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, 2006
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
------------------ ----------
(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 American Stock Exchange
value per share
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, 2006, the aggregate market value of the Registrant's common
stock held by non-affiliates of the registrant was $214,311,432 based on the
closing price as reported on the American Stock Exchange.
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, 2007
- --------------------------------------- --------------------------------
Common Stock, $.001 par value per share 19,625,587 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's proxy statement to be delivered to stockholders in
connection with the Registrant's 2007 Annual Meeting of Stockholders to be held
on May 17, 2007 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 of the Company
include, but are not limited to, changes in: economic conditions generally and
the real estate market specifically, legislative or regulatory provisions
affecting the Company (including changes to laws governing the taxation of Real
Estate Investment Trusts ("REITs")), availability of capital, interest rates,
competition, supply of and demand for office and industrial properties in our
current and proposed market areas, tenant defaults and bankruptcies, and general
accounting principles, policies and guidelines applicable to REITs. In addition,
the actual timing of development, construction, and leasing on the projects that
the Company believes it may acquire in the future under the Berg Land Holdings
Option Agreement is unknown presently. These risks and uncertainties, together
with the other risks described from time to time in our reports and documents
filed with the Securities and Exchange Commission, should be considered in
evaluating forward-looking statements and undue reliance should not be placed on
such statements (see Item 1A, "Risk Factors").
- i -
MISSION WEST PROPERTIES, INC.
2006 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 41
Item 8. Financial Statements and Supplementary Data 42
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 81
Item 9A. Controls and Procedures 81
Item 9B. Other Information 81
PART III
Item 10. Directors, Executive Officers and Corporate Governance 82
Item 11. Executive Compensation 82
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters 82
Item 13. Certain Relationships and Related Transactions, and Director Independence 82
Item 14. Principal Accountant Fees and Services 82
PART IV
Item 15. Exhibits and Financial Statement Schedules 83
Signatures 84
Rule 13a-14(a) Certifications 90
Section 1350 Certifications 93
- 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, 2006,
we owned and managed 107 properties totaling approximately 7.7 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 four tenants who individually lease in excess of 300,000
rentable square feet from us: Microsoft Corporation, Apple Computer, Inc., NEC
Electronics America, Inc. (a subsidiary of NEC Electronics Corporation) and
Ciena Corporation. For federal income tax purposes we have operated as a
self-managed, self-administered and fully integrated Real Estate Investment
Trust ("REIT") since fiscal 1999.
Prior to July 1, 1998, most of our properties were under the ownership or
control of Carl E. Berg, his brother Clyde J. Berg, certain members of their
respective immediate families, and certain entities in which Carl E. Berg and/or
Clyde J. Berg held controlling or other ownership interests (the "Berg Group").
We acquired these properties as of July 1, 1998 by becoming the general partner
of each of the four operating partnerships in an UPREIT transaction. At that
time, we also acquired ten properties comprising approximately 560,000 rentable
square feet from entities controlled by third parties in which the Berg Group
members were significant owners.
Through various property acquisition agreements with the Berg Group and subject
to the approval of the Independent Directors Committee of the Board of
Directors, we have the right to purchase, on pre-negotiated terms, R&D and other
types of office and light industrial properties that the Berg Group develops in
the future. With in-house development, architectural and construction personnel,
the Berg Group continues to focus on a full range of land acquisition,
development and construction activities for R&D properties, often build-to-suit,
to meet the demands of Silicon Valley information technology companies. As the
developer, the Berg Group takes on the risks of purchasing the land, obtaining
regulatory approvals and permits and financing construction. Since September
1998, we have acquired approximately 3,177,000 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 Exchange Rights
Agreement and the Berg Land Holdings Option Agreement. Each agreement defines
the material rights and obligations among us, the Berg Group members, and other
parties to those agreements. Among other things, these agreements give us rights
to:
- - control the operating partnerships;
- - acquire, subject to approval of the Independent Directors Committee of the
Board of Directors, on pre-negotiated terms, all future R&D properties
developed by the Berg Group on land currently owned or acquired in the
future; and
- - acquire R&D, office and industrial properties identified by the Berg Group
in California, Oregon and Washington, subject to approval of the
Independent Directors Committee of the Board of Directors.
- 1 -
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 less than 1% of the outstanding shares of our common stock.
Carl E. Berg, the Company's Chairman of the Board of Directors and Chief
Executive Officer and the controlling member of the Berg Group, has been engaged
in the development and long-term ownership of Silicon Valley real estate for
more than 35 years, most recently through Berg & Berg Enterprises ("Berg &
Berg"). In 1969, Mr. Berg foresaw the rising demand for efficient, multi-purpose
facilities for the rapidly growing information technology industry in the
Silicon Valley. Since 1972, in addition to his real estate activities, Mr. Berg
also has been actively involved in venture capital investments in many
information technology companies in the Silicon Valley, including such companies
as Amdahl Corporation, Sun Microsystems, Inc., and Integrated Device
Technologies, Inc. He serves on the board of directors of numerous information
technology companies. These activities have helped Mr. Berg develop a detailed
understanding of the real estate requirements of information technology
companies, acquire valuable market information and increase his name recognition
within the venture capital and entrepreneurial communities. These activities
also manifest his commitment to the growth and success of Silicon Valley
companies. We believe that Mr. Berg's substantial knowledge of and contacts in
the information technology industry provide a significant benefit to the
Company.
BUSINESS STRATEGY
Our acquisition, growth and operating strategy incorporates the following
elements:
- - working with the Berg Group to take advantage of their abilities and
resources to pursue development opportunities which we have an option to
acquire, on pre-negotiated terms, upon completion and leasing;
- - capitalizing on opportunistic acquisitions from third parties of
high-quality R&D properties that provide attractive initial yields and
significant potential for growth in cash-flow;
- - focusing on general purpose, single-tenant Silicon Valley R&D properties
for information technology companies in order to maintain low operating
costs, reduce tenant turnover and capitalize on our relationships with
these companies and our extensive knowledge of their real estate needs; and
- - maintaining prudent financial management principles that emphasize current
cash flow while building long-term value, the acquisition of pre-leased
properties to reduce development and leasing risks and the maintenance of
sufficient liquidity to acquire and finance properties on desirable terms.
ACQUIRING PROPERTIES DEVELOPED BY THE BERG GROUP
We anticipate that most of our growth, if any, in rentable square footage in the
foreseeable future will come from the acquisition of new R&D properties that are
either currently under development or to be developed in the future by the Berg
Group. The Berg Land Holdings Option Agreement gives us the right to acquire
future R&D property developments by the Berg Group on up to 84 additional acres
of land currently controlled by the Berg Group, which could support
approximately 1.4 million square feet of new development. Nevertheless, at this
time we do not anticipate acquiring any additional newly constructed R&D
properties from the Berg Group for several years because of the current market
conditions in the Silicon Valley.
In light of the overcapacity in the Silicon Valley R&D properties market, the
Berg Group currently is seeking local government approval of a proposed rezoning
of the 160-acre Evergreen site to permit residential development on a
substantial portion of the site. The Independent Directors Committee, which is
responsible for reviewing, evaluating and authorizing action with respect to any
transaction between us and any member of the Berg Group, has authorized removal
of the Evergreen site from the scope of the Berg Land Holdings Option Agreement,
subject to the completion of the rezoning of the 160-acre Evergreen site, or
portion thereof, for residential development. In making this determination, the
Independent Directors Committee considered a number of factors, including risks
and other potentially adverse consequences that could be associated with large
scale residential development activities. Any portion of the Evergreen site that
is not rezoned as residential property is not deemed to be removed from the
scope of the agreement and would remain eligible for potential future
acquisition by the Company under the Berg Land Holdings Option Agreement.
- 2 -
In April 2005, the Berg Group disclosed the receipt of an offer from an
unrelated party to purchase a portion of the Piercy & Hellyer land comprised of
approximately 10 acres in San Jose, California that is subject to the Berg Land
Holdings Option Agreement with us. The prospective purchaser disclosed its
intention to develop "for sale" industrial type buildings and 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, authorized removal of this approximately 10-acre parcel of land
from the scope of the Berg Land Holdings Option Agreement, subject to the
completion of the sale to the unrelated party. The Independent Directors
Committee's approval also included a requirement that in the event this parcel
of land is not sold to this prospective purchaser, the parcel would not be
deemed to be removed from the scope of the agreement and would remain eligible
for potential future acquisition by the Company under the Berg Land Holdings
Option Agreement. In the third quarter of 2006, the Berg Group informed us that
the prospective purchaser withdrew its offer, and therefore, this land remains
subject to Berg Land Holdings Option Agreement.
BERG LAND HOLDINGS OPTION AGREEMENT. We believe that control of high quality,
developable land is an important strategic factor for continued success in the
Silicon Valley market. In December 1998, we entered into the Berg Land Holdings
Option Agreement under which we have an option to purchase all land acquired,
directly or indirectly, by Carl E. Berg or Clyde J. Berg that has not been
improved with completed buildings and which is zoned, intended or appropriate
for R&D, office and/or industrial development or use in the states of
California, Oregon and Washington. In addition, Carl E. Berg has agreed not to
directly or indirectly acquire or develop any real property zoned for office,
industrial or R&D use in the states of California, Oregon and Washington without
first disclosing and making the acquisition opportunity available to us. 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 of December 31, 2006, we had acquired 21 leased R&D properties totaling
approximately 2,034,000 rentable square feet under this agreement at a cost of
approximately $207.8 million, for which we issued 7,933,849 O.P. Units and
assumed debt of approximately $118 million. The principal terms of the agreement
include the following:
- - So long as the Berg Group members and their affiliates own or have the
right to acquire shares representing at least 65% of our common stock on a
Fully Diluted basis, we will have the option to acquire any building
developed by any member of the Berg Group on the land subject to the Berg
Land Holdings Option Agreement at such time as the building has been
leased. Upon our exercise of the option, the option price will equal the
sum of the following or a lesser amount as approved by the Independent
Directors Committee:
1. the full construction cost of the building; plus
2. 10% of the full construction cost of the building; plus
3. interest at LIBOR plus 1.65%, on the amount of the full construction
cost of the building for the period from the date funds were disbursed
by the developer to the close of escrow; plus
4. the original acquisition cost of the parcel on which the improvements
will be constructed, which range from $8.50 to $20.00 per square foot
for land currently owned or under option; plus
5. 10% per annum of the amount of the original acquisition cost of the
parcel from the later of January 1, 1998 and the seller's acquisition
date, to the close of escrow; minus
6. the aggregate principal amount of all debt encumbering the acquired
property.
- - The acquisition cost, net of any debt, will be payable in cash, or O.P.
Units valued at the average closing price of our common stock over the
30-trading-day period preceding the acquisition or, in cash, at the option
of the Berg Group.
- - We also must assume all property tax assessments.
- - If we elect not to exercise the option with respect to any property, the
Berg Group may hold and lease the property for its own account, or may sell
it to a third party.
- - All action taken by us under the Berg Land Holdings Option Agreement,
including any variations from stated terms outlined above must be approved
by a majority of the members of the Independent Directors Committee.
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.
- 3 -
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.
Although we expect to 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").
Given the downturn and current excess capacity in the Silicon Valley real estate
market for R&D/office properties, we do not expect to maintain historical levels
of growth from acquisitions of new developments in the near future.
OPPORTUNISTIC ACQUISITIONS
In addition to our principal opportunities under the Berg Land Holdings Option
Agreement, we believe our acquisitions experience, established network of real
estate and information technology professionals, and overall financial condition
will continue to provide opportunities for external growth. In general, we will
seek opportunistic acquisitions of high quality, well located Silicon Valley R&D
properties in situations where illiquidity or inadequate management permit their
acquisition at favorable prices, and where our management skills and knowledge
of Silicon Valley submarkets may facilitate increases in cash flow and asset
value. For example, in April 2003, we acquired a 36-acre seven building R&D
property campus consisting of approximately 625,000 rentable square feet in the
San Tomas Technology Park for $110 million.
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 (79 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. The Silicon Valley economy and business activity slowed
markedly during 2001 through 2006 after fast-paced growth in 1999 and 2000. In
the past several years, the Silicon Valley R&D property market has fluctuated
with the local economy. According to a recent report by NAI BT Commercial Real
Estate (the "BT Report"), vacancy rates for Silicon Valley R&D property
decreased from approximately 19.6% in late 2005 to 18.3% at the end of 2006.
Total vacant R&D square footage in Silicon Valley at the end of the fourth
quarter of 2006 amounted to 21.9 million rentable square feet, of which 28.3%,
or 6.2 million rentable square feet, was sublease space.
- 4 -
According to the BT Report, total positive net absorption (which is the
computation of gross square footage leased less gross new square footage vacated
for the period presented) in 2005 amounted to approximately 3.6 million rentable
square feet, and in 2006, there was total positive net absorption of
approximately 1.9 million rentable square feet as local economic conditions
improved. According to the BT Report, average asking market rent per square foot
was $0.99 and $0.88 at year-end for 2006 and 2005, respectively, although
individual properties within any particular submarket presently may be leased
above or below the current average asking market rental rates within that
submarket. 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 36 months as a result of the
over-supply of R&D properties in the market.
For the years ended December 31, 2006 and 2005, occupancy for leased properties
in our portfolio was 69.5% and 68.9%, respectively.
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 tenants' financial
conditions and could result in defaults under their lease obligations.
We believe that the average 2007 renewal rental rates for our properties will be
approximately equal to, or perhaps, below current market rents. Leases
representing approximately 742,000 rentable square feet, or 9% of our 2007 cash
rent, are scheduled to expire during 2007. 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; or 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 adversely affected.
OPERATIONS
We operate as a self-administered, self-advised and self-managed REIT with our
own employees. Generally, as the sole general partner of the operating
partnerships, we control the business and assets of the operating partnerships
and have full and complete authority, discretion and responsibility with respect
to the operating partnerships' operations and transactions, including, without
limitation, acquiring additional properties, borrowing funds, raising new
capital, leasing buildings and selecting and supervising all agents of the
operating partnerships.
Although most of our leases are triple net and building maintenance and tenant
improvements are the responsibility of the tenants, from time to time we may be
required to undertake construction and repair work at our properties. We will
bid all major work competitively to subcontractors. Members of the Berg Group
may participate in the competitive bidding for the work, but all contracts with
the Berg Group are subject to review and approval by the Independent Directors
Committee.
We generally will market the properties and negotiate leases with tenants
ourselves. We make the availability of our properties known to the brokerage
community to garner their assistance in locating prospective tenants. As a
result, we expect to retain our policy of paying fixed commissions to tenants'
brokers.
We believe that our business practices provide us with competitive advantages,
including -
- - EXTERNAL DEVELOPMENT AFFILIATE. We have the option to purchase all future
R&D, office, industrial property developments of the Berg Group under the
Berg Land Holdings Option Agreement on land currently held or acquired
directly or indirectly by Carl E. Berg or Clyde J. Berg that is zoned for
those purposes and located in California, Oregon and Washington following
completion and lease-up of the property. The acquisition terms and
conditions for the existing and identified projects have been
pre-negotiated and are documented under the Berg Land Holdings Option
Agreement. This relationship provides us with the economic benefits of
development while eliminating development and initial lease-up risks. It
also provides us with access to one of the most experienced development
teams in the Silicon Valley without the expense of maintaining development
personnel.
- 5 -
- - LEAN ORGANIZATION, EXPERIENCED TEAM. In part because of our primary focus
on Silicon Valley, our experience with the special real estate requirements
of information technology tenants and the long-term triple-net structure of
our leases, we are able to conduct and expand our business with a small
management team comprised of highly qualified and experienced professionals
working within a relatively flat organizational structure. We believe that
the leanness of our organization and our experience will enable us to
rapidly assess and respond to market opportunities and tenant needs,
control operating expenses and develop and maintain excellent relationships
with tenants. We further believe that these advantages translate into
significantly lower costs for operations and give us the ability, along
with the Berg Group, to compete favorably with other R&D property
developers in Silicon Valley, especially for build-to-suit projects subject
to competitive bidding. Furthermore, we believe this lower cost structure
allows us to generate better returns from properties whose value can be
increased through appropriate remodeling and efficient property management.
- - SOUND PROPERTY MANAGEMENT PRACTICES. For each property, the management
team, along with the Berg Group staff, develops a specific marketing and
property management program. We select vendors and subcontractors on a
competitive bid basis from a select group of highly qualified firms with
whom we maintain ongoing relationships and carefully supervise their work.
OPERATING PARTNERSHIP AGREEMENTS
MANAGEMENT
The operating partnerships consist of four separate limited partnerships engaged
in the combined operation and ownership of all our properties. The operating
partnership agreements are identical in all material respects for all four of
the limited partnerships. Pursuant to the operating partnership agreements, we
act as the sole general partner of the operating partnerships, in which capacity
we have exclusive control of the business and assets of the operating
partnerships and generally have full and complete authority, discretion and
responsibility with respect to the operating partnerships' operations and
transactions, including, without limitation, acquisitions of additional
properties, borrowing funds, raising new capital, leasing buildings, as well as
selecting and supervising all employees and agents of the operating
partnerships. Through our authority to manage our business and affairs, our
Board of Directors directs the business of the operating partnerships.
Notwithstanding our effective control of the operating partnerships, the Berg
Group holds a substantial majority of the outstanding O.P. Units and the consent
of the limited partners holding a majority of the outstanding O.P. Units is
required with respect to certain extraordinary actions involving the operating
partnerships, including:
- - the amendment, modification or termination of the operating partnership
agreements;
- - a general assignment for the benefit of creditors or the appointment of a
custodian, receiver or trustee for any of the assets of the operating
partnerships;
- - the institution of any proceeding for bankruptcy of the operating
partnerships;
- - the transfer of any general partnership interests in the operating
partnerships, including, with certain exceptions, transfers attendant to
any merger, consolidation or liquidation of our corporation;
- - the admission of any additional or substitute general partner in the
operating partnerships; and
- - a change of control of the operating partnerships.
In addition, until the ownership interest of the Berg Group and its affiliates
is less than 15% of the common stock on a Fully Diluted basis, the consent of
the limited partners holding a majority of the outstanding O.P. Units is also
required with respect to:
- - the liquidation of the operating partnerships;
- - the sale or other transfer of all or substantially all of the assets of the
operating partnerships and certain mergers and business combinations
resulting in the complete disposition of all O.P. Units; and
- - the issuance of limited partnership interests having seniority as to
distributions, assets and voting over the O.P. Units.
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.
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ADDITIONAL CAPITAL CONTRIBUTIONS AND LOANS
Each operating partnership agreement provides that, if the operating partnership
requires additional funds to pursue its investment objectives, we may fund such
investments by raising additional equity capital and making a capital
contribution to the operating partnerships or by borrowing such funds and
lending the net proceeds of such loans to the operating partnerships. If we
intend to provide additional funds through a contribution to capital and
purchase of units of general partnership interest, the limited partners will
have the right to participate in such funding on a pro rata, pari passu basis
and to acquire additional O.P. Units. If the limited partners do not participate
in such financing, we will acquire additional units of general partnership
interest. In either case, the number of additional units of partnership interest
will be increased based upon the amount of the additional capital contributions
and the value of the operating partnerships as of the date such contributions
are made.
In addition, as general partner of the operating partnerships, we have the
ability to cause the operating partnerships to issue additional O.P. Units. In
the event that the operating partnerships issue new O.P. Units for cash but not
property, the limited partners will have the right to purchase new O.P. Units at
the price we offer in the transaction giving rise to such participation right in
order, and to the extent necessary, to maintain their respective percentage
interests in the operating partnerships.
EXCHANGE RIGHTS, PUT RIGHTS AND REGISTRATION RIGHTS
Under the Exchange Rights Agreement between us and the limited partners, the
limited partners have exchange rights that generally became exercisable on
December 29, 1999. The Exchange Rights Agreement permits every limited partner
to tender O.P. Units to us, and, at our election, to receive common stock on a
one-for-one basis at then-current market value, an equivalent amount of cash, or
a combination of cash and common stock in exchange for the O.P. Units tendered,
subject to the 9% overall ownership limit imposed on non-Berg Group stockholders
under our charter document, or the overall 20% Berg Group ownership limit, as
the case may be. For more information, please refer to 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.
The shares of our common stock issuable in exchange for the O.P. Units
outstanding at July 1, 1998 and the O.P. Units issued pursuant to the Pending
Projects Acquisition Agreement were registered under the Securities Act and
generally may be sold without restriction if they are acquired by limited
partners that are not affiliates, as defined under SEC Rule 144. For more
information please refer to 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.
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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 shall be
equal to the percentage of outstanding shares of common stock and O.P. Units on
an as-converted basis represented by the shares acquired upon exercise of the
option.
TERM
The operating partnerships will continue in full force and effect until December
31, 2048 or until sooner dissolved pursuant to the terms of the operating
partnership agreements.
EMPLOYEES
As of February 28, 2007, we employed five people, all of whom work at our
executive offices at 10050 Bandley Drive, Cupertino, California, 95014.
FACILITIES
We lease office space at 10050 Bandley Drive, Cupertino, California from Berg &
Berg Enterprises, Inc. and share clerical staff and other overhead on what we
consider to be favorable terms. The total monthly rent payable by us to Berg &
Berg Enterprises, Inc. is $7,520.
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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.
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.
SUBSTANTIAL OWNERSHIP INTEREST
The Berg Group currently owns O.P. Units representing approximately 74% of the
equity interests in the operating partnerships and approximately 73.8% of our
equity interests on a Fully Diluted basis. The O.P. Units may be converted into
shares of common stock, subject to limitations set forth in our charter and
other agreements with the Berg Group, and upon conversion would represent voting
control of our corporation. The Berg Group's ability to exchange its O.P. Units
for common stock permits it to exert substantial influence over the management
and direction of our corporation. This influence increases our dependence on the
Berg Group.
LIMITED PARTNER APPROVAL RIGHTS
Mr. Berg and other limited partners, including other members of the Berg Group,
may restrict our operations and activities through rights provided under the
terms of the amended and restated agreement of limited partnership which governs
each of the operating partnerships and our legal relationship to each operating
partnership as its general partner. Matters requiring approval of the holders of
a majority of the O.P. Units, which necessarily would include the Berg Group,
include the following:
- - the amendment, modification or termination of any of the operating
partnership agreements;
- - the transfer of any general partnership interest in the operating
partnerships, including, with certain exceptions, transfers attendant to
any merger, consolidation or liquidation of our corporation;
- - the admission of any additional or substitute general partners in the
operating partnerships;
- - any other change of control of the operating partnerships;
- - a general assignment for the benefit of creditors or the appointment of a
custodian, receiver or trustee for any of the assets of the operating
partnerships; and
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- - 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 $7,520 per month;
- - the Berg Group is permitted to conduct real estate and business activities
other than our business;
- - if we decline an opportunity that has been offered to us, the Berg Group
may pursue it, which would reduce the amount of time that Mr. Berg could
devote to our affairs and could result in the Berg Group's development of
properties that compete with our properties for tenants;
- - in general, we have agreed to limit the liability of the Berg Group to our
corporation and our stockholders arising from the Berg Group's pursuit of
these other opportunities;
- - we acquired most of our properties from the Berg Group on terms that were
not negotiated at arm's length and without many customary representations
and warranties that we would have sought in an acquisition from an
unrelated party; and
- - we have assumed liability for debt to the Berg Group and debt for which the
Berg Group was liable.
The Berg Group has agreed that the Independent Directors Committee of our Board
of Directors must approve all new transactions between us and any of its
members, or between us and any entity in which it directly or indirectly owns 5%
or more of the equity interests, including the operating partnerships for this
purpose. This committee currently consists of three directors who are
independent of the Berg Group.
BERG LAND HOLDINGS
The Berg Group owns several parcels of unimproved land in the Silicon Valley
that the operating partnerships and we have the right to acquire under the terms
of the Berg Land Holdings Option Agreement. We have agreed to pay an amount
based on pre-negotiated terms for any of the properties that we do acquire. We
must pay the acquisition price in cash unless the Berg Group elects, in its
discretion, to receive O.P. Units valued at the average market price of a share
of common stock during the 30-trading-day period preceding the acquisition date.
At the time of acquisition, which is subject to the approval of the Independent
Directors Committee, these properties may be encumbered by debt that we or the
operating partnerships will be required to assume or repay. The use of our cash
or an increase in our indebtedness to acquire these properties could have a
material adverse effect on our financial condition, results of operations and
ability to make cash distributions to our stockholders. The Independent
Directors Committee authorized the removal of a 160-acre site from the Berg Land
Holdings Option Agreement if the Berg Group is able to obtain residential
development zoning for any portion of this land. The Independent Directors
Committee determined that this site is not likely to be of future development
interest to us, and so the Berg Group is now able to pursue its own residential
development opportunities for this site. Any portions of such site that are
rezoned as residential will no longer be subject to the Berg Land Holdings
Option Agreement and will not provide any future benefit to us.
TAX CONSEQUENCES OF SALE OF PROPERTIES
Many of our properties have unrealized taxable gain, and a sale of those
properties could create adverse income tax consequences for the limited partners
of the operating partnerships. We have agreed with Carl E. Berg, Clyde J. Berg
and John Kontrabecki, a limited partner in one of the operating partnerships as
of December 31, 2006, that prior to December 29, 2008, each of them may prevent
us and the operating partnerships from selling or transferring any of the
properties that were acquired from them in our July 1998 UPREIT acquisition if
the proposed sale or other transfer will be a taxable transaction. As a result,
our opportunities to sell these properties may be limited. If we need to sell
any of these properties to raise cash to service our debt, acquire new
properties, pay cash
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distributions to stockholders or for other working capital purposes, we may be
unable to do so. These restrictions could harm our business and cause our stock
price to fall.
TERMS OF TRANSFERS: ENFORCEMENT OF AGREEMENT OF LIMITED PARTNERSHIP
The terms of the Pending Projects Acquisition Agreement, the Berg Land Holdings
Option Agreement, the partnership agreement of each operating partnership and
other material agreements through which we have acquired our interests in the
operating partnerships and the properties formerly controlled by the Berg Group
were not determined through arm's-length negotiations and could be less
favorable to us than those obtained from an unrelated party. In addition, Mr.
Berg and representatives of the Berg Group sitting on our Board of Directors may
be subject to conflicts of interests with respect to their obligations as our
directors to enforce the terms of the partnership agreement of each operating
partnership when such terms conflict with their personal interests. The terms of
our charter and bylaws also were not determined through arm's-length
negotiations. Some of these terms, including representations and warranties
applicable to acquired properties, are not as favorable as those that we would
have sought through arm's-length negotiations with unrelated parties. As a
result, an investment in our common stock may involve risks not found in
businesses in which the terms of material agreements have been negotiated at
arm's length.
RELATED PARTY DEBT
We are liable under a mortgage loan of $9.7 million due June 2010 that we
assumed in connection with our acquisition of the 5300-5350 Hellyer Avenue R&D
properties that we acquired in May 2000 under the Berg Land Holdings Option
Agreement. On October 26, 2005, the Independent Directors Committee approved the
termination of the $20 million line of credit agreement between the Company and
the Berg Group effective October 31, 2005. The Berg Group line of credit was
originally scheduled to mature in March 2006. There are no borrowings currently
outstanding under the Berg Group line of credit, but we might obtain a line of
credit from the Berg Group in the future. If we are unable to repay our debts to
the Berg Group when due, the Berg Group could take action to enforce our payment
obligations. Potential actions by the Berg Group to enforce these obligations
could result in the foreclosure in one or more of our properties and a reduction
in the amount of cash distributions to our stockholders. In turn, if we fail to
meet the minimum distributions test because of a loan default or another reason,
we could lose our REIT classification for federal income tax purposes. For more
information please refer to Item 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
WONERSHIP INTEREST HAS BEEN REDUCED.
The Berg Land Holdings Option Agreement, as amended, which provides us with
significant benefits and opportunities to acquire additional R&D properties from
the Berg Group, will expire when the Berg Group and their affiliates (excluding
us and the operating partnerships) own less than 65% of our common stock on a
Fully Diluted basis. Termination of the Berg Land Holdings Option Agreement
could result in limitation of our growth, which could cause our stock price to
fall.
WE MAY CHANGE OUR INVESTMENT AND FINANCING POLICIES AND INCREASE YOUR RISK
WITHOUT STOCKHOLDER APPROVAL.
Our Board of Directors determines the investment and financing policies of the
operating partnerships and our policies with respect to certain other
activities, including our business growth, debt capitalization, distribution,
and operating policies. Our Board of Directors may amend these policies at any
time without a vote of the stockholders. Changes in these policies could
materially adversely affect our financial condition, results of operations and
ability to make cash distributions to our stockholders, which could harm our
business and cause our stock price to fall. For more information please refer to
Item 7, "Management's Discussion and Analysis of Financial Condition and Results
of Operations - Policies with Respect to Certain Activities."
ANTI-TAKEOVER PROVISIONS IN OUR CHARTER COULD PREVENT ACQUISITIONS OF OUR STOCK
AT A SUBSTANTIAL PREMIUM.
Provisions of our charter and our bylaws could delay, defer or prevent a
transaction or a change in control of our corporation, or a similar transaction,
that might involve a premium price for our shares of common stock or otherwise
be in the best interests of our stockholders. Provisions of the Maryland general
corporation law, which would apply to potential business combinations with
acquirers other than the Berg Group or stockholders who invested in us in
December 1998, also could prevent the acquisition of our stock for a premium, as
discussed in "Certain Provisions of Maryland Law and of our Charter and Bylaws."
AN INVESTMENT IN OUR STOCK INVOLVES RISKS RELATED TO REAL ESTATE INVESTMENTS
THAT COULD HARM OUR BUSINESS AND CAUSE OUR STOCK PRICE TO FALL.
RENTAL INCOME VARIES
Real property investments are subject to varying degrees of risk. Investment
returns available from equity investments in real estate depend in large part on
the amount of income earned and capital appreciation, which our properties
generate, as well as our related expenses incurred. If our properties do not
generate revenues sufficient to meet operating expenses, debt service and
capital expenditures, our income and ability to make distributions to our
stockholders will be adversely affected. Income from our properties
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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 during the past few years after a number of successive
years of rapid growth that resulted in 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.
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. 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.
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
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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.
In 2004, we recorded an impairment charge to reflect the decline in value of one
of our R&D properties held for sale as of the year end. For further discussion
of this charge please refer to Item 8, "Financial Statements and Supplementary
Data - Note 17." There can be no assurance that we will not take additional
charges in the future related to the impairment of our assets. As of the years
ended December 31, 2006 and 2005, 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 to two other
stockholders that permits them to collectively own, directly or indirectly, up
to 18.5% of our common stock on an aggregate basis, subject to the terms of an
ownership limit exemption agreement. In general, our charter prohibits the
transfer of shares that result in a loss of our REIT qualification and provides
that any such transfer or any other transfer that causes a stockholder to exceed
the ownership limit will result in the shares being automatically transferred to
a trust for the benefit of a charitable beneficiary. Accordingly, in the event
that either the Berg Group or the two stockholders increase their stock
ownership in our corporation, a stockholder who acquires shares of our common
stock, even though his, her or its aggregate ownership may be less than 9%, may
be required to transfer a portion of that stockholder's shares to such a trust
in order to preserve our status as a REIT.
- 13 -
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;
- - 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;
- - prospects of tenant renewals and re-leases of properties subject to
expiring leases;
- - cash required for re-leasing activities; and
- - such other factors as our Board of Directors deems relevant.
We cannot assure you that we will be able to meet or maintain our cash
distribution objectives.
OUR PROPERTIES COULD BE SUBJECT TO PROPERTY TAX REASSESSMENTS.
We do not believe that the acquisition of any of our interests in the operating
partnerships has resulted in a statutory change in ownership that could give
rise to a reassessment of any of our properties for California property tax
purposes. We cannot assure you, however, that county assessors or other tax
administrative agencies in California will not attempt to assert that such a
change occurred as a result of these transactions. Although we believe that such
a challenge would not be successful ultimately, we cannot assure you regarding
the outcome of any related dispute or proceeding. A reassessment could result in
increased real estate taxes on our properties that, as a practical matter, we
may be unable to pass through to our tenants in full. This could reduce our net
income and our funds available for distributions and cause our stock price to
fall.
OUR OBLIGATION TO PURCHASE TENDERED O.P. UNITS COULD REDUCE OUR CASH
DISTRIBUTIONS.
Each of the limited partners of the operating partnerships, other than Carl E.
Berg and Clyde J. Berg, has the annual right to cause the operating partnerships
to purchase the limited partner's O.P. Units at a purchase price based on the
average market value of the common stock for the ten-trading-day period
immediately preceding the date of tender. Upon a limited partner's exercise of
any such right, we will have the option to purchase the tendered O.P. Units with
available cash, borrowed funds or the proceeds of an offering of newly issued
shares of common stock. These put rights became exercisable on December 29,
1999, and are available once during a 12-month period. If the total purchase
price of the O.P. Units tendered by all of the eligible limited partners in one
year exceeds $1 million, the operating partnerships or we will be entitled, 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 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, 2006, 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
- 14 -
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, may also be sold in the
market at some time in the future. Future sales of our common stock in the
market could adversely affect the price of our common stock.
MARKET INTEREST RATES MAY REDUCE THE VALUE OF THE COMMON STOCK.
One of the factors that investors consider important in deciding whether to buy
or sell shares of a REIT is the distribution rate on such shares, as a
percentage of the price of such shares, relative to market interest rates. If
market interest rates go up, prospective purchasers of REIT shares may expect a
higher distribution rate. Higher interest rates would not, however, increase the
funds available for us to distribute, and, in fact, would likely increase our
borrowing costs and decrease funds available for distributions. Thus, higher
market interest rates could cause the price of our common stock to fall.
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 the properties have terms ranging from month-to-month to
15 years. Most of the leases provide for fixed periodic rental increases.
Substantially all of the leases are triple-net leases pursuant to which the
tenant is required to pay substantially all of the operating expenses of the
property, property taxes and insurance, including all maintenance and repairs,
and excluding only certain structural repairs to the building shell. Most of the
leases contain renewal options that allow the tenant to extend the lease based
on adjustments to then prevailing market rates, or based on fixed rental
adjustments, which may be at or below market rates.
PROPERTY PORTFOLIO
All of our properties are R&D/office type properties. Generally, these
properties are one- to two-story buildings of tilt-up concrete construction,
have on average 3.5 or more parking spaces per thousand rentable square feet,
clear ceiling heights of less than 18 feet, and range in size from approximately
4,500 to 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, 2006:
Major
Tenants'
Total Percentage Rentable
No. of Rentable Occupied as of Average 2006 Sq. Ft. at 2006 Annual
Location Properties Sq. Ft. Dec. 31, 2006 Occupancy Major Tenants 12/31/06 Base Rents(1)
- ------------------------------------------------------------------------------------------------------------------------------------
5300-5350 Hellyer Avenue (2) 2 160,000 100% 100% Tyco Electronics Corp. 160,000 $3,623,609
10401-10411 Bubb Road (2) 1 20,330 100% 100% Aeroflex, Inc. 15,830 213,705
45365 Northport Loop West 1 64,218 0% 0% Vacant - -
45700 Northport Loop East 1 47,570 0% 0% Vacant - -
45738 Northport Loop West 1 44,256 100% 100% Quicksil, Inc. 44,256 398,304
4050 Starboard Drive 1 52,232 100% 100% Flash Electronics, Inc. 52,232 790,796
3501 W. Warren Avenue & 1 67,864 52% 52% ASM Nutool, Inc. 35,340 716,043
46600 Fremont Blvd.
48800 Milmont Drive 1 53,000 0% 0% Vacant - -
4750 Patrick Henry Drive 1 63,105 100% 50% Infoblox, Inc. 63,105 205,091
- 16 -
Major
Tenants'
Total Percentage Rentable
No. of Rentable Occupied as of Average 2006 Sq. Ft. at 2006 Annual
Location Properties Sq. Ft. Dec. 31, 2006 Occupancy Major Tenants 12/31/06 Base Rents(1)
- ------------------------------------------------------------------------------------------------------------------------------------
Triangle Technology Park (2) 7 416,927 74% 63% Intevac Corporation 129,583 5,283,616
Xicom Technology, Inc. 72,336
LSA Cleanpart, LLC 28,300
SASCO 25,350
IXYS Technologies, Inc. 19,600
5850-5870 Hellyer Avenue 1 109,715 24% 22% MeiVac, Inc. 26,557 250,654
5750 Hellyer Avenue 1 73,312 0% 0% Vacant - -
5500-5550 Hellyer Avenue 2 196,534 23% 23% ACT Electronics, Inc. 46,120 454,282
5400 Hellyer Avenue 1 77,184 43% 43% Nortel Networks, Inc. 32,902 316,388
5325-5345 Hellyer Ave. 2 256,500 100% 100% Celestica Asia, Inc. 256,500 5,294,832
5905-5965 Silver Creek 4 346,000 100% 100% Ciena Corporation 346,000 9,771,911
855 Embedded Way 1 67,912 42% 76% Lynuxworks, Inc. 28,612 1,094,101
1065-1105 La Avenida Street 5 515,700 100% 100% Microsoft Corporation 515,700 11,727,818
1875 Charleston Road 1 42,126 100% 100% Netlogic Microsystems, Inc. 42,126 626,271
1750 Automation Parkway 1 80,641 100% 100% JDS Uniphase Corporation 80,641 1,369,764
1756 Automation Parkway 1 80,640 0% 25% Vacant - 520,041
1762 Automation Parkway 1 61,100 0% 25% Vacant - 599,676
1768 Automation Parkway 1 110,592 40% 31% Becton, Dickinson and Co. 43,699 973,541
255 Caspian Drive 1 119,756 100% 100% Equinix Operating Co., Inc.119,756 2,389,132
245 Caspian Drive (3) 1 - 0% 0% Vacant - -
5970 Optical Court 1 128,520 100% 100% Photon Dynamics, Inc. 128,520 1,864,236
5900 Optical Court 1 165,000 100% 100% Stryker Endoscopy 165,000 3,389,370
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% NEC Electronics Amer., Inc. 80,000 784,434
2880 Scott Boulevard 1 200,000 100% 100% NEC Electronics Amer., Inc.200,000 3,265,512
2890 Scott Boulevard (5) 1 75,000 100% 100% NEC Electronics Amer., Inc. 75,000 2,284,260
2770-2800 Scott Boulevard 1 99,800 100% 100% Nvidia Corporation 99,800 1,173,154
2300 Central Expressway (5) 1 46,338 100% 100% JDS Uniphase Corp. 46,338 3,431,983
2220 Central Expressway 1 62,522 100% 42% Tellabs, Inc. 62,522 271,971
2330 Central Expressway 1 62,522 100% 42% Tellabs, Inc. 62,522 271,971
233 South Hillview Drive 2 95,690 100% 100% Sipex Corporation 95,690 1,025,425
2251 Lawson Lane 1 125,000 0% 16% Vacant - 210,795
1230 East Arques 1 60,000 100% 100% Fujitsu 60,000 327,069
1250 East Arques 4 200,000 100% 100% Fujitsu 200,000 869,311
- 17 -
Major
Tenants'
Total Percentage Rentable
No. of Rentable Occupied as of Average 2006 Sq. Ft. at 2006 Annual
Location Properties Sq. Ft. Dec. 31, 2006 Occupancy Major Tenants 12/31/06 Base Rents(1)
- ------------------------------------------------------------------------------------------------------------------------------------
20400 Mariani Avenue (5) 1 105,000 100% 100% Dade Behring, Inc. 62,323 1,923,347
Apple, Inc. 42,677
10500 De Anza Blvd. 1 211,000 100% 100% Apple, Inc. 211,000 5,206,608
20605-705 Valley Green Drive 2 142,000 100% 100% Apple, Inc. 142,000 3,352,371
10300 Bubb Road 1 23,400 100% 100% Apple, Inc. 23,400 253,422
10440 Bubb Road 1 19,500 56% 74% Novare Surgical Sys., Inc. 10,833 180,270
10450-10460 Bubb Road 1 45,460 27% 49% Blue Lane Tech., Inc. 12,197 253,109
1135 Kern Avenue 1 18,300 0% 0% Vacant - -
450 National Avenue 1 36,100 0% 0% Vacant - -
3301 Olcott Street 1 64,500 0% 0% Vacant - -
2800 Bayview Avenue 1 59,736 0% 0% Vacant - -
5521 Hellyer Avenue 1 203,800 0% 0% Vacant - -
6850 Santa Teresa Blvd. 1 30,000 59% 59% Indala Corporation 17,650 189,738
6810 Santa Teresa Blvd. 1 54,996 13% 13% Silicon Valley Real Estate 7,281 74,266
140-160 Great Oaks Blvd. & 2 105,300 59% 52% Santa Clara Water District 25,429 656,640
6781 Via Del Oro Semiconductor Tooling Serv. 36,800
6540-6541 Via Del Oro & 2 66,600 73% 71% Modutek Corporation 21,376 372,856
6385-6387 San Ignacio Ave.
6311-6351 San Ignacio Ave. 5 362,767 37% 39% Saint Gobain 95,953 2,512,274
Teledex, LLC 30,000
6320-6360 San Ignacio Ave. 1 157,292 12% 26% Quantum 3D, Inc. 19,600 1,176,292
75 East Trimble Road & 2 170,810 59% 59% Comerica Bank 93,984 1,037,052
2610 North First Street
2033-2243 Samaritan Drive (4) - - - - - - 1,827,766
1170 Morse Avenue 1 39,231 100% 100% The Parkinson's Institute 39,231 541,392
3236 Scott Blvd. 1 54,672 100% 100% Celeritek, Inc. 54,672 660,858
1212 Bordeaux Lane 1 71,800 100% 50% Loral Space & Comm. 71,800 345,468
McCandless Technology Park 14 705,958 55% 51% Arrow Electronics, Inc. 92,862 6,003,926
Chartered Semiconductor Mfg.45,312
ST Assembly Test Serv., Inc.33,984
Hermes Microvision, Inc. 25,285
A&D Engineering, Inc. 20,332
1600 Memorex Drive 1 107,500 40% 44% Int'l Network Services 22,800 385,560
Aire Sheet Metal, Inc. 20,000
1688 Richard Avenue 1 52,800 100% 100% NWE Technology, Inc. 52,800 302,840
1700 Richard Avenue 1 58,783 100% 100% Broadwing Comm Serv., Inc. 58,783 790,627
------------------- -------------
TOTAL 107 7,701,359 69% $93,835,748
=================== =============
- 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 was sold in 2006. It is included in this table for the sole
purpose of presenting the annual cash rent received in 2006.
(5) JDS Uniphase, NEC Electronics America and Dade Behring are currently in
negotiation to terminate their lease obligations with us for the indicated
properties. An additional 184,000 rentable square feet will be vacant in
2007 if we accept these lease terminations.
We own 100% of all of the properties, 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 2007, assuming that none of the tenants exercise
existing renewal options or termination rights. The table excludes 2,395,883
rentable square feet that was vacant as of December 31, 2006.
Number of Percentage of Total Annual
Year of Lease Expiring Rentable Square Footage 2007 Annual Base Rent Base Rent Represented By
Expiration Leases Subject to Expiring Leases Under Expiring Leases (1)(3) Expiring Leases (2)
--------------------------------------------------------------------------------------------------------------------
2007 24 742,078 $8,268,614 9.4%
2008 10 230,449 2,457,481 2.8%
2009 20 688,115 9,317,772 10.6%
2010 11 571,460 9,808,771 11.2%
2011 7 931,450 18,891,914 21.6%
2012 11 881,817 13,975,589 15.9%
2013 1 125,044 1,336,720 1.5%
2014 3 709,000 16,065,850 18.3%
2015 3 277,568 4,902,225 5.6%
2017 1 28,739 232,785 0.3%
Thereafter 1 119,756 2,460,986 2.8%
--------------------------------------------------------------------------------------------------
92 5,305,476 $87,718,707 100%
==================================================================================================
(1) The base rent for expiring leases is based on 2007 scheduled cash rent,
which is different than annual rent determined in accordance with GAAP.
(2) Based upon 2007 cash rent as discussed in Note (1).
(3) JDS Uniphase, NEC Electronics America and Dade Behring are currently in
negotiation to terminate certain lease obligations with us. An additional
184,000 rentable square feet will be vacant in 2007 if we accept these
lease terminations.
If we are unable to lease a significant portion of the available space or space
scheduled to expire in 2007 and thereafter at any of our properties; if existing
tenants do not renew their leases; or if rental rates decrease, our results of
operations, financial condition and cash flows would be adversely affected.
ENVIRONMENTAL MATTERS
To date, compliance with laws and regulations relating to the protection of the
environment, including those regarding the discharge of materials into the
environment has not had any material effects upon our capital expenditures,
earnings or competitive position.
Under various federal, state and local laws, ordinances and regulations, an
owner or operator of real property may be held liable for the costs of removal
or remediation of certain hazardous or toxic substances located on or in the
property. Such laws often impose liability on the owner and expose the owner to
governmental proceedings without regard to whether the owner knew of, or was
responsible for, the presence of the hazardous or toxic substances. The cost of
any required remediation or removal of such substances may be substantial. In
addition, the owner's liability as to any specific property is generally not
limited and could exceed the value of
- 19 -
the property and/or the aggregate assets of the owner. The presence of such
substances, or the failure to properly remove or remediate such substances, may
also adversely affect the owner's ability to sell or rent the property or to
borrow using the property as collateral. Persons who arrange for treatment or
the disposal of hazardous or toxic substances may also be liable for the costs
of any required remediation or removal of the hazardous or toxic substances at a
disposal facility, regardless of whether the facility is owned or operated by
such owner or entity. In connection with the ownership of the properties or the
treatment or disposal of hazardous or toxic substances, we may be liable for
such costs.
Some of our properties are leased, in part, to businesses, including
manufacturers that use, store or otherwise handle hazardous or toxic substances
in their business operations. These operations create a potential for the
release of hazardous or toxic substances. In addition, groundwater contaminated
by chemicals used in various manufacturing processes, including semiconductor
fabrication, underlies a significant portion of northeastern Santa Clara County,
where many of our properties are located.
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, the properties nor we are subject to any
material litigation nor, to our knowledge, is any material litigation threatened
against the operating partnerships, the properties or us. From time to time, we
are engaged in legal proceedings arising in the ordinary course of our business.
We do not expect any of such proceedings to have a material adverse effect on
our cash flows, financial condition or results of operations. We are currently
involved in the following legal proceedings which we believe the ultimate
outcome, will have no material adverse effect on our financial statements.
REPUBLIC PROPERTIES CORPORATION ("RPC") V. MISSION WEST PROPERTIES, L.P.
("MWP"), IN THE CIRCUIT COURT OF MARYLAND FOR BALTIMORE CITY CASE NO.
24-C-00-005675. On November 20, 2000, RPC commenced a lawsuit against MWP in the
Circuit Court of Maryland for Baltimore City. After lengthy litigation, which
included a trial on the merits and subsequent appears, in April 2006 Maryland's
highest Court upheld an earlier Maryland Appeals Court ruling in favor of MWP,
finding that the Circuit Court of Maryland could not assert personal
jurisdiction over MWP in the RPC suit. The Court vacated the judgment and
decision in the trial court and dismissed the entire Maryland suit (see Item 8,
"Financial Statements and Supplementary Data - Note 13" for information about
the Hellyer Avenue Limited Partnership and the historical transactions
underlying this litigation).
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 are in the process of seeking a
writ from the California State Court of Appeal for the Sixth District directing
the Superior Court to sustain the demurrer.
If the litigation is ultimately decided in favor of the Company, the Independent
Directors Committee of the Board of Directors has the right, but not the
obligation, to acquire on behalf of the Company the former RPC interest and
related distributions from BBE under the terms of the Berg Land Holdings Option
Agreement and the Acquisition Agreement between the Company and the Berg Group,
as more fully explained under Item 8, "Financial Statements and Supplementary
Data - Note 13."
In January 2004, the GLOBAL CROSSING ESTATE REPRESENTATIVE, FOR ITSELF AND THE
LIQUIDATING TRUSTEE OF THE GLOBAL CROSSING LIQUIDATING TRUST V. MISSION WEST
PROPERTIES L.P. filed an action in United States Bankruptcy Court Southern
District of New York Case No. 02-40188 (REG) asserting that payments of $815,052
made in the ordinary course of business within 90 days of the Global Crossing
bankruptcy filing were avoidable preference payments. During the course of
settlement discussions with Global Crossing's representative, we learned that we
would receive only 2-3% of our unsecured claim of $16,710,605 for unpaid rent
from the final distribution of the assets and proceeds of bankruptcy estate. On
February 21, 2007, we and the Liquidating Trustee entered into a settlement
agreement under which the $815,052 claim against us was dismissed and we agreed
to accept a payment of approximately $150,000 as a final settlement of our claim
for unpaid rent.
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, 2006.
- 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, 2001 to December 31,
2006. The line graph starts December 31, 2001. The graph assumes that the value
of the investment in the Company's common stock was $100 at December 31, 2001
and that all dividends were reinvested. The common stock's price on December 31,
2001 was $12.72. 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 American Stock Exchange ("AMEX") and trades
under the symbol "MSW." The high and low closing price per share of common stock
as reported on AMEX during each quarter of 2006 and 2005 were as follows:
2006 2005
----------------------------- -----------------------------
High Low High Low
------------- ------------- ------------- -------------
1st Quarter $11.90 $9.68 $11.19 $10.04
2nd Quarter $11.90 $10.70 $10.53 $9.50
3rd Quarter $11.62 $10.18 $11.00 $10.02
4th Quarter $13.10 $11.31 $10.26 $9.71
- 22 -
On February 28, 2007, there were 184 registered holders of the Company's common
stock. We declared and paid dividends in each quarter of 2006 and 2005. We
expect to pay quarterly dividends during 2007. The following tables show
information for quarterly dividends for 2006 and 2005.
2006
-----------------------------------------------
Payment Dividend
Record Date Date Per Share
------------- ------------- -------------
1st Quarter 03/31/06 04/06/06 $0.16
2nd Quarter 06/30/06 07/06/06 0.16
3rd Quarter 09/29/06 10/05/06 0.16
4th Quarter 12/29/06 01/04/07 0.16
-------------
Total $0.64
=============
2005
-----------------------------------------------
Payment Dividend
Record Date Date Per Share
------------- ------------- -------------
1st Quarter 03/31/05 04/07/05 $0.16
2nd Quarter 06/30/05 07/07/05 0.16
3rd Quarter 09/30/05 10/06/05 0.16
4th Quarter 12/31/05 01/05/06 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 100% of the dividends
declared in 2006 as taxable ordinary income (unaudited). For 2005, we have
characterized 89% of the dividends declared as taxable ordinary income and 11%
as return of capital (unaudited).
The closing price of our common stock on December 29, 2006, the last trading day
of the year, was $13.10 per share.
- 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,
--------------------------------------------------------------------------
2006 2005 2004 2003 2002
------------- ------------- -------------- ------------- -------------
(dollars in thousands, except per share data)
OPERATING INFORMATION: (1)
Revenue:
Rental revenue from real estate $90,110 $97,735 $115,815 $125,757 $124,189
Tenant reimbursements 13,116 14,115 14,192 17,783 19,104
Other income 20,602 4,591 6,862 4,506 4,232
------------- ------------- -------------- ------------- -------------
Total revenues 123,828 116,441 136,869 148,046 147,525
Expenses:
Property operating, maintenance and real
estate taxes 18,654 18,759 19,111 19,832 22,378
Interest 20,709 21,295 17,581 16,446 9,588
Interest (related parties) 755 972 1,077 1,064 3,422
General and administrative 2,248 1,910 2,011 1,324 1,488
Depreciation and amortization of real estate 21,803 20,553 20,827 19,521 17,058
------------- ------------- -------------- ------------- -------------
Total expenses 64,169 63,489 60,607 58,187 53,934
------------- ------------- -------------- ------------- -------------
Income before equity in earnings of unconsolidated joint
venture and minority interests 59,659 52,952 76,262 89,859 93,591
Equity in earnings of unconsolidated joint venture 1,985 724 2,947 3,885 -
Minority interests (50,150) (44,353) (65,810) (78,117) (78,196)
------------- ------------- -------------- ------------- -------------
Income from continuing operations 11,494 9,323 13,399 15,627 15,395
Discontinued operations, net of minority interests:
Gain from disposal of discontinued operations 2,935 445 - - 1,018
Income/(loss) attributable to discontinued
operations (2) 201 259 (87) 585 702
------------- ------------- -------------- ------------- -------------
Income/(loss) from discontinued operations 3,136 704 (87) 585 1,720
------------- ------------- -------------- ------------- -------------
Net income to common stockholders $14,630 $10,027 $13,312 $16,212 $17,115
============= ============= ============== ============= =============
Net income to minority interests $66,358 $47,524 $66,100 $80,836 $86,641
============= ============= ============== ============= =============
Basic net income from continuing operations per share $0.60 $0.51 $0.74 $0.88 $0.88
Diluted net income from continuing operations per share $0.60 $0.51 $0.74 $0.88 $0.86
Basic net income from discontinued operations per share $0.17 $0.04 - $0.03 $0.10
Diluted net income from discontinued operations per share$0.16 $0.04 - $0.03 $0.10
Basic net income per share $0.77 $0.55 $0.74 $0.91 $0.98
Diluted net income per share $0.76 $0.55 $0.74 $0.91 $0.96
Dividends per share $0.64 $0.64 $0.88 $0.96 $0.96
PROPERTY AND OTHER INFORMATION:
Total properties, end of period (3) 107 107 109 109 101
Total rentable square feet, end of period (000's) 7,701 7,780 7,917 7,917 7,164
Average monthly rental revenue per square foot (4) $1.57 $1.58 $1.80 $1.77 $1.71
Occupancy for leased properties, end of period 69% 69% 71% 77% 84%
Funds from operations (5): $86,585 $79,152 $103,320 $117,918 $118,444
CASH FLOW INFORMATION:
Cash flows provided by operating activities $27,012 $21,898 $38,970 $36,104 $34,452
Cash flows used in investing activities ($5,369) ($2,875) ($1,519) ($109,983) ($20,744)
Cash flows (used in)/provided by financing activities($19,299) $10,899 ($40,061) $73,529 ($14,539)
- 24 -
December 31,
--------------------------------------------------------------------------
2006 2005 2004 2003 2002
------------- ------------- -------------- ------------- -------------
(dollars in thousands)
BALANCE SHEET INFORMATION:
Real estate assets, net of accumulated depr.
& amort. $898,889 $927,381 $960,863 $985,751 $886,122
Total assets $1,027,487 $1,023,377 $1,005,656 $1,032,632 $926,783
Line of credit - related parties - - $9,560 $6,320 $58,792
Revolving line of credit - - $24,208 $23,965 $23,839
Loan payable - - - - $20,000
Mortgage notes payable $348,101 $357,481 $292,822 $299,858 $125,062
Mortgage notes payable - related parties $9,654 $10,051 $10,420 $10,762 $11,078
Total liabilities $397,327 $407,680 $380,355 $394,324 $289,817
Minority interests $501,282 $500,682 $512,089 $524,918 $526,580
Stockholders' equity $128,878 $115,015 $113,212 $113,390 $110,386
Common stock outstanding 19,443,587 18,448,791 18,097,191 17,894,691 17,487,329
O.P. Units issued and outstanding 85,206,199 86,088,095 86,384,695 86,398,064 86,474,032
(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, 2006, 2005, 2004, 2003 and 2002, total properties
include a property at 245 Caspian in Sunnyvale with no building. During
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 instrument used by
REITs to measure and compare operating performance. As defined by the
National Association of Real Estate Investment Trusts ("NAREIT"), FFO
represents net income (loss) before minority interest of unit holders
(computed in accordance with GAAP), including non-recurring events other
than "extraordinary items" under GAAP and 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. We have revised our FFO computations for 2002 for the inclusion of the
amortization of leasing commissions in depreciation and amortization of
real estate in order to be comparable to our 2006, 2005, 2004 and 2003 FFO
presentation and to more closely conform to the NAREIT's FFO definition.
Additionally, our 2006, 2005, 2004 and 2003 FFO calculation includes our
portion of the depreciation and amortization of real estate from our
unconsolidated joint venture, but excludes the above-market lease
intangible asset, which was recorded as a reduction of revenues. Management
considers FFO to be an appropriate supplemental measure of the Company's
operating and financial performance because when compared year over year,
it reflects the impact to operations from trends in occupancy rates, rental
rates, operating costs, general and administrative expenses and interest
costs, providing a perspective not immediately apparent from net income. In
addition, management believes that FFO provides useful information about
the Company's financial performance when compared to other REITs since FFO
is generally recognized as the industry standard for reporting the
operations of REITs. FFO should not be considered as an alternative for
neither net income as a measure of profitability nor is it comparable to
cash flows provided by operating activities determined in accordance with
GAAP. FFO is not comparable to similarly entitled items reported by other
REITs that do not define them exactly as we define FFO.
Our definition of FFO also assumes conversion at the beginning of the period of
all convertible securities, including 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, 2006, 2005, 2004, 2003 and 2002 follows:
Year Ended December 31,
------------------------------------------------------------------------
2006 2005 2004 2003 2002
------------- -------------- ------------- -------------- --------------
(dollars in thousands, except per share data)
Net income to common stockholders $14,630 $10,027 $13,312 $16,212 $17,115
Add:
Minority interests (1) 65,859 47,045 65,614 80,256 86,053
Depreciation and amortization of real estate(2) 24,636 24,286 24,394 22,850 21,379
Less:
Gain on sales of assets or joint venture assets (18,540) (2,206) - (1,400) (6,103)
------------- -------------- ------------- -------------- --------------
FFO $86,585 $79,152 $103,320 $117,918 $118,444
============= ============== ============= ============== ==============
Weighted average common shares & O.P. Units - diluted 104,809,155 104,545,776 104,521,271 104,279,165 104,189,440
FFO per common share & O.P. Unit - diluted $0.83 $0.76 $0.99 $1.13 $1.14
(1) The minority interest for third parties totaling $499, $479, $486, $581 and
$587 in 2006, 2005, 2004, 2003 and 2002, 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 $849, $984, $874 and $874 in
2006, 2005, 2004 and 2003, respectively, and amortization of leasing
commissions totaling $1,513, $1,703, $1,644, $1,203 and $3,020 in 2006,
2005, 2004, 2003 and 2002, 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 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
partnership interests in the operating partnerships through the purchase of the
general partnership interests, and all limited partnership interests in the
operating partnerships were converted into 59,479,633 O.P. Units, which
represented ownership of approximately 87.89% of the operating partnerships. Our
general partnership interests represented the balance of the ownership of the
operating partnerships. At December 31, 2006, we owned an 18.23% general
partnership interest in the operating partnerships, taken as a whole, on a
weighted average basis.
Since the beginning of calendar year 1999, we have been taxed as a qualified
REIT.
Our reincorporation under the laws of the State of Maryland through the merger
of Mission West Properties into Mission West Properties, Inc. occurred on
December 30, 1998, at which time all outstanding shares issued by our
predecessor California corporation were converted into shares of our common
stock on a one-for-one basis.
In July 1999, we completed a public offering of 8,680,000 shares of our common
stock at $8.25 per share. The net proceeds of approximately $66.9 million, after
deducting underwriting discounts and other offering costs, were used primarily
to repay indebtedness.
We have grown through property acquisitions. Since September 1998, we have
acquired a total of approximately 4.3 million rentable square feet of R&D
buildings under the Pending Project Acquisition Agreement, the Berg Land
Holdings Option Agreement, and from unrelated third parties. The total cost of
these properties was approximately $649 million. We issued a total of 27,962,025
O.P. Units and assumed debt totaling approximately $308 million to acquire them.
Since 1998, we have sold a total of approximately 0.9 million rentable square
feet of R&D buildings. The total sales price of these properties was
approximately $128 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 general economic climate;
- - the occupancy rates of the properties;
- - rental rates on new and renewed leases;
- - tenant improvement and leasing costs incurred to obtain and retain tenants;
- - the extent of early lease terminations;
- - operating expenses;
- - cost of capital; and
- - the extent of acquisitions and sales of real estate.
Any negative effects of the above key factors could potentially cause a
deterioration in our revenue and/or earnings.
- 26 -
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. 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. As
discussed in Note 17 - Real Estate Asset Held for Sale and Discontinued
Operations under Item 8, "Financial Statements and Supplementary Data," we
recognized an impairment loss in 2004 on one asset held for sale under the
application of this standard.
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
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.
- 27 -
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 deemed to be
the primary beneficiary in accordance with FASB Interpretation 46R ("FIN 46R"),
a revision to FIN 46, "Consolidation of Variable Interest Entities". As of
December 31, 2006, 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. 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, 2006 TO THE YEAR ENDED DECEMBER 31,
2005
RENTAL REVENUE FROM CONTINUING PROPERTY OPERATIONS
As of December 31, 2006 and 2005, through our controlling interests in the
operating partnerships, we owned 107 R&D properties totaling approximately 7.7
and 7.8 million rentable square feet, respectively. We sold three vacant R&D
properties and acquired three leased R&D properties during 2006.
The following table depicts the amounts of rental revenue from continuing
operations for the years ended December 31, 2006 and 2005 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,
----------------------------------
2006 2005 $ Change % Change
-------------- --------------- -------------- ---------------
(dollars in thousands)
Same Property (1) $88,338 $97,735 ($9,397) (9.6%)
2006 Acquisitions (2) 1,772 - 1,772 100.0%
-------------- --------------- --------------
Total $90,110 $97,735 ($7,625) (7.8%)
============== =============== ==============
(1) "Same Property" is defined as properties owned by us prior to 2005 that we
still owned as of December 31, 2006.
(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.
For the year ended December 31, 2006, our rental revenue from real estate
decreased by ($7.6) million, or (7.8%). Pursuant to SFAS 141, $1.9 million of
amortization expense with respect to above-market leases was offset against
rental revenue from real estate for the years ended December 31, 2006 and 2005.
The ($7.6) million decrease in rental revenue resulted from current adverse
market conditions as "Same Property" rents decreased, due to lease terminations,
cessation of operations and tenant relocation since December 31, 2005.
Our overall occupancy rate for leased properties at December 31, 2006 and 2005
was approximately 69.5% and 68.9%, respectively. According to NAI BT Commercial
Real Estate, the leased occupancy rate for R&D property in the Silicon Valley at
December 31, 2006 was approximately 81.7%. Due to an over supply of R&D
properties and competition from other landlords in the Silicon Valley bidding
for tenants, our occupancy rate may drop further in 2007 if the 742,000 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 our market
specifically and the weaker relative performance of certain properties due to
their location and the weak demand in those submarkets. We are currently
negotiating with three tenants, JDS Uniphase, NEC Electronics America and Dade
Behring, for early termination of leases on approximately 184,000 rentable
square feet. If these leases are terminated, our occupancy rate will decline
further.
EQUITY IN EARNINGS FROM UNCONSOLIDATED JOINT VENTURE
As of December 31, 2006, we had investments in three R&D buildings, totaling
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 January 2003. 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 $0.88 million of which $0.44 million
was our share. 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, 2006 and 2005, equity in earnings from the
unconsolidated joint venture was approximately $2.0 million (including $0.4
million relating to a gain from the sale of real estate) and $0.7 million,
respectively. Our equity in earnings from this unconsolidated joint venture
increased primarily due to a gain on sale of one R&D property and the write-offs
of leasing commission and tenant improvements in 2005 for a tenant that
terminated its lease agreement which did not recur in 2006. The occupancy rate
for the properties owned by this joint venture at December 31, 2006 and 2005 was
approximately 100% and 78.7%, respectively.
OTHER INCOME FROM CONTINUING PROPERTY OPERATIONS
The following table depicts the amounts of other income from continuing
operations for the years ended December 31, 2006 and 2005.
Year Ended December 31,
----------------------------------
2006 2005 $ Change % Change
-------------- -------------- -------------- --------------
(dollars in thousands)
Other income $20,602 $4,591 $16,011 348.7%
Other income of approximately $20.6 million for the year ended December 31, 2006
included approximately $16.1 million from termination fees, $2.3 million from
interest income, $1.1 million from management fee income, $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
- 29 -
miscellaneous income. Other income of approximately $4.6 million for the year
ended December 31, 2005 included approximately $2.4 million from termination
fees, $0.9 million from management fee income, $0.6 million from interest
income, $0.5 million from security deposit forfeitures, $0.1 million from tenant
bankruptcy settlements and $0.1 million from miscellaneous income. A management
fee is paid by the tenant 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, 2006 and 2005 and the percentage of total
decrease in expenses over the period that is represented by each group of
properties.
Year Ended December 31,
----------------------------------
2006 2005 $ Change % Change
-------------- --------------- -------------- ---------------
(dollars in thousands)
Same Property (1) $17,802 $18,427 ($625) (3.4%)
2005 Acquisition (2) 348 332 16 4.8%
2006 Acquisitions (3) 504 - 504 100.0%
-------------- --------------- --------------
Total $18,654 $18,759 ($105) (0.6%)
============== =============== ==============
(1) "Same Property" is defined as properties owned by us prior to 2005 that we
still owned as of December 31, 2006.
(2) Operating expenses for 2005 Acquisition do not reflect a full 12 months of
operations in 2005 because this property was acquired during the year.
(3) 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.
Operating expenses from continuing operations decreased by ($0.1) million, or
(0.6%), from $18.8 million for the year ended December 31, 2005 to $18.7 million
for the year ended December 31, 2006. Tenant reimbursements from continuing
operations decreased by ($1.0) million, or (7.1%), from $14.1 million for the
year ended December 31, 2005 to $13.1 million for the year ended December 31,
2006. The decrease in tenant reimbursements resulted primarily from the JDS
Uniphase lease terminations in early 2006 at three R&D properties consisting of
approximately 252,000 rentable square feet. Total operating expenses exceeded
tenant reimbursements because of vacancies, which reached approximately 2.4
million rentable square feet by year-end 2006. Certain operating expenses such
as property insurance, real estate taxes, and other fixed expenses are not
recoverable from vacant properties. At December 31, 2006 our vacancy rate was
31%.
General and administrative expenses increased by approximately $0.3 million, or
17.7%, from $1.9 million for the year ended December 31, 2005 to $2.2 million
for the year ended December 31, 2006. The increase in general and administrative
expenses was primarily a result of stock option expensing, as well as fees paid
in connection with filing a registration statement for the resale of shares of
common stock to be acquired from time to time upon the exchange of O.P. Units
for stock.
The following table depicts the amounts of depreciation and amortization expense
of real estate from continuing operations for the years ended December 31, 2006
and 2005.
Year Ended December 31,
----------------------------------
2006 2005 $ Change % Change
-------------- -------------- -------------- --------------
(dollars in thousands)
Depreciation and amortization $21,803 $20,553 $1,250 6.1%
Depreciation and amortization expense of real estate from continuing operations
increased by $1.3 million, or 6.1%, primarily due to tenant improvements
write-offs and higher amortization expense for in-place leases arising from the
acquisition of three R&D properties in early 2006.
The following table depicts the amounts of interest expense from operations for
the years ended December 31, 2006 and 2005.
Year Ended December 31,
----------------------------------
2006 2005 $ Change % Change
-------------- -------------- -------------- --------------
(dollars in thousands)
Interest $20,709 $21,295 ($586) (2.8%)
Interest (related parties) 755 972 (217) (22.3%)
-------------- -------------- --------------
Total $21,464 $22,267 ($803) (3.6%)
============== ============== ==============
Interest expense decreased by ($0.6) million, or (2.8%), primarily from a cash
flow interest rate derivative loss of approximately ($0.8) million recognized in
2005 that did not recur in 2006. Interest expense (related parties) decreased by
($0.2) million, or (22.3%), because we paid off the Berg Group line of credit
during 2005 and terminated it effective October 31, 2005.
- 30 -
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, 2006 and
2005.
Year Ended December 31,
--------------------------------
2006 2005 $ Change % Change
------------- -------------- ------------- -------------
(dollars in thousands)
Net income to common stockholders $14,630 $10,027 $4,603 45.9%
Net income to minority interests 66,358 47,524 18,834 39.6%
------------- -------------- -------------
Total $80,988 $57,551 $23,437 40.7%
============= ============== =============
As of December 31, 2006 and 2005, we owned a controlling general partnership
interest of 19.71%, 21.78%, 16.26% and 12.48% and 17.81%, 21.68%, 16.18% and
12.41% 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 18.23% and 17.50% general
partnership interest in the operating partnerships, taken as a whole, on a
consolidated weighted average basis as of December 31, 2006 and 2005,
respectively. Net income to common stockholders in 2006 increased by $4.6
million, or 45.9%, from the year ended December 31, 2005. Our net income
attributable to minority interests in 2006 increased by $18.8 million, or 39.6%,
from the year ended December 31, 2005. The increase in net income attributable
to common stockholders and minority interests is primarily due to higher lease
termination fee income and gain from sale of real estate. Minority interests
represent the limited partners' ownership interest of 81.77% and 82.50% in the
operating partnerships, on a weighted average basis, as of December 31, 2006 and
2005, respectively. The decrease in the minority interest ownership percentage
resulted from the exchange of O.P. Units for common stock and the exercise of
stock options, the proceeds of which we applied to the purchase of additional
general partnership interests.
INCOME FROM DISCONTINUED OPERATIONS
The following table depicts the amounts of income from discontinued operations
for the years ended December 31, 2006 and 2005.
Year Ended December 31,
--------------------------------------------------------------
2006 2005
---------------------------- -----------------------------
(dollars in thousands)
Income attributable to discontinued operations $19,345 $3,874
Minority interests in earnings attributable to discontinued
operations (16,209) (3,170)
---------------------------- -----------------------------
Income from discontinued operations $3,136 $704
============================ =============================
In accordance with our adoption of SFAS 144, in 2006 we sold three R&D
properties consisting of approximately 235,000 rentable square feet 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 restated and presented in discontinued
operations in prior consolidated statements of operations.
We recognized total income of $19.3 million from discontinued operations, of
which $3.1 million and $16.2 million were attributable to common stockholders
and minority interests, respectively, for the year ended December 31, 2006. For
the year ended December 31, 2005, we recognized total income from discontinued
operations of $3.9 million. The income to common stockholders and minority
interests attributable to discontinued operations from these properties in 2005
was approximately $0.7 million and $3.2 million, respectively.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2005 TO THE YEAR ENDED DECEMBER 31,
2004
RENTAL REVENUE FROM CONTINUING PROPERTY OPERATIONS
As of December 31, 2005 and 2004, through our controlling interests in the
operating partnerships, we owned 107 and 109 R&D properties totaling
approximately 7.8 and 7.9 million rentable square feet, respectively. We sold
three vacant R&D properties and acquired one vacant R&D property during 2005.
The following table depicts the amounts of rental revenue from continuing
operations for the years ended December 31, 2005 and 2004 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. We did not
acquire any new properties in 2004.
Year Ended December 31,
----------------------------------
2005 2004 $ Change % Change
-------------- -------------- -------------- --------------
(dollars in thousands)
Same Property $97,735 $115,815 ($18,080) (15.6%)
For the year ended December 31, 2005, our rental revenue from real estate
decreased by ($18.1) million, or (15.6%). Pursuant to SFAS 141, $1.9 million of
amortization expense with respect to above-market leases included in the San
Tomas Technology Park acquisition was offset against rental revenue and not
separately stated as amortization expense for the years ended December 31, 2005
- 31 -
and 2004. The ($18.1) million decrease in rental revenue resulted from current
adverse market conditions as "Same Property" rents decreased, as our portfolio
occupancy rate decreased and market rental rates decreased. The lower rental
rate from a blend and extend lease with Microsoft, which accounted for more than
half the decline, and the loss of several tenants due to cessation of
operations, tenant relocation or tenant requiring lesser space since December
31, 2004 represented the balance of the decline.
Our overall occupancy rate for leased properties at December 31, 2005 and 2004
was approximately 68.9% and 71.2%, respectively. According to NAI BT Commercial
Real Estate, the occupancy rate for R&D property in the Silicon Valley at
December 31, 2005 was approximately 80.4%. 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 our market specifically and the
relative weaker performance of certain properties due to their location and the
weak demand in those submarkets.
EQUITY IN EARNINGS FROM UNCONSOLIDATED JOINT VENTURE
As of December 31, 2005, we had investments in four R&D buildings, totaling
593,000 rentable square feet in Morgan Hill, California, through an
unconsolidated joint venture with TBI, in which we acquired a 50% interest from
the Berg Group in January 2003. We have a non-controlling limited partnership
interest in this joint venture, which we account for using the equity method of
accounting. For the years ended December 31, 2005 and 2004, equity in earnings
from the unconsolidated joint venture was approximately $0.7 million and $2.9
million (including $1.0 million relating to lease termination income),
respectively. Our equity in earnings from this unconsolidated joint venture
declined primarily due to the early termination of a tenant lease agreement in
September 2004 as well as lower rents received from the properties of this joint
venture. The occupancy rate for the properties owned by this joint venture at
December 31, 2005 and 2004 was approximately 78.7%.
OTHER INCOME FROM CONTINUING PROPERTY OPERATIONS
The following table depicts the amounts of other income from continuing
operations for the years ended December 31, 2005 and 2004.
Year Ended December 31,
----------------------------------
2005 2004 $ Change % Change
-------------- -------------- -------------- --------------
(dollars in thousands)
Other income $4,591 $6,862 ($2,271) (33.1%)
Other income of approximately $4.6 million for the year ended December 31, 2005
included approximately $2.4 million from termination fees, $0.9 million from
management fee income, $0.6 million from interest income, $0.5 million from
security deposit forfeitures, $0.1 million from tenant bankruptcy settlements
and $0.1 million from miscellaneous income. Other income of approximately $6.9
million for the year ended December 31, 2004 included approximately $4.3 million
from termination fees, $1.2 million from tenant bankruptcy settlements, $1.2
million from management fee income and $0.2 million from miscellaneous income. A
management fee is paid by the tenant 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 operating expenses from continuing
operations for the years ended December 31, 2005 and 2004 and the percentage of
total decrease in expenses over the period that is represented by each group of
properties.
Year Ended December 31,
----------------------------------
2005 2004 $ Change % Change
-------------- --------------- -------------- ---------------
(dollars in thousands)
Same Property (1) $18,427 $19,111 ($684) (3.6%)
2005 Acquisition (2) 332 - 332 100.0%
-------------- --------------- --------------
Total $18,759 $19,111 ($352) (1.8%)
============== =============== ==============
(1) "Same Property" is defined as properties owned by us prior to 2004 that we
still owned as of December 31, 2005.
(2) Operating expenses for 2005 Acquisition do not reflect a full 12 months of
operations in 2005 because this property was acquired during the year.
Operating expenses for continuing operations decreased by ($0.4) million, or
(1.8%), and tenant reimbursements from continuing operations decreased by ($0.1)
million, or (0.5%), primarily as a result of refunds of real estate taxes in the
amount of approximately $0.7 million from property tax appeals that we filed
under California's Proposition 8 and lower occupancy during the periods
presented. Total operating expenses exceeded tenant reimbursements because of
vacancies, which reached approximately 2.6 million rentable square feet by
year-end 2005. Certain operating expenses such as property insurance, real
estate taxes, and other fixed expenses are not recoverable from vacant
properties. At December 31, 2005 our vacancy rate was 31.1%.
General and administrative expenses decreased by approximately ($0.1) million,
or (5.0%), from $2.0 million for the year ended December 31, 2004 to $1.9
million for the year ended December 31, 2005.
- 32 -
The following table depicts the amounts of depreciation and amortization expense
of real estate from continuing operations for the years ended December 31, 2005
and 2004.
Year Ended December 31,
----------------------------------
2005 2004 $ Change % Change
-------------- -------------- -------------- --------------
(dollars in thousands)
Depreciation and amortization $20,553 $20,827 ($274) (1.3%)
Depreciation and amortization expense of real estate from continuing operations
decreased by ($0.3) million, or (1.3%), primarily due to the disposition of
three R&D properties, a fully amortized in-place lease intangible asset in the
second quarter of 2005, offset by one R&D property acquisition.
The following table depicts the amounts of interest expense from operations for
the years ended December 31, 2005 and 2004.
Year Ended December 31,
----------------------------------
2005 2004 $ Change % Change
-------------- -------------- -------------- --------------
(dollars in thousands)
Interest $21,295 $17,581 $3,714 21.1%
Interest (related parties) 972 1,077 (105) (9.7%)
-------------- -------------- --------------
Total $22,267 $18,658 $3,609 19.3%
============== ============== ==============
Interest expense increased by $3.7 million, or 21.1%, primarily from additional
debt that we incurred under two new collateralized mortgage loans totaling
$150.8 million obtained from Allianz Life Insurance Company of North America in
2005 and from a cash flow interest rate derivative loss of approximately ($0.8)
million. Interest expense (related parties) decreased by ($0.1) million or
(9.7%), because we paid off the Berg Group line of credit during 2005 and
terminated it effective October 31, 2005.
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, 2005 and
2004.
Year Ended December 31,
--------------------------------
2005 2004 $ Change % Change
------------- -------------- ------------- -------------
(dollars in thousands)
Net income to common stockholders $10,027 $13,312 ($3,285) (24.7%)
Net income to minority interests 47,524 66,100 (18,576) (28.1%)
------------- -------------- -------------
Total $57,551 $79,412 ($21,861) (27.5%)
============= ============== =============
As of December 31, 2005 and 2004, we owned a controlling general partnership
interest of 17.81%, 21.68%, 16.18% and 12.41% and 17.16%, 21.63%, 16.14% and
12.38% in the four operating partnerships, Mission West Properties, L.P.,
Mission West Properties, L.P. I, Mission West Properties, L.P. II and Mission
West Properties, L.P. III, respectively. We owned a 17.50% and 17.26% general
partnership interest in the operating partnerships, taken as a whole, on a
consolidated weighted average basis as of December 31, 2005 and 2004,
respectively. Net income to common stockholders in 2005 decreased by ($3.3)
million, or (24.7%), from the year ended December 31, 2004. Our net income
attributable to minority interests in 2005 decreased by ($18.6) million, or
(28.1%), from the year ended December 31, 2004. The decrease in net income
attributable to common stockholders and minority interests is primarily due to
lower income from operations as a result of the decrease in revenues and
increase in interest expense as discussed above. Minority interests represent
the limited partners' ownership interest of 82.50% and 82.74% in the operating
partnerships, on a weighted average basis, as of December 31, 2005 and 2004,
respectively. The decrease in the minority interest ownership percentage
resulted from the exchange of O.P. Units for common stock and the exercise of
stock options, the proceeds of which we applied to the purchase of additional
general partner interests.
INCOME/(LOSS) FROM DISCONTINUED OPERATIONS
The following table depicts the amounts of income/(loss) from discontinued
operations for the years ended December 31, 2005 and 2004.
Year Ended December 31,
--------------------------------------------------------------
2005 2004
---------------------------- -----------------------------
(dollars in thousands)
Income attributable to discontinued operations $3,874 $203
Minority interests in earnings attributable to discontinued
operations (3,170) (290)
---------------------------- -----------------------------
Total income/(loss) from discontinued operations $704 ($87)
============================ =============================
In accordance with our adoption of SFAS 144, in 2005 we sold three R&D
properties consisting of approximately 342,000 rentable square feet and
classified the net gains on sale and operating results of the disposed
properties as discontinued operations. We also sold three R&D properties in 2006
consisting of approximately 235,000 rentable square feet 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
- 33 -
properties to be restated and presented in discontinued operations in prior
consolidated statements of operations. For the years ended December 31, 2005 and
2004, income from discontinued operations included results of operations from
the three R&D properties sold in 2005 and the three R&D properties sold in 2006.
We recognized total income of $3.9 million from discontinued operations, of
which $0.7 million and $3.2 million were attributable to common stockholders and
minority interests, respectively, for the year ended December 31, 2005. For the
year ended December 31, 2004, we recognized total income from discontinued
operations of $0.2 million. The loss to common stockholders attributable to
discontinued operation from these properties in 2004 was approximately
($87,000). The income to minority interests attributable to discontinued
operation from these properties in 2004 was approximately ($0.3) million. In
2004, an impairment charge of approximately ($2.2) million was recorded for an
asset held for sale to reduce the carrying value of the asset to its fair value,
less selling costs.
CHANGES IN FINANCIAL CONDITION
YEAR ENDED DECEMBER 31, 2006
The most significant changes in our financial condition in 2006 resulted from
the acquisition of three R&D properties, the disposition of three R&D
properties, and the exercise of stock options and exchange of O.P. Units for
shares of the Company's common stock.
During 2006, we sold three vacant R&D properties to an unrelated third party for
a total gross sales price of approximately $43.3 million. Those property
dispositions reduced approximately 235,000 rentable square feet of space from
our property portfolio. 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, 2006 (see Item 8, "Financial
Statements and Supplementary Data - Note 6" for further discussion of this
transaction). In addition to those three property dispositions, we also acquired
three R&D properties representing approximately 138,000 rentable square feet for
a total gross combined purchase price of approximately $16.0 million. Two R&D
properties were acquired in a tax-deferred exchange transaction and the other
one in cash.
Debt outstanding, including amounts due related parties, decreased by ($9.7)
million, or (2.7%), from $367.5 million as of December 31, 2005 to $357.8
million as of December 31, 2006 due to normal scheduled debt payments.
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. The total proceeds to the Company of approximately $1.0
million increased paid-in-capital.
In 2006, three limited partners exchanged a total of 871,596 O.P. Units for
871,596 shares of common stock resulting in a reclassification of approximately
$10.2 million from minority interests to paid-in-capital. In 2006, Carl E. Berg
gave 92,300 O.P. Units to charitable institutions. Only 10,300 of those O.P.
Units had been exchanged for 10,300 shares of common stock by December 31, 2006.
The remaining 82,000 O.P. Units were exchanged for 82,000 shares of common stock
in early 2007.
The proceeds from the exercise of stock options and the conversion of O.P. Units
to shares of the Company's common stock were applied to increase our percentage
interest as general partner in the operating partnerships.
YEAR ENDED DECEMBER 31, 2005
The most significant changes in our financial condition in 2005 resulted from
the disposition of three R&D properties, the acquisition of one R&D property,
debt refinancing and the exercise of stock options and exchange of O.P. Units
for shares of the Company's common stock.
During 2005, we sold three vacant R&D properties consisting of approximately
342,000 rentable square feet to unrelated third parties for a total gross sales
price of approximately $27.9 million. The proceeds of approximately $15.1
million from one of 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, 2005. In
addition to those three property dispositions, we also acquired one vacant R&D
property consisting of approximately 204,000 rentable square feet from an
unrelated third party for the purchase price of approximately $14.0 million in a
tax-deferred exchange transaction.
Debt outstanding, including amounts due related parties, increased by $30.5
million, or 9.1%, from $337.0 million as of December 31, 2004 to $367.5 million
as of December 31, 2005 due primarily to two new fixed rate collateralized
mortgage loans from Allianz Life Insurance Company of North America, which were
used primarily to pay down the Citicorp loan, the Berg Group line of credit and
the Cupertino National Bank line of credit.
- 34 -
During the year ended December 31, 2005, stock options to purchase 40,000 shares
of the Company's common stock were exercised at $8.25 per share and stock
options to purchase 15,000 shares of the Company's common stock were exercised
at $10.00 per share. The total proceeds to the Company of approximately $0.5
million increased paid-in-capital.
In 2005, three limited partners exchanged 213,600 O.P. Units for 213,600 shares
of common stock resulting in a reclassification of approximately $2.2 million
from minority interests to paid-in-capital. In 2005, Carl E. Berg gave 83,000
O.P. Units to charitable institutions that exchanged them for 83,000 shares of
common stock resulting in a reclassification of approximately $0.8 million from
minority interest to paid-in-capital.
The proceeds from the exercise of stock options and the conversion of O.P. Units
to shares of the Company's common stock were applied to increase our percentage
interest as general partner in the operating partnerships.
LIQUIDITY AND CAPITAL RESOURCES
In 2007, we anticipate operating cash flows from our property portfolio to be
the same or slightly higher than in 2006. We are still experiencing weak demand
for R&D properties in certain areas of the Silicon Valley (mainly the south San
Jose area). If we are unable to lease a significant portion of the approximately
742,000 rentable square feet scheduled to expire in 2007 and current available
space, our operating cash flows will be affected adversely. In addition, if we
conclude agreements for early lease terminations with JDS Uniphase, NEC
Electronics America and Dade Behring, there could be an additional 184,000
rentable square feet of vacant space. 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 the borrowings
under the line of credit with Santa Clara Valley National Bank (formerly known
as Cupertino National Bank). We expect these sources of liquidity to be adequate
to meet projected distributions to stockholders and other presently anticipated
liquidity requirements in 2007. We expect to meet our long-term liquidity
requirements for the funding of property development, property acquisitions and
other material non-recurring capital improvements through cash and investments,
long-term secured and unsecured indebtedness and the issuance of additional
equity securities by us. We have the ability to meet short-term obligations or
other liquidity needs based on a line of credit with Santa Clara Valley National
Bank and our existing cash reserves. In 2007, we will be obligated to make
payments totaling approximately $11.0 million of debt principal under mortgage
notes without regard to any debt refinancing or new debt obligations that we
might incur, or optional payments of debt principal.
As of December 31, 2006, we were in compliance with loan covenants relating to
the Allianz mortgage loans and the Santa Clara Valley National Bank line of
credit.
Cash and cash equivalents increased by approximately $2.4 million from $31.4
million as of December 31, 2005 to $33.8 million as of December 31, 2006.
Restricted cash totaled $48.2 million as of December 31, 2006. Of this amount,
$43.4 million represents proceeds received from the Samaritan property sale and
earned interest income held in a separate cash account at a trust company for
future use in tax-deferred exchanges (see Item 8, "Financial Statements and
Supplementary Data - Note 6" for further discussion of this transaction). The
remaining $4.8 million represents a balance we consolidated due to our adoption
of FIN 46R, "Consolidation of Variable Interest Entities" (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 currently intend to continue operating as a REIT in 2007. 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.
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 2007, we expect to maintain our current quarterly dividend payment rate to
common stockholders and O.P. Unit holders of $0.16 per share. However,
distributions are declared at the discretion of our Board of Directors and are
subject to actual cash available
- 35 -
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 4, 2007, we paid dividends of $0.16 per share of common stock to all
common stockholders of record as of December 29, 2006. On the same date, the
operating partnerships paid a distribution of $0.16 per O.P. Unit to all holders
of O.P. Units. Aggregate dividends and distributions amounted to approximately
$16.7 million.
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 our contractual obligations as of December 31,
2006 that will impact our liquidity and cash flow in future periods:
------------ ------------ ------------- ------------ ------------ ------------- ------------
2007 2008 2009 2010 2011 Thereafter Total
--------------------------------------------------------------------------------------------
(dollars in thousands)
Long-Term Debt Obligations (1) $11,011 $121,589 $9,561 $10,105 $10,681 $194,808 $357,755
Operating Lease Obligations(2) 95 24 - - - - 119
------------ ------------ ------------- ------------ ------------ ------------- ------------
Total $11,106 $121,613 $9,561 $10,105 $10,681 $194,808 $357,874
============ ============ ============= ============ ============ ============= ============
(1) Our long-term debt obligations are set forth in detail in the schedule
below.
(2) Our operating lease obligations relate to a lease of our corporate office
facility from a related party.
At December 31, 2006, we had total indebtedness of approximately $357.8 million,
all of which is fixed rate mortgage debt. A table listing our indebtedness as of
December 31, 2006 is set forth in Item 8, "Financial Statements and
Supplementary Data - Note 8."
At December 31, 2006, our debt to total market capitalization ratio, which is
computed as our total debt outstanding divided by the sum of total debt
outstanding plus the market value of common stock (based upon the closing price
of $13.10 per share on December 29, 2006) on a fully diluted basis, including
the conversion of all O.P. Units into common stock, was approximately 20.7%. On
December 29, 2006, the last trading day for the year, total market
capitalization was approximately $1.73 billion. By comparison, on December 31,
2005 total debt as a percentage of market capitalization was 26.5% and total
market capitalization was approximately $1.39 billion.
At December 31, 2006, the outstanding balance remaining under certain demand
notes that we owed to the operating partnerships was $1.8 million. The due date
of the demand notes has been extended to September 30, 2008. 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,
-----------------------------------------------------------
2006 2005 2004
----------------- ----------------- -----------------
(dollars in thousands)
Cash flow provided by operating activities $27,012 $21,898 $38,970
Cash flow used in investing activities ($5,369) ($2,875) ($1,519)
Cash flow (used in)/provided by financing activities ($19,299) $10,899 ($40,061)
- 36 -
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2006 TO THE YEAR ENDED DECEMBER 31,
2005
Cash and cash equivalents were approximately $33.8 million at December 31, 2006,
an increase of $2.4 million from $31.4 million at December 31, 2005.
Net cash provided by operating activities for the year ended December 31, 2006
was approximately $27.0 million, compared to approximately $21.9 million for the
prior year. The increase in cash provided by operating activities resulted
primarily from higher lease termination fee income, higher interest income,
higher distributions from our unconsolidated joint venture, higher deferred
rental income and lower leasing commission payments (included in Other assets)
in 2006.
Our cash used in investing is primarily for property acquisitions, property
sales and improvements to our properties. Net cash used in investing activities
was approximately ($5.4) million for the year ended December 31, 2006 compared
to approximately ($2.9) million for the prior year. In 2006, 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 excess
restricted cash of approximately $1.8 million was transferred to our general
cash account. Restricted cash in the amount of approximately $13.5 million was
used to complete the acquisition of two R&D properties in a tax-deferred
exchange transaction involving our former R&D property at 800 Embedded Way, San
Jose, California. We sold three vacant R&D properties for approximately $43.3
million as described above, the proceeds of which are reflected on our
consolidated balance sheet as restricted cash at December 31, 2006. In 2005, we
sold three vacant R&D properties for approximately $27.5 million. We acquired
one vacant R&D property for approximately $14.2 million and incurred capital
expenditures relating to real estate improvements of approximately $1.1 million.
Proceeds of approximately $15.1 million from one of 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, 2005.
Net cash (used in)/provided by financing activities was approximately ($19.3)
million for the year ended December 31, 2006, compared to approximately $10.9
million for the year ended December 31, 2005. During 2006 and 2005, we paid debt
principal and made distributions to holders of our common stock and O.P. Units
utilizing cash generated from operating activities and other borrowed funds.
During 2006, financing activities included the net effect of paying
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 paying approximately $12.1 million to common
stockholders for dividends. During 2005, financing activities included the net
effect of borrowing approximately $150.8 million under two new collateralized
mortgage loans and repaying approximately $120.3 million of outstanding debt. We
also received approximately $0.5 million from stock option exercises, paid
approximately $11.7 million to common stockholders for dividends and paid
approximately $8.4 million to O.P. Unit holders in excess of their share of
earnings for distributions.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2005 TO THE YEAR ENDED DECEMBER 31,
2004
Cash and cash equivalents were approximately $31.4 million at December 31, 2005,
an increase of $29.9 million from $1.5 million at December 31, 2004.
Net cash provided by operating activities for the year ended December 31, 2005
was approximately $21.9 million, compared to approximately $39.0 million for the
prior year. The decrease in cash provided by operating activities resulted
primarily from lower rental revenue with respect to the modification and
extension of our lease with Microsoft, payments of leasing commissions (included
in Other assets) that amounted to approximately $5.3 million, increased interest
expense, lower market rental rates for renewed leases and the loss of several
tenants due to their lease default, cessation of operations, or relocations
resulting in increased vacancy rates for un-leased properties from 29% to 31%
that offset cash savings.
Our cash used in investing is primarily for property acquisitions, property
sales and improvements to our properties. Net cash used in investing activities
was approximately ($2.9) million for the year ended December 31, 2005, compared
to approximately ($1.5) million for the prior year. Cash used in investing
activities during 2005 was primarily for the acquisition of one vacant R&D
property for $14.2 million and capital expenditures relating to real estate
improvements of $1.1 million. We received $27.5 million from the sale of three
vacant R&D properties. Cash used in investing activities during 2004 related to
capital expenditures relating to real estate improvements of $1.5 million.
Net cash provided by/(used in) financing activities was approximately $10.9
million for the year ended December 31, 2005, compared to ($40.1) million for
the year ended December 31, 2004. During 2005, financing activities included the
net effect of borrowing approximately $150.8 million under two new
collateralized mortgage loans and paying approximately $120.3 million for
outstanding debt. We received approximately $0.5 million from stock option
exercises. In 2005 we also used funds for approximately $11.7 million in
dividends to stockholders and approximately $8.4 million in distributions to
O.P. Unit holders. During 2004, financing activities included the net effect of
payment of approximately $7.4 million for outstanding debt, receipt of
approximately $3.6 million from our lines of credit, payment of approximately
$1.6 million for an appeal bond, receipt of approximately $0.2 million from
stock option exercises, payment of approximately $17.3 million to common
stockholders for dividends and payment of approximately $17.6 million to O.P.
Unit holders in excess of their share of earnings for distributions.
- 37 -
CAPITAL EXPENDITURES
The properties require periodic investments of capital for tenant-related
capital expenditures and for general capital improvements. For the years ended
December 31, 2002 through December 31, 2006, the recurring tenant/building
improvement costs and leasing commissions incurred with respect to new leases
and lease renewals of the properties averaged approximately $3.7 million
annually. We will have approximately 742,000 rentable square feet under expiring
leases in 2007. We expect that the average annual cost of recurring
tenant/building improvements and leasing commissions related to these properties
will be approximately $4.0 million during 2007. We believe we will recover
substantially all of these costs from the tenants under the new or renewed
leases through contractual increases in rental rates. Until we actually sign the
leases, however, we cannot assure you that this will occur. Capital expenditures
may fluctuate in any given period subject to the nature, extent, and timing of
improvements required to be made to the properties. Tenant/building improvements
and leasing costs also may fluctuate in any given period year depending upon
factors such as the property, the term of the lease, the type of lease and the
overall market conditions. We expect to meet our long-term liquidity
requirements for the funding of property acquisitions and other material
non-recurring capital improvements through long-term secured and unsecured
indebtedness and the issuance of additional equity securities by the Company,
but cannot be assured that we will be able to meet our requirements on favorable
terms (see "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
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.
- 38 -
While we will emphasize equity real estate investments, we may, in our
discretion and subject to the percentage ownership limitations and gross income
tests necessary for REIT qualification, invest in mortgage and other real estate
interests, including securities of other real estate investment trusts. We have
not previously invested in mortgages or securities of other real estate
investment trusts, and we do not have any present intention to make such
investments.
FINANCING POLICIES
To the extent that our Board of Directors determines to seek additional capital,
we may raise such capital through additional equity offerings, debt financing or
retention of cash flow, or through a combination of these sources, after
consideration of provisions of the Code requiring the distribution by a REIT of
a certain percentage of its taxable income and taking into account taxes that
would be imposed on undistributed taxable income. It is our present intention
that any additional borrowings will be made through the operating partnerships,
although we may incur borrowings that would be re-loaned to the operating
partnerships. Borrowings may be unsecured or may be secured by any or all of our
assets, the operating partnerships or any existing or new property, and may have
full or limited recourse to all or any portion of our assets, the operating
partnerships or any existing or new property.
We have adopted a policy of maintaining a consolidated ratio of debt to total
market capitalization, which includes for this purpose the market value of all
shares of common stock for which outstanding O.P. Units are exchangeable, of
less than 50%. This ratio may not be exceeded without the approval of more than
75% of our entire Board of Directors. We also may determine to finance
acquisitions through the exchange of properties or the issuance of additional
O.P. Units in the operating partnerships, shares of common stock or other
securities.
In the event that the Board of Directors determines to raise additional equity
capital, it has the authority, without stockholder approval, to issue additional
shares of common stock, preferred stock or other capital stock, including
securities senior to the common stock, in any manner and on such terms and for
such consideration it deems appropriate, including in exchange for property. In
the event that we issue any shares of common stock or securities convertible
into or exchangeable or exercisable for, shares of common stock, subject to
limited exceptions, such as the issuance of common stock pursuant to any stock
incentive plan adopted by us or pursuant to limited partners' exercise of the
exchange rights or the put rights, the limited partners will have the right to
purchase common stock or such securities in order to maintain their respective
percentage interests in us on a Fully Diluted basis. If the Board of Directors
determines that we will raise additional equity capital to fund investments by
the operating partnerships, we will contribute such funds to the operating
partnerships as a contribution to capital and purchase of additional general
partnership interest; however, holders of O.P. Units will have the right to
participate in such funding on a pro rata basis. In the event that holders of
O.P. Units sell their O.P. Units to us upon exercise of their put rights, we are
authorized to raise the funds for such purchase by issuing additional shares of
common stock. Alternatively, we may issue additional shares of common stock in
exchange for the tendered O.P. Units.
Our Board of Directors also has the authority to cause the operating
partnerships to issue additional O.P. Units in any manner and on such terms and
for such consideration, as it deems appropriate, including in exchange for
property. In the event that the operating partnerships issue new O.P. Units for
cash, but not property, the limited partners holding O.P. Units in an operating
partnership will have the right to purchase O.P. Units in order, and to the
extent necessary, to maintain their respective percentage interests in that
operating partnership. The new O.P. Units will be exchangeable for common stock
pursuant to the exchange rights or may be tendered to us pursuant to the put
rights.
DISPOSITION POLICIES
From time to time we may dispose of properties in our portfolio, subject to the
required approvals as set forth below. 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. Consequently, it may be in the interests
of the limited partners that we continue to hold the properties in order to
defer such taxable gain. In light of this tax effect, the operating partnership
agreements provide that, until December 29, 2008, or until the Berg Group
members and their affiliates, other than us and the operating partnerships,
beneficially own, in the aggregate, less than 15% of the outstanding shares of
common stock on a Fully Diluted basis, if earlier, Carl E. Berg and Clyde J.
Berg may prohibit the operating partnerships from disposing of properties which
they designate in a taxable transaction. Mr. Kontrabecki has a similar right
with respect to seven of the properties, which right will lapse before the end
of the ten-year period if his beneficial ownership interest falls below 750,000
O.P. Units. The limited partners may seek to cause us to retain the properties
even when such action may not be in the interests of some, or a majority, of our
stockholders. The operating partnerships will be able to effect "tax-deferred,"
like-kind exchanges under Section 1031 of the Code, or in connection with other
non-taxable transactions, such as a contribution of property to a new
partnership, without obtaining the prior written consent of these individuals.
For example, in 2006 we completed the sale of three vacant R&D properties at
Samaritan Drive in San Jose, California consisting of approximately 235,000
rentable square feet. A
- 39 -
total net gain of approximately $18.1 million was recognized on the total sales
price of $43.3 million (see Item 8, "Financial Statements and Supplementary Data
- - Note 6" for further discussion of this transaction). In March 2007, we
acquired 50 acres of vacant land in Morgan Hill, California, which could support
approximately 725,000 rentable square feet of spaces. The acquisition price for
this property was approximately $25.6 million and was funded from a portion of
the proceeds received from the Samaritan property sale, which was classified as
restricted cash as of December 31, 2006.
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 RECENTLY ISSUED ACCOUNTING STANDARDS
We do not believe that recently issued accounting standards will materially
impact our results of operations, cash flows or financial position.
In May 2005, the FASB issued SFAS 154, "Accounting Changes and Error
Corrections" ("SFAS 154"), to replace APB Opinion 20, "Reporting Accounting
Changes in Interim Financial Statements" ("APB 20"). SFAS 154 changes the
requirements for the accounting for and reporting of a change in accounting
principle and requires retrospective application to prior periods' financial
statements, unless it is impracticable to determine period specific effects or
the cumulative effect of the change. SFAS 154 will be effective for accounting
changes and corrections of errors made in fiscal years beginning after December
15, 2005. The adoption of this statement is not expected to have a material
effect on our consolidated results of operations or financial condition.
In June 2006, the FASB issued Interpretation 48, "Accounting for Uncertainty in
Income Taxes" ("FIN 48"). FIN 48 clarifies the accounting for uncertainty in
income taxes recognized in our financial statements in accordance with SFAS 109,
"Accounting for Income Taxes." The provisions of FIN 48 are effective for our
fiscal year beginning January 1, 2007. The adoption of FIN 48 on January 1, 2007
is not expected to have a significant impact on our consolidated results of
operations or financial position.
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 in generally accepted accounting principles, and expands disclosures about
fair value measurements. The provisions of SFAS 157 are effective for our fiscal
year beginning January 1, 2008. We are currently evaluating the impact of the
provisions of SFAS 157 and currently cannot estimate the impact to our
consolidated results of operations or financial position.
- 40 -
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. As of
December 31, 2006, we had no interest rate risk since none of our outstanding
debt is subject to variable interest rates.
We manage our market risk by monitoring interest rates where we try to recognize
the unpredictability of the financial markets and seek to reduce potentially
adverse effect on the results of our operations. This takes frequent evaluation
of available lending rates and examination of opportunities to reduce interest
expense through new sources of debt financing. Several factors affecting the
interest rate risk include governmental monetary and tax policies, domestic and
international economics and other factors that are beyond our control. The
following table provides information about the principal cash flows, weighted
average interest rates, and expected maturity dates for debt outstanding as of
December 31, 2006. The current terms of our outstanding debt are described in
Item 8, "Financial Statements and Supplementary Data - Note 8." Average interest
rates are based on implied LIBOR for the respective time period. For fixed rate
debt, we estimate fair value by using discounted cash flow analyses based on
borrowing rates for similar kinds of borrowing arrangements. The fair value of
the Company's fixed rate debt at December 31, 2006 was approximately $467.7
million.
For fixed rate debt, the table presents the assumption that the outstanding
principal balance at December 31, 2006 will be paid according to scheduled
principal payments and that we will not prepay any of the outstanding principal
balance.
2007 2008 2009 2010 2011 Thereafter Total Fair Value
---- ---- ---- ---- ---- ---------- ----- ----------
(dollars in thousands)
FIXED RATE DEBT:
Secured notes payable $11,011 $121,589 $9,561 $10,105 $10,681 $194,808 $357,755 $467,692
Weighted average interest rate 5.84% 5.84% 5.84% 5.84% 5.84% 5.84%
All of the debt is denominated in United States dollars. The weighted average
interest rate for fixed rate debt was approximately 5.84% for the years ended
December 31, 2006 and 2005. The decrease in interest expense attributable to the
average interest rate difference between 2005 and 2006 was approximately ($0.8)
million, which was a result of normal scheduled debt payments in 2006 and the
termination of the Berg Group line of credit in late 2005.
The primary market risk we face is the risk of interest rate fluctuations. The
Santa Clara Valley National Bank line of credit, which had a balance of zero at
December 31, 2006, is tied to a LIBOR based interest rate. 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. At December 31, 2006, we had no interest rate caps or interest rate swap
contracts.
- 41 -
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
MISSION WEST PROPERTIES, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
---------
Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements 43
Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements 44
Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting 45
Consolidated Balance Sheets as of December 31, 2006 and 2005 46
Consolidated Statements of Operations for the years ended December 31, 2006, 2005 and 2004 47
Consolidated Statements of Stockholders' Equity for the years ended December 31, 2006, 2005 and 2004 48
Consolidated Statements of Cash Flows for the years ended December 31, 2006, 2005 and 2004 49
Notes to Consolidated Financial Statements 50
Supplemental Financial Information 72
Report of Independent Registered Public Accounting Firm on Financial Statement Schedule 73
Report of Independent Registered Public Accounting Firm on Financial Statement Schedule 74
Schedule III: Real Estate and Accumulated Depreciation as of December 31, 2006 76
Schedule III: Real Estate and Accumulated Depreciation as of December 31, 2005 78
- 42 -
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON
CONSOLIDATED FINANCIAL STATEMENTS
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, 2006 and the related
consolidated statements of operations, stockholders' equity and cash flows for
the year then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements 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 the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Mission West
Properties, Inc. as of December 31, 2006, and the results of their operations
and their cash flows for the year then ended in conformity with accounting
principles generally accepted in the United States of America.
As discussed in Note 1 to the consolidated financial statements, on January 1,
2007, the Company changed its method of accounting for stock-based compensation
as a result of adopting Statement of Financial Accounting Standards No. 123R,
Share-Based Payment.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Company's
internal control over financial reporting as of December 31, 2006, 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 12, 2007 expressed an unqualified opinion on management's assessment
of, and the effective operation of, internal control over financial reporting.
We also have audited the adjustments to the consolidated balance sheet as of
December 31, 2005 and the related consolidated statements of operations for the
two years then ended for the retrospective reporting of discontinued operations,
as described in Note 17. In our opinion, such adjustments are appropriate and
have been properly applied. We were not engaged to audit, review, or apply any
procedures to the 2004 and 2005 financial statements of the Company referred to
above other than with respect to the adjustments and, accordingly, we do not
express an opinion or any other form of assurance of the 2004 and 2005 financial
statements taken as a whole.
\S\ Burr, Pilger & Mayer, LLP
San Francisco, California
March 12, 2007
- 43 -
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON
CONSOLIDATED FINANCIAL STATEMENTS
Board of Directors and Stockholders
Mission West Properties, Inc.
Cupertino, California
We have audited, before the effects of the reclassifications to discontinued
operations described in Note 17, the consolidated balance sheet of Mission West
Properties, Inc. (the "Company") as of December 31, 2005 and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the two years in the period ended December 31, 2005 (the 2005 and 2004
financial statements before the effects of the reclassifications to discontinued
operations discussed in Note 17 are not presented herein). These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated 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
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above, before
the effects of the reclassifications to discontinued operations described in
Note 17, present fairly, in all material respects, the financial position of
Mission West Properties, Inc. at December 31, 2005, and the results of its
operations and its cash flows for each of the two years in the period ended
December 31, 2005, in conformity with accounting principles generally accepted
in the United States of America.
We were not engaged to audit, review, or apply any procedures to the
reclassifications to discontinued operations described in Note 17 and,
accordingly, we do not express an opinion or any other form of assurance about
whether such reclassifications are appropriate and have been properly applied.
Those reclassifications were audited by Burr, Pilger & Mayer, LLP.
\S\ BDO Seidman, LLP
San Francisco, California
February 3, 2006
- 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 management's assessment, included in the accompanying
Management's Report on Internal Control over Financial Reporting, that Mission
West Properties, Inc. (the "Company") maintained effective internal control over
financial reporting as of December 31, 2006, based on criteria established in
Internal Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the "COSO criteria"). The Company's
management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on
management's assessment and an opinion on the effectiveness of the Company's
internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that Mission West Properties, Inc.
maintained effective internal control over financial reporting as of December
31, 2006, is fairly stated, in all material respects, based on the COSO
criteria. Also, in our opinion, Mission West Properties, Inc. maintained, in all
material respects, effective internal control over financial reporting as of
December 31, 2006, 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 sheet of
Mission West Properties, Inc. as of December 31, 2006, and the related
consolidated statements of operations, stockholders' equity and cash flows for
the year then ended, and the related financial statement schedule, as of and for
the year ended December 31, 2006, and our report dated March 12, 2007 expressed
an unqualified opinion on those consolidated financial statements and the
related financial statement schedule.
\S\ Burr, Pilger & Mayer, LLP
San Francisco, California
March 12, 2007
- 45 -
MISSION WEST PROPERTIES, INC.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except per share data)
ASSETS
December 31,
---------------------------------------------
2006 2005
---------------------- ---------------------
Real estate:
Land $272,223 $273,933
Buildings and improvements 756,596 766,457
Real estate related intangible assets 19,529 17,410
---------------------- ---------------------
1,048,348 1,057,800
Less accumulated depreciation and amortization (149,459) (130,419)
---------------------- ---------------------
Total investments in real estate, net 898,889 927,381
Cash and cash equivalents 33,785 31,441
Restricted cash 48,245 16,712
Deferred rent receivable, net 18,489 19,218
Investment in unconsolidated joint venture 3,468 3,263
Other assets, net 24,611 25,362
---------------------- ---------------------
Total assets $1,027,487 $1,023,377
====================== =====================
Liabilities:
Mortgage notes payable $348,101 $357,481
Mortgage note payable (related parties) 9,654 10,051
Interest payable 1,375 321
Security deposits 6,977 8,047
Deferred rental income 6,874 6,103
Dividends and distributions payable 16,745 16,725
Accounts payable and accrued expenses 7,601 8,952
---------------------- ---------------------
Total liabilities 397,327 407,680
---------------------- ---------------------
Commitments and contingencies (Note 16)
Minority interests 501,282 500,682
---------------------- ---------------------
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, 19,443,587
and 18,448,791 shares issued and outstanding at December 31, 2006 and 2005 19 18
Paid-in capital 149,541 138,038
Accumulated deficit (20,682) (23,041)
---------------------- ---------------------
Total stockholders' equity 128,878 115,015
---------------------- ---------------------
Total liabilities and stockholders' equity $1,027,487 $1,023,377
====================== =====================
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,
---------------------------------------------------------------
2006 2005 2004
------------------- -------------------- --------------------
Revenues:
Rental revenue from real estate $90,110 $97,735 $115,815
Tenant reimbursements 13,116 14,115 14,192
Other income, including lease terminations, settlements and interest 20,602 4,591 6,862
------------------- -------------------- --------------------
123,828 116,441 136,869
Expenses:
Property operating, maintenance and real estate taxes 18,654 18,759 19,111
Interest 20,709 21,295 17,581
Interest (related parties) 755 972 1,077
General and administrative 2,248 1,910 2,011
Depreciation and amortization of real estate 21,803 20,553 20,827
------------------- -------------------- --------------------
64,169 63,489 60,607
------------------- -------------------- --------------------
Income before equity in earnings of unconsolidated joint venture
and minority interests 59,659 52,952 76,262
Equity in earnings of unconsolidated joint venture 1,985 724 2,947
Minority interests (50,150) (44,353) (65,810)
------------------- -------------------- --------------------
Income from continuing operations 11,494 9,323 13,399
Discontinued operations, net of minority interests:
Gain from disposal of properties classified as discontinued operations 2,935 445 -
Income/(loss) attributable to discontinued operations 201 259 (87)
------------------- -------------------- --------------------
Income/(loss) from discontinued operations 3,136 704 (87)
------------------- -------------------- --------------------
Net income to common stockholders $14,630 $10,027 $13,312
=================== ==================== ====================
Net income to minority interests $66,358 $47,524 $66,100
=================== ==================== ====================
Income per share from continuing operations:
Basic $0.60 $0.51 $0.74
=================== ==================== ====================
Diluted $0.60 $0.51 $0.74
=================== ==================== ====================
Income/(loss) per share from discontinued operations:
Basic $0.17 $0.04 -
=================== ==================== ====================
Diluted $0.16 $0.04 -
=================== ==================== ====================
Net income per share to common stockholders:
Basic $0.77 $0.55 $0.74
=================== ==================== ====================
Diluted $0.76 $0.55 $0.74
=================== ==================== ====================
Weighted average shares of common stock (basic) 19,066,581 18,286,947 18,034,873
=================== ==================== ====================
Weighted average shares of common stock (diluted) 19,298,664 18,325,659 18,076,498
=================== ==================== ====================
Weighted average O.P. Units 85,510,491 86,220,117 86,444,773
=================== ==================== ====================
Outstanding common stock 19,443,587 18,448,791 18,097,191
=================== ==================== ====================
Outstanding O.P. Units 85,206,199 86,088,095 86,384,695
=================== ==================== ====================
See notes to consolidated financial statements.
- 47 -
MISSION WEST PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(dollars in thousands)
Shares of Common Common Paid-in- Accumulated Total Stockholders'
Stock Outstanding Stock Capital Deficit Equity
------------------ -------- ------------ --------------- -------------------
Balance, December 31, 2003 17,894,691 $18 $132,136 ($18,764) $113,390
Net income 13,312 13,312
Dividends declared at $0.88 per share (15,893) (15,893)
Issuance of common stock upon O.P. Unit conversion 182,500 2,238 2,238
Issuance of common stock upon option exercise 20,000 165 165
------------------ -------- ------------ --------------- -------------------
Balance, December 31, 2004 18,097,191 18 134,539 (21,345) 113,212
Net income 10,027 10,027
Dividends declared at $0.64 per share (11,723) (11,723)
Issuance of common stock upon O.P. Unit conversion 296,600 3,019 3,019
Issuance of common stock upon option exercise 55,000 480 480
------------------ -------- ------------ --------------- -------------------
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
Stock option compensation 210 210
Issuance of common stock upon option exercise 112,900 1,014 1,014
------------------ -------- ------------ --------------- -------------------
Balance, December 31, 2006 19,443,587 $19 $149,541 ($20,682) $128,878
================== ======== ============ =============== ===================
See notes to consolidated financial statements.
- 48 -
MISSION WEST PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
Year Ended December 31,
---------------------------------------------------------
2006 2005 2004
----------------- ----------------- ------------------
Cash flows from operating activities:
Net income from continuing operations $11,494 $9,323 $13,399
Net income/(loss) from discontinued operations 3,136 704 (87)
Adjustments to reconcile income from continuing operations to
net cash provided by operating activities:
Minority interests income from continuing operations 50,150 44,353 65,810
Minority interests income from discontinued operations 16,208 3,171 290
Minority interests distributions (55,618) (47,524) (66,100)
Depreciation and amortization of real estate and in-place leases 21,803 20,554 20,826
Depreciation and amortization from discontinued operations 471 1,045 1,050
Amortization of above market lease 1,888 1,888 1,888
Gain from disposal of properties classified as discontinued operations (18,102) (2,206) -
Equity in earnings of unconsolidated joint venture (1,985) (724) (2,947)
Distributions from unconsolidated joint venture 1,780 1,020 1,673
Interest earned on restricted cash (821) (100) -
Lease termination fee income related to restricted cash (4,549) - -
Stock-based compensation expense 236 - -
Asset impairment charge attributable to discontinued operation - - 2,193
Other 37 - -
Change in operating assets and liabilities, net of liabilities assumed:
Deferred rent receivable 729 (707) 459
Other assets 751 (5,709) 2,195
Interest payable 1,054 (6) (5)
Security deposits (1,070) (497) (1,690)
Deferred rental income 771 (4,935) (1,685)
Accounts payable and accrued expenses (1,351) 2,248 1,701
----------------- ----------------- ------------------
Net cash provided by operating activities 27,012 21,898 38,970
----------------- ----------------- ------------------
Cash flows from investing activities:
Improvements to real estate (4,277) (1,138) (1,519)
Proceeds from sales of real estate 42,628 27,508 -
Purchase of real estate (15,959) (14,184) -
Restricted cash held in escrow (43,043) (15,061) -
Restricted cash released for purchase of real estate 13,447 - -
Excess restricted cash 1,835 - -
----------------- ----------------- ------------------
Net cash used in investing activities (5,369) (2,875) (1,519)
----------------- ----------------- ------------------
Cash flows from financing activities:
Proceeds from mortgage loan payable - 150,800 -
Principal payments on mortgage notes payable (9,380) (7,431) (7,036)
Principal payments on mortgage notes payable (related parties) (397) (369) (342)
Net (payments)/proceeds under line of credit (related parties) - (9,560) 3,338
Payment on loan payable - (78,710) -
Net (payments)/proceeds from revolving line of credit - (24,208) 243
Restricted cash for appeal bond - - (1,551)
Refund of appeal bond 1,599 - -
Net proceeds from exercise of stock options 989 480 165
Minority interests distributions in excess of earnings - (8,435) (17,586)
Dividends (12,110) (11,668) (17,292)
----------------- ----------------- ------------------
Net cash (used in)/provided by financing activities (19,299) 10,899 (40,061)
----------------- ----------------- ------------------
Net increase/(decrease) in cash and cash equivalents 2,344 29,922 (2,610)
Cash and cash equivalents, beginning of year 31,441 1,519 4,129
----------------- ----------------- ------------------
Cash and cash equivalents, end of year $33,785 $31,441 $1,519
================= ================= ==================
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
R&D/office properties in the portion of the San Francisco Bay Area commonly
referred to as Silicon Valley. In July 1998, the Company purchased an
approximate 12.11% of four existing limited partnerships (referred to
collectively as the "operating partnerships") and obtained control of these
partnerships by becoming the sole general partner in each one effective July 1,
1998 for financial accounting and reporting purposes. The Company purchased an
approximate 12.11% interest in each of the operating partnerships. All limited
partnership interests in the operating partnerships were converted into
59,479,633 operating partnership ("O.P.") Units, which represented a limited
partnership ownership interest of approximately 87.89% of the operating
partnerships. The operating partnerships are the vehicles through which the
Company holds its real estate investments, makes real estate acquisitions, and
generally conducts its business.
As of December 31, 2006, the Company owns a controlling general partnership
interest of 19.71%, 21.78%, 16.26% and 12.48% 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 18.23% general partnership
interest in the operating partnerships, taken as a whole, on a consolidated
weighted average basis.
The Company, through the operating partnerships, owns interests in 107 R&D
properties at December 31, 2006, all of which are located in Silicon Valley.
BUSINESS SEGMENT INFORMATION
The Company's primary business is the ownership and management of R&D/office
real estate with a geographic concentration in the Silicon Valley of the San
Francisco Bay Area. Accordingly, the Company has concluded it currently has a
single reportable segment for Statement of Financial Accounting Standards
("SFAS") 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 FASB Interpretation 46R ("FIN
46R"), a revision to FIN 46, "Consolidation of Variable Interest Entities."
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.
The purchase price allocation for property acquisitions is determined in
accordance with the following principles under SFAS 141, "Business
Combinations":
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 - Weighted average composite life of 40 years properties
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. In connection with the January 2005 sale of an
asset, an impairment loss of approximately ($2,193) was recorded for the year
ended December 31, 2004 and is classified in discontinued operations, net of
minority interests. No impairment losses were recorded for the years ended
December 31, 2006 and 2005.
ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS
The Company has adopted SFAS 144, which addresses the financial accounting for
the disposal of long lived assets. SFAS 144 requires that the results of
operations and gains or losses on the sale of property sold subsequent to
December 31, 2001 that were not classified as held for sale at December 31, 2001
as well as the results of operations from properties that were classified as
held for sale subsequent to December 31, 2001 be presented in discontinued
operations if both the following criteria are met: (a) the operation and cash
flows of the property have been (or will be) eliminated from the ongoing
operations of the Company as a result of the disposal transaction; and (b) the
Company will not have any significant involvement in the operations of the
property after the disposal transaction. SFAS 144 also requires prior period
results of operations for these properties to be restated and presented in
discontinued operations in prior consolidated statements of operations.
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. Effective January 1, 2002 (through the implementation of SFAS
144), the operating results of real estate assets held for sale and sold are
reported as discontinued operations in the accompanying consolidated statements
of operations. The income/(loss) from discontinued operations includes the
revenues and expenses, including depreciation, associated with the assets. This
classification of operating results as discontinued operations applies
retroactively for all periods presented for assets designated as held for sale
subsequent to January 1, 2002. Additionally, gains and losses on assets
designated as held for sale subsequent to January 1, 2002 are classified as part
of discontinued operations.
- 51 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
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.
RESTRICTED CASH
Restricted cash totaled $48,245 as of December 31, 2006. Of this amount, $43,406
represents proceeds received from the Samaritan property sale and earned
interest income held in a separate cash account at a trust company for future
use in tax-deferred exchanges. The remaining $4,839 represents a balance the
Company consolidated due to its adoption of FIN 46R, "Consolidation of Variable
Interest Entities." 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.
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 and $2,529 in tenant improvements at 5345 Hellyer Avenue in San Jose,
California (see Note 13 below).
MINORITY INTERESTS
Minority interests represent the limited partnership interests in the operating
partnerships. Minority interest in net income is calculated by taking the net
income of the operating partnerships (on a stand-alone basis) multiplied by the
respective minority interest ownership percentage.
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 other income 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. There is no way of predicting or forecasting the timing or amounts of
future lease termination fees.
The Company recognizes income from rent, tenant reimbursements and lease
termination fees and other income once all of the following criteria are met in
accordance with SEC Staff Accounting Bulletin 104, "Revenue Recognition":
- - the agreement has been fully executed and delivered;
- - services have been rendered;
- - the amount is fixed and determinable; and
- - the collectability is reasonably assured.
- 52 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
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, 2006, 2005 and 2004,
no provision for federal income taxes has been included in the accompanying
consolidated financial statements.
For the years ended December 31, 2006 and 2005, the Company's total dividends
paid or payable to the stockholders represent 100% of ordinary income and 89% of
ordinary income and 11% return of capital, respectively, for income tax purposes
(unaudited). For the year ended December 31, 2004, the Company's total dividends
paid or payable to the stockholders represented 98% of ordinary income and 2%
return of capital 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
In December 2004, the FASB issued SFAS 123R, "Share-Based Payment" ("SFAS
123R"), which 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, 2006, the Company had one stock-based
compensation plan. The Company has adopted the requirements of SFAS 123R
effective January 1, 2006 using the modified prospective method of transition.
Accordingly, prior periods have not been restated. The adoption of this standard
did not have a material effect on the Company's consolidated results of
operations, cash flows or financial position.
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. Under SFAS 123R, the Company recorded $236 of expense
for share-based compensation relating to grants of stock options for the year
December 31, 2006.
As of December 31, 2006, there was $92 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 one year.
For 2005 and all prior years, the Company had elected to follow APB 25 and
related interpretations in accounting for its employee and non-employee director
stock options. SFAS 123, "Accounting for Stock-Based Compensation," encourages,
but does not require, companies to record compensation cost for stock-based
employee compensation plans at fair value prior to year 2006. Under APB 25, no
compensation expense related to stock options had been recognized because the
exercise price of the granted options equaled the market price of the underlying
stock on the date of grant. Although the Company had elected to follow APB 25
for previously granted options prior to January 1, 2006, pro forma information
regarding net income and net income per share is required by SFAS 123R for all
periods presented prior to 2006. This information has been determined as if the
Company had accounted for stock options under the fair value method under SFAS
123.
- 53 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
The following table illustrates the unaudited pro forma effect on consolidated
net income available to common stockholders and consolidated earnings per share
if the fair value method had been applied to all outstanding and unvested stock
options for the last two years.
Year Ended December 31,
-------------------------------------------
2005 2004
-------------------- --------------------
(dollars in thousands, except per share data)
Historical net income to common stockholders $10,027 $13,312
Add back compensation expense for stock options included
in historical net income to common stockholders - -
Deduct compensation expense for stock options
determined under fair value based method (161) (176)
Allocation of expense to minority interests 134 145
-------------------- --------------------
Pro forma net income to common stockholders $10,000 $13,281
-------------------- --------------------
Earnings per share - basic:
Historical net income to common stockholders $0.55 $0.74
Pro forma net income to common stockholders $0.55 $0.74
Earnings per share - diluted:
Historical net income to common stockholders $0.55 $0.74
Pro forma net income to common stockholders $0.55 $0.73
In 2005, stock options to purchase 710,000 shares of common stock were granted
to four employees and three non-employee directors. The options vest monthly for
33 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. The options were granted at an exercise price of $10.00 per share.
The estimated fair value of the options granted in 2005 was $1.12 per share on
the date of grant using the Black-Scholes option pricing model with the
following assumptions: dividend yield of 6.4%, volatility of 21.97%, risk free
rates of 4.2% and an expected life of six years. All options were granted at the
fair market value at the date of grant. There were no stock options granted in
years 2006 and 2004.
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 he continues to be employed by the Company.
In April 2005, a total of 290,000 DERs were awarded by the Company's Board of
Directors. The Company recorded DER compensation expense of approximately $186
and $139 in 2006 and 2005, respectively.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments include cash and cash equivalents, accounts
receivable, accounts payable, and debt. Considerable judgment is required in
interpreting market data to develop estimates of fair value. Accordingly, the
estimates presented herein are not necessarily indicative of the amounts that
the Company could realize in a current market exchange. The use of different
market assumptions and/or estimation methodologies may have a material effect on
the estimated fair value amounts. Cash and cash equivalents, accounts
receivable, and accounts payable are carried at amounts that approximate their
fair values due to their short-term maturities. 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, 2006 was approximately $467,692 as
compared to its carrying value of $357,755.
RECLASSIFICATIONS
Certain amounts from prior year's consolidated financial statements have been
reclassified to conform to the presentation of the current year's consolidated
financial statements.
CONCENTRATION OF CREDIT RISK
The Company's properties are not geographically diverse, and its tenants operate
primarily in the information technology industry. Additionally, because the
properties are leased to 79 tenants at December 31, 2006, default by any major
tenant could significantly impact the results of the consolidated total. One
tenant, Microsoft Corporation, accounted for approximately 12.5%, 10.0% and
18.1%
- 54 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
of the Company's cash rental income for the years ended December 31, 2006, 2005
and 2004, respectively, of total cash rental income. Cash rental income from
Microsoft Corporation was $11,728, $10,089 and $21,997 for the years ended
December 31, 2006, 2005 and 2004, respectively. Future minimum rents from this
tenant are $101,331. One other tenant accounted for approximately 10.0%, 12.4%
and 10.8% of the Company's cash rental income for the years ended December 31,
2006, 2005 and 2004, respectively, of total cash rental income. During 2006, six
of the Company's tenants relocated or ceased operations.
NEW ACCOUNTING PRONOUNCEMENTS
In May 2005, the FASB issued SFAS 154, "Accounting Changes and Error
Corrections" ("SFAS 154"), to replace APB Opinion 20, "Reporting Accounting
Changes in Interim Financial Statements" ("APB 20"). SFAS 154 changes the
requirements for the accounting for and reporting of a change in accounting
principle and requires retrospective application to prior periods' financial
statements, unless it is impracticable to determine period specific effects or
the cumulative effect of the change. SFAS 154 will be effective for accounting
changes and corrections of errors made in fiscal years beginning after December
15, 2005. The adoption of this statement is not expected to have a significant
effect on the Company's consolidated results of operations or financial
condition.
In June 2006, the FASB issued Interpretation 48, "Accounting for Uncertainty in
Income Taxes" ("FIN 48"). FIN 48 clarifies the accounting for uncertainty in
income taxes recognized in the Company's financial statements in accordance with
SFAS 109, "Accounting for Income Taxes." The provisions of FIN 48 are effective
for the Company's fiscal year beginning January 1, 2007. The adoption of FIN 48
on January 1, 2007 is not expected to have a significant impact on the Company's
consolidated results of operations or financial position.
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 in generally accepted accounting principles, and expands disclosures about
fair value measurements. The provisions of SFAS 157 are effective for the
Company's fiscal year beginning January 1, 2008. The Company is currently
evaluating the impact of the provisions of SFAS 157 and currently cannot
estimate the impact to the Company's consolidated results of operations or
financial position.
3. DEFERRED RENT ALLOWANCE
The following table represents activity in the deferred rent allowance for the
years ended December 31, 2006, 2005 and 2004.
Provision
Beginning Against Ending
Balance Revenues Charge-off Balance
-------------- ------------ ------------ -------------
(dollars in thousands)
Year ended December 31, 2004 $2,000 $1,313 $1,313 $2,000
Year ended December 31, 2005 $2,000 $785 $785 $2,000
Year ended December 31, 2006 $2,000 $1,216 $1,216 $2,000
4. STOCK TRANSACTIONS
As of December 31, 2006 and 2005, $1,833 and $1,706 remained outstanding under
notes issued in connection with the Company's purchase of its general
partnership interests in 1998 (the "demand notes"), respectively. The demand
notes which accrue interest at 7.25%, along with the interest expense (interest
income to the operating partnerships), are eliminated in consolidation and are
not included in the corresponding line items within the consolidated financial
statements. However, the interest income earned by the operating partnerships,
which is interest expense to the Company, in connection with this debt, is
included in the calculation of minority interest as reported on the consolidated
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, 2008. 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,
- 55 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
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, 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.
During the year ended December 31, 2005, stock options to purchase 40,000 shares
of the Company's common stock were exercised at $8.25 per share and stock
options to purchase 15,000 shares of the Company's common stock were exercised
at $10.00 per share. Total proceeds to the Company were approximately $480.
During the year ended December 31, 2004, stock options to purchase a total of
20,000 shares of the Company's common stock were exercised at $8.25 per share.
Total proceeds to the Company were approximately $165.
In 2006, 2005 and 2004, 881,896, 296,600 and 182,500 O.P. Units were exchanged
for 881,896, 296,600 and 182,500 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.
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 81.77% and 82.50%, on a weighted average basis, of
the ownership interests in the real estate operations of the Company as of
December 31, 2006 and 2005, respectively. 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, 2006, 2005 and 2004, income
associated with the minority interests held by the third parties of the three
consolidated joint ventures was $499, $479 and $486, respectively.
6. REAL ESTATE
PROPERTY ACQUISITIONS
In March 2006, the Company acquired two fully leased office/R&D properties with
approximately 95,700 rentable square feet located at 233 South Hillview Drive in
Milpitas, California from Sipex Corporation in a tax-deferred exchange under
section 1031 of the Internal Revenue Code of 1986. The total acquisition price
for this property was approximately $13,411 and was funded from the proceeds
received from the 800 Embedded Way property sale, which were held by a third
party and classified as restricted cash as of December 31, 2005.
The purchase price of the 233 South Hillview Drive acquisition was allocated to
long-lived assets and the value of an in-place lease. The in-place lease was
valued at fair market so there was no intangible asset allocated to
above-or-below market lease value. The Company recorded $1,374 of the purchase
price as real estate related intangible assets in the accompanying consolidated
balance sheet for the value of an in-place lease. The intangible assets are
amortized over the applicable remaining lease terms.
In April 2006, the Company acquired a fully leased office/R&D property with
approximately 42,100 rentable square feet located at 1875 Charleston Road in
Mountain View, California by purchasing Mission West Charleston, LLC, an entity
controlled by Carl E. Berg. The total acquisition price for this entity was
$2,615, which is subject to a ground lease with an unrelated party for the
underlying property that runs through June 2057. The acquisition was paid in
cash.
The purchase price of the 1875 Charleston Road acquisition was allocated to
long-lived assets and the value of an in-place lease. The in-place lease was
valued at fair market so there was no intangible asset allocated to
above-or-below market lease value. The Company recorded $745 of the purchase
price as real estate related intangible assets in the accompanying consolidated
balance sheet for the value of an in-place lease. The intangible assets are
amortized over the applicable remaining lease term.
- 56 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
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.
In 2005, the Company acquired a 203,800 rentable square feet vacant R&D property
located at 5521 Hellyer Avenue in San Jose, California. The purchase price for
the property was approximately $14,026. The COmpany allocated the purchase price
to land, building, and building improvments based upon the estimated relative
fair values of such assets. Since the property was acquired vacant, there was no
purchase price allocation to lease intangible assets.
PROPERTY DISPOSITIONS
In the fourth quarter, the Company disposed of three vacant R&D properties at
2033-2243 Samaritan Drive in San Jose, California consisting of approximately
235,000 rentable square feet. A total net gain of approximately $18,102 was
recognized and classified as discontinued operations, net of minority interests,
on the total sales price of $43,271. These properties were subject to a contract
of sale from an unrelated party for the purchase of a total of three R&D
properties located at Samaritan Drive that the Company signed on July 17, 2006.
On March 8, 2007, the Company acquired 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 $25,638 and was funded from a portion of the proceeds
received from the Samaritan property sale, which was classified as restricted
cash as of December 31, 2006. The remaining balance in restricted cash will be
used for future tax-deferred property exchanges.
In 2005, the Company completed the sale of three R&D properties consisting of
342,350 rentable square feet, which included the R&D properties at 3120 Scott
Boulevard, Santa Clara, California, 405 Tasman Drive, Sunnyvale, California and
800 Embedded Way, San Jose, California. A loss of approximately ($2,193) was
realized on the sales price of $8,500 for the 3120 Scott Boulevard property and
was provided for in the fourth quarter 2004 as an asset impariment charge under
discontinued operations, net of minority interests. A total gain of
approximately $2,206 was recognized in 2005 and classified as discontinued
operations, net of minority interests, on the total sales price of $19,355 for
the 405 Tasman and 800 Embedded Way properties. The gain from the 405 Tasman
Drive sale was from recognized based on the installment method of profit
recognition since the buyer did not make a sufficient initial down payment.
Proceeds of approximately $15,061 from the 800 Embedded Way sale were classified
as restricted cash to be used in tax-deffered property exchanges as of December
31, 2005. These proceeds were used in 2006 to fund the acquisition of 233 South
Hillview Drive in Milpitas, California.
BERG LAND HOLDINGS OPTION AGREEMENT
Under the terms of the Berg Land Holdings Option Agreement, the Company, through
the operating partnerships, has the option to acquire any future R&D property
developed by the Berg Group on land currently owned or optioned, or acquired for
these purposes in the future, directly or indirectly, by Carl E. Berg or Clyde
J. Berg. At present, there are approximately 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 21
acquisitions under the Berg Land Holdings Option Agreement representing
approximately 2,034,000 rentable square feet. The acquired properties cost
approximately $207,803, for which the Company issued 7,933,849 O.P Units and
assumed debt of approximately $118,042. 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
- 57 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
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%, the Company also has an option to
purchase all land acquired, directly or indirectly, by Carl E. Berg or Clyde J.
Berg in the future which has not been improved with completed buildings and
which is zoned for, intended for or appropriate for R&D, office and/or
industrial development or use in the states of California, Oregon, and
Washington.
Although the Company has the right to acquire the new properties available to it
under the terms of the Berg Land Holdings Option Agreement, there can be no
assurance that the Company actually will consummate any intended transactions.
Furthermore, the Company has not yet determined the means by which it would
acquire and pay for any such properties or the impact of any of the acquisitions
on its business, results of operations, financial condition or available cash
for distribution.
Given the economic downturn in the Silicon Valley, the Company may not be able
to maintain historical levels of growth from acquisitions of new developments in
the future.
7. VARIABLE INTEREST ENTITY
In December 2003, the FASB issued FIN 46R. 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 entitiy 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.
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 March 2006, one of the Company's tenants, JDS Uniphase ("JDS"), entered into
an assignment of lease agreement with an unrelated party, M&M Real Estate
Control & Restructuring, LLC ("M&M"), in connection with leases for
approximately 252,000 rentable square feet located in San Jose, California. M&M
assumed all of JDS's remaining obligations under these leases, acquired certain
personal property of JDS located on the premises and received a payment of
approximately $11,147. At the same time, the Company entered into a consent for
assignment of lease with both parties and a mutual release agreement with JDS,
pursuant to which all of the JDS's obligations under these leases have been
effectively transferred to M&M. M&M must continue to perform all of the
obligations under the assumed JDS leases and has the right to sublease any or
all of the 252,000 rentable square feet vacated by JDS for the remainder of the
current lease terms, which expire in 2006 and 2007. Under the terms of the
agreement, the Company will receive monthly rent payments of approximately $733
from April 2006 through December 2006, $545 from January 2007 through August
2007 and $330 from September 2007 through November 2007. Based upon the
provisions of FIN 46R, the Company determined that M&M is a VIE. The Company
further determined that the Company is the primary beneficiary of this VIE
because the assignment of lease noted above is the only property under
management by M&M, and therefore has consolidated this entity for financial
reporting purposes. Upon consolidation, the Company recognized a lease
termination fee of $11,147 in March 2006.
- 58 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
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 assignment of a lease is the only property under management
by M&M.
- - Because M&M is a newly formed entity it 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 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, 2006 and 2005.
Balance at Maturity Interest
Debt Description Collateral Properties December 31, Date Rate
- ------------------------------------ --------------------------------- ---------------------------- -------------- ---------
2006 2005
- ------------------------------------ --------------------------------- ---------------------------- -------------- --------
(dollars in thousands)
Line of Credit:
Santa Clara Valley Nat'l Bank (1) Not Applicable - - December 2007 (1)
------------- -------------
Mortgage Notes Payable(related parties):5300-5350 Hellyer Ave., San Jose, CA $9,654 $10,051 June 2010 7.650%
------------- -------------
Mortgage Notes Payable: (2)
Prudential Insurance Co. of America (3) 10300 Bubb Road, Cupertino, CA 114,994 117,290 October 2008 6.560%
10500 North De Anza Blvd, Cupertino, CA
4050 Starboard Drive, Fremont, CA
45700 Northport Loop, Fremont, CA
45738 Northport Loop, Fremont, CA
450 National Ave, Mountain View, CA
6311 San Ignacio Avenue, San Jose, CA
6321 San Ignacio Avenue, San Jose, CA
6325 San Ignacio Avenue, San Jose, CA
6331 San Ignacio Avenue, San Jose, CA
6341 San Ignacio Avenue, San Jose, CA
6351 San Ignacio Avenue, San Jose, CA
3236 Scott Blvd, Santa Clara, CA
3560 Bassett Street, Santa Clara, CA
3570 Bassett Street, Santa Clara, CA
3580 Bassett Street, Santa Clara, CA
1135 Kern Avenue, Sunnyvale, CA
1212 Bordeaux Lane, Sunnyvale, CA
1230 E. Arques, Sunnyvale, CA
1250 E. Arques, Sunnyvale, CA
1170 Morse Avenue, Sunnyvale, CA
1600 Memorex Drive, Santa Clara, CA
1688 Richard Avenue, Santa Clara, CA
1700 Richard Avenue, Santa Clara, CA
3540 Bassett Street, Santa Clara, CA
3542 Bassett Street, Santa Clara, CA
3544 Bassett Street, Santa Clara, CA
3550 Bassett Street, Santa Clara, CA
Northwestern Mutual Life Ins. Co. (4) 1750 Automation Parkway, San Jose, CA 88,411 91,417 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
2251 Lawson Lane, Santa Clara, CA
1325 McCandless Drive, Milpitas, CA
1650-1690 McCandless Drive, Milpitas, CA
20605-20705 Valley Green Dr., Cupertino, CA
Allianz Life Insurance Company (I)(5) 5900 Optical Court, San Jose, CA 24,598 25,269 August 2025 5.560%
Allianz Life Insurance Company (II)(5) 5325-5345 Hellyer Avenue, San Jose, CA 120,098 123,505 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
20400 Mariani Avenue, Cupertino, CA
10450-10460 Bubb Road, Cupertino, CA
------------ ------------
348,101 357,481
------------ ------------
Total $357,755 $367,532
============ ============
(1) Santa Clara Valley National Bank ("SCVNB") was formerly known as Cupertino
National Bank. Interest rate for the SCVNB line of credit is LIBOR plus
1.75%. The interest rate for the SCVNB line of credit at December 31, 2006
and 2005 was 7.08% and 6.14%, respectively. On July 22, 2005, the Company
entered into a "Change in Terms Agreement" with SCVNB, which reduced the
maximum borrowing amount on the Company's revolving line of credit facility
with that bank from $40 million to $9 million. In December 2005, the
Company entered into another "Change in Terms Agreement" with SCVNB that
increased the facility from $9 million to $10 million. The SCVNB line of
credit contains certain financial loan and reporting covenants as defined
in the loan agreement. As of December 31, 2006, the Company was in
compliance with these loan covenants.
(2) Mortgage notes payable generally require monthly installments of interest
and principal ranging from $177 to $840 over various terms extending
through the year 2025. The weighted average interest rate of mortgage notes
payable was 5.84% at December 31, 2006 and 2005.
(3) The Prudential Insurance loan is payable in monthly installments of $827,
which includes principal (based upon a 30-year amortization) and interest.
A limited partner, who is not a member of the Berg Group, has guaranteed
approximately $12,000 of this debt. Costs and fees incurred with obtaining
this loan aggregated approximately $900, which were deferred and amortized
over the loan period. The Prudential loan contains certain customary
covenants as defined in the loan agreement. As of December 31, 2006, the
Company was in compliance with these loan covenants.
- 60 -
(4) The Northwestern loan is payable in monthly installments of $696, which
includes principal (based upon a 20-year amortization) and interest. Costs
and fees incurred with obtaining this loan aggregated approximately $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, 2006, the Company was in compliance with these loan
covenants.
(5) The Allianz loans are payable in monthly installments of $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, 2006, the Company was in compliance with
these loan covenants.
Scheduled principal payments on debt as of December 31, 2006 are as follows:
Fixed Rate Debt
(Including Related Parties)
----------------------------------
December 31, 2007 $11,011
December 31, 2008 121,589
December 31, 2009 9,561
December 31, 2010 10,105
December 31, 2011 10,681
Thereafter 194,808
----------------------------------
Total $357,755
==================================
INTEREST RATE DERIVATIVE
In 2005, the Company entered into a cash flow interest rate derivative as a
means to hedge exposure to an increase in interest rates prior to securing a
loan commitment in connection with a refinancing of certain variable rate debt
to fixed rate long term mortgage debt. The Company secured a 20 year fixed rate
mortgage loan commitment for $125,000 at 5.22% annual interest rate and closed
the derivative contracts. Since the interest rate derivative contracts did not
qualify as a designated cash flow interest rate hedge in accordance with SFAS
133, "Accounting for Derivative Instruments and Hedging Activities," the Company
recorded an $834 charge to interest expense in 2005. There were no interest rate
derivatives in 2006.
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.
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 $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 $50,151.
During 2005, 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 $66,887, including $16,725
payable in January 2006. Total distributions attributable to O.P. Units owned by
various members of the Berg Group were $50,209.
During 2004, the Company, as general partner of the operating partnerships,
declared quarterly dividends/distributions aggregating $0.88 per common share
and O.P. Unit for total dividends/distributions of $91,944, including $16,718
payable in January 2005. During the fourth quarter of 2004, the Company's Board
of Directors reduced the quarterly dividends/distributions from $0.24 per common
share and O.P. Unit to $0.16 per common share and O.P. Unit. Total distributions
attributable to O.P. Units owned by various members of the Berg Group were
$69,075, which was financed by the Company as a draw on the Berg Group line of
credit.
- 61 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
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; 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, consultants and directors necessary to build the Company's
infrastructure and to provide ongoing incentives to the Company's employees in
the form of options to purchase the Company's common stock by enabling them to
participate in the Company's success.
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, consultants and directors of the Company. 3,281,089 shares
of common stock were available for future option or award grants under the 2004
Plan as of December 31, 2006 and 2005. In addition, 272,000 shares of common
stock subject to options granted under the Company's 1997 Plan, which options
expired unexercised in 2006, can be added to the reserve of shares available for
future grant under the 2004 Plan.
Stock options to purchase 710,000 shares of common stock were granted to four
employees and three non-employee directors in 2005. The estimated fair value of
the options was $1.12 per share on the date of grant using the Black-Scholes
option pricing model with the following assumptions: dividend yield of 6.4%,
volatility of 21.97%, risk free rates of 4.2% and an expected life of six years.
All options were granted at the fair market value at the date of grant. No
options were granted in years 2006 and 2004.
The remaining contractual lives of unexercised option grants range from April
2009 to April 2011.
The following table shows the combined activity and detail for the 1997 and 2004
Plans for each of the three years in the period ended December 31, 2006.
Weighted Average
Options Exercise Price
Outstanding Per Share
------------------ ----------------------
Balance, December 31, 2003 787,000 $11.36
Options exercised (20,000) $8.25
------------------ ----------------------
Balance, December 31, 2004 767,000 $11.44
Options granted 710,000 $10.00
Options exercised (55,000) $8.73
------------------ ----------------------
Balance, December 31, 2005 1,422,000 $10.83
Options exercised (112,900) $8.76
Options cancelled (272,000) $13.00
------------------ ----------------------
Balance, December 31, 2006 1,037,100 $10.48
================== ======================
Available for grant at December 31, 2006 3,281,089
Available for grant at December 31, 2005 3,281,089
- 62 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
The following table summarizes information regarding options outstanding for the
2004 Plan at December 31, 2006:
Options Outstanding Options Exercisable Options Not Exercisable
-------------------------------------------------------------------------------------------------
Weighted
Average
Remaining Weighted Weighted Weighted
Contractual Life Average Average Average
Range of Exercise Prices Options in Years Exercise Price Options Exercise Price Options Exercise Price
--------------------------------------------------------------------------------------------------------------------------
$10.00 662,100 4.33 $10.00 425,429 $10.00 236,671 $10.00
$11.33 375,000 2.33 $11.33 354,167 $11.33 20,833 $11.33
------------ ------------ ------------
$10.00 to $11.33 1,037,100 3.61 $10.48 779,596 $10.60 257,504 $10.11
============ ============ ============
None of the options granted are contingent upon the attainment of performance
goals or subject to other restrictions. As of December 31, 2006 and 2005,
"in-the-money" outstanding options to purchase 779,596 and 80,000 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, retaining and motivating its personnel which is necessary to
build the Company's infrastructure, achieve the Company's business goals and
enhance stockholder value. No options or awards may be granted under the 2004
Plan after November 24, 2014.
Awards and options granted under the 2004 Plan may be granted to any employees,
non-employee directors or consultants of the Company and any corporation or
other entity affiliated with the Company, including the Operating Partnerships.
Only employees of the Company or a corporate subsidiary may receive incentive
stock options. Options can be granted to non-employee directors and consultants
of the Company and to employees of the Company or a corporate subsidiary. No
individual may receive in any one calendar year awards covering more than
500,000 of the total number of shares of stock.
The options generally are granted at the fair market value of the Company's
common shares at the date of grant, vest over a four-to-six year period, are
exercisable upon vesting and expire six-to-eight years from the date of grant.
The exercise price for all incentive stock options under the 2004 Plan shall not
be less than the fair market value of the underlying common shares at the time
the option was granted.
Under the 2004 Plan, each non-employee member of the board of directors who
became or becomes a member of the board of the directors after November 24,
2004, the date on which the Plan was approved by the Company's stockholders,
will receive automatically a grant of an option to purchase 50,000 shares of
common stock at an exercise price equal to 100% of the fair market value of the
common stock at the date of grant of such option. Such options become
exercisable cumulatively with respect to 1/48th of the underlying shares on the
first day of each month following the date of grant. Generally, the options must
be exercised while the optionee remains a director. In addition, the board of
directors may authorize annual option grants or awards to non-employee directors
in the board's discretion as long as the number of shares or equivalent number
of underlying shares of common stock in the case of certain awards, does not
exceed 50,000 per year. A disinterested majority of the board also may authorize
additional options and awards to a director serving as a Committee chair or
providing other extraordinary service to the Board. The 2004 Plan further
provides that upon an acquisition of the Company in which more than 50% of the
total voting power of the Company's outstanding securities is transferred to the
acquirer or acquiring parties, options and awards held by non-employee directors
will vest in full and become exercisable prior to their expiration.
The board of directors may terminate the 2004 Plan at any earlier time or make
modifications of the 2004 Plan as it deems advisable. Awards and options granted
at any time during the term of the 2004 Plan will not expire solely because of
the termination of the 2004 Plan, and no amendment or modification of the 2004
Plan shall affect the terms of any outstanding award unless the board expressly
provides otherwise. Termination or amendment of the 2004 Plan may not adversely
affect the rights of the recipient of an award without his or her consent. The
Compensation Committee of the Board of Directors may amend the terms of any
option or award previously granted, but such amendment may not impair the rights
of the recipient without his or her consent.
A total of 3,991,089 shares of common stock are reserved for issuance under the
2004 Plan, in addition to 767,000 shares subject to outstanding options if they
expire unexercised, of which options to purchase 272,000 shares of common stock
have expired to date. 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
- 63 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
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, 2006, 2005 and 2004, the Company recognized $103,
$103 and $92 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.
Year Ended Year Ended Year Ended
December 31, 2006 December 31, 2005 December 31, 2004
--------------------------------------------------------------------
(dollars in thousands, except per share data)
Numerator:
Income from continuing operations $11,494 $9,323 $13,399
Income/(loss) from discontinued operations 3,136 704 (87)
------------------- ------------------- --------------------
Net income to common stockholders $14,630 $10,027 $13,312
------------------- ------------------- --------------------
Denominator:
Weighted average shares of common stock (basic) 19,066,581 18,286,947 18,034,873
Effect of dilutive securities:
Incremental shares from assumed stock options exercise 232,083 38,712 41,625
------------------- ------------------- --------------------
Weighted average shares of common stock (diluted) 19,298,664 18,325,659 18,076,498
------------------- ------------------- --------------------
Per share data:
Basic net income per share:
Net income to common stockholders before discontinued
operations $0.60 $0.51 $0.74
Discontinued operations 0.17 0.04 -
------------------- ------------------- --------------------
Net income to common stockholders $0.77 $0.55 $0.74
------------------- ------------------- --------------------
Diluted net income per share:
Net income to common stockholders before discontinued
operations $0.60 $0.51 $0.74
Discontinued operations 0.16 0.04 -
------------------- ------------------- --------------------
Net income to common stockholders $0.76 $0.55 $0.74
=================== =================== ====================
Outstanding options to purchase 647,000 and 272,000 shares in 2005 and 2004,
respectively, were excluded from the computation of diluted net income per share
under the treasury stock method because the option exercise price was greater
than the weighted average exercise price of the Company's common stock during
the respective periods. The outstanding O.P. Units have been excluded from the
diluted net income per share calculation as there would be no effect on the
diluted net income per share since the minority interests' share of income would
also be added back to net income. O.P. Units outstanding at December 31, 2006,
2005 and 2004 were 85,206,199, 86,088,095 and 86,384,695, respectively.
12. OTHER INCOME
Other income from continuing operations was approximately $20,602, $4,591 and
$6,862 for the years ended December 31, 2006, 2005 and 2004, respectively. For
the year ended December 31, 2006, termination fees, prior tenant bankruptcy
settlements, management fee income, interest income and security deposit
forfeitures accounted for approximately $16,068, $183, $1,070, $2,344 and $104,
respectively, of other income. For the year ended December 31, 2005, termination
fees, prior tenant bankruptcy settlements, management fee income, interest
income and security deposit forfeitures accounted for approximately $2,407,
$108, $936, $567 and $455, respectively, of other income. For the year ended
December 31, 2004, termination fees, prior tenant bankruptcy settlements and
- 64 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
management fee income accounted for approximately $4,250, $1,199 and $1,201,
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, 2006 and 2005, the Berg Group owned 77,392,648 and 77,490,528
O.P. Units, respectively, of the total 85,206,199 and 86,088,095 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, 2006 and 2005,
respectively, assuming conversion of the O.P. Units into common shares of the
Company.
The Company periodically acquires un-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 April 2006, the Company acquired a fully leased office/R&D property with
approximately 42,100 rentable square feet located at 1875 Charleston Road in
Mountain View, California by purchasing Mission West Charleston, LLC, an entity
controlled by Carl E. Berg. The total acquisition price for this entity was
$2,615, which is subject to a ground lease with an unrelated party for the
underlying property that runs through June 2057. The acquisition was paid in
cash. The transaction was approved by the Independent Directors Committee of the
Company's Board of Directors.
The Company did not acquire any properties from the Berg Group in 2005.
DEBT WITH THE BERG GROUP
Effective October 31, 2005, the Company and the Berg Group mutually agreed to
terminate the $20 million line of credit with the Berg Group. The Berg Group
line of credit was originally scheduled to mature in March 2006. The Company did
not incur any fees or charges for terminating the Berg Group line of credit.
Additionally, in 2006, 2005 and 2004, the operating partnerships declared
distributions of $0.64, $0.64 and $0.88 per O.P. Unit, respectively. Interest
expense incurred in connection with the Berg Group line of credit was $188 and
$266 for the years ended December 31, 2005 and 2004, respectively.
As of December 31, 2006 and 2005, debt in the amount of $9,654 and $10,051,
respectively, was due the Berg Group under a mortgage note established May 15,
2000 in connection with the acquisition of a 50% interest in Hellyer Avenue
Limited Partnership, the obligor under the mortgage note. The mortgage note
bears interest at 7.65%, and is due in ten years with principal payments
amortized over 20 years. Interest expense incurred in connection with the Berg
Group mortgage note was $755, $784 and $811 for the years ended December 31,
2006, 2005 and 2004, respectively.
TRANSFER OF INTEREST TO BERG GROUP IN CONSOLIDATED JOINT VENTURE
In July 2000, the Hellyer Avenue Limited Partnership ("Hellyer LP") was formally
organized as a California limited partnership between Mission West Properties,
L.P. ("MWP"), of which the Company as the managing general partner, and Republic
Properties 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.
- 65 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
Because RPC's interest in Hellyer LP was attributable solely to its commitment
to obtain Stellex as a tenant for the property, the partnership agreement
provided that if a payment default occurred within the first five years of the
Stellex lease, RPC would lose 100% of its interest in the partnership, and if a
payment default occurred during the second five year period under the lease, RPC
would lose 50% of its interest in Hellyer LP.
Pursuant to RPC's commitment to Hellyer LP, Stellex executed a lease agreement
obligating Stellex, among other things, to pay monthly rent starting at $1.60
per square foot on a triple net basis for 15 years and to reimburse BBE for the
tenant improvement obligations, which ultimately totaled approximately $10.5
million.
Under the lease terms, Stellex was obligated to reimburse BBE in full for the
tenant improvement costs no later than August 25, 2000. Several days before the
due date, representatives of Stellex met with representatives of MWP and
informed them that Stellex could not pay the balance due BBE. Stellex requested
MWP immediately to draw down the letter of credit as a result of default on the
tenant improvement payment required under the lease.
On September 1, 2000, MWP, as the general partner of Hellyer LP, ceased all
allocations of income and cash flow to RPC and exercised the right under the
partnership agreement to cancel RPC's entire interest in the partnership.
Following discussions with and approval by the Independent Directors Committee,
the Company authorized the transfer of RPC's interest in Hellyer LP to BBE.
Under the Berg Land Holdings Option Agreement and the Acquisition Agreement
dated as of May 14, 1998, the Independent Directors Committee of the Board of
Directors had the right, but not the obligation, to reacquire on behalf of the
Company the property interest and the related distributions related to the
property interest at any time. The transfer was effective as of September 1,
2000.
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 $0.8 million, $0.7 million and $0.7
million in 2006, 2005 and 2004, respectively. As of December 31, 2006,
accumulated cash flow distributions from Hellyer LP totaling approximately $3.7
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.
If the litigation is ultimately decided in favor of the Company, the Independent
Directors Committee of the Board of Directors has the right, but not the
obligation, to acquire on behalf of the Company the former RPC interest and
related distributions from BBE under the terms of the Berg Land Holdings Option
Agreement and the Acquisition Agreement between the Company and the Berg Group.
ACQUISITION OF CARL E. BERG'S INTEREST IN UNCONSOLIDATED JOINT VENTURE
In July 1999, 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 $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
- 66 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
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 $8,450. The total gain on the sale was approximately $876 of which
$438 was the Company's share. TBI-MWP currently own three fully leased buildings
totaling approximately 466,600 rentable square feet.
BERG CONTROLLED ENTITIES HAVE FINANCIAL INTERESTS IN CERTAIN TENANTS THAT LEASE
SPACE FROM THE COMPANY
During the years ended December 31, 2006, 2005 and 2004, 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 tenants
contributed $1,875, $731 and $866 in rental revenue in 2006, 2005 and 2004,
respectively. Under the Company's Charter, bylaws and agreements with the Berg
Group, the individual members of the Berg Group are prohibited from acquiring
shares of the Company's common stock if such acquisition would result in their
beneficial ownership percentage of the Company's common stock causing the
Company to violate any REIT qualification requirement.
BERG GROUP COMMITMENT TO COMPLETE FUTURE IMPROVEMENTS AND BUILDING IN CONNECTION
WITH CERTAIN ACQUISITIONS FROM THE BERG GROUP UNDER THE BERG LAND HOLDINGS
OPTION AGREEMENT
The Berg Group has an approximately $2,529 commitment to complete certain tenant
improvements in connection with the Company's 2002 acquisition of 5345 Hellyer
Avenue in San Jose, California. The Company recorded this portion of its
purchase consideration paid to the Berg Group as an "Other assets" on its
consolidated balance sheets. The Berg Group plans to satisfy this commitment to
complete certain tenant improvements when requested by the Company following the
approval of the Independent Directors Committee.
The Berg Group has an approximately $7,494 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 as an
"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
One tenant is currently leasing four R&D buildings from the Company and is also
leasing raw land from Carl E. Berg. Total rent from the tenant is paid directly
to the Company, which includes the land rent. The Company reimburses Carl E.
Berg $85 per month for the land rent portion.
BERG GROUP HIRED TO PERFORM RESTORATIONS
In March 2006, the Company and Fujitsu Limited, or Fujitsu, agreed to the
termination of a lease for one building consisting of approximately 125,000
rentable square feet. Fujitsu is responsible for repairing damages to the
building and with the Company's Independent Directors Committee approval has
hired Berg & Berg Enterprises, LLC to perform the restoration work for a total
of approximately $4,500.
LEASING AND OVERHEAD REIMBURSEMENTS PROVIDED BY BERG CONTROLLED ENTITY
The Company currently leases office space owned by Berg & Berg Enterprises,
Inc., an affiliate of Carl E. Berg and Clyde J. Berg. Rental amount and overhead
reimbursements paid to Berg & Berg Enterprises, Inc. were $90 for each year
ended December 31, 2006, 2005 and 2004.
14. FUTURE MINIMUM RENTS
The Company, through the operating partnerships, owns interests in 107 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, 2006, excluding tenant
reimbursements of expenses are as follows:
- 67 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
Year Minimum Rent
--------------------------------------------
(dollars in thousands)
2007 $87,719
2008 78,376
2009 74,465
2010 67,415
2011 54,974
Thereafter 110,755
---------------------------
Total $473,704
===========================
15. SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest was approximately $20,137, $21,842 and $18,363 for the
years ended December 31, 2006, 2005 and 2004, respectively.
Amounts of approximately $50,166, $50,223 and $75,326 were paid to the Berg
Group for distributions declared to O.P. Unit holders during the years ended
December 31, 2006, 2005 and 2004, respectively. The amounts paid in 2005 and
2004 were treated as draws under the Berg Group line of credit.
For the years ended December 31, 2006, 2005 and 2004, 881,896, 296,600 and
182,500 O.P. Units were exchanged for 881,896, 296,600 and 182,500 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
$10,279, $3,019 and $2,238 for the years ended December 31, 2006, 2005 and 2004,
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. Management is not aware
of any litigation against the Company and believes the ultimate outcome would
not have a material adverse effect on the consolidated cash flows, financial
position or results of operations of the Company. The Company is currently
involved in the following legal proceedings, and does not believe the ultimate
outcome of any of these proceedings will have a material adverse effect on its
financial condition or operating results.
REPUBLIC PROPERTIES CORPORATION ("RPC") V. MISSION WEST PROPERTIES, L.P., IN THE
CIRCUIT COURT OF MARYLAND FOR BALTIMORE CITY CASE NO. 24-C-00-005675. On
November 20, 2000, RPC commenced a lawsuit against the Company in the Circuit
Court of Maryland for Baltimore City. After lengthy litigation, which included a
trial on the merits and subsequent appears, in April 2006 Maryland's highest
Court upheld an earlier Maryland Appeals Court ruling in favor of the Company,
finding that the Circuit Court of Maryland could not assert personal
jurisdiction over the Company in the RPC suit. The Court vacated the judgment
and decision in the trial court and dismissed the entire Maryland suit (see Note
13 above under, "Transfer of Interest to Berg Group in Consolidated Joint
Venture" for information about the Hellyer Avenue Limited Partnership and the
historical transactions underlying this litigation).
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, the Company 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 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. 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 is in the process of seeking a
writ from the California State Court of Appeal for the Sixth District directing
the Superior Court to sustain the demurrer.
In January 2004, the GLOBAL CROSSING ESTATE REPRESENTATIVE, FOR ITSELF AND THE
LIQUIDATING TRUSTEE OF THE GLOBAL CROSSING LIQUIDATING TRUST V. MISSION WEST
PROPERTIES L.P. filed an action in United States Bankruptcy Court Southern
District of New York Case No. 02-40188 (REG) asserting that payments of $815
made in the ordinary course of business within 90 days of the Global Crossing
bankruptcy filing were avoidable preference payments. During the course of
settlement discussions with Global Crossing's representative, we learned that we
would receive only 2-3% of our unsecured claim of $16,711 for unpaid rent from
the final distribution of the assets and proceeds of bankruptcy estate. On
February 21, 2007, we and the Liquidating Trustee entered into a
- 68 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
settlement agreement under which the $815 claim against us was dismissed and we
agreed to accept a payment of approximately $150 as a final settlement of our
claim for unpaid rent.
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, 2006.
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, 2006.
SEISMIC ACTIVITY
The Company's properties are located in an active seismic area of Silicon
Valley. Insurance policies currently maintained by the Company do not cover
seismic activity, although they do cover losses from fires after an earthquake.
ENVIRONMENTAL ISSUES
The environmental investigations that have been conducted on the Company's
properties have not revealed any environmental liability that 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.
BERG LAND HOLDINGS OPTION AGREEMENT
In April 2005, the Berg Group disclosed the receipt of an offer from an
unrelated party to purchase a portion of the Piercy & Hellyer land comprised of
approximately 10 acres in San Jose, California that is subject to the Berg Land
Holdings Option Agreement with the Company. The prospective purchaser disclosed
its intention to develop "for sale" industrial type buildings and the
Independent Directors Committee, which is responsible for reviewing, evaluating
and authorizing action with respect to any transaction between the Company and
any member of the Berg Group, authorized removal of this approximately 10-acre
parcel of land from the scope of the Berg Land Holdings Option Agreement,
subject to the completion of the sale to the unrelated party. The Independent
Directors Committee's approval also included a requirement that in the event
this parcel of land is not sold to this prospective purchaser, the parcel would
not be deemed to be removed from the scope of the agreement and would remain
eligible for potential future acquisition by the Company under the Berg Land
Holdings Option Agreement. In the third quarter of 2006, the Berg Group informed
the Company that the prospective purchaser withdrew its offer.
In light of the overcapacity in the Silicon Valley R&D properties market, the
Berg Group currently is seeking local government approval of a proposed rezoning
of the 160-acre Evergreen site to permit residential development on a
substantial portion of the site. The Independent Directors Committee, which is
responsible for reviewing, evaluating and authorizing action with respect to any
transaction between the Company and any member of the Berg Group, authorized
removal of the Evergreen site from the scope of the Berg Land Holdings Option
Agreement, subject to the completion of the rezoning of the 160-acre Evergreen
site, or portion thereof, for residential development. In making this
determination, the Independent Directors Committee considered a number of
factors, including risks and other potentially adverse consequences that could
be associated with large scale residential development activities. Any portion
of the Evergreen site that is not rezoned as residential property is not deemed
to be removed from the scope of the Berg Land Holdings Option Agreement and
would remain eligible for potential future acquisition by the Company under the
Berg Land Holdings Option Agreement.
- 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 had entered into sales agreements with unrelated parties to sell
Morse Avenue and McCandless Drive 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 buyer. As of December 31,
2006 the contract to sell a portion of the McCandless Drive project expired;
however, the Company is in active discussions with other unrelated prospective
buyers for various portions of the project. As a result of the conditions agreed
to by the Company with the buyers of Morse Avenue and the status of discussions
to sell McCandless Drive, these assets do not meet the criteria set forth in
SFAS 144 to be classified as assets held for sale. The following summarizes the
properties described above:
Property Number of Buildings Rentable Square Feet Acre Sales Price
-------- ------------------- -------------------- ---- -----------
McCandless Drive
Milpitas, California 14 706,000 46.3 N/A
Morse Avenue
Sunnyvale, California 1 39,200 2.25 $8,250
17. REAL ESTATE ASSET HELD FOR SALE AND DISCONTINUED OPERATIONS
Effective January 1, 2002, the Company adopted 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, 2006, 2005 and 2004. 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, 2006, there were no properties under contract to be sold or
otherwise disposed of which would qualify as assets held for sale.
There was one R&D property under contract to be sold or otherwise disposed of
which did qualify as an asset held for sale as of December 31, 2004. Based on
the expected net proceeds of the sale of that property, the Company recorded an
asset impairment charge of ($2,193) in 2004. The property was sold for $8,500 in
January 2005. The Company decided to sell the property after an unsolicited
offer was made from an unrelated third party.
In 2005, the Company sold three R&D properties for a total sales price of
$27,855 (including the one sold in January 2005) resulting in a net gain of
$2,206. In 2006, the Company sold three R&D properties for a total sales price
of $43,271 resulting in a net gain of $18,102. Results of operations for these
properties for the years ended December 31, 2006, 2005 and 2004 are as follows:
Year Ended December 31,
-------------------------------------------------------------
2006 2005 2004
----------------- ----------------- -----------------
Revenues: (dollars in thousands)
Rental revenue from real estate $1,730 $3,044 $4,090
Tenant reimbursements 262 647 845
Other income 255 16 55
----------------- ----------------- -----------------
Total revenues 2,247 3,707 4,990
----------------- ----------------- -----------------
Expenses:
Property operating, maintenance and real estate taxes 534 993 1,544
Depreciation of real estate 471 1,045 1,050
Asset impairment charge - - 2,193
----------------- ----------------- -----------------
Total expenses 1,005 2,038 4,787
----------------- ----------------- -----------------
Income from discontinued operations 1,242 1,669 203
Gain from disposal of discontinued operations 18,102 2,206 -
Minority interests in earnings from discontinued operations (16,208) (3,171) (290)
----------------- ----------------- -----------------
Income/(loss) from discontinued operations $3,136 $704 ($87)
================= ================= =================
For the years ended December 31, 2006, 2005 and 2004, income from discontinued
operations included results of operations from three R&D properties sold in 2006
and three R&D properties sold in 2005.
- 70 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
18. PROPERTY ACQUISITIONS
For real estate acquired subsequent to June 30, 2001, the effective date of SFAS
141, "Business Combinations," the fair value of the real estate acquired is
allocated to the acquired tangible assets, consisting of land, building and
building/tenant improvements, and identified intangible assets and liabilities,
including the value of the above or below market leases and in-place leases.
In March 2006, the Company acquired two R&D properties at 233 South Hillview
Drive in Milpitas, California for $13,411 from an unrelated party in a
tax-deferred exchange transaction. The purchase price was allocated to
long-lived assets and the value of an in-place lease as follows:
Land $ 3,335
Buildings and improvements 8,702
In-place lease 1,374
-------
Total cash purchase price $13,411
=======
In April 2006, the Company acquired one R&D property at 1875 Charleston Road in
Mountain View, California for $2,615 by purchasing Mission West Charleston, LLC,
an entity controlled by Carl E. Berg. The acquisition is subject to a ground
lease with an unrelated party for the underlying property that runs through June
2057. The purchase price was allocated to long-lived assets and the value of an
in-place lease as follows:
Buildings and improvements $1,870
In-place lease 745
------
Total cash purchase price $2,615
======
In 2005, the Company acquired a 203,800 rentable square foot vacant R&D property
located at 5521 Hellyer Avenue in San Jose, California. The purchase price for
the property was approximately $14,026. The Company allocated the purchase price
to land, building, and building improvements based upon the estimated relative
fair values of such assets. Since the property was acquired vacant, there was no
purchase price allocation to lease intangible assets.
The results of operations for the three R&D property acquisitions have 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 terms. Amortization expense related to in-place leases of
$1,613, $1,444 and $1,762 was recorded for the years ended December 31, 2006,
2005 and 2004, respectively.
Details of real estate related intangible assets at December 31, 2006 and 2005
are as follows:
December 31,
-------------------------------------------
2006 2005
------------------- -------------------
(dollars in thousands)
Amortizable intangible assets:
Above-market lease $11,172 $11,172
In-place leases 8,357 6,238
------------------- -------------------
Gross real estate related intangible assets 19,529 17,410
Less accumulated amortization (11,907) (8,405)
------------------- -------------------
Net real estate related intangible assets $7,622 $9,005
=================== ===================
The estimated aggregate amortization expense for the real estate related
intangible assets for each of the five succeeding fiscal years is as follows:
Estimated Above Market
Estimated In-placen Lease Lease Amortization Estimated
Year Amortization (expense) (revenue off-set) Total Amortization
-----------------------------------------------------------------------------------------
(dollars in thousands)
2007 $1,618 $1,888 $3,506
2008 724 1,888 2,612
2009 608 315 923
2010 442 - 442
2011 139 - 139
-----------------------------------------------------------------------
Total $3,531 $4,091 $7,622
=======================================================================
- 71 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
19. SUPPLEMENTAL FINANCIAL INFORMATION (Unaudited)
Quarterly financial information for the year ended December 31, 2006 (1) is as
follows:
For the Three Months Ended
March 31, June 30, September 30, December 31,
(Unaudited)
----------------------------------------------------------------------------------------
Rental revenue from continuing operations $23,576 $21,588 $22,107 $22,839
Income before gain on sales of assets,
equity in earnings of unconsolidated
joint venture and minority interests $27,688 $10,186 $9,966 $11,819
Income from continuing operations (2) $5,068 $2,032 $2,109 $2,286
Income/(loss) from discontinued operations (2) $85 $89 ($3) $2,964
Net income $5,153 $2,121 $2,106 $5,250
Per share data:
Basic net income per share $0.28 $0.11 $0.11 $0.27
Diluted net income per share $0.28 $0.11 $0.11 $0.27
Weighted average shares of common stock (basic) 18,455,897 19,028,240 19,350,672 19,417,823
Weighted average shares of common stock (diluted) 18,520,297 19,123,945 19,418,884 19,630,674
Quarterly financial information for the year ended December 31, 2005 (1) is as
follows:
For the Three Months Ended
March 31, June 30, September 30, December 31,
(Unaudited)
----------------------------------------------------------------------------------------
Rental revenue from continuing operations $25,475 $24,343 $23,935 $23,982
Income before gain on sales of assets,
equity in earnings of unconsolidated
joint venture and minority interests $13,833 $14,488 $11,787 $12,844
Income from continuing operations (2) $2,365 $2,633 $2,069 $2,255
Income from discontinued operations (2) $43 $62 $382 $218
Net income $2,408 $2,695 $2,451 $2,473
Per share data:
Basic net income per share $0.13 $0.15 $0.13 $0.13
Diluted net income per share $0.13 $0.15 $0.13 $0.13
Weighted average shares of common stock (basic) 18,110,524 18,257,982 18,356,278 18,418,855
Weighted average shares of common stock (diluted) 18,136,797 18,283,058 18,407,891 18,432,819
(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) Amounts may not equal previously reported results due to reclassification
between income from continuing operations and income from discontinued
operations.
20. SUBSEQUENT EVENTS
On January 4, 2007, the Company paid dividends of $0.16 per share of common
stock to all common stockholders of record as of December 29, 2006. On the same
date, the operating partnerships paid a distribution of $0.16 per O.P. Unit to
all holders of O.P. Units. Aggregate dividends and distributions amounted to
approximately $16,745.
On March 8, 2007, the Company acquired 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 $25,638 and was funded from a portion of the proceeds
received from the Samaritan property sale, which was classified as restricted
cash as of December 31, 2006.
- 72 -
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON
FINANCIAL STATEMENT SCHEDULE
Board of Directors and Stockholders
Mission West Properties, Inc.
Cupertino, StateCalifornia
The audit referred to in our report dated March 12, 2007 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, 2006.
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, 2006
presents fairly, in all material respects, the information set forth therein.
\S\ Burr, Pilger & Mayer, LLP
San Francisco, California
March 12, 2007
- 73 -
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON
FINANCIAL STATEMENT SCHEDULE
Board of Directors and Stockholders
Mission West Properties, Inc.
Cupertino, California
The audits referred to in our report dated February 3, 2006 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 as of December 31, 2005 listed in the accompanying index.
This financial statement schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion on this financial
statement schedule based upon our audits.
In our opinion such financial statement schedule presents fairly, in all
material respects, the information set forth therein.
\S\ BDO Seidman, LLP
San Francisco, California
February 3, 2006
- 74 -
INTENTIONALLY BLANK
- 75 -
MISSION WEST PROPERTIES, INC.
Schedule III
Real Estate and Accumulated Depreciation and Amortization
December 31, 2006
(dollars in thousands)
Initial Cost Total Cost
---------------------- Cost -----------------------
December 31, Buildings Subsequent to Buildings
2006 and Construction/ and
Property Name City Encumbrances Land Improvements Acquisition Land Improvements Total
- -------------------------------------------- ------------ --------- ------------ ------------- ---------- ------------ ------------
5300-5350 Hellyer Avenue San Jose C $9,654 $5,742 $11,442 $5,742 $11,442 $17,184
10401-10411 Bubb Road Cupertino A 633 3,078 633 3,078 3,711
45365 Northport Loop Fremont 2,447 5,711 $11 2,447 5,722 8,169
45700 Northport Loop Fremont F 1,184 5,760 7 1,184 5,767 6,951
45738 Northport Loop Fremont F 891 4,338 5 891 4,343 5,234
4050 Starboard Drive Fremont F 1,329 6,467 8 1,329 6,475 7,804
3501 W. Warren Ave/Fremont Fremont 1,866 9,082 1,213 1,866 10,295 12,161
48800 Milmont Blvd Fremont 1,013 4,932 1,013 4,932 5,945
4750 Patrick Henry Drive Santa Clara 1,604 7,805 405 1,604 8,210 9,814
3520 Bassett Street Santa Clara D 1,104 5,371 1,104 5,371 6,475
3530 Bassett Street Santa Clara B,D 849 4,133 849 4,133 4,982
5850-5870 Hellyer Avenue San Jose 2,787 6,502 109 2,787 6,611 9,398
5750 Hellyer Avenue San Jose 3,266 3,354 2,455 3,266 5,809 9,075
800 Embedded Way San Jose 1,794 - 1,794 - 1,794
5500 Hellyer Avenue San Jose 4,735 12,484 39 4,735 12,523 17,258
5550 Hellyer Avenue San Jose 3,261 3,478 3,261 3,478 6,739
5400 Hellyer Avenue San Jose 3,238 5,007 215 3,238 5,222 8,460
5325 Hellyer Avenue San Jose H 4,684 10,230 40 4,684 10,270 14,954
5345 Hellyer Avenue San Jose H 4,866 5,822 4,866 5,822 10,688
5905-5965 Silver Crk Valley RdSan Jose 8,437 17,316 8,437 17,316 25,753
5905-5965 Silver Crk Valley RdSan Jose 3,438 2,727 3,438 2,727 6,165
855 Embedded Way San Jose K 3,289 6,521 68 3,289 6,589 9,878
1065-1105 La Avenida Street Mt. View 46,832 109,275 65 46,832 109,340 156,172
1875 Charleston Road Mt. View M - 2,615 - 2,615 2,615
1750 Automation Parkway San Jose G 4,789 11,174 315 4,789 11,489 16,278
1756 Automation Parkway San Jose G 4,378 10,216 15 4,378 10,231 14,609
1762 Automation Parkway San Jose G 4,804 12,224 20 4,804 12,244 17,048
1768 Automation Parkway San Jose H 8,195 19,121 23 8,195 19,144 27,339
255 Caspian Drive Sunnyvale 3,491 7,160 1,658 3,491 8,818 12,309
245 Caspian Drive Sunnyvale 5,894 - 5,894 - 5,894
5970 Optical Court San Jose 2,758 8,395 2,758 8,395 11,153
5900 Optical Court San Jose H 3,634 12,677 83 3,634 12,760 16,394
2630 Orchard Parkway San Jose 2,931 5,863 22 2,931 5,885 8,816
2610 Orchard Parkway San Jose J 2,615 5,231 2,615 5,231 7,846
55 West Trimble Road San Jose J 4,435 8,869 4,435 8,869 13,304
2001 Walsh Avenue Santa Clara E,I 4,610 5,245 4,610 5,245 9,855
2880 Scott Boulevard Santa Clara E,H,I 14,501 25,501 14,501 25,501 40,002
2890 Scott Boulevard Santa Clara E,H,I 3,081 10,844 3,081 10,844 13,925
2770-2800 Scott Boulevard Santa Clara E,H 7,138 7,075 170 7,138 7,245 14,383
2300 Central Expressway Santa Clara E,I 2,390 14,418 2,390 14,418 16,808
2220 Central Expressway Santa Clara E,I 3,304 3,427 816 3,304 4,243 7,547
2330 Central Expressway Santa Clara E 3,673 3,932 677 3,673 4,609 8,282
233 South Hillview Drive Milpitas N 3,335 10,076 3,335 10,076 13,411
2251 Lawson Lane Santa Clara G 1,952 9,498 1,952 9,498 11,450
1230 East Arques Sunnyvale F 540 2,628 39 540 2,667 3,207
1250 East Arques Sunnyvale F 1,335 6,499 1,335 6,499 7,834
20400 Mariani Avenue Cupertino H 1,670 8,125 1,670 8,125 9,795
10500 De Anza Blvd Cupertino F 7,666 37,304 7,666 37,304 44,970
20605-20705 Valley Green Dr. Cupertino G 3,490 16,984 3,490 16,984 20,474
10300 Bubb Road Cupertino F 635 3,090 635 3,090 3,725
10440 Bubb Road Cupertino 434 2,112 102 434 2,214 2,648
10460 Bubb Road Cupertino H 994 4,838 1,252 994 6,090 7,084
1135 Kern Avenue Sunnyvale F 407 1,982 407 1,982 2,389
450 National Avenue Mt. View F 611 2,973 72 611 3,045 3,656
3301 Olcott Street Santa Clara 1,846 8,984 37 1,846 9,021 10,867
2800 Bayview Avenue Fremont 1,070 5,205 60 1,070 5,265 6,335
5521 Hellyer Avenue San Jose 4,534 9,650 4,534 9,650 14,184
6850 Santa Teresa Blvd San Jose 377 1,836 819 377 2,655 3,032
6810 Santa Teresa Blvd San Jose 2,567 5,991 234 2,567 6,225 8,792
Accumulated
Depreciation Date of Depreciable
Property Name City & Amortization Acquisition Life
- -------------------------------------------- ---------------- --------------- -------------
5300-5350 Hellyer Avenue San Jose C $1,895 5/00 L
10401-10411 Bubb Road Cupertino A 656 7/98 L
45365 Northport Loop Fremont 904 10/00 L
45700 Northport Loop Fremont F 1,226 7/98 L
45738 Northport Loop Fremont F 926 7/98 L
4050 Starboard Drive Fremont F 1,378 7/98 L
3501 W. Warren Ave/Fremont Fremont 2,424 7/98 L
48800 Milmont Blvd Fremont 1,049 7/98 L
4750 Patrick Henry Drive Santa Clara 1,836 7/98 L
3520 Bassett Street Santa Clara D 1,142 7/98 L
3530 Bassett Street Santa Clara B,D 880 7/98 L
5850-5870 Hellyer Avenue San Jose 1,346 11/98 L
5750 Hellyer Avenue San Jose 454 8/01 L
800 Embedded Way San Jose - 3/00 L
5500 Hellyer Avenue San Jose 1,857 2/01 L
5550 Hellyer Avenue San Jose 515 6/01 L
5400 Hellyer Avenue San Jose 996 7/00 L
5325 Hellyer Avenue San Jose H 1,581 1/01 L
5345 Hellyer Avenue San Jose H 848 1/02 L
5905-5965 Silver Crk Valley RdSan Jose 2,381 7/01 L
5905-5965 Silver Crk Valley RdSan Jose 358 10/01 L
855 Embedded Way San Jose K 977 5/01 L
1065-1105 La Avenida Street Mt. View 21,182 4/99 L
1875 Charleston Road Mt. View M 141 4/06 L
1750 Automation Parkway San Jose G 2,154 7/99 L
1756 Automation Parkway San Jose G 1,803 1/00 L
1762 Automation Parkway San Jose G 2,083 4/00 L
1768 Automation Parkway San Jose H 2,923 12/00 L
255 Caspian Drive Sunnyvale 1,637 4/00 L
245 Caspian Drive Sunnyvale - 4/01 L
5970 Optical Court San Jose 630 12/03 L
5900 Optical Court San Jose H 1,475 7/02 L
2630 Orchard Parkway San Jose 731 3/02 L
2610 Orchard Parkway San Jose J 632 3/02 L
55 West Trimble Road San Jose J 1,072 3/02 L
2001 Walsh Avenue Santa Clara E,I 1,488 4/03 L
2880 Scott Boulevard Santa Clara E,H,I 4,416 4/03 L
2890 Scott Boulevard Santa Clara E,H,I 1,516 4/03 L
2770-2800 Scott Boulevard Santa Clara E,H 676 4/03 L
2300 Central Expressway Santa Clara E,I 7,800 4/03 L
2220 Central Expressway Santa Clara E,I 433 4/03 L
2330 Central Expressway Santa Clara E 409 4/03 L
233 South Hillview Drive Milpitas N 403 3/06 L
2251 Lawson Lane Santa Clara G 2,020 7/98 L
1230 East Arques Sunnyvale F 595 7/98 L
1250 East Arques Sunnyvale F 1,382 7/98 L
20400 Mariani Avenue Cupertino H 1,729 7/98 L
10500 De Anza Blvd Cupertino F 7,931 7/98 L
20605-20705 Valley Green Dr. Cupertino G 3,613 7/98 L
10300 Bubb Road Cupertino F 658 7/98 L
10440 Bubb Road Cupertino 514 7/98 L
10460 Bubb Road Cupertino H 1,412 7/98 L
1135 Kern Avenue Sunnyvale F 424 7/98 L
450 National Avenue Mt. View F 644 7/98 L
3301 Olcott Street Santa Clara 1,912 7/98 L
2800 Bayview Avenue Fremont 1,168 7/98 L
5521 Hellyer Avenue San Jose 556 2/05 L
6850 Santa Teresa Blvd San Jose 753 7/98 L
6810 Santa Teresa Blvd San Jose 1,234 3/99 L
- 76 -
Initial Cost Total Cost
---------------------- Cost -----------------------
December 31, Buildings Subsequent to Buildings
2006 and Construction/ and
Property Name City Encumbrances Land Improvements Acquisition Land Improvements Total
- -------------------------------------------- ------------ --------- ------------ ------------- ---------- ------------ ------------
140-160 Great Oaks Blvd. San Jose 1,402 6,822 754 1,402 7,576 8,978
6541 Via del Oro/6385 San Ig. San Jose G 1,039 5,057 72 1,039 5,129 6,168
6311-6351 San Ignacio Ave. San Jose F 6,247 30,396 170 6,247 30,566 36,813
6320-6360 San Ignacio Ave. San Jose G 2,616 12,732 439 2,616 13,171 15,787
75 E. Trimble Rd/2610 N. 1st San Jose 3,477 16,919 85 3,477 17,004 20,481
1170 Morse Avenue Sunnyvale F 658 3,201 658 3,201 3,859
3236 Scott Blvd Santa Clara F 1,234 6,005 1,234 6,005 7,239
1212 Bordeaux Lane Sunnyvale F 2,250 10,948 2,250 10,948 13,198
1325-1810 McCandless Drive Milpitas G 13,994 66,213 1,420 13,994 67,633 81,627
1600 Memorex Drive Santa Clara F 1,221 5,940 11 1,221 5,951 7,172
1688 Richard Avenue Santa Clara F 1,248 2,913 6 1,248 2,919 4,167
1700 Richard Avenue Santa Clara F 1,727 4,030 1,727 4,030 5,757
3506-3510 Bassett Street Santa Clara D 943 4,591 182 943 4,773 5,716
3540-3544 Bassett Street Santa Clara F,D 1,565 7,615 195 1,565 7,810 9,375
3550 Bassett Street Santa Clara F,D 1,079 5,251 33 1,079 5,284 6,363
3560 Bassett Street Santa Clara F,D 1,075 5,233 8 1,075 5,241 6,316
3570-3580 Bassett Street Santa Clara F,D 1,075 5,233 1,075 5,233 6,308
Prudential Ins. Co. of America F 114,994
Northwestern Mutual Life Insurance Co. G 88,411
Allianz Life Insurance Company H 144,696
------------ --------- ------------ ------------- ---------- ------------- -----------
$357,755 $272,223 $761,696 $14,429 $272,223 $776,125 $1,048,348
============ ========= ============ ============= ========== ============= ===========
Accumulated
Depreciation Date of Depreciable
Property Name City & Amortization Acquisition Life
- -------------------------------------------- ---------------- --------------- -------------
140-160 Great Oaks Blvd. San Jose 1,744 7/98 L
6541 Via del Oro/6385 San Ig. San Jose G 1,100 7/98 L
6311-6351 San Ignacio Ave. San Jose F 6,592 7/98 L
6320-6360 San Ignacio Ave. San Jose G 2,865 7/98 L
75 E. Trimble Rd/2610 N. 1st San Jose 3,677 7/98 L
1170 Morse Avenue Sunnyvale F 682 7/98 L
3236 Scott Blvd Santa Clara F 1,278 7/98 L
1212 Bordeaux Lane Sunnyvale F 2,330 7/98 L
1325-1810 McCandless Drive Milpitas G 14,671 7/98 L
1600 Memorex Drive Santa Clara F 1,250 7/98 L
1688 Richard Avenue Santa Clara F 624 9/98 L
1700 Richard Avenue Santa Clara F 751 8/99 L
3506-3510 Bassett Street Santa Clara D 1,062 7/98 L
3540-3544 Bassett Street Santa Clara F,D 1,671 7/98 L
3550 Bassett Street Santa Clara F,D 1,148 7/98 L
3560 Bassett Street Santa Clara F,D 1,121 7/98 L
3570-3580 Bassett Street Santa Clara F,D 1,115 7/98 L
Prudential Ins. Co. of America F
Northwestern Mutual Life Insurance Co. G
Allianz Life Insurance Company H
----------------
$149,459
================
(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 $114,994 Prudential Insurance Company of America loan -
full amount of loan shown at the bottom of the schedule.
(G) Encumbered by the $88,411 Northwestern Mutual Life Insurance Company loan -
full amount of loan shown at the bottom of the schedule.
(H) Encumbered by the $144,696 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 $874 was fully amortized in
2005 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.
- 77 -
MISSION WEST PROPERTIES, INC.
Schedule III
Real Estate and Accumulated Depreciation & Amortization
December 31, 2005
(dollars in thousands)
Initial Cost Total Cost
---------------------- Cost -----------------------
December 31, Buildings Subsequent to Buildings
2005 and Construction/ and
Property Name City Encumbrances Land Improvements Acquisition Land Improvements Total
- -------------------------------------------- ------------ --------- ------------ ------------- ---------- ------------ ------------
5300-5350 Hellyer Avenue San Jose C $10,051 $5,742 $11,442 $5,742 $11,442 $17,184
10401-10411 Bubb Road Cupertino A 633 3,078 633 3,078 3,711
45365 Northport Loop Fremont 2,447 5,711 $11 2,447 5,722 8,169
45700 Northport Loop Fremont F 1,184 5,760 7 1,184 5,767 6,951
45738 Northport Loop Fremont F 891 4,338 5 891 4,343 5,234
4050 Starboard Drive Fremont F 1,329 6,467 8 1,329 6,475 7,804
3501 W. Warren Ave/Fremont Fremont 1,866 9,082 1,213 1,866 10,295 12,161
48800 Milmont Blvd Fremont 1,013 4,932 1,013 4,932 5,945
4750 Patrick Henry Drive Santa Clara 1,604 7,805 153 1,604 7,958 9,562
3520 Bassett Street Santa Clara D 1,104 5,371 1,104 5,371 6,475
3530 Bassett Street Santa Clara B,D 849 4,133 849 4,133 4,982
5850-5870 Hellyer Avenue San Jose 2,787 6,502 112 2,787 6,614 9,401
5750 Hellyer Avenue San Jose 3,266 3,354 3,266 3,354 6,620
800 Embedded Way San Jose 1,794 - 1,794 - 1,794
5500 Hellyer Avenue San Jose 4,735 12,484 39 4,735 12,523 17,258
5550 Hellyer Avenue San Jose 3,261 3,478 3,261 3,478 6,739
5400 Hellyer Avenue San Jose 3,238 5,007 215 3,238 5,222 8,460
5325 Hellyer Avenue San Jose H 4,684 10,230 40 4,684 10,270 14,954
5345 Hellyer Avenue San Jose H 4,866 5,822 4,866 5,822 10,688
5905-5965 Silver Crk Valley RdSan Jose 8,437 17,316 8,437 17,316 25,753
5905-5965 Silver Crk Valley RdSan Jose 3,438 2,727 3,438 2,727 6,165
855 Embedded Way San Jose K 3,289 6,521 68 3,289 6,589 9,878
1065-1105 La Avenida St Mt. View 46,832 109,275 65 46,832 109,340 156,172
1750 Automation Parkway San Jose G 4,789 11,174 315 4,789 11,489 16,278
1756 Automation Parkway San Jose G 4,378 10,216 15 4,378 10,231 14,609
1762 Automation Parkway San Jose G 4,804 12,224 20 4,804 12,244 17,048
1768 Automation Parkway San Jose H 8,195 19,121 14 8,195 19,135 27,330
255 Caspian Drive Sunnyvale 3,491 7,160 1,672 3,491 8,832 12,323
245 Caspian Drive Sunnyvale 5,894 - 5,894 - 5,894
5970 Optical Court San Jose 2,758 8,395 2,758 8,395 11,153
5900 Optical Court San Jose H 3,634 12,677 83 3,634 12,760 16,394
2630 Orchard Parkway San Jose 2,931 5,863 22 2,931 5,885 8,816
2610 Orchard Parkway San Jose J 2,615 5,231 2,615 5,231 7,846
55 West Trimble Road San Jose J 4,435 8,869 4,435 8,869 13,304
2001 Walsh Avenue Santa Clara E,I 4,610 5,245 4,610 5,245 9,855
2880 Scott Boulevard Santa Clara E,H,I 14,501 25,501 14,501 25,501 40,002
2890 Scott Boulevard Santa Clara E,H,I 3,081 10,844 3,081 10,844 13,925
2770-2800 Scott Boulevard Santa Clara E,H 7,138 7,075 2 7,138 7,077 14,215
2300 Central Expressway Santa Clara E,I 2,390 14,418 2,390 14,418 16,808
2220 Central Expressway Santa Clara E,I 3,304 3,427 162 3,304 3,589 6,893
2330 Central Expressway Santa Clara E 3,673 3,932 3,673 3,932 7,605
2251 Lawson Lane Santa Clara G 1,952 9,498 1,952 9,498 11,450
1230 East Arques Sunnyvale F 540 2,628 39 540 2,667 3,207
1250 East Arques Sunnyvale F 1,335 6,499 1,335 6,499 7,834
20400 Mariani Avenue Cupertino H 1,670 8,125 1,670 8,125 9,795
10500 De Anza Blvd Cupertino F 7,666 37,304 7,666 37,304 44,970
20605-20705 Valley Green Cupertino G 3,490 16,984 3,490 16,984 20,474
10300 Bubb Road Cupertino F 635 3,090 635 3,090 3,725
10440 Bubb Road Cupertino 434 2,112 61 434 2,173 2,607
10460 Bubb Road Cupertino H 994 4,838 1,325 994 6,163 7,157
1135 Kern Avenue Sunnyvale F 407 1,982 407 1,982 2,389
450 National Avenue Mt. View F 611 2,973 50 611 3,023 3,634
3301 Olcott Street Santa Clara 1,846 8,984 1,846 8,984 10,830
2800 Bayview Avenue Fremont 1,070 5,205 60 1,070 5,265 6,335
5521 Hellyer Avenue San Jose 4,534 9,650 4,534 9,650 14,184
6850 Santa Teresa Blvd San Jose 377 1,836 819 377 2,655 3,032
6810 Santa Teresa Blvd San Jose 2,567 5,991 234 2,567 6,225 8,792
140-160 Great Oaks Blvd San Jose 1,402 6,822 755 1,402 7,577 8,979
MISSION WEST PROPERTIES, INC.
Schedule III
Real Estate and Accumulated Depreciation & Amortization
December 31, 2005
(dollars in thousands)
Accumulated
Depreciation Date of Depreciable
Property Name City & Amortization Acquisition Life
- -------------------------------------------- ---------------- --------------- -------------
5300-5350 Hellyer Avenue San Jose C $1,610 5/00 L
10401-10411 Bubb Road Cupertino A 579 7/98 L
45365 Northport Loop Fremont 758 10/00 L
45700 Northport Loop Fremont F 1,082 7/98 L
45738 Northport Loop Fremont F 817 7/98 L
4050 Starboard Drive Fremont F 1,216 7/98 L
3501 W. Warren Ave/Fremont Fremont 1,954 7/98 L
48800 Milmont Blvd Fremont 926 7/98 L
4750 Patrick Henry Drive Santa Clara 1,595 7/98 L
3520 Bassett Street Santa Clara D 1,008 7/98 L
3530 Bassett Street Santa Clara B,D 776 7/98 L
5850-5870 Hellyer Avenue San Jose 1,168 11/98 L
5750 Hellyer Avenue San Jose 370 8/01 L
800 Embedded Way San Jose - 3/00 L
5500 Hellyer Avenue San Jose 1,531 2/01 L
5550 Hellyer Avenue San Jose 418 6/01 L
5400 Hellyer Avenue San Jose 808 7/00 L
5325 Hellyer Avenue San Jose H 1,317 1/01 L
5345 Hellyer Avenue San Jose H 705 1/02 L
5905-5965 Silver Crk Valley RdSan Jose 1,948 7/01 L
5905-5965 Silver Crk Valley RdSan Jose 290 10/01 L
855 Embedded Way San Jose K 804 5/01 L
1065-1105 La Avenida Street Mt. View 18,449 4/99 L
1750 Automation Parkway San Jose G 1,867 7/99 L
1756 Automation Parkway San Jose G 1,544 1/00 L
1762 Automation Parkway San Jose G 1,771 4/00 L
1768 Automation Parkway San Jose H 2,440 12/00 L
255 Caspian Drive Sunnyvale 1,334 4/00 L
245 Caspian Drive Sunnyvale - 4/01 L
5970 Optical Court San Jose 420 12/03 L
5900 Optical Court San Jose H 1,146 7/02 L
2630 Orchard Parkway San Jose 565 3/02 L
2610 Orchard Parkway San Jose J 502 3/02 L
55 West Trimble Road San Jose J 851 3/02 L
2001 Walsh Avenue Santa Clara E,I 1,071 4/03 L
2880 Scott Boulevard Santa Clara E,H,I 3,197 4/03 L
2890 Scott Boulevard Santa Clara E,H,I 1,101 4/03 L
2770-2800 Scott Boulevard Santa Clara E,H 487 4/03 L
2300 Central Expressway Santa Clara E,I 5,712 4/03 L
2220 Central Expressway Santa Clara E,I 286 4/03 L
2330 Central Expressway Santa Clara E 270 4/03 L
2251 Lawson Lane Santa Clara G 1,782 7/98 L
1230 East Arques Sunnyvale F 524 7/98 L
1250 East Arques Sunnyvale F 1,219 7/98 L
20400 Mariani Avenue Cupertino H 1,526 7/98 L
10500 De Anza Blvd Cupertino F 6,998 7/98 L
20605-20705 Valley Green Cupertino G 3,188 7/98 L
10300 Bubb Road Cupertino F 581 7/98 L
10440 Bubb Road Cupertino 415 7/98 L
10460 Bubb Road Cupertino H 1,119 7/98 L
1135 Kern Avenue Sunnyvale F 375 7/98 L
450 National Avenue Mt. View F 562 7/98 L
3301 Olcott Street Santa Clara 1,687 7/98 L
2800 Bayview Avenue Fremont 997 7/98 L
5521 Hellyer Avenue San Jose 110 2/05 L
6850 Santa Teresa Blvd San Jose 648 7/98 L
6810 Santa Teresa Blvd San Jose 1,042 3/99 L
140-160 Great Oaks Blvd San Jose 1,497 7/98 L
- 78 -
Initial Cost Total Cost
---------------------- Cost -----------------------
December 31, Buildings Subsequent to Buildings
2005 and Construction/ and
Property Name City Encumbrances Land Improvements Acquisition Land Improvements Total
- -------------------------------------------- ------------ --------- ------------ ------------- ---------- ------------ ------------
6541 Via del Oro/6385 San Ig San Jose G 1,039 5,057 91 1,039 5,148 6,187
6311-6351 San Ignacio Avenue San Jose F 6,246 30,396 170 6,246 30,566 36,812
6320-6360 San Ignacio Avenue San Jose G 2,616 12,732 439 2,616 13,171 15,787
75 E. Trimble Rd/2610 N.1st StSan Jose 3,477 16,919 85 3,477 17,004 20,481
2033-2243 Samaritan Drive San Jose 5,046 24,556 154 5,046 24,710 29,756
1170 Morse Avenue Sunnyvale F 658 3,201 658 3,201 3,859
3236 Scott Blvd Santa Clara F 1,234 6,005 1,234 6,005 7,239
1212 Bordeaux Lane Sunnyvale F 2,250 10,948 2,250 10,948 13,198
1325-1810 McCandless Drive Milpitas G 13,994 66,213 1,420 13,994 67,633 81,627
1600 Memorex Drive Santa Clara F 1,221 5,940 11 1,221 5,951 7,172
1688 Richard Avenue Santa Clara F 1,248 2,913 6 1,248 2,919 4,167
1700 Richard Avenue Santa Clara F 1,727 4,030 1,727 4,030 5,757
3506-3510 Bassett Street Santa Clara D 943 4,591 116 943 4,707 5,650
3540-3544 Bassett Street Santa Clara F,D 1,565 7,615 189 1,565 7,804 9,369
3550 Bassett Street Santa Clara F,D 1,079 5,251 33 1,079 5,284 6,363
3560 Bassett Street Santa Clara F,D 1,075 5,233 8 1,075 5,241 6,316
3570-3580 Bassett Street Santa Clara F,D 1,075 5,233 1,075 5,233 6,308
Prudential Ins. Co. of America F 117,290
Northwestern Mutual Life Ins. Co. G 91,417
Allianz Life Insurance Company H 148,774
------------ --------- ---------- ------------- ---------- ------------ ------------
$367,532 $273,933 $773,561 $10,306 $273,933 $783,867 $1,057,800
============ ========= ========== ============= ========== ============ ============
Accumulated
Depreciation Date of Depreciable
Property Name City & Amortization Acquisition Life
- -------------------------------------------- ---------------- --------------- -------------
6541 Via del Oro/6385 San Ig San Jose G 949 7/98 L
6311-6351 San Ignacio Avenue San Jose F 5,809 7/98 L
6320-6360 San Ignacio Avenue San Jose G 2,497 7/98 L
75 E. Trimble Rd/2610 N.1st StSan Jose 3,240 7/98 L
2033-2243 Samaritan Drive San Jose 4,652 7/98 L
1170 Morse Avenue Sunnyvale F 602 7/98 L
3236 Scott Blvd Santa Clara F 1,128 7/98 L
1212 Bordeaux Lane Sunnyvale F 2,056 7/98 L
1325-1810 McCandless Drive Milpitas G 12,854 7/98 L
1600 Memorex Drive Santa Clara F 1,096 7/98 L
1688 Richard Avenue Santa Clara F 550 9/98 L
1700 Richard Avenue Santa Clara F 650 8/99 L
3506-3510 Bassett Street Santa Clara D 915 7/98 L
3540-3544 Bassett Street Santa Clara F,D 1,473 7/98 L
3550 Bassett Street Santa Clara F,D 1,012 7/98 L
3560 Bassett Street Santa Clara F,D 989 7/98 L
3570-3580 Bassett Street Santa Clara F,D 984 7/98 L
Prudential Ins. Co. of America F
Northwestern Mutual Life Ins. Co. G
Allianz Life Insurance Company H
----------------
$130,419
================
(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 $117,290 Prudential Insurance Company of America loan -
full amount of loan shown at the bottom of the schedule.
(G) Encumbered by the $91,417 Northwestern Mutual Life Insurance Company loan -
full amount of loan shown at the bottom of the schedule.
(H) Encumbered by the $148,774 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 $874 was fully amortized in
2005 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.
- 79 -
MISSION WEST PROPERTIES, INC.
NOTE TO SCHEDULE III
December 31, 2006 and 2005
(dollars in thousands)
1. Reconciliation of real estate and accumulated depreciation and
amortization:
2006 2005
------------------------ ------------------------
Real estate investments:
Balance at beginning of year $1,057,800 $1,072,503
Additions 20,304 15,151
Dispositions (29,756) (28,980)
Reclassification - (874)
------------------------ ------------------------
Balance at end of year $1,048,348 $1,057,800
------------------------ ------------------------
Accumulated depreciation and amortization:
Balance at beginning of year $130,419 $111,640
Additions 24,163 23,487
Dispositions (5,123) (3,834)
Reclassification - (874)
------------------------ ------------------------
Balance at end of year $149,459 $130,419
------------------------ ------------------------
Net investments in properties $898,889 $927,381
======================== ========================
- 80 -
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
The Company previously disclosed the change in its independent registered public
accountants on Form 8-K, filed April 10, 2006.
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, 2006 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, 2006. 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, 2006.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect the possibility of human error, misstatements and the
circumvention or overriding of controls. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
Management's assessment of the effectiveness of Mission West Properties, Inc.'s
internal control over financial reporting as of December 31, 2006 has been
audited by Burr, Pilger & Mayer, LLP, an independent registered public
accounting firm, as stated in their report which is included in this Annual
Report on Form 10-K.
(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 2006 that has materially affected, or is reasonably
likely to material affect, our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
None.
- 81 -
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 for its 2007
annual stockholders' meeting.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated by reference from the
section titled "Executive Compensation" in the Company's definitive proxy
statement for its 2007 annual stockholders' meeting, excluding, however, the
sections titled "Executive Compensation - Performance Graph" and "Executive
Compensation - Report on Executive Compensation by the Compensation Committee of
the Board of Directors," none of which are incorporated by reference in response
to this item.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information required by Item 12 is incorporated by reference from the
sections titled "Share Ownership" and "Securities Authorized for Issuance Under
Equity Compensation Plans" in the Company's definitive proxy statement for its
2007 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 for its 2007 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 for its 2007 annual stockholders' meeting.
- 82 -
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, 2006 and 2005, which can be found on
page 76.
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
files as an exhibit to this form are listed under Item 15(a)(3).
- 83 -
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 15, 2007 By: /s/ Carl E. Berg
------------------------------------
Carl E. Berg
Chief Executive Officer
(Principal Executive Officer)
Date: March 15, 2007 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 15, 2007
/s/ John C. Bolger
- ------------------------------
John C. Bolger Director March 15, 2007
/s/ William A. Hasler
- ------------------------------
William A. Hasler Director March 15, 2007
/s/ Lawrence B. Helzel
- ------------------------------
Lawrence B. Helzel Director March 15, 2007
/s/ Raymond V. Marino
- ------------------------------ President, Chief Operating Officer
Raymond V. Marino and Director March 15, 2007
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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 Restated Bylaws of Mission West Properties, Inc.(1)
10.1.1 Amended and Restated Agreement of Limited Partnership of Mission West Properties, L.P.(2a)
10.1.2 Amended and Restated Agreement of Limited Partnership of Mission West Properties, L.P. I(2a)
10.1.3 Amended and Restated Agreement of Limited Partnership of Mission West Properties, L.P. II(2a)
10.1.4 Amended and Restated Agreement of Limited Partnership of Mission West Properties, L.P. III(2a)
10.2 Exchange Rights Agreement between Mission West Properties and the Limited Partners(2a)
10.3.1* 1997 Stock Option Plan(3)
10.3.2* Form of Incentive Stock Option Agreement(1)
10.3.3* Form of Non-statutory Stock Option Agreement(1)
10.3.4* Form of Directors Stock Option Agreement(1)
10.4.1 Acquisition Agreement, dated as of May 14, 1998, among Mission West Properties, certain partnerships and the
Berg Group (as defined therein)(1)
10.4.2 Amendment of Acquisition Agreement, dated as of July 1, 1998(1) 10.4.3 Form of Partnership Interest Purchase
Demand Note (1)
10.5.1 Stock Purchase Agreement dated as of May 4, 1998, between Mission West Properties and the purchasers of
Common Stock in a private placement of 5,800,000 shares and Subscription Agreement relating to same(1)
10.5.2 Stock Purchase Agreement dated as of May 4, 1998 between Mission West Properties and the purchasers of
Common Stock in a private placement of 695,058 shares and Subscription Agreement relating to same(1)
10.5.3 Form of Registration Rights Agreement for purchasers, who acquired shares of Common Stock under the May 4,
1998 Stock Purchase Agreements (2b)
10.6 Pending Projects Acquisition Agreement among Mission West Properties, the Operating Partnership and the Berg
Group(2a)
10.7 Berg Land Holdings Option Agreement between Mission West Properties and certain members of the Berg Group(2a)
10.8 Berg & Berg Enterprises, Inc. Sublease Agreement(1)
10.9 Not in use
10.10 Not in use
10.11 Not in use
10.12 Lease Agreement with Apple Computer, Inc.(4a)
10.13 Lease Agreement with Cisco Systems, Inc,(4b)
10.14 Lease Agreement with Amdahl Corporation(4c)
10.15 Prudential Promissory Note(5)
10.16 Prudential Deed of Trust(5)
10.17 Prudential Certificate Regarding Distribution(5)
10.18 Prudential Guaranty(5)
10.19 Waiver Agreement(6)
10.20 Ownership Limit Exemption Agreement dated December 29, 1998 between Mission West Properties and Dan and Paul
McCarthy(7)
10.21 Lease Agreement with Microsoft Corporation, dated July 25, 1998(8)
10.21.1 Lease Agreement with Microsoft Corporation, dated December 23, 2004(8a)
10.22 Contribution Agreement(8)
10.23 Assumption Agreement for Wells Fargo Line of Credit(9)
10.24 Not in use
10.25 Not in use
10.26 Supplemental Agreement among Mission West Properties, Inc., Carl E. Berg and Clyde J. Berg(9)
10.27 Berg Group Revolving Credit - $100,000,000 Secured Promissory Note(10) (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 Cupertino National Bank Revolving Credit Loan Agreement(13)
10.29.1 Cupertino National Bank Revolving Credit Loan Agreement Change in Terms Agreement(14)
10.29.2 Cupertino National Bank Revolving Credit Loan Agreement Change in Terms Agreement
10.29.3 Cupertino National Bank Revolving Credit Loan Agreement Change in Terms Agreement
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10.30 Mission West Properties, LP Continuing Guaranty(13)
10.31 Mission West Properties, LP II Continuing Guaranty(13)
10.32 Mission West Properties, L.P. Promissory Note to Northwestern Mutual Life Insurance Company(13)
10.33 Mission West Properties, L.P. I Promissory Note to Northwestern Mutual Life Insurance Company(13)
10.34 Mission West Properties, L.P. II Promissory Note to Northwestern Mutual Life Insurance Company(13)
10.35 Mission West Properties, L.P. Deed of Trust and Security Agreement (First Priority) (13)
10.36 Mission West Properties, L.P. Deed of Trust and Security Agreement (Second Priority) (13)
10.37 Mission West Properties, L.P. I Deed of Trust and Security Agreement (First Priority) (13)
10.38 Mission West Properties, L.P. I Deed of Trust and Security Agreement (Second Priority) (13)
10.39 Mission West Properties, L.P. II Deed of Trust and Security Agreement (First Priority) (13)
10.40 Mission West Properties, L.P. II Deed of Trust and Security Agreement (Second Priority) (13)
10.41 Mission West Properties, L.P. Absolute Assignment of Leases and Rents (First Priority) (13)
10.42 Mission West Properties, L.P. I Absolute Assignment of Leases and Rents (First Priority) (13)
10.43 Mission West Properties, L.P. II Absolute Assignment of Leases and Rents (First Priority) (13)
10.44 Not in use
10.45 Citicorp USA, Inc.$80,000,000 Secured Promissory Note (15)
10.45.1 Citicorp USA, Inc.$80,000,000 First Amendment to Promissory Note (11)
10.45.2 Citicorp USA, Inc.$80,000,000 Second Amendment to Promissory Note (16a)
10.45.3 Citicorp USA, Inc.$80,000,000 Third Amendment to Promissory Note (16b)
10.45.4 Citicorp USA, Inc.$80,000,000 Fourth Amendment to Promissory Note (14)
10.46* 2004 Equity Incentive Plan(17)
10.47 Allianz Loan Secured Installment Note(18)
10.48 Allianz Loan Deed of Trust, Security Agreement, Fixture Filing with Absolute Assignment of Rents(18)
10.49 Allianz Loan Limited Guaranty(18)
10.50* Form of Non-statutory Stock Option Agreement with Dividend Rights under 2004 Equity Incentive Plan(18)
10.51 Allianz Loan II Secured Installment Note(19)
10.52 Allianz Loan II Deed of Trust, Security Agreement, Fixture Filing with Absolute Assignment of Rents(19)
10.53 Allianz Loan II Limited Guaranty(19)
10.54 Allianz Loan II Loan Modification Agreement(19)
21.1 Subsidiaries of the Registrant (20)
23.1 Consent of Independent Registered Public Accounting Firm
23.2 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.
(2a) Incorporated herein by reference to the same-numbered exhibit to the
Company's Post-effective Amendment No. 1 to Registration Statement on Form
S-4 filed on Form S-3 on February 11, 1999 (Commission File No.
333-52835-99).
(2b) Incorporated herein by reference to Exhibit 10.8 to the Company's
Post-effective Amendment No. 1 to Registration Statement on Form S-4 filed
on Form S-3 on February 11, 1999 (Commission File No. 333-52835-99).
(3) Incorporated herein by reference to Exhibit E to the Company's Schedule 14A
Proxy Statement filed with the Securities and Exchange Commission on
October 21, 1997.
(4a) Incorporated herein by reference to Exhibit 10.15 to the Company's
Registration Statement on Form S-4/A filed on June 17, 1998 and declared
effective on November 23, 1998.
(4b) Incorporated herein by reference to Exhibit 10.16 to the Company's
Registration Statement on Form S-4/A filed on June 17, 1998 and declared
effective on November 23, 1998.
(4c) Incorporated herein by reference to Exhibit 10.17 to the Company's
Registration Statement on Form S-4/A filed on June 17, 1998 and declared
effective on November 23, 1998.
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(5) Incorporated herein by reference to the same-numbered exhibit to the
Company's Registration Statement on Form S-4/A filed on October 27, 1998
and declared effective on November 23, 1998.
(6) Incorporated herein by reference to the same-numbered exhibit to the
Registration Statement on Form S-4/A filed on November 16, 1998 and
declared effective on November 23, 1998.
(7) Incorporated herein by reference to the same numbered exhibit to the annual
report on Form 10-K for 1998 filed on March 31, 1999.
(8) Incorporated herein by reference to the same-numbered exhibit to current
report on Form 8-K filed on May 14, 1999 (Commission File No. 000-25235).
(8a) Incorporated herein by reference to the same-numbered exhibit to the
quarterly report on Form 10-Q filed on May 10, 2005.
(9) Incorporated herein by reference to the same-numbered exhibit to the
Registration Statement on Form S-11/A filed on June 15, 1999 (Commission
File No. 333-80203).
(10) Incorporated herein by reference to the same-numbered exhibit to the
quarterly report on Form 10-Q filed on November 13, 2001.
(11) Incorporated herein by reference to the same-numbered exhibit to the
quarterly report on Form 10-Q filed on August 12, 2003.
(12) Incorporated herein by reference to the same numbered exhibit to the annual
report on Form 10-K for 1999 filed on March 30, 2000.
(13) Incorporated herein by reference to the same-numbered exhibit to the annual
report on Form 10-K for 2002 filed on March 27, 2003.
(14) Incorporated herein by reference to the same-numbered exhibit to the
quarterly report on Form 10-Q filed on November 2, 2004.
(15) Incorporated herein by reference to the same-numbered exhibit to the
quarterly report on Form 10-Q filed on May 15, 2003.
(16a) Incorporated herein by reference to Exhibit 10.45.1 to the annual report
on Form 10-K for 2003 filed on July 30, 2004.
(16b) Incorporated herein by reference to Exhibit 10.45.2 to the annual report
on Form 10-K for 2003 filed on July 30, 2004.
(17) Incorporated herein by reference to Appendix II to the Company's Schedule
14A Proxy Statement filed with the Securities and Exchange Commission on
October 22, 2004.
(18) Incorporated herein by reference to the same-numbered exhibit to the
quarterly report on Form 10-Q filed on May 10, 2005.
(19) Incorporated herein by reference to the same-numbered exhibit to the
quarterly report on Form 10-Q filed on August 9, 2005.
(20) Incorporated herein by reference to the same-numbered exhibit to the annual
report on Form 10-K for 1998 filed on March 31, 1999.
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