-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, D+Va15wAG+ylyGfzfgWUqr3xh62tBFItAuKyfw5r+dyFmQUP1E/ANwP2bhwJZLi6 IdyiHb4oQ4QRdu9k4S1/aQ== 0001067419-07-000027.txt : 20071108 0001067419-07-000027.hdr.sgml : 20071108 20071108113818 ACCESSION NUMBER: 0001067419-07-000027 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20070930 FILED AS OF DATE: 20071108 DATE AS OF CHANGE: 20071108 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MISSION WEST PROPERTIES INC CENTRAL INDEX KEY: 0001067419 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 952635431 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-25235 FILM NUMBER: 071224134 BUSINESS ADDRESS: STREET 1: 10050 BANDLEY DRIVE CITY: CUPERTINO STATE: CA ZIP: 95014 BUSINESS PHONE: 4087250700 MAIL ADDRESS: STREET 1: 10050 BANDLEY DR CITY: CUPERTINO STATE: CA ZIP: 95014 10-Q 1 mswq310q2007.txt MISSION WEST PROPERTIES 3RD QTR 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------- Form 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2007 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 Identification incorporation or organization) Number) 10050 Bandley Drive Cupertino, California 95014-2188 (Address of principal executive offices) Registrant's telephone number, including area code is (408) 725-0700 ----------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. Large accelerated filer[ ] Accelerated filer[X] Non-accelerated filer[ ] Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes [ ] No [X] 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: 19,640,087 shares outstanding as of October 31, 2007 Mission West Properties, Inc. FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2007 INDEX
Page Part I Financial Information ---- Item 1. Financial Statements: Condensed Consolidated Balance Sheets as of September 30, 2007 and December 31, 2006 (unaudited).......................................................................2 Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2007 and 2006 (unaudited)...........................................3 Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2007 and 2006 (unaudited)...............................................4 Notes to Condensed Consolidated Financial Statements (unaudited)........................................5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....................................................................12 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 5. Other Information......................................................................................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) (unaudited) ---------
September 30, 2007 December 31, 2006 --------------------- ---------------------- ASSETS Real estate: Land $ 312,152 $ 272,223 Buildings and improvements 764,408 756,596 Real estate related intangible assets 6,422 19,529 --------------------- ---------------------- Total investments in properties 1,082,982 1,048,348 Less accumulated depreciation and amortization (155,619) (149,459) --------------------- ---------------------- Total investments in real estate, net 927,363 898,889 Cash and cash equivalents 37,800 33,785 Restricted cash 65,468 48,245 Deferred rent receivable, net 14,523 18,489 Investment in unconsolidated joint venture 2,835 3,468 Other assets, net 25,522 24,611 --------------------- ---------------------- Total assets $1,073,511 $1,027,487 ===================== ====================== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Mortgage notes payable $ 340,225 $ 348,101 Mortgage notes payable (related parties) 9,335 9,654 Interest payable 1,334 1,375 Security deposits 4,738 6,977 Deferred rental income 4,021 6,874 Dividends and distributions payable 16,832 16,745 Accounts payable and accrued expenses 22,906 7,601 --------------------- ---------------------- Total liabilities 399,391 397,327 --------------------- ---------------------- Commitments and contingencies (Note 10) Minority interests 534,268 501,282 --------------------- ---------------------- Stockholders' equity: Preferred stock, $.001 par value, 20,000,000 shares authorized, none issued and outstanding - - Common stock, $.001 par value, 200,000,000 shares authorized, 19,640,087 and 19,443,587 shares issued and outstanding at September 30, 2007 and December 31, 2006 20 19 Paid-in capital 152,619 149,541 Accumulated deficit (12,787) (20,682) --------------------- ---------------------- Total stockholders' equity 139,852 128,878 --------------------- ---------------------- Total liabilities and stockholders' equity $1,073,511 $1,027,487 ===================== ======================
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 September 30, Nine months ended September 30, -------------------------------------- ---------------------------------------- 2007 2006 2007 2006 ------------------ ------------------- -------------------- ------------------ Rental revenue from real estate $19,000 $22,444 $61,350 $68,281 Above market lease intangible asset amortization - (472) (4,091) (1,416) Tenant reimbursements 3,454 3,260 9,908 9,383 Lease termination fees 47,238 - 57,515 16,068 Other income, including interest 1,895 1,011 5,909 2,826 ------------------ ------------------- -------------------- ------------------- Total revenues 71,587 26,243 130,591 95,142 ------------------ ------------------- -------------------- ------------------- Expenses: Property operating, maintenance and real estate taxes 6,229 4,955 15,307 13,558 Interest 5,061 5,172 15,175 15,580 Interest (related parties) 180 188 546 569 General and administrative 982 531 2,369 1,803 Depreciation and amortization of real estate 5,532 5,513 17,084 15,993 ------------------ ------------------- -------------------- ------------------- Total expenses 17,984 16,359 50,481 47,503 ------------------ ------------------- -------------------- ------------------- Income before equity in earnings of unconsolidated joint venture and minority interests 53,603 9,884 80,110 47,639 Equity in earnings of unconsolidated joint venture 371 856 1,058 1,538 Minority interests (43,153) (8,644) (64,980) (39,997) ------------------ ------------------- -------------------- ------------------- Income from continuing operations 10,821 2,096 16,188 9,180 ------------------ ------------------- -------------------- ------------------- Discontinued operations, net of minority interests: Gain from disposal of discontinued operations 1,127 - 1,127 - (Loss)/income attributable to discontinued operations (7) 10 5 200 ------------------ ------------------- -------------------- ------------------- Income from discontinued operations 1,120 10 1,132 200 ------------------ ------------------- -------------------- ------------------- Net income to common stockholders $11,941 $2,106 $17,320 $ 9,380 ================== =================== ==================== =================== Net income to minority interests $48,550 $8,700 $70,469 $41,057 ================== =================== ==================== =================== Income per common share from continuing operations: Basic $0.55 $0.11 $0.82 $0.49 ================== =================== ==================== =================== Diluted $0.54 $0.11 $0.81 $0.48 ================== =================== ==================== =================== Income per common share from discontinued operations: Basic $0.06 - $0.06 $0.01 ================== =================== ==================== =================== Diluted $0.06 - $0.06 $0.01 ================== =================== ==================== =================== Net income per common share to common stockholders: Basic $0.61 $0.11 $0.88 $0.50 ================== =================== ==================== =================== Diluted $0.60 $0.11 $0.87 $0.49 ================== =================== ==================== =================== Weighted average shares of common stock outstanding (basic) 19,640,087 19,350,672 19,621,144 18,948,214 ================== =================== ==================== =================== Weighted average shares of common stock outstanding (diluted) 19,818,806 19,418,884 19,914,374 19,024,662 ================== =================== ==================== ===================
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) ---------
Nine months ended September 30, --------------------------------------- 2007 2006 ------------------- ------------------- Cash flows from operating activities: Net income $17,320 $9,380 Adjustments to reconcile net income to net cash provided by operating activities: Minority interests income 70,469 41,057 Minority interest distributions (41,424) (41,057) Depreciation and amortization of real estate and in-place leases 17,232 16,632 Amortization of above market lease 4,091 1,416 Gain from disposal of properties classified as discontinued operations (6,529) - Equity in earnings of unconsolidated joint venture (1,058) (1,538) Distributions from unconsolidated joint venture 1,691 1,330 Interest earned on restricted cash (722) (314) Lease termination fee related to restricted cash (38,004) (6,748) Stock-based compensation expense 472 176 Other 147 35 Changes in operating assets and liabilities: Deferred rent receivable 3,966 1,048 Other assets (911) (175) Interest payable (41) - Security deposits (2,246) (1,300) Deferred rental income (2,853) 3,185 Accounts payable and accrued expenses 8,294 5,048 ------------------- ------------------- Net cash provided by operating activities 29,894 28,175 ------------------- ------------------- Cash flows from investing activities: Improvements to real estate assets (4,621) (1,349) Proceeds from sale of real estate 15,431 - Restricted cash held in escrow (15,431) - Purchase of real estate (47,491) (15,959) Restricted cash released for purchase of real estate 43,191 13,447 Excess restricted cash 630 1,835 ------------------- ------------------- Net cash used in investing activities (8,291) (2,026) ------------------- ------------------- Cash flows from financing activities: Principal payments on mortgage notes payable (7,876) (7,481) Principal payments on mortgage notes payable (related parties) (319) (295) Refund of appeal bond - 1,551 Net proceeds from exercise of stock options - 802 Minority interest distributions in excess of earnings - (717) Dividends paid to common stockholders (9,393) (9,007) ------------------- ------------------- Net cash used in financing activities (17,588) (15,147) ------------------- ------------------- Net increase in cash and cash equivalents 4,015 11,002 Cash and cash equivalents, beginning of period 33,785 31,441 ------------------- ------------------- Cash and cash equivalents, end of period $37,800 $42,443 =================== =================== Supplemental information: Cash paid for interest $14,704 $15,944 =================== =================== Supplemental schedule of non-cash investing and financing activities: Issuance of common stock upon conversion of O.P. units $ 2,606 $ 9,977 =================== =================== Issuance of operating partnership units in connection with real estate acquisition $ 6,603 - =================== ===================
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 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 September 30, 2007, the Company owns a controlling general partnership interest of 20.08%, 21.78%, 16.26% and 12.48% in Mission West Properties, L.P., Mission West Properties, L.P. I, Mission West Properties, L.P. II and Mission West Properties, L.P. III, respectively, which represents an 18.75% 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 109 R&D properties, all of which are located in 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 and nine months ended September 30, 2007 and 2006. 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 FINANCIAL STATEMENT 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 September 30, 2007, their consolidated results of operations for the three and nine months ended September 30, 2007 and 2006, and their cash flows for the nine months ended September 30, 2007 and 2006. All significant inter-company balances have been eliminated in consolidation. The condensed consolidated financial statements as of September 30, 2007 and for the three and nine months ended September 30, 2007 and 2006 and related footnote disclosures are unaudited. The results of operations for the three and nine months ended September 30, 2007 are not necessarily indicative of the results to be expected for the entire year. The December 31, 2006 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. The Company consolidates all variable interest entities ("VIE") in which it is deemed to be the primary beneficiary in accordance with FASB Interpretation No. 46R, "Consolidation of Variable Interest Entities" ("FIN 46R"). As of September 30, 2007, 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 5 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 In December 2004, 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 September 30, 2007, the Company had one stock-based compensation plan. The Company adopted the requirements of SFAS 123R effective January 1, 2006 using the modified prospective method of transition. 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 2007, stock options to purchase 710,000 shares of common stock were granted to four employees, three non-employee directors and four consultants, which options vest monthly for 48 months from date of grant, subject to continued employment or other service to the Company. Each option grant has a term of six years from the date of grant subject to earlier termination in certain events related to termination of employment. The options were granted at an exercise price of $12.09 per share. The estimated fair value of the options granted in 2007 was $1.45 per share on the date of grant using the Black-Scholes option pricing model with the following assumptions: dividend yield of 5.3%, volatility of 18.94%, risk free rates of 4.5% and an expected life of six years. All options were granted at the fair market value at the date of grant. The following table shows the activity and detail for the 2004 Equity Incentive Plan.
Weighted Average 2004 Equity Option Price Incentive Plan Per Share --------------- ------------------ Balance, December 31, 2006 1,037,100 $10.48 Options granted 710,000 $12.09 Options exercised - Options cancelled - --------------- Balance, September 30, 2007 1,747,100 $11.13 ===============
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 $157 and $59 of expense for the three months ended September 30, 2007 and 2006, respectively, and $472 and $176 of expense for share-based compensation relating to grants of stock options for the nine months ended September 30, 2007 and 2006, respectively. As of September 30, 2007, there was approximately $651 of total unrecognized compensation cost related to unvested share-based compensation arrangements granted under the compensation plan. That cost is expected to be recognized over a weighted-average period of 3.0 years. MINORITY INTERESTS Minority 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 September 30, 2007, these interests accounted for approximately 81.25% of the ownership interests in the real estate operations of the Company on a consolidated weighted average basis. Minority interests in net income is calculated by taking the net income of the operating partnerships (on a stand-alone basis) multiplied by the respective weighted average minority interests ownership percentage. Allocation of corporate general and administrative expenses to the operating partnerships is performed based upon shares and operating partnership 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 2006 condensed consolidated financial statements in order to conform to the 2007 presentation. The following notes, which present interim disclosures as required by the SEC, highlight significant changes to the notes to the Company's December 31, 2006 audited consolidated financial statements and should be read together with the consolidated financial statements and notes thereto included in the Company's 2006 Annual Report on Form 10-K filed on March 15, 2007. - 6 - MISSION WEST PROPERTIES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (dollars in thousands, except per share and per square footage) (unaudited) 3. REAL ESTATE PROPERTY DISPOSITION On August 16, 2007, the Company disposed of one R&D property located at 45700 Northport Loop in Fremont, California consisting of approximately 39,000 rentable square feet. A total net gain of approximately $1,699 was recognized and classified as discontinued operations, net of minority interests, on the total sales price of $7,742. On September 5, 2007, the Company disposed of one R&D property located at 1170 Morse Avenue in Sunnyvale, California consisting of approximately 48,000 rentable square feet. A total net gain of approximately $4,830 was recognized and classified as discontinued operations, net of minority interests, on the total sales price of $8,301. PROPERTY ACQUISITION On September 30, 2007, the Company acquired an approximately 99,000 rentable square foot newly constructed R&D building located at 5845 Hellyer Avenue in San Jose, California from the Berg Group under the Berg Land Holdings Option Agreement. The total acquisition price for this property was approximately $10,903. The Company acquired this property by issuing 548,236 O.P. units to the Berg Group and $4,300 in cash, which was paid in the fourth quarter of 2007. The Company has allocated the purchase price to land and building based upon the estimated relative fair values of such assets. Since the property was acquired vacant, there was no purchase price allocation to lease intangible assets. 4. RESTRICTED CASH Restricted cash totaled approximately $65,468 as of September 30, 2007. Of this amount, approximately $15,493 represents proceeds received from property sales and interest income held in a separate cash account at a trust company for future use in tax-deferred exchanges. The remaining $49,975 represents cash held by the Company's 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. 5. VARIABLE INTEREST ENTITY In December 2003, the FASB issued FIN 46R, a revision to FIN 46, which was issued in January 2003. Under FIN 46R, a variable interest entity must be consolidated by a company if that company is subject to a majority of the entity's expected losses or entitled to receive a majority of the entity's expected residual returns or both. FIN 46R requires disclosures about variable interest entities that a company is not required to consolidate, but in which it has a significant variable interest. Under FIN 46R, for an entity to qualify as a VIE one or more of the following three characteristics must exist: 1. The equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support by any parties, including the equity holders. 2. The equity investors lack one or more of the following essential characteristics of a controlling financial interest: a. The direct or indirect ability to make decisions about the entity's activities through voting or similar rights. b. The obligation to absorb the expected loss of the entity. c. The right to receive the expected residual returns of the entity. 3. The equity investors have voting rights that are not proportionate to their economic interests, and the activities of the entity involve or are conducted on behalf of an investor with a disproportionately small voting interest. In March 2006, one of the Company's tenants, JDS Uniphase ("JDS"), entered into an assignment of lease agreement with an unrelated party, M&M Real Estate Control & Restructuring, LLC ("M&M"), in connection with leases for approximately 252,000 rentable square feet located in San Jose, California. M&M assumed all of JDS's remaining obligations under these leases, acquired certain personal property of JDS located on the premises and received a payment of approximately $11,147. At the same time, the Company entered into a consent for assignment of lease with both parties and a mutual release agreement with JDS, pursuant to which all of the JDS's obligations under these leases have been effectively transferred to M&M. M&M was obligated to continue to perform all of the obligations under the assumed JDS leases and had the right to sublease any or all of the 252,000 rentable square feet vacated by JDS for the remainder of the terms of the assigned leases. Under the terms of the assignment of lease agreement, the Company received monthly rent payments of approximately $733 from April 2006 through December 2006, $545 from January 2007 through August 2007 and is receiving $330 per month from September 2007 through November 2007. Based upon the provisions of FIN 46R, the Company determined that M&M is a variable interest entity. The Company further determined that it is - 7 - MISSION WEST PROPERTIES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (dollars in thousands, except per share and per square footage) (unaudited) the primary beneficiary of this variable interest entity and therefore has consolidated this entity for financial reporting purposes. Upon consolidation, the Company recognized a gross lease termination fee of approximately $11,147 in March 2006. In August 2007, one of the Company's tenants, Ciena, entered into an assignment of lease agreement with M&M, in connection with leases for approximately 445,000 rentable square feet located in San Jose, California. 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 have been 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 will receive monthly rent payments of approximately $789 from July 2007 through June 2008, $818 from July 2008 through June 2009, $849 from July 2009 through June 2010, $881 from July 2010 through June 2011 and $915 from July 2011 through December 2011. Based upon the provisions of FIN 46R, the Company determined that M&M is a variable interest entity. The Company further determined that it is the primary beneficiary of this variable interest entity and therefore has consolidated this entity for financial reporting purposes. Upon consolidation, the Company recognized a gross lease termination fee of $46,000 in August 2007. Factors considered by the Company in determining whether M&M should be considered a VIE for financial reporting purposes included the following: - No equity was contributed by the partners in the formation of M&M. - At present, the assigned leases are the only properties under management by M&M. - Because M&M does not have an operating history that demonstrates its ability to finance its activities without additional subordinated financial support. - All revenues, other than interest income, are generated by M&M from the Company in the form of fees or commissions. The Company remains at risk with respect to the assigned leases because if M&M's operating expenses exceed its interest income, fees and commissions there would be insufficient funds to meet the assigned lease obligation without additional financial support from equity holders or other parties. The Company, which had released the original 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. 6. STOCK TRANSACTIONS During the nine months ended September 30, 2007, two limited partners exchanged a total of 196,500 O.P. units for 196,500 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 $2,606 from minority interests to 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. DISCONTINUED OPERATIONS Effective January 1, 2002, the Company adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), which addresses financial accounting and reporting for the impairment and disposal of long lived assets. In general, income or loss attributable to the operations and sale of property and the operations related to property held for sale is classified as discontinued operations in the condensed consolidated statements of operations. Prior period condensed consolidated statements of operations presented in this report have been reclassified to reflect the income or loss related to properties that were sold and presented as discontinued operations in 2006. All periods presented in this report will likely require further reclassification in future periods if there are properties held for sale or property sales occur. During the third quarter of 2007, the Company sold two R&D properties. See Note 3 above for additional details. In the third quarter of 2006, the Company classified three R&D properties as assets held for sale and sold them in the fourth quarter of 2006, which qualified as discontinued operations. Condensed results of operations for these properties for the three and nine months ended September 30, 2007 and 2006 are as follows: - 8 - MISSION WEST PROPERTIES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (dollars in thousands, except per share and per square footage) (unaudited)
Three Months Ended September 30, Nine Months Ended September 30, -------------------------------- ------------------------------- 2007 2006 2007 2006 ------------- ------------- ------------ ------------ (dollars in thousands) (unaudited) Revenues Rental revenue from real estate $ 118 $ 390 $ 389 $2,140 Tenant reimbursements 56 51 83 303 Other income 1 57 1 64 ------------- ------------- ------------ ------------ Total revenues 175 498 473 2,507 ------------- ------------- ------------ ------------ Expenses Property operating, maintenance and real estate taxes 150 219 233 608 Interest 1 - 1 - Depreciation of real estate 35 214 148 639 ------------- ------------- ------------ ------------ Total expenses 186 433 382 1,247 ------------- ------------- ------------ ------------ (Loss)/income from discontinued operations (11) 65 91 1,260 Gain on disposal of discontinued operations 6,529 - 6,529 - Minority interest in earnings attributable to discontinued operations (5,398) (55) (5,488) (1,060) ------------- ------------- ------------ ------------ Income from discontinued operations $1,120 $ 10 $1,132 $ 200 ============= ============= ============ ============
8. 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 September 30, Nine Months Ended September 30, --------------------------------- --------------------------------- 2007 2006 2007 2006 --------------- -------------- -------------- --------------- Weighted average shares outstanding (basic) 19,640,087 19,350,672 19,621,144 18,948,214 Incremental shares from assumed option exercise 178,719 68,212 293,230 76,448 --------------- -------------- -------------- --------------- Weighted average shares outstanding (diluted) 19,818,806 19,418,884 19,914,374 19,024,662 =============== ============== ============== ===============
Outstanding options to purchase 647,000 shares in 2006 were excluded from the computation of diluted net income per share under the treasury stock method because the option exercise price was greater than the weighted average exercise price of the Company's common stock during the period. The outstanding O.P. units, 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 minority interests' share of income back to net income. The total number of O.P. units outstanding at September 30, 2007 and 2006 was 85,557,935 and 85,231,199, respectively. 9. RELATED PARTY TRANSACTIONS As of September 30, 2007, the Berg Group owned 77,926,384 O.P. units. The Berg Group's combined ownership of O.P. units and shares of common stock as of September 30, 2007 represented approximately 74% of the total equity interests, assuming conversion of all O.P. units outstanding into the Company's common stock. As of September 30, 2007, debt in the amount of approximately $9,335 was due the Berg Group under a mortgage note established on 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. Interest expense incurred in connection with the mortgage note was approximately $180 and $188 for the three months ended September 30, 2007 and 2006, respectively, and $546 and $569 for the nine months ended September 30, 2007 and 2006, respectively. On September 30, 2007, the Company acquired an approximately 99,000 rentable square foot newly constructed R&D building located at 5845 Hellyer Avenue in San Jose, California from the Berg Group under the Berg Land Holdings Option Agreement. The total acquisition price for this property was approximately $10,903. The Company acquired this property by issuing 548,236 O.P. units to the Berg Group and $4,300 in cash, which was paid in the fourth quarter of 2007. The transaction was approved by the Independent Directors Committee of the Company's Board of Directors. - 9 - MISSION WEST PROPERTIES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (dollars in thousands, except per share and per square footage) (unaudited) During the first nine months of 2007 and 2006, Carl E. Berg or entities controlled by Mr. Berg held financial interests in several companies that lease space from the operating partnerships, which include companies where Mr. Berg has a greater than 10% ownership interest. These related tenants contributed approximately $361 and $162 in rental revenue for the three months ended September 30, 2007 and 2006, respectively, and $1,082 and $486 in rental revenue for the nine months ended September 30, 2007 and 2006, respectively. Under the Company's charter, bylaws and agreements with the Berg Group, the individual members of the Berg Group are prohibited from acquiring 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. In March 2006, the Company and Fujitsu Limited, or Fujitsu, agreed to the termination of a lease for one building consisting of approximately 125,000 rentable square feet. Fujitsu is responsible for repairing damage to the building and with the Company's Independent Directors Committee approval has hired Berg & Berg Enterprises, LLC to perform the restoration work for a total of approximately $4,500, which is substantially complete. The Berg Group has an approximately $2,500 commitment to complete certain tenant improvements in connection with the Company's 2002 acquisition of 5345 Hellyer Avenue in San Jose. 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 is in the process of satisfying this commitment to complete certain tenant improvements. 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, Inc., an affiliate of Carl E. Berg and Clyde J. Berg, for the Company's headquarters. Rental amounts and overhead reimbursements paid to Berg & Berg Enterprises, Inc. were approximately $24 and $23 for the three months ended September 30, 2007 and 2006, respectively, and $71 and $68 for the nine months ended September 30, 2007 and 2006, respectively. 10. 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 does not believe the ultimate outcome of any of these proceedings will have a material adverse effect on its financial condition or operating results. Mission West Properties, L.P. v. Republic Properties Corporation, et al. Santa Clara County Superior Court, Case No. CV 796249. 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 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 the right under the partnership agreement to cancel RPC's entire interest in the partnership. Following discussions with and approval by the Independent Directors Committee, the Company authorized the transfer of RPC's interest in Hellyer LP to Berg & Berg Enterprises, Inc. Under the Berg Land Holdings Option Agreement and the Acquisition Agreement dated as of May 14, 1998, 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 the RPC suit. 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 - 10 - claims on statute of limitations grounds. On February 20, 2007, the Court overruled the Company's demurrer. The Company sought a writ from the California State Court of Appeal for the Sixth District to direct the lower court to reverse its decision, but the petition for the writ was denied. A trial in the California Superior Court will commence in early 2008. The Company has a receivable from a Berg Group affiliate for the amount of distributions it has received as the successor to RPC's interest in Hellyer LP. Furthermore, the Company has never accounted for the 50% interest of RPC as its asset, and if it is ultimately determined that RPC should have retained that interest or it reacquires that interest, the Company's balance sheet and financial condition would not be impacted adversely, although to date, the Company has consolidated the assets, liabilities and operating results of Hellyer LP and allocated 50% of the operating income to the minority interest holder. 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 these indemnification agreements is minimal and has recorded no liabilities for these agreements as of September 30, 2007. 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 September 30, 2007. SEISMIC ACTIVITY The Company's properties are located in an active seismic area of Silicon Valley. Insurance policies currently maintained by the Company do not cover seismic activity, although they do cover losses from fires after an earthquake. ENVIRONMENTAL ISSUES The environmental investigations that have been conducted on the Company's properties have not revealed any environmental liability that 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 executed sales contracts as of September 30, 2007 that are subject to material conditions as previously described:
Property Number of Buildings Rentable Square Feet Acres Sales Prices -------- ------------------- -------------------- ----- ------------ McCandless Drive Milpitas, California 8 427,000 23.03 $76,500
11. SUBSEQUENT EVENTS On October 4, 2007, the Company paid dividends of $0.16 per share of common stock to all common stockholders of record as of September 28, 2007. On the same date, the operating partnerships paid a distribution of $0.16 per O.P. unit to all holders of O.P. units. Aggregate dividends and distributions amounted to approximately $16,832. - 11 - 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, 2006. The results for the three and nine months ended September 30, 2007 are not necessarily indicative of the results to be expected for the entire fiscal year ending December 31, 2007. 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: - - 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, and - - changes in general accounting principles, policies and guidelines applicable to REITs. These risks and uncertainties, together with the other risks described under Part I, Item 1A - "Risk Factors" of our 2006 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 September 30, 2007, we owned and managed 109 properties totaling approximately 7.9 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 September 30, 2007, the three tenants who each leased in excess of 300,000 rentable square feet from us were Microsoft Corporation, NEC Electronics America, Inc. (a subsidiary of NEC Electronics 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 - - 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. - 12 - CURRENT ECONOMIC 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 have slowed markedly from 2001 through the middle of 2006 after fast-paced growth in 1999 and 2000, and has been growing steadily since then. According to a recent report by NAI BT Commercial Real Estate (the "BT Report"), the vacancy rate for Silicon Valley R&D property was approximately 18.3% in late 2006 and 16.2% at the end of the third quarter of 2007. Total vacant R&D square footage in Silicon Valley at the end of the third quarter of 2007 amounted to 24.7 million square feet, of which 16.2%, or 4.0 million square feet, was being offered under subleases. According to the BT Report, total positive net absorption (which is the computation of gross square footage leased less gross new square footage vacated for the period presented) in 2006 amounted to approximately 1.9 million square feet, but in the first nine months of 2007, there was total positive net absorption of approximately 3.6 million square feet. According to the BT Report, the average asking market rent per square foot at the end of the third quarter of 2007 was $1.21 compared to $0.99 in late 2006. 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 September 30, 2007 was 62.3% compared to 64.2% at September 30, 2006. We believe that our occupancy rate could decline further going forward if key tenants seek the protection of bankruptcy laws, consolidate operations or discontinue operations. In addition, leases with respect to approximately 227,000 rentable square feet are expiring prior to the end of 2007. The properties subject to these leases may take anywhere from 24 to 36 months or longer to re-lease. We believe that the average 2007 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 adversely affected. 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. 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. The acquisition costs of each property acquired prior to July 1, 2001 were allocated only to building, land and leasing commissions with building depreciation being computed based on an estimated weighted average composite useful life of 40 years and leasing commission amortization being computed over the term of the lease. Acquisitions of properties made subsequent to the effective date of SFAS 141 are based on an allocation of the acquisition cost to land, building, tenant improvements, and intangibles for at market, including lease origination and lease up period costs, and above and below market in place leases, and the determination of their useful lives are guided by a combination of SFAS 141 and management's estimates. Amortization expense of above and below market lease intangible asset is offset against rental revenue in the revenue section while amortization of in-place lease value intangible asset is included in depreciation and amortization of real estate in the expense section of our condensed consolidated statements of - 13 - 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"). If the carrying amount of the asset exceeds its estimated undiscounted net cash flow, before interest, we will recognize an impairment loss equal to the difference between its carrying amount and its estimated fair value. If impairment is recognized, the reduced carrying amount of the asset will be accounted for as its new cost. For a depreciable asset, the new cost will be depreciated over the asset's remaining useful life. Generally, fair values are estimated using discounted cash flow, replacement cost or market comparison analyses. The process of evaluating for impairment requires estimates as to future events and conditions, which are subject to varying market factors, such as the vacancy rates, future rental rates, 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. The recognition of these properties and their operating results are 100% reflected on our condensed consolidated financial statements, with appropriate allocation to minority interests, because we have operational and financial control of the investments. We make judgments and assumptions about the estimated monthly payments made to our minority interest joint venture partners, which are reported with our periodic results of operations. Actual results may differ from these estimates under different assumptions or conditions. INVESTMENT IN UNCONSOLIDATED JOINT VENTURE. We, through an operating partnership, have a 50% non-controlling limited partnership interest in one unconsolidated joint venture. This investment is not consolidated because we do not exercise significant control over major operating and financial decisions. We account for this joint venture interest using the equity method of accounting. FAIR VALUE OF FINANCIAL INSTRUMENTS. 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. In December 2004, the FASB issued 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 and supersedes 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. We have adopted the requirements of SFAS 123R effective January 1, 2006 using the modified prospective method of transition. Accordingly, prior periods have not been restated. The adoption of this standard did not have a material effect on our condensed consolidated statements of operations or financial position. 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 - 14 - 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. - 15 - RESULTS OF OPERATIONS COMPARISON OF THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2007 TO THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 As of September 30, 2007, through our controlling interests in the operating partnerships, we owned 109 properties totaling approximately 7.9 million rentable square feet compared to 110 properties totaling approximately 7.9 million rentable square feet owned by us as of September 30, 2006. This represents a net decrease of approximately 1.0% in total rentable square footage, as we acquired four R&D properties consisting of approximately 247,100 rentable square feet and sold five R&D properties consisting of approximately 321,900 rentable square feet since the third quarter of 2006. Included in the 7.9 million rentable square feet are approximately 854,000 rentable square feet (or 16 buildings), which are in the process of being rezoned for residential development. Rental revenue from real estate for the three and nine months ended September 30, 2007 compared to the same three- and nine-month periods in 2006 are as follows:
Three Months Ended September 30, -------------------------------- % Change by 2007 2006 $ Change Property Group ------------- -------------- --------------- --------------- (dollars in thousands) Same Property (1) $18,429 $21,890 ($3,461) (15.8%) 2006 Acquisitions 554 554 - - 2007 Acquisitions 17 - 17 100% ------------- -------------- --------------- Total $19,000 $22,444 ($3,444) (15.3%) ============= ============== =============== Nine Months Ended September 30, -------------------------------- % Change by 2007 2006 $ Change Property Group ------------- -------------- --------------- --------------- (dollars in thousands) Same Property (1) $59,651 $67,063 ($7,412) (11.1%) 2006 Acquisitions 1,661 1,218 443 36.4% 2007 Acquisitions 38 - 38 100% ------------- -------------- --------------- Total $61,350 $68,281 ($6,931) (10.2%) ============= ============== ===============
(1) "Same Property" is defined as properties owned by us prior to 2007 that we still owned as of September 30, 2007. RENTAL REVENUE FROM REAL ESTATE FROM CONTINUING OPERATIONS For the quarter ended September 30, 2007, rental revenue from real estate decreased by approximately ($3.4) million, or (15.3%), from $22.4 million for the three months ended September 30, 2006 to $19.0 million for the three months ended September 30, 2007. For the nine months ended September 30, 2007, rental revenue from real estate decreased by approximately ($6.9) million, or (10.2%), from $68.3 million for the nine months ended September 30, 2006 to $61.4 million for the nine months ended September 30, 2007. The decline in rental revenue resulted primarily from renewing existing leases at lower rental rates and the loss of several tenants due to lease terminations, relocation or cessation of their operations since September 30, 2006, all of which resulted from current adverse market conditions. Rental revenue was offset by amortization expense of approximately ($0.5) million for the three months ended September 30, 2006, and ($4.1) million and ($1.4) million for the nine months ended September 30, 2007 and 2006, respectively, for an above-market lease intangible asset. The increase year-over-year was attributable to a lease termination in the first quarter of 2007, which resulted in the write-off of all remaining above-market lease intangible asset. Our occupancy rate at September 30, 2007 was approximately 62.6%, compared to approximately 64.2% at September 30, 2006. EQUITY IN EARNINGS FROM UNCONSOLIDATED JOINT VENTURE As of September 30, 2007, we had investments in three R&D buildings, totaling 466,600 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 September 30, 2007, we recorded equity in earnings from the unconsolidated joint venture of approximately $0.37 million compared to equity in earnings of $0.86 million for the same period in 2006. The decline was due to a $0.44 million gain from sale of real estate in 2006 that did not recur in 2007. For the nine-month periods ended September 30, 2007 and 2006, equity in earnings from the unconsolidated joint venture was approximately $1.06 million and $1.54 million, respectively. The occupancy rate for the properties owned by this joint venture at September 30, 2007 and 2006 was 100%. LEASE TERMINATION INCOME Lease termination fees for the three months ended September 30, 2007 were approximately $47.2 million. Lease termination fees for the nine months ended September 30, 2007 and 2006 were approximately $57.5 million and $16.1 million, respectively. These fees were paid by tenants who terminated their lease obligations before the end of the contractual term of the lease by agreement with us. We do not consider those transactions to be recurring items. - 16 - OTHER INCOME FROM CONTINUING OPERATIONS Other income of approximately $1.9 million for the three months ended September 30, 2007 included approximately $0.8 million from interest, $0.2 million from management fees and $0.9 million from miscellaneous income. Other income of approximately $1.0 million for the three months ended September 30, 2006 included approximately $0.6 million from interest, $0.3 million from management fees and $0.2 million from security deposit forfeitures and miscellaneous income. For the nine months ended September 30, 2007, other income of approximately $5.9 million included approximately $1.6 million from a forfeited deposit under a contract for the sale of property, $2.1 million from interest, $0.8 million from management fees, $0.3 million from a bankruptcy settlement claim and $1.1 million from security deposit forfeitures and miscellaneous income. For the nine months ended September 30, 2006, other income of approximately $2.8 million included approximately $1.5 million from interest, $0.8 million from management fees and $0.5 million from bankruptcy settlement claims, security deposit forfeitures and miscellaneous income. EXPENSES FROM CONTINUING OPERATIONS Property operating expenses and real estate taxes during the third quarter of 2007 increased by approximately $1.3 million, or 25.7%, from $4.9 million to $6.2 million for the three months ended September 30, 2006 and 2007, respectively. The increase in 2007 is primarily attributable to a write-off of approximately $1.0 million of lease commissions related to a lease termination. Tenant reimbursements increased by approximately $0.2 million, or 6.0%, from $3.3 million for the three months ended September 30, 2006 to $3.5 million for the three months ended September 30, 2007 due to reimbursements of non-recurring operating expenses. Certain expenses such as property insurance, real estate taxes, and other fixed operating expenses are not recoverable from vacant properties, however. For the nine months ended September 30, 2007, property operating expenses and real estate taxes increased by approximately $1.7 million, or 12.9%, from $13.6 million for the nine months ended September 30, 2006 to $15.3 million for the nine months ended September 30, 2007. The increase in property operating expenses and real estate taxes was mainly due to higher lease commission expense and property taxes. General and administrative expenses increased by approximately $0.5 million, or 84.9%, from $0.5 million to $1.0 million for the three months ended September 30, 2006 and 2007, respectively. The increase in general and administrative expenses was primarily due to higher legal fees associated with a potential acquisition of the Company, salaries and wages and share-based compensation expense. For the nine months ended September 30, 2006 and 2007, general and administrative expenses increased by approximately $0.6 million, or 31.4%, from $1.8 million to $2.4 million, respectively, for similar reasons. Real estate depreciation and amortization expense remained relatively constant at approximately $5.5 million for the three months ended September 30, 2007 and 2006. Real estate depreciation and amortization expense increased by approximately $1.1 million, or 6.8%, from $16.0 million to $17.1 million for the nine months ended September 30, 2006 and 2007, respectively. The increase was attributable primarily to the write-offs of additional amortization expense relating to in-place lease value intangible assets pursuant to SFAS 141 in connection with two lease terminations and additional tenant improvements. Interest expense decreased by approximately ($0.1) million, or (2.1%), from $5.2 million for the three months ended September 30, 2006 to $5.1 million for the three months ended September 30, 2007 due to lower total debt in 2007. Interest expense (related parties) was approximately $0.2 million in both three-month periods ended September 30, 2007 and 2006. Total debt outstanding, including amounts due related parties, decreased by approximately ($8.2) million, or (2.3%), from $357.8 million as of September 30, 2006 to $349.6 million as of September 30, 2007. Overall interest expense, including amounts paid to related parties, for the quarter ended September 30, 2007 decreased by approximately ($0.1) million compared to the same quarter a year ago. Interest expense decreased by approximately ($0.4) million, or (2.6%), from $15.6 million for the nine months ended September 30, 2006 to $15.2 million for the nine months ended September 30, 2007. Interest expense (related parties) was approximately $0.6 million for the nine months ended September 30, 2007 and 2006. INCOME FROM DISCONTINUED OPERATIONS The following table depicts the amounts of income from discontinued operations for the three and nine months ended September 30, 2007 and 2006.
Three Months Ended September 30, Nine Months Ended September 30, ------------------------------ ------------------------------- 2007 2006 2007 2006 ----------- ------------ ------------ ------------ (dollars in thousands) (unaudited) (Loss)/income attributable to discontinued operations ($ 11) $65 $ 91 $ 1,260 Gain on disposal of discontinued operations 6,529 - 6,529 - Minority interests in earnings attributable to discontinued operations (5,398) (55) (5,488) (1,060) ----------- ------------ ------------ ------------ Income from discontinued operations $1,120 $10 $ 1,132 $ 200 =========== ============ ============ ============
In accordance with our adoption of SFAS 144, in the third quarter of 2007 we sold two R&D properties and classified them as discontinued operations, and in the third quarter of 2006 we classified three R&D properties as assets held for sale and sold them in the fourth quarter of 2006 and classified them as discontinued operations. The income to common stockholders attributable to discontinued operations from these properties for the three months ended September 30, 2007 and 2006 was approximately $1.1 million and $10,000, respectively. The income to common stockholders attributable to discontinued operations from these properties for the nine months ended September 30, 2007 and 2006 was approximately $1.1 million and $0.2 million, respectively. - 17 - NET INCOME TO COMMON STOCKHOLDERS AND NET INCOME TO MINORITY INTERESTS Net income to common stockholders increased by approximately $9.8 million, or 467.0%, from $2.1 million for the three months ended September 30, 2006 to $11.9 million for the same period in 2007. The minority interest portion of income increased by approximately $39.9 million, or 458.0%, from $8.7 million for the three months ended September 30, 2006 to $48.6 million for the three months ended September 30, 2007. The increase in the quarter's net income for both common stockholders and minority interests was primarily due to higher lease termination fees in the third quarter of 2007. For the nine months ended September 30, 2007 and 2006, the minority interest portion of income was approximately $65.0 million and $40.0 million, respectively, and net income to common stockholders was approximately $16.2 million and $9.2 million, respectively. The increase in net income for both common stockholders and minority interests in the first nine months of 2007 was primarily from higher lease termination fee income, offset by lower rental income and higher amortization expenses. Minority interest in net income has been calculated by taking the net income of the operating partnerships (on a stand-alone basis) multiplied by the respective minority interest ownership percentage. Minority interests represent the ownership interest of all limited partners in the operating partnerships taken as a whole, which was approximately 81% as of September 30, 2007 and 2006. CHANGES IN FINANCIAL CONDITION The most significant changes in our financial condition during the three months ended September 30, 2007 resulted from the disposition of two R&D properties and the acquisition of one R&D property. At September 30, 2007, total investments in properties increased on a net basis by approximately $34.6 million from December 31, 2006 primarily due to four R&D property acquisitions consisting of approximately 247,000 rentable square feet located in the Silicon Valley, the acquisition of 55 acres of vacant land located in Morgan Hill, California and the construction of additional tenant improvements. Total stockholders' equity, net, increased by approximately $11.0 million from December 31, 2006 as we obtained additional capital from the issuance of 196,500 shares of our common stock for the exchange of O.P. units and a decrease in accumulated deficit of approximately $7.9 million. The newly issued shares of common stock increased additional paid-in capital by approximately $2.6 million. Share-based compensation relating to grants of stock options increased additional paid-in capital by approximately $0.5 million. LIQUIDITY AND CAPITAL RESOURCES We expect a slight increase in operating cash flows from our operating property portfolio in 2007 as compared to 2006. The increase in cash flows is resulting from early lease terminations. If we are unable to lease a significant portion of the approximately 227,000 rentable square feet scheduled to expire during the remainder of 2007 or an equivalent amount of our currently available space of approximately 2.9 million rentable square feet, however, our operating cash flows after 2007 may be affected adversely. With the expectation of lower rental revenues for the remainder of 2007, we expect our properties' net operating income to show a year over year decline when compared to 2006 driven by excess capacity of commercial office and R&D space in the Silicon Valley. We are also subject to risks of decreased occupancy through tenant defaults and bankruptcies and potential reduction in rental rates upon renewal of properties, which would result in reduced cash flow from operations. 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 or future borrowings. We expect these sources of liquidity to be adequate to meet projected distributions to stockholders and other presently anticipated liquidity requirements in 2007. We expect to meet our long-term liquidity requirements for the funding of property development, property acquisitions and other material non-recurring capital improvements through cash and investments, long-term secured and unsecured indebtedness and the issuance of additional equity securities by us. We have the ability to meet short-term obligations or other liquidity needs based on cash reserves or other short-term borrowings. We expect our total interest expense to increase through new financing activities. In the remainder of 2007, we will be obligated to make payments totaling approximately $2.8 million of debt principal under mortgage notes without regard to any debt refinancing or new debt obligations that we might incur, or optional payments of debt principal. Cash and cash equivalents increased by approximately $4.0 million from $33.8 million as of December 31, 2006 to $37.8 million as of September 30, 2007 primarily from lease termination fees. Restricted cash totaled approximately $65.5 million as of September 30, 2007. Of this amount, approximately $15.5 million represents proceeds received from property sales and interest income held in a separate cash account at a trust company for future use in tax-deferred exchanges. The remaining $50.0 million represents cash held by our consolidated VIE from a lease termination in the third quarter of 2007. We include this in our restricted cash under the principles of FIN 46R. We do not possess or control these funds or have any rights to receive them except as provided in the applicable agreements, however. The restricted cash is not available for distribution to stockholders. - 18 - DISTRIBUTIONS On October 4, 2007, we paid dividends of $0.16 per share of common stock to all common stockholders of record as of September 28, 2007. On the same date, the operating partnerships paid a distribution of $0.16 per O.P. unit to all holders of O.P. units. Aggregate dividends and distributions amounted to approximately $16.8 million. For the remainder of 2007, we expect to maintain our current quarterly dividend payment rate to common stockholders and O.P. unit holders of $0.16 per share. However, distributions are declared at the discretion of our Board of Directors and are subject to actual cash available for distribution, our financial condition, capital requirements and such other factors, as our Board of Directors deems relevant. DEBT At September 30, 2007, we had total indebtedness of approximately $349.5 million, including $340.2 million of fixed rate mortgage debt and $9.3 million debt under the Berg Group mortgage note (related parties), as detailed in the table below. The Allianz and SCVNB loans contain certain financial loan and reporting covenants as defined in the loan agreements. As of September 30, 2007, we were in compliance with these loan covenants. CONTRACTUAL OBLIGATIONS The following table identifies the contractual obligations as of September 30, 2007 that will impact our liquidity and cash flow in future periods:
------------ ------------ ------------- ------------ ------------- ------------ ------------ 2007 2008 2009 2010 2011 Thereafter Total ------------ ------------ ------------- ------------ ------------- ------------ ------------ (dollars in thousands) Long-Term Debt Obligations(1) $2,816 $121,589 $9,561 $10,105 $10,681 $194,808 $349,560 Operating Lease Obligations (2) 24 24 - - - - 48 ------------ ------------ ------------- ------------ ------------- ------------ ------------ Total $2,840 $121,613 $9,561 $10,105 $10,681 $194,808 $349,608 ============ ============ ============= ============ ============= ============ ============
(1) Our long-term debt obligations are set forth in detail in the schedule below. (2) Our operating lease obligations relate to a lease of our corporate office facility from a related party. - 19 - The following table sets forth information regarding debt outstanding as of September 30, 2007:
Maturity Interest Debt Description Collateral Properties Balance Date Rate - -------------------------------------------- -------------------------------------- -------------------- ------------- ------------ (dollars in thousands) Line of Credit: Santa Clara Valley National Bank Not Applicable - 12/07 (3) -------------------- Mortgage Notes Payable (related parties): 5300 & 5350 Hellyer Avenue, San Jose, CA $ 9,335 6/10 7.65% -------------------- Mortgage Notes Payable(1): Prudential Insurance Co. of America(2) 10300 Bubb Road, Cupertino, CA 113,171 10/08 6.56% 10500 N. De Anza Boulevard, Cupertino, CA 4050 Starboard Drive, Fremont, CA 45738 Northport Loop, Fremont, CA 450 National Avenue, Mountain View, CA 6311 San Ignacio Avenue, San Jose, CA 6321 San Ignacio Avenue, San Jose, CA 6325 San Ignacio Avenue, San Jose, CA 6331 San Ignacio Avenue, San Jose, CA 6341 San Ignacio Avenue, San Jose, CA 6351 San Ignacio Avenue, San Jose, CA 3236 Scott Boulevard, Santa Clara, CA 3560 Bassett Street, Santa Clara, CA 3570 Bassett Street, Santa Clara, CA 3580 Bassett Street, Santa Clara, CA 1135 Kern Avenue, Sunnyvale, CA 1212 Bordeaux Lane, Sunnyvale, CA 1230 E. Arques, Sunnyvale, CA 1250 E. Arques, Sunnyvale, CA 1170 Morse Avenue, Sunnyvale, CA 1600 Memorex Drive, Santa Clara, CA 1688 Richard Avenue, Santa Clara, CA 3540 Bassett Street, Santa Clara, CA 3542 Bassett Street, Santa Clara, CA 3544 Bassett Street, Santa Clara, CA 3550 Bassett Street, Santa Clara,CA Northwestern Mutual Life Insurance Co.(4) 1750 Automation Parkway, San Jose, CA 85,844 1/13 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 2251 Lawson Lane, Santa Clara, CA 1325 McCandless Drive, Milpitas, CA 1650-1690 McCandless Drive, Milpitas, CA 20605-20705 Valley Green Drive, Cupertino, CA Allianz Life Ins. Co.(Allianz Loan I)(5) 5900 Optical Court, San Jose, CA 24,022 8/25 5.56% Allianz Life Ins. Co.(Allianz Loan II)(5) 5325-5345 Hellyer Avenue, San Jose, CA 117,188 8/25 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 20400 Mariani Avenue, Cupertino, CA 10450-10460 Bubb Road, Cupertino, CA -------------------- 340,224 -------------------- -------------------- TOTAL $349,560 ====================
(1) Mortgage notes payable generally require monthly installments of principal and interest ranging from approximately $177,000 to $840,000 over various terms extending through the year 2025. The weighted average interest rate of mortgage notes payable was 5.85% at September 30, 2007. (2) The Prudential Insurance loan is payable in monthly installments of approximately $827,000, which includes principal (based upon a 30-year amortization) and interest. A limited partner who is not a member of the Berg Group has guaranteed approximately $12.0 million of this debt. Costs and fees incurred with obtaining this loan aggregated approximately $900,000, which were deferred and amortized over the loan period. In the third quarter of 2007, the Company sold 45700 Northport Loop in Fremont, California and 1170 Morse Avenue in Sunnyvale, California, which were collateral properties under the Prudential Insurance loan. Prudential has agreed to release these properties without delivery of substitute properties provided that the Company pay a fee of $40,000 and deposit $1,500,000 in escrow with Prudential for a full year. The Company made the payments in the fourth quarter of 2007. (3) Interest rate equal to LIBOR plus 1.75%. The Santa Clara Valley National Bank ("SCVNB") 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 September 30, 2007, the Company was in compliance with these loan covenants. SCVNB was acquired by Wells Fargo Bank and the Company is in the process of transferring its day-to-day primary banking relationship to Heritage Bank of Commerce. The SCVNB line of credit will expire in December 2007, and at this time, the Company does not perceive a need to establish a new line of credit. (4) The Northwestern loan is payable in monthly installments of approximately $696,000, which includes principal (based upon a 20-year amortization) and interest. Costs and fees incurred with obtaining this loan aggregated approximately $675,000, which were deferred and amortized over the loan period. (5) The Allianz loans are payable in monthly aggregate installments of approximately $1,017,000, which includes principal (based upon a 20-year amortization) and interest. Costs and fees incurred with obtaining these loans aggregated approximately $1,089,000, which were deferred and amortized over the loan periods. The Allianz loans contain certain customary covenants as defined in the loan agreements. As of September 30, 2007, the Company was in compliance with these loan covenants. - 20 - At September 30, 2007, our debt to total market capitalization ratio, which is computed as our total debt outstanding divided by the sum of total debt outstanding plus the market value of common stock (based upon the closing price of $12.15 per share on September 28, 2007) on a fully diluted basis, including the conversion of all O.P. units into common stock, was approximately 21.4%. On September 28, 2007, the last trading day in the quarter, total market capitalization was approximately $1.63 billion. At September 30, 2007, the outstanding balance remaining under certain notes that we owed to the operating partnerships was approximately $1.9 million. The due date of these notes has been extended to September 30, 2008. 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 minority 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 nine months ended September 30, 2007 to the nine months ended September 30, 2006 Net cash provided by operating activities for the nine months ended September 30, 2007 was approximately $29.9 million compared to $28.2 million for the same period in 2006. Cash flow increases came primarily from lease termination fees, a forfeited deposit under a contract for the sale of property, and rent payments from M&M, LLC in 2007 (see Note 5 of Notes to Condensed Consolidated Financial Statements in Part I, Item 1, above). Higher leasing commission payments (included in other assets) in 2007 compared to 2006 reduced the amount of the overall increase in cash flows. Net cash used in investing activities was approximately ($8.3) million and ($2.0) million for the nine months ended September 30, 2007 and 2006, respectively. Cash used in investing activities during the nine months ended September 30, 2007 related principally to the acquisition of 50 acres of vacant land at the Morgan Hill Ranch in Morgan Hill, California for approximately $25.5 million, the acquisition of five acres of vacant land at the Morgan Hill Ranch in Morgan Hill, California for approximately $2.3 million, and the acquisition of three R&D properties at Montague Expressway in Milpitas, California and one R&D property at 5845 Hellyer Avenue in San Jose, California for approximately $19.7 million. The acquisition at Montague Expressway was completed as a tax-deferred exchange transaction involving our former R&D properties at 2033-2243 Samaritan Drive in San Jose, California. The remaining excess restricted cash of approximately $0.6 million was transferred to our general cash account. Capital expenditures for real estate improvements were approximately $4.6 million for the nine months ended September 30, 2007. Net cash used in investing activities during the nine months ended September 30, 2006 related principally to the acquisition of the property at 233 South Hillview Drive in Milpitas, California for approximately $13.5 million, pursuant to a tax-deferred exchange transaction involving our former R&D property at 800 Embedded Way in San Jose, California. Excess restricted cash of approximately $1.8 million from the sale of 800 Embedded Way was transferred to our general cash account. Capital expenditures for real estate improvements were approximately $1.3 million for the nine months ended September 30, 2006. Net cash used in financing activities was approximately ($17.6) million for the nine months ended September 30, 2007 compared to approximately ($15.1) million for the nine months ended September 30, 2006. During the first nine months of 2007, we used approximately $8.2 million to pay outstanding debt and paid approximately $9.4 million of dividends to common stockholders. During the same period in 2006, we received approximately $0.8 million from stock option exercises, received approximately $1.6 million from the refund of an appeal bond, used approximately $7.8 million to pay outstanding debt, paid approximately $9.0 million of dividends to common stockholders and paid approximately $0.7 million to minority interests for distributions in excess of earnings. 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 minority 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 to 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 not 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. - 21 - Our definition of FFO also assumes conversion at the beginning of the period of all convertible securities, including minority 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. FFO for the three and nine months ended September 30, 2007 and 2006, as reconciled to net income to common stockholders, are summarized in the following table:
Three Months Ended September 30, Nine Months Ended September 30, ----------------------------------------- ----------------------------------------- 2007 2006 2007 2006 ------------------ ------------------ ------------------ ------------------ (dollars in thousands) (dollars in thousands) Net income to common stockholders $11,941 $ 2,106 $ 17,320 $ 9,380 Add: Minority interests (1) 48,420 8,566 70,098 40,676 Depreciation & amortization of real estate(2) 7,184 6,333 19,986 18,429 Less: Gain on sale of real estate (6,529) (438) (6,529) (438) ------------------ ------------------ ------------------ ------------------ FFO $61,016 $16,567 $100,875 $68,047 ================== ================== ================== ==================
(1) Minority interests in net income is calculated by taking the net income of the operating partnerships (on a stand-alone basis) multiplied by the respective weighted average minority interests ownership percentage. Minority interests for third parties totaling approximately $130 and $134 for the three months ended September 30, 2007 and 2006, respectively, and $371 and $382 for the nine months ended September 30, 2007 and 2006, respectively, were deducted from total minority interests in calculating FFO. (2) Includes our portion of depreciation and amortization of real estate and leasing commissions from our unconsolidated joint venture totaling approximately $189 and $238 for the three months ended September 30, 2007 and 2006, respectively, and $568 and $660 for the nine months ended September 30, 2007 and 2006, respectively. Also includes our amortization of leasing commissions of approximately $1,426 and $368 for the three months ended September 30, 2007 and 2006, respectively, and $2,187 and $1,138 for the nine months ended September 30, 2007 and 2006, respectively. Amortization of leasing commissions is included in the property operating, maintenance and real estate taxes line item in the Company's condensed consolidated statements of operations. The increase in FFO year-over-year was primarily due to higher lease termination fee income, offset by lower rental income and higher amortization expenses in 2007 compared to 2006. 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 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. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS We do not believe recently issued accounting standards will materially impact our financial position, results of operations, or cash flows. In June 2006, the FASB issued Interpretation 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48"). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in our financial statements in accordance with SFAS No. 109, "Accounting for Income Taxes." The provisions of FIN 48 are effective for our fiscal year beginning January 1, 2007. The adoption of FIN 48 on January 1, 2007 is not expected to have a significant impact on our consolidated results of operations or financial position. In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of SFAS 157 are effective for our fiscal year beginning January 1, 2008. We are currently evaluating the - 22 - impact of the provisions of SFAS 157 and currently cannot estimate the impact to our consolidated results of operations or financial position. In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" ("SFAS 159"). SFAS 159 provides companies with an option to report selected financial assets and liabilities at fair value. SFAS 159's objective is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We are evaluating whether to adopt the provisions of SFAS 159 and cannot estimate the impact to our consolidated results of operations, financial position or cash flows. 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 September 30, 2007. 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 September 30, 2007 will be paid according to scheduled principal payments and that we will not prepay any of the outstanding principal balance.
Three Months Year Ending December 31, Remaining ----------------------------------------------- 2007 2008 2009 2010 2011 Thereafter Total Fair Value ----------- ----------- ----------- ----------- ----------- ----------- ----------- ------------ (dollars in thousands) Fixed Rate Debt: Secured notes payable $2,816 $121,589 $9,561 $10,105 $10,681 $194,808 $349,560 $451,126 Weighted average interest rate 5.85% 5.85% 5.85% 5.85% 5.85% 5.85%
The primary market risks we face are interest rate fluctuations. We pay lower rates of interest in periods of decreasing interest rates and higher rates of interest in periods of increasing interest rates. All of our debt is denominated in United States dollars. We had no interest rate caps or interest rate swap contracts at September 30, 2007. As of September 30, 2007, we had no interest rate risk since there was no variable rate debt outstanding. - 23 - 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 September 30, 2007. 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. - 24 - PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Legal proceedings are incorporated herein by reference from Part I "Item 1. - Notes to Condensed Consolidated Financial Statements - Note 10 - 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, you should carefully review the factors discussed under Item 1A of our 2006 Form 10-K 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 5. OTHER INFORMATION As of October 31, 2007, we are continuing discussions with two interested parties in regarding the possible acquisition of the Company, but otherwise have ceased active efforts to effect an acquisition of the Company with any other parties. 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 - 25 - ================================================================================ 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: November 8, 2007 By: /s/ Carl E. Berg ------------------------------------ Carl E. Berg Chief Executive Officer Date: November 8, 2007 By: /s/ Wayne N. Pham ------------------------------------ Wayne N. Pham Vice President of Finance and Controller (Principal Accounting Officer and Duly Authorized Officer) - 26 - EX-32 2 exh32.txt EXHIBIT 32 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 In connection with the Quarterly Report on Form 10-Q of Mission West Properties, Inc. (the "Company") for the quarterly period ended September 30, 2007 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), each of Carl E. Berg, Chairman of the Board and Chief Executive Officer of the Company, Raymond V. Marino, President and Chief Operating Officer of the Company and Wayne N. Pham, Vice President of Finance and Controller of the Company, hereby certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, to the best of his knowledge, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ Carl E. Berg - ------------------------------------ Carl E. Berg Chairman of the Board and Chief Executive Officer November 8, 2007 /s/ Raymond V. Marino - ------------------------------------ Raymond V. Marino President and Chief Operating Officer November 8, 2007 /s/ Wayne N. Pham - ------------------------------------ Wayne N. Pham Vice President of Finance and Controller November 8, 2007 This certification accompanies this Report pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the Sarbanes-Oxley Act of 2002, or otherwise required, be deemed filed by the Company for purposes of ss. 18 of the Securities Exchange Act of 1934, as amended. EX-31 3 exh31pham.txt EXHIBIT 31.3 EXHIBIT 31.3 CERTIFICATION PURSUANT TO RULE 13a-14 OF THE SECURITIES EXCHANGE ACT OF 1934 I, Wayne N. Pham, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Mission West Properties, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 8, 2007 By: /s/ Wayne N. Pham ---------------------------------------- Wayne N. Pham Vice President of Finance & Controller EX-31 4 exh31marino.txt EXHIBIT 31.2 EXHIBIT 31.2 CERTIFICATION PURSUANT TO RULE 13a-14 OF THE SECURITIES EXCHANGE ACT OF 1934 I, Raymond V. Marino, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Mission West Properties, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 8, 2007 By: /s/ Raymond V. Marino ----------------------------------------- Raymond V. Marino President & Chief Operating Officer EX-31 5 exh31berg.txt EXHIBIT 31.1 EXHIBIT 31.1 CERTIFICATION PURSUANT TO RULE 13a-14 OF THE SECURITIES EXCHANGE ACT OF 1934 I, Carl E. Berg, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Mission West Properties, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 8, 2007 By: /s/ Carl E. Berg ----------------------------------------- Carl E. Berg Chairman & Chief Executive Officer -----END PRIVACY-ENHANCED MESSAGE-----