UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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Form 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2009
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission File Number 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
incorporation or organization) Identification No.)
10050 Bandley Drive
Cupertino, California 95014
(Address of principal executive offices) (Zip Code)
(408) 725-0700
(Registrant's telephone number, including area code)
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. [X] YES [ ] NO
Indicate by check mark whether the registrant has submitted electronically and
posted on its corporate Web site, if any, every Interactive Data File required
to be submitted and posted pursuant to Rule 405 of Regulation S-T (ss.232.405 of
this chapter) during the preceding 12 months (or for such shorter period that
the registrant was required to submit and post such files). [ ] Yes [ ] No
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of "large accelerated filer," "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ] Smaller reporting company [ ]
(Do not check if a smaller
reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). [ ] Yes [X] No
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
As of May 8, 2009, there were 21,748,211 shares of common stock outstanding, par
value $.001 per share.
MISSION WEST PROPERTIES, INC.
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2009
INDEX
Page
Part I Financial Information
Item 1. Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets as of March 31, 2009 (unaudited)
and December 31, 2008...................................................................................2
Condensed Consolidated Statements of Operations for the three
months ended March 31, 2009 and 2008 (unaudited)........................................................3
Condensed Consolidated Statements of Cash Flows for the
three months ended March 31, 2009 and 2008 (unaudited)..................................................4
Notes to Condensed Consolidated Financial Statements (unaudited)........................................5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................................................................13
Item 3. Quantitative and Qualitative Disclosures about Market Risk.............................................23
Item 4. Controls and Procedures................................................................................24
Part II Other Information
Item 1. Legal Proceedings......................................................................................25
Item 1A. Risk Factors...........................................................................................25
Item 6. Exhibits...............................................................................................25
Signatures........................................................................................................26
Exhibits
Exhibit 31.1 - Certification Pursuant to Rule 13a-14(a) of the
Securities Exchange Act of 1934
Exhibit 31.2 - Certification Pursuant to Rule 13a-14(a) of the
Securities Exchange Act of 1934
Exhibit 31.3 - Certification Pursuant to Rule 13a-14(a) of the
Securities Exchange Act of 1934
Exhibit 32 - Certification of CEO and CFO Pursuant to 18
U.S.C. ss. 1350, as Adopted Pursuant to ss. 906
of the Sarbanes-Oxley Act of 2002
- 1 -
PART I - Financial Information
ITEM 1. Condensed Consolidated Financial Statements
MISSION WEST PROPERTIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share and per share amounts)
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March 31, 2009 December 31, 2008
--------------------- ----------------------
(unaudited)
ASSETS
Investments in real estate:
Land $ 320,911 $ 320,911
Buildings and improvements 799,469 799,471
Real estate related intangible assets 3,240 3,240
--------------------- ----------------------
Total investments in properties 1,123,620 1,123,622
Accumulated depreciation and amortization (185,987) (180,043)
--------------------- ----------------------
Net investments in properties 937,633 943,579
Investment in unconsolidated joint venture 3,832 3,768
--------------------- ----------------------
Net investments in real estate 941,465 947,347
Cash and cash equivalents - -
Restricted cash 22,048 39,478
Restricted investment in marketable securities 4,078 -
Investment in marketable securities - 3,368
Deferred rent receivables 18,164 17,841
Other assets, net 26,114 26,251
--------------------- ----------------------
Total assets $1,011,869 $1,034,285
===================== ======================
LIABILITIES AND EQUITY
Liabilities:
Mortgage notes payable $ 327,933 $ 330,908
Mortgage note payable (related parties) 8,639 8,761
Revolving line of credit 5,456 13,079
Interest payable 1,583 1,596
Security deposits 5,122 5,272
Deferred rental income 5,735 3,964
Dividends and distributions payable 21,055 21,055
Accounts payable and accrued expenses 20,063 17,747
--------------------- ----------------------
Total liabilities 395,586 402,382
--------------------- ----------------------
Commitments and contingencies (Note 9)
Equity:
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,
21,748,211 and 19,748,211 shares issued and outstanding
at March 31, 2009 and December 31, 2008 22 20
Additional paid-in capital 169,415 154,412
Distributions in excess of accumulated earnings (22,932) (20,014)
--------------------- ----------------------
Total stockholders' equity 146,505 134,418
Noncontrolling interests 469,778 497,485
--------------------- ----------------------
Total equity 616,283 631,903
--------------------- ----------------------
Total liabilities and equity $1,011,869 $1,034,285
===================== ======================
The accompanying notes are an integral part of these
condensed consolidated financial statements.
- 2 -
MISSION WEST PROPERTIES, INC
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except share and per share amounts)
(unaudited)
---------
Three months ended March 31,
---------------------------------------
-
2009 2008
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Operating revenues:
Rental revenue from real estate $20,655 $18,996
Tenant reimbursements 4,800 3,583
Lease termination income - 1,921
Other income 320 228
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Total operating revenues 25,775 24,728
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Operating expenses:
Property operating, maintenance and real estate taxes 5,952 4,887
General and administrative 531 673
Depreciation and amortization of real estate 5,944 5,623
------------------ --------------------
Total operating expenses 12,427 11,183
------------------ --------------------
Operating income 13,348 13,545
Other income (expenses):
Equity in earnings of unconsolidated joint venture 89 382
Interest and dividend income (59) 558
Unrealized loss from investment (2,757) -
Interest expense (4,806) (4,928)
Interest expense - related parties (181) (436)
------------------ --------------------
Net income 5,634 9,121
Net income attributable to noncontrolling interests (4,202) (7,239)
------------------ --------------------
Net income attributable to common stockholders $ 1,432 $ 1,882
================== ====================
Net income per common share to common stockholders:
Basic $0.07 $0.10
================== ====================
Diluted $0.07 $0.10
================== ====================
Weighted average shares of common stock outstanding (basic) 21,614,878 19,667,605
================== ====================
Weighted average shares of common stock outstanding (diluted) 21,770,489 19,667,605
================== ====================
The accompanying notes are an integral part of these
condensed consolidated financial statements.
- 3 -
MISSION WEST PROPERTIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(unaudited)
---------
Three months ended March 31,
--------------------------------------
2009 2008
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Cash flows from operating activities:
Net income $ 5,634 $ 9,121
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of real estate and in-place leases 5,944 5,623
Unrealized loss from restricted investment in marketable securities 2,757 -
Dividend income from restricted investment in marketable securities (503) -
Equity in earnings of unconsolidated joint venture (89) (382)
Distributions from unconsolidated joint venture 25 450
Interest earned on restricted cash (44) (487)
Lease termination fee related to restricted cash 10,864 1,579
Stock-based compensation expense 25 145
Other 3 29
Changes in operating assets and liabilities:
Deferred rent (323) (706)
Other assets 138 (1,420)
Interest payable (13) (11)
Security deposits (150) 39
Deferred rental income 1,771 1,473
Accounts payable and accrued expenses 2,316 3,307
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Net cash provided by operating activities 28,355 18,760
------------------- ------------------
Cash flows from investing activities:
Improvements to real estate assets - (221)
Purchase of real estate - (35,764)
Restricted cash released for purchase of real estate - 8,082
Excess restricted cash - 7,654
Proceeds from investment in marketable securities 3,645 -
------------------- ------------------
Net cash provided by (used in) investing activities 3,645 (20,249)
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Cash flows from financing activities:
Principal payments on mortgage notes payable (2,975) (2,746)
Principal payments on mortgage note payable (related parties) (122) (112)
Proceeds from real estate purchase financing (related parties) - 19,316
Proceeds from note payable (related parties) 10,775 3,000
Payment on note payable (related parties) (10,775) (3,000)
Payment on line of credit (7,623) -
Payment of loan fees and costs - (18)
Distributions to noncontrolling interests (17,330) (13,885)
Dividends paid to common stockholders (3,950) (3,146)
------------------- ------------------
Net cash used in financing activities (32,000) (591)
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Net decrease in cash and cash equivalents - (2,080)
Cash and cash equivalents, beginning of period - 23,691
------------------- ------------------
Cash and cash equivalents, end of period $ - $21,611
=================== ==================
Supplemental information:
Cash paid for interest $ 4,920 $ 5,060
=================== ==================
Supplemental schedule of non-cash investing and financing activities:
Debt from seller in connection with real estate purchase (related parties) $ - $19,068
=================== ==================
Issuance of common stock upon conversion of O.P. units $14,978 $ 54
=================== ==================
The accompanying notes are an integral part of these
condensed consolidated financial statements.
- 4 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share and per square footage)
(unaudited)
1. ORGANIZATION AND FORMATION OF THE COMPANY
Mission West Properties, Inc. (the "Company") is a fully integrated,
self-administered and self-managed real estate company that acquires and
manages 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. All limited partnership interests in the
operating partnerships were converted into 59,479,633 operating partnership
("O.P.") units, which represented a limited partnership ownership interest
of approximately 87.89% of the operating partnerships. The operating
partnerships are the vehicles through which the Company holds its real
estate investments, makes real estate acquisitions, and generally conducts
its business.
On December 30, 1998, the Company was reincorporated under the laws of the
State of Maryland through a merger with and into Mission West Properties,
Inc. Accordingly, shares of the former company, Mission West Properties, a
California corporation (no par), which were outstanding at December 30,
1998, were converted into shares of common stock, $.001 par value per
share, on a one-for-one basis.
As of March 31, 2009, the Company owns a controlling general partnership
interest of 23.79%, 21.85%, 16.31% and 12.52% in Mission West Properties,
L.P., Mission West Properties, L.P. I, Mission West Properties, L.P. II and
Mission West Properties, L.P. III, respectively, which represents a 20.53%
general partnership interest in the operating partnerships, taken as a
whole, on a consolidated weighted average basis.
Through the operating partnerships, the Company owns interests in 111
R&D/office properties, all of which are located in the Silicon Valley.
The Company has elected to be taxed as a real estate investment trust
("REIT") under the Internal Revenue Code of 1986, as amended. Accordingly,
no provision has been made for income taxes for the three months ended
March 31, 2009 and 2008.
BUSINESS SEGMENT INFORMATION
The Company's primary business is the ownership and management of
R&D/office real estate with a geographic concentration in the Silicon
Valley of the San Francisco Bay Area. Accordingly, the Company has
concluded it currently has a single reportable segment for Statement of
Financial Accounting Standards ("SFAS") No. 131, "Disclosures about
Segments of an Enterprise and Related Information," purposes.
2. BASIS OF PRESENTATION
PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
The accompanying unaudited interim condensed consolidated financial
statements of the Company have been prepared in accordance with Rule 10-01
of Regulation S-X promulgated by the Securities and Exchange Commission
("SEC") and, therefore, do not include all information and footnotes
necessary for a fair presentation of financial position, results of
operations and cash flows in conformity with accounting principles
generally accepted in the United States of America. In the opinion of the
Company, however, the accompanying unaudited interim condensed consolidated
financial statements contain all adjustments, consisting only of normal
recurring adjustments, necessary to present fairly the Company's
consolidated financial position as of March 31, 2009, their consolidated
results of operations for the three months ended March 31, 2009 and 2008,
and their cash flows for the three months ended March 31, 2009 and 2008.
All significant inter-company balances have been eliminated in
consolidation. The condensed consolidated financial statements as of March
31, 2009 and for the three months ended March 31, 2009 and 2008 and related
footnote disclosures are unaudited. The results of operations for the three
months ended March 31, 2009 are not necessarily indicative of the results
to be expected for the entire year.
The December 31, 2008 condensed consolidated balance sheet data was derived
from audited financial statements, but does not include all disclosures
required by accounting principles generally accepted in the United States
of America ("GAAP").
The Company evaluates all joint venture arrangements for consolidation. The
percentage interest in the joint venture, evaluation of control and whether
a variable interest entity ("VIE") exists are all considered in determining
if the arrangement qualifies for consolidation in accordance with FASB
Interpretation No. 46R, "Consolidation of Variable Interest Entities" ("FIN
46R"). As of March 31, 2009, the Company consolidated one VIE in the
accompanying condensed consolidated balance sheets in connection with an
assignment of a lease agreement with an unrelated party, M&M Real Estate
Control & Restructuring, LLC. See Note 3 for further discussion of this
transaction.
- 5 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(dollars in thousands, except per share and per square footage)
(unaudited)
STOCK-BASED OPTION COMPENSATION ACCOUNTING
The FASB issued SFAS No. 123R, "Share-Based Payment" ("SFAS 123R"), which
addresses the accounting for stock options. SFAS 123R requires that the
cost of all employee, director and consultant stock options, as well as
other equity-based compensation arrangements, be reflected in the financial
statements based on the estimated fair value of the awards. SFAS 123R is an
amendment to SFAS 123, "Accounting for Stock-Based Compensation," and
supersedes Accounting Principles Board Opinion No. 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. At March 31, 2009, the Company had one stock-based compensation
plan. The adoption of this standard did not have a material effect on the
Company's condensed consolidated statements of operations, cash flows or
financial position.
In the first quarter of 2009, the Company's Compensation Committee
rescinded the options to purchase a total of 650,000 shares of common stock
granted to an employee in November 2008. The rescission was made because
the option grant exceeded the maximum number of options that can be granted
by the Company in any calendar year under its 2004 Equity Incentive Plan.
In the first quarter of 2009, stock options to purchase 500,000 shares of
common stock were granted to one employee. Of this total grant, options to
purchase 175,000 shares vested immediately, options to purchase 100,000
shares vest monthly for nine months and options to purchase 225,000 shares
vest monthly for 36 months, subject to continued employment with the
Company. This 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 with the Company. The option was granted at an exercise price of
$5.99 per share. The estimated fair value of the options granted was $0.14
per share on the date of grant using the Black-Scholes option pricing model
with the following assumptions: dividend yield of 13.36%, volatility of
23.77%, risk free rates of 1.83% and an expected life of 5.5 years. The
options were granted at the fair market value on the date of grant and were
approved by the Compensation Committee.
In the first quarter of 2009, options to purchase 200,000 shares of common
stock held by an employee of the Company expired.
The following table shows the activity and detail for the 2004 Equity
Incentive Plan.
Weighted Average
Options Option Price
Outstanding Per Share
--------------- ------------------
Balance, December 31, 2008 3,332,500 $9.62
Options granted 500,000 $5.99
Options canceled (200,000) $9.51
---------------
Balance, March 31, 2009 3,632,500 $9.13
===============
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 condensed consolidated statements of operations.
Under SFAS 123R, the Company recorded approximately $25 and $145 of expense
for the three months ended March 31, 2009 and 2008, respectively, for
share-based compensation relating to grants of stock options.
As of March 31, 2009, the total amount of unrecognized compensation cost
related to unvested share-based compensation arrangements granted under the
compensation plan was approximately $515. This cost is expected to be
recognized over a weighted-average period of 2.43 years.
NONCONTROLLING INTERESTS
The Company adopted the provisions of SFAS 160, "Noncontrolling Interests
in Consolidated Financial Statements - an amendment of ARB No. 51" ("SFAS
160"), effective January 1, 2009. SFAS 160 clarifies that a noncontrolling
interest in a subsidiary is an ownership interest in a consolidated entity,
which should be reported as equity in the parent's consolidated financial
statements. SFAS 160 requires disclosure, on the face of the consolidated
income statement, of those amounts of consolidated net income and other
comprehensive other income attributable to controlling and noncontrolling
interests, eliminating the past practice of reporting amounts of income
attributable to noncontrolling interest as an adjustment in arriving at
consolidated net income.
In connection with the adoption of SFAS 160, the Company reclassified into
the Company's condensed consolidated equity the historical balances related
to noncontrolling interests in the consolidated operating partnerships. At
December 31, 2008, the carrying amount of noncontrolling interests in the
consolidated operating partnerships was approximately $497,485.
- 6 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(dollars in thousands, except per share and per square footage)
(unaudited)
The following table presents a reconciliation of the December 31, 2008 and
March 31, 2009, carrying amounts for equity and the related amounts of
equity attributable to stockholders' equity and noncontrolling interests:
Equity
---------------------------------------------------------------------------------
Additional Distributions in
Common Paid-in Excess of Noncontrolling
Stock Capital Accumulated Earnings Interests Total
---------------------------------------------------------------------------------
(dollars in thousands)
Balance, December 31, 2008 $20 $154,412 ($20,014) $497,485 $631,903
Net income 1,432 4,202 5,634
Amortization of previously granted share awards 25 25
Conversions of operating partnership units 2 14,978 (14,980) -
Cash dividends/distributions (4,350) (16,929) (21,279)
---------------------------------------------------------------------------------
Balance, March 31, 2009 $22 $169,415 ($22,932) $469,778 $616,283
=================================================================================
Noncontrolling interests represent the aggregate partnership interest in
the operating partnership held by the operating partnership limited partner
unit holders. Income allocated to noncontrolling interests is based on the
unit holders' ownership percentage of the operating partnership. Because an
O.P. unit is generally redeemable for cash or a share of common stock at
the option of the Company, it is deemed to be equivalent to a share of
common stock. Therefore, such transactions are treated as capital
transactions and result in an allocation between stockholders' equity and
noncontrolling interests in the accompanying condensed balance sheets to
account for the change in the ownership of the underlying equity in the
operating partnerships. The Company's noncontrolling interests represent
the separate private ownership of the operating partnerships by the Berg
Group (defined as Carl E. Berg, his brother Clyde J. Berg, members of their
respective immediate families, and certain entities they control) and other
non-affiliate interests. As of March 31, 2009, these interests accounted
for approximately 79.3% of the ownership interests in the real estate
operations of the Company on a consolidated weighted average basis. The
amount of noncontrolling 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 noncontrolling interests'
ownership percentage.
Allocation of corporate general and administrative expenses to the
operating partnerships is performed based upon shares and O. P. units
outstanding for each operating partnership in relation to the total for all
four operating partnerships.
RECLASSIFICATIONS
Certain reclassifications have been made to the previously reported 2008
condensed consolidated financial statements in order to conform to the 2009
presentation. The reclassifications were to reflect the retrospective
adoption of SFAS 160. The reclassification resulted in (i) the
reclassification of the Company's minority interests in the consolidated
operating partnerships to "noncontrolling interests," a component of equity
on the Company's condensed consolidated balance sheets, and (ii) the
reclassification of minority interests to "net income attributable to
noncontrolling interests" on the Company's condensed consolidated
statements of operations. The reclassifications had no impact on previously
reported net income attributable to common stockholders or net income per
common share to common stockholders.
The following notes, which present interim disclosures as required by the
SEC, highlight significant changes to the notes to the Company's December
31, 2008 audited consolidated financial statements and should be read
together with the consolidated financial statements and notes thereto
included in the Company's 2008 Annual Report on Form 10-K filed on March
16, 2009.
ACCOUNTING PRONOUNCEMENTS
In September 2006, the FASB issued SFAS 157, "Fair Value Measurements"
("SFAS 157"). SFAS 157 defines fair value, establishes a framework for
measuring fair value and expands disclosures about fair value measurements.
SFAS 157 applies under other accounting pronouncements that require or
permit fair value measurements. Accordingly, this statement does not
require any new fair value measurements. This guidance was issued to
increase consistency and comparability in fair value measurements and to
expand disclosures about fair value measurements. SFAS establishes and
requires disclosure of fair value hierarchy that distinguishes between data
obtained from sources independent of the reporting entity and the reporting
entity's own assumptions about market participant assumptions. The three
levels of hierarchy are 1) using quoted prices in active markets for
identical assets and liabilities, 2) "significant other observable inputs"
and 3) "significant unobservable inputs". "Significant other observable
inputs" can include quoted prices for similar assets or liabilities in
active markets, as well as inputs that are observable for the asset or
liability, such as interest rates, foreign exchange rates and yield curves
that are observable at commonly quoted intervals. "Significant unobservable
inputs" are typically based on an entity's own assumptions, as there is
little, if any, related market activity. SFAS 157 is effective for
financial statements issued for fiscal years beginning after November 15,
2007. Adoption on January 1, 2008 did not have a material effect on the
Company's consolidated financial statements.
In February 2007, the FASB issued SFAS 159, "The Fair Value Option for
Financial Assets and Financial Liabilities" ("SFAS 159"). SFAS 159 provides
companies with an option to report selected financial assets and
liabilities at fair value. SFAS 159's objective is to reduce both
complexity in accounting for financial instruments and the volatility in
earnings caused by measuring related assets and liabilities differently.
SFAS 159 is effective for financial statements issued for fiscal years
beginning after
- 7 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(dollars in thousands, except per share and per square footage)
(unaudited)
November 15, 2007. The Company adopted SFAS 159 on a prospective basis on
January 1, 2008. The implementation of SFAS 159 did not have a material
impact on the Company's 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 requires that
acquisition-related costs and restructuring costs be recognized separately
from the business combination and expensed as incurred. 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. Based on historical acquisition costs and activity
levels, the adoption of SFAS 141R on January 1, 2009 did not have a
significant impact on the Company's results of operations and financial
position.
In December 2007, the FASB issued SFAS 160, "Noncontrolling Interests in
Consolidated Financial Statements - an amendment of ARB No. 51." SFAS 160
requires that noncontrolling interests (previously referred to as minority
interests) be presented as a component of consolidated equity, eliminates
"minority interest accounting" such that the amount of net income
attributable to 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 requires a
reconciliation of equity attributable to noncontrolling interests and
disclosure of those amounts of consolidated net income attributable to
noncontrolling interests. SFAS 160 is effective for fiscal years beginning
on or after December 15, 2008. The adoption of SFAS 160 on January 1, 2009,
which required retroactive adoption of the presentation and disclosure
requirements for existing minority interests, had a significant impact on
the Company's computation of net income and its presentation of the balance
sheet.
3. VARIABLE INTEREST ENTITY
Under FIN 46R, a VIE must be consolidated by a company if it is subject to
a majority of the entity's expected losses or is entitled to receive a
majority of the entity's expected residual returns or both. In addition,
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.
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, 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 expire in 2011. Under the terms of the assignment
of lease agreement, the Company received monthly rent payments of
approximately $789 from July 2007 through June 2008, is receiving $818 from
July 2008 through June 2009, and will receive $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.
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.
- 8 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(dollars in thousands, except per share and per square footage)
(unaudited)
- 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 tenants from its obligations
under the leases, would have to absorb the majority of any loss, making it
the primary beneficiary of M&M's activities.
4. RESTRICTED CASH
Restricted cash totaled approximately $22,048 on March 31, 2009. The entire
amount represents cash held by M&M Real Estate Control & Restructuring,
LLC, a consolidated VIE. The Company does not have possession or control
over these funds or any right to receive them except in accordance with the
payment terms of the lease agreement that has been assigned to the VIE and
any other additional agreements with the VIE.
5. RESTRICTED INVESTMENT IN MARKETABLE SECURITIES
In accordance with SFAS 115, "Accounting for Certain Investments in Debt
and Equity Securities," investments in debt and equity "marketable"
securities are classified at acquisition, and on subsequent reporting
dates, into one of the following categories: (a) Trading Securities - debt
and equity securities purchased and held principally for the purpose of
selling them in the near future. (b) Available-for-Sale Securities - debt
securities not classified as held-to-maturity, and debt and equity
securities not classified as trading securities. (c) Held-to-Maturity Debt
Securities - those debt securities for which the company has the "positive
intent and ability to hold the securities to maturity."
The Company's restricted investment in marketable securities on March 31,
2009 was classified as trading securities, whereas unrealized holdings
gains and losses (differences between the initial cost and the fair value
at the balance sheet date) are included in net income of the current
period, and interest and dividend revenue, as well as realized gains and
losses on sales, are included in net income of the current period. The
marketable securities are classified as Level 1 of the fair value hierarchy
in accordance with SFAS 157 and thus measured at fair value using quoted
market prices for identical instruments in active markets from an
independent third party source. See Note 2 above under Accounting
Pronouncements for further discussion of SFAS 157.
Restricted investment in marketable securities totaled approximately $4,078
on March 31, 2009, which was funded by the Company's restricted cash
through its VIE. The amount represents an investment in marketable
securities of a real estate investment trust company traded on the New York
Stock Exchange Euronext. The marketable securities are adjusted to fair
value at the end of each accounting period, with the corresponding loss and
gain recorded in unrealized loss or gain from investment in the Company's
consolidated statement of operations. For the three months ended March 31,
2009, the Company recorded net unrealized loss of approximately $2,757
related to the decrease in fair value of the marketable securities.
6. STOCK TRANSACTIONS
During the three months ended March 31, 2009, one limited partner exchanged
a total of 2,000,000 O.P. units for 2,000,000 shares of the Company's
common stock under the terms of the Exchange Rights Agreement among the
Company and all limited partners of the operating partnerships resulting in
a reclassification of approximately $14,978 from noncontrolling interests
to additional paid-in capital. Neither the Company nor the operating
partnerships received any proceeds from the issuance of the common stock in
exchange for O.P. units.
7. NET INCOME PER SHARE
Basic operating net income per share is computed by dividing net income by
the weighted average number of common shares outstanding for the period.
Diluted operating net income per share is computed by dividing net income
by the sum of the weighted-average number of common shares outstanding for
the period plus the assumed exercise of all dilutive securities using the
treasury stock method.
The computation for weighted average shares is detailed below:
Three Months Ended March 31,
---------------------------------
2009 2008
--------------- --------------
Weighted average shares outstanding (basic) 21,614,878 19,667,605
Incremental shares from assumed option exercise 155,611 -
--------------- --------------
Weighted average shares outstanding (diluted) 21,770,489 19,667,605
=============== ==============
- 9 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(dollars in thousands, except per share and per square footage)
(unaudited)
At March 31, 2009, outstanding options to purchase 2,427,500 shares of
common stock were excluded from the computation of diluted net income per
share under the treasury stock method for the three months ended March 31,
2009 because the option exercise price was greater than the weighted
average closing price of the Company's common stock during the period. The
outstanding O.P. units, which are exchangeable at the unit holder's option,
subject to certain conditions, for shares of common stock on a one-for-one
basis have been excluded from the diluted net income per share calculation,
as there would be no effect on the calculation after adding the
noncontrolling interests' share of income back to net income. The total
number of O.P. units outstanding at March 31, 2009 and 2008 was 83,526,965
and 85,528,215, respectively.
8. RELATED PARTY TRANSACTIONS
As of March 31, 2009, the Berg Group owned 75,902,384 O.P. units. The Berg
Group's combined ownership of O.P. units and shares of common stock as of
March 31, 2009 represented approximately 74% of the total equity interests,
assuming conversion of all O.P. units outstanding into the Company's common
stock.
As of March 31, 2009, debt in the amount of approximately $8,639 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 June 2010 with principal payments amortized
over 20 years. On October 1, 2008, the Company and the Berg Group agreed to
extend the maturity due date to June 2013. Interest expense incurred in
connection with the mortgage note was approximately $167 and $176 for the
three months ended March 31, 2009 and 2008, respectively.
During the first quarter of 2009, debt in the amount of approximately
$10,760 was borrowed and repaid to the Berg Group under a short-term note
payable established on January 8, 2009 in connection with the fourth
quarter 2008 dividend distributions. The note payable interest was
calculated at LIBOR plus 2%. Interest expense incurred in connection with
the loan was approximately $14 for the three months ended March 31, 2009.
During the first three months of 2009 and 2008, Carl E. Berg or entities
controlled by him 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 approximately $293 and $307 in rental revenue for the three
months ended March 31, 2009 and 2008, respectively.
Under the Company's charter, bylaws and agreements with the Berg Group, the
individual members of the Berg Group are prohibited from acquiring or
holding shares of the Company's common stock if such acquisition would
result in their beneficial ownership percentage of the Company's common
stock causing the Company to violate any REIT qualification requirement.
Currently their share ownership is below a level at which rent from related
tenants would be excluded in determining compliance with REIT qualification
tests.
The Berg Group has an approximately $7,500 commitment to complete an
approximately 75,000 to 90,000 square foot building in connection with the
Company's 2001 acquisition of 245 Caspian in Sunnyvale which is comprised
of approximately three acres of unimproved land. The Company has recorded
this portion of the purchase price paid to the Berg Group in "Other assets"
on its condensed consolidated balance sheets. The Berg Group plans to
satisfy this commitment to construct a building when requested by the
Company following the approval of the Independent Directors Committee.
The Company currently leases office space owned by Berg & Berg Enterprises
for the Company's headquarters. Rental amounts and overhead reimbursements
paid to Berg & Berg Enterprises were approximately $30 and $24 for the
three months ended March 31, 2009 and 2008, respectively.
9. COMMITMENTS AND CONTINGENCIES
Neither the operating partnerships, the Company's properties nor the
Company are subject to any material litigation nor, to the Company's
knowledge, is any material litigation threatened against the operating
partnerships, the properties or the Company. From time to time, the Company
is engaged in legal proceedings arising in the ordinary course of business.
The Company does not expect any of such proceedings to have a material
adverse effect on its cash flows, financial condition or results of
operations. The Company is currently involved in the following legal
proceedings and it believes that the ultimate outcome of these proceedings
will not have a material adverse effect on its 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. Republic Properties
Corporation ("RPC") is a former 50% partner with Mission West Properties,
L.P. in the Hellyer Avenue Limited Partnership ("Hellyer LP"), which was
formed in July 2000. Under the terms of the Hellyer LP partnership
agreement and
- 10 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(dollars in thousands, except per share and per square footage)
(unaudited)
other related contracts, Mission West Properties, L.P. ("MWP") had the
right to obtain RPC's entire interest in Hellyer LP in the event of certain
payment defaults which occurred in August 2000. Therefore, on September 1,
2000, MWP, as the general partner of Hellyer LP, ceased all allocations of
income and cash flow to RPC and exercised its 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 Berg &
Berg Enterprises, Inc. ("BBE"). Under the Berg Land Holdings Option
Agreement and the Acquisition Agreement dated as of May 14, 1998, the
Company acting through the Independent Directors Committee had the right,
but not the obligation, to reacquire the property interest and the related
distributions related to the property interest at any time. The transfer
was effective as of September 1, 2000. On November 20, 2000, RPC commenced
a lawsuit against MWP in the Circuit Court of Maryland for Baltimore City.
After lengthy litigation, which included a trial on the merits and
subsequent appeals, in April 2006, Maryland's highest court upheld an
earlier Maryland Appeals Court ruling in favor of MWP, finding that the
Circuit Court of Maryland could not assert personal jurisdiction over MWP
in Maryland. The court vacated the judgment and decision in the trial court
and dismissed the entire Maryland suit. In February 2001, while the
Maryland case was pending, the Company filed a suit against RPC in the
Superior Court of the State of California for the County of Santa Clara.
The case was stayed pending resolution of the Maryland case, and the
Company dismissed its suit on March 4, 2005. In April 2005, RPC submitted a
motion asking the Superior Court to reinstate the case, which the Court
granted on May 25, 2005. On July 5, 2006, RPC filed a cross-complaint in
the case seeking partnership distributions to which the Company demurred.
The Court sustained the Company's demurrer with leave to amend.
Subsequently, RPC filed an amended complaint and the Company submitted
another demurrer seeking dismissal of the claims on statute of limitations
grounds. On February 20, 2007, the Court overruled the Company's demurrer.
The Company sought a writ from the California State Court of Appeal for the
Sixth District to direct the lower court to reverse its decision, but the
petition for the writ was denied. In April 2008, the Company filed a motion
for summary judgment in the California Superior Court which was denied. In
October 2008, a motion filed by RPC for summary judgment in the California
Superior Court was denied. A trial in the California Superior Court is
scheduled to commence in late 2008. A trial in the California Superior
Court commenced in February 2009 and is expected to conclude in May 2009.
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 noncontrolling interest held by the noncontrolling
partner (first RPC and then BBE). In each period, the Company has accrued
amounts payable by Hellyer LP to the noncontrolling interest partner,
including BBE prior to payment. BBE's share of earnings allocated to its
50% noncontrolling interest was approximately $0.2 million in the first
three months of 2009 and 2008. As of March 31, 2009, accumulated cash flow
distributions from Hellyer LP totaling approximately $5.5 million were
accrued and distributed to BBE. If the Company's litigation with RPC is
ultimately decided in RPC's favor, the Company anticipates that BBE may be
required to return RPC's former interest in Hellyer LP and all prior
distributions to RPC. As a result of this uncertainty, in October 2003, the
Company recorded such distributions as an account receivable from BBE,
which is included in "Other assets" on the Company's consolidated balance
sheets, with an offsetting account payable to BBE.
The Independent Directors Committee of the Board of Directors has exercised
the right to acquire on behalf of the Company the former RPC interest and
related distributions from Berg & Berg Enterprises, Inc. under the terms of
the Berg Land Holdings Option Agreement between the Company and the Berg
Group if the litigation is ultimately decided in favor of the Company.
GUARANTEES AND INDEMNITIES
Under its articles of incorporation and bylaws, the Company has agreed to
indemnify its officers and directors for certain events or occurrences
arising as a result of the officer or director's serving in such capacity.
The maximum potential amount of future payments the Company could be
required to make under these indemnification agreements is unlimited. The
Company believes the estimated fair value of its obligations under these
indemnification agreements is minimal and has recorded no liabilities for
these agreements as of March 31, 2009.
The Company also enters into indemnification provisions under its
agreements with other companies in the ordinary course of business,
typically with lenders, joint venture partners, contractors, and tenants.
Under these provisions the Company typically agrees to indemnify and hold
harmless the indemnified party for losses suffered or incurred by the
indemnified party as a result of certain kinds of activities or inactions
of the Company. These indemnification provisions generally survive
termination of the underlying agreement. The maximum potential amount of
future payments the Company could be required to make under these
indemnification provisions is unlimited. To date, the Company has not
incurred material costs to defend lawsuits or settle claims related to
these indemnification agreements. As a result, the Company believes the
estimated fair value of these agreements is minimal. Accordingly, the
Company has recorded no liabilities for these agreements as of March 31,
2009.
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.
- 11 -
MISSION WEST PROPERTIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(dollars in thousands, except per share and per square footage)
(unaudited)
ENVIRONMENTAL ISSUES
The environmental investigations that have been conducted on the Company's
properties have not revealed any environmental liability that the Company
believes would have a material adverse effect on its financial condition,
results of operations and assets, and the Company is not aware of any such
liability. Nonetheless, it is possible that there are material
environmental liabilities of which the Company is unaware. In addition, the
Company cannot assure that future laws, ordinances, or regulations will not
impose any material environmental liability, or that the current
environmental condition of the properties has not been, or will not be,
affected by tenants and occupants of the properties, by the condition of
properties in the vicinity of the properties, or by third parties unrelated
to the Company.
ASSET DISPOSITIONS SUBJECT TO CERTAIN CONDITIONS
The Company has entered into sales agreements 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 an executed
sales contract as of March 31, 2009 that is subject to such material
conditions:
Property Number of Buildings Rentable Square Feet Acres Sales Price
-------- ------------------- -------------------- ----- -----------
McCandless Drive
Milpitas, California 8 427,000 23.03 $76,500
10. SUBSEQUENT EVENTS
On April 9, 2009, the Company paid dividends of $0.20 per share of common
stock to all common stockholders of record as of March 31, 2009. On the
same date, the operating partnerships paid a distribution of $0.20 per O.P.
unit to all holders of O.P. units, with the exception of the Berg Group.
Aggregate dividends and distributions amounted to approximately $21,055.
On April 9, 2009, the Company issued a short-term note for approximately
$12,360 to the Berg Group in connection with the first quarter 2009
dividend distributions. The note interest rate was LIBOR plus 2% and was
fully repaid in April 2009.
In April 2009, the Company issued two short-term notes in the aggregate
amount of $15,000 to M&M. The notes bear interest at LIBOR plus 2% and are
due June 30, 2009. The proceeds were used to pay an outstanding short-term
note issued to the Berg Group and general corporate purposes.
- 12 -
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and Results of
Operations should be read in conjunction with the accompanying condensed
consolidated financial statements and notes thereto under Part I, Item 1 of this
Report and our audited consolidated financial statements and notes thereto
contained in our Annual Report on Form 10-K as of and for the year ended
December 31, 2008. The results for the three months ended March 31, 2009 are not
necessarily indicative of the results to be expected for the entire fiscal year
ending December 31, 2009.
FORWARD-LOOKING INFORMATION
This quarterly report on Form 10-Q contains forward-looking statements within
the meaning of the federal securities laws. We intend such forward-looking
statements to be covered by the safe harbor provisions for forward-looking
statements contained in the Private Securities Reform Act of 1995, and are
including this statement for purposes of complying with these safe harbor
provisions. Forward-looking statements, which are based on certain assumptions
and describe future plans, strategies and expectations of the Company, are
generally identifiable by use of the words "believe," "expect," "intend,"
"anticipate," "estimate," "project" or similar expressions. Additionally, all
disclosures under Part I, Item 3 constitute forward-looking statements. Our
ability to predict results or the actual effect of future plans or strategies is
inherently uncertain.
Factors that could have a material adverse effect on our operations and future
prospects or would cause actual results in the future to differ materially from
any of our forward-looking statements include, but are not limited to, the
following:
- the current turmoil in the credit markets could limit the demands for R&D
space and affect the overall availability and cost of credit,
- economic conditions generally and the real estate market specifically,
- the occupancy rates of the properties,
- rental rates on new and renewed leases,
- legislative or regulatory provisions (including changes to laws governing
the taxation of REITs),
- availability of capital,
- interest rates,
- competition,
- supply of and demand for R&D, office and industrial properties in our
current and proposed market areas,
- tenant defaults and bankruptcies,
- lease term expirations and renewals,
- changes in general accounting principles, policies and guidelines
applicable to REITs, and
- ability to timely refinance maturing debt obligations and the terms of any
such refinancing.
These risks and uncertainties, together with the other risks described under
Part I, Item 1A - "Risk Factors" of our 2008 Annual Report on Form 10-K and from
time to time in our other reports and documents filed with the Securities and
Exchange Commission ("SEC"), should be considered in evaluating forward-looking
statements and undue reliance should not be placed on such statements.
OVERVIEW
We acquire, market, lease, and manage R&D/office properties, primarily located
in the Silicon Valley portion of the San Francisco Bay Area. As of March 31,
2009, we owned and managed 111 properties totaling approximately 8.0 million
rentable square feet through four limited partnerships, or operating
partnerships, for which we are the sole general partner. This class of property
is designed for research and development and office uses and, in some cases,
includes space for light manufacturing operations with loading docks. We believe
that we have one of the largest portfolios of R&D/office properties in the
Silicon Valley. As of March 31, 2009, two tenants individually lease in excess
of 300,000 rentable square feet from us: Microsoft Corporation and Apple, Inc.
For federal income tax purposes, we have operated as a self-managed,
self-administered and fully integrated real estate investment trust ("REIT")
since the beginning of fiscal 1999.
Our acquisition, growth and operating strategy incorporates the following
elements:
- working with the Berg Group to take advantage of their abilities and
resources to pursue development opportunities which we have an option to
acquire, on pre-negotiated terms, upon completion and leasing;
- capitalizing on opportunistic acquisitions from third parties of
high-quality R&D/office properties that provide attractive initial yields
and significant potential for growth in cash-flow;
- focusing on general purpose, single-tenant Silicon Valley R&D/office
properties for information technology companies in order to maintain low
operating costs, reduce tenant turnover and capitalize on our relationships
with these companies and our extensive knowledge of their real estate
needs; and
- 13 -
- maintaining prudent financial management principles that emphasize current
cash flow while building long-term value, the acquisition of pre-leased
properties to reduce development and leasing risks and the maintenance of
sufficient liquidity to acquire and finance properties on desirable terms.
CURRENT ECONOMIC ENVIRONMENT
In the first quarter of 2009, the overall U.S. economy weakened further,
particularly with the increased turmoil in the credit markets, the housing
recession and growing unemployment. These factors have resulted in a
considerable reduction in business spending. As credit requirements have
tightened with many financial institutions, current tenants and prospective
tenants may find it more difficult to obtain credit. In effect, this may impact
the stability of our current tenants' financial condition and limit our ability
to lease spaces to credit worthy prospective tenants.
Given the current financial markets crisis and general economic conditions,
there can be no assurances that our operating results will not decrease. We have
a strong balance sheet and have maintained one of the lowest levels of leverage
in the REIT industry. The current crisis in the financial markets has resulted
in de-leveraging throughout the global finance system. The displacement in the
current financing market has resulted in a very difficult borrowing environment.
All of our properties are located in the Northern California area known as
Silicon Valley, which generally consists of portions of Santa Clara County,
Southwestern Alameda County, Southeastern San Mateo County and Eastern Santa
Cruz County. Historically, the Silicon Valley R&D property market has fluctuated
with the local economy. The Silicon Valley economy and business activity slowed
markedly from 2001 through 2006 and grew slowly until the second half of 2008.
Since September 2008, the impact of the worldwide recession has adversely
affected the local economy. According to a recent report by NAI BT Commercial
Real Estate (the "BT Report"), the vacancy rate for Silicon Valley R&D property
was approximately 16.3% in late 2008 and 18.0% at the end of the first quarter
of 2009. Total vacant R&D square footage in Silicon Valley at the end of the
first quarter of 2009 amounted to approximately 27.8 million square feet, of
which 17.2%, or 4.8 million square feet, was being offered under subleases.
According to the BT Report, total negative net absorption (which is the
computation of gross square footage leased less gross new square footage vacated
for the period presented) in 2008 amounted to approximately 33,000 square feet,
and in the first three months of 2009 there was total negative net absorption of
approximately 2.6 million square feet. Also according to the BT Report, the
average asking market rent per square foot at the end of the first quarter of
2009 was $1.17 compared with $1.26 in late 2008. 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, however,
and 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.
Our occupancy rate at March 31, 2009 was 65.3% compared with 64.4% at March 31,
2008. We believe that our occupancy rate could decline if key tenants seek the
protection of bankruptcy laws, consolidate operations or discontinue operations.
In addition, leases with respect to approximately 140,000 rentable square feet
are expiring prior to the end of 2009. The properties subject to these leases
may take anywhere from 24 to 40 months or longer to re-lease. We believe that
the average 2009 renewal rental rates for our properties will be approximately
equal to, or perhaps below, current market rents, but we cannot give any
assurance that leases will be renewed or that available space will be re-leased
at rental rates equal to or above the current quoted market rates.
Despite our strategic focus on single tenant properties and leases, in order to
meet market conditions, we have been, and expect to continue leasing less than
the entire premises of some of our R&D properties to a single tenant from time
to time. Leasing our R&D properties, which generally have been built for single
tenant occupancy, to multiple tenants can increase our leasing costs and
operating expenses and reduce the profitability of our leasing activities.
If we are unable to lease a significant portion of any vacant space or space
subject to expiring leases; if we experience significant tenant defaults as a
result of the current economic downturn; if we are not able to lease space at or
above current market rates; if we restructure existing leases and lower existing
rents in order to retain tenants for an extended term; or if we increase our
lease costs and operating expenses substantially to accommodate multiple tenants
in our R&D properties, our results of operations and cash flows will be affected
adversely. Furthermore, in this event it is probable that our board of directors
will reduce the quarterly dividend on the common stock and the outstanding O.P.
units. Our operating results and ability to pay dividends at current levels
remain subject to a number of material risks, as indicated under the caption
"Forward-Looking Information" above and in the section entitled "Risk Factors"
in our most recent Annual Report on Form 10-K.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We prepare the condensed 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 condensed consolidated
financial statements, disclosure of contingent assets and liabilities and
related footnotes. Accounting and disclosure decisions with respect to material
transactions that are subject to significant management judgments or estimates
include impairment of long lived assets, deferred rent reserves, and allocation
of purchase price relating to property acquisitions and the related depreciable
lives assigned. Actual results may differ from these estimates under different
assumptions or conditions.
- 14 -
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
condensed consolidated financial statements, and potentially result in
materially different results under different conditions and assumptions. We
believe that the following best describe our critical accounting policies:
BUSINESS COMBINATIONS. Statement of Financial Accounting Standards ("SFAS") No.
141, "Business Combinations" ("SFAS 141"), was effective July 1, 2001. We
account for acquisitions of properties prior to January 1, 2009 in accordance
with SFAS 141. For acquisitions consummated after January 1, 2009, we will
follow SFAS 141R, "Business Combinations". The fair value of the real estate
acquired is allocated to 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, acquired
in-place leases and the value of tenant relationships, based in each case on
their fair values. The determination of the tangible and intangible assets'
useful lives are guided by a combination of SFAS 141R and management's
estimates. SFAS 141R requires that acquisition-related costs and restructuring
costs be recognized separately from the business combination and expensed as
incurred.
The capitalized above-market lease values and the capitalized below-market lease
values are amortized as an adjustment to rental income over the initial lease
term while amortization of in-place lease value intangible asset is included in
depreciation and amortization of real estate in the expense section of our
condensed 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 SFAS No. 144, "Accounting for
the Impairment and Disposal of Long-Lived Assets" ("SFAS 144"). We evaluate the
recoverability of our investments in real estate assets to be held and used each
quarter and record an impairment charge when there is an indicator of impairment
and the undiscounted projected cash flows are less than the carrying amount for
a particular property. 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 the our views of market and economic conditions, which
are subject to varying market factors, such as the vacancy rates, future rental
rates, lease periods, deferred maintenance and operating costs for R&D
facilities in the Silicon Valley area and related submarkets. Therefore, it is
reasonably possible that a change in estimate resulting from judgments as to
future events could occur which would affect the recorded amounts of the
property.
ALLOWANCE FOR DOUBTFUL ACCOUNTS AND DEFERRED RENT. We must estimate the
uncollectibility of our accounts receivable based on the evaluation of our
tenants' financial position, analyses of accounts receivable and current
economic trends. We also make estimates for reserves against our deferred rent
receivable for existing tenants with the potential of early termination,
bankruptcy or ceasing operations. We charge or credit rental income for
increases or decreases to our deferred rent reserves. Our estimates are based on
our review of tenants' payment histories, the remaining lease term, whether or
not the tenant is currently occupying our building, publicly available financial
information and such additional information about their financial condition as
tenants provide to us. The information available to us might lead us to
overstate or understate these reserve amounts. The use of different estimates or
assumptions could produce different results. Moreover, actual future collections
of accounts receivable or reductions in future reported rental income due to
tenant bankruptcies or other business failures could differ materially from our
estimates.
CONSOLIDATED JOINT VENTURES. We, through an operating partnership, own three
properties that are in joint ventures of which we have controlling interests. We
manage and operate all three properties. We recognize these properties and 100%
of their operating results in our condensed consolidated financial statements,
with appropriate allocation to noncontrolling interests, because we have
operational and financial control of the investments. We make judgments and
assumptions about the estimated monthly payments made to our noncontrolling
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 evaluate all joint venture
arrangements for consolidation. The percentage interest in the joint venture,
evaluation of control and whether a variable interest entity ("VIE") exists are
all considered in determining if the arrangement qualifies for consolidation in
accordance with FASB Interpretation No. 46R, "Consolidation of Variable Interest
Entities". We, through an operating partnership, have a 50% non-controlling
limited partnership interest in one unconsolidated joint venture. This
investment is not consolidated because we do not exercise significant control
over major operating and financial decisions. We account for this joint venture
interest using the equity method of accounting.
FAIR VALUE OF FINANCIAL INSTRUMENTS. On January 1, 2008, we adopted the
provisions of SFAS 157, "Fair Value Measurements" ("SFAS 157") for our financial
assets and liabilities measured at fair value on a recurring basis. SFAS 157
defines fair value as the price that would be received to sell an asset or paid
to transfer a liability in an orderly transaction between market participants.
SFAS 157 also specifies a three-level hierarchy of valuation techniques based
upon whether the inputs reflect assumptions other market participants would use
based upon market data obtained from independent sources (observable inputs) or
reflect its own assumptions of market participant valuation (unobservable
inputs) and requires the use of observable inputs if such data is available
without undue cost and effort. At March 31, 2009, we had approximately $4.1
million of financial assets classified as Level 1 and thus measured at fair
value using quoted market prices for identical instruments in active markets
from an independent third party source.
- 15 -
The only financial asset or liability recorded at fair value in our consolidated
financial statements is the restricted investment in marketable securities. We
determined the fair value for the marketable securities using quoted prices in
active markets for identical securities.
Our financial instruments include cash and cash equivalents, accounts
receivable, accounts payable, and debt. Considerable judgment is required in
interpreting market data to develop estimates of fair value. Our estimates of
fair value are not necessarily indicative of the amounts that we could realize
in a current market exchange. The use of different market assumptions and/or
estimation methodologies may have a material effect on the estimated fair value
amounts. Cash and cash equivalents, accounts receivable, and accounts payable
are carried at amounts that approximate their fair values due to their
short-term maturities. The carrying amounts of our variable rate debt
approximate fair value since the interest rates on these instruments are
equivalent to rates currently offered to us. For fixed rate debt, we estimate
fair value by using discounted cash flow analyses based on borrowing rates for
similar kinds of borrowing arrangements.
STOCK-BASED COMPENSATION. SFAS 123R requires that the cost of all employee,
director and consultant stock options, as well as other equity-based
compensation arrangements, be reflected in the financial statements based on the
estimated fair value of the awards. SFAS 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.
Compensation cost under SFAS 123R may differ due to different assumptions and
treatment of forfeitures.
REVENUE RECOGNITION. Rental revenue is recognized on the straight-line method of
accounting required by GAAP under which contractual rent payment increases are
recognized evenly over the lease term, regardless of when the rent payments are
received by us. The difference between recognized rental income and rental cash
receipts is recorded as "Deferred rent receivable" on the condensed 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, and other appropriate measures. Our judgments
and estimations about tenants' capacity to continue to meet their lease
obligations will affect the rental revenue recognized. Material differences may
result in the amount and timing of our rental revenue for any period if we made
different judgments or estimations.
SFAS No. 66, "Accounting for Sales of Real Estate" ("SFAS 66"), establishes
accounting standards for recognizing profit or loss on sales of real estate. The
gain on the sale is only recognized proportionately as the seller receives
payments from the purchaser. Interest income is recognized on an accrual basis,
when appropriate.
Lease termination fees are recognized as other income when there is a signed
termination letter agreement, all of the conditions of the agreement have been
met, and when the tenant no longer has the right to occupy the property. These
fees are paid by tenants who want to terminate their lease obligations before
the end of the contractual term of the lease. We cannot predict or forecast the
timing or amounts of future lease termination fees.
We recognize income from rent, tenant reimbursements and lease termination fees
and other income once all of the following criteria are met in accordance with
SEC Staff Accounting Bulletin 104:
- the agreement has been fully executed and delivered;
- services have been rendered;
- the amount is fixed and determinable; and
- collectibility is reasonably assured.
With 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. The Audit Committee has reviewed the critical accounting
policies we identified.
- 16 -
RESULTS OF OPERATIONS
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2009 WITH THE THREE MONTHS ENDED
MARCH 31, 2008
As of March 31, 2009 and 2008, through our controlling interests in the
operating partnerships, we owned 111 properties totaling approximately 8.0
million rentable square feet. Included in the 8.0 million rentable square feet
are approximately 854,000 rentable square feet (or 16 buildings) that we are
seeking to have rezoned for residential development.
Rental revenue from real estate for the three months ended March 31, 2009
compared with the same three-month period in 2008 was as follows:
Three Months Ended March 31,
--------------------------------
% Change by
2009 2008 $ Change Property Group
------------- -------------- --------------- ---------------
(dollars in thousands)
Same Property (1) $20,327 $18,887 $1,440 7.6%
2008 Acquisitions 328 109 219 200.0%
------------- -------------- ---------------
Total $20,655 $18,996 $1,659 8.7%
============= ============== ===============
(1) "Same Property" is defined as properties owned by us prior to 2008 that we
still owned as of March 31, 2009.
RENTAL REVENUE FROM REAL ESTATE OPERATIONS
For the quarter ended March 31, 2009, rental revenue from real estate increased
by approximately $1.7 million, or 8.7%, from $19.0 million for the three months
ended March 31, 2008 to $20.7 million for the three months ended March 31, 2009.
The increase in rental revenue resulted primarily from new leases since March
31, 2008, renewing existing leases at slightly higher rental rates and the
absence of significant lease terminations during the quarter ended March 31,
2009. Our occupancy rate at March 31, 2009 was approximately 65.3%, compared
with 64.4% at March 31, 2008.
LEASE TERMINATION INCOME
We had no lease termination fee income in the first quarter of 2009. Lease
termination fee income for the three months ended March 31, 2008 was
approximately $1.9 million that was paid by a tenant who terminated its lease
obligations before the end of the lease term. We do not consider that
transaction to be a recurring item.
OTHER INCOME
Other income of approximately $0.32 million for the three months ended March 31,
2009 included approximately $0.25 million from management fees and $0.07 million
from miscellaneous income. Other income of approximately $0.23 million for the
three months ended March 31, 2008 was from management fees.
EXPENSES FROM OPERATIONS
Property operating expenses and real estate taxes during the first quarter of
2009 increased by approximately $1.1 million, or 21.8%, from $4.9 million to
$6.0 million for the three months ended March 31, 2008 and 2009, respectively.
The increase was primarily attributable to higher real estate tax expense and
property tax refunds in 2008 that did not recur in 2009. Tenant reimbursements
increased by approximately $1.2 million, or 34.0%, from $3.6 million for the
three months ended March 31, 2008 to $4.8 million for the three months ended
March 31, 2009 due to reimbursements of recurring operating expenses, including
real estate taxes. The level of tenant reimbursements is affected by vacancies
because certain recurring expenses such as property insurance, real estate
taxes, and other fixed operating expenses are not recoverable from vacant
properties.
General and administrative expenses decreased by approximately ($0.14) million,
or (21.1%), from $0.67 million to $0.53 million for the three months ended March
31, 2008 and 2009, respectively. During the three months ended March 31, 2009,
we adjusted stock compensation expense relating to consultant share awards and
performance share awards in the amount of approximately ($0.07) million which
did not occur during the three months ended March 31, 2008.
Real estate depreciation and amortization expense increased by approximately
$0.3 million, or 5.7%, from $5.6 million to $5.9 million for the three months
ended March 31, 2008 and 2009, respectively. The increase resulted from
additional tenant improvements since March 31, 2008.
EQUITY IN EARNINGS FROM UNCONSOLIDATED JOINT VENTURE
As of March 31, 2009, we held investments in one R&D building totaling
approximately 155,500 rentable square feet through an unconsolidated joint
venture, TBI-MWP, in which we acquired a 50% interest in January 2003 from the
Berg Group under the Berg Land Holdings Option Agreement. We have a
non-controlling limited partnership interest in this joint venture, which we
account for using the equity method of accounting. For the three months ended
March 31, 2009, we recorded equity in earnings from the unconsolidated joint
venture of approximately $0.09 million compared with equity in earnings of $0.38
million for the same period in 2008. The decrease was attributable to the sale
of two R&D properties subsequent to March 31, 2008. The occupancy rate for the
properties owned by this joint venture at March 31, 2009 and 2008 was 100%.
- 17 -
INTEREST AND DIVIDEND INCOME
Interest and dividend income decreased by approximately ($0.6) million, or
(110.6%), from $0.6 million to ($0.06) million for the three months ended March
31, 2008 and 2009, respectively. The decrease was primarily due to lower cash
reserve on hand in 2009 and the reversal of an accrual from 2008.
INTEREST EXPENSE
Interest expense was approximately $4.8 million and $4.9 million for the three
months ended March 31, 2009 and 2008, respectively. Interest expense (related
parties) decreased by approximately ($0.2) million, or (58.5%), from $0.4
million for the three months ended March 31, 2008 to $0.2 million for the three
months ended March 31, 2009 due to higher related party debt incurred in the
quarter ended March 31, 2008. Total debt outstanding, including debt due related
parties, decreased by approximately ($21.2) million, or (5.8%), from $363.2
million as of March 31, 2008 to $342.0 million as of March 31, 2009.
NET INCOME ATTRIBUTABLE TO COMMON STOCKHOLDERS AND NET INCOME ATTRIBUTABLE TO
NONCONTROLLING INTERESTS
Net income to common stockholders decreased by approximately ($0.5) million, or
(23.9%), from $1.9 million for the three months ended March 31, 2008 to $1.4
million for the same period in 2009. The noncontrolling interests portion of
income decreased by approximately ($3.0) million, or (42.0%), from $7.2 million
for the three months ended March 31, 2008 to $4.2 million for the three months
ended March 31, 2009. The decrease in the quarter's net income for both common
stockholders and noncontrolling interests was primarily due to an unrealized
loss from investment, higher operating expenses, lower equity in earnings of
unconsolidated joint venture and lower interest and dividend income.
The amount of noncontrolling interests in net income has been calculated by
multiplying the net income of the operating partnerships (on a stand-alone
basis) by the respective noncontrolling interest ownership percentage.
Noncontrolling interests represent the ownership interest of all limited
partners in the operating partnerships taken as a whole, which was approximately
79% and 81% as of March 31, 2009 and 2008, respectively.
CHANGES IN FINANCIAL CONDITION
Total stockholders' equity, net, increased by approximately $12.1 million from
December 31, 2008. We obtained additional capital from the issuance of 2,000,000
shares of our common stock for the exchange of O.P. units, which increased
additional paid-in capital by approximately $15.0 million. Stockholders' equity
was reduced during the first quarter of 2009 by distributions in excess of
accumulated earnings of approximately ($2.9) million.
LIQUIDITY AND CAPITAL RESOURCES
We expect an increase in operating cash flows from our operating property
portfolio in 2009 compared with 2008 primarily from new leases and payments from
M&M Real Estate Control & Restructuring relating to the Ciena lease termination
in 2007 (see Note 3 above). If we are unable to lease a significant portion of
the approximately 140,000 rentable square feet scheduled to expire during the
remainder of 2009 or an equivalent amount of our currently available space of
approximately 2.8 million rentable square feet, however, our operating cash
flows after 2009 may be affected adversely. With the expectation of higher
rental revenues for the remainder of 2009, we expect our properties' operating
income to show a year-over-year increase compared to 2008 driven by new leases.
We are also subject to risks of decreased occupancy through tenant defaults and
bankruptcies and potential reduction in rental rates upon renewal of properties,
however, which would result in reduced cash flow from operations instead. Cash
flows from lease terminations are non-recurring and to maintain or increase cash
flows in the future we must re-lease our vacant properties.
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, as well as borrowings
under our line of credit with Heritage Bank of Commerce ("HBC"). We expect these
sources of liquidity to be adequate to meet projected distributions to
stockholders and other presently anticipated liquidity requirements in 2009. We
expect to meet our long-term liquidity requirements for the funding of property
development, property acquisitions and other material non-recurring capital
improvements through cash and investments, long-term secured and unsecured
indebtedness, and potentially, the issuance of additional equity securities by
us.
As of March 31, 2009, restricted cash totaled approximately $22.0 million. The
entire amount represents cash held by M&M Real Estate Control & Restructuring,
LLC, a consolidated VIE involving the Ciena lease termination in 2007. We do not
possess or control these funds or have any rights to receive them except as
provided in the applicable agreements and any other additional agreements with
the VIE. We include this in our restricted cash under the principles of FIN 46R.
The restricted cash is not available for distribution to stockholders.
DISTRIBUTIONS
On April 9, 2009, we paid dividends of $0.20 per share of common stock to all
common stockholders of record as of March 31, 2009. On the same date, the
operating partnerships paid a distribution of $0.20 per O.P. unit to all holders
of O.P. units, with the exception of the Berg Group. The aggregate dividends and
distributions amounted to approximately $21.1 million. On April 9, 2009, we
issued a short-term note for approximately $12.4 million to the Berg Group in
connection with the first quarter 2009 dividend distributions. This note had an
interest rate of LIBOR plus 2% and was fully repaid on April 21, 2009.
- 18 -
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.
DEBT
We currently have a $17.5 million unsecured revolving line of credit with HBC
established in April 2008. The revolving line of credit carries a variable
interest rate based on the one-month LIBOR plus 1.75% per annum and matures June
15, 2009. We expect to renew the HBC line of credit in June 2009 when it
matures.
On January 8, 2009, we issued a short-term note for approximately $10.8 million
to the Berg Group in connection with the fourth quarter 2008 dividend
distributions. The note interest rate was LIBOR plus 2% and was fully repaid in
February 2009.
At March 31, 2009, we had total indebtedness of approximately $342.0 million,
including $327.9 million of fixed rate mortgage debt, $5.5 million under the HBC
line of credit and $8.6 million debt under the Berg Group mortgage note (related
parties), as detailed in the table below. The Northwestern, Allianz, Hartford
and HBC loans contain certain financial loan and reporting covenants as defined
in the loan agreements. As of March 31, 2009, we were in compliance with these
loan covenants.
CONTRACTUAL OBLIGATIONS
The following table identifies the contractual obligations with respect to the
maturities and scheduled principal repayments of our secured debt, Note, Credit
Facility and scheduled interest payments of our fixed-rate and variable-rate
debt at March 31, 2009 and provides information about our operating lease
obligations that will impact our liquidity and cash flow in future periods.
------------- ------------- ------------- -------------- ------------- ------------- ------------
2009 2010 2011 2012 2013 Thereafter Total
------------- ------------- ------------- -------------- ------------- ------------- ------------
Principal payments(1) $14,950 $13,327 $14,109 $14,935 $81,269 $203,438 $342,028
Interest payments-fixed rate debt(2) 14,326 18,433 17,652 16,826 12,820 62,288 142,345
Interest payments-variable rate debt(3) 25 - - - - - 25
Operating lease obligations(4) 90 30 - - - - 120
------------- ------------- ------------- -------------- ------------- ------------- ------------
Total $29,391 $31,790 $31,761 $31,761 $94,089 $265,726 $484,518
============= ============= ============= ============== ============= ============= ============
(1) As of March 31, 2009, 98.4% of our debt was contractually fixed and 1.6% of
our debt bore interest at variable rates. Our debt obligations are set
forth in detail in the table below.
(2) The information in the table above reflects our projected interest rate
obligations for the fixed-rate payments based on the contractual interest
rates, interest payment dates and scheduled maturity dates.
(3) The information in the table above reflects our projected interest rate
obligations for the variable-rate payments based on LIBOR plus a spread
that ranged from 1.75% to 2.00% at March 31, 2009, the scheduled interest
payment dates and maturity dates.
(4) Our operating lease obligations relate to a lease of our corporate office
facility from a related party.
- 19 -
The following table sets forth information regarding debt outstanding as of
March 31, 2009:
Maturity Interest
Debt Description Collateral Properties Balance Date Rate
----------------------------------------------- --------------------------------------- ------------------ ------------- -----------
(dollars in thousands)
Line of Credit:
Heritage Bank of Commerce Not Applicable $ 5,456 June 2009 (1)
------------------
Mortgage Note Payable (related parties) (2) : 5300 & 5350 Hellyer Avenue, San Jose, CA 8,639 June 2013 7.65%
------------------
Mortgage Notes Payable (2):
Hartford Life Insurance Company 5981 Optical Court, San Jose, CA 113,774 October 2018 6.21%
Hartford Life and Accident Insurance Company 5500 Hellyer Avenue, San Jose, CA
Hartford Life and Annuity Insurance Company 5550 Hellyer Avenue, San Jose, CA
(collectively known as the "Hartford Loan") (3) 4050 Starboard Drive, Fremont, CA
45738 Northport Loop, Fremont, CA
233 South Hillview Drive, Milpitas, CA
10300 Bubb Road, Cupertino, CA
1230 E. Arques, Sunnyvale, CA
1250-1280 E. Arques, Sunnyvale, CA
1212 Bordeaux Lane, Sunnyvale, CA
2904 Orchard Parkway, San Jose, CA
3236 Scott Blvd, Santa Clara, CA
6311 San Ignacio Avenue, San Jose, CA
6321-6325 San Ignacio Avenue, San Jose, CA
6331 San Ignacio Avenue, San Jose, CA
6341-6351 San Ignacio Avenue, San Jose, CA
3540-3580 Bassett Street, Santa Clara, CA
Northwestern Mutual Life Insurance Company (4) 1750 Automation Parkway, San Jose, CA 80,347 January 2013 5.64%
1756 Automation Parkway, San Jose, CA
1762 Automation Parkway, San Jose, CA
6320 San Ignacio Avenue, San Jose, CA
6540-6541 Via Del Oro, San Jose, CA
6385-6387 San Ignacio Avenue, San Jose, CA
20605-20705 Valley Green Drive, Cupertino, CA
2001 Walsh Avenue, Santa Clara, CA
2220 Central Expressway, Santa Clara, CA
2300 Central Expressway, Santa Clara, CA
2330 Central Expressway, Santa Clara, CA
Allianz Life Ins. Co. (Allianz Loan I) (5) 5900 Optical Court, San Jose, CA 22,797 August 2025 5.56%
Allianz Life Ins. Co. (Allianz Loan II) (5) 5325-5345 Hellyer Avenue, San Jose, CA 111,015 August 2025 5.22%
1768 Automation Parkway, San Jose, CA
2880 Scott Boulevard, Santa Clara, CA
2890 Scott Boulevard, Santa Clara, CA
2800 Scott Boulevard, Santa Clara, CA
10450-10460 Bubb Road, Cupertino, CA
6800-6810 Santa Teresa Blvd., San Jose, CA
6850 Santa Teresa Blvd., San Jose, CA
4750 Patrick Henry Drive, Santa Clara, CA
------------------
327,933
------------------
TOTAL $342,028
==================
(1) Loan carries a variable interest rate equal to LIBOR plus 1.75%. The
interest rate at March 31, 2009 was 2.21%. The Heritage Bank of Commerce
line of credit contains certain financial loan and reporting covenants as
defined in the loan agreements, including minimum tangible net worth and
debt service coverage ratio. As of March 31, 2009, we were in compliance
with these loan covenants.
(2) Mortgage notes payable generally require monthly installments of principal
and interest ranging from approximately $96 to $840 over various terms
extending through the year 2025. The weighted average interest rate of
mortgage notes payable was 5.74% at March 31, 2009.
(3) The Hartford loan is payable in monthly installments of approximately $838,
which includes principal (based upon a 20-year amortization) and interest.
Costs and fees incurred with obtaining this loan aggregated approximately
$1,058, which were deferred and amortized over the loan period. The
Hartford loan contains certain customary covenants as defined in the loan
agreement. As of March 31, 2009, we were in compliance with these loan
covenants.
(4) The Northwestern loan is payable in monthly installments of approximately
$696, which includes principal (based upon a 20-year amortization) and
interest. Costs and fees incurred with obtaining this loan aggregated
approximately $675, which were deferred and amortized over the loan period.
The Northwestern loan contains certain customary covenants as defined in
the loan agreement. As of March 31, 2009, we were in compliance with these
loan covenants.
(5) The Allianz loans are payable in monthly aggregate installments of
approximately $1,017, which includes principal (based upon a 20-year
amortization) and interest. Costs and fees incurred with obtaining these
loans aggregated approximately $1,089, which were deferred and amortized
over the loan periods. The Allianz loans contain certain customary
covenants as defined in the loan agreements. As of March 31, 2009, we were
in compliance with these loan covenants.
- 20 -
At March 31, 2009, 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 $6.40 per share on March 31, 2009) on a fully diluted basis, including the
conversion of all O.P. units into common stock, was approximately 33.2%. On
March 31, 2009, the last trading day in the quarter, total market capitalization
was approximately $1.03 billion.
At March 31, 2009, the outstanding balance remaining under certain notes that we
owed to the operating partnerships was approximately $2.2 million. The due date
of these notes has been extended to September 30, 2010. The principal amount of
these notes, along with the interest expense, which is interest income to the
operating partnerships, is eliminated in consolidation and is not included in
the corresponding line items within the condensed 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 noncontrolling interests as reported on the condensed
consolidated statement of operations, thereby reducing our net income by this
same amount. At present, our only means for repayment of this debt is through
distributions that we receive from the operating partnerships that are in excess
of the amount of dividends to be paid to our stockholders or by raising
additional equity capital.
HISTORICAL CASH FLOWS
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2009 WITH THE THREE MONTHS ENDED
MARCH 31, 2008
Net cash provided by operating activities for the three months ended March 31,
2009 was approximately $28.4 million compared with $18.8 million for the same
period in 2008. Cash flow increases came primarily from payment by our VIE of
prepaid rent for one year with respect to the Ciena lease termination in 2007.
See Note 3 above for further discussion of this transaction.
Net cash provided by (used in) investing activities was approximately $3.6
million and ($20.2) million for the three months ended March 31, 2009 and 2008,
respectively. Cash provided by investing activities during the three months
ended March 31, 2009 related principally to the reimbursement of investment in
marketable securities from our VIE through restricted cash.
Net cash used in investing activities during the three months ended March 31,
2008 related principally to the acquisition of one R&D property at 5981 Optical
Court in San Jose, California and one R&D property at 2904 Orchard Parkway in
San Jose, California for approximately $35.8 million. The acquisition at 2904
Orchard Parkway was completed as a tax-deferred exchange transaction involving
our former R&D property at 1170 Morse Avenue in Sunnyvale, California. The
remaining excess restricted cash of approximately $7.7 million was transferred
to our general cash account. Capital expenditures for real estate improvements
were approximately $0.2 million.
Net cash used in financing activities was approximately $32.0 million for the
three months ended March 31, 2009 compared with approximately $0.6 million for
the three months ended March 31, 2008. During the first three months of 2009, we
financed approximately $10.8 million in short-term debt, paid approximately
$21.5 million towards outstanding debt, paid approximately $17.3 million to
noncontrolling interests and paid approximately $4.0 million of dividends to
common stockholders. During the same period in 2008, we financed approximately
$22.3 million in short-term debt, paid approximately $5.9 million towards
outstanding debt, paid approximately $13.9 million to noncontrolling interests
and paid approximately $3.1 million of dividends to common stockholders.
FUNDS FROM OPERATIONS ("FFO")
FFO is a non-GAAP financial measurement used by real estate investment trusts to
measure and compare operating performance. As defined by NAREIT, FFO represents
net income (loss) before noncontrolling interest of O.P. unit holders, computed
in accordance with GAAP, plus non-recurring events other than "extraordinary
items" under GAAP, excluding gains and losses from sales of depreciable
operating properties, plus real estate related depreciation and amortization,
excluding amortization of deferred financing costs and depreciation of non-real
estate assets, and after adjustments for unconsolidated partnerships and joint
ventures. FFO does include impairment losses for properties held for sale and
held for use. Management considers FFO to be an appropriate supplemental measure
of 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 with other REITs because FFO is generally recognized
as the industry standard for reporting the operations of REITs. In addition to
the disclosure of operating earnings per share, we will continue to use FFO as a
measure of our performance. FFO should neither be considered as an alternative
for net income as a measure of profitability nor is it comparable to cash flows
provided by operating activities determined in accordance with GAAP, nor is FFO
necessarily indicative of funds available to meet our cash needs, including the
need to make cash distributions to satisfy REIT requirements. For example, FFO
is not adjusted for payments of debt principal required under our debt service
obligations.
Our definition of FFO also assumes conversion at the beginning of the period of
all convertible securities, including noncontrolling interests represented by
O.P. Units that might be exchanged for common stock. FFO does not represent the
amount available for management's discretionary use; as such funds may be needed
for capital replacement or expansion, debt service obligations or other
commitments and uncertainties. Furthermore, FFO is not comparable to similarly
entitled items reported by other REITs that do not define FFO exactly as we do.
- 21 -
FFO for the three months ended March 31, 2009 and 2008, as reconciled to net
income to common stockholders, are summarized in the following table:
Three Months Ended March 31,
-----------------------------------------
2009 2008
------------------ ------------------
(dollars in thousands)
Net income $ 5,634 $ 9,121
Add:
Depreciation and amortization of real estate(1) 6,475 6,213
Less:
Noncontrolling interests in joint ventures (39) (111)
------------------ ------------------
FFO $12,070 $15,223
================== ==================
(1) Includes our portion of depreciation and amortization of real estate and
leasing commissions from our unconsolidated joint venture totaling
approximately $60 and $189 for the three months ended March 31, 2009 and
2008, respectively. Also includes our amortization of leasing commissions
of approximately $472 and $401 for the three months ended March 31, 2009
and 2008, respectively. Amortization of leasing commissions is included in
the property operating, maintenance and real estate taxes line item in the
condensed consolidated statements of operations.
The decrease in FFO year-over-year was primarily due to a recording of an
unrealized loss from investment in 2009.
DISTRIBUTION POLICY
Our board of directors determines the amount and timing of distributions to our
stockholders. The board of directors will consider many factors prior to making
any distributions, including the following:
- the amount of cash available for distribution;
- our ability to refinance maturing debt obligations;
- our financial condition;
- whether to reinvest funds rather than to distribute such funds;
- our committed and projected capital expenditures;
- the amount of cash required for new property acquisitions, including
acquisitions under existing agreements with the Berg Group;
- the amount of our annual debt service requirements;
- prospects of tenant renewals and re-leases of properties subject to
expiring leases;
- cash required for re-leasing activities;
- the annual distribution requirements under the REIT provisions of the
federal income tax laws; and
- such other factors as the board of directors deems relevant.
We cannot assure you that we will be able to meet or maintain our cash
distribution objectives.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not generally hold market risk sensitive instruments for trading purposes.
We use fixed and variable rate debt to finance our operations. Our exposure to
market risk for changes in interest rates relates primarily to our current
variable rate debt and future debt obligations. We are vulnerable to significant
fluctuations of interest rates on our floating rate debt and pricing on our
future debt. We manage our market risk by monitoring interest rates where we try
to recognize the unpredictability of the financial markets and seek to reduce
potentially adverse effect on the results of our operations. This takes frequent
evaluation of available lending rates and examination of opportunities to reduce
interest expense through new sources of debt financing. Several factors
affecting the interest rate risk include governmental monetary and tax policies,
domestic and international economics and other factors that are beyond our
control. The following table provides information about the principal cash
flows, weighted average interest rates, and expected maturity dates for debt
outstanding as of March 31, 2009. The current terms of this debt are described
in Item 2, "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Liquidity and Capital Resources." For fixed rate debt,
we estimate fair value by using discounted cash flow analyses based on borrowing
rates for similar kinds of borrowing arrangements.
For fixed rate debt, the table presents the assumption that the outstanding
principal balance at March 31, 2009 will be paid according to scheduled
principal payments and that we will not prepay any of the outstanding principal
balance.
For variable rate debt, the table presents the assumption that the outstanding
principal balance at March 31, 2009 will be paid upon maturity.
Nine
Months Year Ending December 31,
Remaining -----------------------------------------------
2009 2010 2011 2012 2013 Thereafter Total Fair Value
----------------------------------------------------------------------------------------------
(dollars in thousands)
Fixed Rate Debt:
Secured notes payable $9,494 $13,327 $14,109 $14,935 $81,269 $203,438 $336,572 $488,143
Weighted average interest rate 5.74% 5.74% 5.74% 5.74% 5.74% 5.74%
Variable Rate Debt:
Unsecured debt $5,456 - - - - - $5,456 $5,456
Weighted average interest rate 2.21%
The primary market risks we face are interest rate fluctuations. As a result, we
pay lower rates of interest in periods of decreasing interest rates and higher
rates of interest in periods of increasing interest rates. We had no interest
rate caps or interest rate swap contracts at March 31, 2009. The only variable
debt that we had as of March 31, 2009 was approximately $5.5 million owed to the
Heritage Bank of Commerce. This represented approximately 1.6% of the total
$342.0 million of outstanding debt as of March 31, 2009. All of our debt is
denominated in United States dollars.
The following discussion of market risk is based solely on a possible
hypothetical change in future market conditions related to our variable-rate
debt. It includes "forward-looking statements," as previously defined, regarding
market risk, but we are not forecasting the occurrence of these market changes.
Based on the amount of variable debt outstanding as of March 31, 2009, a 1%
increase or decrease in interest rates on our approximately $5.5 million of
floating rate debt would decrease or increase, respectively, earnings and cash
flows for the three-month period then ended by approximately $14,000, as a
result of the increased or decreased interest expense associated with the change
in rate, and would not have an impact on the fair value of the floating rate
debt. This amount is determined by considering the impact of hypothetical
interest rates on our borrowing cost. Due to the uncertainty of fluctuations in
interest rates and the specific actions that might be taken by us to mitigate
such fluctuations and their possible effects, the foregoing sensitivity analysis
assumes no changes to our financial structure.
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ITEM 4. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES
We strive to maintain disclosure controls and procedures that are designed to
ensure that information required to be disclosed in our Exchange Act reports is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms, and that such information is accumulated and
communicated to our management, including our chief executive officer and chief
financial officer, as appropriate, to allow for timely decisions regarding
required disclosure. In designing and evaluating the disclosure controls and
procedures, management recognizes that any controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance of
achieving the desired control objectives and management necessarily is required
to apply its judgment in evaluating the cost-benefit relationship of possible
controls and procedures.
As required by SEC Rule 13a-15(b) we conducted an evaluation, under the
supervision and with the participation of our management, including our Chief
Executive Officer, President and Vice President of Finance, of the effectiveness
of the design and operation of our disclosure controls and procedures. Based
upon that evaluation, the Chief Executive Officer, President and Vice President
of Finance concluded that our disclosure controls and procedures (as defined in
Rule 13a-15(e) or Rule 15d-15(e)) were effective as of March 31, 2009.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There was no material change in our internal control over financial reporting
during the last fiscal quarter that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The discussion of legal proceedings is incorporated herein by reference from
Part I "Item 1. - Notes to Condensed Consolidated Financial Statements - Note 9
- Commitments and Contingencies."
ITEM 1A. RISK FACTORS
While we attempt to identify, manage and mitigate risks and uncertainties
associated with our business to the extent practical under the circumstances,
some level of risk and uncertainty will always be present. In addition to the
other information contained in this report and the risk factor listed below, you
should carefully review the factors discussed under Item 1A of our annual report
on Form 10-K for the year ended December 31, 2008 which describes some of the
risks and uncertainties associated with our business. These risks and
uncertainties have the potential to materially affect our business, financial
condition, results of operations, cash flows, and future prospects. Additional
risks and uncertainties not presently known to us or that we currently deem
immaterial also may impair our business operations.
ITEM 6. Exhibits
31.1 Section 1350 Certificate of CEO
31.2 Section 1350 Certificate of President & COO
31.3 Section 1350 Certificate of Principal Financial Officer
32 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
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================================================================================
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.
Mission West Properties, Inc.
(Registrant)
Date: May 8, 2009 By: /s/ Carl E. Berg
-------------------------------------
Carl E. Berg
Chief Executive Officer
Date: May 8, 2009 By: /s/ Wayne N. Pham
-------------------------------------
Wayne N. Pham
Vice President of Finance
(Principal Accounting Officer and
Duly Authorized Officer)
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