SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------ FORM 10-Q Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended August 31, 1995 Commission File Number 1-8383 MISSION WEST PROPERTIES Incorporated in California IRS Employer Identification Number: 95-2635431 Principal Executive Offices: Telephone: (619) 450-3135 6815 Flanders Drive, Suite 250 San Diego, California 92121-3914 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 [_] The number of shares of the Registrant's common stock outstanding as of August 31, 1995 was 1,368,721. PART I FINANCIAL INFORMATION Item 1. Quarterly Financial Statements - ---------------------------------------- Following are three-month third quarter and nine-month year-to-date (as applicable) fiscal year 1995 consolidated financial statements (unaudited) and accompanying notes (unaudited). - 2 - MISSION WEST PROPERTIES Consolidated Balance Sheets (Unaudited) August 31 November 30 ASSETS 1995 1994 ------ ------------ ----------- Cash and cash equivalents (Note 2) $ 1,466,000 $ 2,192,000 Short-term investments (Note 3) 2,154,000 2,719,000 Real estate investments: Rental Properties, less accumulated depreciation of $8,713,000 in 1995 and $7,702,000 in 1994 ($45,972,000 pledged in 1995 and $47,428,000 in 1994) 47,470,000 48,887,000 Unimproved land ($461,000 pledged in 1995 and 1994) 725,000 725,000 ----------- ----------- 48,195,000 49,612,000 Less allowance for estimated losses (4,413,000) (4,413,000) ----------- ----------- Net real estate investments 43,782,000 45,199,000 Other assets, less allowances of $1,547,000 in 1995 and $2,694,000 in 1994 and accumulated depreciation of $310,000 in 1995 and $304,000 in 1994 1,135,000 853,000 ----------- ----------- $48,537,000 $50,963,000 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ Notes payable (Note 4) $32,977,000 $34,382,000 Accounts payable and accrued expenses 1,531,000 1,861,000 ----------- ----------- Total liabilities 34,508,000 36,243,000 ----------- ----------- Commitments and contingencies (Note 5) Shareholders' equity: Common stock, no par value, 10,000,000 shares authorized; 1,368,721 shares issued and outstanding (1,468,721 in 1994) (Note 2) 19,446,000 20,081,000 Accumulated deficit (5,417,000) (5,361,000) ----------- ----------- Total shareholders' equity 14,029,000 14,720,000 ----------- ----------- $48,537,000 $50,963,000 =========== =========== See accompanying notes to consolidated financial statements. - 3 - MISSION WEST PROPERTIES Consolidated Statements of Operations (Unaudited) Three Months Ended Nine Months Ended ------------------------- ------------------------ August 31 August 31 August 31 August 31 1995 1994 1995 1994 ----------- ----------- ----------- ---------- REVENUES: Rental revenues from real estate $1,801,000 $1,550,000 $5,320,000 $4,816,000 Sales of real estate 28,000 63,000 125,000 1,691,000 Other, including interest 96,000 204,000 282,000 389,000 ---------- ---------- ---------- ---------- 1,925,000 1,817,000 5,727,000 6,896,000 ---------- ---------- ---------- ---------- EXPENSES: Operating expenses of real estate 659,000 567,000 1,435,000 1,672,000 Depreciation of real estate 334,000 339,000 1,011,000 1,091,000 Costs of real estate sold 3,000 7,000 13,000 188,000 General and administrative 231,000 312,000 701,000 870,000 Interest 876,000 807,000 2,663,000 2,249,000 ---------- ---------- ---------- ---------- 2,103,000 2,032,000 5,823,000 6,070,000 ---------- ---------- ---------- ---------- Income (loss) before income taxes and cumulative effect of change in accounting (178,000) (215,000) (96,000) 826,000 Provision for (benefit from) income taxes (70,000) (54,000) (40,000) 364,000 ---------- ---------- ---------- ---------- Income (loss) before cumulative effect of change in accounting (108,000) (161,000) (56,000) 462,000 Cumulative effect on prior years of change in accounting for income taxes (Note 6) - - - 440,000 ---------- ---------- ---------- ---------- NET INCOME (LOSS) $ (108,000) $ (161,000) $ (56,000) $ 902,000 ========== ========== ========== ========== PER SHARE (Note 7): Income (loss) before cumulative effect of change in accounting $ (0.08) $ (0.11) $ (0.04) $ 0.31 Cumulative effect on prior years of change in accounting for income taxes - - - 0.30 ------- ------- ------- ------ Net income (loss) $ (0.08) $ (0.11) $ (0.04) $ 0.61 ======= ======= ======= ====== See accompanying notes to consolidated financial statements. - 4- MISSION WEST PROPERTIES Consolidated Statements of Cash Flows (Unaudited) Nine Months Ended --------------------------- August 31 August 31 1995 1994 ------------ ------------ Cash flows from operating activities: Net income (loss) $ (56,000) $ 902,000 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation 1,016,000 1,095,000 Cumulative effect of change in accounting for income taxes - (440,000) Compensation expense of stock options - 82,000 Changes in assets and liabilities: Increase in net real estate investments (229,000) (448,000) Decrease (increase) in other assets (287,000) 557,000 Increase (decrease) in accounts payable and accrued expenses (330,000) 97,000 Decrease in deferred income taxes - (342,000) ----------- ----------- Net cash provided by operating activities 114,000 1,503,000 ----------- ----------- Cash flows from investing activities: Net redemptions (purchases) of short-term investments 565,000 (717,000) ----------- ----------- Net cash provided by (used for) investing activities 565,000 (717,000) ----------- ----------- Cash flows from financing activities: Repayments on notes payable (1,405,000) (1,291,000) ----------- ----------- Net cash used for financing activities (1,405,000) (1,291,000) ----------- ----------- Net decrease in cash and cash equivalents (726,000) (505,000) Cash and cash equivalents at beginning of period 2,192,000 806,000 ----------- ----------- Cash and cash equivalents at end of period (Note 2) $ 1,466,000 $ 301,000 =========== =========== See accompanying notes to consolidated financial statements. - 5 - MISSION WEST PROPERTIES Notes to Consolidated Financial Statements (Unaudited) August 31, 1995 NOTE 1 -- BASIS OF PRESENTATION The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and, therefore, do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. The operating results for the interim period are not necessarily indicative of the results to be expected for a full fiscal year. In the opinion of Management, the information furnished herein reflects all adjustments, consisting only of normal recurring accruals, that are necessary for a fair presentation of results for the unaudited interim period. NOTE 2 -- CASH FLOW INFORMATION For purposes of reporting cash flows, cash and cash equivalents include cash on hand, money market funds, certificates of deposit, and obligations of the U.S. Treasury with an original maturity of 90 days or less. Short-term investments consist of certificates of deposit and obligations of the U.S. Treasury with an original maturity exceeding 90 days. Cash paid during the nine months ended August 31 for interest was $2,656,000 in 1995 and $2,272,000 in 1994. Cash paid for income taxes during the nine-month periods was $236,000 in 1995 and $481,000 in 1994. During the first quarter of fiscal 1995, in a noncash transaction, the Company reacquired and retired 100,000 shares of its common stock and transferred an equal value of real estate assets, consisting of certain tenant improvements, to an affiliated tenant. NOTE 3 -- SHORT-TERM INVESTMENTS Effective December 1, 1994, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities," which requires that investments be classified as either held-to-maturity, trading, or available-for-sale. Held-to-maturity investments are carried at amortized costs; unrealized gains and losses are included in earnings for trading investments and are recorded directly to shareholders' equity for available-for-sale investments. Management determines the classification of investments at the time of purchase; the Company's short- term investments are classified as held-to-maturity and are carried at their amortized costs. Adoption of SFAS No. 115 had no effect on the Company's financial position or results of operations. NOTE 4 -- NOTES PAYABLE Notes payable comprise the following: August 31 November 30 1995 1994 ----------- ----------- Secured notes payable to banks, due 1996 through 1998, interest rates $31,452,000 $32,532,000 ranging from 9.75% (prime plus 1%) to 10.75% (prime plus 2%), principal and interest due in monthly installments of $348,000, balance of principal due at maturity Unsecured note payable to bank, due 1996, interest rate of 10.25% (prime - 250,000 plus 1.5%), interest only due monthly, principal due at maturity Secured note payable to insurance company, due 1997, interest rate of 10%, principal and interest due in monthly installments of $21,000 1,525,000 1,600,000 ----------- ----------- $32,977,000 $34,382,000 =========== =========== - 6 - Notes to Consolidated Financial Statements, continued - ----------------------------------------------------- NOTE 5 -- COMMITMENTS AND CONTINGENCIES As disclosed in the second quarter fiscal 1995 Form 10-Q, the Company has been named as one of 50 defendants in a civil claim for an unspecified amount of damages by residents in Kennedy Heights and certain nearby residential developments, all of which are located in Houston, Texas. No significant developments have occurred with respect to this claim during the third quarter. The matter is currently in its discovery stage; the Company intends to defend its position vigorously and pursue any and all appropriate defenses and remedies. NOTE 6 -- INCOME TAXES The Company adopted SFAS No. 109, "Accounting for Income Taxes," on a prospective basis, effective December 1, 1993, the beginning of its fiscal year. SFAS No. 109 required a change from the deferral method to the asset and liability method of accounting for income taxes. The asset and liability approach requires recognition of deferred tax assets and liabilities for "temporary differences" between the financial statement carrying amounts and the tax basis of assets and liabilities, at currently enacted tax rates (the Company had no significant permanent differences). The cumulative effect of the change in the method of accounting, which resulted in a $440,000 increase in net income, was reported in the consolidated statements of operations for the first quarter of fiscal 1994. NOTE 7 -- NET INCOME (LOSS) PER SHARE Net income (loss) per share, and the cumulative effect on prior years of change in accounting for income taxes per share, is based on 1,368,721 and 1,468,721 shares for the quarters ended August 31, and 1,401,203 and 1,468,721 for the nine months ended August 31, the weighted average number of shares outstanding during the periods presented for fiscal years 1995 and 1994, respectively. The effect of stock options is either antidilutive or not significant; such effect is not reflected in the per share computations. - 7 - Item 2. Management's Discussion and Analysis of Financial Condition and Results - -------------------------------------------------------------------------------- of Operations ------------- RESULTS OF OPERATIONS: Third Quarter Fiscal 1995 Compared to Third Quarter Fiscal 1994 - --------------------------------------------------------------- Compared to the third quarter of fiscal 1994, the Company's rental revenues from real estate increased $251,000, or 16 percent, in 1995; the related operating expenses of real estate increased $92,000, or 16 percent. The increase in rental revenue resulted from the effects of the $5,200,000 in adjustments recorded during the fourth quarter of fiscal 1994 to real estate investments and other assets (reduces charges in fiscal 1995). The increase in operating expenses resulted from an increase in building repairs/reconditioning and property taxes (Arizona), offset by decreases in bad debt expenses and lease commission amortization (additional effect of 1994 adjustment) and refunds of prior year property taxes (successful assessment appeals). Other revenue decreased $108,000 during the third quarter of fiscal 1995 compared to the third quarter of fiscal 1994. This reduction resulted from nonrecurring excess leasehold improvement reimbursements that were recorded in fiscal 1994. During the third quarter fiscal 1995 compared to fiscal 1994, general and administrative expenses decreased $81,000 due to nonrecurring outside consultant fees recorded in fiscal 1994. Interest expense increased $69,000 between quarters as a result of increases in prime lending rates (interest on most of the Company's notes is variable), offset by a $1,670,000 reduction in outstanding notes payable. Prime rates averaged 8.83 percent during the third quarter of fiscal 1995 compared to 7.33 percent during the third quarter of fiscal 1994. First Nine Months Fiscal 1995 Compared to First Nine Months Fiscal 1994 - ----------------------------------------------------------------------- During the nine months ended August 31, 1995, compared to 1994, rental revenues from real estate increased $504,000, or ten percent, and the related operating expenses of real estate decreased $237,000, or 14 percent. These improvements were the result of the effects of the $5,200,000 in adjustments recorded during the fourth quarter of fiscal 1994 to real estate investments and other assets (reduces amortized expenses in fiscal 1995), a reduction in bad debt expenses, and refunds of prior year property taxes. Offsetting these improvements was an increase in repair/reconditioning expense. For the nine-month periods, sales of real estate decreased $1,566,000. During the first quarter of fiscal 1994, the Company recorded $1,500,000 in sales of real estate as a result of settling litigation related to property sold by the Company in 1986. The related costs of real estate sold consists of legal costs and distributions in accordance with the Company's Management Incentive Plan. Interest expense is $414,000 higher and general and administrative expenses are $169,000 lower in 1995 than 1994, the result of factors previously detailed in the third quarter results of operations discussion above. As discussed in Note 6 to the Consolidated Financial Statements, the Company adopted SFAS No. 109 effective December 1, 1993. This required change in accounting for income taxes resulted in a $440,000 cumulative effect, directly increasing net income for the nine months ended August 31, 1994. CHANGES IN FINANCIAL POSITION: August 31, 1995 Compared to November 30, 1994 - --------------------------------------------- During the first nine months of fiscal 1995, cash and investments decreased $1,291,000. These funds were used primarily for debt service ($1,405,000 in principal amortization and paydowns), tenant improvements, and income taxes. During the first quarter of fiscal 1995, the Company reacquired 100,000 shares of its common stock from its majority owner; the shares were retired. The Company transferred real estate assets, consisting of certain tenant improvements, to an affiliated tenant in consideration for reacquiring the shares. - 8 - Management's Discussion and Analysis of Financial Condition and Results of - -------------------------------------------------------------------------- Operations, continued - --------------------- LIQUIDITY AND CAPITAL RESOURCES: The Company's rental properties continue to generate sufficient rental revenue to cover real estate operating expenses and interest; they generate cash, after normal debt service (interest and principal amortization), and contribute to overhead, lease commission, and tenant improvement expenditures The rental properties currently are, in aggregate, 90 percent leased. Historically, the Company has experienced significant net income and cash increases in the years properties were sold and has experienced losses and cash decreases in the years where no property sales occurred. The occurrences of major property sales depends on several factors, including prevailing market conditions and available financing for potential purchasers. In November 1994, the Company announced it had entered into an agreement to sell all its rental properties. In January 1995, the Company announced it had signed the Definitive Agreement for this sale, subject to completion of standard due diligence, satisfaction of regulatory requirements, and approval by the Company's shareholders. This proposed sale transaction was terminated effective February 3, 1995. Since the termination, management has concentrated on operating the Company, has considered its future strategic course, and intends to pursue all viable growth or other opportunities. The Company currently has no projects under development and none planned. The only capital expenditures anticipated are interior tenant improvements to existing buildings, which may be required as new tenants are obtained or existing leases extended. The need for additional capital financing in the future will depend primarily on the number and size of new projects undertaken, if any. The Company's notes payable continue to be amortized monthly. During the past 18 months, as prime lending rates have increased from six percent to 8.75 percent, the Company has experienced increased interest expense (interest on most of the Company's notes payable is variable). Management is in the process of restructuring certain of the Company's notes payable; this restructure may result in an additional principal reduction of as much as $1 million during the fourth quarter of fiscal 1995. In exchange for the principal reduction, the Company is anticipating a reduced interest rate on the notes and an extension of maturities, among other terms. A majority of the leases between the Company and its tenants have terms from one to five years. Management devotes a significant amount of time to renewing leases with existing tenants and replacing tenants that vacate at lease maturity (or sooner in the case of tenant business failures). Because economic trends in recent years have placed downward pressure on market rental rates, management believes leases may continue to be renewed or replaced at lower rental rates than those of currently existing leases. PART II OTHER INFORMATION Item 1. Legal Proceedings - -------------------------- As disclosed in the second quarter fiscal 1995 Form 10-Q, the Company has been named as one of 50 defendants in a civil claim for an unspecified amount of damages by residents in Kennedy Heights and certain nearby residential developments, all of which are located in Houston, Texas. No significant developments have occurred with respect to this claim during the third quarter. The matter is currently in its discovery stage; the Company intends to defend its position vigorously and pursue any and all appropriate defenses and remedies. During the quarter ended August 31, 1995, the Company was also party to other lawsuits and legal claims arising out of its ordinary course of business. In the opinion of management, resolution of these other legal matters will not have a material adverse impact on the Company. - 9 - Item 2. Changes in Securities - ------------------------------ No changes in the rights of the Company's securities occurred during the quarter ended August 31, 1995. Item 3. Defaults Upon Senior Securities - ---------------------------------------- Not applicable. Item 4. Submission of Matters to a Vote of Security Holders - ------------------------------------------------------------ No matters were submitted to a vote of the Company's shareholders during the quarter ended August 31, 1995. Item 5. Other Information - -------------------------- Not applicable. Item 6. Exhibits and Reports on Form 8-K - ----------------------------------------- (a) Exhibits -------- (27) Financial Data Schedule (b) Reports on Form 8-K ------------------- No reports on Form 8-K were filed during the quarter ended August 31, 1995. SIGNATURE Pursuant to the requirements of section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Quarterly Report to be signed on its behalf by the undersigned, thereunto duly authorized. MISSION WEST PROPERTIES - ----------------------- Registrant By: /s/ Katrina L. Thompson --------------------------------------- Katrina L. Thompson Chief Financial Officer & Secretary (Principal Financial and Accounting Officer) September 28, 1995 - 10 -