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, 2007
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 value American Stock Exchange
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, 2007, the aggregate market value of the Registrant's common
stock held by non-affiliates of the registrant was $273,782,813 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 29, 2008
- --------------------------------------- --------------------------------
Common Stock, $.001 par value per share 19,669,807 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's proxy statement to be delivered to stockholders in
connection with the Registrant's 2008 Annual Meeting of Stockholders to be held
on May 22, 2008 are incorporated by reference into Part III of this Form 10-K.
The Registrant intends to file its proxy statement within 120 days after its
fiscal year end.
FORWARD LOOKING INFORMATION
This annual report contains forward-looking statements within the meaning of the
federal securities laws. We intend such forward-looking statements to be covered
by the safe harbor provisions for forward-looking statements contained in the
Private Securities Litigation Reform Act of 1995, and are including this
statement for purposes of complying with these safe harbor provisions.
Forward-looking statements include our discussion of "Quantitative and
Qualitative Disclosures about Market Risks" in Item 7A below. Forward-looking
statements, which are based on certain assumptions and describe future plans,
strategies and expectations of us, are generally identifiable by use of the
words "believe," "expect," "intend," "anticipate," "estimate," "project" or
similar expressions. Our ability to predict results or the actual effect of
future plans or strategies is inherently uncertain. Factors which could have a
material adverse effect on the operations and future prospects or would cause
actual results in the future to differ materially from any of our
forward-looking statements of the Company include, but are not limited to,
changes in: economic conditions generally and the real estate market
specifically, legislative or regulatory provisions affecting the Company
(including changes to laws governing the taxation of Real Estate Investment
Trusts ("REITs")), availability of capital, interest rates, competition, supply
of and demand for office and industrial properties in our current and proposed
market areas, tenant defaults and bankruptcies, and general accounting
principles, policies and guidelines applicable to REITs. In addition, the actual
timing of development, construction, and leasing on the projects that the
Company believes it may acquire in the future is unknown presently. These risks
and uncertainties, together with the other risks described from time to time in
our reports and documents filed with the Securities and Exchange Commission,
should be considered in evaluating forward-looking statements and undue reliance
should not be placed on such statements (see Item 1A, "Risk Factors").
i
MISSION WEST PROPERTIES, INC.
2007 FORM 10-K ANNUAL REPORT
Table of Contents
PART I Page No.
--------
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, 2007,
we owned and managed 109 properties totaling approximately 7.9 million rentable
square feet of R&D properties through four limited partnerships, or operating
partnerships, for which we are the sole general partner. R&D property is
designed for research and development and office uses and, in some cases,
includes space for light manufacturing operations with loading docks. We believe
that we have one of the largest portfolios of R&D properties in the Silicon
Valley. There are two tenants who individually lease in excess of 300,000
rentable square feet from us: Microsoft Corporation and Apple Computer, Inc. For
federal income tax purposes we have operated as a self-managed,
self-administered and fully integrated Real Estate Investment Trust ("REIT")
since fiscal 1999.
Prior to July 1, 1998, most of our properties were under the ownership or
control of Carl E. Berg, his brother Clyde J. Berg, certain members of their
respective immediate families, and certain entities in which Carl E. Berg and/or
Clyde J. Berg held controlling or other ownership interests, including Berg &
Berg Developers, Berg & Berg Enterprises, Inc. and Berg & Berg Enterprises, LLC
(the "Berg Group"). We acquired these properties as of July 1, 1998 by becoming
the general partner of each of the four operating partnerships in an UPREIT
transaction. At that time, we also acquired ten properties comprising
approximately 560,000 rentable square feet from entities controlled by third
parties in which the Berg Group members were significant owners.
Through various property acquisition agreements with the Berg Group and subject
to the approval of the Independent Directors Committee of the Board of
Directors, we have the right to purchase, on pre-negotiated terms, R&D and other
types of office and light industrial properties that the Berg Group develops in
the future. With in-house development, architectural and construction personnel,
the Berg Group continues to focus on a full range of land acquisition,
development and construction activities for R&D properties, often build-to-suit,
to meet the demands of Silicon Valley information technology companies. As the
developer, the Berg Group takes on the risks of purchasing the land, obtaining
regulatory approvals and permits and financing construction. Since September
1998, we have acquired approximately 3,275,000 additional rentable square feet
of R&D properties from the Berg Group under these agreements.
Our executive offices are located at 10050 Bandley Drive, Cupertino, California
95014, and our telephone number is (408) 725-0700. Our website is located at
http://www.missionwest.com. On our website, you can access, free of charge, our
annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K and amendments to those reports filed or furnished pursuant to Section
13(a) or 15(d) of the Exchange Act of 1934, as amended, as soon as reasonably
practicable after such material is electronically filed with, or furnished to,
the Securities and Exchange Commission (the "SEC"). A copy of these filings is
available to all interested parties upon written request to "Investor Relations"
at our corporate offices.
We file annual, quarterly and special reports, proxy statements and other
information with the SEC. You may read and copy any document we file with the
SEC at the SEC's Public Reference Room at 100 F Street, N.W., Washington, D.C.
20549. You may obtain information about the operation of the SEC's Public
Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a
website that contains reports, proxy and information statements, and other
information regarding registrants that file electronically with the SEC
(http://www.sec.gov).
OUR RELATIONSHIP WITH THE BERG GROUP
Through a series of transactions occurring between May 1997 and December 1998,
we became the vehicle for substantially all of the Silicon Valley R&D property
operating activities of the Berg Group. We are the general partner pursuant to
the partnership agreements of the operating partnerships and, along with members
of the Berg Group and other individuals, are party to an acquisition agreement
dated as of May 14, 1998 and amended, as of July 1, 1997, 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. 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 entered into the Berg Land Holdings Option Agreement dated as of December 29,
1998 and amended as of June 28, 1999 under which we have an option to purchase
all land acquired, directly or indirectly, by Carl E. Berg or Clyde J. Berg that
has not been improved with completed buildings and which is zoned, intended or
appropriate for R&D, office and/or industrial development or use in the states
of California, Oregon and Washington. Currently, the Berg Land Holdings Option
Agreement gives us the right to acquire future R&D property developments by the
Berg Group on up to 84 additional acres of land currently controlled by the Berg
Group, which could support approximately 1.4 million square feet of new
development. At this time we do not anticipate acquiring any additional newly
constructed R&D properties from the Berg Group for several years because of the
current market conditions in the Silicon Valley.
For example, 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
2
agreement and would remain eligible for potential future acquisition by the
Company under the Berg Land Holdings Option Agreement.
As of December 31, 2007, we had acquired 22 leased R&D properties totaling
approximately 2,133,000 rentable square feet under this agreement at a cost of
approximately $218.7 million, for which we issued 8,482,085 O.P. Units and
assumed debt of approximately $122.3 million. The principal terms of the
agreement include the following:
- - So long as the Berg Group members and their affiliates own or have the
right to acquire shares representing at least 65% of our common stock on a
Fully Diluted basis, or until December 31, 2010, whichever occurs first, we
will have the option to acquire any building developed by any member of the
Berg Group on the land subject to the Berg Land Holdings Option Agreement
at such time as the building has been leased. Upon our exercise of the
option, the option price will equal the sum of the following or a lesser
amount as approved by the Independent Directors Committee:
1. the full construction cost of the building; plus
2. 10% of the full construction cost of the building; plus
3. interest at LIBOR plus 1.65%, on the amount of the full construction
cost of the building for the period from the date funds were disbursed
by the developer to the close of escrow; plus
4. the original acquisition cost of the parcel on which the improvements
will be constructed, which range from $8.50 to $20.00 per square foot
for land currently owned or under option; plus
5. 10% per annum of the amount of the original acquisition cost of the
parcel from the later of January 1, 1998 and the seller's acquisition
date, to the close of escrow; minus
6. the aggregate principal amount of all debt encumbering the acquired
property.
- - The acquisition cost, net of any debt, will be payable in cash, or O.P.
Units valued at the average closing price of our common stock over the
30-trading-day period preceding the acquisition or, in cash, at the option
of the Berg Group.
- - We also must assume all property tax assessments.
- - If we elect not to exercise the option with respect to any property, the
Berg Group may hold and lease the property for its own account, or may sell
it to a third party.
- - All action taken by us under the Berg Land Holdings Option Agreement,
including any variations from stated terms outlined above must be approved
by a majority of the members of the Independent Directors Committee.
In addition, under the Acquisition Agreement Carl E. Berg has agreed not to
directly or indirectly acquire or develop any real property zoned for office,
industrial or R&D use in the states of California, Oregon and Washington without
first disclosing and making the acquisition opportunity available to us. The
Independent Directors Committee decides whether we will pursue each opportunity
presented to us by Mr. Berg. This restriction will expire when there is no Berg
Group nominee on our board of directors and the Berg Group's fully diluted
ownership percentage, which is calculated based on all outstanding shares of
common stock and all shares of common stock that could be acquired upon the
exercise of all outstanding options to acquire our voting stock, as well as all
shares of common stock issuable upon exchange of all O.P. Units ("Fully
Diluted"), falls below 25%.
As a general policy which has been established by the Independent Directors
Committee, we do not acquire properties under the Berg Land Holdings Option
Agreement until they have been leased. We are responsible for a significant
portion of the leasing process in connection with such acquisitions, however.
The following table presents certain information concerning currently identified
land that we have the right to acquire under the Berg Land Holdings Option
Agreement.
Approximate Rentable Area
Available Land: Net Acres (Square Feet)
----------------------------------- ---------------------- ------------------------------
Piercy & Hellyer 30 490,000
Morgan Hill (1) 18 288,000
King Ranch 12 207,000
Fremont & Cushing 24 387,000
---------------------- ------------------------------
Total 84 1,372,000
====================== ==============================
(1) This land is owned by the TBI joint ventures partnership. We expect to own
an approximate 50% interest in the partnership through one of our operating
partnerships. The property will be operated and managed by the other joint
venture partner in the entity.
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
3
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, however, 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 potential acquisition opportunities under the Berg Land
Holdings Option Agreement, we believe our acquisitions experience, established
network of real estate and information technology professionals, and overall
financial condition will continue to provide opportunities for external growth.
In general, we will seek opportunistic acquisitions of high quality, well
located Silicon Valley R&D properties in situations where illiquidity or
inadequate management permit their acquisition at favorable prices, and where
our management skills and knowledge of Silicon Valley submarkets may facilitate
increases in cash flow and asset value.
Furthermore, our use of the operating partnership structure allows us to offer
prospective sellers the opportunity to contribute properties on a tax-deferred
basis in exchange for O.P. Units. Although we have not consummated any
transactions on this basis since our July 1, 1998 acquisition of the Berg Group
properties, this capacity to complete tax-deferred transactions with sellers of
real property further enhances our ability to acquire additional properties.
FOCUS ON SINGLE TENANT SILICON VALLEY R&D PROPERTIES
We intend to continue to emphasize the acquisition of single-tenant rather than
multi-tenant properties, a practice that has historically contributed to the
relatively low turnover and higher occupancy rates on our properties. We believe
that the relatively small number of tenants (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. In the past several years, the Silicon Valley R&D property
market has fluctuated with the local economy. The Silicon Valley economy and
business activity slowed markedly during 2001 through 2006 after fast-paced
growth in 1999 and 2000, and has been growing steadily since then. 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 18.3% in late
2006 to 16.6% at the end of 2007. Total vacant R&D square footage in Silicon
Valley at the end of the fourth quarter of 2007 amounted to 25.3 million
rentable square feet, of which 14.2%, or 3.6 million rentable square feet, was
sublease space. According to the BT Report in 2006, total positive net
absorption (which is the computation of gross square footage leased less gross
new square footage vacated for the period presented) amounted to approximately
1.9 million rentable square feet, and in 2007, there was total positive net
absorption of approximately 2.9 million rentable square feet as local economic
conditions improved. According to the BT Report, average asking market rent per
square foot was $1.26 and $0.99 at year-end for 2007 and 2006, 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 and the region as a whole. Moreover, the impact of vacancies has not
been uniform throughout the area. The Silicon Valley R&D property market is
characterized by a substantial number of submarkets, with rent and vacancy rates
varying by submarket and location within each submarket.
In addition, leasing activity for new build-to-suit and vacated R&D properties
has slowed considerably during the past several years. The time to complete the
marketing and lease up of vacant space has increased from an average of several
months to as much as an average of 18 to 36 months as a result of the
over-supply of R&D properties in the market.
For the years ended December 31, 2007 and 2006, occupancy for leased properties
in our portfolio was 61.7% and 69.5%, respectively.
4
Despite our strategic focus on single tenant properties and leases, in order to
meet market conditions we have been, and expect to continue, leasing less than
the entire premises of some of our R&D properties to a single tenant from time
to time. Leasing our R&D properties, which generally have been built for single
tenant occupancy, to multiple tenants tends to increase our leasing costs and
operating expenses and reduce the profitability of our leasing activities.
Although we scrutinize each prospective tenant's creditworthiness and
continually evaluate the financial capacity of both our prospective and existing
tenants, a downturn in tenants' businesses may weaken their financial condition
and could result in defaults under their lease obligations.
We believe that the average 2008 renewal rental rates for our properties will be
approximately equal to, or perhaps, below current market rents. Leases
representing approximately 328,000 rentable square feet, or 1.6% of our 2008
cash rent, are scheduled to expire during 2008. If we are unable to lease a
significant portion of any vacant space or space scheduled to expire; if we
experience significant tenant defaults as a result of the current economic
downturn; if we restructure existing leases and lower existing rents in order to
retain tenants for an extended term; if we increase our lease costs and
operating expenses substantially to accommodate multiple tenants in our R&D
properties; or if we are not able to lease space at or above current market
rates, our results of operations and cash flows will be affected adversely.
OPERATIONS
We operate as a self-administered, self-advised and self-managed REIT with our
own employees. As the sole general partner of the operating partnerships, we
control the business and assets of the operating partnerships and have full and
complete authority, discretion and responsibility with respect to the operating
partnerships' operations and transactions, including, without limitation,
acquiring additional properties, borrowing funds, raising new capital, leasing
buildings and selecting and supervising all agents of the operating
partnerships.
Although most of our leases are triple net and building maintenance and tenant
improvements are the responsibility of the tenants, from time to time we may be
required to undertake construction and repair work at our properties. We 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 our properties and negotiate leases ourselves. We make
the availability of our properties known to the brokerage community to garner
their assistance in locating prospective tenants, however. As a result, we
expect to retain our policy of paying fixed commissions to tenants' brokers.
We believe that our business practices provide us with competitive advantages,
including -
- - EXTERNAL DEVELOPMENT AFFILIATE. We have the option to purchase all future
R&D, office, industrial property developments of the Berg Group under the
Berg Land Holdings Option Agreement on land currently held or acquired
directly or indirectly by Carl E. Berg or Clyde J. Berg that is zoned for
those purposes and located in California, Oregon and Washington following
completion and lease-up of the property. The acquisition terms and
conditions for the existing and identified projects have been
pre-negotiated and are documented under the Berg Land Holdings Option
Agreement. This relationship provides us with the economic benefits of
development while eliminating development and initial lease-up risks. It
also provides us with access to one of the most experienced development
teams in the Silicon Valley without the expense of maintaining development
personnel.
- - LEAN ORGANIZATION, EXPERIENCED TEAM. In part because of our primary focus
on Silicon Valley, our experience with the special real estate requirements
of information technology tenants and the long-term triple-net structure of
our leases, we are able to conduct and expand our business with a small
management team comprised of highly qualified and experienced professionals
working within a relatively flat organizational structure. We believe that
the leanness of our organization and our experience will enable us to
rapidly assess and respond to market opportunities and tenant needs,
control operating expenses and develop and maintain excellent relationships
with tenants. We further believe that these advantages translate into
significantly lower costs for operations and give us the ability, along
with the Berg Group, to compete favorably with other R&D property
developers in Silicon Valley, especially for build-to-suit projects subject
to competitive bidding. Furthermore, we believe this lower cost structure
allows us to generate better returns from properties whose value can be
increased through appropriate remodeling and efficient property management.
- - SOUND PROPERTY MANAGEMENT PRACTICES. For each property, the management
team, along with the Berg Group staff, develops a specific marketing and
property management program. We select vendors and subcontractors on a
competitive bid basis from a select group of highly qualified firms with
whom we maintain ongoing relationships and carefully supervise their work.
5
OPERATING PARTNERSHIP AGREEMENTS
MANAGEMENT
The operating partnerships consist of four separate limited partnerships engaged
in the combined operation and ownership of all our properties. The operating
partnership agreements are identical in all material respects for all four of
the limited partnerships. Pursuant to the operating partnership agreements, we
act as the sole general partner of the operating partnerships, in which capacity
we have exclusive control of the business and assets of the operating
partnerships and generally have full and complete authority, discretion and
responsibility with respect to the operating partnerships' operations and
transactions, including, without limitation, acquisitions of additional
properties, borrowing funds, raising new capital, leasing buildings, as well as
selecting and supervising all employees and agents of the operating
partnerships. Through our authority to manage our business and affairs, our
Board of Directors directs the business of the operating partnerships.
Notwithstanding our effective control of the operating partnerships, the Berg
Group holds a substantial majority of the outstanding O.P. Units and the consent
of the limited partners holding a majority of the outstanding O.P. Units is
required with respect to certain extraordinary actions involving the operating
partnerships, including:
- - the amendment, modification or termination of the operating partnership
agreements;
- - a general assignment for the benefit of creditors or the appointment of a
custodian, receiver or trustee for any of the assets of the operating
partnerships;
- - the institution of any proceeding for bankruptcy of the operating
partnerships;
- - the transfer of any general 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.
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
6
the right to purchase new O.P. Units at the price we offer in the transaction
giving rise to such participation right in order, and to the extent necessary,
to maintain their respective percentage interests in the operating partnerships.
EXCHANGE RIGHTS, PUT RIGHTS AND REGISTRATION RIGHTS
Under the Exchange Rights Agreement between us and the limited partners, the
limited partners have exchange rights that generally became exercisable on
December 29, 1999. The Exchange Rights Agreement permits every limited partner
to tender O.P. Units to us, and, at our election, to receive common stock on a
one-for-one basis at then-current market value, an equivalent amount of cash, or
a combination of cash and common stock in exchange for the O.P. Units tendered,
subject to the 9% overall ownership limit imposed on non-Berg Group stockholders
under our charter document, or the overall 20% Berg Group ownership limit, as
the case may be. For more information, please refer to Item 1A, "Risk Factors -
Failure to satisfy federal income tax requirements for REITs could reduce our
distributions, reduce our income and cause our stock price to fall." This
exchange ratio is subject to adjustment for stock splits, stock dividends,
recapitalizations of our common stock and similar types of corporate actions. In
addition, once in each 12-month period beginning each December 29, the limited
partners, other than Carl E. Berg and Clyde J. Berg, may exercise a put right to
sell their O.P. Units to the operating partnerships at a price equal to the
average market price of the common stock for the 10-trading day period
immediately preceding the date of tender. Upon any exercise of the put rights,
we will have the opportunity for a period of 15 days to elect to fund the
purchase of the O.P. Units and purchase additional general partner interests in
the operating partnerships for cash, unless the purchase price exceeds $1
million in the aggregate for all tendering limited partners, in which case, the
operating partnerships or we will be entitled, but not required, to reduce
proportionally the number of O.P. Units to be acquired from each tendering
limited partner so that the total purchase price is not more than $1 million.
Through December 31, 2007 no limited partner ever has exercised this put right.
The number of shares of our common stock issuable in exchange for the total
number of O.P. Units outstanding at July 1, 1998 and the O.P. Units issued
pursuant to the Pending Projects Acquisition Agreement were registered under the
Securities Act and generally may be sold without restriction if they are
acquired by limited partners that are not affiliates, as defined under SEC Rule
144. For more information please refer to Item 1A, "Risk Factors - Shares
eligible for future sale could affect the market price of our stock." The
Exchange Rights Agreement gives the holders of O.P. Units the right to
participate in any registered public offering of the common stock initiated by
us to the extent of 25% of the total shares sold in the offering upon converting
O.P. Units to shares of common stock, but subject to the underwriters' unlimited
right to reduce the participation of all selling stockholders. The holders of
O.P. Units will be able to request resale registrations of shares of common
stock acquired on exchange of O.P. Units on a Form S-3, or any equivalent form
of registration statement, subject to limitations and restrictions contained in
the Exchange Rights Agreement. In April 2006, we registered up to 86,088,095
shares of common stock issuable on exchange of O.P. Units for resale pursuant to
the prospectus included in a registration statement on Form S-3 that the SEC
declared effective on April 28, 2006. We intend to maintain the effectiveness of
this registration statement in order to facilitate re-sales of shares of common
stock acquired by O.P. Unit holders from time to time without volume limitations
or other resale restrictions under SEC Rule 144.
OTHER MATTERS
The operating partnership agreements require that the operating partnerships be
operated in a manner that will enable us to satisfy the requirements for being
classified as a REIT and to avoid any federal income or excise tax liability.
The operating partnership agreements provide that the combined net operating
cash flow from all the operating partnerships, as well as net sales and
refinancing proceeds, will be distributed from time to time as determined by our
Board of Directors, but not less frequently than quarterly, pro rata in
accordance with the partners' percentage interests in the operating
partnerships, taken as a whole. This provision is intended to cause the periodic
distributions per O.P. Unit and per share of our common stock to be equal. As a
consequence of this provision, the capital interest of a partner in each of the
operating partnerships, including our capital interests, might at times differ
significantly from the partner's percentage interest in the net income and cash
flow of that operating partnership. We do not believe that such differences
would have a material impact on our business, financial condition or funds
available for distributions, however.
Pursuant to the operating partnership agreements, the operating partnerships
will also assume and pay when due, or reimburse us for payment of, certain costs
and expenses relating to our continuity of existence and operations.
The operating partnership agreements provide that, upon the exercise of an
outstanding option under the 2004 Equity Incentive Plan (including options
granted originally under the 1997 Stock Option Plan), we may purchase additional
general partner interests in the operating partnerships by contributing the
exercise proceeds to the operating partnerships. Our increased interest 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.
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TERM
The operating partnerships will continue in full force and effect until December
31, 2048 or until sooner dissolved pursuant to the terms of the operating
partnership agreements.
EMPLOYEES
As of February 29, 2008, we employed six people, all of whom work at our
executive offices at 10050 Bandley Drive, Cupertino, California, 95014.
FACILITIES
We lease office space at 10050 Bandley Drive, Cupertino, California from Berg &
Berg Enterprises, Inc. and share clerical staff and other overhead on what we
consider to be favorable terms. The total monthly rent payable by us to Berg &
Berg Enterprises, Inc. is $8,020.
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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 74.1% of the
equity interests in the operating partnerships and approximately 73.9% 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
9
- - 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 $8,020 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. This agreement will
expire on December 31, 2010, after which we will no longer have the right to
acquire properties from the Berg Group or the pre-determined terms provided in
that agreement.
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, 2007, that prior to December 29, 2008, each of them may prevent
us and the operating partnerships from selling or transferring any of the
properties that were acquired from them in our July 1998 UPREIT acquisition if
the proposed sale or other transfer will be a taxable transaction. As a result,
our opportunities to sell these properties may be limited. If we need to sell
any of these properties to raise cash to service our debt, acquire new
properties, pay cash distributions to stockholders or for other working capital
purposes, we may be unable to do so. These restrictions could harm our business
and cause our stock price to fall.
10
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 $9.2 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. In October 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. 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
OWNERSHIP INTEREST HAS BEEN REDUCED.
The Berg Land Holdings Option Agreement, as amended, which provides us with
significant benefits and opportunities to acquire additional R&D properties from
the Berg Group, will expire when the Berg Group and their affiliates (excluding
us and the operating partnerships) own less than 65% of our common stock on a
Fully Diluted basis. Termination of the Berg Land Holdings Option Agreement
could result in limitation of our growth, which could cause our stock price to
fall.
WE MAY CHANGE OUR INVESTMENT AND FINANCING POLICIES AND INCREASE YOUR RISK
WITHOUT STOCKHOLDER APPROVAL.
Our Board of Directors determines the investment and financing policies of the
operating partnerships and our policies with respect to certain other
activities, including our business growth, debt capitalization, distribution,
and operating policies. Our Board of Directors may amend these policies at any
time without a vote of the stockholders. Changes in these policies could
materially adversely affect our financial condition, results of operations and
ability to make cash distributions to our stockholders, which could harm our
business and cause our stock price to fall. For more information please refer to
Item 7, "Management's Discussion and Analysis of Financial Condition and Results
of Operations - Policies with Respect to Certain Activities."
ANTI-TAKEOVER PROVISIONS IN OUR CHARTER COULD PREVENT ACQUISITIONS OF OUR STOCK
AT A SUBSTANTIAL PREMIUM.
Provisions of our charter and our bylaws could delay, defer or prevent a
transaction or a change in control of our corporation, or a similar transaction,
that might involve a premium price for our shares of common stock or otherwise
be in the best interests of our stockholders. Provisions of the Maryland general
corporation law, which would apply to potential business combinations with
acquirers other than the Berg Group or stockholders who invested in us in
December 1998, also could prevent the acquisition of our stock for a premium, as
discussed in "Certain Provisions of Maryland Law and of our Charter and Bylaws."
AN INVESTMENT IN OUR STOCK INVOLVES RISKS RELATED TO REAL ESTATE INVESTMENTS
THAT COULD HARM OUR BUSINESS AND CAUSE OUR STOCK PRICE TO FALL.
RENTAL INCOME VARIES
Real property investments are subject to varying degrees of risk. Investment
returns available from equity investments in real estate depend in large part on
the amount of income earned and capital appreciation, which our properties
generate, as well as our related expenses incurred. If our properties do not
generate revenues sufficient to meet operating expenses, debt service and
capital expenditures, our income and ability to make distributions to our
stockholders will be adversely affected. Income from our properties may also be
adversely affected by general economic conditions, local economic conditions
such as oversupply of commercial real estate, the attractiveness of our
properties to tenants and prospective tenants, competition from other available
rental property, our ability to provide adequate maintenance and insurance, the
cost of tenant improvements, leasing commissions and tenant inducements and the
potential of increased operating costs, including real estate taxes.
11
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. Our mortgage loan from Prudential Insurance
Company of America which had a principal balance owed of approximately $112.5
million as of December 31, 2007 matures in October 2008. Although we expect to
be able to refinance this debt prior to maturity, we currently have not secured
a commitment for replacement financing, and replacement financing is not
assured. Furthermore, our mortgage loans may be subject to covenants that we are
obligated to satisfy. For example, under our mortgage loan agreements with
Northwestern Mutual Life Insurance Company, the payment of all $100 million
outstanding could be accelerated upon the sale or certain other transfers of
more than 51% of the total number of O.P. Units and shares of common stock of
the Company held by the members of the Berg Group. We have no reason to expect
such a sale or transfer in the foreseeable future, but the members of the Berg
Group have no obligation to us to refrain from any such sale or other transfer.
We have adopted a policy of maintaining a consolidated ratio of debt to total
market capitalization, which includes for this purpose the market value of all
shares of common stock for which outstanding O.P. Units are exchangeable, of
less than 50%. This ratio may not be exceeded without the approval of more than
75% of our entire Board of Directors. Our Board of Directors may vote to change
this policy, however, and we could become more highly leveraged, resulting in an
increased risk of default on our obligations and an increase in debt service
requirements that could adversely affect our financial condition, our operating
results and our ability to make distributions to our stockholders.
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
12
to be economical. If an earthquake occurs and results in substantial damage to
our properties, we could lose our investment in those properties, which loss
could have a material adverse effect on our financial condition, our operating
results and our ability to make distributions to our stockholders.
OUR REAL ESTATE ASSETS MAY BE SUBJECT TO IMPAIRMENT CHARGES.
We continually evaluate the recoverability of the carrying value of our real
estate assets for impairment indicators. Factors considered in evaluating
impairment of our existing real estate assets include significant declines in
property operating profits, recurring property operating losses and other
significant adverse changes in general market conditions that are considered
permanent in nature. Generally, a real estate asset is not considered impaired
if the undiscounted, estimated future cash flows of the asset over its estimated
holding period are in excess of the asset's net book value at the balance sheet
date. Assumptions used to estimate annual and residual cash flow, the estimated
holding period of such assets, the lease up period when properties are vacant
and future rental income require the judgment of management. Actual results
could be different than our estimates.
There can be no assurance that we will not take impairment charges in the future
related to the impairment of our assets. As of the years ended December 31, 2007
and 2006, management believed it had applied reasonable estimates and judgments
in determining the proper classification of its real estate assets. However,
should external or internal circumstances change requiring the need to shorten
the holding periods or adjust the estimated future cash flows of certain of our
assets, we could be required to record additional impairment charges. If any
real estate asset held for sale is considered impaired, a loss is provided to
reduce the carrying value of the asset to its fair value, less selling costs.
Any future impairment could have a material adverse affect on the Company's
results of operations and funds from operations in the period in which the
charge is taken.
FAILURE TO SATISFY FEDERAL INCOME TAX REQUIREMENTS FOR REITS COULD REDUCE OUR
DISTRIBUTIONS, REDUCE OUR INCOME AND CAUSE OUR STOCK PRICE TO FALL.
FAILURE TO QUALIFY AS A REIT
Although we currently operate in a manner designed to enable us to qualify and
maintain our REIT status, it is possible that economic, market, legal, tax or
other considerations may cause us to fail to qualify as a REIT or may cause our
Board of Directors either to refrain from making the REIT election or to revoke
that election once made. To maintain REIT status, we must meet certain tests for
income, assets, distributions to stockholders, ownership interests, and other
significant conditions. If we fail to qualify as a REIT in any taxable year, we
will not be allowed a deduction for distributions to our stockholders in
computing our taxable income and would be subject to federal income tax,
including any applicable alternative minimum tax, on our taxable income at
regular corporate rates. Moreover, unless we were entitled to relief under
certain provisions of the tax laws, we would be disqualified from treatment as a
REIT for the four taxable years following the year in which our qualification
was lost. As a result, funds available for distributions to our stockholders
would be reduced for each of the years involved and, in addition, we would no
longer be required to make distributions to our stockholders.
REIT DISTRIBUTION REQUIREMENTS
To maintain REIT status, we must distribute as a dividend to our stockholders at
least 90% of our otherwise net taxable income, after certain adjustments, with
respect to each tax year. We also may be subject to a 4% non-deductible excise
tax in the event our distributions to stockholders fail to meet certain other
requirements. Failure to comply with these requirements could result in our
income being subject to tax at regular corporate rates and could cause us to be
liable for the excise tax.
OWNERSHIP LIMIT NECESSARY TO MAINTAIN REIT QUALIFICATION
As a REIT, the federal tax laws restrict the percentage of the total value of
our stock that may be owned by five or fewer individuals to 50% or less. Our
charter generally prohibits the direct or indirect ownership of more than 9% of
our common stock by any stockholder. This limit excludes the Berg Group, which
has an aggregate ownership limit of 20%. In addition, as permitted by our
charter, our Board of Directors has authorized an exception applicable to two
other stockholders that permits them to collectively own, directly or
indirectly, up to 18.5% of our common stock on an aggregate basis, subject to
the terms of an ownership limit exemption agreement. In general, our charter
prohibits the transfer of shares that result in a loss of our REIT qualification
and provides that any such transfer or any other transfer that causes a
stockholder to exceed the ownership limit will result in the shares being
automatically transferred to a trust for the benefit of a charitable
beneficiary. Accordingly, in the event that either the Berg Group or the two
stockholders increase their stock ownership in our corporation, a stockholder
who acquires shares of our common stock, even though his, her or its aggregate
ownership may be less than 9%, may be required to transfer a portion of that
stockholder's shares to such a trust in order to preserve our status as a REIT.
STOCKHOLDERS ARE NOT ASSURED OF RECEIVING CASH DISTRIBUTIONS FROM US.
Our income consists primarily of our share of the income of the operating
partnerships, and our cash flow consists primarily of our share of distributions
from the operating partnerships. Differences in timing between the receipt of
income and the payment of expenses in arriving at our taxable income or the
taxable income of the operating partnerships and the effect of required debt
13
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, 2007, all outstanding shares of
our common stock, other than shares controlled by affiliates, were eligible for
sale in the public market without resale restrictions under the federal
securities laws. Sales of substantial amounts of common stock, including shares
issued in connection with the exercise of the exchange rights held by the
limited partners of the operating partnerships, or the perception that such
sales could occur, could adversely affect prevailing market prices for the
common stock. Additional shares of common stock may be issued to limited
partners, subject to the applicable REIT qualification ownership limit, if they
exchange their O.P. Units for shares of common stock pursuant to their exchange
rights, or may be sold by us to raise funds required to purchase such O.P. Units
if eligible limited partners elect to tender O.P. Units to us using their put
rights. Shares of stock controlled by our affiliates may be sold subject to Rule
144, including the limitation under Rule 144(e)
14
on the number of shares that may be sold within a three-month period. In
addition, pursuant to a registration statement on Form S-3 declared effective by
the SEC in April 2006, all shares of common stock acquired upon exchange of
currently outstanding O.P. Units may be resold without any such restrictions.
Additional common stock reserved under our 2004 Equity Incentive Plan, including
stock options, also may be sold in the market at some time in the future. Future
sales of our common stock in the market could adversely affect the price of our
common stock.
MARKET INTEREST RATES MAY REDUCE THE VALUE OF THE COMMON STOCK.
One of the factors that investors consider important in deciding whether to buy
or sell shares of a REIT is the distribution rate on such shares, as a
percentage of the price of such shares, relative to market interest rates. If
market interest rates go up, prospective purchasers of REIT shares may expect a
higher distribution rate. Higher interest rates would not, however, increase the
funds available for us to distribute, and, in fact, would likely increase our
borrowing costs and decrease funds available for distributions. Thus, higher
market interest rates could cause the price of our common stock to fall.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
15
ITEM 2. PROPERTIES
GEOGRAPHIC AND TENANT FOCUS
We focus principally on the facility requirements of information technology
companies in the Silicon Valley, which include space for office, R&D, light
manufacturing and assembly. With the Silicon Valley's highly educated and
skilled work force, history of numerous successful start-up companies and large
contingent of venture capital firms, we believe that this region will, following
the current significant slowdown in the market, continue to spawn successful new
high-growth industries and entrepreneurial businesses to an extent matched
nowhere else in the United States. We believe that our focus and thorough
understanding of the Silicon Valley real estate market enables us to:
- - anticipate trends in the market;
- - identify and concentrate our efforts on the most favorably located
sub-markets;
- - take advantage of our experience and extensive contacts and relationships
with local government agencies, real estate brokers and subcontractors, as
well as with tenants and prospective tenants; and
- - identify strong tenants.
All of our properties are general-purpose R&D/office type properties located in
desirable sub-markets of the Silicon Valley. Many of our properties have been
developed for or leased to single tenants, many of whom are large, publicly
traded information technology companies. Most of our major tenants have occupied
our properties for many years under triple-net leases that require the tenant to
pay substantially all operating costs, including property insurance, real estate
taxes and general operating costs.
LEASING
The current leases for 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, 2007:
Major
Tenants'
Total Percentage Average Rentable
No. of Rentable Occupied as of 2007 Sq. Ft. at 2007 Annual
Location Properties Sq. Ft. Dec. 31, 2007 Occupancy Major Tenants 12/31/07 Base Rents(1)
- ------------------------------------------------------------------------------------------------------------------------------------
5300-5350 Hellyer Avenue (2) 2 160,000 100% 100% Tyco Electronics Corporation 160,000 $3,732,320
10401-10411 Bubb Road (2) 1 20,330 78% 78% Aeroflex, Inc. 15,830 206,582
45365 Northport Loop West 1 64,218 0% 0% Vacant - -
45700 Northport Loop East (4) - - - - - - 28,139
45738 Northport Loop West 1 44,256 100% 100% Quicksil, Inc. 44,256 553,200
4050 Starboard Drive 1 52,232 100% 100% Flash Electronics, Inc. 52,232 859,215
3501 West Warren Avenue & 1 67,864 76% 68% ASM Nutool, Inc. 35,340 817,102
46600 Fremont Boulevard Oakland Fluid System Tech, Inc. 16,524
48800 Milmont Drive 1 53,000 0% 0% Vacant - -
4750 Patrick Henry Drive 1 63,105 100% 100% Infoblox, Inc. 63,105 498,530
16
Major
Tenants'
Total Percentage Average Rentable
No. of Rentable Occupied as of 2007 Sq. Ft. at 2007 Annual
Location Properties Sq. Ft. Dec. 31, 2007 Occupancy Major Tenants 12/31/07 Base Rents(1)
- ------------------------------------------------------------------------------------------------------------------------------------
Triangle Technology Park (2) 7 416,927 78% 78% Intevac Corporation 169,795 3,976,141
Xicom Technology, Inc. 72,336
LSA Cleanpart, LLC 28,300
SASCO 25,350
IXYS Technologies, Inc. 19,600
5830-5870 Hellyer Avenue 1 109,715 24% 24% MeiVac, Inc. 26,557 261,321
5750 Hellyer Avenue 1 73,312 100% 92% NDS Surgical Imaging, LLC 73,312 616,704
5500-5550 Hellyer Avenue 2 196,534 0% 10% Vacant - 196,010
5400 Hellyer Avenue 1 77,184 45% 45% Nortel Networks, Inc. 34,702 361,190
5325-5345 Hellyer Avenue 2 256,500 100% 100% Celestica Asia, Inc. 256,500 5,506,632
5905-5965 Silver Creek 4 346,000 0% 50% Vacant - 4,991,760
Valley Rd.
5845 Hellyer Avenue 1 98,500 0% 0% Vacant - -
855 Embedded Way 1 67,912 42% 42% Lynuxworks, Inc. 28,612 625,560
1065-1105 La Avenida Street 5 515,700 100% 100% Microsoft Corporation 515,700 12,287,704
1875 Charleston Road 1 42,126 100% 100% Netlogic Microsystems, Inc. 42,126 851,592
1750 Automation Parkway 1 80,641 100% 100% JDS Uniphase Corporation 80,641 1,418,149
1756 Automation Parkway 1 80,640 36% 27% A&D Engineering, Inc. 28,739 232,785
1762 Automation Parkway 1 61,100 100% 42% Hermes Microvision, Inc. 61,100 253,175
1768 Automation Parkway 1 110,592 88% 56% 2Wire, Inc. 53,741 569,838
Becton, Dickinson and Company 43,699
255 Caspian Drive 1 119,756 100% 100% Equinix Operating Co., Inc. 119,756 2,460,986
245 Caspian Drive (3) 1 - - - - - -
5970 Optical Court 1 128,520 100% 100% Photon Dynamics, Inc. 128,520 1,941,348
5900 Optical Court 1 165,000 100% 100% Stryker Corporation 165,000 3,451,470
2630 Orchard Parkway 1 60,633 0% 0% Vacant - -
2610 Orchard Parkway 1 54,093 0% 0% Vacant - -
55 West Trimble Road 1 91,722 0% 0% Vacant - -
2001 Walsh Avenue 1 80,000 100% 100% Nvidia Corporation 80,000 772,990
2880 Scott Boulevard 1 200,000 100% 100% NEC Electronics America, Inc. 200,000 3,541,764
2890 Scott Boulevard 1 75,000 0% 83% Vacant - 1,940,098
2770-2800 Scott Boulevard 1 99,800 100% 100% Nvidia Corporation 99,800 1,233,034
2300 Central Expressway 1 46,338 100% 100% Juniper Networks, Inc. 46,338 1,297,043
2220 Central Expressway 1 62,522 100% 100% Tellabs, Inc. 62,522 668,360
2330 Central Expressway 1 62,522 100% 100% Tellabs, Inc. 62,522 668,360
233 South Hillview Drive 2 95,690 100% 100% Exar Corporation 95,690 1,291,530
2251 Lawson Lane 1 125,000 0% 0% Vacant - -
1230 East Arques 1 60,000 100% 100% Fujitsu 60,000 346,149
17
Major
Tenants'
Total Percentage Average Rentable
No. of Rentable Occupied as of 2007 Sq. Ft. at 2007 Annual
Location Properties Sq. Ft. Dec. 31, 2007 Occupancy Major Tenants 12/31/07 Base Rents(1)
- ------------------------------------------------------------------------------------------------------------------------------------
1250 East Arques 4 200,000 100% 100% Fujitsu 200,000 869,311
20400 Mariani Avenue 1 105,000 100% 100% Siemens Healthcare Diag., Inc. 62,323 1,963,110
Apple, Inc. 42,677
10500 De Anza Boulevard 1 211,000 100% 100% Apple, Inc. 211,000 4,503,080
20605-705 Valley Green Drive 2 142,000 100% 100% Apple, Inc. 142,000 3,453,153
10300 Bubb Road 1 23,400 100% 100% Apple, Inc. 23,400 261,612
10440 Bubb Road 1 19,500 100% 82% Novare Surgical Systems, Inc. 10,833 200,200
10450-10460 Bubb Road 1 45,460 94% 66% Ricoh Corporation 30,460 399,898
1135 Kern Avenue 1 18,300 0% 0% Vacant - -
450 National Avenue 1 36,100 47% 47% Agitar Software, Inc. 17,068 172,800
3301 Olcott Street 1 64,500 0% 0% Vacant - -
2800 Bayview Avenue 1 59,736 0% 0% Vacant - -
5521 Hellyer Avenue 1 203,800 44% 22% Nanosolar, Inc. 89,040 267,120
6850 Santa Teresa Boulevard 1 30,000 41% 38% Bio-Medical Applications of CA 12,350 109,391
6810 Santa Teresa Boulevard & 1 54,996 87% 50% ZiLOG, Inc. 40,527 206,553
180 Great Oaks Boulevard
140-160 Great Oaks Boulevard 2 105,300 75% 75% Semiconductor Tooling Services 53,300 888,966
& 6781 Via Del Oro Santa Clara Valley Water Dist. 25,429
6540-6541 Via Del Oro & 2 66,600 80% 77% Modutek Corporation 21,376 466,079
6385-6387 San Ignacio Avenue
6311-6351 San Ignacio Avenue 5 362,767 37% 37% Saint Gobain 95,953 2,574,874
Teledex, LLC 30,000
6320-6360 San Ignacio Avenue 1 157,292 12% 12% Quantum 3D, Inc. 19,600 361,986
75 East Trimble Road & 2 170,810 59% 59% Comerica, Inc. 93,984 1,093,440
2610 North First Street
1170 Morse Avenue (4) - - - - - - 360,927
3236 Scott Boulevard 1 54,672 100% 100% Mimix Broadband, Inc. 54,672 693,663
1212 Bordeaux Lane 1 71,800 100% 100% Loral Space & Comm., Inc. 71,800 701,298
McCandless Technology Park 14 705,958 30% 36% ST Assembly Test Services, Inc.33,984 2,155,227
Consentry Networks, Inc. 33,821
1600 Memorex Drive 1 107,500 21% 26% International Network Serv.,Inc.22,800 231,634
1688 Richard Avenue 1 52,800 100% 100% NWE Technology, Inc. 52,800 314,084
1700 Richard Avenue 1 58,783 100% 100% Cincinnati Bell, Inc. 58,783 825,900
Morgan Hill Land (5) - - - - - - -
300 Montague Expressway 1 49,457 5% 5% Radio Shack Corporation 2,598 44,759
337 Trade Zone Boulevard 1 42,912 0% 0% Vacant - -
324-368 Montague Expressway 1 56,265 0% 0% Vacant - 9,176
-------------------- --------------
TOTAL 109 7,861,692 62% $81,585,022
==================== ==============
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 2007. It is included in this table for the sole
purpose of presenting the annual cash rent received in 2007.
(5) This property comprises of 55 acres of vacant land, which could support
approximately 800,000 rentable square feet of space. The vacant land is
currently zoned for industrial use and a portion has the potential to be
rezoned for residential use.
We own 100% of all of the properties listed in the table, except: one of the
buildings in the Triangle Technology Park, which is owned by a joint venture in
which we, through an operating partnership, own a 75% interest; the property at
10401-10411 Bubb Road, which is owned by a joint venture in which we, through an
operating partnership, own an 83.33% interest; and the properties at 5300-5350
Hellyer Avenue, which are owned by a joint venture in which we, through an
operating partnership, own a 50% interest, and a Berg affiliate owns the other
50% venture interest.
SCHEDULE OF LEASE EXPIRATIONS
The following table sets forth a schedule of the lease expirations for the
properties beginning with 2008, assuming that none of the tenants exercise
existing renewal options or termination rights. The table excludes 3,027,526
rentable square feet that were vacant as of December 31, 2007.
Number of Percentage of Total Annual
Year of Lease Expiring Rentable Square Footage 2008 Annual Base Rent Base Rent Represented By
Expiration Leases Subject to Expiring Leases Under Expiring Leases (1) Expiring Leases (2)
--------------------------------------------------------------------------------------------------------------------
2008 18 327,534 $1,113,359 1.6%
2009 22 726,241 7,126,949 10.0%
2010 12 551,157 8,554,637 12.0%
2011 6 381,182 4,889,812 6.9%
2012 13 938,868 12,966,340 18.3%
2013 1 125,044 1,411,747 2.0%
2014 7 889,227 18,568,272 26.1%
2015 3 277,568 5,141,868 7.2%
2016 1 256,500 5,726,892 8.1%
2017 3 241,089 2,967,340 4.2%
Thereafter 1 119,756 2,532,839 3.6%
--------------------------------------------------------------------------------------------------
87 4,834,166 $71,000,055 100%
==================================================================================================
(1) The base rent for expiring leases is based on 2008 scheduled cash rent,
which is different than annual rent determined in accordance with GAAP.
(2) Based upon 2008 cash rent as discussed in Note (1).
If we are unable to lease a significant portion of the available space or space
scheduled to expire in 2008 and thereafter at any of our properties; if existing
tenants do not renew their leases; or if rental rates decrease, our results of
operations, financial condition and cash flows would be affected adversely.
ENVIRONMENTAL MATTERS
To date, compliance with laws and regulations relating to the protection of the
environment, including those regarding the discharge of materials into the
environment has not had any material effects upon our capital expenditures,
earnings or competitive position.
Under various federal, state and local laws, ordinances and regulations, an
owner or operator of real property may be held liable for the costs of removal
or remediation of certain hazardous or toxic substances located on or in the
property. Such laws often impose liability on the owner and expose the owner to
governmental proceedings without regard to whether the owner knew of, or was
responsible for, the presence of the hazardous or toxic substances. The cost of
any required remediation or removal of such substances may be substantial. In
addition, the owner's liability as to any specific property is generally not
limited and could exceed the value of the property and/or the aggregate assets
of the owner. The presence of such substances, or the failure to properly remove
or remediate
19
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 and we believe that the ultimate
outcome of these proceedings will not have a material adverse effect on our
operating results, cash flows or financial condition.
MISSION WEST PROPERTIES, L.P. V. REPUBLIC PROPERTIES CORPORATION, ET AL. SANTA
CLARA COUNTY SUPERIOR COURT, CASE NO. CV 796249. In February 2001, while the
Maryland case was pending, we filed a suit against RPC in the Superior Court of
the State of California for the County of Santa Clara, Case No. CV 796249. The
case was stayed pending resolution of the Maryland case, and we dismissed our
suit on March 4, 2005. In April 2005, RPC submitted a motion asking the Superior
Court to reinstate the case, which the Court granted on May 25, 2005. On July 5,
2006, RPC filed a cross-complaint in the case seeking partnership distributions
to which we demurred. The Court sustained our demurrer with leave to amend.
Subsequently, RPC filed an amended complaint, and we submitted another demurrer
seeking dismissal of the claims on statute of limitations grounds. On February
20, 2007, the Court overruled our demurrer. We sought a writ from the California
State Court of Appeal for the Sixth District to direct the lower court to
reverse its decision, but the petition for the writ was denied. A trial in the
California Superior Court will commence in early 2008.
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."
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, 2007.
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, 2002 to December 31,
2007. The line graph starts December 31, 2002. The graph assumes that the value
of the investment in the Company's common stock was $100 at December 31, 2002
and that all dividends were reinvested. The common stock's price on December 31,
2002 was $9.90. 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 closing price of our common stock on December 31,
2007, the last trading day of the year, was $9.51 per share. The high and low
closing price per share of common stock as reported on AMEX during each quarter
of 2007 and 2006 were as follows:
2007 2006
----------------------------- -----------------------------
High Low High Low
------------- ------------- ------------- -------------
1st Quarter $14.60 $11.89 $11.90 $9.68
2nd Quarter $14.85 $13.00 $11.90 $10.70
3rd Quarter $14.01 $11.30 $11.62 $10.18
4th Quarter $12.50 $9.23 $13.10 $11.31
On February 6, 2008, the Company's Board of Directors approved the decision to
de-list our common stock from the AMEX and to become listed on the NASDAQ Stock
Market effective on or about March 24, 2008.
22
On February 29, 2008, there were 175 registered holders of the Company's common
stock.
DIVIDEND POLICY
We declared and paid dividends in each quarter of 2007 and 2006. We expect to
pay quarterly dividends during 2008. The following tables show information for
quarterly dividends for 2007 and 2006.
2007
-----------------------------------------------
Dividend
Record Date Payment Date Per Share
------------- ------------- -------------
1st Quarter 03/30/07 04/05/07 $0.16
2nd Quarter 06/30/07 07/05/07 0.16
3rd Quarter 09/28/07 10/04/07 0.16
4th Quarter 12/31/07 01/03/08 0.16
-------------
Total $0.64
=============
2006
-----------------------------------------------
Dividend
Record Date Payment 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
=============
The declaration and payment of dividends and distributions will continue to be
determined by the Board of Directors in light of conditions then existing,
including the Company's earnings, financial condition, capital requirements,
debt service requirements and other factors.
For federal income tax purposes, we have characterized the dividends declared in
2007 as follows: 97% taxable ordinary income, 2% capital gain and 1%
unrecaptured section 1250 gain (unaudited). For 2006, we have characterized 100%
of the dividends declared as taxable ordinary income (unaudited).
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
See Item 12 of Part III of this Report regarding information about securities
authorized for issuance under our equity compensation plans.
23
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected historical financial information for
Mission West Properties, Inc. (see Item 7, "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Overview and Background" for
discussion of business combinations and property dispositions that materially
affect the comparability of the selected financial data).
Selected consolidated financial data is derived from the audited financial
statements and notes thereto (see Item 8, "Financial Statements and
Supplementary Data") and is as follows:
Year Ended December 31,
--------------------------------------------------------------------------
2007 2006 2005 2004 2003
------------- ------------- ------------- -------------- -------------
(dollars in thousands, except per share data)
OPERATING INFORMATION: (1)
Revenue:
Rental revenue from real estate $80,337 $91,457 $99,082 $116,410 $126,004
Above market lease intangible asset amortization (4,091) (1,888) (1,888) (1,888) (1,416)
Tenant reimbursements 13,355 13,061 14,030 14,054 17,629
Other income, including lease terminations,
settlements and interest 65,068 20,566 4,590 6,861 4,506
------------- ------------- ------------- -------------- -------------
Total revenues 154,669 123,196 115,814 135,437 146,723
Expenses:
Property operating, maintenance and real
estate taxes 20,371 18,505 18,613 18,952 19,602
Interest 20,131 20,708 21,294 17,581 16,446
Interest (related parties) 724 755 972 1,077 1,064
General and administrative 3,035 2,248 1,910 2,011 1,324
Depreciation and amortization of real estate 22,588 21,579 20,329 20,602 19,297
------------- ------------- ------------- -------------- -------------
Total expenses 66,849 63,795 63,118 60,223 57,733
------------- ------------- ------------- -------------- -------------
Income before equity in earnings of unconsolidated
joint venture and minority interests 87,820 59,401 52,696 75,214 88,990
Equity in earnings of unconsolidated joint venture 1,408 1,985 724 2,947 3,885
Minority interests (71,471) (49,928) (44,136) (64,936) (77,392)
------------- ------------- ------------- -------------- -------------
Income from continuing operations 17,757 11,458 9,284 13,225 15,483
Discontinued operations, net of minority interests:
Gain from disposal of discontinued operations(2) 1,126 2,935 445 - -
Income attributable to discontinued operations(2) 5 237 298 87 729
------------- ------------- ------------- -------------- -------------
Income from discontinued operations 1,131 3,172 743 87 729
------------- ------------- ------------- -------------- -------------
Net income to common stockholders $18,888 $14,630 $10,027 $13,312 $16,212
============= ============= ============= ============== =============
Net income to minority interests $76,960 $66,358 $47,524 $66,100 $80,836
============= ============= ============= ============== =============
Basic net income from continuing operations per share $0.90 $0.60 $0.51 $0.73 $0.87
Diluted net income from continuing operations per share$0.89 $0.59 $0.51 $0.73 $0.87
Basic net income from discontinued operations per share$0.06 $0.17 $0.04 $0.01 $0.04
Diluted net income from discontinued operations
per share $0.06 $0.17 $0.04 $0.01 $0.04
Basic net income per share $0.96 $0.77 $0.55 $0.74 $0.91
Diluted net income per share $0.95 $0.76 $0.55 $0.74 $0.91
Dividends per share $0.64 $0.64 $0.64 $0.88 $0.96
PROPERTY AND OTHER INFORMATION:
Total properties, end of period (3) 109 107 107 109 109
Total rentable square feet, end of period (000's) 7,862 7,701 7,780 7,917 7,917
Average monthly rental revenue per square foot(4) $1.42 $1.57 $1.58 $1.80 $1.77
Occupancy for leased properties, end of period 62% 69% 69% 71% 77%
Funds from operations (5): $114,867 $86,585 $79,152 $103,320 $117,918
CASH FLOW INFORMATION:
Cash flows provided by operating activities $23,501 $27,012 $21,898 $38,970 $36,104
Cash flows used in investing activities ($8,548) ($5,369) ($2,875) ($1,519) ($109,983)
Cash flows (used in)/provided by financing
activities ($25,047) ($19,299) $10,899 ($40,061) $73,529
24
December 31,
--------------------------------------------------------------------------
2007 2006 2005 2004 2003
------------- ------------- ------------- -------------- -------------
(dollars in thousands)
BALANCE SHEET INFORMATION:
Real estate assets, net of accumulated depr. & amort. $922,117 $898,889 $927,381 $960,863 $985,751
Total assets $1,053,885 $1,027,487 $1,023,377 $1,005,656 $1,032,632
Line of credit - related parties - - - $9,560 $6,320
Revolving line of credit - - - $24,208 $23,965
Mortgage notes payable $337,520 $348,101 $357,481 $292,822 $299,858
Mortgage notes payable - related parties $9,224 $9,654 $10,051 $10,420 $10,762
Total liabilities $388,581 $397,327 $407,680 $380,355 $394,324
Minority interests $526,626 $501,282 $500,682 $512,089 $524,918
Stockholders' equity $138,678 $128,878 $115,015 $113,212 $113,390
Common stock outstanding 19,664,087 19,443,587 18,448,791 18,097,191 17,894,691
O.P. Units issued and outstanding 85,533,935 85,206,199 86,088,095 86,384,695 86,398,064
(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, 2007, 2006, 2005, 2004 and 2003, total properties
include a property at 245 Caspian in Sunnyvale with no building. In 2001,
we paid the Berg Group approximately $7.5 million for their commitment to
complete an approximate 75,000 to 90,000 square foot building on the
property.
(4) Average monthly rental revenue per square foot has been determined by
taking the total cash base rent for the period divided by the number of
months in the period, and then divided by the average occupied square feet
in the period.
(5) Funds from Operations ("FFO") is a non-GAAP financial term used by REITs to
measure and compare operating performance. As defined by the National
Association of Real Estate Investment Trusts ("NAREIT"), FFO represents net
income (loss) before minority interest of unit holders (computed in
accordance with GAAP), including non-recurring events other than
"extraordinary items" under GAAP and excluding gains and losses from sales
of discontinued operations or depreciable operating properties, plus real
estate related depreciation and amortization (excluding amortization of
deferred financing costs and depreciation of non-real estate assets) and
after adjustments for unconsolidated partnerships and joint ventures. FFO
does include impairment losses for properties held for sale and held for
use. Additionally, our 2007, 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 our operating
and financial performance because when compared year over year, it reflects
the impact to operations from trends in occupancy rates, rental rates,
operating costs, general and administrative expenses and interest costs,
providing a perspective not immediately apparent from net income. In
addition, management believes that FFO provides useful information about
our financial performance when compared to other REITs because FFO is
generally recognized as the industry standard for reporting the operations
of REITs. FFO should neither be considered as an alternative for neither
net income as a measure of profitability nor is it comparable to cash flows
provided by operating activities determined in accordance with GAAP. FFO is
not comparable to similarly entitled items reported by other REITs that do
not define them exactly as we define FFO.
Our definition of FFO also assumes conversion at the beginning of the period of
all convertible securities, including O.P. Units represented by O.P. Units that
may be exchanged for shares of common stock. Our FFO does not represent the
amount available for management's discretionary use; as such funds may be needed
for capital replacement or expansion, debt service obligations or other
commitments and uncertainties. Furthermore, FFO is not comparable to similarly
entitled items reported by other REITs that do not define FFO exactly as we do.
A reconciliation of net income to common stockholders to FFO for the years ended
December 31, 2007, 2006, 2005, 2004 and 2003 follows:
Year Ended December 31,
------------------------------------------------------------------------
2007 2006 2005 2004 2003
-------------- ------------- -------------- ------------- --------------
(dollars in thousands, except per share data)
Net income to common stockholders $18,888 $14,630 $10,027 $13,312 $16,212
Add:
Minority interests (1) 76,458 65,859 47,045 65,614 80,256
Depreciation and amortization of real estate (2) 26,050 24,636 24,286 24,394 22,850
Less:
Gain on sales of assets or joint venture assets (6,529) (18,540) (2,206) - (1,400)
-------------- ------------- -------------- ------------- --------------
FFO $114,867 $86,585 $79,152 $103,320 $117,918
============== ============= ============== ============= ==============
Weighted average common shares and O.P. Units -
diluted 105,016,651 104,809,155 104,545,776 104,521,271 104,279,165
FFO per common share and O.P. Unit - diluted $1.09 $0.83 $0.76 $0.99 $1.13
(1) Minority interests in net income is calculated by taking the net income of
the operating partnerships (on a stand-alone basis) multiplied by the
respective weighted average minority interests ownership percentage.
Minority interests for third parties totaling $502, $499, $479, $486 and
$581 in 2007, 2006, 2005, 2004 and 2003, 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 $757, $849, $984, $874 and
$874 in 2007, 2006, 2005, 2004 and 2003, respectively, and amortization of
leasing commissions totaling $2,558, $1,513, $1,703, $1,644 and $1,203 in
2007, 2006, 2005, 2004 and 2003, respectively. Amortization of leasing
commissions is included in the property operating, maintenance and real
estate taxes line item in our consolidated statements of operations.
(dollars in thousands)
25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION INCLUDES FORWARD-LOOKING STATEMENTS, INCLUDING BUT NOT
LIMITED TO STATEMENTS WITH RESPECT TO THE FUTURE FINANCIAL PERFORMANCE,
OPERATING RESULTS, PLANS AND OBJECTIVES OF MISSION WEST PROPERTIES, INC. ACTUAL
RESULTS MAY DIFFER MATERIALLY FROM THOSE CURRENTLY ANTICIPATED DEPENDING UPON A
VARIETY OF FACTORS, INCLUDING THOSE DESCRIBED IN PART I - ITEM 1A, RISK FACTORS.
OVERVIEW AND BACKGROUND
Our original predecessor was formed in 1969 as Palomar Mortgage Investors, a
California business trust, which operated as a mortgage REIT until 1979 when,
under the name of Mission Investment Trust, it terminated its status as a REIT
and began to develop and market its own properties. In 1982, Mission West
Properties was incorporated as a successor to Mission Investment Trust. In 1997,
our predecessor, Mission West Properties, sold all of its real estate assets and
paid a special dividend of $9.00 per share to stockholders, after which it
retained only nominal assets. Subsequently, the Berg Group acquired control of
the corporation as a vehicle to acquire R&D properties, or interests in entities
owning such properties in a transaction completed on September 2, 1997. At that
time the Berg Group and other investors acquired an aggregate 79.6% controlling
ownership position. In May 1998, we, the Berg Group members, an independent
limited partner, and certain other persons entered into an acquisition agreement
providing, among other things, for our acquisition of interests as the sole
general partner in the operating partnerships. At the time, the operating
partnerships held approximately 4.34 million rentable square feet of R&D
property located in Silicon Valley. The agreement also provided for the parties
to enter into the Pending Projects Acquisition Agreement, the Berg Land Holdings
Option Agreement and the Exchange Rights Agreement, following stockholder
approval. Effective July 1, 1998, we consummated our acquisition of the general
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, 2007, we owned an 18.73% 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 6.95 million rentable square feet of R&D
buildings and vacant land under the Pending Project Acquisition Agreement, the
Berg Land Holdings Option Agreement, and from unrelated third parties. The total
cost of these properties was approximately $703.6 million. To acquire these
properties, we paid in cash or by exchange for existing properties, issued a
total of 28,510,261 O.P. Units and assumed debt totaling approximately $312.3
million.
Since 1998, we have sold a total of approximately 1.0 million rentable square
feet of R&D buildings. The total sales price of these properties was
approximately $144.2 million.
Almost all of our earnings and cash flow is derived from rental revenue received
pursuant to leased R&D space at our properties. Key factors that affect our
business and financial results include the following:
- - economic conditions generally and the real estate market specifically;
- - the occupancy rates of the properties;
- - rental rates on new and renewed leases;
- - tenant improvement and leasing costs incurred to obtain and retain tenants;
- - operating expenses;
- - cost and availability of capital;
- - the extent of acquisitions and sales of real estate;
- - legislative or regulatory provisions (including changes to laws governing
the taxation of REITs);
- - competition;
- - supply of and demand for R&D, office and industrial properties in our
current and proposed market areas;
- - tenant defaults and bankruptcies;
26
- - lease term expirations and renewals; and
- - changes in general accounting principles, policies and guidelines
applicable to REITs.
Negative effects from any of these factors could cause a deterioration in our
operating results, cash flows and financial condition.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We prepare our consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America ("GAAP"), which
requires us to make certain estimates, judgments and assumptions that affect the
reported amounts in the accompanying consolidated financial statements,
disclosure of contingent assets and liabilities and related footnotes.
Accounting and disclosure decisions with respect to material transactions that
are subject to significant management judgments or estimates include impairment
of long lived assets, deferred rent receivables, and allocation of purchase
price relating to property acquisitions and the related depreciable lives
assigned. Actual results may differ from these estimates under different
assumptions or conditions.
Critical accounting policies are defined as those that require management to
make estimates, judgments and assumptions, giving due consideration to
materiality, in certain circumstances that affect amounts reported in the
consolidated financial statements, and potentially result in materially
different results under different conditions and assumptions. We believe that
the following best describe our critical accounting policies:
REAL ESTATE ASSETS
Real estate assets are stated at cost. Cost includes expenditures for
improvements or replacements. Maintenance and repairs are charged to expense as
incurred. Gains and losses from sales are included in income in accordance with
Statement of Financial Accounting Standard ("SFAS") 66, "Accounting for Sales of
Real Estate." The gain on the sale is only recognized proportionately as the
seller receives payments from the purchaser. Interest income is recognized on an
accrual basis, when appropriate.
BUSINESS COMBINATIONS
Statement of Financial Accounting Standards 141, "Business Combinations" ("SFAS
141"), was effective July 1, 2001. The acquisition costs of each property
acquired prior to July 1, 2001 were allocated only to building, land and leasing
commission with building depreciation being computed based on an estimated
weighted average composite useful life of 40 years and leasing commission
amortization being computed over the term of the lease. Acquisitions of
properties made subsequent to the effective date of SFAS 141 are based on an
allocation of the acquisition cost to land, building, tenant improvements, and
intangibles for at market and above market in place leases, and the
determination of their useful lives are guided by a combination SFAS 141 and
management's estimates. Amortization expense of above and below market lease
intangible asset is offset against rental revenue in the revenue section while
amortization of in-place lease value intangible asset is included in
depreciation and amortization of real estate in the expense section of our
consolidated statements of operations. If we do not appropriately allocate these
components or we incorrectly estimate the useful lives of these components, our
computation of depreciation and amortization expense may not appropriately
reflect the actual impact of these costs over future periods, which will affect
net income.
IMPAIRMENT OF LONG-LIVED ASSETS
We review real estate assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable in accordance with Statement of Financial Accounting Standards 144,
"Accounting for the Impairment and Disposal of Long-Lived Assets" ("SFAS 144").
If the carrying amount of the asset exceeds its estimated undiscounted net cash
flow, before interest, we will recognize an impairment loss equal to the
difference between its carrying amount and its estimated fair value. If
impairment is recognized, the reduced carrying amount of the asset will be
accounted for as its new cost. For a depreciable asset, the new cost will be
depreciated over the asset's remaining useful life. Generally, fair values are
estimated using discounted cash flow, replacement cost or market comparison
analyses. The process of evaluating for impairment requires estimates as to
future events and conditions, which are subject to varying market factors, such
as the vacancy rates, future rental rates and operating costs for R&D facilities
in the Silicon Valley area and related submarkets. The analysis that we prepare
in connection with determining if there may be any asset impairment loss under
SFAS 144 considers several assumptions: holding period of ten years, 36 months
lease up period and cap rate ranging from 8% to 9%. Therefore, it is reasonably
possible that a change in estimate resulting from judgments as to future events
could occur which would affect the recorded amounts of the property.
ALLOWANCE FOR DEFERRED RENT AND DOUBTFUL ACCOUNTS
The preparation of the consolidated financial statements requires us to make
estimates and assumptions. As such, we must make estimates of the
uncollectability of our accounts receivable based on the evaluation of our
tenants' financial position, analyses of accounts receivable and current
economic trends. We also make estimates for a straight-line adjustment reserve
for existing tenants with the potential of early termination, bankruptcy or
ceasing operations. Our estimates are based on our review of tenants' payment
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
27
results. Moreover, actual future collections of accounts receivable or
reductions in future reported rental income due to tenant bankruptcies or other
business failures could differ materially from our estimates.
CONSOLIDATION OF JOINT VENTURES
We, through an operating partnership, own three properties that are in joint
ventures of which we have controlling interests. We manage and operate all three
properties. The recognition of these properties and their operating results are
100% reflected on our consolidated financial statements, with appropriate
allocation to minority interest, because we have operational and financial
control of the investments. We make judgments and assumptions about the
estimated monthly payments made to our minority interest joint venture partners,
which are reported with our periodic results of operations. Actual results may
differ from these estimates under different assumptions or conditions.
INVESTMENT IN UNCONSOLIDATED JOINT VENTURE
We, through an operating partnership, have a 50% non-controlling limited
partnership interest in one unconsolidated joint venture. This investment is not
consolidated because we do not exercise significant control over major operating
and financial decisions. We account for the joint venture using the equity
method of accounting.
CONSOLIDATION OF VARIABLE INTEREST ENTITIES
We consolidate all variable interest entities ("VIE") in which we are deemed to
be the primary beneficiary in accordance with FASB Interpretation 46 (Revised
December 2003), "Consolidation of Variable Interest Entities" ("FIN 46R"). As of
December 31, 2007, we consolidated one VIE in the accompanying consolidated
financial statements in connection with an assignment of a lease agreement with
an unrelated party, M&M Real Estate Control & Restructuring, LLC (see Item 8,
"Financial Statements and Supplementary Data - Note 7" for further discussion of
this transaction).
REVENUE RECOGNITION
Rental revenue is recognized on the straight-line method of accounting required
by GAAP under which contractual rent payment increases are recognized evenly
over the lease term, regardless of when the rent payments are received by us.
The difference between recognized rental income and rental cash receipts is
recorded as "Deferred rent receivable" on the consolidated balance sheets.
Rental revenue is affected if existing tenants terminate or amend their leases.
We try to identify tenants who may be likely to declare bankruptcy, cease
operations or are likely to seek a negotiated settlement of their obligation. By
anticipating these events in advance, we expect to take steps to minimize their
impact on our reported results of operations through lease renegotiations,
reserves against deferred rent receivable, and other appropriate measures. Our
judgments and estimations about tenants' capacity to continue to meet their
lease obligations will affect the rental revenue recognized. Material
differences may result in the amount and timing of our rental revenue for any
period if we made different judgments or estimations.
Lease termination fees are recognized as other income when there is a signed
termination letter agreement, all of the conditions of the agreement have been
met, and when the tenant no longer has the right to occupy the property. These
fees are paid by tenants who want to terminate their lease obligations before
the end of the contractual term of the lease by agreement with us. We cannot
predict or forecast the timing or amounts of future lease termination fees.
We recognize income from rent, tenant reimbursements and lease termination fees
and other income once all of the following criteria are met in accordance with
SEC Staff Accounting Bulletin 104:
- - the agreement has been fully executed and delivered;
- - services have been rendered;
- - the amount is fixed and determinable; and
- - collectability is reasonably assured.
With regard to critical accounting policies, where applicable, we have explained
and discussed the criteria for identification and selection, methodology in
application and impact on the financial statements with the Audit Committee of
our Board of Directors, which has reviewed these policies.
28
RESULTS OF OPERATIONS
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2007 TO THE YEAR ENDED DECEMBER 31,
2006
RENTAL REVENUE FROM CONTINUING PROPERTY OPERATIONS
As of December 31, 2007 and 2006, through our controlling interests in the
operating partnerships, we owned 109 and 107 R&D properties totaling
approximately 7.9 and 7.7 million rentable square feet, respectively. We sold
two R&D properties and acquired four R&D properties and 55 acres of vacant land
during 2007.
The following table depicts the amounts of rental revenue from continuing
operations for the years ended December 31, 2007 and 2006 represented by our
historical properties and the percentage of the total decrease in rental revenue
over the period that is represented by each group of properties.
Year Ended December 31,
----------------------------------
2007 2006 $ Change % Change
-------------- --------------- -------------- ---------------
(dollars in thousands)
Same Property (1) $78,067 $89,685 ($11,618) (13.0%)
2006 Acquisitions (2) 2,215 1,772 443 25.0%
2007 Acquisitions (3) 55 - 55 100.0%
-------------- --------------- --------------
Total $80,337 $91,457 ($11,120) (12.2%)
============== =============== ==============
(1) "Same Property" is defined as properties owned by us prior to 2006 that we
still owned as of December 31, 2007.
(2) Operating rental revenue for 2006 Acquisitions do not reflect a full 12
months of operations in 2006 because these properties were acquired at
various times during the year.
(3) Operating rental revenue for 2007 Acquisitions do not reflect a full 12
months of operations in 2007 because these properties were acquired at
various times during the year.
For the year ended December 31, 2007, our rental revenue from real estate
decreased by ($11.1) million, or (12.2%). Pursuant to SFAS 141, $4.1 million and
$1.9 million of amortization expense with respect to above-market leases that we
obtained through property acquisitions was offset against revenue for the years
ended December 31, 2007 and 2006, respectively. The ($11.1) million decrease in
rental revenue resulted from current adverse market conditions as "Same
Property" rents decreased, due to lease terminations, cessation of tenant
operations and tenant relocations since December 31, 2006.
Our overall occupancy rate for leased properties at December 31, 2007 and 2006
was approximately 61.7% and 69.5%, respectively. According to the BT Report, the
leased occupancy rate for R&D property in the Silicon Valley at December 31,
2007 was approximately 83.4%. Due to an over supply of R&D properties and
competitive bidding for tenants by other landlords in the Silicon Valley bidding
for tenants, our occupancy rate may drop further in 2008 if the 328,000 rentable
square feet scheduled to expire is not renewed or re-leased. Factors that
contributed to our low occupancy rate were primarily the general downturn in the
Silicon Valley's economy in recent years, the softening of the R&D property
market specifically, as well as the weaker relative performance of certain
properties due to their location and the weak demand in those submarkets.
EQUITY IN EARNINGS FROM UNCONSOLIDATED JOINT VENTURE
As of December 31, 2007, 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. We have a non-controlling limited partnership
interest in this joint venture, which we account for using the equity method of
accounting. For the years ended December 31, 2007 and 2006, equity in earnings
from the unconsolidated joint venture was approximately $1.4 million and $2.0
million, respectively. Our equity in earnings from this unconsolidated joint
venture decreased primarily due to a gain on sale of one R&D property in 2006
that did not recur in 2007. The occupancy rate for the properties owned by this
joint venture at December 31, 2007 and 2006 was 100%.
OTHER INCOME FROM CONTINUING PROPERTY OPERATIONS
The following table depicts the amounts of other income, including lease
terminations, settlements and interest, from continuing operations for the years
ended December 31, 2007 and 2006.
Year Ended December 31,
----------------------------------
2007 2006 $ Change % Change
-------------- --------------- -------------- ---------------
(dollars in thousands)
Other income $65,068 $20,566 $44,502 216.4%
Other income, including lease terminations, settlements and interest, of
approximately $65.1 million for the year ended December 31, 2007 included
approximately $57.5 million from lease termination fees, $3.1 million from
interest income, $1.8 million from security deposit forfeitures, $1.0 million
from management fees, $0.3 million from tenant bankruptcy settlements and $1.4
million from miscellaneous income. In 2007, of the $57.5 million in lease
termination fees, approximately $46 million was from the Ciena Corporation lease
termination. Other income, including lease terminations, settlements and
interest, of approximately $20.6 million for
29
the year ended December 31, 2006 included approximately $16.1 million from lease
termination fees, $2.3 million from interest income, $1.1 million from
management fees, $0.5 million from a property tax accrual, $0.2 million from
tenant bankruptcy settlements, $0.1 million from security deposit forfeitures
and $0.3 million from miscellaneous income. In 2006, of the $16.1 million in
lease termination fees, approximately $11.1 million was from the JDS Uniphase
lease termination. Management fees are paid by the tenants to the landlord for
the administration and supervision of the property. We do not consider
termination fees and tenant bankruptcy settlements to be recurring items.
EXPENSES FROM CONTINUING PROPERTY OPERATIONS
The following table reflects the amounts of property operating and maintenance
expenses and real estate taxes ("operating expenses") from continuing operations
for the years ended December 31, 2007 and 2006 and the percentage of total
increase in expenses over the period that is represented by each group of
properties.
Year Ended December 31,
----------------------------------
2007 2006 $ Change % Change
-------------- --------------- -------------- ---------------
(dollars in thousands)
Same Property (1) $19,393 $18,001 $1,392 7.7%
2006 Acquisitions (2) 714 504 210 41.7%
2007 Acquisitions (3) 264 - 264 100.0%
-------------- --------------- --------------
Total $20,371 $18,505 $1,866 10.1%
============== =============== ==============
(1) "Same Property" is defined as properties owned by us prior to 2006 that we
still owned as of December 31, 2007.
(2) Operating expenses for 2006 Acquisitions do not reflect a full 12 months of
operations in 2006 because these properties were acquired at various times
during the year.
(3) Operating expenses for 2007 Acquisitions do not reflect a full 12 months of
operations in 2007 because these properties were acquired at various times
during the year.
Operating expenses from continuing operations increased by $1.9 million, or
10.1%, from $18.5 million for the year ended December 31, 2006 to $20.4 million
for the year ended December 31, 2007 primarily due to increase in real estate
taxes, higher maintenance and repair costs and lease commission write-offs
associated with lease terminations. Tenant reimbursements from continuing
operations increased by $0.3 million, or 2.3%, from $13.1 million for the year
ended December 31, 2006 to $13.4 million for the year ended December 31, 2007.
The increase in tenant reimbursements resulted primarily from the increase in
operating expenses. Total operating expenses exceeded tenant reimbursements
because of vacancies, which reached approximately 3.0 million rentable square
feet by year-end 2007. Certain operating expenses such as property insurance,
real estate taxes, and other fixed expenses are not recoverable from vacant
properties. At December 31, 2007 our vacancy rate was approximately 38%.
General and administrative expenses increased by approximately $0.8 million, or
35.0%, from $2.2 million for the year ended December 31, 2006 to $3.0 million
for the year ended December 31, 2007. The increase in general and administrative
expenses was primarily a result of higher legal fees associated with a potential
acquisition of the Company, salaries and wages and share-based compensation
expense.
The following table
depicts the amounts of depreciation and amortization expense
of real estate from continuing operations for the years ended December 31, 2007
and 2006.
Year Ended December 31,
----------------------------------
2007 2006 $ Change % Change
-------------- --------------- -------------- ---------------
(dollars in thousands)
Depreciation and amortization $22,588 $21,579 $1,009 4.7%
Depreciation and amortization expense of real estate from continuing operations
increased by $1.0 million, or 4.7%, primarily due to new construction of tenant
improvements and the write-offs of additional amortization expense relating to
in-place lease value intangible assets pursuant to SFAS 141 in connection with
two lease terminations.
The following table depicts the amounts of interest expense from operations for
the years ended December 31, 2007 and 2006.
Year Ended December 31,
----------------------------------
2007 2006 $ Change % Change
-------------- --------------- -------------- ---------------
(dollars in thousands)
Interest $20,131 $20,708 ($577) (2.8%)
Interest (related parties) 724 755 (31) (4.1%)
-------------- --------------- --------------
Total $20,855 $21,463 ($608) (2.8%)
============== =============== ==============
Interest expense decreased by ($0.6) million, or (2.8%). Interest expense
(related parties) decreased by ($0.03) million, or (4.1%).
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, 2007 and
2006.
Year Ended December 31,
-------------------------------
2007 2006 $ Change % Change
------------- ------------- ------------- -------------
(dollars in thousands)
Net income to common stockholders $18,888 $14,630 $4,258 29.1%
Net income to minority interests 76,960 66,358 10,602 16.0%
------------- ------------- -------------
Total $95,848 $80,988 $14,860 18.3%
============= ============= =============
As of December 31, 2007 and 2006, we owned a controlling general partnership
interest of 19.94%, 21.78%, 16.26% and 12.48% and 19.71%, 21.78%, 16.26% and
12.48% in the four operating partnerships, Mission West Properties, L.P.,
Mission West Properties, L.P. I, Mission West Properties, L.P. II and Mission
West Properties, L.P. III, respectively. We owned an 18.73% and 18.23% general
partnership interest in the operating partnerships, taken as a whole, on a
consolidated weighted average basis as of December 31, 2007 and 2006,
respectively. Net income to common stockholders in 2007 increased by $4.3
million, or 29.1%, from December 31, 2006. Our net income attributable to
minority interests in 2007 increased by $10.6 million, or 16.0%, from December
31, 2006. The increase in net income attributable to common stockholders and
minority interests resulted primarily due to higher lease termination fee income
described above.
Minority interests represent the limited partners' ownership interest of 81.27%
and 81.77% in the operating partnerships, on a weighted average basis, as of
December 31, 2007 and 2006, respectively. The decrease in the minority interest
ownership percentage resulted from the exchange of O.P. Units for shares of the
Company's common stock.
INCOME FROM DISCONTINUED OPERATIONS
The following table depicts the amounts of income from discontinued operations
for the years ended December 31, 2007 and 2006.
Year Ended December 31,
--------------------------------------------------------------
2007 2006
----------------------------- ----------------------------
(dollars in thousands)
Income attributable to discontinued operations $6,620 $19,603
Minority interests in earnings attributable to discontinued operations (5,489) (16,431)
----------------------------- ----------------------------
Income from discontinued operations $1,131 $3,172
============================= ============================
In 2007, we sold two R&D properties and in accordance with our adoption of SFAS
144, classified the net gains on sale and operating results of the disposed
properties as discontinued operations, and in 2006, we sold three R&D properties
and classified the net gains on sale and operating results of the disposed
properties as discontinued operations. SFAS 144 requires prior period results of
operations for these properties to be retrospectively adjusted and presented in
discontinued operations in prior consolidated statements of operations.
We recognized total income of $6.6 million from discontinued operations, of
which $1.1 million and $5.5 million were attributable to common stockholders and
minority interests, respectively, for the year ended December 31, 2007. For the
year ended December 31, 2006, we recognized total income from discontinued
operations of $19.6 million. The income to common stockholders and minority
interests attributable to discontinued operations from these properties in 2006
was approximately $3.2 million and $16.4 million, respectively.
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) $89,685 $99,082 ($9,397) (9.5%)
2006 Acquisitions (2) 1,772 - 1,772 100.0%
-------------- --------------- --------------
Total $91,457 $99,082 ($7,625) (7.7%)
============== =============== ==============
31
(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 (7.7%). Pursuant to SFAS 141, $1.9 million of
amortization expense with respect to above-market leases was offset against
revenue 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 tenant
operations and tenant relocations 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 the BT Report, the
leased occupancy rate for R&D property in the Silicon Valley at December 31,
2006 was approximately 81.7%. Factors that contributed to our low occupancy rate
were primarily the general downturn in the Silicon Valley's economy in recent
years, the softening of the R&D property market specifically and the weaker
relative 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, 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, this joint venture 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 $20,566 $4,590 $15,976 348.1%
Other income, including lease terminations, settlements and interest, 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 fees, $0.5 million from a property tax
accrual, $0.2 million from tenant bankruptcy settlements, $0.1 million from
security deposit forfeitures and $0.3 million from miscellaneous income. In
2006, of the $16.1 million in lease termination fees, approximately $11.1
million was from the JDS Uniphase lease termination. Other income, including
lease terminations, settlements and interest, 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.
Management fees are paid by the tenants to the landlord for the administration
and supervision of the property. We do not consider termination fees and tenant
bankruptcy settlements to be recurring items.
EXPENSES FROM CONTINUING PROPERTY OPERATIONS
The following table reflects the amounts of property operating and maintenance
expenses and real estate taxes ("operating expenses") from continuing operations
for the years ended December 31, 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) $17,653 $18,281 ($628) (3.4%)
2005 Acquisition (2) 348 332 16 4.8%
2006 Acquisitions (3) 504 - 504 100.0%
-------------- --------------- --------------
Total $18,505 $18,613 ($108) (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.
32
Operating expenses from continuing operations decreased by ($0.1) million, or
(0.6%), from $18.6 million for the year ended December 31, 2005 to $18.5 million
for the year ended December 31, 2006. Tenant reimbursements from continuing
operations decreased by ($1.0) million, or (6.9%), from $14.0 million for the
year ended December 31, 2005 to $13.0 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
approximately 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 share-based compensation 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 shares of the Company's common 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 $21,579 $20,329 $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 $20,708 $21,294 ($586) (2.8%)
Interest (related parties) 755 972 (217) (22.3%)
-------------- --------------- --------------
Total $21,463 $22,266 ($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.
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 December 31, 2005. Our net income attributable to
minority interests in 2006 increased by $18.8 million, or 39.6%, from December
31, 2005. The increase in net income attributable to common stockholders and
minority interests resulted 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
33
resulted from the exchange of O.P. Units for shares of the Company's 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 $19,603 $4,131
Minority interests in earnings attributable to discontinued operations (16,431) (3,388)
----------------------------- ----------------------------
Income from discontinued operations $3,172 $743
============================= ============================
In accordance with our adoption of SFAS 144, in 2006 we sold three R&D
properties and classified the net gains on sale and operating results of the
disposed properties as discontinued operations. SFAS 144 requires prior period
results of operations for these properties to be retrospectively adjusted and
presented in discontinued operations in prior consolidated statements of
operations.
We recognized total income of $19.6 million from discontinued operations, of
which $3.2 million and $16.4 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 $4.1 million. The income to common stockholders and minority
interests attributable to discontinued operations from these properties in 2005
was approximately $0.7 million and $3.4 million, respectively.
CHANGES IN FINANCIAL CONDITION
YEAR ENDED DECEMBER 31, 2007
The most significant changes in our financial condition in 2007 resulted from
the acquisition of four R&D properties, the acquisition of 55 acres of vacant
land, the disposition of two R&D properties and the exchange of O.P. Units for
shares of the Company's common stock.
During 2007, we acquired four R&D properties representing approximately 247,000
rentable square feet for an aggregate gross purchase price of approximately
$26.3 million. We acquired three of the R&D properties in tax-deferred exchange
transactions and paid cash and issued O.P. Units to members of the Berg Group to
acquire the fourth property. We also acquired 55 acres of vacant land for
approximately $27.8 million in a tax-deferred exchange transaction. In addition
to those property acquisitions, we sold two R&D properties to unrelated third
parties for a total gross sales price of approximately $16.0 million. Those
property dispositions reduced approximately 87,000 rentable square feet. The
proceeds were classified as restricted cash for use in tax-deferred property
exchanges and were reflected on our consolidated balance sheet as restricted
cash at December 31, 2007 (see Item 8, "Financial Statements and Supplementary
Data - Note 6" for further discussion of this transaction).
Debt outstanding, including amounts due related parties, decreased by ($11.1)
million, or (3.1%), from $357.8 million as of December 31, 2006 to $346.7
million as of December 31, 2007 due to normal scheduled debt payments.
In 2007, two limited partners exchanged a total of 220,500 O.P. Units for
220,500 shares of common stock pursuant to the Exchange Rights Agreement
resulting in a reclassification of approximately $2.9 million from minority
interests to paid-in-capital.
The conversion of O.P. Units to shares of the Company's common stock was applied
to increase our percentage interest as general partner in the operating
partnerships.
YEAR ENDED DECEMBER 31, 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.
34
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 the Company's 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 the Company's common
stock by December 31, 2006. The remaining 82,000 O.P. Units were exchanged for
82,000 shares of the Company's 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.
LIQUIDITY AND CAPITAL RESOURCES
In 2008, we anticipate operating cash flows from our property portfolio to be
lower compared to 2007. We are still experiencing weak demand for our 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
328,000 rentable square feet scheduled to expire in 2008 and current available
space, our operating cash flows will be affected adversely. We are also subject
to risks of decreased occupancy through tenant defaults and bankruptcies, and
potential reduction in rental rates upon renewal of properties, which would
result in reduction in cash flows from operations beyond the level we are
anticipating currently.
We expect our principal source of liquidity for distributions to stockholders
and O.P. Unit holders, debt service, leasing commissions and recurring capital
expenditures to come from cash provided by operations and/or future borrowings
under our $10 million line of credit with the Heritage Bank of Commerce, which
we obtained in early 2008. We expect these sources of liquidity to be adequate
to meet projected distributions to stockholders and other presently anticipated
liquidity requirements in 2008. We expect to meet our long-term liquidity
requirements for the funding of property development, property acquisitions and
other material non-recurring capital improvements through cash and investments,
long-term secured and unsecured indebtedness and the issuance of additional
equity securities by us. We have the ability to meet short-term obligations or
other liquidity needs based on our existing cash reserves. In 2008, we will be
obligated to make payments totaling approximately $121.6 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
including approximately $112.5 million owed to the Prudential Insurance Company
of America loan which matures in October 2008. We currently are seeking to
refinance the Prudential loan and expect to obtain a replacement loan. We cannot
be assured of refinancing this loan however, and especially in light of current
conditions in the credit market, may be required to pay higher interest expense
and financing fees for new debt.
As of December 31, 2007, we were in compliance with loan covenants relating to
the Prudential Insurance, Northwestern Mutual and Allianz mortgage loans.
Cash and cash equivalents decreased by approximately ($10.1) million from $33.8
million as of December 31, 2006 to $23.7 million as of December 31, 2007.
Restricted cash totaled $65.5 million as of December 31, 2007. Of this amount,
$15.6 million represents proceeds received from the Northport and Morse property
sales 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). $48.4 million represents a balance we consolidated due to our
adoption of FIN 46R (see Item 8, "Financial Statements and Supplementary Data -
Note 7" for further discussion of this transaction). The remaining $1.5 million
represents a certificate of deposit setup for a current loan escrow. 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 2008. 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.
35
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 2008, we will increase our quarterly dividend payment rate to common
stockholders and O.P. Unit holders from $0.16 to $0.20 per share. However,
distributions are declared at the discretion of our Board of Directors and are
subject to actual cash available for distribution, our financial condition,
capital requirements and such other factors, as our Board of Directors deems
relevant (see Item 1A, "Risk Factors - Stockholders are not assured of receiving
cash distributions from us"). On January 3, 2008, we paid dividends of $0.16 per
share of common stock to all common stockholders of record as of December 31,
2007. 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 $16.8 million.
On January 7, 2008, we borrowed $3 million from Carl E. Berg on a short-term
basis to fund an anticipated property acquisition. The $3 million loan was
repaid on January 30, 2008. The transaction was approved by the Independent
Directors Committee of the Company's Board of Directors.
Funds available for distributions does not represent cash generated from
operating activities and is not necessarily indicative of cash available to fund
cash needs. The actual return that we will realize and the amount available for
distributions to stockholders will be affected by a number of factors, including
the revenues received from our properties, our operating expenses, debt service
on borrowings, and planned and unanticipated capital expenditures.
We anticipate that cash available for distribution will exceed earnings and
profits for federal income tax purposes, as the latter figure takes into account
non-cash expenses such as depreciation and amortization that we will incur.
Distributions other than capital gain distributions by us to the extent of our
current and accumulated earnings and profits for federal income tax purposes
most likely will be taxable to U.S. stockholders as ordinary dividend income
unless a stockholder is a tax-exempt entity. Distributions in excess of earnings
and profits generally will be treated as a non-taxable reduction of the U.S.
stockholder's basis in the common stock to the extent of such basis, and
thereafter as taxable gain. The percentage of such distributions in excess of
earnings and profits, if any, may vary from period to period.
CONTRACTUAL OBLIGATIONS
The following table identifies the contractual obligations as of December 31,
2007 that will impact our liquidity and cash flow in future periods:
------------ ------------ ------------- ------------ ------------ ------------ -------------
2008 2009 2010 2011 2012 Thereafter Total
--------------------------------------------------------------------------------------------
(dollars in thousands)
Long-Term Debt Obligations (1) $121,589 $9,561 $10,105 $10,681 $11,032 $183,776 $346,744
Operating Lease Obligations (2) 114 30 - - - - 144
------------ ------------ ------------- ------------ ------------ ------------ -------------
Total $121,703 $9,591 $10,105 $10,681 $11,032 $183,776 $346,888
============ ============ ============= ============ ============ ============ =============
(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, 2007, we had total indebtedness of approximately $346.7 million,
all of which is fixed rate mortgage debt. A table listing our indebtedness as of
December 31, 2007 is set forth in Item 8, "Financial Statements and
Supplementary Data - Note 8."
At December 31, 2007, 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 $9.51 per share on December 31, 2007) on a fully diluted basis, including the
conversion of all O.P. Units into common stock, was approximately 25.7%. On
December 31, 2007, the last trading day for the year, total market
capitalization was approximately $1.35 billion. By comparison, on December 29,
2006 total debt as a percentage of market capitalization was 20.7% and total
market capitalization was approximately $1.73 billion.
At December 31, 2007, the outstanding balance remaining under certain demand
notes that we owed to the operating partnerships was $2.0 million. The due date
of the demand notes has been extended to September 30, 2009. 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.
36
HISTORICAL CASH FLOWS
The Company's cash flow activities are summarized as follows:
Year Ended December 31,
-----------------------------------------------------------
2007 2006 2005
----------------- ---------------- ----------------
(dollars in thousands)
Cash flow provided by operating activities $23,501 $27,012 $21,898
Cash flow used in investing activities ($8,548) ($5,369) ($2,875)
Cash flow (used in)/provided by financing activities($25,047) ($19,299) $10,899
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2007 TO THE YEAR ENDED DECEMBER 31,
2006
Cash and cash equivalents were approximately $23.7 million at December 31, 2007,
a decrease of ($10.1) million from $33.8 million at December 31, 2006.
Net cash provided by operating activities for the year ended December 31, 2007
was approximately $23.5 million, compared to approximately $27.0 million for the
prior year. The decrease in cash provided by operating activities resulted
primarily from lower lease termination fee payment, lower deferred rental income
and higher leasing commission payments (included in other assets) in 2007.
Cash used in investing primarily consists of property acquisitions, property
sales and improvements to our properties. Net cash used in investing activities
was approximately ($8.5) million for the year ended December 31, 2007 compared
to approximately ($5.4) million for the prior year. In 2007, we acquired six
properties for approximately $47.5 million, incurred capital expenditures
relating to real estate improvements of approximately $4.9 million and
transferred excess restricted cash of approximately $0.6 million to our general
cash account. We used restricted cash totaling approximately $43.2 million of
the acquisition of three R&D properties and 55 acres of vacant land in
tax-deferred exchange transactions involving our former R&D properties at
Samaritan Drive in San Jose, California. We sold two R&D properties for
approximately $15.4 million, net, as described above, the proceeds of which are
reflected on our consolidated balance sheet as restricted cash at December 31,
2007. In 2006, we sold three vacant R&D properties for approximately $42.6
million, net. We acquired three R&D properties for approximately $16.0 million,
incurred capital expenditures relating to real estate improvements of
approximately $4.3 million and transferred approximately $1.8 million of excess
restricted cash to our general cash account. We used restricted cash totaling
approximately $13.5 million to complete the acquisition of two R&D properties in
a tax-deferred exchange transaction involving our former R&D property at 800
Embedded Way, San Jose, California. Proceeds of approximately $43.0 million,
which included earned interest, from the three vacant R&D property dispositions
were classified as restricted cash for use in tax-deferred property exchanges
and were reflected on our consolidated balance sheet as restricted cash at
December 31, 2006.
Net cash used in financing activities was approximately ($25.0) million for the
year ended December 31, 2007, compared to approximately ($19.3) million for the
year ended December 31, 2006. During 2007, financing activities included
payments of approximately $11.0 million for outstanding debt, payment of
approximately $1.5 million for a certificate of deposit related to a current
loan escrow and payments of approximately $12.5 million to common stockholders
as dividends. During 2006, financing activities included the net effect of
payments of approximately $9.8 million for outstanding debt, receipt of
approximately $1.6 million from the refund of an appeal bond, receipt of
approximately $1.0 million from stock option exercises and payments of
approximately $12.1 million to common stockholders as dividends.
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 payment, 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 $42.6
million, net, as described above. Proceeds of approximately $43.0 million, which
included earned interest, from the three vacant R&D property dispositions were
classified as restricted cash for use in tax-deferred property exchanges and
were reflected on our consolidated balance sheet as restricted cash at December
31, 2006.
37
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, financing activities
included the net effect of payments of approximately $9.8 million for
outstanding debt, receipt of approximately $1.6 million from the refund of an
appeal bond, receipt of approximately $1.0 million from stock option exercises
and payments of approximately $12.1 million to common stockholders as dividends.
During 2005, financing activities included the net effect of borrowing
approximately $150.8 million under two new collateralized mortgage loans and
payments of approximately $120.3 million for outstanding debt. We also received
approximately $0.5 million from stock option exercises, paid approximately $11.7
million to common stockholders as dividends and paid approximately $8.4 million
to O.P. Unit holders for distributions in excess of their share of earnings.
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, 2003 through December 31, 2007, the recurring tenant/building
improvement costs and leasing commissions incurred with respect to new leases
and lease renewals of the properties averaged approximately $5.0 million
annually. We will have approximately 328,000 rentable square feet under expiring
leases in 2008. 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 2008. We believe we will recover
substantially all of these costs from the tenants under the new or renewed
leases through contractual increases in rental rates. Until we actually sign the
leases, however, we cannot assure you that this will occur. Capital expenditures
may fluctuate in any given period subject to the nature, extent, and timing of
improvements required to be made to the properties. Tenant/building improvements
and leasing costs also may fluctuate in any given period year depending upon
factors such as the property, the term of the lease, the type of lease and the
overall market conditions. We expect to meet our long-term liquidity
requirements for the funding of property acquisitions and other material
non-recurring capital improvements through our currently available sources of
capital, including operating cash flows, cash on hand, and our existing line of
credit with Heritage Bank of Commerce (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
38
- - we cannot undertake certain other specified transactions, including the
issuance of debt securities, and borrowings in excess of specified limits,
or the amendment of our charter and bylaws, without the approval of more
than 75% of the entire Board of Directors.
INVESTMENT POLICIES
We expect to pursue our business and investment objectives principally through
the direct ownership by the operating partnerships of our properties and future
acquired properties. Development or investment activities are not limited to any
specified percentage of our assets. We may also participate with other entities
in property ownership, through joint ventures or other types of co-ownership.
Equity investments may be subject to existing mortgage financing and other
indebtedness that have priority over our equity interests.
While we will emphasize equity real estate investments, we may, in our
discretion and subject to the percentage ownership limitations and gross income
tests necessary for REIT qualification, invest in mortgage and other real estate
interests, including securities of other real estate investment trusts. We have
not previously invested in mortgages or securities of other real estate
investment trusts, however, and 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
39
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, 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. 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.
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 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." FIN 48 provides guidance on derecognition,
classification, interest and penalties, and accounting in interim periods and
requires expanded disclosure with respect to the uncertainty in income taxes.
The provisions of FIN 48 are effective for our fiscal year beginning January 1,
2007. Based on our evaluation, we have concluded that there are no significant
uncertain tax positions requiring recognition in our financial statements. The
adoption of FIN 48 on January 1, 2007 did not have a material impact on our
consolidated results of operations, financial position or cash flows.
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. The FASB has approved a one-year deferral for
the implementation of the Statement for non-financial assets and non-financial
liabilities that are recognized or disclosed at fair value in the financial
statements on a nonrecurring basis. 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.
In February 2007, the FASB issued SFAS 159, "The Fair Value Option for Financial
Assets and Financial Liabilities" ("SFAS 159"). SFAS 159 provides companies with
an option to report selected financial assets and liabilities at fair value.
SFAS 159's objective is to reduce both complexity in accounting for financial
instruments and the volatility in earnings caused by measuring related assets
and liabilities differently. SFAS 159 is effective for financial statements
issued for fiscal years beginning after November 15, 2007. We adopted SFAS 159
on a prospective basis on January 1, 2008. We do not expect the implementation
of SFAS 159 to have a material impact on our consolidated financial statements.
In December 2007, the FASB issued SFAS 141 (Revised 2007), "Business
Combinations" ("SFAS 141R"). SFAS 141R will change the accounting for business
combinations. Under SFAS 141R, an acquiring entity will be required to recognize
all the assets acquired and liabilities assumed in a transaction at the
acquisition date fair value with limited exceptions. SFAS 141R will change the
accounting treatment and disclosure for certain specific items in a business
combination. SFAS 141R applies prospectively to business combinations for which
the acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008. Early adoption is prohibited. We
are currently evaluating the impact SFAS 141R will have on our consolidated
financial statements.
In December 2007, the FASB issued SFAS 160, "Noncontrolling Interests in
Consolidated Financial Statements" ("SFAS 160"). SFAS 160 requires that
noncontrolling interests be presented as a component of consolidated
stockholders' equity, eliminates "minority interest accounting" such that the
amount of net income attributable to the noncontrolling interests will be
presented as part of consolidated net income on the consolidated statement of
operations and not as a separate component of income and expenses. SFAS 160 is
effective for fiscal years beginning on or after December 15, 2008. Early
adoption is prohibited. We are currently evaluating the impact SFAS 160 will
have on our consolidated financial statements.
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, 2007, 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 effects on the results of our operations. This takes frequent evaluation
of available lending rates and examination of opportunities to reduce interest
expense through new sources of debt financing. Several factors affecting the
interest rate risk include governmental monetary and tax policies, domestic and
international economics and other factors that are beyond our control. The
following table provides information about the principal cash flows, weighted
average interest rates, and expected maturity dates for debt outstanding as of
December 31, 2007. The current terms of our outstanding debt are described in
Item 8, "Financial Statements and Supplementary Data - Note 8." For fixed rate
debt, we estimate fair value by using discounted cash flow analyses based on
borrowing rates for similar kinds of borrowing arrangements. We estimated that
the fair value of fixed rate debt at December 31, 2007 was approximately $444.3
million.
For fixed rate debt, the table presents the assumption that the outstanding
principal balance at December 31, 2007 will be paid according to scheduled
principal payments and that we will not prepay any of the outstanding principal
balance.
2008 2009 2010 2011 2012 Thereafter Total Fair Value
----------------------------------------------------------------------------------------------
(dollars in thousands)
Fixed Rate Debt:
Secured notes payable $121,589 $9,561 $10,105 $10,681 $11,032 $183,776 $346,744 $444,288
Weighted average interest rate 5.85% 5.85% 5.85% 5.85% 5.85% 5.85%
All of our debt is denominated in United States dollars. The weighted average
interest rate for the fixed rate debt was approximately 5.85% and 5.84% for the
years ended December 31, 2007 and 2006. The decrease in interest expense
attributable to the average interest rate difference between 2006 and 2007 was
approximately ($0.6) million, which was a result of normal scheduled debt
payments in 2007.
The primary market risk we face is the risk of interest rate fluctuations. 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, 2007, we had no interest rate caps or interest
rate swap contracts and had no variable rate debt outstanding, and thus had no
interest rate risk.
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, 2007 and 2006 46
Consolidated Statements of Operations for the years ended December 31, 2007, 2006 and 2005 47
Consolidated Statements of Stockholders' Equity for the years ended December 31, 2007, 2006 and 2005 48
Consolidated Statements of Cash Flows for the years ended December 31, 2007, 2006 and 2005 49
Notes to Consolidated Financial Statements 50
Supplemental Financial Information 72
Report of Independent Registered Public Accounting Firm on Financial Statement Schedule 74
Schedule III: Real Estate and Accumulated Depreciation as of December 31, 2007 76
Schedule III: Real Estate and Accumulated Depreciation as of December 31, 2006 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 sheet of Mission West
Properties, Inc. (the "Company") as of December 31, 2007 and 2006 and the
related consolidated statements of operations, stockholders' equity and cash
flows for the years 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 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 present
fairly, in all material respects, the financial position of Mission West
Properties, Inc. as of December 31, 2007 and 2006, and the results of their
operations and their cash flows for the years then ended, in conformity with
accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the Company's internal control over
financial reporting as of December 31, 2007, 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, 2008
expressed an unqualified opinion on the Company's internal control over
financial reporting.
We also have audited the adjustments to the related consolidated statements of
operations for the year ended December 31, 2005 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 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 on the
2005 financial statements taken as a whole.
\S\ Burr, Pilger & Mayer, LLP
San Francisco, California
March 12, 2008
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, Mission West Properties, Inc. (the "Company")
consolidated statements of operations, stockholders' equity, and cash flows for
the year ended December 31, 2005 (the 2005 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 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, before
the effects of the reclassifications to discontinued operations described in
Note 17, present fairly, in all material respects, Mission West Properties,
Inc.'s results of its operations and its cash flows for the year 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 the internal control over financial reporting of Mission West
Properties, Inc. (the "Company") as of December 31, 2007, based on criteria
established in Internal Control--Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (the "COSO criteria"). The
Company's management is responsible for maintaining effective internal control
over financial reporting and for its assessment of the effectiveness of internal
control over financial reporting included in the accompanying Management's
Report on Internal Control over Financial Reporting. Our responsibility is to
express an opinion on the 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 audits included obtaining an understanding of internal control
over financial reporting, assessing the risk that a material weakness exists,
testing and evaluating the design and operating effectiveness of internal
control based on the assessed risk, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a
reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect that transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, Mission West Properties, Inc. maintained, in all material
respects, effective internal control over financial reporting as of December 31,
2007, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
Mission West Properties, Inc. as of December 31, 2007 and 2006, and the related
consolidated statements of operations, stockholders' equity and cash flows for
the years then ended, and the related financial statement schedules listed in
the Index at Item 15(a), and our reports dated March 12, 2008 expressed an
unqualified opinion thereon.
\S\ Burr, Pilger & Mayer, LLP
San Francisco, California
March 12, 2008
45
MISSION WEST PROPERTIES, INC.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except per share data)
ASSETS
December 31,
---------------------------------------------
2007 2006
---------------------- ---------------------
Real estate:
Land $ 312,152 $ 272,223
Buildings and improvements 764,665 756,596
Real estate related intangible assets 2,119 19,529
---------------------- ---------------------
1,078,936 1,048,348
Less accumulated depreciation and amortization (156,819) (149,459)
---------------------- ---------------------
Total investments in real estate, net 922,117 898,889
Cash and cash equivalents 23,691 33,785
Restricted cash 65,509 48,245
Deferred rent receivable, net 14,833 18,489
Investment in unconsolidated joint venture 2,735 3,468
Other assets, net 25,000 24,611
---------------------- ---------------------
Total assets $1,053,885 $1,027,487
====================== =====================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Mortgage notes payable $ 337,520 $ 348,101
Mortgage note payable (related parties) 9,224 9,654
Interest payable 1,331 1,375
Security deposits 4,754 6,977
Deferred rental income 3,302 6,874
Dividends and distributions payable 16,832 16,745
Accounts payable and accrued expenses 15,618 7,601
---------------------- ---------------------
Total liabilities 388,581 397,327
---------------------- ---------------------
Commitments and contingencies (Note 16)
Minority interests 526,626 501,282
---------------------- ---------------------
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, 19,664,087
and 19,443,587 shares issued and outstanding at December 31, 2007 and 2006 20 19
Additional paid-in capital 153,024 149,541
Distributions in excess of accumulated earnings (14,366) (20,682)
---------------------- ---------------------
Total stockholders' equity 138,678 128,878
---------------------- ---------------------
Total liabilities and stockholders' equity $1,053,885 $1,027,487
====================== =====================
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,
------------------------------------------------------------------
2007 2006 2005
-------------------- --------------------- ---------------------
Revenues:
Rental revenue from real estate $80,337 $91,457 $99,082
Above market lease intangible asset amortization (4,091) (1,888) (1,888)
Tenant reimbursements 13,355 13,061 14,030
Other income, including lease terminations, settlements and interest 65,068 20,566 4,590
-------------------- --------------------- ---------------------
154,669 123,196 115,814
Expenses:
Property operating, maintenance and real estate taxes 20,371 18,505 18,613
Interest 20,131 20,708 21,294
Interest (related parties) 724 755 972
General and administrative 3,035 2,248 1,910
Depreciation and amortization of real estate 22,588 21,579 20,329
-------------------- --------------------- ---------------------
66,849 63,795 63,118
-------------------- --------------------- ---------------------
Income before equity in earnings of unconsolidated joint venture
and minority interests 87,820 59,401 52,696
Equity in earnings of unconsolidated joint venture 1,408 1,985 724
Minority interests (71,471) (49,928) (44,136)
-------------------- --------------------- ---------------------
Income from continuing operations 17,757 11,458 9,284
Discontinued operations, net of minority interests:
Gain from disposal of properties classified as discontinued operations 1,126 2,935 445
Income attributable to discontinued operations 5 237 298
-------------------- --------------------- ---------------------
Income from discontinued operations 1,131 3,172 743
-------------------- --------------------- ---------------------
Net income to common stockholders $18,888 $14,630 $10,027
==================== ===================== =====================
Net income to minority interests $76,960 $66,358 $47,524
==================== ===================== =====================
Income per share from continuing operations:
Basic $0.90 $0.60 $0.51
==================== ===================== =====================
Diluted $0.89 $0.59 $0.51
==================== ===================== =====================
Income per share from discontinued operations:
Basic $0.06 $0.17 $0.04
==================== ===================== =====================
Diluted $0.06 $0.17 $0.04
==================== ===================== =====================
Net income per share to common stockholders:
Basic $0.96 $0.77 $0.55
==================== ===================== =====================
Diluted $0.95 $0.76 $0.55
==================== ===================== =====================
Weighted average shares of common stock (basic) 19,627,234 19,066,581 18,286,947
==================== ===================== =====================
Weighted average shares of common stock (diluted) 19,854,411 19,298,664 18,325,659
==================== ===================== =====================
Weighted average O.P. Units 85,162,240 85,510,491 86,220,117
==================== ===================== =====================
Outstanding common stock 19,664,087 19,443,587 18,448,791
==================== ===================== =====================
Outstanding O.P. Units 85,533,935 85,206,199 86,088,095
==================== ===================== =====================
See notes to consolidated financial statements.
47
MISSION WEST PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(dollars in thousands, except per share data)
Distributions in
Additional Excess of
Shares of Common Common Paid-in Accumulated Total Stockholders'
Stock Outstanding Stock Capital Earnings Equity
------------------- ---------- ------------- ----------------- -------------------
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
Issuance of common stock upon option exercise 112,900 1,014 1,014
Stock-based compensation 210 210
------------------- ---------- ------------- ----------------- -------------------
Balance, December 31, 2006 19,443,587 19 149,541 (20,682) 128,878
Net income 18,888 18,888
Dividends declared at $0.64 per share (12,572) (12,572)
Issuance of common stock upon O.P. Unit conversion 220,500 1 2,854 2,855
Stock-based compensation 629 629
------------------- ---------- ------------- ----------------- -------------------
Balance, December 31, 2007 19,664,087 $20 $153,024 ($14,366) $138,678
=================== ========== ============= ================= ===================
See notes to consolidated financial statements.
48
MISSION WEST PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
Year Ended December 31,
---------------------------------------------------------------
2007 2006 2005
------------------- ------------------- --------------------
Cash flows from operating activities:
Net income from continuing operations $17,757 $11,458 $ 9,284
Net income from discontinued operations 1,131 3,172 743
Adjustments to reconcile income from continuing operations to
net cash provided by operating activities:
Minority interests income from continuing operations 71,471 49,928 44,136
Minority interests income from discontinued operations 5,489 16,430 3,388
Minority interests distributions (55,313) (55,618) (47,524)
Depreciation and amortization of real estate and in-place leases 22,588 21,579 20,329
Depreciation and amortization from discontinued operations 147 695 1,270
Amortization of above market lease 4,091 1,888 1,888
Gain from disposal of properties classified as discontinued operations(6,529) (18,102) (2,206)
Equity in earnings of unconsolidated joint venture (1,408) (1,985) (724)
Distributions from unconsolidated joint venture 2,141 1,780 1,020
Interest earned on restricted cash (1,631) (821) (100)
Lease termination fee income related to restricted cash (35,636) (4,549) -
Stock-based compensation expense 629 236 -
Other 147 37 -
Change in operating assets and liabilities, net of liabilities assumed:
Deferred rent receivable 3,656 729 (707)
Other assets (389) 751 (5,709)
Interest payable (44) 1,054 (6)
Security deposits (2,230) (1,070) (497)
Deferred rental income (3,572) 771 (4,935)
Accounts payable and accrued expenses 1,006 (1,351) 2,248
------------------- ------------------- --------------------
Net cash provided by operating activities 23,501 27,012 21,898
------------------- ------------------- --------------------
Cash flows from investing activities:
Improvements to real estate (4,878) (4,277) (1,138)
Proceeds from sales of real estate 15,431 42,628 27,508
Purchase of real estate (47,491) (15,959) (14,184)
Restricted cash held in escrow (15,431) (43,043) (15,061)
Restricted cash released for purchase of real estate 43,191 13,447 -
Excess cash from release of restricted cash 630 1,835 -
------------------- ------------------- --------------------
Net cash used in investing activities (8,548) (5,369) (2,875)
------------------- ------------------- --------------------
Cash flows from financing activities:
Proceeds from mortgage loan payable - - 150,800
Principal payments on mortgage notes payable (10,581) (9,380) (7,431)
Principal payments on mortgage notes payable (related parties) (430) (397) (369)
Net payments under line of credit (related parties) - - (9,560)
Payment on loan payable - - (78,710)
Net payments under revolving line of credit - - (24,208)
Loan escrow (1,500) - -
Refund of appeal bond - 1,599 -
Net proceeds from exercise of stock options - 989 480
Minority interests distributions in excess of earnings - - (8,435)
Dividends paid (12,536) (12,110) (11,668)
------------------- ------------------- --------------------
Net cash (used in)/provided by financing activities (25,047) (19,299) 10,899
------------------- ------------------- --------------------
Net (decrease)/increase in cash and cash equivalents (10,094) 2,344 29,922
Cash and cash equivalents, beginning of year 33,785 31,441 1,519
------------------- ------------------- --------------------
Cash and cash equivalents, end of year $23,691 $33,785 $31,441
=================== =================== ====================
See notes to consolidated financial statements.
49
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)
1. ORGANIZATIONS AND FORMATION OF THE COMPANY
Mission West Properties, Inc. ("the Company") is a fully integrated,
self-administered and self-managed real estate company that acquires and manages
research and development ("R&D")/office properties in the portion of the San
Francisco Bay Area commonly referred to as Silicon Valley. In July 1998, the
Company purchased an approximate 12.11% 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, 2007, the Company owns a controlling general partnership
interest of 19.94%, 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 18.73% general partnership
interest in the operating partnerships, taken as a whole, on a consolidated
weighted average basis.
The Company, through the operating partnerships, owns interests in 109 R&D
properties at December 31, 2007, all of which are located in the Silicon Valley.
BUSINESS SEGMENT INFORMATION
The Company's primary business is the ownership and management of R&D/office
real estate with a geographic concentration in the Silicon Valley of the San
Francisco Bay Area. Accordingly, the Company has concluded 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 No. 46
(Revised December 2003), "Consolidation of Variable Interest Entities"("FIN
46R").
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America ("GAAP") requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the dates of
the financial statements and the reported amounts of revenue and expenses during
the reporting periods. Accounting and disclosure decisions with respect to
material transactions that are subject to significant management judgments or
estimates include impairment of long lived assets, realizability of deferred
rent receivables, and allocation of purchase price relating to property
acquisitions and the related depreciable lives assigned. Actual results could
differ materially from those estimates.
REAL ESTATE ASSETS AND RELATED INTANGIBLE ASSETS
Real estate assets are stated at cost. Cost includes expenditures for
improvements or replacements. Maintenance and repairs are charged to expense as
incurred.
For purchases of real estate that were consummated 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 tenant improvements, and identified intangible assets and
liabilities, consisting of the value of above-market and below-market leases,
other value of in-place leases and value of tenant relationships, based in each
case on their relative fair values.
The fair value of the tangible assets of an acquired property, which includes
land, building and tenant improvements, is determined by valuing the property as
if it were vacant, and the "as-if-vacant" value is then allocated to land,
building and tenant improvements based on management's determination of the
relative fair values of these assets. Factors considered by management in
performing these analyses include certain costs during the lease-up periods
considering current market conditions and costs to execute similar leases. These
costs include estimates of lost rental revenue, leasing commissions, and tenant
improvements.
50
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
In allocating the fair value of the identified intangible assets of the acquired
property, above-market in-place lease value is recorded based on the present
value, using an interest rate which reflects the risks associated with the lease
acquired, of the difference between (i) the contractual amounts to be paid
pursuant to the in-place lease and (ii) management's estimate of fair market
lease rate for the corresponding in-place lease, measured over a period equal to
the remaining non-cancelable lease term. The capitalized above-market lease
value, included in real estate related intangible assets, is amortized as an
offset to rental revenue from real estate over the remaining non-cancelable
lease term. The value of in-place leases, exclusive of the value of above-market
in-place lease, is amortized to expense over the remaining non-cancelable
periods of the respective leases. If a lease were to be terminated prior to its
stated expiration, all unamortized amounts relating to that lease would be
written off in the period that the lease is terminated.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization are computed using the straight-line method over
estimated useful lives as follows:
Building shell and base building improvements of newly acquired properties - Weighted average composite life of 40 years
Base building improvements made subsequent to initial property acquisition - 25 years acquisition Tenant
Tenant improvements and furniture and fixtures - Lesser of life of asset, generally 5-10 years,
or term of lease
Above-market and in-place lease value - Term of lease
IMPAIRMENT OF LONG-LIVED ASSETS
The Company reviews real estate assets for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable in accordance with SFAS 144, "Accounting for the Impairment and
Disposal of Long-Lived Assets." If the carrying amount of the asset, including
any intangible assets associated with that asset, exceeds its estimated
undiscounted net cash flow, before interest, the Company will recognize an
impairment loss equal to the difference between its carrying amount and its
estimated fair value. If impairment is recognized, the reduced carrying amount
of the asset will be accounted for as its new cost. For a depreciable asset, the
new cost will be depreciated over the asset's remaining useful life. Generally,
fair values are estimated using discounted cash flow, replacement cost or market
comparison analyses. The analysis that the Company prepares in connection with
determining if there may be any asset impairment loss under SFAS 144 considers
several assumptions: holding period of ten years, 36 months lease up period and
cap rate ranging from 8% to 9%. The process of evaluating for impairment
requires estimates as to future events and conditions, which are subject to
varying market and economic factors, such as the vacancy rates, rental rates and
operating costs for R&D facilities in the Silicon Valley area and related
submarkets. Therefore, it is reasonably possible that a change in estimate
resulting from judgments as to future events could occur which would affect the
recorded amounts of the property. No impairment losses were recorded for the
years ended December 31, 2007 and 2006.
ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS
In accordance with SFAS 144, the results of operations and gains or losses on
the sale of property are presented as discontinued operations if both the
following criteria are met: (a) the operation and cash flows of the property
have been (or will be) eliminated from the ongoing operations of the Company as
a result of the disposal transaction; and (b) the Company will not have any
significant involvement in the operations of the property after the disposal
transaction. SFAS 144 also requires prior period results of operations for these
properties to be retrospectively adjusted and presented in discontinued
operations in prior consolidated statements of operations.
An asset is generally classified as held for sale once management has committed
to an action to sell the asset, the asset is available for immediate sale in its
present condition (subject to terms that are usual and customary for sales of
such assets), an active program to locate a buyer is initiated, the sale is
probable, the asset is being actively marketed for sale at a price that is
reasonable in relation to its current fair value and actions required to
complete the plan indicate that it is unlikely that significant changes to the
plan will be made or that the plan will be withdrawn. Properties for sale with
significant contingencies that may prevent their sale, such as obtaining
rezoning approval from the city, are not classified as assets held for sale.
Upon the classification of a real estate asset as held for sale, the carrying
value of the asset is reduced to the lower of its net book value or its fair
value, less costs to sell the asset. Subsequent to the classification of assets
as held for sale, no further depreciation expense is recorded. Real estate
assets held for sale are stated separately on the accompanying consolidated
balance sheets. The operating results of real estate assets held for sale and
sold are reported as discontinued operations in the accompanying consolidated
statements of operations. The income/(loss) from discontinued operations
includes the revenues and expenses, including depreciation, associated with the
assets. This classification of operating results as discontinued operations
applies retroactively for all periods presented for assets designated as held
for sale. Additionally, gains and losses on assets designated as held for sale
are classified as part of discontinued operations.
CASH AND CASH EQUIVALENTS
The Company considers highly liquid short-term investments with initial
maturities of three months or less to be cash equivalents. Cash and cash
equivalents are primarily held in one or more financial institutions, and at
times, such balances may be in excess of the Federal Deposit Insurance
Corporation insurance limit.
51
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
RESTRICTED CASH
Restricted cash totaled $65,509 as of December 31, 2007. Of this amount, $48,358
represents a balance the Company consolidated due to its adoption of FIN 46R,
$15,651 represents proceeds received plus interest earned from the Northport and
Morse property sales held in a separate cash account at a trust company for
future use in tax-deferred exchanges, and the remaining $1,500 represents a
certificate of deposit setup for a current loan escrow. 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 in the operating partnerships represent the proportionate
share of the equity in the operating partnerships of the limited partners.
Minority interests in net income is calculated by taking the net income of the
operating partnerships (on a stand-alone basis) multiplied by the respective
minority interests ownership percentage.
REVENUE RECOGNITION
Rental income is derived from operating leases and recognized on the
straight-line method of accounting required by GAAP under which contractual rent
payment increases are recognized evenly over the lease term. The difference
between recognized rental income and rental cash receipts is recorded as
"Deferred rent receivable" on the consolidated balance sheets. Certain lease
agreements contain terms that provide for additional rents based on
reimbursement of certain costs including property operating expenses,
maintenance and real estate taxes. These additional rents from tenant
reimbursements are reflected on the accrual basis.
Rental revenue is affected if existing tenants terminate or amend their leases.
The Company tries to identify tenants who may be likely to declare bankruptcy,
cease operations or otherwise terminate leases prior to the end of the lease
term, such as tenants who do not occupy all or a large portion of the property
being leased. By anticipating these events in advance, the Company expects to
take steps to minimize their impact on its reported results of operations
through lease renegotiations and other appropriate measures. Reserves against
"Deferred rent receivable" are estimated by management based on known financial
conditions of tenants and management's estimate of net realizability of such
receivables based on existing or expected negotiations with tenants. The
Company's judgments and estimations about tenants' capacity to continue to meet
their lease obligations will affect the rental revenue recognized. To date,
actual reductions in revenue as a result of early terminations and the tenants'
inability to pay have been within management's estimates. However, material
differences may result in the amount and timing of the Company's rental revenue
for any period if it made different judgments or estimations.
Lease termination fees are recognized in 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 by agreement with us. 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, 2007, 2006 and 2005,
no provision for federal income taxes has been included in the accompanying
consolidated financial statements.
For the year ended December 31, 2007, the Company's total dividends paid or
payable to the stockholders represented approximately 97% ordinary income, 2%
capital gain and 1% unrecaptured section 1250 gain for income tax purposes
(unaudited). For the year ended December 31, 2006, the Company's total dividends
paid or payable to the stockholders represented 100% ordinary income for income
tax purposes (unaudited). For the year ended December 31, 2005, the Company's
total dividends paid or payable to the stockholders represented 89% ordinary
income and 11% 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 123 (Revised 2004), "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, 2007, 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. For the year ended December 31, 2007, under SFAS 123R,
the Company recorded $629 of expense for share-based compensation relating to
stock options.
As of December 31, 2007, there was $495 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 three years.
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.
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 year ended December 31, 2005.
53
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
December 31, 2005
--------------------
(dollars in thousands,
except per share data)
Historical net income to common stockholders $10,027
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)
Allocation of expense to minority interests 134
--------------------
Pro forma net income to common stockholders $10,000
--------------------
Earnings per share - basic:
Historical net income to common stockholders $0.55
Pro forma net income to common stockholders $0.55
Earnings per share - diluted:
Historical net income to common stockholders $0.55
Pro forma net income to common stockholders $0.55
In 2007, stock options to purchase 710,000 shares of common stock were granted
to four employees, three non-employee directors and four consultants. The
options vest monthly for 48 months from date of grant, subject to continued
employment or other service to the Company. Each option grant has a term of six
years from the date of grant subject to earlier termination in certain events
related to termination of employment. The options were granted at an exercise
price of $12.09 per share. The estimated fair value of the options granted in
2007 was $1.45 per share on the date of grant using the Black-Scholes option
pricing model with the following assumptions: dividend yield of 5.29%,
volatility of 18.94%, risk free rates of 4.53% and an expected life of six
years. All options were granted at the fair market value at the date of grant.
There were no stock options granted in 2006.
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 6.40%, volatility of 21.97%, risk free
rates of 4.20% and an expected life of six years. All options were granted at
the fair market value at the date of grant.
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,
$186 and $139 in 2007, 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, 2007 was approximately $444,288 as
compared to its carrying value of $346,744.
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.
54
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
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, 2007, default by any major
tenant could significantly impact the results of the consolidated total. One
tenant, Microsoft Corporation, accounted for approximately 15.1%, 12.5% and
10.0% of the Company's cash rental income for the years ended December 31, 2007,
2006 and 2005, respectively, of total cash rental income. Cash rental income
from Microsoft Corporation was $12,288, $11,728 and $10,089 for the years ended
December 31, 2007, 2006 and 2005, respectively. Future minimum rents from this
tenant are $89,043. One other tenant accounted for approximately 10.8%, 10.0%
and 8.9% of the Company's cash rental income for the years ended December 31,
2007, 2006 and 2005, respectively, of total cash rental income. During 2007, six
of the Company's tenants relocated or ceased operations.
NEW ACCOUNTING PRONOUNCEMENTS
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." FIN 48 provides guidance on derecognition,
classification, interest and penalties, and accounting in interim periods and
requires expanded disclosure with respect to the uncertainty in income taxes.
The provisions of FIN 48 are effective for the fiscal year beginning January 1,
2007. Based on the Company's evaluation, it has concluded that there are no
significant uncertain tax positions requiring recognition in its financial
statements. The adoption of FIN 48 on January 1, 2007 did not have a material
impact on the Company's consolidated results of operations, financial position
or cash flows.
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 fiscal
year beginning January 1, 2008. The FASB has approved a one-year deferral for
the implementation of the Statement for non-financial assets and non-financial
liabilities that are recognized or disclosed at fair value in the financial
statements on a nonrecurring basis. The Company is currently evaluating the
impact of the provisions of SFAS 157 and currently cannot estimate the impact to
its consolidated results of operations or financial position.
In February 2007, the FASB issued SFAS 159, "The Fair Value Option for Financial
Assets and Financial Liabilities" ("SFAS 159"). SFAS 159 provides companies with
an option to report selected financial assets and liabilities at fair value.
SFAS 159's objective is to reduce both complexity in accounting for financial
instruments and the volatility in earnings caused by measuring related assets
and liabilities differently. SFAS 159 is effective for financial statements
issued for fiscal years beginning after November 15, 2007. The Company does not
expect the implementation of SFAS 159 to have a material impact on its
consolidated financial statements.
In December 2007, the FASB issued revised SFAS 141, "Business Combinations"
("SFAS 141R"). SFAS 141R will change the accounting for business combinations.
Under SFAS 141R, an acquiring entity will be required to recognize all the
assets acquired and liabilities assumed in a transaction at the acquisition date
fair value with limited exceptions. SFAS 141R will change the accounting
treatment and disclosure for certain specific items in a business combination.
SFAS 141R applies prospectively to business combinations for which the
acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008. Early adoption is prohibited.
The Company is currently evaluating the impact SFAS 141R will have on its
consolidated financial statements.
In December 2007, the FASB issued SFAS 160, "Noncontrolling Interests in
Consolidated Financial Statements" ("SFAS 160"). SFAS 160 requires that
noncontrolling interests be presented as a component of consolidated
stockholders' equity, eliminates "minority interest accounting" such that the
amount of net income attributable to the noncontrolling interests will be
presented as part of consolidated net income on the consolidated statement of
operations and not as a separate component of income and expenses. SFAS 160 is
effective for fiscal years beginning on or after December 15, 2008. Early
adoption is prohibited. The Company is currently evaluating the impact SFAS 160
will have on its consolidated financial statements.
3. DEFERRED RENT RECEIVABLE, NET
The following table represents activity in the allowance against deferred rent
receivable, net for the years ended December 31, 2007, 2006 and 2005.
55
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
Provision
Beginning Against Ending
Balance Revenue Charge-off Balance
------------------------------------------------------
(dollars in thousands)
Year ended December 31, 2005 $2,000 $785 $785 $2,000
Year ended December 31, 2006 $2,000 $1,216 $1,216 $2,000
Year ended December 31, 2007 $2,000 $4,457 $2,707 $250
4. STOCK TRANSACTIONS
As of December 31, 2007 and 2006, $1,970 and $1,833 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, 2009. At present, the Company's only
means for repayment of this debt is through distributions received from the
operating partnerships in excess of the amount of dividends to be paid to the
Company's stockholders or by raising additional equity capital.
The limited partners of the operating partnerships have the right to tender
their O.P. Units to the Company for shares of common stock or, at the Company's
election, for cash. Each of the limited partners of the operating partnerships
(other than Carl E. Berg and Clyde J. Berg) has the annual right to exercise put
rights and cause the operating partnerships to purchase a portion of the limited
partner's O.P. Units at a purchase price based on the average market value of
the common stock for the 10-trading day period immediately preceding the date of
tender, generally limited to one-third of the aggregate number of O.P. Units
owned by each limited partner. Upon the exercise of any such right by a limited
partner, the Company will have the option to purchase the tendered O.P. Units
with available cash, borrowed funds or the proceeds of an offering of newly
issued shares of common stock. These put rights are available once a year. If
the total purchase price of the O.P. Units tendered by all of the eligible
limited partners in one year exceeds $1 million, the Company or the operating
partnerships is entitled in its discretion to reduce proportionately the number
of O.P. Units to be acquired from each tendering limited partner so that the
total purchase price does not exceed $1 million.
There were no stock option exercises in 2007.
During the year ended December 31, 2006, stock options to purchase 80,000 shares
of the Company's common stock were exercised at $8.25 per share and stock
options to purchase 32,900 shares of the Company's common stock were exercised
at $10.00 per share. Total proceeds to the Company were approximately $989.
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.
In 2007, 2006 and 2005, 220,500, 881,896 and 296,600 O.P. Units were exchanged
for 220,500, 881,896 and 296,600 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 81.27% and 81.77%, on a weighted average basis, of
the ownership interests in the real estate operations of the Company as of
December 31, 2007 and 2006, 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, 2007, 2006 and 2005, income
56
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
associated with the minority interests held by the third parties of the three
consolidated joint ventures was $502, $499 and $479, respectively.
6. REAL ESTATE
PROPERTY ACQUISITIONS
In March 2007, the Company acquired approximately 50 acres of vacant land in
Morgan Hill, California, which could support approximately 725,000 rentable
square feet of space. The land is currently zoned for industrial use and a
portion has the potential to be rezoned for residential use. The acquisition
price for this property was approximately $25,543 and was funded from a portion
of the proceeds received from the Samaritan property sale (see below under
"Property Dispositions"), which were held by a third party and classified as
restricted cash as of December 31, 2006.
In April 2007, the Company acquired three office/R&D buildings comprised of
approximately 149,000 rentable square feet at Montague Expressway in Milpitas,
California for approximately $15,351. The acquisition was funded from a portion
of the proceeds received from the Samaritan property sale (see below under
"Property Dispositions"), which were held by a third party. With the exception
of one lease, the property was purchased without any long-term tenants. The
Company has allocated the purchase price to land and building based upon the
estimated relative fair values of such assets. There was no purchase price
allocation to lease intangible assets.
In April 2007, the Company acquired approximately five acres of vacant land in
Morgan Hill, California, which could support approximately 73,000 rentable
square feet of space. The land is currently zoned for industrial use. The
acquisition price for this property was approximately $2,297 and was funded from
the remaining proceeds received from the Samaritan property sale (see below
under "Property Dispositions"), which were held by a third party.
In September 2007, the Company acquired an approximately 99,000 rentable square
foot newly constructed R&D building located at 5845 Hellyer Avenue in San Jose,
California from the Berg Group under the Berg Land Holdings Option Agreement.
The total acquisition price for this property was approximately $10,903. The
Company acquired this property by issuing 548,236 O.P. Units to the Berg Group
and $4,300 in cash, which was paid in the fourth quarter of 2007. The Company
has allocated the purchase price to land and building based upon the estimated
relative fair values of such assets. Since the property was vacant when
acquired, there was no purchase price allocation to lease intangible assets.
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 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 being amortized over the applicable remaining lease term.
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 of
$2,615 was paid in cash. The property is subject to a ground lease with an
unrelated party for the underlying land that runs through June 2057. The
purchase price 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 being amortized over the applicable remaining lease term.
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.
57
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
- - The capitalized in-place lease value, included in real estate related
intangible assets in the accompanying consolidated balance sheets, is
amortized to expense as amortization of real estate over the remaining
non-cancelable lease term. If a lease were to be terminated prior to its
stated expiration, all unamortized amounts relating to that lease would be
written off in the period that the lease is terminated.
PROPERTY DISPOSITIONS
In August 2007, the Company disposed of one R&D property located at 45700
Northport Loop in Fremont, California consisting of approximately 39,000
rentable square feet. A total net gain of approximately $1,699 was recognized
and classified as discontinued operations, net of minority interests, on the
total sales price of $7,742. Proceeds from the sale were classified as
restricted cash to be used in tax-deferred property exchanges as of December 31,
2007.
In September 2007, the Company disposed of one R&D property located at 1170
Morse Avenue in Sunnyvale, California consisting of approximately 48,000
rentable square feet. A total net gain of approximately $4,830 was recognized
and classified as discontinued operations, net of minority interests, on the
total sales price of $8,301. Proceeds from the sale were classified as
restricted cash to be used in tax-deferred property exchanges as of December 31,
2007.
In October 2006, 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.
Proceeds from the sale were classified as restricted cash to be used in
tax-deferred property exchanges as of December 31, 2006.
BERG LAND HOLDINGS OPTION AGREEMENT
Under the terms of the Berg Land Holdings Option Agreement, the Company, through
the operating partnerships, has the option to acquire any future R&D property
developed by the Berg Group on land currently owned or optioned, or acquired for
these purposes in the future, directly or indirectly, by Carl E. Berg or Clyde
J. Berg. This agreement will expire on December 31, 2010, after which the
Company will no longer have the right to acquire properties from the Berg Group
or the pre-determined terms provided in that agreement. At present, there are
approximately 84 acres of Silicon Valley land, including land under development,
owned directly or under 50% joint venture entities by certain members of the
Berg Group that are subject to the terms of the Berg Land Holdings Option
Agreement. The owners of the future R&D property developments may obtain cash
or, at their option, O.P. Units valued at the average closing price of the
shares of common stock over the 30-trading-day period preceding the acquisition
date. To date, the Company has completed 22 acquisitions under the Berg Land
Holdings Option Agreement representing approximately 2,133,000 rentable square
feet. The acquired properties cost approximately $218,707, for which the Company
issued 8,482,085 O.P Units and assumed debt of approximately $122,342. Upon the
Company's exercise of an option to purchase any of the future R&D property
developments, the acquisition price will equal the sum of (a) the full
construction cost of the building; plus (b) 10% of the full construction cost of
the building; plus (c) interest at LIBOR (London Interbank Offered Rate) plus
1.65% on the amount of the full construction cost of the building for the period
from the date funds were disbursed by the developer to the close of escrow; plus
(d) the original acquisition cost of the parcel on which the improvements will
be constructed, which range from $8.50 to $20.00 per square foot for land
currently owned; plus (e) 10% per annum of the amount of the original
acquisition cost of the parcel from the later of January 1, 1998 or the seller's
acquisition date to the close of escrow; minus (f) the aggregate principal
amount of all debt encumbering the acquired property, or a lesser amount as
approved by the members of the Independent Directors committee of the Company's
Board of Directors. Generally, the Company will not acquire any projects until
they are fully completed and leased.
No estimate can be given at this time as to the total cost to the Company to
acquire future projects under the Berg Land Holdings Option Agreement, or the
timing as to when the Company will acquire such projects. In addition to any
projects currently under development, the Company has the right to acquire
future developments by the Berg Group on up to 84 additional acres of land
currently controlled by the Berg Group, which could support approximately 1.4
million square feet of new developments. Under the Berg Land Holdings Option
Agreement, as long as the Berg Group ownership in the Company and the operating
partnerships taken as a whole is at least 65%, or until December 31, 2010,
whichever occurs first, the Company also has an option to purchase all land
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
58
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
Company has not yet determined the means by which it would acquire and pay for
any such properties or the impact of any of the acquisitions on its business,
results of operations, financial condition or available cash for distribution.
7. VARIABLE INTEREST ENTITY
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 entity to qualify as a VIE one or more of the following
three characteristics must exist:
1. The equity investment at risk is not sufficient to permit the entity to
finance its activities without additional subordinated financial support by
any parties, including the equity holders.
2. The equity investors lack one or more of the following essential
characteristics of a controlling financial interest:
a. the direct or indirect ability to make decisions about the entity's
activities through voting or similar rights;
b. the obligation to absorb the expected loss of the entity;
c. the right to receive the expected residual returns of the entity; or
3. The equity investors have voting rights that are not proportionate to their
economic interests, and the activities of the entity involve or are
conducted on behalf of an investor with a disproportionately small voting
interest.
In August 2007, one of the Company's tenants, Ciena Corporation, entered into an
assignment of lease agreement with an unrelated party, M&M Real Estate Control &
Restructuring, LLC ("M&M"), in connection with leases for approximately 445,000
rentable square feet located in San Jose, California. As a result of the
assignment, M&M assumed all of Ciena's remaining obligations under these leases
and received a payment from Ciena of $53,000, of which $7,000 was reserved for
tenant improvements. At the same time, the Company entered into a consent for
assignment of lease with both parties and a mutual release agreement with Ciena,
pursuant to which all of Ciena's obligations under these leases were effectively
transferred to M&M. M&M is obligated to continue to perform all of the
obligations under the assumed Ciena leases and has the right to sublease any or
all of the 445,000 rentable square feet vacated by Ciena for the remainder of
the current lease term, which expires in 2011. Under the terms of the assignment
of lease agreement, the Company will receive monthly rent payments of
approximately $789 from July 2007 through June 2008, $818 from July 2008 through
June 2009, $849 from July 2009 through June 2010, $881 from July 2010 through
June 2011 and $915 from July 2011 through December 2011. Based upon the
provisions of FIN 46R, the Company determined that M&M is a VIE. The Company
further determined that it is the primary beneficiary of this VIE and therefore
has consolidated this entity for financial reporting purposes. Upon
consolidation, the Company recognized a gross lease termination fee of $46,000
in August 2007.
In March 2006, one of the Company's tenants, JDS Uniphase Corporation ("JDS"),
entered into an assignment of lease agreement with M&M, in connection with
leases for approximately 252,000 rentable square feet located in San Jose,
California that expired in November 2007 as a result of the assignment. 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 were
effectively transferred to M&M. M&M was obligated to continue to perform all of
the obligations under the assumed JDS leases and had the right to sublease any
or all of the 252,000 rentable square feet vacated by JDS for the remainder of
the terms of the assigned leases. Under the terms of the assignment of lease
agreement, the Company received 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 it is the primary beneficiary of this VIE and therefore has consolidated
this entity for financial reporting purposes. Upon consolidation, the Company
recognized a gross lease termination fee of approximately $11,147 in March 2006.
Factors considered by the Company in determining whether M&M should be
considered a VIE for financial reporting purposes included the following:
- - No equity was contributed by the partners in the formation of M&M.
- - At present, the assigned leases are the only properties under management by
M&M.
59
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
- - Because M&M does not have an operating history that demonstrates its
ability to finance its activities without additional subordinated financial
support.
- - All revenues, other than interest income, are generated by M&M from the
Company in the form of fees or commissions.
The Company remains at risk with respect to the assigned leases because if M&M's
operating expenses exceed its interest income, fees and commissions there would
be insufficient funds to meet the assigned lease obligation without additional
financial support from equity holders or other parties. The Company, which had
released the original tenant from its obligations under the lease, would have to
absorb the majority of any loss, making it the primary beneficiary of M&M's
activities.
8. DEBT
The following table sets forth certain information regarding debt outstanding as
of December 31, 2007 and 2006.
Balance at Maturity Interest
Debt Description Collateral Properties December 31, Date Rate
- --------------------------------------- --------------------------------------- --------------------------- ----------- ---------
2007 2006
- --------------------------------------- --------------------------------------- --------------------------- ----------- ---------
(dollars in thousands)
Line of Credit:
Santa Clara Valley National Bank(1) Not Applicable - - December 2007 (1)
------------ -------------
Mortgage Notes Payable(related parties): 5300-5350 Hellyer Avenue, San Jose, CA $9,224 $9,654 June 2010 7.650%
------------ -------------
Mortgage Notes Payable: (2)
Prudential Insurance Co. of America (3) 10300 Bubb Road, Cupertino, CA 112,543 114,994 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 84,959 88,411 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 Co. (I)(5) 5900 Optical Court, San Jose, CA 23,825 24,598 August 2025 5.560%
Allianz Life Insurance Co. (II)(5) 5325-5345 Hellyer Avenue, San Jose, CA 116,193 120,098 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
------------ -------------
337,520 348,101
------------ -------------
Total $346,744 $357,755
============ =============
60
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
(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%. SCVNB was acquired by Wells Fargo Bank and the Company transferred
its day-to-day primary banking relationship to Heritage Bank of Commerce.
The SCVNB line of credit expired on December 22, 2007.
(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 5.85% and 5.84% at December 31, 2007 and 2006, respectively.
(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. In the third quarter of 2007, the Company sold 45700
Northport Loop in Fremont, California and 1170 Morse Avenue in Sunnyvale,
California, which were collateral properties under the Prudential Insurance
loan. Prudential Insurance has agreed to release these two properties
without delivery of substitute properties provided that the Company pay a
fee of $20 and deposit a $1.5 million certificate of deposit in escrow with
Prudential Insurance for a full year. The Prudential loan contains certain
customary covenants as defined in the loan agreement. As of December 31,
2007, the Company was in compliance with these loan covenants.
(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, 2007, 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, 2007, the Company was in compliance with
these loan covenants.
Scheduled principal payments on debt as of December 31, 2007 are as follows:
Fixed Rate Debt
(Including Related
Parties)
-------------------------
December 31, 2008 $121,589
December 31, 2009 9,561
December 31, 2010 10,105
December 31, 2011 10,681
December 31, 2012 11,032
Thereafter 183,776
-------------------------
Total $346,744
=========================
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 interest expense of $834 in 2005. The Company did not obtain any
interest rate derivatives in 2006 or 2007.
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 2007, the Company, as general partner of the operating partnerships,
declared quarterly dividends/distributions aggregating $0.64 per common share
and O.P. Unit for total dividends/distributions of $67,152, including $16,832
payable in January 2008. Total distributions attributable to O.P. Units owned by
various members of the Berg Group were $50,271.
61
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
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.
10. EQUITY-BASED COMPENSATION AND RETIREMENT INVESTMENT PLANS
The Company's 1997 Stock Option Plan ("1997 Plan") was approved by the Company's
stockholders on November 10, 1997. On November 24, 2004, the 2004 Equity
Incentive Plan ("2004 Plan") was approved by the Company's stockholders and
replaced the 1997 Plan. The Company's board of directors approved the 2004 Plan
in September 2004. No further options are available or will be granted under the
1997 Plan. In replacing the 1997 Plan, the 2004 Plan:
- - transferred up to 3,991,089 remaining shares available for issuance under
the Company's 1997 Plan and terminated the 1997 Plan for any new grants;
- - transferred up to an additional 767,000 shares subject to outstanding
options under the 1997 Plan if they expire without being exercised, of
which 272,000 shares had been transferred as of December 31, 2007; 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. 2,843,089 and
3,553,089 shares of common stock were available for future option or award
grants under the 2004 Plan as of December 31, 2007 and 2006, respectively.
In 2007, stock options to purchase 710,000 shares of common stock were granted
to four employees, three non-employee directors and four consultants, which
options vest monthly for 48 months from date of grant, subject to continued
employment or other service to the Company. Each option grant has a term of six
years from the date of grant subject to earlier termination in certain events
related to termination of employment. The options were granted at an exercise
price of $12.09 per share. The estimated fair value of the options was $1.45 per
share on the date of grant using the Black-Scholes option pricing model with the
following assumptions: dividend yield of 5.29%, volatility of 18.94%, risk free
rates of 4.53% and an expected life of six years. All options were granted at
the fair market value at the date of grant.
No options were granted in year 2006.
In 2005, stock options to purchase 710,000 shares of common stock were granted
to four employees and three non-employee directors, which 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 was $1.12 per share on the date of grant
using the Black-Scholes option pricing model with the following assumptions:
dividend yield of 6.40%, volatility of 21.97%, risk free rates of 4.20% and an
expected life of six years. All options were granted at the fair market value at
the date of grant.
The remaining contractual lives of unexercised option grants range from April
2009 to January 2013.
The following table shows the activity and detail for the 2004 Plan for each of
the three years in the period ended December 31, 2007.
62
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
Weighted Average
Options Exercise Price
Outstanding Per Share
-------------------- ---------------------
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
Options granted 710,000 $12.09
--------------------
Balance, December 31, 2007 1,747,100 $11.13
====================
Available for grant at December 31, 2007 2,843,089
====================
Available for grant at December 31, 2006 3,553,089
====================
The following table summarizes information regarding options outstanding for the
2004 Plan at December 31, 2007:
Options Outstanding Options Exercisable Options Not Exercisable
----------------------------------------------------------------------------------------
Weighted
Average Weighted Weighted Weighted
Remaining Average Average Average
Contractual Exercise Exercise Exercise
Range of Exercise Prices Options Life in Years Price Options Price Options Price
------------------------------------------------------------------------------------------------------------------
$10.00 662,100 3.33 $10.00 662,100 $10.00 - -
$11.33 375,000 1.33 $11.33 375,000 $11.33 - -
$12.09 710,000 5.00 $12.09 162,713 $12.09 547,287 $12.09
------------ ------------- ------------
$10.00 to $12.09 1,747,100 3.58 $11.13 1,199,813 $10.70 547,287 $12.09
============ ============= ============
None of the options granted are contingent upon the attainment of performance
goals or subject to other restrictions. As of December 31, 2007 and 2006,
"in-the-money" outstanding options to purchase zero and 779,596 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
63
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
securities is transferred to the acquirer or acquiring parties, options and
awards held by non-employee directors will vest in full and become exercisable
prior to their expiration.
The board of directors may terminate the 2004 Plan at any earlier time or make
modifications of the 2004 Plan as it deems advisable. Awards and options granted
at any time during the term of the 2004 Plan will not expire solely because of
the termination of the 2004 Plan, and no amendment or modification of the 2004
Plan shall affect the terms of any outstanding award unless the board expressly
provides otherwise. Termination or amendment of the 2004 Plan may not adversely
affect the rights of the recipient of an award without his or her consent. The
Compensation Committee of the Board of Directors may amend the terms of any
option or award previously granted, but such amendment may not impair the rights
of the recipient without his or her consent.
A total of 4,263,089 shares of common stock are reserved for issuance under the
2004 Plan, in addition to 375,000 shares subject to outstanding options if they
expire unexercised. At no time may the number of shares issued pursuant to or
subject to outstanding awards granted under the 2004 Plan exceed this number,
subject to the provisions for increase and adjustment set forth in the 2004
Plan. If any option or award expires, terminates or is cancelled without being
exercised in full, or any other award is forfeited, the shares forfeited or not
purchased will be available for future grant of awards.
The Company has adopted an employee investment plan (the "Plan"), under Section
401(k) of the Internal Revenue Code. Employees who are at least 21 years old and
who have completed six months of eligibility service may become participants in
the Plan. Each participant may make contributions to the Plan through salary
deferrals in amounts of at least 1% to a maximum of 15% of the participant's
compensation, subject to certain limitations imposed by the Internal Revenue
Code. The Company contributes an amount up to 15% of the participant's
compensation, based upon management's discretion. A participant's contribution
to the Plan is 100% vested and non-forfeitable. A participant will become vested
in 100% of the Company's contributions after two years of eligible service. For
the years ended December 31, 2007, 2006 and 2005, the Company recognized $123,
$103 and $103 of expense for employer contributions made in connection with this
Plan, respectively.
11. NET INCOME PER SHARE
Basic net income per share is computed by dividing net income by the
weighted-average number of common shares outstanding for the period. Diluted net
income per share is computed by dividing net income by the sum of
weighted-average number of common shares outstanding for the period plus the
assumed exercise of all dilutive securities.
The following table provides a reconciliation of net income to common
stockholders and the number of shares used in the computations of "basic" net
income per share to common stockholders and "diluted" net income per share to
common stockholders.
Year Ended Year Ended Year Ended
December 31, 2007 December 31, 2006 December 31, 2005
-------------------- -------------------- -------------------
(dollars in thousands, except per share data)
Numerator:
Income from continuing operations $17,757 $11,458 $9,284
Income from discontinued operations 1,131 3,172 743
-------------------- -------------------- -------------------
Net income to common stockholders $18,888 $14,630 $10,027
==================== ==================== ===================
Denominator:
Weighted average shares of common stock (basic) 19,627,234 19,066,581 18,286,947
Effect of dilutive securities:
Incremental shares from assumed stock options exercise 227,177 232,083 38,712
-------------------- -------------------- -------------------
Weighted average shares of common stock (diluted) 19,854,411 19,298,664 18,325,659
==================== ==================== ===================
Per share data:
Basic net income per share:
Net income to common stockholders before discontinued
operations $0.90 $0.60 $0.51
Discontinued operations 0.06 0.17 0.04
-------------------- -------------------- -------------------
Net income to common stockholders $0.96 $0.77 $0.55
==================== ==================== ===================
Diluted net income per share:
Net income to common stockholders before discontinued
operations $0.89 $0.59 $0.51
Discontinued operations 0.06 0.17 0.04
-------------------- -------------------- ------------------
Net income to common stockholders $0.95 $0.76 $0.55
==================== ==================== ===================
Outstanding options to purchase 647,000 shares in 2005 were excluded from the
computation of diluted net income per share under the treasury stock method
because the option exercise price was greater than the weighted average exercise
price of the Company's
64
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
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, 2007, 2006 and 2005 were 85,533,935, 85,206,199 and 86,088,095,
respectively.
12. OTHER INCOME
Other income from continuing operations was approximately $65,068, $20,566 and
$4,590 for the years ended December 31, 2007, 2006 and 2005, respectively. For
the year ended December 31, 2007, termination fees, prior tenant bankruptcy
settlements, management fee income, interest income, security deposit
forfeitures and miscellaneous income accounted for approximately $57,515, $300,
$981, $3,087, $1,799 and $1,386, respectively, of other income. For the year
ended December 31, 2006, termination fees, prior tenant bankruptcy settlements,
management fee income, interest income, security deposit forfeitures and
miscellaneous income accounted for approximately $16,068, $183, $1,070, $2,344,
$104 and $797, respectively, of other income. For the year ended December 31,
2005, termination fees, prior tenant bankruptcy settlements, management fee
income, interest income, security deposit forfeitures and miscellaneous income
accounted for approximately $2,407, $108, $935, $567, $455 and $118,
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, 2007 and 2006, the Berg Group owned 77,902,384 and 77,392,648
O.P. Units, respectively, of the total 85,533,935 and 85,206,199 O.P. Units
issued and outstanding, respectively. The Berg Group's interest in the Company
represents 74.1% and 74.0% of the Company as of December 31, 2007 and 2006,
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 September 2007, the Company acquired an approximately 99,000 rentable square
foot newly constructed R&D building located at 5845 Hellyer Avenue in San Jose,
California from the Berg Group under the Berg Land Holdings Option Agreement.
The total acquisition price for this property was approximately $10,903. The
Company acquired this property by issuing 548,236 O.P. Units and paying $4,300
in cash to the selling members of the Berg Group. The transaction was approved
by the Independent Directors Committee of the Company's Board of Directors.
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 for $2,615. The property is subject to a ground lease
with an unrelated party for the underlying land 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.
DEBT WITH THE BERG GROUP
As of December 31, 2007 and 2006, debt in the amount of $9,224 and $9,654,
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 $724, $755 and $784 for the years ended December 31,
2007, 2006 and 2005, respectively.
The Berg Group line of credit was originally scheduled to mature in March 2006,
but through mutual agreement it was terminated in October 2005 by the Company
and the Berg Group. For the year ended December 31, 2005, interest expense
incurred in connection with the Berg Group line of credit was $188.
65
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
TRANSFER OF INTEREST TO BERG GROUP IN CONSOLIDATED JOINT VENTURE
In July 2000, the Hellyer Avenue Limited Partnership ("Hellyer LP") was formally
organized as a California limited partnership between Mission West Properties,
L.P. ("MWP"), of which the Company as the managing general partner, and Republic
Properties Corporation ("RPC"), an unaffiliated third party, as general partner
and limited partners. MWP was designated as the managing general partner of
Hellyer LP. For a 50% ownership interest in Hellyer LP, RPC agreed to cause
Stellex Microwave Systems, Inc. ("Stellex") to provide a 15-year lease on
approximately 160,000 square foot R&D buildings to be constructed by Berg & Berg
Enterprises, Inc. ("BBE") on land owned by another Berg Group member.
As part of the transaction, MWP acquired the underlying land pursuant to the
Berg Land Holdings Option Agreement for a price of $5.7 million by issuing
659,223 O.P. Units to the Berg Group entity that owned the property. Further,
under the terms of the Hellyer LP partnership agreement MWP then contributed the
land to the partnership at an agreed value of $9.6 million, which amount was to
be amortized and paid to MWP in the form of income and cash flow preferences.
The transaction was reviewed and approved by the Independent Directors Committee
of the Company's Board of Directors.
In connection with the transaction, BBE built and paid for all improvements on
the land. The total cost of the R&D buildings, exclusive of specified tenant
improvements obligations, was approximately $11.4 million. Hellyer LP issued a
note for the amount of those construction costs to BBE, which note was secured
by the buildings.
Because RPC's interest in Hellyer LP was attributable solely to its commitment
to obtain Stellex as a tenant for the property, the partnership agreement
provided that if a payment default occurred within the first five years of the
Stellex lease, RPC would lose 100% of its interest in the partnership, and if a
payment default occurred during the second five year period under the lease, RPC
would lose 50% of its interest in Hellyer LP.
Pursuant to RPC's commitment to Hellyer LP, Stellex executed a lease agreement
obligating Stellex, among other things, to pay monthly rent starting at $1.60
per square foot on a triple net basis for 15 years and to reimburse BBE for the
tenant improvement obligations, which ultimately totaled approximately $10.5
million.
Under the lease terms, Stellex was obligated to reimburse BBE in full for the
tenant improvement costs no later than August 25, 2000. Several days before the
due date, representatives of Stellex met with representatives of MWP and
informed them that Stellex could not pay the balance due BBE. Stellex requested
MWP immediately to draw down the letter of credit as a result of default on the
tenant improvement payment required under the lease.
On September 1, 2000, MWP, as the general partner of Hellyer LP, ceased all
allocations of income and cash flow to RPC and exercised the right under the
partnership agreement to cancel RPC's entire interest in the partnership.
Following discussions with and approval by the Independent Directors Committee,
the Company authorized the transfer of RPC's interest in Hellyer LP to BBE.
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 $0.7 million, $0.8 million and $0.7
million in 2007, 2006 and 2005, respectively. As of December 31, 2007,
accumulated cash flow distributions from Hellyer LP totaling approximately $4.4
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.
66
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
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
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 owns 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, 2007, 2006 and 2005, Carl E. Berg or
entities controlled by Mr. Berg held financial interests in several companies
that lease space from the operating partnerships, which include companies where
Mr. Berg has a greater than 10% ownership interest. These related tenants
contributed $1,227, $1,875 and $731 in rental revenue in 2007, 2006 and 2005,
respectively. Under the Company's Charter, bylaws and agreements with the Berg
Group, the individual members of the Berg Group are prohibited from acquiring
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, and currently their share
ownership is below a level at which rent from related tenants would be excluded
in determining compliance with REIT qualification tests.
BERG GROUP COMMITMENT TO COMPLETE FUTURE IMPROVEMENTS AND BUILDING IN CONNECTION
WITH CERTAIN ACQUISITIONS FROM THE BERG GROUP UNDER THE BERG LAND HOLDINGS
OPTION AGREEMENT
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 is in the process of satisfying this
commitment to complete certain tenant improvements.
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 was leasing four R&D buildings from the Company and was also leasing
raw land from Carl E. Berg. Total rent from the tenant was paid directly to the
Company, which included the land rent. The Company reimbursed Carl E. Berg $85
per month for the land rent. That tenant terminated its lease obligations with
the Company effective July 1, 2007, and the Company acquired the land in
connection with a completed 99,000 rentable square feet shell building (see
"Property Acquisitions" above under Note 6) and after July 1, 2007 no further
rent was paid to Carl E. Berg.
67
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
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 was responsible for repairing damages to the
building and with the Company's Independent Directors Committee approval hired
Berg & Berg Enterprises to perform the restoration work for a total of
approximately $4,500, which was completed in 2007.
LEASING AND OVERHEAD REIMBURSEMENTS PROVIDED BY BERG CONTROLLED ENTITY
The Company currently leases office space owned by Berg & Berg Enterprises for
the Company's headquarters. Rental amount and overhead reimbursements paid to
Berg & Berg Enterprises, Inc. were $95, $90 and $90 for the years ended December
31, 2007, 2006 and 2005.
14. FUTURE MINIMUM RENTS
The Company, through the operating partnerships, owns interests in 109 R&D
properties that are leased to tenants under net operating leases with initial
terms extending to the year 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, 2007, excluding tenant
reimbursements of expenses, are as follows:
Year Minimum Rent
--------------------------------------------
(dollars in thousands)
2008 $70,914
2009 68,886
2010 63,749
2011 55,911
2012 43,197
Thereafter 101,358
----------------------------
Total $404,015
============================
15. SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest was approximately $20,617, $20,137 and $21,842 for the
years ended December 31, 2007, 2006 and 2005, respectively.
In connection with a property acquisition from the Berg Group, the Company
issued 548,236 O.P. Units for a total acquisition value of approximately $6,603
for the year ended December 31, 2007.
Amounts of approximately $50,189, $50,166 and $50,223 were paid to the Berg
Group for distributions declared to O.P. Unit holders during the years ended
December 31, 2007, 2006 and 2005, respectively. The amount paid in 2005 was
treated as draws under the Berg Group line of credit.
For the years ended December 31, 2007, 2006 and 2005, 220,500, 881,896 and
296,600 O.P. Units were exchanged for 220,500, 881,896 and 296,600 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 $2,855,
$10,280 and $3,019 for the years ended December 31, 2007, 2006 and 2005,
respectively, based on the market closing price on the day of the transactions.
16. COMMITMENTS AND CONTINGENCIES
The Company and the operating partnerships, from time to time, are parties to
litigation arising out of the normal course of business. The Company is
currently involved in the following legal proceedings, and does not believe the
ultimate outcome of any of these proceedings will have a material adverse effect
on its financial condition or operating results.
MISSION WEST PROPERTIES, L.P. V. REPUBLIC PROPERTIES CORPORATION, ET AL. SANTA
CLARA COUNTY SUPERIOR COURT, CASE NO. CV 796249. In February 2001, while a
related case in Maryland was pending, the Company filed a suit against Republic
Properties Corporation ("RPC") in the Superior Court of the State of California
for the County of Santa Clara, Case No. CV 796249. The case was stayed pending
resolution of the Maryland case, and the Company dismissed its suit on March 4,
2005. In April 2005, RPC submitted a motion asking the Superior Court to
reinstate the case, which the Court granted on May 25, 2005. In April 2006, the
Maryland case was dismissed by the highest court in Maryland for lack of
personal jurisdiction. On July 5, 2006, RPC filed a cross-complaint in the case
seeking partnership distributions to which the Company demurred. The Court
sustained the Company's demurrer with leave to
68
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
amend. Subsequently, RPC filed an amended complaint and the Company submitted
another demurrer seeking dismissal of the claims on statute of limitations
grounds. On February 20, 2007, the Court overruled the Company's demurrer. The
Company sought a writ from the California State Court of Appeal for the Sixth
District to direct the lower court to reverse its decision, but the petition for
the writ was denied. A trial in the California Superior Court will commence in
early 2008.
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, 2007.
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, 2007.
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.
ASSET DISPOSITION SUBJECT TO CERTAIN CONDITIONS
The Company has entered into a sales agreement with unrelated parties subject to
numerous material conditions, including but not limited to re-zoning of the
property and negotiating certain agreements with the local municipality
acceptable to the buyer. As a result of the conditions agreed to by the Company
and the respective buyers, these assets do not meet the criteria set forth in
SFAS 144 to be classified as assets held for sale. The following summarizes the
assets for which the Company has executed a sales contract as of December 31,
2007 that are subject to material conditions as previously described:
Property Number of Buildings Rentable Square Feet Acres Sales Price
-------- ------------------- -------------------- ----- -----------
McCandless Drive
Milpitas, California 8 427,000 23.03 $76,500
17. REAL ESTATE ASSET HELD FOR SALE AND DISCONTINUED OPERATIONS
The Company follows SFAS 144, which addresses financial accounting and reporting
for the impairment and disposal of long lived assets. In general, income or loss
attributable to the operations and sale of property and the operations related
to property held for sale are classified as discontinued operations in the
consolidated statements of operations. Prior period consolidated statements of
operations presented in this report have been reclassified to reflect the income
or loss related to properties that were held for sale or sold and presented as
discontinued operations for the years ended December 31, 2007, 2006 and 2005.
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, 2007, there were no properties under contract to be sold or
otherwise disposed of which would qualify as assets held for sale.
69
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
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. In 2007, the Company sold two R&D
properties for a total sales price of $16,043 resulting in a net gain of
$6,529.Results of operations for these properties for the years ended December
31, 2007, 2006 and 2005 are as follows:
Year Ended December 31,
-----------------------------------------------------------------
2007 2006 2005
------------------ ------------------- ------------------
(dollars in thousands)
Revenues:
Rental revenue from real estate $389 $2,271 $3,585
Tenant reimbursements 83 317 733
Other income 1 291 16
------------------ ------------------- ------------------
Total revenues 473 2,879 4,334
------------------ ------------------- ------------------
Expenses:
Property operating, maintenance and real estate taxes 233 683 1,139
Interest 1 1 1
Depreciation of real estate 148 694 1,269
------------------ ------------------- ------------------
Total expenses 382 1,378 2,409
------------------ ------------------- ------------------
Income from discontinued operations 91 1,501 1,925
Gain from disposal of discontinued operations 6,529 18,102 2,206
Minority interests in earnings from discontinued (5,489) (16,431) (3,388)
operations
------------------ ------------------- ------------------
Income from discontinued operations $1,131 $3,172 $743
================== =================== ==================
For the years ended December 31, 2007, 2006 and 2005, income from discontinued
operations included results of operations from two R&D properties sold in 2007,
three R&D properties sold in 2006 and three R&D properties sold in 2005.
18. PROPERTY ACQUISITIONS
In March 2007, the Company acquired approximately 50 acres of vacant land in
Morgan Hill, California for approximately $25,543 from an unrelated party in a
tax-deferred exchange transaction. The entire purchase price was allocated to
land.
In April 2007, the Company acquired three R&D/office properties at Montague
Expressway in Milpitas, California for approximately $15,351 from an unrelated
party in a tax-deferred exchange transaction. With the exception of one lease,
the property was purchased without any long-term tenants. The purchase price was
allocated to land and building based upon the estimated relative fair values of
such assets. There was no purchase price allocation to lease intangible assets
due to vacant buildings and short-term leases of one to two months.
In April 2007, the Company acquired approximately five acres of vacant land in
Morgan Hill, California for approximately $2,297 from an unrelated party in a
tax-deferred exchange transaction. The entire purchase price was allocated to
land.
In September 2007, the Company acquired an approximately 99,000 rentable square
foot newly constructed R&D building located at 5845 Hellyer Avenue in San Jose,
California from the Berg Group under the Berg Land Holdings Option Agreement for
approximately $10,903. The purchase price was allocated to land and building
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.
70
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
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
=================
The results of operations for the six 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
$2,153, $1,613 and $1,444 was recorded for the years ended December 31, 2007,
2006 and 2005, respectively.
Details of real estate related intangible assets at December 31, 2007 and 2006
are as follows:
December 31,
------------------------------------------
2007 2006
------------------ -------------------
(dollars in thousands)
Amortizable intangible assets:
Above-market lease - $11,172
In-place leases $2,119 8,357
------------------ -------------------
Gross real estate related intangible assets 2,119 19,529
Less accumulated amortization (741) (11,907)
------------------ -------------------
Net real estate related intangible assets $1,378 $7,622
================== ===================
The estimated aggregate amortization expense for the real estate related
intangible assets for each of the four succeeding fiscal years is as follows:
Estimated In-place Lease
Year Amortization (expense)
------------------------------------------
(dollars in thousands)
2008 $413
2009 413
2010 413
2011 139
------------------------
Total $1,378
========================
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, 2007 (1) is as
follows:
For the Three Months Ended
March 31, June 30, September 30, December 31,
(Unaudited)
--------------------------------------------------------------------------------------
Rental revenue from continuing operations, net $17,111 $21,148 $19,000 $18,986
Income before gain on sales of assets,
equity in earnings of unconsolidated joint
venture and minority interests $16,850 $9,658 $53,603 $7,709
Income from continuing operations (2) $3,366 $2,001 $10,821 $1,568
Income from discontinued operations (2) $9 $3 $1,120 -
Net income to common stockholders $3,375 $2,004 $11,941 $1,568
Per share data:
Basic net income per share $0.17 $0.10 $0.61 $0.08
Diluted net income per share $0.17 $0.10 $0.60 $0.08
Weighted average shares of common stock (basic) 19,582,787 19,639,928 19,640,087 19,645,304
Weighted average shares of common stock (diluted) 19,889,453 20,020,596 19,818,806 19,710,909
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, net $23,441 $21,452 $21,972 $22,703
Income before gain on sales of assets,
equity in earnings of unconsolidated joint
venture and minority interests $27,630 $10,124 $9,884 $11,762
Income from continuing operations (2) $5,059 $2,023 $2,096 $2,279
Income from discontinued operations (2) $93 $98 $10 $2,971
Net income to common stockholders $5,152 $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
(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 1, 2008, the Company granted a total of 1,025,000 stock options to
purchase shares of common stock to certain key employees, consultants and
Directors. The stock options vest monthly for 48 months from date of grant,
subject to continued employment or other service to the Company. Each option
grant has an exercise price of $9.51 per share and has a term of six years from
the date of grant. The estimated fair value of the options was $0.57 per share
on the date of grant. Compensation expense will be charged to earnings over the
respective vesting period.
On January 3, 2008, the Company paid dividends of $0.16 per share of common
stock to all common stockholders of record as of December 31, 2007. 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 $16,832.
On January 7, 2008, the Company borrowed $3,000 from Carl E. Berg on a
short-term basis to fund an anticipated property acquisition. The $3,000 loan
was repaid on January 30, 2008. The transaction was approved by the Independent
Directors Committee of the Company's Board of Directors.
On February 6, 2008, the Company announced that its Board of Directors declared
its regular quarterly dividend on the Company's common stock for the first
quarter of 2008. The declared dividend represents a 25.0%, or $0.04 per share,
increase over the Company's prior quarterly dividend of $0.16 per share. The
common stock dividend is $0.20 per share and is payable on April 3, 2008 to all
common stockholders of record as of March 31, 2008.
72
MISSION WEST PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Dollars in thousands, except per share data)
On February 6, 2008, the Company's Board of Directors approved the decision to
de-list its common stock from the American Stock Exchange and to become listed
on the NASDAQ Stock Market effective on or about March 24, 2008.
On February 29, 2008, the Company acquired one fully leased R&D/office property
comprised of approximately 75,000 rentable square feet at 2904 Orchard Parkway
in San Jose, California for approximately $16,696. The acquisition was partially
funded from the proceeds received from the Morse property sale, which were held
by a third party and classified as restricted cash as of December 31, 2007.
On March 4, 2008, the Company entered into an agreement with Heritage Bank of
Commerce for an unsecured revolving line of credit of $10,000. The revolving
line of credit carries a variable interest rate based on the one-month LIBOR
plus 1.75% per annum, adjustable monthly. The revolving line of credit contains
certain customary covenants as defined in the loan agreement. The revolving line
of credit matures June 15, 2009. The Company paid $10 in fees in obtaining the
revolving line of credit.
73
Report of Independent Registered Public Accounting Firm on
Financial Statement Schedule
Board of Directors and Stockholders
Mission West Properties, Inc.
Cupertino, California
The audit referred to in our report dated March 12, 2008 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, 2007 and
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, 2007 and
2006 presents fairly, in all material respects, the information set forth
therein.
\S\ Burr, Pilger & Mayer, LLP
San Francisco, California
March 12, 2008
74
INTENTIONALLY BLANK
75
MISSION WEST PROPERTIES, INC.
Schedule III
Real Estate and Accumulated Depreciation and Amortization
December 31, 2007
(dollars in thousands)
Initial Cost
--------------------------------
Cost
December 31, Buildings Subsequent to
2007 and Construction/
Property Name City Encumbrances Land Improvements Acquisition
- --------------------------------------------------------- -------------- ------------- -------------- -------------
5300-5350 Hellyer Avenue San Jose C $9,224 $5,742 $11,442
10401-10411 Bubb Road Cupertino A 633 3,078
45365 Northport Loop Fremont 2,447 5,711 $11
45738 Northport Loop Fremont F 891 4,338 5
4050 Starboard Drive Fremont F 1,329 6,467 8
3501 W. Warren Ave/Fremont Fremont 1,866 9,082 1,382
48800 Milmont Blvd Fremont 1,013 4,932
4750 Patrick Henry Drive Santa Clara 1,604 7,805 405
3520 Bassett Street Santa Clara D 1,104 5,371
3530 Bassett Street Santa Clara B,D 849 4,133
5850-5870 Hellyer Avenue San Jose 2,787 6,502 131
5750 Hellyer Avenue San Jose 3,266 3,354 3,127
800 Embedded Way San Jose K 1,794 -
5500 Hellyer Avenue San Jose 4,735 12,485 39
5550 Hellyer Avenue San Jose 3,261 3,478
5400 Hellyer Avenue San Jose 3,238 5,007 215
5325 Hellyer Avenue San Jose H 4,684 10,230 40
5345 Hellyer Avenue San Jose H 4,866 5,822
5905-5965 Silver Creek Valley Rd San Jose 8,437 17,316
5905-5965 Silver Creek Valley Rd San Jose 3,438 2,727
5845 Hellyer Avenue San Jose 6,090 5,029
855 Embedded Way San Jose 3,289 6,521 68
1065-1105 La Avenida Street Mountain View 46,832 109,275 65
1875 Charleston Road Mountain View M - 2,615
1750 Automation Parkway San Jose G 4,789 11,174 315
1756 Automation Parkway San Jose G 4,378 10,216 704
1762 Automation Parkway San Jose G 4,804 12,224 1,332
1768 Automation Parkway San Jose H 8,195 19,121 142
255 Caspian Drive Sunnyvale 3,491 7,160 1,658
245 Caspian Drive Sunnyvale 5,894 -
5970 Optical Court San Jose 2,758 8,395
5900 Optical Court San Jose H 3,634 12,677 83
2630 Orchard Parkway San Jose 2,931 5,863 22
2610 Orchard Parkway San Jose J 2,615 5,231
55 West Trimble Road San Jose J 4,435 8,869
2001 Walsh Avenue Santa Clara E,I 4,610 3,887
2880 Scott Boulevard Santa Clara E,H,I 14,501 22,555
2890 Scott Boulevard Santa Clara E,H,I 3,081 9,696 25
2770-2800 Scott Boulevard Santa Clara E,H 7,138 7,075 170
2300 Central Expressway Santa Clara E,I 2,390 2,459
2220 Central Expressway Santa Clara E,I 3,304 3,427 816
2330 Central Expressway Santa Clara E 3,673 3,932 677
233 South Hillview Drive Milpitas N 3,335 10,076
2251 Lawson Lane Santa Clara G 1,952 9,498
1230 East Arques Sunnyvale F 540 2,628 39
1250 East Arques Sunnyvale F 1,335 6,499
20400 Mariani Avenue Cupertino H 1,670 8,125 866
10500 De Anza Blvd Cupertino F 7,666 37,304
20605-20705 Valley Green Drive Cupertino G 3,490 16,984
10300 Bubb Road Cupertino F 635 3,090
10440 Bubb Road Cupertino 434 2,112 114
10460 Bubb Road Cupertino H 994 4,838 1,279
1135 Kern Avenue Sunnyvale F 407 1,982
450 National Avenue Mountain View F 611 2,973 72
3301 Olcott Street Santa Clara 1,846 8,984 37
2800 Bayview Avenue Fremont 1,070 5,205 60
5521 Hellyer Avenue San Jose 4,534 9,650
6850 Santa Teresa Blvd San Jose 377 1,836 819
6810 Santa Teresa Blvd San Jose 2,567 5,991 774
76
MISSION WEST PROPERTIES, INC.
Schedule III
Real Estate and Accumulated Depreciation and Amortization
December 31, 2007
(dollars in thousands)
Total Cost
----------------------------
Buildings Accumulated
and Depreciation Date of Depreciable
Property Name Land Improvements Total & Amortization Acquisition Life
- ----------------------------------- ----------- -------------- ------------ -------------- ----------- -----------
5300-5350 Hellyer Avenue $5,742 $11,442 $17,184 $2,181 5/00 L
10401-10411 Bubb Road 633 3,078 3,711 733 7/98 L
45365 Northport Loop 2,447 5,722 8,169 1,047 10/00 L
45738 Northport Loop 891 4,343 5,234 1,034 7/98 L
4050 Starboard Drive 1,329 6,475 7,804 1,540 7/98 L
3501 W. Warren Ave/Fremont 1,866 10,464 12,330 2,916 7/98 L
48800 Milmont Blvd 1,013 4,932 5,945 1,173 7/98 L
4750 Patrick Henry Drive 1,604 8,210 9,814 2,113 7/98 L
3520 Bassett Street 1,104 5,371 6,475 1,276 7/98 L
3530 Bassett Street 849 4,133 4,982 983 7/98 L
5850-5870 Hellyer Avenue 2,787 6,633 9,420 1,530 11/98 L
5750 Hellyer Avenue 3,266 6,481 9,747 882 8/01 L
800 Embedded Way 1,794 - 1,794 - 3/00 -
5500 Hellyer Avenue 4,735 12,524 17,259 2,159 2/01 L
5550 Hellyer Avenue 3,261 3,478 6,739 612 6/01 L
5400 Hellyer Avenue 3,238 5,222 8,460 1,141 7/00 L
5325 Hellyer Avenue 4,684 10,270 14,954 1,836 1/01 L
5345 Hellyer Avenue 4,866 5,822 10,688 1,000 1/02 L
5905-5965 Silver Creek Valley Rd 8,437 17,316 25,753 2,814 7/01 L
5905-5965 Silver Creek Valley Rd 3,438 2,727 6,165 426 10/01 L
5845 Hellyer Avenue 6,090 5,029 11,119 32 9/07 L
855 Embedded Way 3,289 6,589 9,878 1,150 5/01 L
1065-1105 La Avenida Street 46,832 109,340 156,172 23,916 4/99 L
1875 Charleston Road - 2,615 2,615 330 4/06 L
1750 Automation Parkway 4,789 11,489 16,278 2,441 7/99 L
1756 Automation Parkway 4,378 10,920 15,298 2,110 1/00 L
1762 Automation Parkway 4,804 13,556 18,360 2,468 4/00 L
1768 Automation Parkway 8,195 19,263 27,458 3,423 12/00 L
255 Caspian Drive 3,491 8,818 12,309 1,940 4/00 L
245 Caspian Drive 5,894 - 5,894 - 4/01 -
5970 Optical Court 2,758 8,395 11,153 840 12/03 L
5900 Optical Court 3,634 12,760 16,394 1,804 7/02 L
2630 Orchard Parkway 2,931 5,885 8,816 877 3/02 L
2610 Orchard Parkway 2,615 5,231 7,846 763 3/02 L
55 West Trimble Road 4,435 8,869 13,304 1,294 3/02 L
2001 Walsh Avenue 4,610 3,887 8,497 466 4/03 L
2880 Scott Boulevard 14,501 22,555 37,056 2,689 4/03 L
2890 Scott Boulevard 3,081 9,721 12,802 1,156 4/03 L
2770-2800 Scott Boulevard 7,138 7,245 14,383 860 4/03 L
2300 Central Expressway 2,390 2,459 4,849 295 4/03 L
2220 Central Expressway 3,304 4,243 7,547 636 4/03 L
2330 Central Expressway 3,673 4,609 8,282 604 4/03 L
233 South Hillview Drive 3,335 10,076 13,411 892 3/06 L
2251 Lawson Lane 1,952 9,498 11,450 2,257 7/98 L
1230 East Arques 540 2,667 3,207 666 7/98 L
1250 East Arques 1,335 6,499 7,834 1,544 7/98 L
20400 Mariani Avenue 1,670 8,991 10,661 2,018 7/98 L
10500 De Anza Blvd 7,666 37,304 44,970 8,863 7/98 L
20605-20705 Valley Green Drive 3,490 16,984 20,474 4,037 7/98 L
10300 Bubb Road 635 3,090 3,725 735 7/98 L
10440 Bubb Road 434 2,226 2,660 584 7/98 L
10460 Bubb Road 994 6,117 7,111 1,582 7/98 L
1135 Kern Avenue 407 1,982 2,389 474 7/98 L
450 National Avenue 611 3,045 3,656 733 7/98 L
3301 Olcott Street 1,846 9,021 10,867 2,144 7/98 L
2800 Bayview Avenue 1,070 5,265 6,335 1,298 7/98 L
5521 Hellyer Avenue 4,534 9,650 14,184 859 2/05 L
6850 Santa Teresa Blvd 377 2,655 3,032 864 7/98 L
6810 Santa Teresa Blvd 2,567 6,765 9,332 1,477 3/99 L
MISSION WEST PROPERTIES, INC.
Schedule III
Real Estate and Accumulated Depreciation and Amortization
December 31, 2007
(dollars in thousands)
Initial Cost
--------------------------------
Cost
December 31, Buildings Subsequent to
2007 and Construction/
Property Name City Encumbrances Land Improvements Acquisition
- --------------------------------------------------------- -------------- ------------- -------------- -------------
140-160 Great Oaks Blvd San Jose 1,402 6,822 754
6541 Via del Oro/6385 San Ignacio San Jose G 1,039 5,057 81
6311-6351 San Ignacio Avenue San Jose F 6,247 30,396 170
6320-6360 San Ignacio Avenue San Jose G 2,616 12,732 439
75 E. Trimble Rd/2610 N. First St San Jose 3,477 16,919 85
3236 Scott Blvd Santa Clara F 1,234 6,005
1212 Bordeaux Lane Sunnyvale F 2,250 10,948
1325-1810 McCandless Drive Milpitas G 13,994 66,213 1,455
1600 Memorex Drive Santa Clara F 1,221 5,940 11
1688 Richard Avenue Santa Clara F 1,248 2,913 6
1700 Richard Avenue Santa Clara F 1,727 4,030
Morgan Hill Land Morgan Hill 25,543 -
Morgan Hill Land Morgan Hill 2,297 -
300 Montague Expressway Milpitas 2,609 2,499
337 Trade Zone Boulevard Milpitas 2,264 2,168
324-368 Montague Expressway Milpitas 2,968 2,843
3506-3510 Bassett Street Santa Clara D 943 4,591 182
3540-3544 Bassett Street Santa Clara F,D 1,565 7,616 195
3550 Bassett Street Santa Clara F,D 1,079 5,251 33
3560 Bassett Street Santa Clara F,D 1,075 5,233 8
3570-3580 Bassett Street Santa Clara F,D 1,075 5,233
Prudential Insurance Company of America Loan F 112,543
Northwestern Mutual Life Insurance Company G 84,959
Allianz Life Insurance Company H 140,018
--------------- ------------- -------------- -------------
$346,744 $312,152 $747,865 $18,919
=============== ============= ============== =============
77
MISSION WEST PROPERTIES, INC.
Schedule III
Real Estate and Accumulated Depreciation and Amortization
December 31, 2007
(dollars in thousands)
Total Cost
----------------------------
Buildings Accumulated
and Depreciation Date of Depreciable
Property Name Land Improvements Total & Amortization Acquisition Life
- ----------------------------------- ----------- -------------- ------------ -------------- ----------- -----------
140-160 Great Oaks Blvd 1,402 7,576 8,978 1,975 7/98 L
6541 Via del Oro/6385 San Ignacio 1,039 5,138 6,177 1,240 7/98 L
6311-6351 San Ignacio Avenue 6,247 30,566 36,813 7,372 7/98 L
6320-6360 San Ignacio Avenue 2,616 13,171 15,787 3,207 7/98 L
75 E. Trimble Rd/2610 N. First St 3,477 17,004 20,481 4,109 7/98 L
3236 Scott Blvd 1,234 6,005 7,239 1,428 7/98 L
1212 Bordeaux Lane 2,250 10,948 13,198 2,603 7/98 L
1325-1810 McCandless Drive 13,994 67,668 81,662 16,452 7/98 L
1600 Memorex Drive 1,221 5,951 7,172 1,398 7/98 L
1688 Richard Avenue 1,248 2,919 4,167 697 9/98 L
1700 Richard Avenue 1,727 4,030 5,757 852 8/99 L
Morgan Hill Land 25,543 - 25,543 - 3/07 -
Morgan Hill Land 2,297 - 2,297 - 4/07 -
300 Montague Expressway 2,609 2,499 5,108 42 4/07 L
337 Trade Zone Boulevard 2,264 2,168 4,432 36 4/07 L
324-368 Montague Expressway 2,968 2,843 5,811 47 4/07 L
3506-3510 Bassett Street 943 4,773 5,716 1,191 7/98 L
3540-3544 Bassett Street 1,565 7,811 9,376 1,871 7/98 L
3550 Bassett Street 1,079 5,284 6,363 1,284 7/98 L
3560 Bassett Street 1,075 5,241 6,316 1,253 7/98 L
3570-3580 Bassett Street 1,075 5,233 6,308 1,245 7/98 L
----------- ------------- ------------ -----------
$312,152 $766,784 $1,078,936 $156,819
=========== ============= ============ ===========
(A) 16.67% of this property's ownership is held by unaffiliated parties outside
the operating partnerships of the Company.
(B) 25% of this property's ownership is held by unaffiliated parties outside
the operating partnerships of the Company.
(C) 50% of this property's ownership is held by an affiliated party since
September 2000.
(D) Part of the property group referred to as the Triangle Technology Park.
(E) Part of the property group referred to as the San Tomas Technology Park.
(F) Encumbered by the $112,543 Prudential Insurance Company of America loan -
full amount of loan shown at the bottom of the schedule.
(G) Encumbered by the $84,959 Northwestern Mutual Life Insurance Company loan -
full amount of loan shown at the bottom of the schedule.
(H) Encumbered by the $140,018 Allianz Life Insurance Company loan - full
amount of loan shown at the bottom of the schedule.
(I) Purchase price allocated to real estate related intangible assets pursuant
to SFAS 141 amounted to $18,284. Approximately $17,410 and $874 was fully
amortized in 2007 and 2005, respectively, and the asset cost and its
related accumulated amortization was removed from the accounts.
(J) Purchase price allocated to real estate related intangible assets pursuant
to SFAS 141 amounted to $1,367. The amount was fully amortized in 2004 and
the asset cost and its related accumulated amortization was removed from
the accounts.
(K) This property was sold in October 2005. The Company retained 32.5%, or
approximately 7.9 acres, of raw land.
(L) Depreciation is computed based on the following estimated lives:
1. Building shell and base building tenant improvements of newly acquired
properties are being depreciated on a weighted average composite
useful life of 40 years.
2. Real estate intangible assets allocated pursuant to SFAS 141 are being
amortized over the remaining life of the underlying leases.
3. Tenant improvements, furniture and fixtures are being depreciated over
their estimated useful lives ranging from 5 to 10 years.
(M) Purchase price allocated to real estate related intangible assets pursuant
to SFAS 141 amounted to $745.
(N) Purchase price allocated to real estate related intangible assets pursuant
to SFAS 141 amounted to $1,374.
MISSION WEST PROPERTIES, INC.
Schedule III
Real Estate and Accumulated Depreciation and Amortization
December 31, 2006
(dollars in thousands)
Initial Cost
--------------------------------
Cost
December 31, Buildings Subsequent to
2007 and Construction/
Property Name City Encumbrances Land Improvements Acquisition
- --------------------------------------------------------- -------------- ------------- -------------- -------------
5300-5350 Hellyer Avenue San Jose C $9,654 $5,742 $11,442
10401-10411 Bubb Road Cupertino A 633 3,078
45365 Northport Loop Fremont 2,447 5,711 $11
45700 Northport Loop Fremont F 1,184 5,760 7
45738 Northport Loop Fremont F 891 4,338 5
4050 Starboard Drive Fremont F 1,329 6,467 8
3501 W. Warren Ave/Fremont Blvd Fremont 1,866 9,082 1,213
48800 Milmont Blvd Fremont 1,013 4,932
4750 Patrick Henry Drive Santa Clara 1,604 7,805 405
3520 Bassett Street Santa Clara D 1,104 5,371
3530 Bassett Street Santa Clara B,D 849 4,133
5850-5870 Hellyer Avenue San Jose 2,787 6,502 109
5750 Hellyer Avenue San Jose 3,266 3,354 2,455
800 Embedded Way San Jose K 1,794 -
5500 Hellyer Avenue San Jose 4,735 12,484 39
5550 Hellyer Avenue San Jose 3,261 3,478
5400 Hellyer Avenue San Jose 3,238 5,007 215
5325 Hellyer Avenue San Jose H 4,684 10,230 40
5345 Hellyer Avenue San Jose H 4,866 5,822
5905-5965 Silver Crk Valley Rd San Jose 8,437 17,316
5905-5965 Silver Crk Valley Rd San Jose 3,438 2,727
855 Embedded Way San Jose 3,289 6,521 68
1065-1105 La Avenida Street Mt. View 46,832 109,275 65
1875 Charleston Road Mt. View M - 2,615
1750 Automation Parkway San Jose G 4,789 11,174 315
1756 Automation Parkway San Jose G 4,378 10,216 15
1762 Automation Parkway San Jose G 4,804 12,224 20
1768 Automation Parkway San Jose H 8,195 19,121 23
255 Caspian Drive Sunnyvale 3,491 7,160 1,658
245 Caspian Drive Sunnyvale 5,894 -
5970 Optical Court San Jose 2,758 8,395
5900 Optical Court San Jose H 3,634 12,677 83
2630 Orchard Parkway San Jose 2,931 5,863 22
2610 Orchard Parkway San Jose J 2,615 5,231
55 West Trimble Road San Jose J 4,435 8,869
2001 Walsh Avenue Santa Clara E,I 4,610 5,245
2880 Scott Boulevard Santa Clara E,H,I 14,501 25,501
2890 Scott Boulevard Santa Clara E,H,I 3,081 10,844
2770-2800 Scott Boulevard Santa Clara E,H 7,138 7,075 170
2300 Central Expressway Santa Clara E,I 2,390 14,418
2220 Central Expressway Santa Clara E,I 3,304 3,427 816
2330 Central Expressway Santa Clara E 3,673 3,932 677
233 South Hillview Drive Milpitas N 3,335 10,076
2251 Lawson Lane Santa Clara G 1,952 9,498
1230 East Arques Sunnyvale F 540 2,628 39
1250 East Arques Sunnyvale F 1,335 6,499
20400 Mariani Avenue Cupertino H 1,670 8,125
10500 De Anza Blvd Cupertino F 7,666 37,304
20605-20705 Valley Green Dr. Cupertino G 3,490 16,984
10300 Bubb Road Cupertino F 635 3,090
10440 Bubb Road Cupertino 434 2,112 102
10460 Bubb Road Cupertino H 994 4,838 1,252
1135 Kern Avenue Sunnyvale F 407 1,982
450 National Avenue Mt. View F 611 2,973 72
3301 Olcott Street Santa Clara 1,846 8,984 37
2800 Bayview Avenue Fremont 1,070 5,205 60
5521 Hellyer Avenue San Jose 4,534 9,650
6850 Santa Teresa Blvd San Jose 377 1,836 819
78
MISSION WEST PROPERTIES, INC.
Schedule III
Real Estate and Accumulated Depreciation and Amortization
December 31, 2006
(dollars in thousands)
Total Cost
----------------------------
Buildings Accumulated
and Depreciation Date of Depreciable
Property Name Land Improvements Total & Amortization Acquisition Life
- ----------------------------------- ----------- -------------- ------------ -------------- ----------- -----------
5300-5350 Hellyer Avenue $5,742 $11,442 $17,184 $1,895 5/00 L
10401-10411 Bubb Road 633 3,078 3,711 656 7/98 L
45365 Northport Loop 2,447 5,722 8,169 904 10/00 L
45700 Northport Loop 1,184 5,767 6,951 1,226 7/98 L
45738 Northport Loop 891 4,343 5,234 926 7/98 L
4050 Starboard Drive 1,329 6,475 7,804 1,378 7/98 L
3501 W. Warren Ave/Fremont 1,866 10,295 12,161 2,424 7/98 L
48800 Milmont Blvd 1,013 4,932 5,945 1,049 7/98 L
4750 Patrick Henry Drive 1,604 8,210 9,814 1,836 7/98 L
3520 Bassett Street 1,104 5,371 6,475 1,142 7/98 L
3530 Bassett Street 849 4,133 4,982 880 7/98 L
5850-5870 Hellyer Avenue 2,787 6,611 9,398 1,346 11/98 L
5750 Hellyer Avenue 3,266 5,809 9,075 454 8/01 L
800 Embedded Way 1,794 - 1,794 - 3/00 -
5500 Hellyer Avenue 4,735 12,523 17,258 1,857 2/01 L
5550 Hellyer Avenue 3,261 3,478 6,739 515 6/01 L
5400 Hellyer Avenue 3,238 5,222 8,460 996 7/00 L
5325 Hellyer Avenue 4,684 10,270 14,954 1,581 1/01 L
5345 Hellyer Avenue 4,866 5,822 10,688 848 1/02 L
5905-5965 Silver Crk Valley Rd 8,437 17,316 25,753 2,381 7/01 L
5905-5965 Silver Crk Valley Rd 3,438 2,727 6,165 358 10/01 L
855 Embedded Way 3,289 6,589 9,878 977 5/01 L
1065-1105 La Avenida Street 46,832 109,340 156,172 21,182 4/99 L
1875 Charleston Road - 2,615 2,615 141 4/06 L
1750 Automation Parkway 4,789 11,489 16,278 2,154 7/99 L
1756 Automation Parkway 4,378 10,231 14,609 1,803 1/00 L
1762 Automation Parkway 4,804 12,244 17,048 2,083 4/00 L
1768 Automation Parkway 8,195 19,144 27,339 2,923 12/00 L
255 Caspian Drive 3,491 8,818 12,309 1,637 4/00 L
245 Caspian Drive 5,894 - 5,894 - 4/01 -
5970 Optical Court 2,758 8,395 11,153 630 12/03 L
5900 Optical Court 3,634 12,760 16,394 1,475 7/02 L
2630 Orchard Parkway 2,931 5,885 8,816 731 3/02 L
2610 Orchard Parkway 2,615 5,231 7,846 632 3/02 L
55 West Trimble Road 4,435 8,869 13,304 1,072 3/02 L
2001 Walsh Avenue 4,610 5,245 9,855 1,488 4/03 L
2880 Scott Boulevard 14,501 25,501 40,002 4,416 4/03 L
2890 Scott Boulevard 3,081 10,844 13,925 1,516 4/03 L
2770-2800 Scott Boulevard 7,138 7,245 14,383 676 4/03 L
2300 Central Expressway 2,390 14,418 16,808 7,800 4/03 L
2220 Central Expressway 3,304 4,243 7,547 433 4/03 L
2330 Central Expressway 3,673 4,609 8,282 409 4/03 L
233 South Hillview Drive 3,335 10,076 13,411 403 3/06 L
2251 Lawson Lane 1,952 9,498 11,450 2,020 7/98 L
1230 East Arques 540 2,667 3,207 595 7/98 L
1250 East Arques 1,335 6,499 7,834 1,382 7/98 L
20400 Mariani Avenue 1,670 8,125 9,795 1,729 7/98 L
10500 De Anza Blvd 7,666 37,304 44,970 7,931 7/98 L
20605-20705 Valley Green Dr. 3,490 16,984 20,474 3,613 7/98 L
10300 Bubb Road 635 3,090 3,725 658 7/98 L
10440 Bubb Road 434 2,214 2,648 514 7/98 L
10460 Bubb Road 994 6,090 7,084 1,412 7/98 L
1135 Kern Avenue 407 1,982 2,389 424 7/98 L
450 National Avenue 611 3,045 3,656 644 7/98 L
3301 Olcott Street 1,846 9,021 10,867 1,912 7/98 L
2800 Bayview Avenue 1,070 5,265 6,335 1,168 7/98 L
5521 Hellyer Avenue 4,534 9,650 14,184 556 2/05 L
6850 Santa Teresa Blvd 377 2,655 3,032 753 7/98 L
MISSION WEST PROPERTIES, INC.
Schedule III
Real Estate and Accumulated Depreciation and Amortization
December 31, 2006
(dollars in thousands)
Cost
December 31, Buildings Subsequent to
2007 and Construction/
Property Name City Encumbrances Land Improvements Acquisition
- --------------------------------------------------------- -------------- ------------- -------------- -------------
6810 Santa Teresa Blvd San Jose 2,567 5,991 234
140-160 Great Oaks Blvd. San Jose 1,402 6,822 754
6541 Via del Oro/6385 San Ig. San Jose G 1,039 5,057 72
6311-6351 San Ignacio Ave. San Jose F 6,247 30,396 170
6320-6360 San Ignacio Ave. San Jose G 2,616 12,732 439
75 E. Trimble Rd/2610 N. 1st San Jose 3,477 16,919 85
1170 Morse Avenue Sunnyvale F 658 3,201
3236 Scott Blvd Santa Clara F 1,234 6,005
1212 Bordeaux Lane Sunnyvale F 2,250 10,948
1325-1810 McCandless Drive Milpitas G 13,994 66,213 1,420
1600 Memorex Drive Santa Clara F 1,221 5,940 11
1688 Richard Avenue Santa Clara F 1,248 2,913 6
1700 Richard Avenue Santa Clara F 1,727 4,030
3506-3510 Bassett Street Santa Clara D 943 4,591 182
3540-3544 Bassett Street Santa Clara F,D 1,565 7,615 195
3550 Bassett Street Santa Clara F,D 1,079 5,251 33
3560 Bassett Street Santa Clara F,D 1,075 5,233 8
3570-3580 Bassett Street Santa Clara F,D 1,075 5,233
Prudential 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
============== ============= ============== =============
79
MISSION WEST PROPERTIES, INC.
Schedule III
Real Estate and Accumulated Depreciation and Amortization
December 31, 2006
(dollars in thousands)
Total Cost
----------------------------
Buildings Accumulated
and Depreciation Date of Depreciable
Property Name Land Improvements Total & Amortization Acquisition Life
- ----------------------------------- ----------- -------------- ------------ -------------- ----------- -----------
6810 Santa Teresa Blvd 2,567 6,225 8,792 1,234 3/99 L
140-160 Great Oaks Blvd. 1,402 7,576 8,978 1,744 7/98 L
6541 Via del Oro/6385 San Ig. 1,039 5,129 6,168 1,100 7/98 L
6311-6351 San Ignacio Ave. 6,247 30,566 36,813 6,592 7/98 L
6320-6360 San Ignacio Ave. 2,616 13,171 15,787 2,865 7/98 L
75 E. Trimble Rd/2610 N. 1st 3,477 17,004 20,481 3,677 7/98 L
1170 Morse Avenue 658 3,201 3,859 682 7/98 L
3236 Scott Blvd 1,234 6,005 7,239 1,278 7/98 L
1212 Bordeaux Lane 2,250 10,948 13,198 2,330 7/98 L
1325-1810 McCandless Drive 13,994 67,633 81,627 14,671 7/98 L
1600 Memorex Drive 1,221 5,951 7,172 1,250 7/98 L
1688 Richard Avenue 1,248 2,919 4,167 624 9/98 L
1700 Richard Avenue 1,727 4,030 5,757 751 8/99 L
3506-3510 Bassett Street 943 4,773 5,716 1,062 7/98 L
3540-3544 Bassett Street 1,565 7,810 9,375 1,671 7/98 L
3550 Bassett Street 1,079 5,284 6,363 1,148 7/98 L
3560 Bassett Street 1,075 5,241 6,316 1,121 7/98 L
3570-3580 Bassett Street 1,075 5,233 6,308 1,115 7/98 L
----------- -------------- ------------ --------------
$272,223 $776,125 $1,048,348 $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.
MISSION WEST PROPERTIES, INC.
NOTE TO SCHEDULE III
December 31, 2007 and 2006
(dollars in thousands)
1. Reconciliation of real estate and accumulated depreciation and
amortization:
2007 2006
------------------------ ------------------------
Real estate investments:
Balance at beginning of year $1,048,348 $1,057,800
Additions 58,972 20,304
Dispositions (10,974) (29,756)
Reclassification (17,410) -
------------------------ ------------------------
Balance at end of year $1,078,936 $1,048,348
------------------------ ------------------------
Accumulated depreciation and amortization:
Balance at beginning of year $149,459 $130,419
Additions 26,826 24,163
Dispositions (2,056) (5,123)
Reclassification (17,410) -
------------------------ ------------------------
Balance at end of year $156,819 $149,459
------------------------ ------------------------
Net investments in real estate $922,117 $898,889
======================== ========================
80
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
As required by SEC Rule 13a-15(b) we conducted an evaluation, under the
supervision and with the participation of our management, including our Chief
Executive Officer, President and Vice President of Finance, of the effectiveness
of the design and operation of our disclosure controls and procedures (as
defined in Rule 13a-15(f) or Rule 15d-15(f) of the Securities Exchange Act of
1934). Based upon that evaluation, the Chief Executive Officer, President and
Vice President of Finance concluded that as of December 31, 2007 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, 2007. 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, 2007.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect the possibility of human error, misstatements and the
circumvention or overriding of controls. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
Burr, Pilger & Mayer, LLP, our independent registered public accounting firm,
has audited our consolidated financial statements included in this Annual Report
on Form 10-K and has issued a report on the effectiveness of our internal
control over financial reporting.
(c) Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting during the
fourth fiscal quarter of 2007 that has materially affected, or is reasonably
likely to material affect, our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
As of December 31, 2007, we have ceased all efforts previously interested to
effect an acquisition of the Company with all previously interested parties.
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 2008
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 2008 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
2008 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 2008 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 2008 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, 2007 and 2006, which can be found on
pages 76 and 78, respectively.
3. The exhibits listed on the Exhibit Index either are filed with this
Annual Report on Form 10-K or have been filed previously with the SEC
and are incorporated by reference to those prior filings.
(b) The exhibits required by Item 601 of Regulation S-K, including each
management contract or compensatory plan or arrangement required to be
filed as an exhibit to this form are listed under Item 15(a)(3).
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 13, 2008 By: /s/ Carl E. Berg
----------------------------------------
Carl E. Berg
Chief Executive Officer
(Principal Executive Officer)
Date: March 13, 2008 By: /s/ Wayne N. Pham
----------------------------------------
Wayne N. Pham
Vice President of Finance and Controller
(Principal Financial and Accounting
Officer)
- --------------------------------------------------------------------------------
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Carl E. Berg his true and lawful attorney-in-fact
with the power of substitution, to sign any amendments to this Report on Form
10-K and to file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that each of said attorney-in-fact, or his or her
substitute, may do or choose to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Carl E. Berg
------------------------------- Chairman of the Board, Chief
Carl E. Berg Executive Officer and Director March 13, 2008
/s/ John C. Bolger
-------------------------------
John C. Bolger Director March 13, 2008
/s/ William A. Hasler
-------------------------------
William A. Hasler Director March 13, 2008
/s/ Lawrence B. Helzel
-------------------------------
Lawrence B. Helzel Director March 13, 2008
/s/ Raymond V. Marino
------------------------------- President, Chief Operating Officer
Raymond V. Marino and Director March 13, 2008
84
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 Not in use
10.14 Lease Agreement with Amdahl Corporation(4b)
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 Not in use
10.24 Not in use
10.25 Not in use
10.26 Supplemental Agreement among Mission West Properties, Inc., Carl E. Berg and Clyde J. Berg(9)
10.27 Berg Group Revolving Credit - $100,000,000 Secured Promissory Note(10) (Terminated)
10.27.1 Third Amendment to Berg Group $100,000,000 Revolving Line of Credit(11) (Terminated)
10.28 Berg Group Deed of Trust Securing Revolving Promissory Note(12)
10.29 Not in use
10.29.1 Not in use
10.29.2 Not in use
10.29.3 Not in use
85
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 Not in use
10.45.1 Not in use
10.45.2 Not in use
10.45.3 Not in use
10.45.4 Not in use
10.46* 2004 Equity Incentive Plan(1(4))
10.47 Allianz Loan Secured Installment Note(1(5))
10.48 Allianz Loan Deed of Trust, Security Agreement, Fixture Filing with Absolute Assignment of Rents(1(5))
10.49 Allianz Loan Limited Guaranty(1(5))
10.50* Form of Non-statutory Stock Option Agreement with Dividend Rights under 2004 Equity Incentive Plan(1(5))
10.51 Allianz Loan II Secured Installment Note(1(6))
10.52 Allianz Loan II Deed of Trust, Security Agreement, Fixture Filing with Absolute Assignment of Rents(1(6))
10.53 Allianz Loan II Limited Guaranty(1(6))
10.54 Allianz Loan II Loan Modification Agreement(1(6))
21.1 Subsidiaries of the Registrant (17)
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 10.17 to the Company's
Registration Statement on Form S-4/A filed on June 17, 1998 and declared
effective on November 23, 1998.
(5) Incorporated herein by reference to the same-numbered exhibit to the
Company's Registration Statement on Form S-4/A filed on October 27, 1998
and declared effective on November 23, 1998.
86
(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 Appendix II to the Company's Schedule
14A Proxy Statement filed with the Securities and Exchange Commission on
October 22, 2004.
(15) Incorporated herein by reference to the same-numbered exhibit to the
quarterly report on Form 10-Q filed on May 10, 2005.
(16) Incorporated herein by reference to the same-numbered exhibit to the
quarterly report on Form 10-Q filed on August 9, 2005.
(17) Incorporated herein by reference to the same-numbered exhibit to the annual
report on Form 10-K for 1998 filed on March 31, 1999.
87
EXHIBIT 23.1
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Mission West Properties, Inc.
Cupertino, California
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-3, SEC Nos. 333-133335 and 333-52835-99, and Form S-8, SEC
File Nos. 333-80369 and 333-123466 of Mission West Properties, Inc. of our
reports dated March 12, 2008, relating to the consolidated financial statements
and the effectiveness of Mission West Properties, Inc.'s internal control over
financial reporting, which appear in this Annual Report on Form 10-K. We also
consent to the incorporation by reference of our report dated March 12, 2008
relating to the financial statement schedule which appear in this Form 10-K.
\S\ Burr, Pilger & Mayer, LLP
San Francisco, California
March 12, 2008
88
EXHIBIT 23.2
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Mission West Properties, Inc.
Cupertino, California
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-3 (No.'s 333-133335 and 333-52835-99) and Form S-8 (No.'s
333-80369 and 333-123466) of Mission West Properties, Inc. of our report dated
February 3, 2006, relating to the consolidated financial statements, which
appears in this Form 10-K.
\S\ BDO Seidman, LLP
San Francisco, California
March 12, 2008
89