company.
- 69 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
ASSET DISPOSITION SUBJECT TO CERTAIN CONDITIONS
The Company has entered into a sales agreement with unrelated parties subject to
numerous material conditions, including but not limited to re-zoning of the
property and negotiating certain agreements with the local municipality
acceptable to the buyer. As a result of the conditions agreed to by the Company
and the respective buyers, these assets do not meet the criteria set forth in
SFAS 144 to be classified as assets held for sale. The following summarizes the
assets for which the Company has executed a sales contract as of December 31,
2008 that are subject to material conditions as previously described:
Property Number of Buildings Rentable Square Feet Acres Sales Price
-------- ------------------- -------------------- ----- -----------
McCandless Drive
Milpitas, California 8 427,000 23.03 $76,500
17. REAL ESTATE ASSET HELD FOR SALE AND DISCONTINUED OPERATIONS
The Company follows SFAS 144, which addresses financial accounting and reporting
for the impairment and disposal of long lived assets. In general, income or loss
attributable to the operations and sale of property and the operations related
to property held for sale are classified as discontinued operations in the
consolidated statements of operations. Prior period consolidated statements of
operations presented in this report have been reclassified to reflect the income
or loss related to properties that were held for sale or sold and presented as
discontinued operations for the years ended December 31, 2008, 2007 and 2006.
Additionally, all periods presented in this report will likely require further
reclassification in future periods if additional properties are held for sale or
property sales occur.
As of December 31, 2008, there were no properties under contract to be sold or
otherwise disposed of which would qualify as assets held for sale.
In 2007, the Company sold two R&D properties for a total sales price of
approximately $16,043 resulting in a net gain of approximately $6,529. In 2006,
the Company sold three R&D properties for a total sales price of approximately
$43,271 resulting in a net gain of approximately $18,102. Results of operations
for these properties for the years ended December 31, 2007 and 2006 are as
follows:
Year Ended December 31,
------------------------------------------
2007 2006
------------------ -------------------
(dollars in thousands)
Revenues:
Rental revenue from real estate $389 $2,271
Tenant reimbursements 83 317
Other income 1 291
------------------ -------------------
Total revenues 473 2,879
------------------ -------------------
Expenses:
Property operating, maintenance and real estate taxes 233 683
Depreciation of real estate 148 694
------------------ -------------------
Total expenses 381 1,377
------------------ -------------------
Operating income 92 1,502
Other income (expenses):
Interest (1) (1)
------------------ -------------------
Income from discontinued operations 91 1,501
Gain from disposal of discontinued operations 6,529 18,102
Minority interests in earnings from discontinued (5,489) (16,431)
operations
------------------ -------------------
Income from discontinued operations $1,131 $3,172
================== ===================
For the years ended December 31, 2007 and 2006, income from discontinued
operations included results of operations from two R&D properties sold in 2007
and three R&D properties sold in 2006.
- 70 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
18. ACQUISITION-RELATED INTANGIBLE ASSETS
In February 2008, the Company acquired a fully leased office/R&D building at
2904 Orchard Parkway in San Jose, California for approximately $16,696 from an
unrelated party. The purchase price was allocated to long-lived assets and the
value of an in-place lease as follows:
Land $4,704
Buildings and improvements 10,871
In-place lease 1,121
-----------------
Total cash purchase price $16,696
=================
The result of operations for this property acquisition has been included in the
Company's consolidated statements of operations since the date of acquisition.
The intangible assets are being amortized over the applicable remaining lease
term. Amortization expense related to in-place leases of approximately $600,
$2,153 and $1,613 was recorded for the years ended December 31, 2008, 2007 and
2006, respectively.
Details of real estate related intangible assets at December 31, 2008 and 2007
are as follows:
December 31,
------------------------------------------
2008 2007
------------------ -------------------
(dollars in thousands)
Amortizable intangible assets:
In-place leases $3,240 $2,119
Accumulated amortization (1,341) (741)
------------------ -------------------
Net real estate related intangible assets $1,899 $1,378
================== ===================
The estimated aggregate amortization expense for the real estate related
intangible assets for each of the five succeeding fiscal years is as follows:
Year Estimated In-place
Lease
Amortization (expense)
------------------------------------------
(dollars in
thousands)
2009 $637
2010 637
2011 363
2012 224
2013 38
------------------------
Total $1,899
========================
19. FAIR VALUE
The only financial asset or liability recorded at fair value in the Company's
consolidated financial statements is the marketable securities. The Company
determined the fair value for the marketable securities using quoted prices in
active markets for identical securities (Level 1 - see Note 2 under New
Accounting Pronouncements). As of December 31, 2008, the fair value of the
marketable securities totaled approximately $3,368 and the cost thereof was
approximately $3,646. The marketable securities are adjusted to fair value at
the end of each accounting period, with the corresponding losses and gains
recorded in unrealized losses or gains from investment. For the year ended
December 31, 2008, the Company recorded net unrealized losses of approximately
$278 related to the decrease in fair value of the marketable securities, which
was reported in unrealized loss from investment in the Company's consolidated
statement of operations.
- 71 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
20. SUPPLEMENTAL FINANCIAL INFORMATION (Unaudited)
Quarterly financial information for the year ended December 31, 2008 (1) is as
follows:
For the Three Months Ended
March 31, June 30, September 30, December 31,
(Unaudited)
----------------------------------------------------------------------------------------
Rental revenue from continuing operations, net $18,996 $19,359 $20,256 $20,464
Operating income from continuing operations $13,545 $11,452 $12,952 $12,436
Income from continuing operations $1,882 $1,359 $1,635 $5,257
Net income to common stockholders $1,882 $1,359 $1,635 $5,257
Per share data:
Basic net income per share $0.10 $0.07 $0.08 $0.27
Diluted net income per share $0.10 $0.07 $0.08 $0.26
Weighted average shares of common stock(basic) 19,667,605 19,695,988 19,745,141 19,748,211
Weighted average shares of common stock(diluted) 19,667,605 19,902,304 19,783,507 19,889,016
Quarterly financial information for the year ended December 31, 2007 (1) is as
follows:
For the Three Months Ended
March 31, June 30, September 30, December 31,
(Unaudited)
----------------------------------------------------------------------------------------
Rental revenue from continuing operations, net $17,111 $21,148 $19,000 $18,986
Operating income from continuing operations $21,235 $14,402 $58,093 $11,858
Income from continuing operations (2) $3,366 $2,001 $10,821 $1,568
Income from discontinued operations (2) $9 $3 $1,120 -
Net income to common stockholders $3,375 $2,004 $11,941 $1,568
Per share data:
Basic net income per share $0.17 $0.10 $0.61 $0.08
Diluted net income per share $0.17 $0.10 $0.60 $0.08
Weighted average shares of common stock(basic) 19,582,787 19,639,928 19,640,087 19,645,304
Weighted average shares of common stock(diluted) 19,889,453 20,020,596 19,818,806 19,710,909
(1) The summation of the quarterly financial data may not equal the annual
number reported on the consolidated statements of operations due to
rounding differences.
(2) The quarterly financial data may not equal previously reported results on
the Company's quarterly reports on Form 10-Q due to reclassification of
revenues and expenses to discontinued operations in accordance with SFAS
144.
21. SUBSEQUENT EVENTS
On January 7, 2009, one limited partner exchanged a total of 2,000,000 O.P.
Units for 2,000,000 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. Neither the Company nor the operating partnerships
received any proceeds from the issuance of the common stock in exchange for O.P.
Units.
On January 8, 2009, the Company paid dividends of $0.20 per share of common
stock to all common stockholders of record as of December 31, 2008. On the same
date, the operating partnerships paid a distribution of $0.20 per O.P. Unit to
all holders of O.P. Units, with the exception of the Berg Group. Aggregate
dividends and distributions amounted to approximately $21,055.
On January 8, 2009, a short-term note payable in the amount of approximately
$10,760 was issued to the Berg Group in connection with the fourth quarter 2008
dividend distributions. The note payable bears interest at LIBOR plus 2% and was
fully repaid in February 2009.
- 72 -
Report of Independent Registered Public Accounting Firm on
Financial Statement Schedule
Board of Directors and Stockholders
Mission West Properties, Inc.
Cupertino, California
The audit referred to in our report dated March 13, 2009 relating to the
consolidated financial statements of Mission West Properties, Inc., which is
contained in Item 8 of this Form 10-K, included the audit of the financial
statement schedule listed in the accompanying index as of December 31, 2008 and
2007. This financial statement schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion on this financial
statement schedule based upon our audit.
In our opinion such financial statement schedule as of December 31, 2008 and
2007 presents fairly, in all material respects, the information set forth
therein.
\S\ Burr, Pilger & Mayer, LLP
San Francisco, California
March 13, 2009
- 73 -
INTENTIONALLY BLANK
- 74 -
MISSION WEST PROPERTIES, INC.
Schedule III
Real Estate and Accumulated Depreciation and Amortization
December 31, 2008
(dollars in thousands)
Initial Cost
------------------------------ Cost
Buildings Subsequent to
December 31, 2008 and Construction/
Property Name City Encumbrances Land Improvements Acquisition
----------------------------------------------- ----------------- ------------- --------------- -------------
5300-5350 Hellyer Avenue San Jose C $8,761 $5,742 $11,442
10401-10411 Bubb Road Cupertino A 633 3,078
45365 Northport Loop Fremont 2,447 5,711 $11
45738 Northport Loop Fremont F 891 4,338 5
4050 Starboard Drive Fremont F 1,329 6,467 8
3501 W. Warren Ave/Fremont Blvd Fremont 1,866 9,082 1,382
48800 Milmont Blvd Fremont 1,013 4,932
4750 Patrick Henry Drive Santa Clara H 1,604 7,805 405
3520 Bassett Street Santa Clara D 1,104 5,371
3530 Bassett Street Santa Clara B,D 849 4,133
5850-5870 Hellyer Avenue San Jose 2,787 6,502 131
5750 Hellyer Avenue San Jose 3,266 3,354 2,798
800 Embedded Way San Jose K 1,794 -
5500 Hellyer Avenue San Jose F 4,735 12,485 1,575
5550 Hellyer Avenue San Jose F 3,261 3,478 3,755
5400 Hellyer Avenue San Jose 3,238 5,007 215
5325 Hellyer Avenue San Jose H 4,684 10,230 40
5345 Hellyer Avenue San Jose H 4,866 5,822 2,529
5905-5965 Silver Creek Valley Rd San Jose 8,437 17,316
5905-5965 Silver Creek Valley Rd San Jose 3,438 2,727
5845 Hellyer Avenue San Jose 6,090 5,029
855 Embedded Way San Jose 3,289 6,521 150
1065-1105 La Avenida Street Mountain View 46,832 109,275 65
1875 Charleston Road Mountain View M - 2,615
1750 Automation Parkway San Jose G 4,789 11,174 315
1756 Automation Parkway San Jose G 4,378 10,216 704
1762 Automation Parkway San Jose G 4,804 12,224 1,332
1768 Automation Parkway San Jose H 8,195 19,121 218
255 Caspian Drive Sunnyvale 3,491 7,160 1,658
245 Caspian Drive Sunnyvale 5,894 -
5981 Optical Court San Jose F 4,054 14,938 298
5970 Optical Court San Jose 2,758 8,395
5900 Optical Court San Jose 3,634 12,677 83
2630 Orchard Parkway San Jose 2,932 5,863 22
2610 Orchard Parkway San Jose J 2,615 5,231
55 West Trimble Road San Jose J 4,435 8,869
2001 Walsh Avenue Santa Clara E,G,I 4,610 3,887
2880 Scott Blvd Santa Clara E,H,I 14,501 22,555 471
2890 Scott Blvd Santa Clara E,H,I 3,081 9,696 25
2770-2800 Scott Blvd Santa Clara E,H 7,138 7,075 170
2300 Central Expressway Santa Clara E,G,I 2,390 2,459
2220 Central Expressway Santa Clara E,G,I 3,305 3,427 816
2330 Central Expressway Santa Clara E,G 3,673 3,932 677
233 South Hillview Drive Milpitas F,N 3,335 10,076
2251 Lawson Lane Santa Clara 1,952 9,498 501
1230 East Arques Sunnyvale F 540 2,628 39
1250 East Arques Sunnyvale F 1,335 6,499
20400 Mariani Avenue Cupertino 1,670 8,125 946
10500 De Anza Blvd Cupertino 7,666 37,304
20605-20705 Valley Green Drive Cupertino G 3,490 16,984
10300 Bubb Road Cupertino F 635 3,090
10440 Bubb Road Cupertino 434 2,112 114
10460 Bubb Road Cupertino H 994 4,838 1,279
1135 Kern Avenue Sunnyvale 407 1,982
450 National Avenue Mountain View 611 2,973 72
3301 Olcott Street Santa Clara 1,846 8,984 37
2800 Bayview Avenue Fremont 1,070 5,205 60
5521 Hellyer Avenue San Jose 4,534 9,650
6850 Santa Teresa Blvd San Jose H 377 1,836 819
Total Cost
---------------------------
Buildings Accumulated
and Depreciation Date of Depreciable
Property Name City Land Improvements Total & Amortization Acquisition Life
----------------------------------------------- ----------- -------------- ------------ -------------- ----------- -----------
5300-5350 Hellyer Avenue San Jose C $5,742 $11,442 $17,184 $2,467 5/00 L
10401-10411 Bubb Road Cupertino A 633 3,078 3,711 810 7/98 L
45365 Northport Loop Fremont 2,447 5,722 8,169 1,189 10/00 L
45738 Northport Loop Fremont F 891 4,343 5,234 1,143 7/98 L
4050 Starboard Drive Fremont F 1,329 6,475 7,804 1,702 7/98 L
3501 W. Warren Ave/Fremont Blvd Fremont 1,866 10,464 12,330 3,656 7/98 L
48800 Milmont Blvd Fremont 1,013 4,932 5,945 1,296 7/98 L
4750 Patrick Henry Drive Santa Clara H 1,604 8,210 9,814 2,390 7/98 L
3520 Bassett Street Santa Clara D 1,104 5,371 6,475 1,411 7/98 L
3530 Bassett Street Santa Clara B,D 849 4,133 4,982 1,086 7/98 L
5850-5870 Hellyer Avenue San Jose 2,787 6,633 9,420 1,715 11/98 L
5750 Hellyer Avenue San Jose 3,266 6,152 9,418 1,312 8/01 L
800 Embedded Way San Jose K 1,794 - 1,794 - 3/00 -
5500 Hellyer Avenue San Jose F 4,735 14,060 18,795 2,515 2/01 L
5550 Hellyer Avenue San Jose F 3,261 7,233 10,494 966 6/01 L
5400 Hellyer Avenue San Jose 3,238 5,222 8,460 1,281 7/00 L
5325 Hellyer Avenue San Jose H 4,684 10,270 14,954 2,093 1/01 L
5345 Hellyer Avenue San Jose H 4,866 8,351 13,217 1,145 1/02 L
5905-5965 Silver Creek Valley Rd San Jose 8,437 17,316 25,753 3,247 7/01 L
5905-5965 Silver Creek Valley Rd San Jose 3,438 2,727 6,165 494 10/01 L
5845 Hellyer Avenue San Jose 6,090 5,029 11,119 161 9/07 L
855 Embedded Way San Jose 3,289 6,671 9,960 1,320 5/01 L
1065-1105 La Avenida Street Mountain View 46,832 109,340 156,172 26,649 4/99 L
1875 Charleston Road Mountain View M - 2,615 2,615 519 4/06 L
1750 Automation Parkway San Jose G 4,789 11,489 16,278 2,729 7/99 L
1756 Automation Parkway San Jose G 4,378 10,920 15,298 2,434 1/00 L
1762 Automation Parkway San Jose G 4,804 13,556 18,360 2,961 4/00 L
1768 Automation Parkway San Jose H 8,195 19,339 27,534 3,977 12/00 L
255 Caspian Drive Sunnyvale 3,491 8,818 12,309 2,243 4/00 L
245 Caspian Drive Sunnyvale 5,894 - 5,894 - 4/01 -
5981 Optical Court San Jose F 4,054 15,236 19,290 874 1/08 L
5970 Optical Court San Jose 2,758 8,395 11,153 1,049 12/03 L
5900 Optical Court San Jose 3,634 12,760 16,394 2,133 7/02 L
2630 Orchard Parkway San Jose 2,932 5,885 8,817 1,024 3/02 L
2610 Orchard Parkway San Jose J 2,615 5,231 7,846 894 3/02 L
55 West Trimble Road San Jose J 4,435 8,869 13,304 1,516 3/02 L
2001 Walsh Avenue Santa Clara E,G,I 4,610 3,887 8,497 564 4/03 L
2880 Scott Blvd Santa Clara E,H,I 14,501 23,026 37,527 3,300 4/03 L
2890 Scott Blvd Santa Clara E,H,I 3,081 9,721 12,802 1,402 4/03 L
2770-2800 Scott Blvd Santa Clara E,H 7,138 7,245 14,383 1,089 4/03 L
2300 Central Expressway Santa Clara E,G,I 2,390 2,459 4,849 356 4/03 L
2220 Central Expressway Santa Clara E,G,I 3,305 4,243 7,548 838 4/03 L
2330 Central Expressway Santa Clara E,G 3,673 4,609 8,282 799 4/03 L
233 South Hillview Drive Milpitas F,N 3,335 10,076 13,411 1,381 3/06 L
2251 Lawson Lane Santa Clara 1,952 9,999 11,951 2,503 7/98 L
1230 East Arques Sunnyvale F 540 2,667 3,207 733 7/98 L
1250 East Arques Sunnyvale F 1,335 6,499 7,834 1,707 7/98 L
20400 Mariani Avenue Cupertino 1,670 9,071 10,741 2,403 7/98 L
10500 De Anza Blvd Cupertino 7,666 37,304 44,970 9,796 7/98 L
20605-20705 Valley Green Drive Cupertino G 3,490 16,984 20,474 4,462 7/98 L
10300 Bubb Road Cupertino F 635 3,090 3,725 813 7/98 L
10440 Bubb Road Cupertino 434 2,226 2,660 650 7/98 L
10460 Bubb Road Cupertino H 994 6,117 7,111 1,748 7/98 L
1135 Kern Avenue Sunnyvale 407 1,982 2,389 524 7/98 L
450 National Avenue Mountain View 611 3,045 3,656 821 7/98 L
3301 Olcott Street Santa Clara 1,846 9,021 10,867 2,376 7/98 L
2800 Bayview Avenue Fremont 1,070 5,265 6,335 1,428 7/98 L
5521 Hellyer Avenue San Jose 4,534 9,650 14,184 1,162 2/05 L
6850 Santa Teresa Blvd San Jose H 377 2,655 3,032 934 7/98 L
- 75 -
Initial Cost
------------------------------ Cost
Buildings Subsequent to
December 31, 2008 and Construction/
Property Name City Encumbrances Land Improvements Acquisition
----------------------------------------------- ----------------- ------------- --------------- -------------
6810 Santa Teresa Blvd San Jose H 2,567 5,991 772
140-160 Great Oaks Blvd San Jose 1,402 6,822 754
6541 Via del Oro/6385 San Ignacio San Jose G 1,039 5,057 81
6311-6351 San Ignacio Avenue San Jose F 6,246 30,396 170
6320-6360 San Ignacio Avenue San Jose G 2,616 12,732 439
75 E. Trimble Rd/2610 N. First St San Jose 3,477 16,919 85
2904 Orchard Parkway San Jose F,O 4,704 11,992
3236 Scott Blvd Santa Clara F 1,234 6,005
1212 Bordeaux Lane Sunnyvale F 2,250 10,948
1325-1810 McCandless Drive Milpitas 13,994 66,213 1,455
1600 Memorex Drive Santa Clara 1,221 5,940 11
1688 Richard Avenue Santa Clara 1,248 2,913 6
1700 Richard Avenue Santa Clara 1,727 4,030
Morgan Hill Land Morgan Hill 25,543 -
Morgan Hill Land Morgan Hill 2,297 -
300 Montague Expressway Milpitas 2,609 2,499
337 Trade Zone Blvd Milpitas 2,264 2,168
324-368 Montague Expressway Milpitas 2,968 2,843
3506-3510 Bassett Street Santa Clara D 943 4,591 182
3540-3544 Bassett Street Santa Clara F,D 1,565 7,616 195
3550 Bassett Street Santa Clara F,D 1,079 5,251 33
3560 Bassett Street Santa Clara F,D 1,075 5,233 8
3570-3580 Bassett Street Santa Clara F,D 1,075 5,233
Hartford Loan F 114,513
Northwestern Mutual Life Ins. Co. G 81,308
Allianz Life Insurance Company H 135,087
----------------- ------------- --------------- -------------
$339,669 $320,911 $774,795 $27,916
================= ============= =============== =============
Total Cost
---------------------------
Buildings Accumulated
and Depreciation Date of Depreciable
Property Name City Land Improvements Total & Amortization Acquisition Life
----------------------------------------------- ----------- -------------- ------------ -------------- ----------- -----------
6810 Santa Teresa Blvd San Jose H 2,567 6,763 9,330 1,772 3/99 L
140-160 Great Oaks Blvd San Jose 1,402 7,576 8,978 2,206 7/98 L
6541 Via del Oro/6385 San Ignacio San Jose G 1,039 5,138 6,177 1,380 7/98 L
6311-6351 San Ignacio Avenue San Jose F 6,246 30,566 36,812 8,143 7/98 L
6320-6360 San Ignacio Avenue San Jose G 2,616 13,171 15,787 3,548 7/98 L
75 E. Trimble Rd/2610 N. First St San Jose 3,477 17,004 20,481 4,532 7/98 L
2904 Orchard Parkway San Jose F,O 4,704 11,992 16,696 413 2/08 L
3236 Scott Blvd Santa Clara F 1,234 6,005 7,239 1,578 7/98 L
1212 Bordeaux Lane Sunnyvale F 2,250 10,948 13,198 2,877 7/98 L
1325-1810 McCandless Drive Milpitas 13,994 67,668 81,662 18,258 7/98 L
1600 Memorex Drive Santa Clara 1,221 5,951 7,172 1,547 7/98 L
1688 Richard Avenue Santa Clara 1,248 2,919 4,167 770 9/98 L
1700 Richard Avenue Santa Clara 1,727 4,030 5,757 952 8/99 L
Morgan Hill Land Morgan Hill 25,543 - 25,543 - 3/07 -
Morgan Hill Land Morgan Hill 2,297 - 2,297 - 4/07 -
300 Montague Expressway Milpitas 2,609 2,499 5,108 104 4/07 L
337 Trade Zone Blvd Milpitas 2,264 2,168 4,432 90 4/07 L
324-368 Montague Expressway Milpitas 2,968 2,843 5,811 118 4/07 L
3506-3510 Bassett Street Santa Clara D 943 4,773 5,716 1,320 7/98 L
3540-3544 Bassett Street Santa Clara F,D 1,565 7,811 9,376 2,070 7/98 L
3550 Bassett Street Santa Clara F,D 1,079 5,284 6,363 1,415 7/98 L
3560 Bassett Street Santa Clara F,D 1,075 5,241 6,316 1,384 7/98 L
3570-3580 Bassett Street Santa Clara F,D 1,075 5,233 6,308 1,376 7/98 L
Hartford Loan F
Northwestern Mutual Life Ins. Co. G
Allianz Life Insurance Company H
----------- -------------- ----------- -------------
$320,911 $802,711 $1,123,622 $180,043
=========== ============== =========== =============
(A) 16.67% of this property's ownership is held by unaffiliated parties outside
the operating partnerships of the Company.
(B) 25% of this property's ownership is held by unaffiliated parties outside
the operating partnerships of the Company.
(C) 50% of this property's ownership is held by an affiliated party since
September 2000.
(D) Part of the property group referred to as the Triangle Technology Park.
(E) Part of the property group referred to as the San Tomas Technology Park.
(F) Encumbered by the $114,513 Hartford loan - full amount of loan shown at the
bottom of the schedule.
(G) Encumbered by the $81,308 Northwestern Mutual Life Insurance Company loan -
full amount of loan shown at the bottom of the schedule.
(H) Encumbered by the $135,087 Allianz Life Insurance Company loan - full
amount of loan shown at the bottom of the schedule.
(I) Purchase price allocated to real estate related intangible assets pursuant
to SFAS 141 amounted to $18,284. Approximately $17,410 and $874 was fully
amortized in 2007 and 2005, respectively, and the asset cost and its
related accumulated amortization was removed from the accounts.
(J) Purchase price allocated to real estate related intangible assets pursuant
to SFAS 141 amounted to $1,367. The amount was fully amortized in 2004 and
the asset cost and its related accumulated amortization was removed from
the accounts.
(K) This property was sold in October 2005. The Company retained 32.5%, or
approximately 7.9 acres, of raw land.
(L) Depreciation is computed based on the following estimated lives:
1. Building shell and base building tenant improvements of newly acquired
properties are being depreciated on a weighted average composite
useful life of 40 years.
2. Real estate intangible assets allocated pursuant to SFAS 141 are being
amortized over the remaining life of the underlying leases.
3. Tenant improvements, furniture and fixtures are being depreciated over
their estimated useful lives ranging from 5 to 10 years.
(M) Purchase price allocated to real estate related intangible assets pursuant
to SFAS 141 amounted to $745.
(N) Purchase price allocated to real estate related intangible assets pursuant
to SFAS 141 amounted to $1,374.
(O) Purchase price allocated to real estate related intangible assets pursuant
to SFAS 141 amounted to $1,121.
- 76 -
MISSION WEST PROPERTIES, INC.
Schedule III
Real Estate and Accumulated Depreciation and Amortization
December 31, 2007
(dollars in thousands)
Initial Cost
------------------------------ Cost
Buildings Subsequent to
December 31, 2007 and Construction/
Property Name City Encumbrances Land Improvements Acquisition
----------------------------------------------- ----------------- ------------- --------------- -------------
5300-5350 Hellyer Avenue San Jose C $9,224 $5,742 $11,442
10401-10411 Bubb Road Cupertino A 633 3,078
45365 Northport Loop Fremont 2,447 5,711 $11
45738 Northport Loop Fremont F 891 4,338 5
4050 Starboard Drive Fremont F 1,329 6,467 8
3501 W. Warren Ave/Fremont Blvd Fremont 1,866 9,082 1,382
48800 Milmont Blvd Fremont 1,013 4,932
4750 Patrick Henry Drive Santa Clara 1,604 7,805 405
3520 Bassett Street Santa Clara D 1,104 5,371
3530 Bassett Street Santa Clara B,D 849 4,133
5850-5870 Hellyer Avenue San Jose 2,787 6,502 131
5750 Hellyer Avenue San Jose 3,266 3,354 3,127
800 Embedded Way San Jose K 1,794 -
5500 Hellyer Avenue San Jose 4,735 12,485 39
5550 Hellyer Avenue San Jose 3,261 3,478
5400 Hellyer Avenue San Jose 3,238 5,007 215
5325 Hellyer Avenue San Jose H 4,684 10,230 40
5345 Hellyer Avenue San Jose H 4,866 5,822
5905-5965 Silver Creek Valley Rd San Jose 8,437 17,316
5905-5965 Silver Creek Valley Rd San Jose 3,438 2,727
5845 Hellyer Avenue San Jose 6,090 5,029
855 Embedded Way San Jose 3,289 6,521 68
1065-1105 La Avenida Street Mountain View 46,832 109,275 65
1875 Charleston Road Mountain View M - 2,615
1750 Automation Parkway San Jose G 4,789 11,174 315
1756 Automation Parkway San Jose G 4,378 10,216 704
1762 Automation Parkway San Jose G 4,804 12,224 1,332
1768 Automation Parkway San Jose H 8,195 19,121 142
255 Caspian Drive Sunnyvale 3,491 7,160 1,658
245 Caspian Drive Sunnyvale 5,894 -
5970 Optical Court San Jose 2,758 8,395
5900 Optical Court San Jose H 3,634 12,677 83
2630 Orchard Parkway San Jose 2,931 5,863 22
2610 Orchard Parkway San Jose J 2,615 5,231
55 West Trimble Road San Jose J 4,435 8,869
2001 Walsh Avenue Santa Clara E,I 4,610 3,887
2880 Scott Blvd Santa Clara E,H,I 14,501 22,555
2890 Scott Blvd Santa Clara E,H,I 3,081 9,696 25
2770-2800 Scott Blvd Santa Clara E,H 7,138 7,075 170
2300 Central Expressway Santa Clara E,I 2,390 2,459
2220 Central Expressway Santa Clara E,I 3,304 3,427 816
2330 Central Expressway Santa Clara E 3,673 3,932 677
233 South Hillview Drive Milpitas N 3,335 10,076
2251 Lawson Lane Santa Clara G 1,952 9,498
1230 East Arques Sunnyvale F 540 2,628 39
1250 East Arques Sunnyvale F 1,335 6,499
20400 Mariani Avenue Cupertino H 1,670 8,125 866
10500 De Anza Blvd Cupertino F 7,666 37,304
20605-20705 Valley Green Drive Cupertino G 3,490 16,984
10300 Bubb Road Cupertino F 635 3,090
10440 Bubb Road Cupertino 434 2,112 114
10460 Bubb Road Cupertino H 994 4,838 1,279
1135 Kern Avenue Sunnyvale F 407 1,982
450 National Avenue Mountain View F 611 2,973 72
3301 Olcott Street Santa Clara 1,846 8,984 37
2800 Bayview Avenue Fremont 1,070 5,205 60
5521 Hellyer Avenue San Jose 4,534 9,650
6850 Santa Teresa Blvd San Jose 377 1,836 819
Total Cost
---------------------------
Buildings Accumulated
and Depreciation Date of Depreciable
Property Name City Land Improvements Total & Amortization Acquisition Life
----------------------------------------------- ----------- -------------- ------------ -------------- ----------- -----------
5300-5350 Hellyer Avenue San Jose C $5,742 $11,442 $17,184 $2,181 5/00 L
10401-10411 Bubb Road Cupertino A 633 3,078 3,711 733 7/98 L
45365 Northport Loop Fremont 2,447 5,722 8,169 1,047 10/00 L
45738 Northport Loop Fremont F 891 4,343 5,234 1,034 7/98 L
4050 Starboard Drive Fremont F 1,329 6,475 7,804 1,540 7/98 L
3501 W. Warren Ave/Fremont Blvd Fremont 1,866 10,464 12,330 2,916 7/98 L
48800 Milmont Blvd Fremont 1,013 4,932 5,945 1,173 7/98 L
4750 Patrick Henry Drive Santa Clara 1,604 8,210 9,814 2,113 7/98 L
3520 Bassett Street Santa Clara D 1,104 5,371 6,475 1,276 7/98 L
3530 Bassett Street Santa Clara B,D 849 4,133 4,982 983 7/98 L
5850-5870 Hellyer Avenue San Jose 2,787 6,633 9,420 1,530 11/98 L
5750 Hellyer Avenue San Jose 3,266 6,481 9,747 882 8/01 L
800 Embedded Way San Jose K 1,794 - 1,794 - 3/00 -
5500 Hellyer Avenue San Jose 4,735 12,524 17,259 2,159 2/01 L
5550 Hellyer Avenue San Jose 3,261 3,478 6,739 612 6/01 L
5400 Hellyer Avenue San Jose 3,238 5,222 8,460 1,141 7/00 L
5325 Hellyer Avenue San Jose H 4,684 10,270 14,954 1,836 1/01 L
5345 Hellyer Avenue San Jose H 4,866 5,822 10,688 1,000 1/02 L
5905-5965 Silver Creek Valley Rd San Jose 8,437 17,316 25,753 2,814 7/01 L
5905-5965 Silver Creek Valley Rd San Jose 3,438 2,727 6,165 426 10/01 L
5845 Hellyer Avenue San Jose 6,090 5,029 11,119 32 9/07 L
855 Embedded Way San Jose 3,289 6,589 9,878 1,150 5/01 L
1065-1105 La Avenida Street Mountain View 46,832 109,340 156,172 23,916 4/99 L
1875 Charleston Road Mountain View M - 2,615 2,615 330 4/06 L
1750 Automation Parkway San Jose G 4,789 11,489 16,278 2,441 7/99 L
1756 Automation Parkway San Jose G 4,378 10,920 15,298 2,110 1/00 L
1762 Automation Parkway San Jose G 4,804 13,556 18,360 2,468 4/00 L
1768 Automation Parkway San Jose H 8,195 19,263 27,458 3,423 12/00 L
255 Caspian Drive Sunnyvale 3,491 8,818 12,309 1,940 4/00 L
245 Caspian Drive Sunnyvale 5,894 - 5,894 - 4/01 -
5970 Optical Court San Jose 2,758 8,395 11,153 840 12/03 L
5900 Optical Court San Jose H 3,634 12,760 16,394 1,804 7/02 L
2630 Orchard Parkway San Jose 2,931 5,885 8,816 877 3/02 L
2610 Orchard Parkway San Jose J 2,615 5,231 7,846 763 3/02 L
55 West Trimble Road San Jose J 4,435 8,869 13,304 1,294 3/02 L
2001 Walsh Avenue Santa Clara E,I 4,610 3,887 8,497 466 4/03 L
2880 Scott Blvd Santa Clara E,H,I 14,501 22,555 37,056 2,689 4/03 L
2890 Scott Blvd Santa Clara E,H,I 3,081 9,721 12,802 1,156 4/03 L
2770-2800 Scott Blvd Santa Clara E,H 7,138 7,245 14,383 860 4/03 L
2300 Central Expressway Santa Clara E,I 2,390 2,459 4,849 295 4/03 L
2220 Central Expressway Santa Clara E,I 3,304 4,243 7,547 636 4/03 L
2330 Central Expressway Santa Clara E 3,673 4,609 8,282 604 4/03 L
233 South Hillview Drive Milpitas N 3,335 10,076 13,411 892 3/06 L
2251 Lawson Lane Santa Clara G 1,952 9,498 11,450 2,257 7/98 L
1230 East Arques Sunnyvale F 540 2,667 3,207 666 7/98 L
1250 East Arques Sunnyvale F 1,335 6,499 7,834 1,544 7/98 L
20400 Mariani Avenue Cupertino H 1,670 8,991 10,661 2,018 7/98 L
10500 De Anza Blvd Cupertino F 7,666 37,304 44,970 8,863 7/98 L
20605-20705 Valley Green Drive Cupertino G 3,490 16,984 20,474 4,037 7/98 L
10300 Bubb Road Cupertino F 635 3,090 3,725 735 7/98 L
10440 Bubb Road Cupertino 434 2,226 2,660 584 7/98 L
10460 Bubb Road Cupertino H 994 6,117 7,111 1,582 7/98 L
1135 Kern Avenue Sunnyvale F 407 1,982 2,389 474 7/98 L
450 National Avenue Mountain View F 611 3,045 3,656 733 7/98 L
3301 Olcott Street Santa Clara 1,846 9,021 10,867 2,144 7/98 L
2800 Bayview Avenue Fremont 1,070 5,265 6,335 1,298 7/98 L
5521 Hellyer Avenue San Jose 4,534 9,650 14,184 859 2/05 L
6850 Santa Teresa Blvd San Jose 377 2,655 3,032 864 7/98 L
- 77 -
MISSION WEST PROPERTIES, INC.
Schedule III
Real Estate and Accumulated Depreciation and Amortization
December 31, 2007
(dollars in thousands)
Initial Cost
------------------------------ Cost
Buildings Subsequent to
December 31, 2007 and Construction/
Property Name City Encumbrances Land Improvements Acquisition
----------------------------------------------- ----------------- ------------- --------------- -------------
6810 Santa Teresa Blvd San Jose 2,567 5,991 774
140-160 Great Oaks Blvd San Jose 1,402 6,822 754
6541 Via del Oro/6385 San Ignacio San Jose G 1,039 5,057 81
6311-6351 San Ignacio Avenue San Jose F 6,247 30,396 170
6320-6360 San Ignacio Avenue San Jose G 2,616 12,732 439
75 E. Trimble Rd/2610 N.First St San Jose 3,477 16,919 85
3236 Scott Blvd Santa Clara F 1,234 6,005
1212 Bordeaux Lane Sunnyvale F 2,250 10,948
1325-1810 McCandless Drive Milpitas G 13,994 66,213 1,455
1600 Memorex Drive Santa Clara F 1,221 5,940 11
1688 Richard Avenue Santa Clara F 1,248 2,913 6
1700 Richard Avenue Santa Clara F 1,727 4,030
Morgan Hill Land Morgan Hill 25,543 -
Morgan Hill Land Morgan Hill 2,297 -
300 Montague Expressway Milpitas 2,609 2,499
337 Trade Zone Blvd Milpitas 2,264 2,168
324-368 Montague Expressway Milpitas 2,968 2,843
3506-3510 Bassett Street Santa Clara D 943 4,591 182
3540-3544 Bassett Street Santa Clara F,D 1,565 7,616 195
3550 Bassett Street Santa Clara F,D 1,079 5,251 33
3560 Bassett Street Santa Clara F,D 1,075 5,233 8
3570-3580 Bassett Street Santa Clara F,D 1,075 5,233
Prudential Mortgage Capital Co. F 112,543
Northwestern Mutual Life Ins. Co. G 84,959
Allianz Life Insurance Company H 140,018
----------------- ------------- --------------- -------------
$346,744 $312,152 $747,865 $18,919
================= ============= =============== =============
Total Cost
---------------------------
Buildings Accumulated
and Depreciation Date of Depreciable
Property Name City Land Improvements Total & Amortization Acquisition Life
----------------------------------------------- ----------- -------------- ------------ -------------- ----------- -----------
6810 Santa Teresa Blvd San Jose 2,567 6,765 9,332 1,477 3/99 L
140-160 Great Oaks Blvd San Jose 1,402 7,576 8,978 1,975 7/98 L
6541 Via del Oro/6385 San Ignacio San Jose G 1,039 5,138 6,177 1,240 7/98 L
6311-6351 San Ignacio Avenue San Jose F 6,247 30,566 36,813 7,372 7/98 L
6320-6360 San Ignacio Avenue San Jose G 2,616 13,171 15,787 3,207 7/98 L
75 E. Trimble Rd/2610 N.First St San Jose 3,477 17,004 20,481 4,109 7/98 L
3236 Scott Blvd Santa Clara F 1,234 6,005 7,239 1,428 7/98 L
1212 Bordeaux Lane Sunnyvale F 2,250 10,948 13,198 2,603 7/98 L
1325-1810 McCandless Drive Milpitas G 13,994 67,668 81,662 16,452 7/98 L
1600 Memorex Drive Santa Clara F 1,221 5,951 7,172 1,398 7/98 L
1688 Richard Avenue Santa Clara F 1,248 2,919 4,167 697 9/98 L
1700 Richard Avenue Santa Clara F 1,727 4,030 5,757 852 8/99 L
Morgan Hill Land Morgan Hill 25,543 - 25,543 - 3/07 -
Morgan Hill Land Morgan Hill 2,297 - 2,297 - 4/07 -
300 Montague Expressway Milpitas 2,609 2,499 5,108 42 4/07 L
337 Trade Zone Blvd Milpitas 2,264 2,168 4,432 36 4/07 L
324-368 Montague Expressway Milpitas 2,968 2,843 5,811 47 4/07 L
3506-3510 Bassett Street Santa Clara D 943 4,773 5,716 1,191 7/98 L
3540-3544 Bassett Street Santa Clara F,D 1,565 7,811 9,376 1,871 7/98 L
3550 Bassett Street Santa Clara F,D 1,079 5,284 6,363 1,284 7/98 L
3560 Bassett Street Santa Clara F,D 1,075 5,241 6,316 1,253 7/98 L
3570-3580 Bassett Street Santa Clara F,D 1,075 5,233 6,308 1,245 7/98 L
Prudential Mortgage Capital Co. F
Northwestern Mutual Life Ins. Co. G
Allianz Life Insurance Company H
----------- -------------- ------------ --------------
$312,152 $766,784 $1,078,936 $156,819
=========== ============== ============ ==============
(A) 16.67% of this property's ownership is held by unaffiliated parties outside
the operating partnerships of the Company.
(B) 25% of this property's ownership is held by unaffiliated parties outside
the operating partnerships of the Company.
(C) 50% of this property's ownership is held by an affiliated party since
September 2000.
(D) Part of the property group referred to as the Triangle Technology Park.
(E) Part of the property group referred to as the San Tomas Technology Park.
(F) Encumbered by the $112,543 Prudential Mortgage Capital Company loan - full
amount of loan shown at the bottom of the schedule.
(G) Encumbered by the $84,959 Northwestern Mutual Life Insurance Company loan -
full amount of loan shown at the bottom of the schedule.
(H) Encumbered by the $140,018 Allianz Life Insurance Company loan - full
amount of loan shown at the bottom of the schedule.
(I) Purchase price allocated to real estate related intangible assets pursuant
to SFAS 141 amounted to $18,284. Approximately $17,410 and $874 was fully
amortized in 2007 and 2005, respectively, and the asset cost and its
related accumulated amortization was removed from the accounts.
(J) Purchase price allocated to real estate related intangible assets pursuant
to SFAS 141 amounted to $1,367. The amount was fully amortized in 2004 and
the asset cost and its related accumulated amortization was removed from
the accounts.
(K) This property was sold in October 2005. The Company retained 32.5%, or
approximately 7.9 acres, of raw land.
(L) Depreciation is computed based on the following estimated lives:
1. Building shell and base building tenant improvements of newly acquired
properties are being depreciated on a weighted average composite
useful life of 40 years.
2. Real estate intangible assets allocated pursuant to SFAS 141 are being
amortized over the remaining life of the underlying leases.
3. Tenant improvements, furniture and fixtures are being depreciated over
their estimated useful lives ranging from 5 to 10 years.
(M) Purchase price allocated to real estate related intangible assets pursuant
to SFAS 141 amounted to $745. (N) Purchase price allocated to real estate
related intangible assets pursuant to SFAS 141 amounted to $1,374.
- 78 -
MISSION WEST PROPERTIES, INC.
NOTE TO SCHEDULE III
December 31, 2008, 2007 and 2006
(dollars in thousands)
1. Reconciliation of real estate and accumulated depreciation and
amortization:
2008 2007 2006
------------------------ ------------------------ -----------------------
Real estate investments:
Balance at beginning of year $1,078,936 $1,048,348 $1,057,800
Additions 42,157 58,972 20,304
Dispositions - (10,974) (29,756)
Reclassification 2,529 (17,410) -
------------------------ ------------------------ -----------------------
Balance at end of year $1,123,622 $1,078,936 $1,048,348
------------------------ ------------------------ -----------------------
Accumulated depreciation and amortization:
Balance at beginning of year $156,819 $149,459 $130,419
Additions 23,224 26,826 24,163
Dispositions - (2,056) (5,123)
Reclassification - (17,410) -
------------------------ ------------------------ -----------------------
Balance at end of year $180,043 $156,819 $149,459
------------------------ ------------------------ -----------------------
Net investments in real estate $943,579 $922,117 $898,889
======================== ======================== =======================
- 79 -
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure 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 (as
defined in Rule 13a-15(f) or Rule 15d-15(f) of the Securities Exchange Act of
1934). Based upon that evaluation, the Chief Executive Officer, President and
Vice President of Finance concluded that as of December 31, 2008 our disclosure
controls and procedures were effective such that the information required to be
disclosed in our reports filed with the Securities and Exchange Commission is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms such information is accumulated and communicated to
our management, including our Chief Executive Officer, President and Vice
President of Finance, as appropriate, to allow for timely decisions regarding
required disclosure.
(b) Management's Report on Internal Control over Financial Reporting
Management of Mission West Properties, Inc. is responsible for establishing and
maintaining adequate internal control over financial reporting as defined in
Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934.
Management assessed the effectiveness of Mission West Properties, Inc.'s
internal control over financial reporting as of December 31, 2008. Management
based this assessment on the criteria for effective internal control over
financial reporting established in Internal Control - Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO). Management's assessment included an evaluation of the design of Mission
West Properties, Inc.'s internal control over financial reporting and testing of
the operational effectiveness of its internal control over financial reporting.
Management reviewed the results of its assessment with the Audit Committee of
the Board of Directors. Based on this assessment, management determined that
Mission West Properties, Inc. maintained effective internal control over
financial reporting as of December 31, 2008.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect the possibility of human error, misstatements and the
circumvention or overriding of controls. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
Burr, Pilger & Mayer, LLP, our independent registered public accounting firm,
has audited our consolidated financial statements included in this Annual Report
on Form 10-K and has issued a report on the effectiveness of our internal
control over financial reporting.
(c) Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting during the
fourth fiscal quarter of 2008 that has materially affected, or is reasonably
likely to material affect, our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
None.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by Item 10 is incorporated by reference from the
sections titled "Management - Directors and Executive Officers," "Corporate
Governance" and "Code of Ethics" and "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Company's definitive proxy statement to be filed
with respect to the 2009 annual stockholders' meeting.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated by reference from the
section titled "Executive Compensation" in the Company's definitive proxy
statement to be filed with respect to the 2009 annual stockholders' meeting,
excluding, however, the sections titled "Executive Compensation - Performance
Graph" and "Executive Compensation - Report on Executive Compensation by the
Compensation Committee of the Board of Directors," none of which are
incorporated by reference in response to this item.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information required by Item 12 is incorporated by reference from the
sections titled "Share Ownership" and "Securities Authorized for Issuance Under
Equity Compensation Plans" in the Company's definitive proxy statement to be
filed with respect to the 2009 annual stockholders' meeting.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
The information required by Item 13 is incorporated by reference from the
sections titled "Certain Relationships and Related Transactions" and "Corporate
Governance" in the Company's definitive proxy statement to be filed with respect
to the 2009 annual stockholders' meeting.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by Item 14 is incorporated by reference from the
sections titled "Principal Accountant Fees and Services" in the Company's
definitive proxy statement to be filed with respect to the 2009 annual
stockholders' meeting.
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PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this report:
1. The consolidated financial statements are set forth in Item 8 of this
Annual Report on Form 10-K.
The following financial statement schedules should be read in
conjunction with the consolidated financial statements included in
Item 8 of this Annual Report on Form 10-K.
2. Schedule III - Real Estate and Accumulated Depreciation and
Amortization as of December 31, 2008 and 2007, which can be found on
pages 75 and 77, respectively.
3. The exhibits listed on the Exhibit Index either are filed with this
Annual Report on Form 10-K or have been filed previously with the SEC
and are incorporated by reference to those prior filings.
(b) The exhibits required by Item 601 of Regulation S-K, including each
management contract or compensatory plan or arrangement required to be
filed as an exhibit to this form are listed under Item 15(a)(3).
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SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
MISSION WEST PROPERTIES, INC.
Date: March 13, 2009 By: /s/ Carl E. Berg
-------------------------------
Carl E. Berg
Chief Executive Officer
(Principal Executive Officer)
Date: March 13, 2009 By: /s/ Wayne N. Pham
-------------------------------
Wayne N. Pham
Vice President of Finance and
Controller (Principal Financial
and Accounting Officer)
--------------------------------------------------------------------------------
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Carl E. Berg his true and lawful attorney-in-fact
with the power of substitution, to sign any amendments to this Report on Form
10-K and to file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that each of said attorney-in-fact, or his or her
substitute, may do or choose to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Signature Title Date
/s/ Carl E. Berg
------------------------------- Chairman of the Board, Chief
Carl E. Berg Executive Officer and Director March 13, 2009
/s/ William A. Hasler
-------------------------------
William A. Hasler Director March 13, 2009
/s/ Lawrence B. Helzel
-------------------------------
Lawrence B. Helzel Director March 13, 2009
/s/ Raymond V. Marino
------------------------------- President, Chief Operating Officer
Raymond V. Marino and Director March 13, 2009
/s/ Martin S. Roher
-------------------------------
Martin S. Roher Director March 13, 2009
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Exhibits required by Item 601 of Regulation S-K.
EXHIBIT INDEX
3.2.1 Articles of Amendment and Restatement of Mission West Properties, Inc. (1)
3.2.2 Amended and Restated Bylaws of Mission West Properties, Inc. as of December 18, 2007 (1a)
4.1 Description of Capital Stock (2)
4.1.1 Specimen Common Stock certificate (2)
10.1.1 Amended and Restated Agreement of Limited Partnership of Mission West Properties, L.P. (2b)
10.1.2 Amended and Restated Agreement of Limited Partnership of Mission West Properties, L.P. I (2b)
10.1.3 Amended and Restated Agreement of Limited Partnership of Mission West Properties, L.P. II (2b)
10.1.4 Amended and Restated Agreement of Limited Partnership of Mission West Properties, L.P. III (2b)
10.2 Exchange Rights Agreement between Mission West Properties and the Limited Partners(2b)
10.3.1* 1997 Stock Option Plan (3)
10.3.2* Form of Incentive Stock Option Agreement (1)
10.3.3* Form of Non-statutory Stock Option Agreement (1)
10.3.4* Form of Directors Stock Option Agreement (1)
10.4.1 Acquisition Agreement, dated as of May 14, 1998, among Mission West Properties, certain partnerships
and the Berg Group (as defined therein) (1)
10.4.2 Amendment of Acquisition Agreement, dated as of July 1, 1998 (1)
10.4.3 Form of Partnership Interest Purchase Demand Note (1)
10.5.1 Stock Purchase Agreement dated as of May 4, 1998, between Mission West Properties and the purchasers of
Common Stock in a private placement of 5,800,000 shares and Subscription Agreement relating to same (1)
10.5.2 Stock Purchase Agreement dated as of May 4, 1998 between Mission West Properties and the purchasers of Common
Stock in a private placement of 695,058 shares and Subscription Agreement relating to same (1)
10.5.3 Form of Registration Rights Agreement for purchasers, who acquired shares of Common Stock under the May 4,
1998 Stock Purchase Agreements (2c)
10.6 Pending Projects Acquisition Agreement among Mission West Properties, the Operating Partnership and the
Berg Group (2b)
10.7 Berg Land Holdings Option Agreement between Mission West Properties and certain members of the Berg Group(2b)
10.8 Berg & Berg Enterprises, Inc. Sublease Agreement (1)
10.9 Not in use
10.10 Not in use
10.11 Not in use
10.12 Lease Agreement with Apple Computer, Inc. (4a)
10.13 Not in use
10.14 Lease Agreement with Amdahl Corporation (4b)
10.15 Hartford Fixed Rate Term Loan Agreement ((5))
10.15.1 Hartford Life Insurance Company Promissory Note ((5))
10.15.2 Hartford Life and Annuity Insurance Company Promissory Note ((5))
10.15.3 Hartford Life and Accident Insurance Company Promissory Note ((5))
10.15.4 Hartford-Mission West Properties, L.P. (Santa Clara) Deed of Trust, Security Agreement and Fixture
Filing (5)
10.15.5 Hartford-Mission West Properties, L.P. (Alameda) Deed of Trust, Security Agreement and Fixture Filing (5)
10.15.6 Hartford-Mission West Properties, L.P. I Deed of Trust, Security Agreement and Fixture Filing ((5))
10.15.7 Hartford-Mission West Properties, L.P. II Deed of Trust, Security Agreement and Fixture Filing ((5))
10.15.8 Hartford-Mission West Properties, L.P. III Deed of Trust, Security Agreement and Fixture Filing ((5))
10.15.9 Hartford Carveout Indemnity Agreement (5)
10.15.10 Hartford Environmental Indemnity Agreement (5)
10.19 Waiver Agreement (6)
10.20 Ownership Limit Exemption Agreement dated December 29, 1998 between Mission West Properties and Dan and
Paul McCarthy (7)
10.21 Lease Agreement with Microsoft Corporation, dated July 25, 1998 (8)
10.21.1 Lease Agreement with Microsoft Corporation, dated December 23, 2004 (8a)
10.22 Contribution Agreement (8)
10.23 Not in use
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10.24 Not in use
10.25 Not in use
10.26 Supplemental Agreement among Mission West Properties, Inc., Carl E. Berg and Clyde J. Berg (9)
10.27 Berg Group Revolving Credit - $100,000,000 Secured Promissory Note (10) (Terminated)
10.27.1 Third Amendment to Berg Group $100,000,000 Revolving Line of Credit (11) (Terminated)
10.28 Berg Group Deed of Trust Securing Revolving Promissory Note (12)
10.29 Not in use
10.30 Mission West Properties, LP Continuing Guaranty (13)
10.31 Mission West Properties, LP II Continuing Guaranty (13)
10.32 Mission West Properties, L.P. Promissory Note to Northwestern Mutual Life Insurance Company (13)
10.32.1 Mission West Properties, L.P. First Amendment to Promissory Note to Northwestern Mutual Life Insurance
Company
10.33 Mission West Properties, L.P. I Promissory Note to Northwestern Mutual Life Insurance Company (13)
10.33.1 Mission West Properties, L.P. I First Amendment to Promissory Note to Northwestern Mutual Life Insurance
Company
10.34 Mission West Properties, L.P. II Promissory Note to Northwestern Mutual Life Insurance Company (13)
10.34.1 Mission West Properties, L.P. II First Amendment to Promissory Note to Northwestern Mutual Life Insurance
Company
10.35 Mission West Properties, L.P. Deed of Trust and Security Agreement (First Priority) (13)
10.36 Mission West Properties, L.P. Deed of Trust and Security Agreement (Second Priority) (13)
10.36.1 Mission West Properties, L.P. First Amendment to Deed of Trust and Security Agreement
10.37 Mission West Properties, L.P. I Deed of Trust and Security Agreement (First Priority) (13)
10.38 Mission West Properties, L.P. I Deed of Trust and Security Agreement (Second Priority) (13)
10.38.1 Mission West Properties, L.P. I First Amendment to Deed of Trust and Security Agreement
10.39 Mission West Properties, L.P. II Deed of Trust and Security Agreement (First Priority) (13)
10.40 Mission West Properties, L.P. II Deed of Trust and Security Agreement (Second Priority) (13)
10.40.1 Mission West Properties, L.P. II First Amendment to Deed of Trust and Security Agreement
10.41 Mission West Properties, L.P. Absolute Assignment of Leases and Rents (First Priority) (13)
10.42 Mission West Properties, L.P. I Absolute Assignment of Leases and Rents (First Priority) (13)
10.43 Mission West Properties, L.P. II Absolute Assignment of Leases and Rents (First Priority) (13)
10.44 Mission West Properties L.P., L.P. I and L.P. II First Amendment to Contribution and Reimbursement Agreement
10.45 Not in use
10.46* 2004 Equity Incentive Plan (14)
10.47 Allianz Loan Secured Installment Note (15)
10.48 Allianz Loan Deed of Trust, Security Agreement, Fixture Filing with Absolute Assignment of Rents(15)
10.49 Allianz Loan Limited Guaranty (15)
10.50* Form of Non-statutory Stock Option Agreement with Dividend Rights under 2004 Equity Incentive Plan (15)
10.51 Allianz Loan II Secured Installment Note (16)
10.52 Allianz Loan II Deed of Trust, Security Agreement, Fixture Filing with Absolute Assignment of Rents (16)
10.53 Allianz Loan II Limited Guaranty (16)
10.54 Allianz Loan II Loan Modification Agreement(16)
10.55 Allianz Loan II Loan Modification Agreement and Amendment of Deed of Trust
21.1 Subsidiaries of the Registrant (17)
23.1 Consent of Independent Registered Public Accounting Firm
24.1 Powers of Attorney (included on the signature page hereto)
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
31.2 Certification of Chief Operating Officer pursuant to Rule 13a-14(a)
31.3 Certification of Chief Financial Officer pursuant to Rule 13a-14(a)
32.1 Certificate Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
*Management contract or compensatory plan or arrangement
(1) Incorporated herein by reference to the same-numbered exhibit to the
Company's Registration Statement on Form S-4/A filed on July 20, 1998 and
declared effective on November 23, 1998 (Commission File No. 333-52835-99).
(1a) Incorporated herein by reference to Exhibit 3.2 to the current report on
Form 8-K filed December 20, 2007
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(Commission File No. 000-25235).
(2) Incorporated herein by reference to the registration statement on Form
8-A/A filed March 21, 2008 (Commission File No. 001-34000).
(2a) Incorporated herein by reference to the same numbered exhibit to the
registration statement on Form 8-A/A filed March 21, 2008 (Commission File
No. 001-34000).
(2b) Incorporated herein by reference to the same-numbered exhibit to the
Company's Post-effective Amendment No. 1 to Registration Statement on Form
S-4 filed on Form S-3 on February 11, 1999 (Commission File No.
333-52835-99).
(2c) Incorporated herein by reference to Exhibit 10.8 to the Company's
Post-effective Amendment No. 1 to Registration Statement on Form S-4 filed
on Form S-3 on February 11, 1999 (Commission File No. 333-52835-99).
(3) Incorporated herein by reference to Exhibit E to the Company's Schedule 14A
Proxy Statement filed with the Securities and Exchange Commission on
October 21, 1997 (Commission File No. 001-08383).
(4a) Incorporated herein by reference to Exhibit 10.15 to the Company's
Registration Statement on Form S-4/A filed on June 17, 1998 and declared
effective on November 23, 1998 (Commission File No. 333-52835).
(4b) Incorporated herein by reference to Exhibit 10.17 to the Company's
Registration Statement on Form S-4/A filed on June 17, 1998 and declared
effective on November 23, 1998 (Commission File No. 333-52835).
(5) Incorporated herein by reference to the same-numbered exhibit to current
report on Form 8-K filed on October 7, 2008 (Commission File No.
001-34000).
(6) Incorporated herein by reference to the same-numbered exhibit to the
Registration Statement on Form S-4/A filed on November 16, 1998 and
declared effective on November 23, 1998 (Commission File No. 333-52835-99).
(7) Incorporated herein by reference to the same numbered exhibit to the annual
report on Form 10-K for 1998 filed on March 31, 1999 (Commission File No.
000-25235).
(8) Incorporated herein by reference to the same-numbered exhibit to current
report on Form 8-K filed on May 14, 1999 (Commission File No. 000-25235).
(8a) Incorporated herein by reference to the same-numbered exhibit to the
quarterly report on Form 10-Q filed on May 10, 2005 (Commission File No.
000-25235).
(9) Incorporated herein by reference to the same-numbered exhibit to the
Registration Statement on Form S-11/A filed on June 15, 1999 (Commission
File No. 333-80203).
(10) Incorporated herein by reference to the same-numbered exhibit to the
quarterly report on Form 10-Q filed on November 13, 2001 (Commission File
No. 000-25235).
(11) Incorporated herein by reference to the same-numbered exhibit to the
quarterly report on Form 10-Q filed on August 12, 2003 (Commission File No.
000-25235).
(12) Incorporated herein by reference to the same numbered exhibit to the annual
report on Form 10-K for 1999 filed on March 30, 2000 (Commission File No.
000-25235).
(13) Incorporated herein by reference to the same-numbered exhibit to the annual
report on Form 10-K for 2002 filed on March 27, 2003 (Commission File No.
000-25235).
(14) Incorporated herein by reference to Appendix II to the Company's Schedule
14A Proxy Statement filed with the Securities and Exchange Commission on
October 22, 2004 (Commission File No. 000-25235).
(15) Incorporated herein by reference to the same-numbered exhibit to the
quarterly report on Form 10-Q filed on May 10, 2005 (Commission File No.
000-25235).
(16) Incorporated herein by reference to the same-numbered exhibit to the
quarterly report on Form 10-Q filed on August 9, 2005 (Commission File No.
000-25235).
(17) Incorporated herein by reference to the same-numbered exhibit to the annual
report on Form 10-K for 1998 filed on March 31, 1999 (Commission File No.
000-25235).
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