UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from ___________ to _____________
Commission file number 1-12993
ALEXANDRIA REAL ESTATE EQUITIES, INC.(Exact name of registrant as specified in its charter)
ALEXANDRIA REAL ESTATE EQUITIES, INC.
Maryland(State or other jurisdiction of incorporation or organization)
95-4502084
385 East Colorado BoulevardSuite 299Pasadena, California 91101 (Address of principal executive offices including zip code)
Registrant's telephone number, including area code: (626) 578-0777
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Name of Each Exchange on Which Registered
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES x NO ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES ¨ NO x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ¨ NO x
The aggregate market value of the shares of Common Stock held by non-affiliates of registrant was approximately $1.5 billion based on the closing price for such shares on the New York Stock Exchange on June 30, 2005.
As of March 13, 2006, the registrant had outstanding 22,778,820 shares of Common Stock.
Documents Incorporated By Reference
Part III of this report incorporates certain information by reference from the registrant's definitive proxy statement to be filed within 120 days of the end of the fiscal year covered by this report in connection with the registrant's annual meeting of stockholders to be held on or about May 18, 2006.
PDF provided as courtesy INDEX TO FORM 10-KALEXANDRIA REAL ESTATE EQUITIES, INC.
INDEX TO FORM 10-KALEXANDRIA REAL ESTATE EQUITIES, INC.
PART I
Page
Item 1.
Business
1
Item 2.
Properties
14
Item 3.
Legal Proceedings
17
Item 4.
Submission of Matters to a Vote of Security Holders
PART II
Item 5.
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
18
Item 6.
Selected Financial Data
19
Item 7.
Management's Discussion and Analysis of Financial Condition and Results of Operation
21
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
37
Item 8.
Financial Statements and Supplementary Data
38
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
Item 9A.
Controls and Procedures
39
Item 9B.
Other Information
41
PART III
Item 10.
Directors and Executive Officers of the Registrant
Item 11.
Executive Compensation
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13.
Certain Relationships and Related Transactions
Item 14.
Principal Accounting Fees and Services
Item 15.
Exhibits, Financial Statement Schedule
42
This document contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. You can identify some of the forward-looking statements by the use of forward-looking words such as "believes", "expects", "may", "will", "should", "seeks", "intends", "plans", "estimates" or "anticipates", or the negative of these words or similar words. Forward-looking statements involve inherent risks and uncertainties regarding events, conditions and financial trends that may affect our future plans of operation, business strategy, results of operations and financial position. A number of important factors could cause actual results to differ materially from those included within or contemplated by such forward-looking statements, including, but not limited to, those described below in this report and under the headings "Item 1. Business-Business Risks" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations". We do not undertake any responsibility to update any of these factors or to announce publicly any revisions to any of the forward-looking statements contained in this or any other document, whether as a result of new information, future events or otherwise.
As used in this Form 10-K, references to the "Company", "we", "our", and "us" refer to Alexandria Real Estate Equities, Inc. and its subsidiaries.
Item 1. Business
General
We are a Maryland corporation formed in October 1994 that has elected to be taxed as a real estate investment trust ("REIT") for federal income tax purposes. We are engaged principally in the ownership, operation, management, acquisition and selective redevelopment and development of high quality, strategically located properties containing office/laboratory space designed and improved for lease primarily to institutional (universities and not-for-profit institutions), pharmaceutical, biotechnology, life science product, service, biodefense and translational research entities, as well as government agencies (collectively, the "life science industry"). Our properties leased to tenants in the life science industry typically consist of buildings containing scientific research and development laboratories and other improvements that are generic to tenants operating in the life science industry. We refer to such properties as "life science properties". As of December 31, 2005, we owned 134 properties (131 properties located in nine states and three properties located in Canada) with approximately 8.8 million rentable square feet of office/laboratory space.
Business and Growth Strategy
We focus our property operations and investment activities principally in the following life science markets:
Our tenant base is broad and diverse within the life science industry and reflects our focus on regional, national and international tenants with substantial financial and operational resources. For a more detailed description of our properties and tenants, see "Item 2. Properties." We have an experienced Board of Directors and are led by a senior management team with extensive experience in both the real estate and life science industries.
We seek to maximize growth in funds from operations ("FFO") and cash available for distribution to stockholders through the ownership, operation, management, acquisition and selective redevelopment and development of life science properties, as well as management of our balance sheet. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Funds from Operations" for a discussion of how we compute and view FFO, as well as a discussion of other measures of cash flow. In particular, we seek to increase FFO and cash available for distribution by:
Internal Growth. We seek to achieve internal growth from several sources. For example, we seek to:
Our ability to negotiate contractual rent escalations in future leases and to achieve increases in rental rates will depend upon market conditions and the demand for life science properties at the time the leases are negotiated and the increases are proposed.
Acquisitions. We seek to identify and acquire high quality life science properties in our target life science markets. Critical evaluation of prospective property acquisitions is an essential component of our acquisition strategy. When evaluating acquisition opportunities, we assess a full range of matters relating to the properties, including:
Redevelopment. We seek to enhance our growth by redeveloping existing office, warehouse or vacant space as generic laboratory space that can be leased at higher rates. As of December 31, 2005, we had 15 properties in our redevelopment program that contained a total of approximately 1,009,000 square feet. Of this total, approximately 548,000 square feet are under redevelopment and currently vacant, and the remaining 461,000 square feet are currently leased. In addition to properties under active redevelopment, as of December 31, 2005, our asset base contained imbedded opportunities for a future permanent change of use to office/laboratory space through redevelopment aggregating approximately 1.0 million square feet.
Development. We seek to acquire strategic land parcels in key life science markets to enhance our growth through ground-up development projects. Our development strategy is primarily to pursue selective projects where we expect to achieve investment returns that will equal or exceed our returns on acquisitions. We generally have undertaken ground-up development projects only if our investment in infrastructure will be substantially made for generic, rather than tenant specific, improvements. As of December 31, 2005, we had six parcels of land under development for approximately 510,000 rentable square feet of office/laboratory space. In addition, as of December 31, 2005, our asset base contained strategically located land with ground-up development opportunities for approximately 5.1 million developable square feet of office/laboratory space.
Financing and Working Capital. We believe that cash provided by operations, our unsecured line of credit and our unsecured term loan will be sufficient to fund our working capital requirements. We generally expect to finance future acquisitions and redevelopment and development projects through our unsecured line of credit and unsecured term loan and, then, to refinance some or all of that indebtedness periodically with additional equity or debt capital. We may also issue shares of our common stock, preferred stock or interests in our subsidiaries to fund future operations. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources-Unsecured Line of Credit and Unsecured Term Loan".
We seek to maintain a balance between the amounts of our fixed and variable rate debt with a view to moderating our exposure to interest rate risk. We also use financial instruments, such as interest rate swap agreements, to hedge a portion of our exposure to the variable interest rates associated with our unsecured line of credit and our unsecured term loan. Interest rate swap agreements involve an exchange of fixed and floating rate interest payments without the exchange of the underlying principal or "notional amount". Interest received under our current interest rate swap agreements is based on the one-month London interbank offered rate, or LIBOR. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources-Interest Rate Swaps" for a more complete discussion of our unsecured line of credit, unsecured term loan, interest rate swap agreements and other outstanding indebtedness.
Preferred Securities. We expect to continue to issue additional series of preferred stock that are senior to our common stock. At December 31, 2005, we had preferred stock with a liquidation preference of approximately $187.1 million. The preferred stock has general preference rights with respect to liquidation and quarterly distributions. In June 2004, we completed a public offering of 5,185,500 shares of our 8.375% Series C cumulative redeemable preferred stock with aggregate proceeds of approximately $124.0 million. In July 2004, we redeemed all 1,543,500 outstanding shares of our 9.50% Series A cumulative redeemable preferred stock at an aggregate redemption price of approximately $38.6 million. Future redemptions or repurchases of our preferred securities may occur after their respective call dates. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources- Other Resources and Liquidity Requirements".
Business Risks
We Are Largely Dependent on the Life Science Industry for Revenues from Lease Payments
In general, our strategy is to invest primarily in properties used by tenants in the life science industry. Our business could be adversely affected if the life science industry experiences an economic downturn. Because of our industry focus, events within the life science industry may have a more pronounced effect on our ability to make distributions to our stockholders than if we had more diversified investments. Also, some of our properties may be better suited for a particular life science industry tenant and could require modification before we are able to re-lease vacant space to another life science industry tenant. Generally, our properties may not be suitable for lease to traditional office tenants without significant expenditures on renovations.
Our Tenants May Not Be Able to Pay Us if They Are Unsuccessful in Discovering, Developing, Making or Selling Their Products and Technologies
Our life science industry tenants are subject to a number of risks, including the following, any one or more of which may adversely affect their ability to make rental payments to us.
We cannot assure you that our tenants will be able to develop, make, market or sell their products and technologies due to the risks inherent in the life science industry. Any tenant that is unable to avoid, or sufficiently mitigate, the risks described above, may have difficulty making rental payments to us.
We Could be Held Liable for Damages Resulting from Our Tenants' Use of Hazardous Materials
Many of our life science industry tenants engage in research and development activities that involve the controlled use of hazardous materials, chemicals and biological and radioactive compounds. In the event of contamination or injury from the use of these hazardous materials, we could be held liable for damages that result. This liability could exceed our resources and any recovery available through any applicable environmental remediation insurance coverage, and could adversely affect our ability to make distributions to our stockholders.
Together with our tenants, we must comply with federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of hazardous materials and waste products. Failure to comply with, or changes in, these laws and regulations could adversely affect our business or our tenants' business and their ability to make rental payments to us.
The Inability of A Tenant to Pay Us Rent Could Adversely Affect Our Business
Our revenues are derived primarily from rental payments and reimbursement of operating expenses under our leases. If our tenants, especially significant tenants, fail to make rental payments under their leases, our financial condition, cash flow and our ability to make distributions to our stockholders could be adversely affected.
As of December 31, 2005, we had 283 leases with a total of 237 tenants, and 73 of our 134 properties were single-tenant properties. Our three largest tenants accounted for approximately 11.6% of our aggregate annualized base rent, or approximately 4.4%, 4.1% and 3.1%, respectively. "Annualized base rent" means the annualized fixed base rental amount in effect as of December 31, 2005, using rental revenues calculated on a straight-line basis in accordance with United States generally accepted accounting principles ("GAAP"). Annualized base rent does not include reimbursements for real estate taxes and insurance, common area and other operating expenses, substantially all of which are borne by the tenants in the case of triple net leases.
The bankruptcy or insolvency of a major tenant may also adversely affect the income produced by a property. If any of our tenants becomes a debtor in a case under the U.S. Bankruptcy Code, we cannot evict that tenant solely because of its bankruptcy. The bankruptcy court may authorize the tenant to reject and terminate its lease with us. Our claim against such a tenant for unpaid future rent would be subject to a statutory limitation that might be substantially less than the remaining rent actually owed to us under the tenant's lease. Any shortfall in rent payments could adversely affect our cash flow and our ability to make distributions to our stockholders.
Our U.S. Government Tenants May Not Receive Annual Budget Appropriations, Which Could Adversely Affect Their Ability to Pay Us
U.S. government tenants may be subject to annual budget appropriations. If one of our U.S. government tenants fails to receive its annual budget appropriation, it might not be able to make its lease payments to us. In addition, defaults under leases with federal government tenants are governed by federal statute and not by state eviction or rent deficiency laws. All of our leases with U.S. government tenants provide that the government tenant may terminate the lease under certain circumstances. As of December 31, 2005, leases with U.S. government tenants at our properties accounted for approximately 3.8% of our aggregate annualized base rent.
Loss of a Tenant Could Have a Negative Impact on Our Business
A tenant may not renew its lease upon the expiration of the initial term. In addition, we may not be able to locate a qualified replacement tenant upon expiration or termination of a lease. Consequently, we could lose the cash flow from the affected property, which could negatively impact our business. We may have to divert cash flow generated by other properties to meet our mortgage payments, if any, or to pay other expenses related to owning the affected property. As of December 31, 2005, leases at our properties representing approximately 10.5% and 8.9% of the total square footage of our properties were scheduled to expire in 2006 and 2007, respectively.
Poor Economic Conditions in Our Markets Could Adversely Affect Our Business
Our properties are located only in the following markets:
As a result of our geographic concentration, we depend upon the local economic conditions in these markets, including local real estate conditions. We are, therefore, subject to increased exposure (positive or negative) to economic and other competitive factors specific to markets in confined geographic areas. Our operations may also be affected if too many competing properties are built in any of these markets. An economic downturn in any of these markets could adversely affect our operations and our ability to make distributions to stockholders. We cannot assure you that these markets will continue to grow or will remain favorable to the life science industry.
We May Have Difficulty Managing Our Growth
We expect to continue to grow by acquiring, redeveloping and selectively developing additional properties. To manage our growth effectively, we must successfully integrate new properties into our existing operations. We may not succeed with the integration. In addition, we may not effectively manage new properties, and new properties may not perform as expected. Our business could be adversely affected if we are unsuccessful in managing our growth.
Our Debt Service Obligations May Have Adverse Consequences on Our Business Operations
We use debt to finance our operations, including acquisitions of properties. Our use of debt may have adverse consequences, including the following:
As of December 31, 2005, we had outstanding mortgage indebtedness of approximately $667 million, secured by 67 properties and three land development parcels, and outstanding debt under our unsecured line of credit and unsecured term loan of $740 million.
Our Unsecured Line of Credit and Unsecured Term Loan Restrict Our Ability to Engage in Some Business Activities
Our unsecured line of credit and unsecured term loan facilities contain customary negative covenants and other financial and operating covenants that, among other things:
These restrictions could cause us to default on our unsecured line of credit and unsecured term loan or negatively affect our operations and our ability to make distributions to our stockholders.
We May Not Be Able to Obtain Additional Capital to Further Our Business Objectives
Our ability to acquire, redevelop or develop properties depends upon our ability to obtain capital. Periodically, the real estate industry experiences reduced supplies of favorably-priced equity or debt capital, which decreases the level of new investment activity by publicly-traded real estate companies. A prolonged period in which we cannot effectively access the public equity or debt markets may result in heavier reliance on alternative financing sources to undertake new investments. An inability to obtain equity or debt capital on acceptable terms could delay or prevent us from acquiring, structuring and completing desirable investments, which could adversely affect our business. Also, the issuance of additional shares of capital stock or interests in subsidiaries to fund future operations could dilute the ownership of then existing stockholders.
We have filed a "shelf" registration statement on Form S-3, under which we may offer from time to time and at our discretion, common stock, preferred stock, warrants and debt securities in amounts, at prices and on terms to be determined at the time of offering. As of December 31, 2005 we had approximately $305 million of available capacity for future issuances of securities under the shelf registration statement.
If Interest Rates Rise, Our Debt Service Costs Will Increase
Borrowings outstanding under our unsecured line of credit, unsecured term loan and certain other borrowings bear interest at a variable rate, and we may incur additional variable rate debt in the future. Increases in market interest rates would increase our interest expense under these debt instruments and would increase the costs of refinancing existing indebtedness or obtaining new debt. Accordingly, these increases could adversely affect our financial position and our ability to make distributions to stockholders.
We May Not Be Able to Acquire Properties or Operate Them Successfully
Our success depends in large part upon our ability to acquire additional properties on satisfactory terms and to operate them successfully. If we are unable to do so, our business could be adversely affected. In addition, the acquisition of life science properties generally involves a higher per square foot price than the acquisition of traditional suburban office properties.
The acquisition, ownership and operation of real estate is subject to many risks that may adversely affect our business and our ability to make payments to stockholders, including the risks that:
If we encounter any of these risks, our business and our ability to make payments to stockholders could be adversely affected.
We May Not Be Able to Complete Redevelopment and Development Projects Effectively
Our redevelopment and development activities subject us to many risks, including those associated with:
In addition, redevelopment and development activities, regardless of whether they are ultimately successful, typically require a substantial portion of management's time and attention. This may distract management from focusing on other operational activities. If we are unable to complete redevelopment and development projects successfully, our business may be adversely affected.
If Our Revenues Are Less Than Our Expenses, We May Have to Borrow Additional Funds and We May Not Be Able to Make Distributions to Our Stockholders
If our properties do not generate revenues sufficient to meet our operating expenses, including debt service and other capital expenditures, we may have to borrow additional amounts to cover fixed costs and cash flow needs. This could adversely affect our ability to make distributions to our stockholders. Factors that could adversely affect the revenues from, and the values of, our properties include:
In addition, if a lease at a property is not a triple net lease, we will have greater expenses associated with that property and greater exposure to increases in such expenses. Significant expenditures, such as mortgage payments, real estate taxes, insurance and maintenance costs, generally are fixed and do not decrease when revenues at the related property decrease.
Improvements to Life Science Properties Are Significantly More Costly Than Traditional Office Space
Our properties contain generic infrastructure improvements that are significantly more costly than other property types. Although we have historically been able to recover the additional investment in generic infrastructure improvements through higher rental rates, there is the risk that we will not be able to continue to do so in the future. Typical improvements include:
We May Not Be Able to Sell Our Properties Quickly to Raise Money
Investments in real estate are relatively illiquid. Accordingly, we may not be able to sell our properties when we desire or at acceptable prices in response to changes in economic or other conditions. In addition, the Internal Revenue Code limits our ability to sell properties held for fewer than four years. These limitations on our ability to sell our properties may adversely affect our cash flows and our ability to make distributions to stockholders.
We Face Substantial Competition in Our Target Markets
The significant competition for business in our target markets could have an adverse effect on our operations. We compete for investment opportunities with:
Many of these entities have substantially greater financial resources than we do and may be able to pay more than us or accept more risk than we are willing to accept. These entities may be less sensitive to risks with respect to the creditworthiness of a tenant or the geographic concentration of their investments. Competition may also reduce the number of suitable investment opportunities available to us or may increase the bargaining power of property owners seeking to sell.
Our Properties May Have Defects That Are Unknown to Us
Although we review the physical condition of our properties before they are acquired, and on a periodic basis after acquisition, any of our properties may have characteristics or deficiencies unknown to us that could adversely affect the property's value or revenue potential.
If We Fail to Qualify as a REIT, We Would Be Taxed at Corporate Rates and Would Not Be Able to Take Certain Deductions When Computing Our Taxable Income
If, in any taxable year, we fail to qualify as a REIT:
As a result of any additional tax liability, we might need to borrow funds or liquidate certain investments in order to pay the applicable tax. Accordingly, funds available for investment or distribution to our stockholders would be reduced for each of the years involved.
Qualification as a REIT involves the application of highly technical and complex provisions of the Internal Revenue Code to our operations and financial results, and the determination of various factual matters and circumstances not entirely within our control. There are only limited judicial or administrative interpretations of these provisions. Although we believe that we have operated, commencing with our taxable year ended December 31, 1996, in a manner so as to qualify as a REIT, we cannot assure you that we are or will remain so qualified.
In addition, although we are not aware of any pending tax legislation that would adversely affect our ability to operate as a REIT, new legislation, regulations, administrative interpretations or court decisions could change the tax laws or interpretations of the tax laws regarding qualification as a REIT, or the federal income tax consequences of that qualification, in a manner that is adverse to our stockholders.
There Are Limits on the Ownership of Our Capital Stock Under Which A Stockholder May Lose Beneficial Ownership of Its Shares
The Internal Revenue Code provides that, in order for us to maintain our qualification as a REIT, not more than 50% of the value of our outstanding capital stock may be owned, directly or constructively, by five or fewer individuals or entities.
In addition, our charter prohibits, with certain limited exceptions, direct or constructive ownership of shares of our capital stock representing more than 9.8% of the combined total value of the outstanding shares of our capital stock by any person (the "Ownership Limit"). Our Board of Directors may exempt a stockholder from the Ownership Limit if, prior to the exemption, our Board of Directors receives all information it deems necessary to determine or ensure our status as a REIT.
The constructive ownership rules are complex and may cause shares of our common stock owned directly or constructively by a group of related individuals or entities to be constructively owned by one individual or entity. A transfer of shares to a person who, as a result of the transfer, violates the Ownership Limit, may be void or may be deemed to be made to a trust, for the benefit of one or more qualified charitable organizations designated by us. In that case, the intended transferee will have only a right to share, to the extent of the transferee's original purchase price for such shares, in proceeds from the trust's sale of those shares.
In Addition to the Ownership Limit, Certain Provisions of Our Charter and Bylaws and Our Stockholder Rights Plan May Delay or Prevent Transactions That May Be Deemed to Be Desirable to Our Stockholders
As authorized by Maryland law, our charter allows our Board of Directors to cause us to issue additional authorized but unissued shares of our common stock or preferred stock and to classify or reclassify unissued shares of common or preferred stock without any stockholder approval. Our Board of Directors could establish a series of preferred stock that could delay, defer or prevent a transaction that might involve a premium price for our common stock or for other reasons be desired by our common stockholders or that have a dividend preference which may adversely affect our ability to pay dividends on our common stock.
Our charter permits the removal of a director only upon a two-thirds vote of the votes entitled to be cast generally in the election of directors and our bylaws require advance notice of a stockholder's intention to nominate directors or to present business for consideration by stockholders at an annual meeting of our stockholders. Our charter and bylaws also contain other provisions that may delay, defer or prevent a transaction or change in control that involves a premium price for our common stock or that for other reasons may be desired by our stockholders.
Under our Stockholder Rights Plan, if a stockholder acquires beneficial ownership of 15% or more of our common stock, other stockholders would become entitled to purchase our common stock at half the market price, which would likely result in substantial dilution to the 15% or greater stockholder. This may also have the effect of delaying or preventing a change in control or other transaction that might involve a premium price for our common stock or for other reasons desired by our common stockholders.
Our Insurance May Not Adequately Cover All Potential Losses
If we experience a loss at any of our properties that is not covered by insurance or that exceeds our insurance policy limits, we could lose the capital invested in the affected property and, possibly, future revenues from that property. In addition, we could continue to be obligated on any mortgage indebtedness or other obligations related to the affected properties. We carry comprehensive liability, fire, extended coverage and rental loss insurance with respect to our properties. We have obtained earthquake insurance for all of our properties because many of them are located in the vicinity of active earthquake faults. We also carry environmental remediation insurance and have title insurance policies on all of our properties. We obtain our title insurance policies when we acquire the property, with each policy covering an amount equal to the initial purchase price of each property. Accordingly, any of our title insurance policies may be in an amount less than the current value of the related property.
We believe that our insurance policy specifications, insured limits and deductibles are consistent with or superior to those customarily carried for similar properties. Our tenants are also required to maintain comprehensive insurance, including liability and casualty insurance, that is customarily obtained for similar properties. There are, however, certain types of losses that we and our tenants do not generally insure against because they are uninsurable or because it is not economical to insure against them. In the current market, there have recently been substantial increases in the premium cost of property and liability insurance. The availability of coverage against certain types of losses, such as from terrorism or toxic mold, has become more limited and, when available, is at a significantly higher premium cost. We cannot predict whether insurance coverage against terrorism or toxic mold will remain available for our properties because insurance companies may no longer offer coverage against such losses or, if offered, such coverage may become prohibitively expensive. Many, but not all, of our properties are low-rise buildings.
We Could Incur Significant Costs Complying With Environmental Laws
Federal, state and local environmental laws and regulations may require us, as a current or prior owner or operator of real estate, to investigate and clean up hazardous or toxic substances or petroleum products released at or from any of our properties. The cost of investigating and cleaning up contamination could be substantial and could exceed the amount of any environmental remediation insurance coverage available to us. In addition, the presence of contamination, or the failure to properly clean it up, may adversely affect our ability to lease or sell an affected property, or to borrow funds using that property as collateral.
Under environmental laws and regulations, we may have to pay governmental entities or third parties for property damage and for investigation and clean-up costs incurred by those parties relating to contaminated properties regardless of whether we knew of or caused the contamination. Even if more than one party may have been responsible for the contamination, we may be held responsible for all of the clean-up costs. In addition, third parties may sue us for damages and costs resulting from environmental contamination or jointly responsible parties may contest their responsibility or be financially unable to pay their share of such costs.
Environmental laws also govern the presence, maintenance and removal of asbestos-containing materials. These laws may impose fines and penalties on us for the release of asbestos-containing materials and may allow third parties to seek recovery from us for personal injury from exposure to asbestos fibers. We have detected asbestos-containing materials at some of our properties, but we do not expect that it will result in material environmental costs or liabilities to us.
Environmental laws and regulations also require the removal or upgrading of certain underground storage tanks and regulate:
Many of our tenants routinely handle hazardous substances and wastes as part of their operations at our properties. Environmental laws and regulations subject our tenants, and potentially us, to liability resulting from these activities. Environmental liabilities could also affect a tenant's ability to make rental payments to us. We require our tenants to comply with these environmental laws and regulations and to indemnify us for any related liabilities.
Independent environmental consultants have conducted Phase I or similar environmental assessments at all of our properties. We intend to use consultants to conduct similar environmental assessments on our future acquisitions. This type of assessment generally includes a site inspection, interviews and a public records review, but no subsurface sampling. These assessments and certain additional investigations of our properties have not to date revealed any environmental liability that we believe would have a material adverse effect on our business or results of operations.
The additional investigations have included, as appropriate:
Nevertheless, it is possible that the assessments on our properties have not revealed, or that assessments on future acquisitions, will not reveal all environmental liabilities. Consequently, there may be material environmental liabilities of which we are unaware that may result in substantial costs to us or our tenants and that could have a material adverse effect on our business.
We May Incur Significant Costs Complying With the Americans With Disabilities Act and Similar Laws
Under the Americans With Disabilities Act, places of public accommodation and/or commercial facilities are required to meet federal requirements related to access and use by disabled persons. We may be required to make substantial capital expenditures at our properties to comply with this law. In addition, our noncompliance could result in the imposition of fines or an award of damages to private litigants.
A number of additional federal, state and local laws and regulations exist regarding access by disabled persons. These regulations may require modifications to our properties or may affect future renovations. This may limit the overall returns on our investments.
We believe that our properties are substantially in compliance with the present requirements of the Americans With Disabilities Act and similar laws.
We May Incur Significant Costs If We Fail to Comply With Laws or If Laws Change
Our properties are subject to many federal, state and local regulatory requirements and to state and local fire and life-safety requirements. If we do not comply with all of these requirements, we may have to pay fines to governmental authorities or damage awards to private litigants. We believe that our properties are currently in compliance with all of these regulatory requirements. We do not know whether these requirements will change or whether new requirements will be imposed. Changes in these regulatory requirements could require us to make significant unanticipated expenditures. These expenditures could have an adverse effect on us and our ability to make distributions to stockholders.
The Loss of Services of Any of Our Senior Executive Officers Could Adversely Affect Us
We depend upon the services of relatively few executive officers. The loss of services of any one of them may adversely affect our business, financial condition and prospects. We use the extensive personal and business relationships that members of our management have developed over time with owners of life science properties and with major life science industry tenants. We cannot assure you that our senior executive officers will remain employed with us.
We May Change Our Business Policies Without Stockholder Approval
Our Board of Directors determines all of our material business policies, with management's input, including those related to our:
Our Board of Directors may amend or revise these policies at any time without a vote of our stockholders. A change in these policies could adversely affect our business and our ability to make distributions to our stockholders.
We Could Become Highly Leveraged and Our Debt Service Obligations Could Increase
Our organizational documents do not limit the amount of debt that we may incur. Therefore, we could become highly leveraged. This would result in an increase in our debt service obligations that could adversely affect our cash flow and our ability to make distributions to our stockholders.
We have adopted a policy of incurring debt only if, upon such incurrence, our debt to total market capitalization ratio would not exceed 60.0%. Our total market capitalization is the market value of our capital stock, including interests exchangeable for shares of capital stock, plus total debt. Our Board of Directors could, however, change or eliminate this policy at any time. Higher leverage could also increase the risk of default on our debt obligations.
Our Distributions to Stockholders May Decline at Any Time
We may not continue our current level of distributions to stockholders. Our Board of Directors will determine future distributions based on a number of factors, including:
Possible Future Sales of Shares of Our Common Stock Could Adversely Affect Its Market Price
We cannot predict the effect, if any, of future sales of shares of our common stock on the market price of our common stock from time to time. Sales of substantial amounts of capital stock (including common stock issued upon the exercise of stock options), or the perception that such sales may occur, could adversely affect prevailing market prices for our common stock.
We have reserved for issuance to our officers, directors and employees pursuant to our Amended and Restated 1997 Stock Award and Incentive Plan that number of shares of our common stock that equals 12% of the total number of shares outstanding at any time, provided that in no event may the number of shares of our common stock available for issuance under the plan exceed 3,000,000 shares at any time.
As of December 31, 2005, options to purchase 492,016 shares of our common stock were outstanding, all of which were exercisable. We have filed a registration statement with respect to the issuance of shares of our common stock pursuant to grants under our equity incentive plan. In addition, any shares issued under our equity incentive plan will be available for sale in the public market from time to time without restriction by persons who are not our "affiliates" (as defined in Rule 144 adopted under the Securities Act of 1933). Affiliates will be able to sell shares of our common stock pursuant to exemptions from registration requirements or upon registration.
External Factors May Adversely Impact the Valuation of Investments
We hold equity investments in certain publicly-traded companies and privately held entities primarily involved in the life science industry. The valuation of these investments is affected by many external factors beyond our control, including, but not limited to, market prices, market conditions, prospects for favorable or unfavorable clinical trial results, new product initiatives and new collaborative agreements. Unfavorable developments with respect to any of these factors may have an adverse impact on the valuation of our investments.
We Are Subject to Risks from Potential Fluctuations in Exchange Rates Between the U.S. Dollar and Foreign Currencies
As of December 31, 2005, we had three properties located in Canada. We are pursuing, and intend to continue to pursue, additional growth opportunities in Canada and other international markets. Investments in countries where the U.S. dollar is not the national currency are subject to international currency risk from the potential fluctuations in exchange rates between the U.S. dollar and the local currency. A significant decrease in the value of the Canadian dollar or other foreign currencies where we have a significant investment could materially affect our results of operations. We may attempt to mitigate such effects by borrowing in the local foreign currency in which we invest. Any international currency gain recognized with respect to changes in exchange rates may not qualify under the 75% gross income test or the 95% gross income test that we must satisfy annually in order to qualify and maintain our status as a REIT.
Available Information
We will provide, upon request and free of charge, paper copies of our annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, including any amendments to the foregoing reports, as soon as is reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission. These materials, along with our corporate governance guidelines, business integrity policy and board committee charters, are also available through our corporate website at http://www.labspace.com. The public may also download these materials from the Securities and Exchange Commission's website at http://www.sec.gov. Any amendments to, and waivers of, our Business Integrity Policy will be posted on our corporate website.
Employees
As of December 31, 2005, we had 93 full-time employees. We believe that we have good relations with our employees. We have adopted a Business Integrity Policy that applies to all of our employees. Its receipt and review by each employee is documented and verified annually.
Item 2. Properties
General.
As of December 31, 2005, we owned 134 properties comprising of approximately 8.8 million rentable square feet of office/laboratory space. Excluding properties under redevelopment, our properties were approximately 93.2% leased as of December 31, 2005. Our properties, some of which consist of multiple buildings, range in size up to 284,000 square feet, are built to accommodate single or multiple tenants and are generally one or two story concrete tilt-up, block and/or steel frame structures. The exteriors typically resemble traditional suburban office properties, but the interior infrastructures are designed to accommodate the needs of life science industry tenants. These improvements typically are generic to life science industry tenants rather than being specific to a particular tenant. As a result, we believe that the improvements have long-term value and utility and are usable by a wide range of life science industry tenants. Generic infrastructure improvements to our life science properties typically include:
We own a fee simple interest in each of our properties, except for the following twelve properties that account for approximately 10% of the total rentable square footage of our properties:
As of December 31, 2005, we had 283 leases with a total of 237 tenants, and 73 of our 134 properties were single-tenant properties. Leases in our multi-tenant buildings typically have terms of three to seven years, while the single-tenant building leases typically have initial terms of 10 to 20 years. As of December 31, 2005:
Our leases also typically give us the right to review and approve tenant alterations to the property. Generally, tenant-installed improvements to the properties remain our property after termination of the lease at our election. However, we are permitted under the terms of most of our leases to require that the tenant, at its expense, remove the improvements and restore the premises to their original condition.
As of December 31, 2005, we managed all of our properties.
Location of Properties
The locations of our properties are diversified among a number of life science markets. The following table sets forth, as of December 31, 2005, the total rentable square footage, annualized base rent and encumbrances of our properties in each of our existing markets (dollars in thousands).
% of Total Total Number Rentable Rentable % of of Square Square Annualized Annualized Markets Properties Footage Footage Base Rent (1) Base Rent Encumbrances (2) - --------------- --------- ----------- ---------- -------------- ----------- --------------- California - Pasadena 1 31,343 0.3% $793 0.4% $ -- California - San Diego 26 1,246,717 14.1% 27,509 13.8% 209,279 California - San Francisco Bay 18 1,302,280 14.8% 37,222 18.6% 40,867 Eastern Massachusetts 25 1,450,665 16.4% 37,290 18.7% 90,843 New Jersey/Suburban Philadelphia 8 501,223 5.7% 8,229 4.1% -- Southeast (3) 9 492,646 5.6% 8,059 4.0% 19,970 Suburban Washington D.C. 33 2,663,010 30.2% 50,430 25.3% 185,705 Washington - Seattle 11 840,123 9.5% 23,995 12.0% 66,025 International - Canada 3 296,362 3.4% 6,223 3.1% 6,387 --------- ----------- ---------- -------------- ----------- --------------- Total 134 8,824,369 100.0% $199,750 100.0% $619,076 (4) ========= =========== ========== ============== =========== ===============
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(1) Annualized base rent means the annualized fixed base rental amount in effect as of December 31, 2005 (using rental revenue computed on a straight-line basis in accordance with GAAP).
(2) Certain properties are pledged as security under our secured debt as of December 31, 2005. See Schedule III - Consolidated Financial Statement Schedule of Rental Properties and Accumulated Depreciation in "Item 15. Exhibits, Financial Statement Schedule" for additional information on our properties, including encumbered properties.
(3) North Carolina and Georgia.
(4) Excludes $47.6 million of encumbrances related to three land parcels located in the San Francisco Bay and Seattle markets.
In addition, as of December 31, 2005, our asset base contained strategically located ground-up development opportunities for approximately 5.1 million developable square feet of office/laboratory space.
Tenants
Our life science properties are leased principally to a diverse group of tenants, with no tenant being responsible for more than 4.4% of our annualized base rent. The following table sets forth information regarding leases with our 20 largest tenants based upon annualized base rent as of December 31, 2005.
20 Largest Tenants
Remaining Percentage Lease Approximate Percentage Percentage Annualized of Aggregate Number Term Aggregate of Aggregate Annualized of Aggregate Net Effective Annualized of in Rentable Leased Base Rent (in Annualized Rent (in Net Effective Tenant Leases Years Square Feet Square Feet thousands) (1) Base Rent thousands) (2) Rent - ---------------------------------------- -------- ------------ ------------ -------------- ------------ -------------- ------------- ZymoGenetics, Inc. 2 13.4 203,369 2.6% 8,747 4.4% $8,742 4.8% Human Genome Sciences, Inc. 4 1.1 260,258 3.4% 8,237 4.1% 8,078 4.4% Theravance, Inc. 2 6.3 170,244 2.2% 6,136 3.1% 5,885 3.2% GlaxoSmithKline 3 13.4 (3) 142,642 1.8% 5,871 2.9% 5,838 3.2% Oscient Pharmaceuticals Corporat 2 2.8 (4) 149,916 1.9% 5,413 2.7% 5,083 2.8% Quest Diagnostics Incorporated 1 11.0 248,186 3.2% 4,341 2.2% 4,340 2.4% Infinity Pharmaceuticals, Inc. 2 7.0 67,167 0.9% 4,302 2.2% 4,043 2.2% Telik, Inc. 1 8.4 91,644 1.2% 3,711 1.9% 3,607 2.0% Fred Hutchinson Cancer Research 3 8.0 (5) 116,606 1.5% 3,589 1.8% 3,231 1.8% Digene Corporation 1 10.8 143,585 1.9% 3,480 1.7% 3,047 1.7% ArQule, Inc. 1 9.4 128,325 1.7% 3,398 1.7% 3,398 1.9% Gene Logic Inc. 4 3.9 (6) 149,168 1.9% 3,352 1.7% 2,822 1.5% Amgen, Inc. 1 2.2 116,284 1.5% 3,295 1.7% 3,295 1.8% Merck & Co., Inc. 3 2.9 (7) 166,007 2.1% 3,250 1.6% 3,001 1.6% Senomyx, Inc. 1 1.0 86,962 1.1% 3,090 1.6% 2,956 1.6% Sunesis Pharmaceuticals, Inc. 1 7.5 53,980 0.7% 2,813 1.4% 2,231 1.2% Neurochem Inc. 1 14.9 162,362 2.1% 2,677 1.3% 2,677 1.5% Amylin Pharmaceuticals, Inc. 2 9.1 86,764 1.1% 2,672 1.3% 2,402 1.3% Johnson & Johnson 1 6.7 59,000 0.8% 2,671 1.3% 2,500 1.4% Bio Veris Corporation 2 4.1 (8) 117,241 1.5% 2,615 1.3% 2,469 1.3% ------- -------- ------------ ------------ -------------- ------------ -------------- ------------- Total/Weighted Average (9): 38 7.3 2,719,710 35.1% 83,660 41.9% $79,645 43.6% ======= ======== ============ ============ ============== ============ ============== =============
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(2) Annualized net effective rent is the annualized base rent in effect as of December 31, 2005 (using rental revenue computed on a straight-line basis in accordance with GAAP), less (for gross leases) real estate taxes and insurance, common area and other operating expenses and (for all leases) amortization of tenant improvements and leasing commissions.
(3) Amount shown is a weighted average of multiple leases with this tenant for 128,759 rentable square feet and 13,883 rentable square feet with remaining lease terms of 14.3 years and 5.8 years, respectively.
(4) Amount shown is a weighted average of multiple leases with this tenant for 68,460 rentable square feet and 81,456 rentable square feet with remaining lease terms of 5.2 years and 0.9 years, respectively.
(5) Amount shown is a weighted average of multiple leases with this tenant for 100,295 rentable square feet, 11,162 rentable square feet and 5,149 rentable square feet with remaining lease terms of 8.9 years, 2.9 years and 1.4 years, respectively.
(6) Amount shown is a weighted average of multiple leases with this tenant for 26,127 rentable square feet, 57,410 rentable square feet, 16,406 rentable square feet and 49,225 rentable square feet with remaining lease terms of 5.2 years, 5.1 years, 4.1 years and 1.9 years, respectively.
(7) Amount shown is a weighted average of multiple leases with this tenant for 89,923 rentable square feet and 76,084 rentable square feet with remaining lease terms of 4.8 years and 0.8 years, respectively.
(8) Amount shown is a weighted average of multiple leases with this tenant for 83,541 rentable square feet and 33,700 rentable square feet with remaining lease terms of 4.5 years and 3.1 years, respectively.
(9) Weighted average based on percentage of aggregate leased square feet.
Item 3. Legal Proceedings
To our knowledge, no litigation is pending against us, other than routine actions and administrative proceedings, substantially all of which are expected to be covered by liability insurance and which, in the aggregate, are not expected to have a material adverse effect on our financial condition, results of operations or cash flows.
Item 4. Submission of Matters to a Vote of Security Holders
We did not submit any matters to a vote of our security holders in the fourth quarter of the fiscal year ended December 31, 2005.
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded on the New York Stock Exchange ("NYSE") under the symbol "ARE". On March 13, 2006, the last reported sales price per share of our common stock was $92.57, and there were approximately 272 holders of record of our common stock (excluding beneficial owners whose shares are held in the name of CEDE & Co.). The following table sets forth the quarterly high and low sales prices per share of our common stock as reported on the NYSE and the distributions paid by us with respect to each such period.
Per Share Period High Low Distribution - ------ ------ ------ ------------ 2005 Fourth Quarter........................ $85.00 $76.02 $0.70 Third Quarter......................... $85.85 $73.02 $0.68 Second Quarter........................ $75.42 $62.09 $0.68 First Quarter......................... $74.50 $63.15 $0.66 2004 Fourth Quarter........................ $75.24 $65.51 $0.66 Third Quarter......................... $66.67 $56.50 $0.64 Second Quarter........................ $64.76 $50.88 $0.62 First Quarter......................... $65.20 $57.30 $0.60
Future distributions on our common stock will be determined by and at the discretion of our Board of Directors and will be dependent upon a number of factors, including actual cash available for distribution, our financial condition and capital requirements, the annual distribution requirements under the REIT provisions of the Internal Revenue Code and such other factors as our Board of Directors deems relevant. To maintain our qualification as a REIT, we must make annual distributions to stockholders of at least 90% of our taxable income for the current taxable year, determined without regard to deductions for dividends paid and excluding any net capital gains. Under certain circumstances, we may be required to make distributions in excess of cash flow available for distributions to meet these distribution requirements. In such a case, we may borrow funds or may raise funds through the issuance of additional debt or equity capital. We cannot assure you that we will make any future distributions.
The tax treatment of distributions on common stock paid in 2005 is as follows: (1) 71.8% ordinary dividend, (2) 24.1% return of capital, (3) 3.9% capital gain at 15%, and (4) 0.2% Section 1250 capital gain at 25%. The tax treatment of distributions paid in 2004 is as follows: (1) 76.8% ordinary dividend, (2) 19.8% return of capital, (3) 2.4% capital gain at 15%, and (4) 1.0% Section 1250 capital gain at 25%.
See "Item 12. Security Ownership of Certain Beneficial Owners and Management" for information on securities authorized for issuance under equity compensation plans.
Item 6. Selected Financial Data
The following table should be read in conjunction with our consolidated financial statements and notes thereto appearing elsewhere in this Form 10-K. See "Item 15. Exhibits, Financial Statement Schedule".
Year Ended December 31, --------------------------------------------------------------- 2005 2004 2003 2002 2001 ----------- ----------- ----------- ----------- ----------- (Dollars in thousands, except per share amounts) Operating Data: Total revenue ............................................................. $ $244,084 $ $183,081 $ $160,354 $ $142,067 $ $120,658 Total expenses ............................................................ 180,149 124,645 111,995 103,936 93,217 Minority interest ......................................................... 634 - - - - ----------- ----------- ----------- ----------- ----------- Income from continuing operations.......................................... 63,301 58,436 48,359 38,131 27,441 Income from discontinued operations, net.................................. 132 1,759 11,284 1,901 2,836 ----------- ----------- ----------- ----------- ----------- Net income................................................................. 63,433 60,195 59,643 40,032 30,277 Dividends on preferred stock............................................... 16,090 12,595 8,898 8,579 3,666 Preferred stock redemption charge.......................................... - 1,876 - - - ----------- ----------- ----------- ----------- ----------- Net income available to common stockholders................................ $ 47,343 $ 45,724 $ 50,745 $ 31,453 $ 26,611 =========== =========== =========== =========== =========== Earnings per share - basic: Continuing operations (net of preferred stock dividends and preferred stock redemption charge) .......................... $ 2.25 $ 2.28 $ 2.08 $ 1.68 $ 1.49 Discontinued operations, net........................................ 0.01 0.09 0.59 0.11 0.18 ----------- ----------- ----------- ----------- ----------- Earnings per share - basic.......................................... $ 2.26 $ 2.37 $ 2.67 $ 1.79 $ 1.67 =========== =========== =========== =========== =========== Earnings per share - diluted: Continuing operations (net of preferred stock dividends and preferred stock redemption charge) .......................... $ 2.21 $ 2.24 $ 2.05 $ 1.65 $ 1.47 Discontinued operations, net........................................ 0.01 0.09 0.59 0.11 0.17 ----------- ----------- ----------- ----------- ----------- Earnings per share - diluted........................................ $ 2.22 $ 2.33 $ 2.64 $ 1.76 $ 1.64 =========== =========== =========== =========== =========== Weighted average shares of common stock outstanding Basic .............................................................. 20,948,915 19,315,364 18,993,856 17,594,228 15,953,459 =========== =========== =========== =========== =========== Diluted ............................................................ 21,316,886 19,658,759 19,247,790 17,859,787 16,208,178 =========== =========== =========== =========== =========== Cash dividends declared per share of common stock.......................... $ 2.72 $ 2.52 $ 2.20 $ 2.00 $ 1.84 =========== =========== =========== =========== =========== Year Ended December 31, --------------------------------------------------------------- 2005 2004 2003 2002 2001 ----------- ----------- ----------- ----------- ----------- (Dollars in thousands) Balance Sheet Data (at year end): Rental properties, net .................................................... $ 1,788,818 $ 1,427,853 $ 982,297 $ 976,422 $ 796,626 Total assets .............................................................. $ 2,362,450 $ 1,872,284 $ 1,272,577 $ 1,159,243 $ 962,146 Secured notes payable, unsecured line of credit and unsecured term loan ... $ 1,406,666 $ 1,186,946 $ 709,007 $ 614,878 $ 573,161 Total liabilities ......................................................... $ 1,512,535 $ 1,251,811 $ 765,442 $ 673,390 $ 629,508 Minority interest ......................................................... $ 20,115 $ - $ - $ - $ - Stockholders' equity ...................................................... $ 829,800 $ 620,473 $ 507,135 $ 485,853 $ 332,638 Reconciliation of Net Income Available to Common Stockholders to Funds from Operations Available to Common Stockholders: Net income available to common stockholders (1)............................ $ 47,343 $ 45,724 $ 50,745 $ 31,453 $ 26,611 Add: Depreciation and amortization (2).......................................... 55,416 42,523 38,901 34,071 30,578 Impairment of investments.................................................. - - - 2,545 - Minority interest.......................................................... 634 - - - - Subtract: Gain/loss on sales of property (3)......................................... (36) (1,627) (8,286) - - FFO allocable to minority interest......................................... (668) - - - - ----------- ----------- ----------- ----------- ----------- Funds from operations available to common stockholders (4) ................ $ 102,689 $ 86,620 $ 81,360 $ 68,069 $ 57,189 =========== =========== =========== =========== =========== Other Data: Cash flows from operating activities ...................................... $ 120,678 65,316 74,311 67,050 60,340 Cash flows from investing activities ...................................... $ (432,900) (448,252) (139,274) (227,840) (192,179) Cash flows from financing activities ...................................... $ 312,975 381,109 66,158 162,204 131,439 Number of properties owned at year end .................................... 134 113 91 91 85 Rentable square feet of properties owned at year end....................... 8,824,369 7,448,570 5,728,470 5,799,562 5,372,485 Occupancy of properties owned at year end ................................. 88% 87% 88% 89% 89% Occupancy of properties owned at year end, excluding properties under redevelopment........................................................... 93% 95% 94% 96% 99%
(1) During the second quarter of 2004, we elected to redeem the 9.50% Series A cumulative redeemable preferred stock ("Series A preferred stock"). Accordingly, in compliance with Emerging Issues Task Force Topic D-42, we recorded a charge of $1,876,000, or $0.10 per common share (diluted) in the second quarter of 2004 for costs related to the redemption of the Series A preferred stock.
(2) Includes depreciation and amortization on assets "held for sale" reflected as discontinued operations (for the periods prior to when such assets were designated as "held for sale").
(3) Gain/loss on sales of property relates to the disposition of a property in the Southeast market during the third quarter of 2005, the disposition of a property in the Suburban Washington D.C. market during the first quarter of 2004, the disposition of a property in the Suburban Washington D.C. market during the fourth quarter of 2003, the disposition of a property in the Eastern Massachusetts market during the third quarter of 2003, and the disposition of a property in the San Francisco Bay market during the first quarter of 2003. Gain/loss on sales of property is included in the income statement in income from discontinued operations, net.
(4) GAAP basis accounting for real estate assets utilizes historical cost accounting and assumes real estate values diminish over time. In an effort to overcome the difference between real estate values and historical cost accounting for real estate assets, the Board of Governors of the National Association of Real Estate Investment Trusts ("NAREIT") established the measurement tool of Funds From Operations ("FFO"). Since its introduction, FFO has become a widely used non-GAAP financial measure by REITs. We believe that FFO is helpful to investors as an additional measure of the performance of an equity REIT. We compute FFO in accordance with standards established by the Board of Governors of NAREIT in its April 2002 White Paper (the "White Paper") and related implementation guidance, which may differ from the methodology for calculating FFO utilized by other equity REITs, and, accordingly, may not be comparable to such other REITs. The White Paper defines FFO as net income (loss) (computed in accordance with GAAP), excluding gains (or losses) from sales, plus real estate related depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. While FFO is a relevant and widely used measure of operating performance for REITs, it should not be considered as an alternative to net income (determined in accordance with GAAP) as an indication of financial performance, or to cash flows from operating activities (determined in accordance with GAAP) as a measure of our liquidity, nor is it indicative of funds available to fund our cash needs, including our ability to make distributions. For a more detailed discussion of FFO, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Funds From Operations".
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation
The terms "Company", "we", "our" and "us" as used in this Form 10-K refer to Alexandria Real Estate Equities, Inc. and its subsidiaries. The following discussion should be read in conjunction with our consolidated financial statements and notes in "Item 15. Exhibits, Financial Statement Schedule".
Overview
The following factors, among others, could cause actual results and future events to differ from those set forth or contemplated in the forward-looking statements:
Our success also depends upon economic trends and various market conditions. We caution you not to place undue reliance on forward-looking statements, which reflect our analysis only and speak as of the date of this report or, if different, as of the dates indicated in the statements. We assume no obligation to update or supplement forward-looking statements.
We are a publicly-traded real estate investment trust focused principally on the ownership, operation, management, acquisition and selective redevelopment and development of properties containing office/laboratory space. Such properties are designed and improved for lease primarily to institutional (universities and not-for-profit institutions), pharmaceutical, biotechnology, life science product, service, biodefense and translational research entities, as well as government agencies.
In 2005, we:
As of December 31, 2005, we had 134 properties containing approximately 8.8 million rentable square feet of office/laboratory space. As of that date, our properties were approximately 93% leased, excluding those properties in our redevelopment program.
Our primary sources of revenue are rental income and tenant recoveries from leases of our properties. The comparability of financial data from period to period is affected by the timing of our property acquisition, development and redevelopment activities. Of the 134 properties as of December 31, 2005, four were acquired in 1994, nine in 1996, nine in 1997, 27 in 1998, six in 1999, 11 in 2000, five in 2001, four in 2002, four in 2003, 22 in 2004 and 19 in 2005. In addition, we completed the development of one property in 1999, five properties in 2000 (together with the 11 properties acquired in 2000), two properties in 2001 (together with the five properties acquired in 2001), two properties in 2002 (together with the four properties acquired in 2002), one property in 2004 (together with the 22 properties acquired in 2004, the "2004 Properties") and three properties in 2005 (together with the 19 properties acquired in 2005, the "2005 Properties"). As a result of these acquisition and development activities, as well as our ongoing leasing and redevelopment activities, there have been significant increases in total revenues and expenses, including significant increases in total revenues and expenses for 2005 as compared to 2004, and for 2004 as compared to 2003.
As of December 31, 2005, approximately 85% of our leases (on a square footage basis) were triple net leases, requiring tenants to pay substantially all real estate taxes and insurance, common area and other operating expenses, including increases thereto. In addition, as of December 31, 2005, approximately 6% of our leases (on a square footage basis) required the tenants to pay a majority of operating expenses. Additionally, as of December 31, 2005, approximately 89% of our leases (on a square footage basis) provided for the recapture of certain capital expenditures and approximately 90% of our leases (on a square footage basis) contained effective annual rent escalations that are either fixed or indexed based on the consumer price index or another index.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles ("GAAP"). Our significant accounting policies are described in the notes to our consolidated financial statements in "Item 15. Exhibits, Financial Statement Schedule". The preparation of these financial statements in conformity with GAAP requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. We base these estimates, judgments and assumptions on historical experience and on various other factors that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.
REIT Compliance
We have elected to be taxed as a real estate investment trust ("REIT") under the Internal Revenue Code. Qualification as a REIT involves the application of highly technical and complex provisions of the Internal Revenue Code to our operations and financial results, and the determination of various factual matters and circumstances not entirely within our control. We believe that our current organization and method of operation comply with the rules and regulations promulgated under the Internal Revenue Code to enable us to qualify, and continue to qualify, as a REIT. However, it is possible that we have been organized or have operated in a manner that would not allow us to qualify as a REIT, or that our future operations could cause us to fail to qualify.
If we fail to qualify as a REIT in any taxable year, then we will be required to pay federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates. If we lose our REIT status, then our net earnings available for investment or distribution to stockholders would be significantly reduced for each of the years involved and we would no longer be required to make distributions to our stockholders.
Rental Properties, Properties Under Development and Land Held For Development
In accordance with Statement of Financial Accounting Standards No. 141, "Business Combinations", we perform the following procedures when making an allocation of the purchase price of real estate: (1) estimate the value of the real estate as of the acquisition date on an "as if vacant" basis; (2) allocate the "as if vacant" value among land, land improvements, buildings, building improvements, tenant improvements and equipment; (3) calculate the value of the intangibles as the difference between the "as if vacant" value and the purchase price; and (4) allocate the intangible value to above, below and at market leases, origination costs associated with in-place leases, tenant relationships and other intangible assets.
The values allocated to land improvements, buildings, building improvements, tenant improvements and equipment are depreciated on a straight-line basis using an estimated life of 20 years for land improvements, 40 years for buildings and building improvements, the respective lease term for tenant improvements and the estimated useful life for equipment. The values of above and below market leases are amortized over the life of the related lease and recorded as either an increase (for below market leases) or a decrease (for above market leases) to rental income. The values of at-market leases and origination costs are classified as leasing costs, included in other assets on our balance sheets and amortized over the remaining life of the lease.
Rental properties, properties under development and land held for development are individually evaluated for impairment when conditions exist which may indicate that it is probable that the sum of expected future undiscounted cash flows is less than the carrying amount of the property. Upon determination that an impairment has occurred, a write-down is recorded to reduce the carrying amount of the property to its estimated fair value.
Capitalization of Costs
In accordance with Statement of Financial Accounting Standards No. 34, "Capitalization of Interest Cost" ("SFAS 34") and Statement of Financial Accounting Standards No. 67, "Accounting for Costs and Initial Rental Operations of Real Estate Projects" ("SFAS 67"), we capitalize direct construction, including predevelopment costs, interest, property taxes, insurance and other costs directly related and essential to the acquisition, development, redevelopment or construction of a project. Pursuant to SFAS 34 and SFAS 67, capitalization of construction, development and redevelopment costs is required while activities are ongoing to prepare an asset for its intended use. Costs incurred after a project is substantially complete and ready for its intended use are expensed as incurred. Costs previously capitalized related to abandoned acquisition or development opportunities are written off. Should development, redevelopment or construction activity cease, a portion of interest, property taxes, insurance and certain costs would no longer be eligible for capitalization, and would be expensed as incurred. Expenditures for repairs and maintenance are expensed as incurred.
We also capitalize costs directly related and essential to our leasing activities. These costs are amortized on a straight-line basis over the terms of the related leases. Costs that were previously capitalized and which related to unsuccessful leasing opportunities are written off.
Accounting for Investments
We hold equity investments in certain publicly-traded companies and privately held entities primarily involved in the life science industry. All of our investments in publicly-traded companies are considered "available for sale" in accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"), and are recorded at fair value. Fair value has been determined as the closing trading price at the balance sheet date, with unrealized gains and losses shown as a separate component of stockholders' equity. The classification of investments under SFAS 115 is determined at the time each investment is made, and such determination is reevaluated at each balance sheet date. The cost of investments sold is determined by the specific identification method, with net realized gains included in other income.
Investments in privately held entities are generally accounted for under the cost method because we do not influence any operating or financial policies of the entities in which we invest. Certain investments are accounted for under the equity method in accordance with Accounting Principles Board Opinion No. 18, "The Equity Method of Accounting for Investments in Common Stock" and Emerging Issues Task Force Topic D-46, "Accounting for Limited Partnership Investments". Under the equity method of accounting, we record our investment initially at cost and adjust the carrying amount of the investment to recognize our share of the earnings or losses of the investee subsequent to the date of our investment.
For all of our investments, if a decline in the fair value of an investment below its carrying value is determined to be other than temporary, such investment is written down to its estimated fair value with a non-cash charge to current earnings. The factors that we consider in making these assessments include, but are not limited to, market prices, market conditions, financial condition, prospects for favorable or unfavorable clinical trial results, new product initiatives and/or sales, and new collaborative agreements.
Interest Rate Swap Agreements
We utilize interest rate swap agreements to hedge a portion of our exposure to variable interest rates associated with our unsecured line of credit and unsecured term loan. These agreements involve an exchange of fixed and floating rate interest payments without the exchange of the underlying principal amount (the "notional amount"). Interest received under all of our swap agreements is based on the one-month LIBOR rate. The net difference between the interest paid and the interest received is reflected as an adjustment to interest expense.
We reflect our interest rate swap agreements on the balance sheet at their estimated fair values with an offsetting adjustment reflected as unrealized gains/losses in accumulated other comprehensive income in stockholders' equity. We use a variety of methods and assumptions based on market conditions and risks existing at each balance sheet date to determine the fair values of our interest rate swap agreements. These methods of assessing fair value result in a general approximation of value, and such value may never be realized.
All of our interest rate swap agreements meet the criteria to be deemed "highly effective" under the provisions of Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133") in reducing our exposure to variable interest rates. In accordance with SFAS 133, we formally document all relationships between interest rate swap agreements and hedged items, including the method for evaluating effectiveness and the risk strategy. Accordingly, we have categorized these instruments as cash flow hedges. We make an assessment at the inception of each interest rate swap agreement and on an on-going basis to determine whether these instruments are highly effective in offsetting changes in cash flows associated with the hedged items. While we intend to continue to meet the conditions for such hedge accounting, if hedges did not qualify as "highly effective", the changes in the fair values of the derivatives used as hedges would be reflected in earnings.
We do not believe we are exposed to a significant amount of credit risk in our interest rate swap agreements as our counterparties are established, well-capitalized financial institutions.
Recognition of Rental Income and Tenant Recoveries
Rental income from leases with scheduled rent increases, free rent, incentives and other rent adjustments is recognized on a straight-line basis over the respective lease terms. We include amounts currently recognized as income, and expected to be received in later years, in deferred rent in the accompanying consolidated balance sheets. Amounts received currently, but recognized as income in future years, are included as unearned rent in accounts payable, accrued expenses and tenant security deposits in the accompanying consolidated balance sheets. We commence recognition of rental income at the date the tenant takes possession of or controls the physical use of the property.
Tenant recoveries related to reimbursement of real estate taxes, insurance, repairs and maintenance, and other operating expenses are recognized as revenue in the period the applicable expenses are incurred.
We maintain an allowance for estimated losses that may result from the inability of our tenants to make payments required under the terms of the lease. If a tenant fails to make contractual payments beyond any allowance, we may recognize additional bad debt expense in future periods equal to the amount of unpaid rent and unrealized deferred rent.
Discontinued Operations
We follow the provisions of Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" in determining whether a property qualifies as an asset "held for sale" and should be classified as "discontinued operations". A property is classified as "held for sale" when all of the following criteria for a plan of sale have been met: (1) management, having the authority to approve the action, commits to a plan to sell the property; (2) the property is available for immediate sale in its present condition, subject only to the terms that are usual and customary; (3) an active program to locate a buyer, and other actions required to complete the plan to sell, have been initiated; (4) the sale of the property is probable and is expected to be completed within one year; (5) the property is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and (6) actions necessary to complete the plan of sale indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. When all of these criteria have been met, the property is classified as "held for sale" and its operations are classified as discontinued operations in our consolidated statements of income. When a property is designated as "held for sale", amounts for all prior periods presented are reclassified from continuing operations to discontinued operations. A loss is recognized for any initial adjustment of the asset's carrying amount to fair value less costs to sell in the period the asset qualifies as "held for sale". Depreciation of assets is discontinued commencing on the date they are designated as "held for sale".
Results of Operations
Comparison of the Year Ended December 31, 2005 to the Year Ended December 31, 2004
Rental revenues increased by $45.6 million, or 32%, to $189.3 million for 2005 compared to $143.7 million for 2004. The increase resulted primarily from the 2004 Properties being owned for a full year and the addition of the 2005 Properties.
Tenant recoveries increased by $14.1 million, or 39%, to $50.0 million for 2005 compared to $35.8 million for 2004. The increase resulted primarily from the 2004 Properties being owned for a full year and the addition of the 2005 Properties.
Other income increased by $1.3 million, or 35%, to $4.8 million for 2005 compared to $3.5 million for 2004, primarily due to an increase in miscellaneous sources of income.
Rental operating expenses increased by $16.1 million, or 42%, to $54.5 million for 2005 compared to $38.4 million for 2004. The increase resulted primarily from increases in rental operating expenses (primarily property taxes and utilities) from properties acquired, placed in service or redeveloped in 2005. The majority of the increase in rental operating expenses is recoverable from our tenants through tenant recoveries.
General and administrative expenses increased by $6.0 million, or 40%, to $21.1 million for 2005 compared to $15.1 million for 2004, primarily due to the growth in both the depth and breadth of our operations in multiple markets, including internationally, from 113 properties with approximately 7.4 million rentable square feet as of December 31, 2004 to 134 properties with approximately 8.8 million rentable square feet as of December 31, 2005 and the costs associated with continued compliance with Section 404 of the Sarbanes-Oxley Act. As a percentage of total revenues, general and administrative expenses for 2005 remained relatively consistent with 2004.
Interest expense increased by $20.4 million, or 71%, to $49.1 million for 2005 compared to $28.7 million for 2004. The increase resulted primarily from increases in indebtedness on our unsecured line of credit, unsecured term loan and secured notes payable, and increases in the floating interest rates on our unsecured line of credit, unsecured term loan and other floating rate debt. These borrowings were utilized to finance the acquisition of the 2004 and 2005 Properties, and the development and redevelopment of properties. The weighted average effective interest rate on our unsecured line of credit and unsecured term loan (not including the effect of interest rate swap agreements) increased from 3.72% as of December 31, 2004 to 5.68% as of December 31, 2005. We have entered into certain swap agreements to hedge a portion of our exposure to variable interest rates with our unsecured line of credit and unsecured term loan (see "Liquidity and Capital Resources - Interest Rate Swaps").
Depreciation and amortization increased by $12.9 million, or 30%, to $55.4 million for 2005 compared to $42.5 million for 2004. The increase resulted primarily from depreciation associated with the 2004 Properties being owned for a full year and the addition of the 2005 Properties.
Income from discontinued operations of $132,000 for 2005 reflects the results of operations of one property that was designated as "held for sale" as of June 30, 2005. In connection with the sale of this property in the third quarter of 2005, we recorded a gain of approximately $36,000. Income from discontinued operations of $1.8 million for 2004 primarily reflects the results of operations of one property that was designated as "held for sale" as of December 31, 2003. In connection with the sale of this property in the first quarter of 2004, we recorded a gain of approximately $1.6 million.
Comparison of the Year Ended December 31, 2004 to the Year Ended December 31, 2003
Rental revenues increased by $17.5 million, or 14%, to $143.7 million for 2004 compared to $126.2 million for 2003. The increase resulted primarily from the 2003 Properties being owned for a full year and the addition of the 2004 Properties.
Tenant recoveries increased by $3.8 million, or 12%, to $35.8 million for 2004 compared to $32.0 million for 2003. The increase resulted primarily from the 2003 Properties being owned for a full year and the addition of the 2004 Properties.
Other income increased by $1.5 million, or 71%, to $3.5 million for 2004 compared to $2.1 million for 2003, primarily due to an increase in net realized gains on investments and from an increase in miscellaneous sources of income.
Rental operating expenses increased by $5.6 million, or 17%, to $38.4 million for 2004 compared to $32.8 million for 2003. The increase resulted primarily from the 2003 Properties being owned for a full year and the addition of the 2004 Properties.
General and administrative expenses increased by $894,000, or 6%, to $15.1 million for 2004 compared to $14.2 million for 2003, mainly due to compliance with Section 404 of the Sarbanes-Oxley Act, Operation Outreach and general increases in administrative costs. Our Operation Outreach program provides financial assistance to families of activated and deployed soldiers that face considerable financial challenges and have significant financial needs. As a percentage of total revenues, general and administrative expenses for 2004 remained relatively consistent with 2003.
Interest expense increased by $2.3 million, or 9%, to $28.7 million for 2004 compared to $26.4 million for 2003. The increase resulted primarily from increases in indebtedness on our unsecured line of credit, unsecured term loan and secured notes payable, and to increases in the floating interest rates on our unsecured line of credit and unsecured term loan. These borrowings were utilized to finance the acquisition of the 2003 and 2004 Properties, and the development and redevelopment of properties. The weighted average effective interest rate on these borrowings (not including the effect of interest rate swap agreements) increased from 2.64% as of December 31, 2003 to 3.72% as of December 31, 2004. We have entered into certain swap agreements to hedge a portion of our exposure to variable interest rates with our unsecured line of credit and unsecured term loan (see "Liquidity and Capital Resources - Interest Rate Swaps").
Depreciation and amortization increased by $3.9 million, or 10%, to $42.5 million for 2004 compared to $38.6 million for 2003. The increase resulted primarily from depreciation associated with the 2003 Properties being owned for a full year and the addition of the 2004 Properties.
Income from discontinued operations of $1.8 million for 2004 primarily reflects the results of operations of one property that was designated as "held for sale" as of December 31, 2003. In connection with this sale, we recorded a gain of approximately $1.6 million during 2004. Income from discontinued operations of $11.3 million for 2003 primarily reflects the results of operations of three properties that were designated as "held for sale" as of December 31, 2002. In connection with the sale of these properties, we recorded a net gain of approximately $8.3 million during 2003.
Liquidity and Capital Resources
Cash Flows
Net cash provided by operating activities for 2005 increased by $55.4 million to $120.7 million compared to $65.3 million for 2004. The increase resulted primarily from increases in cash flows from our operating properties, and increases in accounts payable, accrued expenses and tenant security deposits.
Net cash used in investing activities for 2005 decreased by $15.4 million to $432.9 million compared to $448.3 million for 2004. This decrease was primarily due to decreases in additions to properties under development and land held for development, and property acquisitions, partially offset by an increase in additions to rental properties.
Net cash provided by financing activities for 2005 decreased by $68.1 million to $313.0 million compared to $381.1 million for 2004. This decrease was primarily due to decreases in the proceeds from secured notes payable and from issuances of preferred stock, an increase in the principal reductions of secured notes payable, and increases in dividends paid on common stock and preferred stock. This was partially offset by the net proceeds from issuances of common stock, a decrease in repayments of our unsecured line of credit and unsecured term loan and the decrease in redemption of preferred stock.
Off-Balance Sheet Arrangements
As of December 31, 2005, we had no off-balance sheet arrangements.
Contractual Obligations and Commitments
Contractual obligations as of December 31, 2005, consisted of the following (in thousands):
Payments by Period ----------------------------------------------- Total 2006 2007-2008 2009-2010 Thereafter - -------------------------------------------------------------------------------------------- Secured notes payable (1) $ 662,147 $ 44,552 $ 206,813 $ 130,637 $ 280,145 Unsecured line of credit and unsecured term loan 740,000 -- 240,000 500,000 -- Ground lease obligations 62,774 1,730 3,538 3,664 53,842 Other obligations 6,248 887 1,816 1,819 1,726 ------------ ----------- ------------ ---------- ------------ Total $ 1,471,169 $ 47,169 $ 452,167 $ 636,120 $ 335,713 ============ =========== ============ ========== ============
(1) Excludes unamortized premiums of $4.5 million as of December 31, 2005.
Secured notes payable as of December 31, 2005 included 34 notes secured by 67 properties and three land development parcels.
In November 2005, we amended our unsecured line of credit and our unsecured term loan (see "Unsecured Line of Credit and Unsecured Term Loan " below). The unsecured line of credit matures in December 2007 and may be extended at our sole option for an additional one-year period. The unsecured term loan matures in December 2009.
Ground lease obligations as of December 31, 2005 included leases for seven of our properties and one land development parcel. These lease obligations have remaining lease terms of 27 to 50 years, exclusive of extension options.
In addition to the above, we were committed as of December 31, 2005 under the terms of contracts to complete the construction of properties under development at a remaining aggregate cost of $46.4 million.
As of December 31, 2005, we were also committed to fund approximately $20.1 million for the construction of building infrastructure improvements under the terms of leases and/or construction contracts and approximately $13.3 million for certain investments.
Tenant Security Deposits and Other Restricted Cash
Tenant security deposits and other restricted cash consisted of the following (in thousands):
December 31, ---------------------- 2005 2004 ---------- ---------- Funds held in trust under the terms of certain secured notes payable $ 13,838 $ 11,241 Security deposit funds based on the terms of certain lease agreements 2,047 2,045 Other funds held in escrow 5,128 4,383 ---------- ---------- $ 21,013 $ 17,669 ========== ==========
Secured Notes Payable
Secured notes payable consisted of the following (in thousands):
December 31, --------------------- 2005 2004 ---------- ---------- Secured notes payable, interest rates varying from 4.32% to 8.75%, $ 662,147 $ 635,432 (weighted average effective interest rate of 6.31% and 5.67% at December 31, 2005 and 2004, respectively), maturity dates ranging from January 2006 to June 2016 Unamortized premiums 4,519 3,514 ----------- ---------- Total secured notes payable $ 666,666 $ 638,946 ======================
Our secured notes payable generally require monthly payments of principal and interest. The total book values of properties securing debt were $848,286,000 and $776,342,000 at December 31, 2005 and 2004, respectively. At December 31, 2005, our secured notes payable were comprised of $595.9 million and $70.8 million of fixed and variable rate debt, respectively, compared to $437.2 million and $201.7 million of fixed and variable rate debt, respectively, at December 31, 2004.
The following is a summary of the scheduled principal payments for our secured notes payable and the weighted average interest rates as of December 31, 2005 (in thousands):
Weighted Average Year Amount Interest Rate(1) ----------------------- ----------- ------------- 2006 $ 44,552 6.32% 2007 83,623 6.26% 2008 123,190 6.16% 2009 42,084 6.52% 2010 88,553 6.48% Thereafter 280,145 6.24% ----------- Subtotal 662,147 Unamortized premiums 4,519 ----------- Total secured notes payable $ 666,666 ===========
(1) The weighted average interest rate is calculated based on the outstanding debt as of January 1st of each year.
Unsecured Line of Credit and Unsecured Term Loan
In November 2005, we entered into an amendment to our amended and restated credit agreement to increase the maximum permitted borrowings under our unsecured credit facilities from $750 million to $1 billion consisting of a $500 million unsecured revolving credit facility and a $500 million unsecured term loan. We may in the future elect to increase commitments under the unsecured credit facilities by up to an additional $200 million.
Borrowings under our unsecured line of credit, as amended, bear interest at a floating rate based on our election of either a LIBOR- based rate or the higher of the bank's reference rate and the Federal Funds rate, plus 0.5%. For each LIBOR-based advance, we must elect a LIBOR period of one, two, three or six months. The unsecured line of credit matures in December 2007 and may be extended at our sole option for an additional one-year period. As of December 31, 2005, we had borrowings of $240 million outstanding on the unsecured line of credit with a weighted average interest rate of 5.69%.
Our unsecured term loan bears interest at a floating rate based on our election of either a LIBOR-based rate or the higher of the bank's reference rate and the Federal Funds rate, plus 0.5%. For each LIBOR-based advance, we must elect to fix for a period of one, two, three or six months. The unsecured term loan matures in December 2009. As of December 31, 2005, we had borrowings of $500 million outstanding on the unsecured term loan with a weighted average interest rate of 5.67%.
Our unsecured line of credit and unsecured term loan contain financial covenants, including, among other things, maintenance of minimum net worth, a leverage ratio and a fixed charge coverage ratio. In addition, the terms of the unsecured line of credit and unsecured term loan restrict, among other things, certain investments, indebtedness, distributions and mergers.
Aggregate borrowings under the unsecured line of credit and unsecured term loan may be limited to an amount based on the net operating income derived from a pool of unencumbered properties. Accordingly, as we acquire or complete the development or redevelopment of additional unencumbered properties, aggregate borrowings available under the unsecured line of credit and unsecured term loan will increase up to a maximum combined amount of $1 billion. Under these provisions as of December 31, 2005, aggregate borrowings under our unsecured line of credit and unsecured term loan were limited to $863 million.
Interest Rate Swaps
The following table summarizes our interest rate swap agreements as of December 31, 2005 (dollars in thousands):
Notional Effective at Interest Termination Fair Transaction Dates Effective Dates Amounts December 31, 2005 Pay Rates Dates Values - ------------------ ---------------- --------- ------------------- --------- ---------------- --------- December 2002 January 2, 2003 $25,000 $ 25,000 3.285% June 30, 2006 $ 167 December 2002 January 2, 2003 25,000 25,000 3.285% June 30, 2006 167 December 2003 December 30, 2005 50,000 50,000 4.150% December 29, 2006 280 December 2003 December 29, 2006 50,000 -- 5.090% October 31, 2008 (313) March 2004 December 31, 2004 25,000 25,000 2.956% December 31, 2006 434 March 2004 December 31, 2004 25,000 25,000 2.956% December 31, 2006 434 April 2004 April 29, 2005 50,000 50,000 3.140% April 28, 2006 230 April 2004 April 28, 2006 50,000 -- 4.230% April 30, 2007 274 April 2004 April 30, 2007 50,000 -- 4.850% April 30, 2008 (63) June 2004 June 30, 2005 50,000 50,000 4.343% June 30, 2007 284 December 2004 December 31, 2004 50,000 50,000 3.590% January 2, 2008 1,129 December 2004 January 3, 2006 50,000 -- 3.927% July 1, 2008 950 May 2005 December 30, 2005 25,000 25,000 4.120% November 30, 2006 136 May 2005 June 30, 2006 50,000 -- 4.270% June 29, 2007 250 May 2005 November 30, 2006 25,000 -- 4.330% November 30, 2007 103 May 2005 June 29, 2007 50,000 -- 4.400% June 30, 2008 162 May 2005 November 30, 2007 25,000 -- 4.460% November 28, 2008 61 May 2005 June 30, 2008 50,000 -- 4.509% June 30, 2009 112 May 2005 November 28, 2008 25,000 -- 4.615% November 30, 2009 41 December 2005 December 29, 2006 50,000 -- 4.730% November 30, 2009 17 December 2005 December 29, 2006 50,000 -- 4.740% November 30, 2009 4 December 2005 January 2, 2008 50,000 -- 4.768% December 31, 2010 8 ------------------- --------- Total Interest Rate Swap Agreements in $ 325,000 $ 4,867 Effect at December 31, 2005 =================== =========
We do not believe we are exposed to a significant amount of credit risk in our interest rate swap agreements as our counterparties are established, well-capitalized financial institutions. In addition, we have entered into master derivative agreements with each counterparty. These master derivative agreements (all of which are on the standard International Swaps & Derivatives Association, Inc. form) define certain terms between us and each counterparty to address and minimize certain risks associated with our swap agreements, including a default by a counterparty.
As of December 31, 2005, our interest rate swap agreements were classified in other assets at their fair values aggregating approximately $4.9 million, with the offsetting adjustment reflected as unrealized gains in accumulated other comprehensive income in stockholders' equity. As of December 31, 2004, our interest rate swap agreements were classified in accounts payable, accrued expenses and tenant security deposits at their fair values aggregating approximately $2.1 million, with the offsetting adjustment reflected as unrealized losses in accumulated other comprehensive income in stockholders' equity. Balances in accumulated other comprehensive income are recognized in earnings as swap payments are made. During the next twelve months, we expect to reclassify $3.3 million from accumulated other comprehensive income to interest income.
Other Resources and Liquidity Requirements
In March 2005, we sold 1,437,500 shares of our common stock in an underwritten offering (including the shares issued upon exercise of the underwriter's over-allotment option). The shares were issued at a price of $62.51 per share, resulting in aggregate proceeds of approximately $89.1 million (after deducting underwriting discounts and other offering costs).
In September 2005, we sold 1,248,000 shares of our common stock in an underwritten offering (including shares issued upon exercise of the underwriter's over-allotment option). The shares were issued at a price of $81.00 per share, resulting in net proceeds of approximately $100.3 million (after deducting underwriting discounts and other offering costs).
As of December 31, 2005, we had approximately $305 million of available capacity for future issuances of debt, equity and other securities under a shelf registration statement filed with the Securities and Exchange Commission. These securities may be issued from time to time and at our discretion based on our needs and market conditions.
In November 2005, we entered into an amendment to our existing amended and restated credit agreement. The maximum permitted borrowings under the credit facilities was increased from $750 million to $1 billion consisting of a $500 million unsecured revolving credit facility and a $500 million unsecured term loan. We may in the future elect to increase commitments under the unsecured credit facilities by up to an additional $200 million.
We expect to continue meeting our short-term liquidity and capital requirements generally through our working capital and net cash provided by operating activities. We believe that the net cash provided by operating activities will continue to be sufficient to enable us to make distributions necessary to continue qualifying as a REIT. We also believe that net cash provided by operating activities will be sufficient to fund recurring non-revenue enhancing capital expenditures, tenant improvements and leasing commissions.
We expect to meet certain long-term liquidity requirements, such as for property acquisitions, property development and redevelopment activities, scheduled debt maturities, expansions and other non-recurring capital improvements, through net cash provided by operating activities, long-term secured and unsecured indebtedness, including borrowings under the unsecured line of credit and unsecured term loan, and the issuance of additional debt and/or equity securities.
Exposure to Environmental Liabilities
In connection with the acquisition of all of our properties, we have obtained Phase I environmental assessments to ascertain the existence of any environmental liabilities or other issues. The Phase I environmental assessments of our properties have not revealed any environmental liabilities that we believe would have a material adverse effect on our financial condition or results of operations taken as a whole, nor are we aware of any material environmental liabilities that have occurred since the Phase I environmental assessments were completed. In addition, we carry a policy of pollution legal liability insurance covering exposure to certain environmental losses at all of our properties
Capital Expenditures, Tenant Improvements and Leasing Costs
The following table shows total and weighted average per square foot property-related capital expenditures, tenant improvements and leasing costs (all of which are added to the basis of the properties) related to our life science properties (excluding capital expenditures and tenant improvements that are recoverable from tenants, revenue-enhancing or related to properties that have undergone redevelopment) for the years ended December 31, 2005, 2004, 2003, 2002 and 2001, attributable to leases that commenced at our properties after our acquisition:
Total/ Weighted Average 2005 2004 2003 2002 2001 ----------- ----------- ---------- ---------- ---------- ---------- Capital expenditures (1): Major capital expenditures $ 6,807,000 $ 972,000 $2,628,000 (2)$1,632,000 (3)$ 959,000 $ 616,000 Recurring capital expenditures $ 5,460,000 $ 1,278,000 $1,243,000 $ 853,000 $1,472,000 (4)$ 614,000 Weighted average square feet in portfolio 30,591,968 8,128,690 6,123,807 5,708,635 5,499,660 5,131,176 Per weighted average square foot in portfolio Major capital expenditures $ 0.22 $ 0.12 $ 0.43 (2)$ 0.29 (3)$ 0.17 $ 0.12 Recurring capital expenditures $ 0.18 $ 0.16 $ 0.20 $ 0.15 $ 0.27 (4)$ 0.12 Tenant improvements and leasing costs: Retenanted space (5) Tenant improvements and leasing costs $ 4,891,000 $ 324,000 $ 713,000 $2,890,000 $ 498,000 $ 466,000 Retenanted square feet 991,992 130,887 142,814 248,488 318,642 151,161 (5) Per square foot leased of retenanted space $ 4.93 $ 2.48 $ 4.99 $ 11.63 $ 1.56 $ 3.08 Renewal space Tenant improvements and leasing costs $ 2,797,000 $ 778,000 $ 937,000 $ 105,000 $ 526,000 $ 451,000 Renewal square feet 2,184,863 666,058 558,874 271,236 255,978 432,717 Per square foot leased of renewal space $ 1.28 $ 1.17 $ 1.68 $ 0.39 $ 2.05 $ 1.04
(1) Property-related capital expenditures include all major capital and recurring capital expenditures except capital expenditures that are recoverable from tenants, revenue-enhancing capital expenditures, or costs related to the redevelopment of a property. Major capital expenditures consisted of roof replacements and HVAC systems that are typically identified and considered at the time a property is acquired. Major capital expenditures for 2003 also included one-time costs related to the implementation of our national branding and signage program. Recurring capital expenditures exclude major capital expenditures.
(2) Major capital expenditures for 2004 included a one-time HVAC system upgrade at one property totaling $1,551,000 or $0.25 per square foot.
(3) Major capital expenditures for 2003 included $1,072,000 or $0.19 per square foot in one-time costs related to the implementation of our national branding and signage program.
(4) Recurring capital expenditures for 2002 included $552,000 or $0.10 per square foot related to a fully leased property in San Diego, California that underwent substantial renovation in 2002.
(5) Excludes space that has undergone redevelopment before retenanting.
Capital expenditures fluctuate in any given period due to the nature, extent and timing of improvements required and the extent to which they are recoverable from our tenants. Approximately 89% of our leases provide for the recapture of certain capital expenditures (such as HVAC systems maintenance and/or replacement, roof replacement and parking lot resurfacing). In addition, we maintain an active preventative maintenance program at each of our properties to minimize capital expenditures required.
Tenant improvements and leasing costs also fluctuate in any given year depending upon factors such as the timing and extent of vacancies, property age, location and characteristics, the type of lease (renewal tenant or retenanted space), the involvement of external leasing agents and overall competitive market conditions.
Inflation
As of December 31, 2005, approximately 85% of our leases (on a square footage basis) were triple net leases, requiring tenants to pay substantially all real estate taxes and insurance, common area and other operating expenses, including increases thereto. In addition, as of December 31, 2005, approximately 6% of our leases (on a square footage basis) required the tenants to pay a majority of operating expenses. Approximately 90% of our leases (on a square footage basis) contained effective annual rent escalations that are either fixed (generally ranging from 3% to 3.5%) or indexed based on the consumer price index or another index. Accordingly, we do not believe that our earnings or cash flow from real estate operations are subject to any significant risk from inflation. An increase in inflation, however, could result in an increase in the cost of our variable rate borrowings, including our unsecured line of credit and unsecured term loan.
Funds from Operations
GAAP basis accounting for real estate assets utilizes historical cost accounting and assumes real estate values diminish over time. In an effort to overcome the difference between real estate values and historical cost accounting for real estate assets, the Board of Governors of the National Association of Real Estate Investment Trusts ("NAREIT") established the measurement tool of Funds From Operations ("FFO"). Since its introduction, FFO has become a widely used non-GAAP financial measure by REITs. We believe that FFO is helpful to investors as an additional measure of the performance of an equity REIT. We compute FFO in accordance with standards established by the Board of Governors of NAREIT in its April 2002 White Paper (the "White Paper") and related implementation guidance, which may differ from the methodology for calculating FFO utilized by other equity REITs, and, accordingly, may not be comparable to such other REITs. The White Paper defines FFO as net income (loss) (computed in accordance with GAAP), excluding gains (or losses) from sales, plus real estate related depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. While FFO is a relevant and widely used measure of operating performance for REITs, it should not be considered as an alternative to net income (determined in accordance with GAAP) as an indication of financial performance, or to cash flows from operating activities (determined in accordance with GAAP) as a measure of our liquidity, nor is it indicative of funds available to fund our cash needs, including our ability to make distributions. (See "Liquidity and Capital Resources - Cash Flows" above for information regarding these measures of cash flow.)
The following table presents a reconciliation of net income available to common stockholders to funds from operations available to common stockholders for the years ended December 31, (in thousands):
Year Ended December 31, ----------------------- 2005 2004 ----------- ---------- Net income available to common stockholders (1) $47,343 $45,724 Add: Depreciation and amortization (2) 55,416 42,523 Minority interest 634 - Less: Gain on sales of property (3) (36) (1,627) FFO allocable to minority interest (668) - ----------- ---------- Funds from operations available to common stockholders $102,689 $86,620 =========== ==========
(1) During the second quarter of 2004, we elected to redeem the 9.50% Series A cumulative redeemable preferred stock. Accordingly, in compliance with Emerging Issues Task Force Topic D-42, we recorded a charge of $1,876,000, or $0.10 per common share (diluted) in the second quarter of 2004 for costs related to the redemption of the Series A preferred stock.
(3) Gain on sales of property relates to the disposition of one property in the Southeast market during the third quarter of 2005 and the disposition of one property in the Suburban Washington D.C. market during the first quarter of 2004. Gain on sales of property is included in the income statement in income from discontinued operations, net.
Property and Lease Information
The following table is a summary of our properties as of December 31, 2005 (dollars in thousands):
Rentable Annualized Number of Square Base Occupancy Markets Properties Feet Rent Percentages - ------------------------------------- ---------- ----------- --------- ----------- California - Pasadena 1 31,343 $793 100.0% California - San Diego 23 1,070,477 27,509 92.2% California - San Francisco Bay 15 1,043,737 30,583 96.5% Eastern Massachusetts 22 1,263,077 34,603 93.6% New Jersey/Suburban Philadelphia 7 458,623 7,900 98.5% Southeast 8 432,127 7,460 85.9%(1) Suburban Washington D.C. 31 2,439,146 46,936 93.0%(2) Washington - Seattle 9 780,211 23,081 87.8% International - Canada 3 296,362 6,223 100.0% ---------- ----------- --------- ----------- Total Operating Properties 119 7,815,103 $185,088 93.2%(2) ========== =========== ========= =========== Properties Under Redevelopment 15 1,009,266 $14,662 45.7% ---------- ----------- --------- ----------- Total Properties 134 8,824,369 $199,750 87.7%(2) ---------- ----------- --------- -----------
(1) Substantially all of the vacant space is office or warehouse space.
(2) Excluding one lease for approximately 103,000 square feet that terminated in the fourth quarter of 2005, occupancy percentages for Suburban Washington D.C., total operating properties and total properties would have been 97.2%, 94.5% and 88.9%, respectively.
The following table summarizes information with respect to the lease expirations at our properties as of December 31, 2005:
Square Annualized Base Year of Number of Footage of Percentage of Rent of Expiring Lease Expiring Expiring Aggregate Leased Leases (per Expiration Leases Leases Square Feet square foot) - ---------- ----------- ---------- -------------- --------------- 2006 79 (1) 924,223 11.9% $24.98 2007 39 786,824 10.2% $26.30 2008 27 630,784 8.1% $26.24 2009 26 492,926 6.4% $21.77 2010 33 740,788 9.6% $22.40 Thereafter 79 4,165,798 53.8% $26.91
(1) Includes month-to-month leases for approximately 56,000 square feet.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market risk is the exposure to loss resulting from changes in interest rates, foreign currency exchange rates, commodity prices and equity prices. The primary market risk to which we believe we are exposed is interest rate risk, which may result from many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors that are beyond our control.
In order to modify and manage the interest rate characteristics of our outstanding debt and to limit the effects of interest rate risks on our operations, we may utilize a variety of financial instruments, including interest rate swaps, caps, floors and other interest rate exchange contracts. The use of these types of instruments to hedge a portion of our exposure to changes in interest rates carries additional risks, such as counter-party credit risk and the legal enforceability of hedging contracts.
Our future earnings and fair values relating to financial instruments are primarily dependent upon prevalent market rates of interest, such as LIBOR. However, our interest rate swap agreements are intended to reduce the effects of interest rate changes. Based on interest rates at, and our swap agreements in effect on, December 31, 2005 and 2004, we estimate that a 1% increase in interest rates on our variable debt, including our unsecured line of credit and unsecured term loan, after considering the effect of our interest rate swap agreements, would decrease annual future earnings by approximately $2.1 million and $2.0 million, respectively. We further estimate that a 1% decrease in interest rates on our variable debt, including our unsecured line of credit and unsecured term loan, after considering the effect of our interest rate swap agreements in effect on December 31, 2005 and 2004, would increase annual future earnings by approximately $2.1 million and $2.0 million, respectively. A 1% increase in interest rates on our secured debt and interest rate swap agreements would decrease their aggregate fair values by approximately $36.8 million and $27.2 million at December 31, 2005 and 2004, respectively. A 1% decrease in interest rates on our secured debt and interest rate swap agreements would increase their aggregate fair values by approximately $38.4 million and $28.4 million at December 31, 2005 and 2004, respectively.
These amounts are determined by considering the impact of the hypothetical interest rates on our borrowing cost and our interest rate swap agreements in effect on December 31, 2005 and 2004 . These analyses do not consider the effects of the reduced level of overall economic activity that could exist in such an environment. Further, in the event of a change of such magnitude, we would consider taking actions to further mitigate our exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, the sensitivity analysis assumes no changes in our capital structure.
We have exposure to equity price market risk because of our equity investments in certain publicly-traded companies and privately held entities. We classify investments in publicly-traded companies as available-for-sale and, consequently, record them on our balance sheet at fair value with unrealized gains or losses reported as a component of comprehensive income or loss. Investments in privately held entities are generally accounted for under the cost method because we do not influence any of the operating or financial policies of the entities in which we invest. For all investments, we recognize other than temporary declines in value against earnings in the same period the decline in value was deemed to have occurred. There is no assurance that future declines in values will not have a material adverse impact on our future results of operations. By way of example, a 10% decrease in the fair value of our equity investments as of December 31, 2005 and 2004 would decrease their fair values by approximately $8.2 million and $6.7 million, respectively.
We have exposure to foreign currency exchange rate market risk related to our wholly-owned subsidiaries operating in Canada. The functional currency of our foreign subsidiaries operating in Canada is the local currency, the Canadian dollar. Gains or losses resulting from the translation of our foreign subsidiaries' balance sheets and income statements are included in accumulated other comprehensive income as a separate component of stockholders' equity. Gains or losses will be reflected in our income statement when a transaction with a third party, denominated in a currency other than the entity's functional currency, is settled and the functional currency cash flows realized are more or less than the exchange rate in effect when the transaction was initiated.
Item 8. Financial Statements and Supplementary Data
The information required by this Item is included as a separate section in this Annual Report on Form 10-K. See "Item 15. Exhibits, Financial Statement Schedule".
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
Changes in Internal Control Over Financial Reporting
There have been no significant changes in our internal control over financial reporting during the quarter ended December 31, 2005 that could materially affect, or is reasonably likely to materially affect, our internal control over financial reporting.
Evaluation of Disclosure Controls and Procedures
As of December 31, 2005, we performed an evaluation, under the supervision of our Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), of the effectiveness of the design and operation of our disclosure controls and procedures. These controls and procedures have been designed to ensure that information required for disclosure is recorded, processed, summarized and reported within the requisite time periods. Based on our evaluation, the CEO and CFO concluded that our disclosure controls and procedures were effective as of December 31, 2005.
Management's Annual Report on Internal Control Over Financial Reporting
The management of Alexandria Real Estate Equities, Inc. and subsidiaries (the "Company") is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles. The Company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with the authorizations of the Company's management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of assets that could have a material effect on the financial statements. Management has assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2005. In making its assessment, management has utilized the criteria set forth by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission in "Internal Control - Integrated Framework". Management concluded that based on its assessment, the Company's internal control over financial reporting was effective as of December 31, 2005. Management's assessment of the effectiveness of the Company's internal control over financial reporting as of December 31, 2005 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report on the next page.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders ofAlexandria Real Estate Equities, Inc.
We have audited management's assessment, included in the accompanying Annual Management's Report on Internal Control Over Financial Reporting, that Alexandria Real Estate Equities, Inc. and subsidiaries (the "Company") maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the "COSO criteria"). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that the Company maintained effective internal control over financial reporting as of December 31, 2005 is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the COSO criteria.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the accompanying consolidated balance sheets of the Company as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2005, and our report dated March 9, 2006 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Los Angeles, CaliforniaMarch 9, 2006
Item 9B. Other Information
Item 10. Directors and Executive Officers of the Registrant
The information required by this Item is incorporated herein by reference from our definitive proxy statement for our 2006 annual meeting of stockholders to be filed pursuant to Regulation 14A within 120 days after the end of our fiscal year (the "2006 Proxy Statement") under the caption "Board of Directors, Executive Officers and Senior Management".
Item 11. Executive Compensation
The information required by this Item is incorporated herein by reference from our 2006 Proxy Statement under the caption "Board of Directors, Executive Officers and Senior Management - Executive Compensation".
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table sets forth information on the Company's equity compensation plan as of December 31, 2005:
Equity Compensation Plan Information
Number of securities to be issued upon exercise of outstanding options, warrants and rights
(a)
Weighted-average exercise price of outstanding options, warrants and rights
(b)
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
(c)
Equity Compensation Plan Approved by Stockholders - 1997 Incentive Plan
492,016
$34.92
413,501
The other information required by this Item is incorporated herein by reference from our 2006 Proxy Statement under the caption "Security Ownership of Management and Principal Stockholders".
Item 13. Certain Relationships and Related Transactions
The information required by this Item is incorporated herein by reference from our 2006 Proxy Statement.
Item 14. Principal Accounting Fees and Services
The information required by this Item is incorporated herein by reference from our 2006 Proxy Statement under the caption "Fees Billed by Independent Registered Public Accountants".
PART IV
Item 15. Exhibits, Financial Statement Schedule
(a)(1) and (2) Financial Statements and Schedule
The financial statements and schedule required by this Item are included as a separate section of this Annual Report on Form 10-K, beginning on page F-1.
(a)(3) See Exhibits and Index to Exhibits below.
F-1
Audited Consolidated Financial Statements:
F-2
F-3
F-4
Consolidated Statements of Cash Flows for the Years EndedDecember 31, 2005, 2004 and 2003
F-5
Notes to Consolidated Financial Statements
F-6
Schedule III - Consolidated Financial Statement Schedule of Rental Properties and Accumulated Depreciation
F-31
(b) Exhibits and Index to Exhibits
Exhibit Number
Exhibit Title
3.1 *
Articles of Amendment and Restatement of Alexandria, filed as an exhibit to Alexandria's quarterly report on Form 10-Q filed with the Commission on August 14, 1997
3.2 *
Certificate of Correction of Alexandria, filed as an exhibit to Alexandria's quarterly report on Form 10-Q filed with the Commission on August 14, 1997
3.3
Bylaws of Alexandria (as amended February 27, 2006)
3.4 *
Articles Supplementary, dated February 10, 2000, relating to the election to be subject to Subtitle 8 of Title 3 of the Maryland General Corporation Law, filed as an exhibit to Alexandria's current report on Form 8-K filed with the Commission on February 10, 2000
3.5 *
Articles Supplementary, dated January 28, 2002, relating to the 9.10% Series B Cumulative Redeemable Preferred Stock, filed as an exhibit to Alexandria's current report on Form 8-A filed with the Commission on February 17, 2002
4.1 *
Rights Agreement, dated as of February 10, 2000, between the Company and American Stock Transfer & Trust Company, as Rights Agent, including the forms of Articles Supplementary setting forth the terms of the Series A Junior Participating Preferred Stock, par value $.01 per share, Rights Certificate and the Summary of Rights to Purchase Preferred Stock attached as exhibits to the Rights Agreement. Pursuant to the Rights Agreement, printed Rights Certificates will not be mailed until after the Distribution Date (as defined in the Rights Agreement), filed as an exhibit to Alexandria's current report on Form 8-K filed with the Commission on February 10, 2000
4.2 *
Specimen certificate representing shares of Common Stock, filed as an exhibit to Alexandria's Registration Statement on Form S-11 (No. 333-23545)
4.3 *
Specimen certificate representing shares of 9.10% Series B Cumulative Redeemable Preferred Stock, filed as an exhibit to Alexandria's current report on Form 8-A filed with the Commission on February 17, 2002
4.4 *
Specimen certificate representing shares of 8.375% Series C Cumulative Redeemable Preferred Stock, filed as an exhibit to Alexandria's current report on Form 8-A filed with the Commission on June 28, 2004
10.1 * (1)
Amended and Restated 1997 Stock Award and Incentive Plan of Alexandria, dated December 29, 2000, filed as an exhibit to Alexandria's annual report on Form 10-K filed with the Commission on March 29, 2002
10.2 * (1)
Form of Non-Employee Director Stock Option Agreement for use in connection with options issued pursuant to the Amended and Restated 1997 Stock Award and Incentive Plan, filed as an exhibit to Alexandria's Registration Statement on Form S-11 (No. 333-23545)
10.3 * (1)
Form of Incentive Stock Option Agreement for use in connection with options issued pursuant to the Amended and Restated 1997 Stock Award and Incentive Plan, filed as an exhibit to Alexandria's Registration Statement on Form S-11 (No. 333-23545)
10.4 * (1)
Form of Nonqualified Stock Option Agreement for use in connection with options issued pursuant to the Amended and Restated 1997 Stock Award and Incentive Plan, filed as an exhibit to Alexandria's Registration Statement on Form S-11 (No. 333-23545)
10.5 * (1)
Form of Employee Restricted Stock Agreement for use in connection with shares of restricted stock issued to employees pursuant to the Amended and Restated 1997 Stock Award and Incentive Plan, filed as an exhibit to Alexandria's quarterly report on Form 10-Q filed with the Commission on November 15, 1999
10.6 * (1)
Form of Independent Contractor Restricted Stock Agreement for use in connection with shares of restricted stock issued to independent contractors pursuant to the Amended and Restated 1997 Stock Award and Incentive Plan, filed as an exhibit to Alexandria's quarterly report on Form 10-Q filed with the Commission on November 15, 1999
10.7 * (1)
Alexandria's 2000 Deferred Compensation Plans, effective December 1, 2000, filed as an exhibit to Alexandria's annual report on Form 10-K filed with the Commission on March 29, 2002
10.8*
Amended and Restated Credit Agreement as of December 22, 2004, among Alexandria Real Estate, Inc., Alexandria Real Estate Equities, L.P., ARE-QRS Corp., ARE Acquisitions, LLC, and the other borrowers then and thereafter a party thereto, the banks therein named, the other banks which may become parties thereto, Bank of America, N.A. as Administrative Agent, Citicorp North America, Inc. and Commerzbank AG New York and Grand Cayman Branches, as Co-Syndication Agents, Societe Generale and Eurohypo AG, New York Branch, as Co-Documentation Agents, Banc of America Securities LLC and Citigroup Global Markets, Inc., as Joint Lead Arrangers and Joint Bookrunners, filed as an exhibit to Alexandria's annual report on Form 10-K filed with the Commission on March 16, 2005.
10.9
Second Amendment to Amended and Restated Credit Agreement as of November 16, 2005, among Alexandria Real Estate, Inc., Alexandria Real Estate Equities, L.P., ARE-QRS Corp., ARE Acquisitions, LLC, and the other subsidiaries party hereto as the borrowers then and thereafter a party thereto, the banks therein named, the other banks which may become parties thereto, Bank of America, N.A. as Administrative Agent, Swing Line Lender and L/C Issuer, Citicorp North America, Inc. and Commerzbank AG New York and Grand Cayman Branches, as Co-Syndication Agents, Societe Generale and Eurohypo AG, New York Branch, as Co-Documentation Agents, Banc of America Securities LLC and Citigroup Global Markets, Inc., as Joint Lead Arrangers and Joint Bookrunners
10.10 (1)
Executive Employment Agreement between Alexandria Real Estate Equities, Inc. and James H. Richardson, dated January 9, 2006
10.11 (1)
Executive Employment Agreement between Alexandria Real Estate Equities, Inc. and Joel S. Marcus, dated March 13, 2006
10.12 (1)
Summary of Director Compensation Arrangements
12.1
Computation of Consolidated Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends
14.1*
Alexandria Real Estate Equities, Inc. Business Integrity Policy and Procedures for Reporting Non-Compliance (code of ethics pursuant to Item 406 Regulation S-K)
21.1
List of Subsidiaries of Alexandria
23.1
Consent of Ernst & Young LLP
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32
Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
___________________
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated March 16, 2006
By: /s/ JOEL S. MARCUSJoel S. MarcusChief Executive Officer
KNOW ALL THOSE BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Jerry M. Sudarsky and Joel S. Marcus, and each of them, as his true and lawful attorneys-in-fact and agents, each with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this report, and to file the same, with exhibits thereto and other documents in connection therewith, if any, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that each of said attorneys-in-fact and agents of their substitute or substitutes may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ JERRY M. SUDARSKY
Chairman of the Board of Directors
March 15, 2006
/s/ JOEL S. MARCUS
Chief Executive Officer (Principal Executive Officer) and Director
March 16, 2006
/s/ JAMES H. RICHARDSON
President and Director
/s/ DEAN A. SHIGENAGA
Chief Financial Officer (Principal Financial and Accounting Officer)
/s/ RICHARD B. JENNINGS
Director
March 9, 2006
/s/ RICHARD H. KLEIN
/s/ MARTIN A. SIMONETTI
/s/ ALAN G. WALTON
/s/ RICHMOND A. WOLF
Report of Independent Registered Public Accounting FirmTo the Board of Directors and Stockholders ofAlexandria Real Estate Equities, Inc. We have audited the accompanying consolidated balance sheets of Alexandria Real Estate Equities, Inc. and subsidiaries (the "Company") as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedule listed in the index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Alexandria Real Estate Equities, Inc. and subsidiaries at December 31, 2005 and 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company's internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 9, 2006, expressed an unqualified opinion thereon./s/ Ernst & Young LLP Los Angeles, CaliforniaMarch 9, 2006 Alexandria Real Estate Equities, Inc. and SubsidiariesConsolidated Balance Sheets(Dollars in thousands, except per share amounts)December 31, ---------------------- 2005 2004 ---------- ---------- Assets Rental properties, net $1,788,818 $1,427,853 Properties under development and land held for development 329,338 252,249 Cash and cash equivalents 3,911 3,158 Tenant security deposits and other restricted cash 21,013 17,669 Tenant receivables 4,764 2,542 Deferred rent 54,573 43,166 Investments 82,010 67,419 Other assets 78,023 58,228 ---------- ---------- Total assets $2,362,450 $1,872,284 ========== ==========Liabilities and Stockholders' EquitySecured notes payable $ 666,666 $ 638,946 Unsecured line of credit and unsecured term loan 740,000 548,000 Accounts payable, accrued expenses and tenant security deposits 86,391 48,581 Dividends payable 19,478 16,284 ---------- ---------- Total liabilities 1,512,535 1,251,811 Commitments and contingencies Minority interest 20,115 - Stockholders' equity: 9.10% Series B cumulative redeemable preferred stock, $0.01 par value per share, 2,300,000 shares authorized; 2,300,000 shares issued and outstanding at December 31, 2005 and 2004; $25.00 liquidation value per share 57,500 57,500 8.375% Series C cumulative redeemable preferred stock $0.01 par value per share, 5,750,000 shares authorized; 5,185,500 shares issued and outstanding at December 31, 2005 and 2004; $25.00 liquidation value per share 129,638 129,638 Common stock, $0.01 par value per share, 100,000,000 shares authorized; 22,441,294 and 19,594,418 shares issued and outstanding at December 31, 2005 and 2004, respectively 224 196 Additional paid-in capital 607,405 414,028 Retained earnings - 5,267 Accumulated other comprehensive income 35,033 13,844 ---------- ---------- Total stockholders' equity 829,800 620,473 ---------- ---------- Total liabilities and stockholders' equity $2,362,450 $1,872,284 ========== ==========See the accompanying Notes to Consolidated Financial Statements.Alexandria Real Estate Equities, Inc. and SubsidiariesConsolidated Statements of Income(Dollars in thousands, except per share amounts)Year Ended December 31, -------------------------------------- 2005 2004 2003 ----------- ----------- ----------- Revenues Rental $ 189,312 $ 143,700 $ 126,236 Tenant recoveries 49,974 35,840 32,050 Other income 4,798 3,541 2,068 ----------- ----------- ----------- 244,084 183,081 160,354ExpensesRental operations 54,540 38,394 32,770 General and administrative 21,094 15,105 14,211 Interest 49,116 28,670 26,416 Depreciation and amortization 55,399 42,476 38,598 ----------- ----------- ----------- 180,149 124,645 111,995 Minority interest 634 - - ----------- ----------- ----------- Income from continuing operations 63,301 58,436 48,359 Income from discontinued operations, net 132 1,759 11,284 ----------- ----------- ----------- Net income 63,433 60,195 59,643 Dividends on preferred stock 16,090 12,595 8,898 Preferred stock redemption charge - 1,876 - ----------- ----------- ----------- Net income available to common stockholders $ 47,343 $ 45,724 $ 50,745 =========== =========== =========== Earnings per share - basic: Continuing operations (net of preferred stock dividends and preferred stock redemption charge) $ 2.25 $ 2.28 $ 2.08 Discontinued operations, net 0.01 0.09 0.59 ----------- ----------- ----------- Earnings per share - basic $ 2.26 $ 2.37 $ 2.67 =========== =========== =========== Earnings per share - diluted: Continuing operations (net of preferred stock dividends and preferred stock redemption charge) $ 2.21 $ 2.24 $ 2.05 Discontinued operations, net 0.01 0.09 0.59 ----------- ----------- ----------- Earnings per share - diluted $ 2.22 $ 2.33 $ 2.64 =========== =========== =========== Weighted average shares of common stock outstanding: Basic 20,948,915 19,315,364 18,993,856 =========== =========== =========== Diluted 21,316,886 19,658,759 19,247,790 =========== =========== ===========See the accompanying Notes to Consolidated Financial Statements.Alexandria Real Estate Equities, Inc. and SubsidiariesConsolidated Statements of Stockholders' Equity(Dollars in thousands)Accumulated Series A Series B Series C Number of Additional Other Preferred Preferred Preferred Common Common Paid-In Retained Comprehensive Stock Stock Stock Shares Stock Capital Earnings Income (Loss) Total ---------- ---------- ---------- ----------- ------- --------- ----------- ------------ ---------- Balance at December 31, 2002 $ 38,588 57,500 - 18,973,957 $ 190 $ 398,399 $ - $ (8,824) $ 485,853 Net income - - - - - - 59,643 - 59,643 Unrealized gain on marketable securities - - - - - - - 610 610 Unrealized gain on swap agreements - - - - - - - 2,739 2,739 ---------- Comprehensive income - - - - - - - - 62,992 Issuances pursuant to Stock Plan (options and awards) - - - 290,066 3 9,295 - - 9,298 Dividends declared on preferred stock - - - - - - (8,898) - (8,898) Dividends declared on common stock - - - - - - (42,110) - (42,110) ---------- ---------- ---------- ----------- ------- --------- ----------- ------------ ----------Balance at December 31, 2003 38,588 57,500 - 19,264,023 193 407,694 8,635 (5,475) 507,135 Net income - - - - - - 60,195 - 60,195 Unrealized gain on marketable securities - - - - - - - 15,110 15,110 Unrealized gain on swap agreements - - - - - - - 4,209 4,209 ---------- Comprehensive income - - - - - - - - 79,514 Issuance of Series C preferred stock, net of offering costs - - 129,638 - - (5,629) - - 124,009 Redemption of Series A preferred stock (38,588) - - - - 1,876 (1,876) - (38,588) Issuances pursuant to Stock Plan (options and awards) - - - 330,395 3 10,087 - - 10,090 Dividends declared on preferred stock - - - - - - (12,595) - (12,595) Dividends declared on common stock - - - - - - (49,092) - (49,092) ---------- ---------- ---------- ----------- ------- --------- ----------- ------------ ----------Balance at December 31, 2004 - 57,500 129,638 19,594,418 196 414,028 5,267 13,844 620,473 Net income - - - - - - 63,433 - 63,433 Unrealized gain on marketable securities - - - - - - - 12,439 12,439 Unrealized gain on swap agreements - - - - - - - 6,957 6,957 Foreign currency translation - - - - - - - 1,793 1,793 ---------- Comprehensive income - - - - - - - - 84,622 Issuance of common stock, net of offering costs - - - 2,685,500 27 189,344 - - 189,371 Amortization of stock compensation expense - - - - - - - - 0 Issuances pursuant to Stock Plan (options and awards) - - - 161,376 1 10,929 - - 10,930 Dividends declared on preferred stock - - - - - - (16,090) - (16,090) Dividends declared on common stock - - - - - (6,896) (52,610) - (59,506) ---------- ---------- ---------- ----------- ------- --------- ----------- ------------ ----------Balance at December 31, 2005 $ - $ 57,500 $ 129,638 22,441,294 $ 224 $ 607,405 $ - $ 35,033 $ 829,800 ========== ========== ========== =========== ======= ========= =========== ============ ==========See the accompanying Notes to Consolidated Financial Statements.Alexandria Real Estate Equities, Inc. and SubsidiariesConsolidated Statements of Cash Flows(In thousands)Year Ended December 31, ------------------------------------- 2005 2004 2003 ----------- ----------- ----------- Operating Activities Net income $ 63,433 $ 60,195 $ 59,643 Adjustments to reconcile net income to net cash provided by operating activities: Equity in income related to investments (483) (208) (306) Realized (gain)/loss on sales of investments (1,811) (2,228) (230) (Gain)/loss on sales of property (36) (1,627) (8,286) Minority interest 634 - - Depreciation and amortization 55,416 42,523 38,901 Amortization of loan fees and costs 6,666 2,374 2,133 Amortization of premiums on secured notes payable (1,089) (161) (290) Stock compensation expense 5,136 2,470 2,734 Changes in operating assets and liabilities: Tenant security deposits and other restricted cash (3,344) (6,612) (3,037) Tenant receivables (2,214) (573) 672 Deferred rent (14,904) (11,671) (6,826) Other assets (26,586) (18,261) (10,828) Accounts payable, accrued expenses and tenant security deposits 39,860 (905) 31 ----------- ----------- ----------- Net cash provided by operating activities 120,678 65,316 74,311Investing ActivitiesPurchase of rental properties (223,862) (251,091) (48,729) Proceeds from sales of rental properties 1,182 5,454 42,376 Additions to rental properties (92,417) (70,248) (48,264) Additions to properties under development and land held for development (117,945) (129,620) (78,327) Additions to investments (10,367) (7,993) (8,818) Proceeds from investments 10,509 5,246 2,488 ----------- ----------- ----------- Net cash used in investing activities (432,900) (448,252) (139,274)Financing ActivitiesProceeds from secured notes payable 153,398 198,400 64,667 Proceeds from issuances of common stock 189,371 - - Proceeds from issuance of preferred stock - 124,009 - Redemption of Series A preferred stock - (38,588) - Proceeds from exercise of stock options 4,291 7,094 5,941 Borrowings from unsecured line of credit and unsecured term loan 515,000 490,000 310,083 Repayments of unsecured line of credit (323,000) (331,000) (259,083) Principal reductions of secured notes payable (153,015) (10,376) (6,125) Dividends paid on common stock (56,312) (47,333) (40,427) Dividends paid on preferred stock (16,090) (11,097) (8,898) Distributions to minority interest (668) - - ----------- ----------- ----------- Net cash provided by financing activities 312,975 381,109 66,158 Net increase (decrease) in cash and cash equivalents 753 (1,827) 1,195 Cash and cash equivalents at beginning of year 3,158 4,985 3,790 ----------- ----------- ----------- Cash and cash equivalents at end of year $ 3,911 $ 3,158 $ 4,985 =========== =========== ===========Supplemental Disclosure of Cash Flow InformationCash paid during the year for interest, net of interest capitalized $ 39,292 $ 28,714 $ 28,143 =========== =========== ===========See the accompanying Notes to Consolidated Financial Statements.Alexandria Real Estate Equities, Inc. and SubsidiariesNotes to Consolidated Financial Statements 1. BackgroundReferences to the "Company", "we", "our" and "us" refer to Alexandria Real Estate Equities, Inc. and its subsidiaries.Alexandria Real Estate Equities, Inc. is a real estate investment trust ("REIT") formed in 1994. We are engaged principally in the ownership, operation, management, acquisition, and selective redevelopment and development of properties containing office/laboratory space. We refer to these properties as "life science properties". Our life science properties are designed and improved for lease primarily to institutional (universities and not-for-profit institutions), pharmaceutical, biotechnology, life science product, service, biodefense and translational research entities, as well as government agencies. As of December 31, 2005, we had 134 properties (131 properties located in nine states and three properties located in Canada) with approximately 8.8 million rentable square feet of office/laboratory space, compared to 113 properties in nine states with approximately 7.4 million rentable square feet of office/laboratory space as of December 31, 2004.As of December 31, 2005, approximately 85% of our leases (on a square footage basis) were triple net leases, requiring tenants to pay substantially all real estate taxes and insurance, common area and other operating expenses, including increases thereto. In addition, as of December 31, 2005, approximately 6% of our leases (on a square footage basis) required the tenants to pay a majority of operating expenses. Additionally, as of December 31, 2005, approximately 89% of our leases (on a square footage basis) provided for the recapture of certain capital expenditures and approximately 90% of our leases (on a square footage basis) contained effective annual rent escalations that are either fixed or indexed based on the consumer price index or another index. The information provided in this paragraph is unaudited.2. Basis of Presentation and Summary of Significant Accounting PoliciesBasis of PresentationThe accompanying consolidated financial statements include the accounts of Alexandria Real Estate Equities, Inc. and its subsidiaries. All significant intercompany balances and transactions have been eliminated. The Company holds interests, together with certain third parties, in a limited partnership and in a limited liability company which we consolidate in our financial statements. Such interests are subject to provisions of FASB Interpretation No. 46R, "Consolidation of Variable Interest Entities", FASB Emerging Issues Task Force Issue No. 96-16, "Investor's Accounting for an Investee When the Investor Has a Majority of the Voting Interest but the Minority Shareholder or Shareholders Have Certain Approval or Veto Rights", and AICPA Statement of Position 78-9, "Accounting for Investments in Real Estate Ventures". Based on the provisions set forth in these rules, we consolidate the limited partnership and limited liability company because we exercise significant control over major decisions by these entities, such as investment activity and changes in financing.Use of EstimatesThe preparation of financial statements in conformity with United States generally accepted accounting principles requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. ReclassificationsCertain prior year amounts have been reclassified to conform to the current year presentation.Fair Value of Financial InstrumentsThe carrying amounts of cash and cash equivalents, tenant receivables, unsecured line of credit and unsecured term loan, and accounts payable, accrued expenses and tenant security deposits approximate fair value. The fair value of our secured notes payable was estimated using discounted cash flows analyses based on borrowing rates we believe we could obtain with similar terms and maturities. As of December 31, 2005 and 2004, the fair values of our secured notes payable were approximately $682,835,000 and $652,100,000, respectively. Operating SegmentsWe view our operations as principally one segment and the financial information disclosed herein represents all of the financial information related to our principal operating segment.International OperationsThe functional currency for our subsidiaries operating in the United States is the U.S. dollar. During 2005, we acquired three operating properties in Canada through wholly-owned Canadian subsidiaries. The functional currency for our foreign subsidiaries operating in Canada is the local currency, the Canadian dollar. The assets and liabilities of our foreign subsidiaries are translated into U.S. dollars at the exchange rate in effect as of the financial statement date. Income statement accounts of our foreign subsidiaries are translated using the average exchange rate for the period presented. Gains resulting from the translation are included in accumulated other comprehensive income as a separate component of stockholders' equity.The appropriate amounts of exchange gains or losses included in accumulated other comprehensive income are reflected in income when there is a sale or partial sale of the Company's investment in these operations or upon a complete or substantially complete liquidation of the investment.Rental Properties, Properties Under Development and Land Held For DevelopmentIn accordance with Statement of Financial Accounting Standards No. 141, "Business Combinations", we perform the following procedures when making an allocation of the purchase price of real estate: (1) estimate the value of the real estate as of the acquisition date on an "as if vacant" basis; (2) allocate the "as if vacant" value among land, land improvements, buildings, building improvements, tenant improvements and equipment; (3) calculate the value of the intangibles as the difference between the "as if vacant" value and the purchase price; and (4) allocate the intangible value to above, below and at market leases, origination costs associated with in-place leases, tenant relationships and other intangible assets.The values allocated to land improvements, buildings, building improvements, tenant improvements and equipment are depreciated on a straight-line basis using an estimated life of 20 years for land improvements, 40 years for buildings and building improvements, the respective lease term for tenant improvements and the estimated useful life for equipment. The values of above and below market leases are amortized over the life of the related lease and recorded as either an increase (for below market leases) or a decrease (for above market leases) to rental income. The values of at-market leases and origination costs are classified as leasing costs, included in other assets in the accompanying consolidated balance sheets and amortized over the remaining life of the lease. Rental properties, properties under development and land held for development are individually evaluated for impairment when conditions exist which may indicate that it is probable that the sum of expected future undiscounted cash flows is less than the carrying amount of the property. Upon determination that an impairment has occurred, a write-down is recorded to reduce the carrying amount of the property to its estimated fair value. In accordance with Statement of Financial Accounting Standards No. 34, "Capitalization of Interest Cost" ("SFAS 34") and Statement of Financial Accounting Standards No. 67, "Accounting for Costs and Initial Rental Operations of Real Estate Projects" ("SFAS 67"), we capitalize direct construction and development costs, including predevelopment costs, interest, property taxes, insurance and other costs directly related and essential to the acquisition, development or construction of a project. Pursuant to SFAS 34 and SFAS 67, capitalization of construction and development costs is required while activities are ongoing to prepare an asset for its intended use. Costs incurred after a project is substantially complete and ready for its intended use are expensed as incurred. Costs previously capitalized related to abandoned acquisition or development opportunities are written off. Should development activity cease, a portion of interest, property taxes, insurance and certain costs would no longer be eligible for capitalization, and would be expensed as incurred. Expenditures for repairs and maintenance are expensed as incurred.In accordance with Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), we classify a property as "held for sale" when all of the following criteria for a plan of sale have been met: (1) management, having the authority to approve the action, commits to a plan to sell the property; (2) the property is available for immediate sale in its present condition, subject only to the terms that are usual and customary; (3) an active program to locate a buyer, and other actions required to complete the plan to sell, have been initiated; (4) the sale of the property is probable and is expected to be completed within one year; (5) the property is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and (6) actions necessary to complete the plan of sale indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. When the property is classified as "held for sale", its operations are classified as discontinued operations in our consolidated statements of income. When a property is designated as "held for sale", amounts for all prior periods presented are reclassified from continuing operations to discontinued operations. A loss is recognized for any initial adjustment of the asset's carrying amount to fair value less costs to sell in the period the asset qualifies as "held for sale". Depreciation of assets is discontinued commencing on the date they are designated as "held for sale". Cash EquivalentsWe consider all highly liquid investments with original maturities of three months or less when purchased to be cash equivalents.Tenant Security Deposits and Other Restricted CashTenant security deposits and other restricted cash consisted of the following (in thousands): December 31, -------------------------- 2005 2004 ----------- ------------- Funds held in trust under the terms of certain secured notes payable $ 13,838 $ 11,241 Security deposit funds based on the terms of certain lease agreement 2,047 2,045 Other funds held in escrow 5,128 4,383 ----------- ------------- $ 21,013 $ 17,669 =========== =============InvestmentsWe hold equity investments in certain publicly-traded companies and privately held entities primarily involved in the life science industry. All of our investments in publicly-traded companies are considered "available for sale" in accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"), and are recorded at fair value. Fair value has been determined as the closing trading price at the balance sheet date, with unrealized gains and losses shown as a separate component of stockholders' equity. The classification of investments under SFAS 115 is determined at the time each investment is made, and such determination is reevaluated at each balance sheet date. The cost of investments sold is determined by the specific identification method, with realized gains and losses included in other income in the accompanying consolidated statements of income.Investments in privately held entities are generally accounted for under the cost method because we do not influence any operating or financial policies of the entities in which we invest. Certain investments are accounted for under the equity method in accordance with Accounting Principles Board Opinion No. 18, "The Equity Method of Accounting for Investments in Common Stock" ("APB 18") and Emerging Issues Task Force Topic D-46, "Accounting for Limited Partnership Investments" ("EITF Topic D-46"). Under the equity method we record our investment initially at cost and adjust the carrying amount of the investment to recognize our share of the earnings or losses of the investee subsequent to the date of our investment.For all of our investments, if a decline in the fair value of an investment below its carrying value is determined to be other than temporary, such investment is written down to its estimated fair value with a non-cash charge to current earnings. The factors that we consider in making these assessments include, but are not limited to, market prices, market conditions, prospects for favorable or unfavorable clinical trial results, new product initiatives and new collaborative agreements. Leasing CostsCosts directly related and essential to our leasing activities are capitalized and amortized on a straight-line basis over the term of the related lease. Costs that were previously capitalized and which related to unsuccessful leasing opportunities are written off. Leasing costs, net of related amortization, totaled $32,924,000 and $29,747,000 as of December 31, 2005 and 2004, respectively, and are included in other assets in the accompanying consolidated balance sheets. Loan Fees and CostsFees and costs incurred in obtaining long-term financing are amortized over the terms of the related loans and included in interest expense in the accompanying consolidated statements of income. Loan fees and costs, net of related amortization, totaled $14,789,000 and $14,075,000 as of December 31, 2005 and 2004, respectively, and are included in other assets in the accompanying consolidated balance sheets. Interest Rate SwapsWe utilize interest rate swap agreements to hedge a portion of our exposure to variable interest rates associated with our unsecured line of credit and unsecured term loan. These agreements involve an exchange of fixed and floating rate interest payments without the exchange of the underlying principal amount (the "notional amount"). Interest received under all of our swap agreements is based on the one-month LIBOR rate. The net difference between the interest paid and the interest received is reflected as an adjustment to interest expense.Statement of Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging Activities", as amended by Statement of Financial Accounting Standards No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities" establishes accounting and reporting standards for derivative financial instruments such as our interest rate swap agreements. All of our interest rate swap agreements meet the criteria to be deemed "highly effective" under SFAS 133 in reducing our exposure to variable interest rates. In accordance with SFAS 133, we formally document all relationships between interest rate swap agreements and hedged items, including the method for evaluating effectiveness and the risk strategy. Accordingly, we have categorized these instruments as cash flow hedges. We make an assessment at the inception of each interest rate swap agreement and on an on-going basis to determine whether these instruments are highly effective in offsetting changes in cash flows associated with the hedged items. The ineffective portion of each interest rate swap agreement is immediately recognized in earnings. While we intend to continue to meet the conditions for such hedge accounting, if hedges did not qualify as "highly effective", the changes in the fair values of the derivatives used as hedges would be reflected in earnings.Pursuant to SFAS 133, interest rate swaps are reflected at their estimated fair values in the accompanying consolidated balance sheets. We use a variety of methods and assumptions based on market conditions and risks existing at each balance sheet date to determine the fair values of our interest rate swap agreements. These methods of assessing fair value result in a general approximation of value.We do not believe we are exposed to a significant amount of credit risk in our interest rate swap agreements as our counterparties are established, well-capitalized financial institutions. Accumulated Other Comprehensive Income Accumulated other comprehensive income consisted of the following (in thousands):December 31, ----------------------- 2005 2004 ----------- ----------- Unrealized gain on marketable securities $ 28,373 $ 15,934 Unrealized gain (loss) on interest rate swap agreements 4,867 (2,090) Unrealized foreign currency translation gain 1,793 -- ----------- ----------- $ 35,033 $ 13,844 =========== ===========Rental Income and Tenant RecoveriesRental income from leases with scheduled rent increases, free rent, incentives and other rent adjustments are recognized on a straight-line basis over the respective lease terms. We include amounts currently recognized as income, and expected to be received in later years, in deferred rent in the accompanying consolidated balance sheets. Amounts received currently, but recognized as income in future years, are included as unearned rent in accounts payable, accrued expenses and tenant security deposits in the accompanying consolidated balance sheets. We commence recognition of rental income at the date the tenant takes possession of or controls the physical use of the property.Tenant recoveries related to reimbursement of real estate taxes, insurance, repairs and maintenance, and other operating expenses are recognized as revenue in the period the applicable expenses are incurred. We maintain an allowance for estimated losses that may result from the inability of our tenants to make required payments. If a tenant fails to make contractual payments beyond any allowance, we may recognize additional bad debt expense in future periods equal to the amount of unpaid rent and unrealized deferred rent. As of December 31, 2005 and 2004, we had no allowance for doubtful accounts.Interest IncomeInterest income was $578,000, $181,000 and $108,000 in 2005, 2004 and 2003, respectively, and is included in other income in the accompanying consolidated statements of income.Income TaxesAs a REIT, we are not subject to federal income taxation as long as we meet a number of organizational and operational requirements and make distributions greater than or equal to 100% of our taxable income to our stockholders. Since we believe we have met these requirements and our distributions exceeded taxable income, no federal income tax provision has been reflected in the accompanying consolidated financial statements for the years ended December 31, 2005, 2004 and 2003. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate tax rates. During 2005, 2004 and 2003, we declared dividends on our common stock of $2.72, $2.52 and $2.20 per share, respectively. During 2004 and 2003, we declared dividends on our Series A cumulative redeemable preferred stock of $1.72847 and $2.375 per share, respectively. During 2005, 2004 and 2003, we declared dividends on our Series B cumulative redeemable preferred stock of $2.275, $2.275 and $2.275, respectively. During 2005 and 2004, we declared dividends on our Series C cumulative redeemable preferred stock of $2.09375 and $0.61649 per share, respectively. See Note 11, Preferred Stock and Excess Stock.The tax treatment of distributions on common stock paid in 2005 is as follows: (1) 71.8% ordinary dividend, (2) 24.1% return of capital, (3) 3.9% capital gain at 15%, and (4) 0.2% Section 1250 capital gain at 25%. The tax treatment of distributions paid in 2004 is as follows: (1) 76.8% ordinary dividend, (2) 19.8% return of capital, (3) 2.4% capital gain at 15%, and (4) 1.0% Section 1250 capital gain at 25%. The information provided in this paragraph is unaudited.Earnings Per Share, Dividends Declared and Preferred Stock Redemption Cost The following table shows the computation of earnings per share, and dividends declared per common share: Year Ended December 31, ------------------------------------------ 2005 2004 2003 ------------ ------------- ------------- (Dollars in thousands, except per share amounts) Net income available to common stockholders $ 47,343 $ 45,724 $ 50,745 ============ ============= ============= Weighted average shares of common stock outstanding - basic 20,948,915 19,315,364 18,993,856 Add: dilutive effect of stock options and stock grants 367,971 343,395 253,934 ------------ ------------- ------------- Weighted average shares of common stock outstanding - diluted 21,316,886 19,658,759 19,247,790 ============ ============= ============= Earnings per share - basic $ 2.26 $ 2.37 $ 2.67 ============ ============= ============= Earnings per share - diluted $ 2.22 $ 2.33 $ 2.64 ============ ============= ============= Dividends declared per common share $ 2.72 $ 2.52 $ 2.20 ============ ============= =============Emerging Issues Task Force Topic D-42, "The Effect on the Calculation of Earnings Per Share for the Redemption or Induced Conversion of Preferred Stock" ("EITF Topic D-42") provides, among other things, that any excess of (1) the fair value of the consideration transferred to the holders of preferred stock redeemed over (2) the carrying amount of the preferred stock, should be subtracted from net earnings to determine net income available to common stockholders in the calculation of earnings per share. The cost to issue our preferred stock was recorded as a reduction to additional paid-in capital in the years that the preferred stock was issued. Upon any redemption of our preferred stock, the respective offering costs, representing the excess of the fair value of the consideration transferred to the holders over the carrying amount of the preferred stock, will be recognized as a dividend to preferred stockholders. During 2004, we recorded a charge of approximately $1,876,000 to net income available to common stockholders for costs related to the redemption of our 9.5% Series A cumulative redeemable preferred stock. Dividends on preferred stock are deducted from net income to arrive at net income allocable to common stockholders.Stock-Based Compensation ExpenseFor 2002 and all prior years, we have elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related Interpretations in accounting for our employee and non-employee director stock options, stock grants and stock appreciation rights. Effective January 1, 2003, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), prospectively to all employee awards granted, modified or settled after January 1, 2003. We have not granted any stock options since 2002. Under APB 25, because the exercise price of the options we granted equals the market price of the underlying stock on the date of grant, no compensation expense has been recognized. Although we have elected to follow APB 25 for previously granted options, pro forma information regarding net income available to common stockholders and earnings per share is required by SFAS 123. This information has been determined as if we had accounted for our stock options under the fair value method under SFAS 123.For purposes of the following pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting periods (in thousands, except per share information): Year Ended December 31, ------------------------------------------ 2005 2004 2003 ------------ ------------- ------------- Net income available to common stockholders, as reported $ 47,343 $ 45,724 $ 50,745 Fair value of stock-based compensation cost (152) (733) (1,323) ------------ ------------- ------------- Pro forma net income available to common stockholders $ 47,191 $ 44,991 $ 49,422 ============ ============= ============= Earnings per share: Basic - as reported $ 2.26 $ 2.37 $ 2.67 Basic - pro forma $ 2.25 $ 2.33 $ 2.60 Diluted - as reported $ $2.22 $ $2.33 $ 2.64 Diluted - pro forma $ $2.21 $ $2.29 $ 2.57Impact of Recently Issued Accounting StandardsIn March 2004, the Emerging Issues Task Force ("EITF") of the Financial Accounting Standards Board ("FASB") reached a consensus on Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" ("EITF 03-1"). EITF 03-1 provides guidance on other-than-temporary impairment of marketable debt and equity securities accounted for under Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115") and Statement of Financial Accounting Standards No. 124, "Accounting for Certain Investments Held by Not-for-Profit Organizations" ("SFAS 124"), and non-marketable equity securities accounted for under the cost method. EITF 03-1 provides a three-step model to determine (1) when an investment is considered impaired; (2) whether the impairment is other-than-temporary; and (3) the measurement of the impairment loss. The guidance also requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. In addition, EITF 03-1 provides that a company does not have to estimate the fair value of an investment accounted for under the cost method if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value of the investment. In September 2004, the FASB issued FASB Staff Position ("FSP") No. EITF Issue 03-1-1, "Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments", which delays the effective date of the recognition and measurement provisions of EITF 03-1 until certain implementation issues are addressed and a final FSP providing implementation guidance is issued. In November 2005, the FASB issued FSP 115-1 and FSP 124-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" ("FSP 115-1 and FSP 124-1") which replaces the guidance set forth in paragraphs 10-18 of EITF 03-1 with reference to existing guidance including SFAS 115, SEC Staff Accounting Bulletin No. 59, "Accounting for Noncurrent Marketable Equity Securities" and Accounting Principles Board Opinion No. 18, "The Equity Method of Accounting for Investments in Common Stock". FSP 115-1 and FSP 124-1 is effective for other-than-temporary impairment analysis conducted in periods beginning after December 15, 2005. The Company adopted FSP 115-1 and FSP 124-1 in December 2005. The adoption of FSP 115-1 and FSP 124-1 did not have a material impact on our financial statements.In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment" ("SFAS 123R"). SFAS 123R requires measurement of all employee stock-based compensation awards using a fair value method and the recording of such expense in the financial statements. This eliminates the accounting for such awards using the intrinsic method pursuant to Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). In April 2005, the Securities and Exchange Commission amended the compliance date for SFAS 123R to no later than the beginning of the registrant's first fiscal year beginning after June 15, 2005. Accordingly, we plan to adopt SFAS 123R on January 1, 2006. Upon adoption of SFAS 123R, we intend to use the modified-prospective transition method whereby compensation expense will be recognized relating to the remaining unvested portion of outstanding stock options at the time of adoption, and the expense will be recognized over the remaining service period. We do not expect the adoption of SFAS 123R to have a material impact on our financial statements since all awards accounted for under APB 25 were fully vested on December 31, 2005. In December 2004, the FASB issued Statement of Financial Accounting Standards No. 153, "Exchanges of Nonmonetary Assets" ("SFAS 153"), which amends Accounting Principles Board Opinion No. 29, "Accounting for Nonmonetary Transactions" ("APB 29"). SFAS 153 addresses the measurement of exchanges of nonmonetary assets and redefines the scope of transactions that should be measured based on the fair values of the assets exchanged. SFAS 153 is effective for nonmonetary asset exchanges beginning in our third quarter of 2005. The adoption of SFAS 153 did not have a material impact on our financial statements.In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, "Accounting Changes and Error Corrections" ("SFAS 154"), which replaces Accounting Principles Board Opinion No. 20, "Accounting Changes" and Statement of Financial Accounting Standards No. 3, "Reporting Accounting Changes in Interim Financial Statements". SFAS 154 requires retrospective application to prior periods' financial statements of voluntary changes in accounting principles, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. We do not expect the adoption of SFAS 154 to have an impact on our financial statements.3. Rental Properties, Net, Properties Under Development and Land Held For DevelopmentRental properties, net consisted of the following (in thousands): December 31, --------------------------- 2005 2004 ------------ ------------- Land $ 296,841 $ 217,201 Buildings and improvements 1,559,385 1,246,888 Tenant and other improvements 153,482 139,823 ------------ ------------- 2,009,708 1,603,912 Less accumulated depreciation (220,890) (176,059) ------------ ------------- $ 1,788,818 $ 1,427,853 ============ =============As of December 31, 2005 and 2004, certain of our rental properties were encumbered by deeds of trust and assignments of rents and leases associated with the properties. See Note 5, Secured Notes Payable. The net book values of encumbered properties including land parcels as of December 31, 2005 and 2004 were $848,286,000 and $776,342,000, respectively.We lease space under noncancelable leases with remaining terms of one to 18 years. Included in rental properties, net as of December 31, 2005 and 2004 were 15 and 17 properties, respectively, in our redevelopment program. The allocated net book values of the portion of these properties undergoing redevelopment as of December 31, 2005 and 2004 were approximately $139,661,000 and $150,627,000, respectively. Depreciation ceases on the portion of a property undergoing redevelopment during the period of redevelopment. In accordance with SFAS 34, we are required to capitalize interest on construction, development and redevelopment projects during the period an asset is undergoing activities to prepare it for its intended use. Capitalization of interest ceases after a project is substantially complete and ready for its intended use. In addition, should construction, development or redevelopment activity cease, interest would be expensed as incurred. Total interest capitalized for the years ended December 31, 2005, 2004 and 2003 was $27,490,000, $17,902,000 and $13,941,000, respectively. Total interest incurred for the years ended December 31, 2005, 2004 and 2003 was $77,695,000, $46,733,000 and $41,571,000, respectively.Minimum lease payments to be received under the terms of the operating lease agreements, excluding expense reimbursements, as of December 31, 2005 are as follows (in thousands):Year Amount - --------------------------------------- ------------ 2006 $ 182,666 2007 164,884 2008 153,116 2009 139,673 2010 130,859 Thereafter 478,638 ------------ $ 1,249,836 ============4. InvestmentsWe hold equity investments in certain publicly-traded companies and privately held entities primarily involved in the life science industry. All of our investments in publicly-traded companies are considered "available for sale" in accordance with SFAS 115, and are recorded at fair value. Investments in privately held entities are generally accounted for under the cost method because we do not influence any operating or financial policies of the entities in which we invest. Certain investments are accounted for under the equity method in accordance with APB 18 and EITF Topic D-46. For all of our investments, if a decline in the fair value of an investment below its carrying value is determined to be other than temporary, such investment is written down to its estimated fair value with a non-cash charge to current earnings. The factors that we consider in making these assessments include, but are not limited to, market prices, market conditions, prospects for favorable or unfavorable clinical trial results, new product initiatives and new collaborative agreements. For additional discussion of our accounting policies with respect to investments, see Note 2, Basis of Presentation and Summary of Significant Accounting Policies.The following table summarizes our available-for-sale securities (in thousands):December 31, -------------------- 2005 2004 --------- --------- Adjusted cost of available-for-sale securities $ 4,740 $ 3,190 Gross unrealized gains 29,135 16,110 Gross unrealized losses (762) (176) --------- --------- Fair value of available-for-sale securities $ 33,113 $ 19,124 ========= =========Investments in available-for-sale securities with gross unrealized losses as of December 31, 2005 and 2004 have been in a continuous unrealized loss position for less than twelve months. We believe that these unrealized losses are temporary and accordingly we have not recognized an other-than-temporary impairment related to available-for-sale securities as of December 31, 2005 and 2004.Our investments in privately held entities as of December 31, 2005 and 2004 totaled $48,897,000 and $48,295,000, respectively. Of these totals, $47,164,000 and $47,433,000 are accounted for under the cost method. The remainder ($1,733,000 and $862,000 for 2005 and 2004, respectively) are accounted for under the equity method in accordance with APB 18 and EITF Topic D-46. As of December 31, 2005 and 2004, there were no unrealized losses in our investments in privately held entities. Net investment income of $2,294,000, $2,436,000 and $536,000 was recognized in 2005, 2004 and 2003, respectively, and is included in other income in the accompanying consolidated statements of income. Net investment income in 2005 consisted of equity in income of $483,000 related to investments in privately held entities accounted for under the equity method, gross realized gains of $2,433,000, and gross realized losses of $622,000. Net investment income in 2004 consisted of equity in income of $208,000 related to investments in privately held entities accounted for under the equity method, gross realized gains of $2,508,000, and gross realized losses of $280,000. Net investment income in 2003 consisted of equity in income of $306,000 related to investments in privately held entities accounted for under the equity method, gross realized gains of $532,000, and gross realized losses of $302,000. 5. Secured Notes Payable Secured notes payable consisted of the following (in thousands): December 31, --------------------- 2005 2004 ---------- ---------- Secured notes payable, interest rates varying from 4.32% to 8.75%, $ 662,147 $ 635,432 (weighted average effective interest rate of 6.31% and 5.67% at December 31, 2005 and 2004, respectively), maturity dates ranging from January 2006 to June 2016 Unamortized premiums 4,519 3,514 ----------- ---------- Total secured notes payable $ 666,666 $ 638,946 ======================Our secured notes payable generally require monthly payments of principal and interest. The total net book values of properties securing debt were $848,286,000 and $776,342,000 at December 31, 2005 and 2004, respectively. At December 31, 2005, our secured notes payable were comprised of $595.9 million and $70.8 million of fixed and variable rate debt, respectively, compared to $437.2 million and $201.7 million of fixed and variable rate debt, respectively, at December 31, 2004.Future principal payments due on secured notes payable as of December 31, 2005, are as follows (in thousands): Weighted Average Year Amount Interest Rate (1) - ---------------------------------- ------------ ------------- 2006 $ 44,552 6.32% 2007 83,623 6.26% 2008 123,190 6.16% 2009 42,084 6.52% 2010 88,553 6.48% Thereafter 280,145 6.24% ------------ Subtotal 662,147 Unamortized premiums 4,519 Total secured notes payable ------------ $ 666,666 ============ (1) The weighted average interest rate is calculated based on the outstanding debt as of January 1st of each year.6. Unsecured Line of Credit and Unsecured Term LoanIn November 2005, we entered into an amendment to our amended and restated credit agreement to increase the maximum permitted borrowings under our unsecured credit facilities from $750 million to $1 billion consisting of a $500 million unsecured revolving credit facility and a $500 million unsecured term loan. We may in the future elect to increase commitments under the unsecured credit facilities by up to an additional $200 million.Borrowings under our unsecured line of credit, as amended, bear interest at a floating rate based on our election of either a LIBOR-based rate or the higher of the bank's reference rate and the Federal Funds rate, plus 0.5%. For each LIBOR-based advance, we must elect a LIBOR period of one, two, three or six months. The unsecured line of credit matures in December 2007 and may be extended at our sole option for an additional one-year period. As of December 31, 2005, we had borrowings of $240 million outstanding on the unsecured line of credit with a weighted average interest rate of 5.69%. Our unsecured term loan bears interest at a floating rate based on our election of either a LIBOR-based rate or the higher of the bank's reference rate and the Federal Funds rate, plus 0.5%. For each LIBOR-based advance, we must elect to fix for a period of one, two, three or six months. The unsecured term loan matures in December 2009. As of December 31, 2005, we had borrowings of $500 million outstanding on the unsecured term loan with a weighted average interest rate of 5.67%.Our unsecured line of credit and unsecured term loan contain financial covenants, including, among other things, maintenance of minimum net worth, a leverage ratio and a fixed charge coverage ratio. In addition, the terms of the unsecured line of credit and unsecured term loan restrict, among other things, certain investments, indebtedness, distributions and mergers. Aggregate borrowings under the unsecured line of credit and unsecured term loan may be limited to an amount based on the net operating income derived from a pool of unencumbered properties. Accordingly, as we acquire or complete the development or redevelopment of additional unencumbered properties, aggregate borrowings available under the unsecured line of credit and unsecured term loan will increase up to a maximum combined amount of $1 billion. Under these provisions as of December 31, 2005, aggregate borrowings under our unsecured line of credit and unsecured term loan were limited to $863 million. 7. Interest Rate SwapsWe utilize interest rate swap agreements to hedge a portion of our exposure to variable interest rates associated with our unsecured line of credit and unsecured term loan. These agreements involve an exchange of fixed and floating rate interest payments without the exchange of the underlying principal amount (the "notional amount"). Interest received under all of our swap agreements is based on the one-month LIBOR rate. The net difference between the interest paid and the interest received is reflected as an adjustment to interest expense.Statement of Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging Activities", as amended by Statement of Financial Accounting Standards No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities" establishes accounting and reporting standards for derivative financial instruments such as our interest rate swap agreements. All of our interest rate swap agreements meet the criteria to be deemed "highly effective" under SFAS 133 in reducing our exposure to variable interest rates. In accordance with SFAS 133, we formally document all relationships between interest rate swap agreements and hedged items, including the method for evaluating effectiveness and the risk strategy. Accordingly, we have categorized these instruments as cash flow hedges. We make an assessment at the inception of each interest rate swap agreement and on an on-going basis to determine whether these instruments are highly effective in offsetting changes in cash flows associated with the hedged items. While we intend to continue to meet the conditions for such hedge accounting, if hedges did not qualify as "highly effective", the changes in the fair values of the derivatives used as hedges would be reflected in earnings.As of December 31, 2005, our interest rate swap agreements were classified in other assets at their fair values aggregating approximately $4.9 million, with the offsetting adjustment reflected as unrealized gains in accumulated other comprehensive income in stockholders' equity. As of December 31, 2004, our interest rate swap agreements were classified in accounts payable, accrued expenses and tenant security deposits at their fair values aggregating approximately $2.1 million, with the offsetting adjustment reflected as unrealized losses in accumulated other comprehensive income in stockholders' equity. Balances in accumulated other comprehensive income are recognized in earnings as swap payments are made. During the next twelve months, we expect to reclassify $3.3 million from accumulated other comprehensive income to interest income.The following table summarizes our interest rate swap agreements as of December 31, 2005 (dollars in thousands):Notional Effective at Interest Termination Fair Transaction Dates Effective Dates Amounts December 31, 2005 Pay Rates Dates Values - ------------------ ---------------- --------- ------------------- --------- ---------------- --------- December 2002 January 2, 2003 $25,000 $ 25,000 3.285% June 30, 2006 $ 167 December 2002 January 2, 2003 25,000 25,000 3.285% June 30, 2006 167 December 2003 December 30, 2005 50,000 50,000 4.150% December 29, 2006 280 December 2003 December 29, 2006 50,000 -- 5.090% October 31, 2008 (313) March 2004 December 31, 2004 25,000 25,000 2.956% December 31, 2006 434 March 2004 December 31, 2004 25,000 25,000 2.956% December 31, 2006 434 April 2004 April 29, 2005 50,000 50,000 3.140% April 28, 2006 230 April 2004 April 28, 2006 50,000 -- 4.230% April 30, 2007 274 April 2004 April 30, 2007 50,000 -- 4.850% April 30, 2008 (63) June 2004 June 30, 2005 50,000 50,000 4.343% June 30, 2007 284 December 2004 December 31, 2004 50,000 50,000 3.590% January 2, 2008 1,129 December 2004 January 3, 2006 50,000 -- 3.927% July 1, 2008 950 May 2005 December 30, 2005 25,000 25,000 4.120% November 30, 2006 136 May 2005 June 30, 2006 50,000 -- 4.270% June 29, 2007 250 May 2005 November 30, 2006 25,000 -- 4.330% November 30, 2007 103 May 2005 June 29, 2007 50,000 -- 4.400% June 30, 2008 162 May 2005 November 30, 2007 25,000 -- 4.460% November 28, 2008 61 May 2005 June 30, 2008 50,000 -- 4.509% June 30, 2009 112 May 2005 November 28, 2008 25,000 -- 4.615% November 30, 2009 41 December 2005 December 29, 2006 50,000 -- 4.730% November 30, 2009 17 December 2005 December 29, 2006 50,000 -- 4.740% November 30, 2009 4 December 2005 January 2, 2008 50,000 -- 4.768% December 31, 2010 8 ------------------- --------- Total Interest Rate Swap Agreements in $ 325,000 $ 4,867 Effect at December 31, 2005 =================== =========8. Commitments and ContingenciesEmployee Retirement Savings PlanWe have a retirement savings plan pursuant to Section 401(k) of the Internal Revenue Code whereby our employees may contribute a portion of their compensation to their respective retirement accounts, in an amount not to exceed the maximum allowed under the Internal Revenue Code. In addition to employee contributions, we have elected to provide discretionary profit sharing contributions (subject to statutory limitations), which amounted to $552,000, $515,000 and $461,000, respectively, for the years ended December 31, 2005, 2004 and 2003. Employees who participate in the plan are immediately vested in their contributions and in the contributions of the company. Concentration of Credit RiskWe maintain our cash and cash equivalents at insured financial institutions. The combined account balances at each institution periodically exceed FDIC insurance coverage, and, as a result, there is a concentration of credit risk related to amounts in excess of FDIC insurance coverage. We believe that the risk is not significant. We are dependent on rental income from relatively few tenants in the life science industry. The inability of any single tenant to make its lease payments could adversely affect our operations. As of December 31, 2005, we held 283 leases with a total of 237 tenants and 73 of our 134 properties were each leased to a single tenant. At December 31, 2005, our three largest tenants accounted for approximately 11.6% of our aggregate annualized base rent. We generally do not require collateral or other security from our tenants, other than security deposits. In addition to security deposits held in cash, we held $35.1 million in irrevocable letters of credit available from certain tenants as security deposits for 86 leases as of December 31, 2005.CommitmentsAs of December 31, 2005, we were committed under the terms of contracts to complete the construction of properties under development at a remaining aggregate cost of approximately $46.4 million. As of December 31, 2005, we were also committed to fund approximately $20.1 million for the construction of building infrastructure improvements under the terms of leases and/or construction contracts and approximately $13.3 million for certain investments. As of December 31, 2005, we were committed under the terms of eight ground leases. These lease obligations totaling approximately $62.8 million have remaining lease terms of 27 to 50 years, exclusive of extension options. In addition, as of December 31, 2005, we were committed under the terms of certain operating leases for our headquarters and field offices. These lease obligations totaling approximately $6.2 million have remaining lease terms of two to seven years, exclusive of extension options.9. Minority InterestMinority interest represents the interests in a limited partnership and in a limited liability company held by certain third parties, which own two properties and are included in our consolidated financial statements. We recognize minority interest in these entities in which we have a controlling interest. Minority interest is adjusted for additional contributions, distributions to minority holders and the minority holders' proportionate share of the net earnings or losses of each respective entity. Distributions, profits and losses related to these entities are allocated in accordance with the respective operating agreements. As of December 31, 2005 the aggregate minority interest balance related to these entities was approximately $20.1 million and is classified as minority interest in the accompanying consolidated balance sheet. 10. Issuances of Common StockIn March 2005, we sold 1,437,500 shares of our common stock in an underwritten offering (including the shares issued upon exercise of the underwriter's over-allotment option). The shares were issued at a price of $62.51 per share, resulting in net proceeds of approximately $89.1 million (after deducting underwriting discounts and other offering costs).In September 2005, we sold 1,248,000 shares of our common stock in an underwritten offering (including shares issued upon exercise of the underwriter's over-allotment option). The shares were issued at a price of $81.00 per share, resulting in net proceeds of approximately $100.3 million (after deducting underwriting discounts and other offering costs). 11. Preferred Stock and Excess StockSeries A Cumulative Redeemable Preferred StockIn July 2004, we redeemed all 1,543,500 outstanding shares of our 9.50% Series A cumulative redeemable preferred stock ("Series A preferred stock") at a redemption price of $25.00 per share plus $0.5409722 per share representing accumulated and unpaid dividends to the redemption date. In accordance with EITF Topic D-42, we recorded a charge of approximately $1,876,000 to net income available to common stockholders during the second quarter of 2004 for costs related to the redemption of the Series A preferred stock. We redeemed our Series A preferred stock with proceeds from the Series C preferred stock offering.Series B Cumulative Redeemable Preferred StockIn January 2002, we completed a public offering of 2,300,000 shares of our 9.10% Series B cumulative redeemable preferred stock ("Series B preferred stock") (including the shares issued upon exercise of the underwriters' over-allotment option). The shares were issued at a price of $25.00 per share, resulting in aggregate proceeds of approximately $55.1 million (after deducting underwriters' discounts and other offering costs). The dividends on our Series B preferred stock are cumulative and accrue from the date of original issuance. We pay dividends quarterly in arrears at an annual rate of $2.275 per share. Our Series B preferred stock has no stated maturity, is not subject to any sinking fund or mandatory redemption and is not redeemable prior to January 22, 2007, except in order to preserve our status as a REIT. Investors in our Series B preferred stock generally have no voting rights. On or after January 22, 2007, we may, at our option, redeem our Series B preferred stock, in whole or in part, at any time with proceeds from the sale of equity securities at a redemption price of $25.00 per share, plus accrued and unpaid dividends. Series C Cumulative Redeemable Preferred StockIn June 2004, we completed a public offering of 5,185,500 shares of our 8.375% Series C cumulative redeemable preferred stock ("Series C preferred stock") (including the shares issued upon exercise of the underwriters' over-allotment option). The shares were issued at a price of $25.00 per share, resulting in aggregate proceeds of approximately $124.0 million (after deducting underwriters' discounts and other offering costs). The proceeds were used to redeem our Series A preferred stock with the remaining portion used to pay down our unsecured line of credit. The dividends on our Series C preferred stock are cumulative and accrue from the date of original issuance. We pay dividends quarterly in arrears at an annual rate of $2.09375 per share. Our Series C preferred stock has no stated maturity, is not subject to any sinking fund or mandatory redemption and is not redeemable prior to June 29, 2009, except in order to preserve our status as a REIT. Investors in our Series C preferred stock generally have no voting rights. On or after June 29, 2009, we may, at our option, redeem our Series C preferred stock, in whole or in part, at any time for cash at a redemption price of $25.00 per share, plus accrued and unpaid dividends.Preferred Stock and Excess Stock AuthorizationsOur charter authorizes the issuance of up to 100,000,000 shares of preferred stock, of which 7,485,500 shares were issued and outstanding as of December 31, 2005. In addition, 200,000,000 shares of "excess stock" (as defined) are authorized, none of which were issued and outstanding at December 31, 2005. 12. Stock Option Plans and Stock Grants1997 Stock PlanIn 1997, we adopted a stock option and incentive plan (the "Stock Plan") for the purpose of attracting and retaining the highest quality personnel, providing for additional incentives and promoting the success of the company by providing employees the opportunity to acquire common stock pursuant to (i) options to purchase common stock; and (ii) share awards. As of December 31, 2005, a total of 413,501 shares were reserved for the granting of future options and share awards under the Stock Plan. Options under our plan have been granted at prices that are equal to the market value of the stock on the date of grant and expire ten years after the date of grant. Employee options vest ratably in three annual installments from the date of grant. Non-employee director options vest immediately on the date of grant. The options outstanding under the Stock Plan expire at various dates through October 2012. In addition, the Stock Plan permits us to issue share awards to our employees and non-employee directors. A share award is an award of common stock, which (i) may be fully vested upon issuance or (ii) may be subject to the risk of forfeiture under Section 83 of the Internal Revenue Code. Shares issued generally vest over a one to three year period from the date of issuance and the sale of the shares is restricted prior to the date of vesting. During 2005, we awarded 162,387 shares of common stock. The unearned portion of these awards is amortized as stock compensation expense on a straight-line basis over the vesting period. The fair values of the options issued under the Stock Plan were estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for 2005, 2004 and 2003: Year Ended December 31, ------------------------------------------ 2005 2004 2003 ------------ ------------- ------------- Risk-free interest rate 4.34% 3.94% 3.65% Dividend yield 3.19% 3.79% 3.95% Volatility factor of the expected market price 21.14% 21.50% 21.20% Weighted average expected life of the options 5.2 years 6.7 years 7.0 yearsA summary of the stock option activity under our Stock Plan and related information for the years ended December 31, 2005, 2004 and 2003 follows: 2005 2004 2003 ---------------------- ---------------------- ----------------------- Weighted Weighted Weighted Average Average Average Stock Exercise Stock Exercise Stock Exercise Options Price Options Price Options Price ---------- ---------- ---------- ---------- ---------- ---------- Outstanding-beginning of year 607,331 $ 35.36 809,583 $ 35.39 1,011,166 $ 34.39 Granted -- -- -- -- -- -- Exercised (115,315) 37.22 (200,252) 35.44 (197,583) 30.08 Forfeited -- -- (2,000) 42.15 (4,000) 43.23 ---------- ---------- ---------- ---------- ---------- ---------- Outstanding-end of year 492,016 $ 34.92 607,331 $ 35.36 809,583 $ 35.39 ========== ========== ========== ========== ========== ========== Exercisable at end of year 492,016 $ 34.92 500,000 $ 33.38 533,420 $ 31.35 ========== ========== ========== ========== ========== ========== Weighted average fair value of options granted $ - $ - $ - ========== ========== ==========The following table summarizes information about stock options outstanding at December 31, 2005:Options Outstanding Options Exercisable ----------------------------------- ---------------------- Weighted Average Weighted Weighted Range of Number Remaining Average Number Average Exercise Outstanding Contractual Exercise Exercisable Exercise Prices at 12/31/05 Life Price at 12/31/05 Price - --------------- ------------ ------------ --------- ------------ --------- $20.00-$30.88 166,400 1.66 $22.19 166,400 $22.19 $31.88-$43.50 222,616 5.00 $38.55 222,616 $38.55 $44.99-$47.69 103,000 6.47 $47.65 103,000 $47.65 ------------ ------------ $20.00-$47.69 492,016 4.18 $34.92 492,016 $34.92 ============ ============13. Non-Cash TransactionsDuring the twelve months ended December 31, 2005, we assumed seven secured notes payable in connection with the acquisitions of seven properties, in seven separate transactions, located in the San Francisco Bay, Suburban Washington D.C., Eastern Massachusetts, Seattle and Canada markets. During the twelve months ended December 31, 2004, we assumed six secured note payables in connection with the acquisitions of ten properties, in six separate transactions, located in the Eastern Massachusetts, Southeast, Suburban Washington D.C. and San Diego markets. The following table summarizes these transactions (in thousands):2005 2004 2003 ------------ ------------- ------------- Aggregate purchase price $ 55,400 $ 185,912 $ 6,900 Secured notes payable assumed 31,853 127,653 3,384 ------------ ------------- ------------- Cash paid for the properties $ 23,547 $ 58,259 $ 3,516 ============ ============= =============In connection with the sale of a property in the Eastern Massachusetts market in August 2003, the buyer assumed a secured note payable totaling $17.3 million.In 2005, 2004 and 2003, we incurred $5,136,000, $3,157,000 and $3,354,000, respectively, in non-cash stock compensation expense. 14. Discontinued Operations The following is a summary of operations and net assets of the properties included in discontinued operations presented in compliance with SFAS 144 (in thousands):Year Ended December 31, ------------------------------------------ 2005 2004 2003 ------------ ------------- ------------- Total revenue $ 127 $ 217 $ 5,653 Operating expenses 14 38 1,428 ------------ ------------- ------------- Revenue less operating expenses 113 179 4,225 Interest -- -- 924 Depreciation 17 47 303 ------------ ------------- ------------- Income before gain/loss on sales of property 96 132 2,998 Gain/loss on sales of property 36 1,627 8,286 ------------ ------------- ------------- Income from discontinued operations, net $ 132 $ 1,759 $ 11,284 ============ ============= ============= December 31, --------------------------- 2005 2004 ------------ ------------- Properties held for sale, net $ -- $ 1,016 Other assets -- 142 ------------ ------------- Total assets $ -- $ 1,158 ============ ============= Total liabilities -- 50 ------------ ------------- Net assets of discontinued operations $ -- $ 1,108 ============ =============Income from discontinued operations, net includes the results of operations of one property we sold during 2005, one property we sold during 2004 and three properties we sold during 2003 in accordance with the provisions of SFAS 144. See Note 2, Basis of Presentation and Summary of Significant Accounting Policies.As of December 31, 2005 and 2004, we had no properties designated as "held for sale" in accordance with SFAS 144. During the third quarter of 2005, we sold one property located in the Southeast market that had been designated as "held for sale" as of June 30, 2005. The total sale price for the property was approximately $1.3 million. In connection with this sale, we recorded a gain on sale of property of approximately $36,000. During the first quarter of 2004, we sold one property located in the Suburban Washington D.C. market that had been designated as "held for sale" as of December 31, 2003. The total sale price for the property was approximately $5.7 million. In connection with the sale, we recorded a gain on sale of property of approximately $1.6 million. During the fourth quarter of 2003, we sold one property located in the Suburban Washington D.C. market that had been designated as "held for sale" during the fourth quarter of 2003. The total sale price for the property was approximately $9.0 million. In connection with the sale, we recorded a loss on sale of property of approximately $36,000. During the third quarter of 2003, we sold one property located in the Eastern Massachusetts market that had been previously designated as "held for sale" as of December 31, 2002. The total sale price for the property was approximately $46.5 million. In connection with this sale, we recorded a gain on sale of property of approximately $8.8 million. Interest expense included in discontinued operations represents interest related to a secured note payable, which was assumed by the buyer in connection with the sale of this property. During the first quarter of 2003, we sold one property located in the San Francisco Bay market which could not be redeveloped pursuant to our original strategic objectives and that had been designated as "held for sale" as of December 31, 2002. The total sale price for the property was approximately $6.8 million. In connection with this sale, we recorded a loss on sale of property of approximately $455,000 in 2003. Gains and losses on sales of these properties are included in the income statement in income from discontinued operations, net.15. Quarterly Financial Data (Unaudited)The following is a summary of consolidated financial information on a quarterly basis for 2005 and 2004: Quarter ---------------------------------------------------------- First Second Third Fourth ------------- ------------- ------------- ------------- (In thousands, except per share amounts) 2005 - ---- Revenues $ 56,039 $ 58,217 $ 63,752 $ 66,076 Net income available to common stockholders $ 10,967 $ 12,250 $ 11,969 $ 12,157 Earnings per share: Basic $ 0.56 $ 0.59 $ 0.57 $ 0.55 Diluted $ 0.55 $ 0.58 $ 0.56 $ 0.54 Quarter ---------------------------------------------------------- First Second Third Fourth ------------- ------------- ------------- ------------- (In thousands, except per share amounts) 2004 - ---- Revenues $ 42,724 $ 43,472 $ 46,459 $ 50,426 Net income available to common stockholders $ 13,115 $ 9,757 $ 11,370 $ 11,482 Earnings per share: Basic $ 0.68 $ 0.51 $ 0.59 $ 0.59 Diluted $ 0.67 $ 0.50 $ 0.58 $ 0.58Alexandria Real Estate Equities, Inc. and SubsidiariesSchedule IIIConsolidated Financial Statement Schedule of Rental Propertiesand Accumulated DepreciationDecember 31, 2005 (Unaudited) (In thousands, except square foot data)Initial Costs Costs Total Costs Square ----------------------- Capitalized ---------------------- Footage Buildings and Subsequent to Buildings and Accumulated Year Built/ Property Name (unaudited) Land Improvements Acquisition Land Improvements Total Depreciation (1) Encumbrances (27) Renovated ------------- ---------- -------- ------------- ------------- -------- ------------ ----------- ---------------- ---------------- ------------------- North Torrey Pines Road #1 107,710 $ 1,321 $ 5,960 $ 6,719 $ 1,321 $ 12,679 $ 14,000 $ 2,915 $ - 1971/2003 Science Park Road 74,557 1,013 - 16,767 1,013 16,767 17,780 4,673 - 2000 North Torrey Pines Road #3 44,733 620 9,531 9,052 620 18,583 19,203 201 - 1962/2005 North Torrey Pines Road #2 86,962 2,663 10,649 5,203 2,663 15,852 18,515 5,362 - 1986/1996 General Atomics Court #1 76,084 2,651 18,046 1,447 2,651 19,493 22,144 6,888 37,928 (2) 1986/2000 General Atomics Court #2 43,600 1,227 9,554 30 1,227 9,584 10,811 3,466 - (2) 1991 Roselle Street #1 18,173 463 1,840 2,774 463 4,614 5,077 1,109 - (3) 1983/1998 Nexus Centre Drive 67,050 2,548 13,638 45 2,548 13,683 16,231 4,324 32,296 (4) 1989 Nancy Ridge Drive #1 29,333 733 2,273 1,878 733 4,151 4,884 1,655 - (5) 1997 Roselle Street #2 17,603 444 1,699 1,842 444 3,541 3,985 1,111 - late 1970's/1999 Tansy Street 15,410 651 1,375 1,899 651 3,274 3,925 1,422 - 1978/1999 John Hopkins Court #1 34,723 1,122 - 3,881 1,122 3,881 5,003 560 - (2) 2000 John Hopkins Court #2 55,200 1,683 - 5,647 1,683 5,647 7,330 1,084 - (2) 1999 Towne Centre Drive #1 45,030 275 8,621 3,661 275 12,282 12,557 1,754 89,580 (18) 1987/2003 Towne Centre Drive #2 52,228 320 10,070 2,948 320 13,018 13,338 2,342 - (18) 1987/2000 Towne Centre Drive #3 41,780 258 8,170 7,903 258 16,073 16,331 2,696 - (18) 1987/2000 Roselle Street #3 17,590 455 2,581 1,019 455 3,600 4,055 178 23,175 (3) 1981 Roselle Street #4 30,147 754 4,288 341 754 4,629 5,383 525 - (3) 1981/1998 Roselle Street #5 22,577 564 3,224 43 564 3,267 3,831 497 - (3) 1981/1995 Roselle Street #6 17,433 436 2,480 81 436 2,561 2,997 349 - (3) 1981/1999 Roselle Street #7 24,208 605 3,459 42 605 3,501 4,106 533 - (3) 1981/1995 Nancy Ridge Drive #2 21,940 515 1,566 2,502 515 4,068 4,583 750 - early 1980's/2001 Campus Point Drive 71,510 4,246 16,165 9,290 4,246 25,455 29,701 1,191 10,673 1986/1998 Nancy Ridge Drive #3 56,698 1,984 10,397 43 1,984 10,440 12,424 522 - (18) 1987/2001 Torreyana Road 87,140 9,980 9,448 1,975 9,980 11,423 21,403 112 - 1980 Nancy Ridge Drive #4 87,298 3,492 18,285 199 3,492 18,484 21,976 469 15,627 (17) 1999/2000 North Hill Avenue 31,343 2,172 812 9,848 2,172 10,660 12,832 1,697 - 1940's/2002 Harbor Bay Parkway #1 61,015 1,506 5,357 3,670 1,506 9,027 10,533 3,066 - (4) 1983/1999 Harbor Bay Parkway #2 27,745 775 1,917 1,632 775 3,549 4,324 1,141 - (4) 1984/2000 Harbor Bay Parkway #3 47,777 1,200 3,880 448 1,200 4,328 5,528 1,094 - (4) 1986/1994 Harbor Bay Parkway #4 68,711 1,800 9,731 743 1,800 10,474 12,274 2,336 1,230 1985/1994 Mitten Road & Malcolm Road 153,837 4,751 12,612 14,283 4,751 26,895 31,646 4,838 - 1962/2002 Hanover Street 32,074 - 6,628 7,840 - 14,468 14,468 4,029 - 1968/2000 Garcia Avenue & Bayshore Parkway 98,964 - 21,323 20,571 - 41,894 41,894 5,771 - 1980/2003 Oyster Point Boulevard #1 53,980 3,519 - 12,942 3,519 12,942 16,461 3,307 32,750 (6) 2001 Oyster Point Boulevard #2 53,980 3,519 - 7,671 3,519 7,671 11,190 1,433 - (6) 2001 Gateway Boulevard #1 110,428 7,730 24,397 24 7,730 24,421 32,151 2,290 - 2000 Gateway Boulevard #2 59,816 4,187 14,020 25 4,187 14,045 18,232 2,004 - 2002 Harbor Bay Parkway #5 67,482 1,349 9,915 59 1,349 9,974 11,323 529 - 1984/2001 Porter Drive 91,644 - 19,154 1,074 - 20,228 20,228 1,004 - (18) 1962/2002 Shoreline Court 140,143 7,038 39,704 2,407 7,038 42,111 49,149 1,289 - 2001 Bayshore Road 60,000 4,800 6,693 2,871 4,800 9,564 14,364 76 6,886 (19) 1982 Grand Avenue 116,284 28,276 - - 28,276 - 28,276 - - 1985 Bernardo Avenue 58,400 3,504 5,255 - 3,504 5,255 8,759 - - 1982/1999 Columbia Street #1 162,394 5,654 22,916 15,518 5,654 38,434 44,088 9,960 15,539 (7) 1975/1997 Columbia Street #2 46,303 912 612 2,688 912 3,300 4,212 32 - (7) 1975/1997 Western Avenue 47,746 1,432 7,497 3,096 1,432 10,593 12,025 2,863 33,430 (8) 1929/2000 First Avenue 70,647 2,119 11,275 4,703 2,119 15,978 18,097 4,747 - 1980/2000 Eastlake Avenue #1 106,003 4,240 31,232 25 4,240 31,257 35,497 2,539 - 1997 Eastlake Avenue #2 97,366 1,570 15,917 14,929 1,570 30,846 32,416 1,966 - 1997 Eastlake Avenue #3 125,066 5,245 - 38,866 5,245 38,866 44,111 1,058 - 2004 Harrison Street 32,279 2,097 1,645 5,352 2,097 6,997 9,094 124 - 1962 Elliot Avenue West 2,896 1,700 344 103 1,700 447 2,147 17 - 1951 Eastlake Avenue #5 121,790 8,525 20,064 164 8,525 20,228 28,753 505 13,000 1962/2000 Fairview Avenue 27,633 2,212 6,788 22 2,212 6,810 9,022 85 4,056 (20) 1998 Professional Drive #1 47,558 871 5,362 3,095 871 8,457 9,328 2,807 - 1989/1999 Professional Drive #2 62,739 1,129 6,940 48 1,129 6,988 8,117 1,666 - 1987 West Watkins Mill Road #1 138,938 3,281 14,416 189 3,281 14,605 17,886 3,508 23,690 (9) 1989/1997 Quince Orchard Road #1 49,225 1,267 3,031 5,168 1,267 8,199 9,466 4,706 - (9) 1982/1997 Clopper Road #1 44,464 900 2,732 1,576 900 4,308 5,208 1,804 - (10) 1989 East Gude Drive #1 45,989 748 3,609 1,608 748 5,217 5,965 1,292 - (11) 1981/2003 Research Boulevard 105,000 1,733 9,611 3,598 1,733 13,209 14,942 2,601 - 1967/2000 East Gude Drive #2 44,500 775 4,122 329 775 4,451 5,226 990 - (11) 1981/1995 Piccard Drive 131,415 2,800 11,533 19,527 2,800 31,060 33,860 2,086 - 1994/2005 Newbrook Drive 248,186 4,800 27,639 390 4,800 28,029 32,829 6,188 - (8) 1992 Virginia Manor Road 191,884 - 13,679 1,484 - 15,163 15,163 3,303 29,234 (11) 1990/2003 Old Columbia Road 75,500 1,510 5,210 1,627 1,510 6,837 8,347 2,197 - 1983/1997 West Watkins Mill Road #4 102,815 1,783 18,946 20 1,783 18,966 20,749 221 - 2005 Firstfield Road #1 25,175 376 3,192 2,114 376 5,306 5,682 902 - 1974/2000 West Watkins Mill Road #2 57,410 859 4,149 2,482 859 6,631 7,490 1,420 - 1988/2000 Clopper Road #2 143,585 2,463 493 17,893 2,463 18,386 20,849 6,738 27,219 (10) 2000 Firstfield Road #2 53,464 971 5,141 6,410 971 11,551 12,522 2,220 - (12) 1980/2001 Firstfield Road #3 54,000 947 5,092 4,560 947 9,652 10,599 1,090 - (12) 1980/2003 Quince Orchard Road #2 54,874 970 5,138 1,053 970 6,191 7,161 831 9,458 (12) 1981/2003 Clopper Road #3 59,838 983 6,638 90 983 6,728 7,711 1,105 - (10) 1989/1992 Research Place 58,632 1,466 5,708 4,182 1,466 9,890 11,356 984 - 1972/2003 West Watkins Mill Road #3 92,449 2,773 23,906 2,630 2,773 26,536 29,309 439 - 1999 Parklawn Drive 49,185 1,476 7,267 37 1,476 7,304 8,780 243 - 1963/1979 Broschart Road 37,861 2,576 5,661 46 2,576 5,707 8,283 190 - 1999 Medical Center Drive #1 58,733 - 8,070 268 - 8,338 8,338 259 - 1998 Research Court 54,906 1,647 13,258 734 1,647 13,992 15,639 387 - 1970/1992 Clopper Road #4 180,650 5,527 26,365 1,394 5,527 27,759 33,286 768 15,498 1982 Medical Center Drive #2 41,887 1,480 14,532 590 1,480 15,122 16,602 375 77,208 (14) 1996/2002 Medical Center Drive #3 60,485 2,138 20,868 5,768 2,138 26,636 28,774 538 - (14) 1996/2002 Medical Center Drive #4 125,008 4,419 43,110 1,338 4,419 44,448 48,867 1,111 - (14) 1996/2002 Medical Center Drive #5 56,987 2,015 19,660 1,049 2,015 20,709 22,724 516 - (14) 1996/2002 Professional Drive #3 26,127 784 4,705 85 784 4,790 5,574 99 3,398 (21) 2000/2003 Industrial Drive 83,541 2,924 19,664 86 2,924 19,750 22,674 123 - 1972/1983 Charlestown Navy Yard 24,940 - 6,247 397 - 6,644 6,644 1,335 - (15) 1880/1991 Pond Street 24,867 622 3,053 59 622 3,112 3,734 353 - 1965/1990 Westview Street 40,200 960 3,032 8,194 960 11,226 12,186 845 - 1975 Plantation Street #1 92,711 2,352 14,173 1,098 2,352 15,271 17,623 2,981 18,067 (5) 1993 Innovation Drive 115,179 2,734 14,567 3,966 2,734 18,533 21,267 3,468 8,505 1991 Plantation Street #2 92,423 651 - 15,749 651 15,749 16,400 6,651 - 2000 Arsenal Street #1 92,500 3,360 7,316 14,729 3,360 22,045 25,405 5,334 - 1978/2001 Hartwell Avenue #1 59,000 1,475 7,194 11,399 1,475 18,593 20,068 3,040 37,068 (15) 1972/2002 Arsenal Street #2 96,150 6,413 5,457 28,939 6,413 34,396 40,809 1,408 - 1980/2003 Memorial Drive #1 51,000 6,507 - 21,759 6,507 21,759 28,266 3,135 - 2002 Memorial Drive #2 47,497 6,058 - 21,285 6,058 21,285 27,343 1,885 - 2002 Hartwell Avenue #2 46,700 2,567 4,522 9,763 2,567 14,285 16,852 489 - (18) 1972 Belmont Street 78,916 1,578 10,195 29 1,578 10,224 11,802 426 9,298 (16) 1929/2003 Plantation Street #3 11,774 228 1,501 151 228 1,652 1,880 45 - (16) 1940/2003 Wiggins Avenue 48,640 876 5,033 17 876 5,050 5,926 147 - 1975/1997 Bearfoot Road 60,759 1,220 22,375 44 1,220 22,419 23,639 467 - 1977 Beaver Street 81,456 1,466 9,046 482 1,466 9,528 10,994 178 7,400 1982/1997 Hartwell Avenue #3 26,828 1,341 8,448 36 1,341 8,484 9,825 141 5,857 (22) 1975/2000 Presidential Way 128,325 12,833 27,333 53 12,833 27,386 40,219 456 - 1999 DeAngelo Drive 30,000 750 3,312 37 750 3,349 4,099 56 2,739 (23) 1972/2001 First Street 45,820 2,749 7,679 332 2,749 8,011 10,760 80 - 1907/1982 Fortune Boulevard 36,000 1,440 5,238 14 1,440 5,252 6,692 66 - 1985/1996 Wiggins Avenue #2 38,000 893 4,000 67 893 4,067 4,960 25 1,909 (24) 1975/2004 Sidney Street 26,589 1,595 3,554 - 1,595 3,554 5,149 - - 1920 Preston Court 54,391 1,278 7,057 - 1,278 7,057 8,335 29 - 1973/2000 Canada #1 68,000 2,924 17,735 856 2,924 18,591 21,515 387 - 2004 Canada #2 162,362 6,982 20,651 1 6,982 20,652 27,634 43 - 1999 Canada #3 66,000 2,276 8,612 - 2,276 8,612 10,888 - 6,387 (25) 1969/2003 College Road 107,874 1,943 9,764 1,550 1,943 11,314 13,257 2,527 - 1968/1984 Williams Drive 37,000 740 4,506 1,264 740 5,770 6,510 877 - 1982/1994 Phillips Parkway 78,501 1,840 2,298 14,546 1,840 16,844 18,684 4,146 - (15) late 1960's/1999 Campus Drive 42,782 654 4,234 402 654 4,636 5,290 993 - (15) 1989 Electronic Drive 40,000 600 3,110 3,289 600 6,399 6,999 2,950 - 1983/1998 Princeton Road 42,600 1,075 1,438 4,179 1,075 5,617 6,692 2,327 - 1984/1999 Welsh Pool Road 41,015 621 4,258 31 621 4,289 4,910 151 - 1968 Lawrence Road 111,451 1,289 12,039 70 1,289 12,109 13,398 433 - 1997/2004 Capitola Drive #1 65,114 337 5,795 845 337 6,640 6,977 1,499 - (13) 1986 Capitola Drive #2 59,397 288 5,789 5,611 288 11,400 11,688 3,891 11,522 (13) 1985 Capitola Drive #3 60,519 289 5,899 6,951 289 12,850 13,139 1,978 - (13) 1985 Technology Parkway 20,580 214 3,802 - 214 3,802 4,016 678 - 1976/1993 Triangle Drive 32,120 161 3,410 224 161 3,634 3,795 740 - 1981 Alexander Road 86,239 - 376 11,609 - 11,985 11,985 1,947 - 2000 Kit Creek Road #1 38,861 339 3,383 7,164 339 10,547 10,886 1,656 - 1995/2003 Kit Creek Road #2 48,236 364 8,734 3,789 364 12,523 12,887 - - 2005 State Highway 54 81,580 713 12,827 168 713 12,995 13,708 432 8,449 1995 ---------- -------- ------------- ------------- -------- ------------ ----------- ---------------- ---------------- 8,824,369 $296,841 $ 1,161,446 $ 551,421 $296,841 $ 1,712,867 $ 2,009,708 $ 220,890 $ 619,076 ========== ======== ============= ============= ======== ============ =========== ================ ================_________________The depreciable life ranges from 30 to 40 years for buildings and improvements, 20 years for land improvements, and the term of the respective lease for tenant improvements.Loan secured by General Atomics Court #1, General Atomics Court #2, John Hopkins Court #1 and John Hopkins Court #2 is shown under General Atomics Court #1.Loan secured by Roselle Street #1, Roselle Street #3, Roselle Street #4, Roselle Street #5, Roselle Street #6 and Roselle Street #7 is shown under Roselle Street #3.Loan secured by Nexus Centre Drive, Harbor Bay Parkway #1, Harbor Bay Parkway #2 and Harbor Bay Parkway #3 is shown under Nexus Centre Drive.Loan secured by Nancy Ridge Drive #1 and Plantation Street #1 is shown under Plantation Street #1.Loan secured by Oyster Point Boulevard #1 and Oyster Point Boulevard #2 is shown under Oyster Point Boulevard #1.Loan secured by Columbia Street #1 and Columbia Street #2 is shown under Columbia Street #1.Loan secured by Western Avenue and Newbrook Drive is shown under Western Avenue.Loan secured by West Watkins Mill Road #1 and Quince Orchard Road #1 is shown under West Watkins Mill Road #1.Loan secured by Clopper Road #1, Clopper Road #2 and Clopper Road #3 is shown under Clopper Road #2.Loan secured by East Gude Drive #1, East Gude Drive #2 and Virginia Manor is shown under Virginia Manor.Loan secured by Firstfield Road #2, Firstfield Road #3 and Quince Orchard Road #2 is shown under Quince Orchard Road #2.Loan secured by Capitola Drive #1, Capitola Drive #2 and Capitola Drive #3 is shown under Capitola Drive #2. Loan secured by Medical Center Drive #2, Medical Center Drive #3, Medical Center Drive #4 and Medical Center Drive #5 is shown under Medical Center Drive #2. The balance shown includes an unamortized premium of $1,208,000. Loan secured by Hartwell Avenue #1, Charlestown Navy Yard, Phillips Parkway and Campus Drive is shown under Hartwell Avenue #1. Loan secured by Belmont Street and Plantation Street #3 is shown under Belmont Street.The balance shown includes an unamortized premium of $1,504,000.Loan secured by Towne Centre Drive #1, Towne Centre Drive #2, Towne Centre Drive #3, Nancy Ridge Drive #3, Porter Drive and Hartwell Avenue #2 is shown under Towne Centre Drive #1.The balance shown includes an unamortized premium of $175,000.The balance shown includes an unamortized premium of $329,000.The balance shown includes an unamortized premium of $231,000.The balance shown includes an unamortized premium of $418,000.The balance shown includes an unamortized premium of $287,000.The balance shown includes an unamortized premium of $108,000.The balance shown includes an unamortized premium of $259,000.The aggregate cost of real estate for federal income tax purposes is not materially different from the cost basis under GAAP (unaudited).Excludes $47.6 million of encumbrances related to three land parcels located in the San Francisco and Seattle markets. A summary of activity of consolidated rental properties and accumulated depreciation is as follows (in thousands): Rental Properties Year Ended December 31, ------------------------------------------ 2005 2004 2003 ------------ ------------- ------------- Balance at beginning of period $ 1,603,912 $ 1,123,857 $ 1,089,899 Purchase of rental properties 272,532 383,350 48,729 Sale of properties (1,237) (4,084) (56,741) Additions 94,210 70,248 48,264 Transfer of costs from (to) properties under development 40,291 30,541 (6,294) ------------ ------------- ------------- Balance at end of period $ 2,009,708 $ 1,603,912 $ 1,123,857 ============ ============= ============= Accumulated Depreciation December 31, ------------------------------------------ 2005 2004 2003 ------------ ------------- ------------- Balance at beginning of period $176,059 $141,560 $113,477 Depreciation expense on rental properties 45,066 35,052 32,786 Accumulated depreciation on properties sold (235) (553) (4,703) ------------ ------------- ------------- Balance at end of period $220,890 $176,059 $141,560 ============ ============= =============
We have audited the accompanying consolidated balance sheets of Alexandria Real Estate Equities, Inc. and subsidiaries (the "Company") as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedule listed in the index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Alexandria Real Estate Equities, Inc. and subsidiaries at December 31, 2005 and 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company's internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 9, 2006, expressed an unqualified opinion thereon.
Alexandria Real Estate Equities, Inc. and Subsidiaries
Consolidated Balance Sheets(Dollars in thousands, except per share amounts)
December 31, ---------------------- 2005 2004 ---------- ---------- Assets Rental properties, net $1,788,818 $1,427,853 Properties under development and land held for development 329,338 252,249 Cash and cash equivalents 3,911 3,158 Tenant security deposits and other restricted cash 21,013 17,669 Tenant receivables 4,764 2,542 Deferred rent 54,573 43,166 Investments 82,010 67,419 Other assets 78,023 58,228 ---------- ---------- Total assets $2,362,450 $1,872,284 ========== ==========Liabilities and Stockholders' EquitySecured notes payable $ 666,666 $ 638,946 Unsecured line of credit and unsecured term loan 740,000 548,000 Accounts payable, accrued expenses and tenant security deposits 86,391 48,581 Dividends payable 19,478 16,284 ---------- ---------- Total liabilities 1,512,535 1,251,811 Commitments and contingencies Minority interest 20,115 - Stockholders' equity: 9.10% Series B cumulative redeemable preferred stock, $0.01 par value per share, 2,300,000 shares authorized; 2,300,000 shares issued and outstanding at December 31, 2005 and 2004; $25.00 liquidation value per share 57,500 57,500 8.375% Series C cumulative redeemable preferred stock $0.01 par value per share, 5,750,000 shares authorized; 5,185,500 shares issued and outstanding at December 31, 2005 and 2004; $25.00 liquidation value per share 129,638 129,638 Common stock, $0.01 par value per share, 100,000,000 shares authorized; 22,441,294 and 19,594,418 shares issued and outstanding at December 31, 2005 and 2004, respectively 224 196 Additional paid-in capital 607,405 414,028 Retained earnings - 5,267 Accumulated other comprehensive income 35,033 13,844 ---------- ---------- Total stockholders' equity 829,800 620,473 ---------- ---------- Total liabilities and stockholders' equity $2,362,450 $1,872,284 ========== ==========
See the accompanying Notes to Consolidated Financial Statements.
Consolidated Statements of Income(Dollars in thousands, except per share amounts)
Year Ended December 31, -------------------------------------- 2005 2004 2003 ----------- ----------- ----------- Revenues Rental $ 189,312 $ 143,700 $ 126,236 Tenant recoveries 49,974 35,840 32,050 Other income 4,798 3,541 2,068 ----------- ----------- ----------- 244,084 183,081 160,354ExpensesRental operations 54,540 38,394 32,770 General and administrative 21,094 15,105 14,211 Interest 49,116 28,670 26,416 Depreciation and amortization 55,399 42,476 38,598 ----------- ----------- ----------- 180,149 124,645 111,995 Minority interest 634 - - ----------- ----------- ----------- Income from continuing operations 63,301 58,436 48,359 Income from discontinued operations, net 132 1,759 11,284 ----------- ----------- ----------- Net income 63,433 60,195 59,643 Dividends on preferred stock 16,090 12,595 8,898 Preferred stock redemption charge - 1,876 - ----------- ----------- ----------- Net income available to common stockholders $ 47,343 $ 45,724 $ 50,745 =========== =========== =========== Earnings per share - basic: Continuing operations (net of preferred stock dividends and preferred stock redemption charge) $ 2.25 $ 2.28 $ 2.08 Discontinued operations, net 0.01 0.09 0.59 ----------- ----------- ----------- Earnings per share - basic $ 2.26 $ 2.37 $ 2.67 =========== =========== =========== Earnings per share - diluted: Continuing operations (net of preferred stock dividends and preferred stock redemption charge) $ 2.21 $ 2.24 $ 2.05 Discontinued operations, net 0.01 0.09 0.59 ----------- ----------- ----------- Earnings per share - diluted $ 2.22 $ 2.33 $ 2.64 =========== =========== =========== Weighted average shares of common stock outstanding: Basic 20,948,915 19,315,364 18,993,856 =========== =========== =========== Diluted 21,316,886 19,658,759 19,247,790 =========== =========== ===========
Consolidated Statements of Stockholders' Equity
(Dollars in thousands)
Accumulated Series A Series B Series C Number of Additional Other Preferred Preferred Preferred Common Common Paid-In Retained Comprehensive Stock Stock Stock Shares Stock Capital Earnings Income (Loss) Total ---------- ---------- ---------- ----------- ------- --------- ----------- ------------ ---------- Balance at December 31, 2002 $ 38,588 57,500 - 18,973,957 $ 190 $ 398,399 $ - $ (8,824) $ 485,853 Net income - - - - - - 59,643 - 59,643 Unrealized gain on marketable securities - - - - - - - 610 610 Unrealized gain on swap agreements - - - - - - - 2,739 2,739 ---------- Comprehensive income - - - - - - - - 62,992 Issuances pursuant to Stock Plan (options and awards) - - - 290,066 3 9,295 - - 9,298 Dividends declared on preferred stock - - - - - - (8,898) - (8,898) Dividends declared on common stock - - - - - - (42,110) - (42,110) ---------- ---------- ---------- ----------- ------- --------- ----------- ------------ ----------Balance at December 31, 2003 38,588 57,500 - 19,264,023 193 407,694 8,635 (5,475) 507,135 Net income - - - - - - 60,195 - 60,195 Unrealized gain on marketable securities - - - - - - - 15,110 15,110 Unrealized gain on swap agreements - - - - - - - 4,209 4,209 ---------- Comprehensive income - - - - - - - - 79,514 Issuance of Series C preferred stock, net of offering costs - - 129,638 - - (5,629) - - 124,009 Redemption of Series A preferred stock (38,588) - - - - 1,876 (1,876) - (38,588) Issuances pursuant to Stock Plan (options and awards) - - - 330,395 3 10,087 - - 10,090 Dividends declared on preferred stock - - - - - - (12,595) - (12,595) Dividends declared on common stock - - - - - - (49,092) - (49,092) ---------- ---------- ---------- ----------- ------- --------- ----------- ------------ ----------Balance at December 31, 2004 - 57,500 129,638 19,594,418 196 414,028 5,267 13,844 620,473 Net income - - - - - - 63,433 - 63,433 Unrealized gain on marketable securities - - - - - - - 12,439 12,439 Unrealized gain on swap agreements - - - - - - - 6,957 6,957 Foreign currency translation - - - - - - - 1,793 1,793 ---------- Comprehensive income - - - - - - - - 84,622 Issuance of common stock, net of offering costs - - - 2,685,500 27 189,344 - - 189,371 Amortization of stock compensation expense - - - - - - - - 0 Issuances pursuant to Stock Plan (options and awards) - - - 161,376 1 10,929 - - 10,930 Dividends declared on preferred stock - - - - - - (16,090) - (16,090) Dividends declared on common stock - - - - - (6,896) (52,610) - (59,506) ---------- ---------- ---------- ----------- ------- --------- ----------- ------------ ----------Balance at December 31, 2005 $ - $ 57,500 $ 129,638 22,441,294 $ 224 $ 607,405 $ - $ 35,033 $ 829,800 ========== ========== ========== =========== ======= ========= =========== ============ ==========
Consolidated Statements of Cash Flows(In thousands)
Year Ended December 31, ------------------------------------- 2005 2004 2003 ----------- ----------- ----------- Operating Activities Net income $ 63,433 $ 60,195 $ 59,643 Adjustments to reconcile net income to net cash provided by operating activities: Equity in income related to investments (483) (208) (306) Realized (gain)/loss on sales of investments (1,811) (2,228) (230) (Gain)/loss on sales of property (36) (1,627) (8,286) Minority interest 634 - - Depreciation and amortization 55,416 42,523 38,901 Amortization of loan fees and costs 6,666 2,374 2,133 Amortization of premiums on secured notes payable (1,089) (161) (290) Stock compensation expense 5,136 2,470 2,734 Changes in operating assets and liabilities: Tenant security deposits and other restricted cash (3,344) (6,612) (3,037) Tenant receivables (2,214) (573) 672 Deferred rent (14,904) (11,671) (6,826) Other assets (26,586) (18,261) (10,828) Accounts payable, accrued expenses and tenant security deposits 39,860 (905) 31 ----------- ----------- ----------- Net cash provided by operating activities 120,678 65,316 74,311Investing ActivitiesPurchase of rental properties (223,862) (251,091) (48,729) Proceeds from sales of rental properties 1,182 5,454 42,376 Additions to rental properties (92,417) (70,248) (48,264) Additions to properties under development and land held for development (117,945) (129,620) (78,327) Additions to investments (10,367) (7,993) (8,818) Proceeds from investments 10,509 5,246 2,488 ----------- ----------- ----------- Net cash used in investing activities (432,900) (448,252) (139,274)Financing ActivitiesProceeds from secured notes payable 153,398 198,400 64,667 Proceeds from issuances of common stock 189,371 - - Proceeds from issuance of preferred stock - 124,009 - Redemption of Series A preferred stock - (38,588) - Proceeds from exercise of stock options 4,291 7,094 5,941 Borrowings from unsecured line of credit and unsecured term loan 515,000 490,000 310,083 Repayments of unsecured line of credit (323,000) (331,000) (259,083) Principal reductions of secured notes payable (153,015) (10,376) (6,125) Dividends paid on common stock (56,312) (47,333) (40,427) Dividends paid on preferred stock (16,090) (11,097) (8,898) Distributions to minority interest (668) - - ----------- ----------- ----------- Net cash provided by financing activities 312,975 381,109 66,158 Net increase (decrease) in cash and cash equivalents 753 (1,827) 1,195 Cash and cash equivalents at beginning of year 3,158 4,985 3,790 ----------- ----------- ----------- Cash and cash equivalents at end of year $ 3,911 $ 3,158 $ 4,985 =========== =========== ===========Supplemental Disclosure of Cash Flow InformationCash paid during the year for interest, net of interest capitalized $ 39,292 $ 28,714 $ 28,143 =========== =========== ===========
Alexandria Real Estate Equities, Inc. and SubsidiariesNotes to Consolidated Financial Statements
1. Background
References to the "Company", "we", "our" and "us" refer to Alexandria Real Estate Equities, Inc. and its subsidiaries.
Alexandria Real Estate Equities, Inc. is a real estate investment trust ("REIT") formed in 1994. We are engaged principally in the ownership, operation, management, acquisition, and selective redevelopment and development of properties containing office/laboratory space. We refer to these properties as "life science properties". Our life science properties are designed and improved for lease primarily to institutional (universities and not-for-profit institutions), pharmaceutical, biotechnology, life science product, service, biodefense and translational research entities, as well as government agencies. As of December 31, 2005, we had 134 properties (131 properties located in nine states and three properties located in Canada) with approximately 8.8 million rentable square feet of office/laboratory space, compared to 113 properties in nine states with approximately 7.4 million rentable square feet of office/laboratory space as of December 31, 2004.
As of December 31, 2005, approximately 85% of our leases (on a square footage basis) were triple net leases, requiring tenants to pay substantially all real estate taxes and insurance, common area and other operating expenses, including increases thereto. In addition, as of December 31, 2005, approximately 6% of our leases (on a square footage basis) required the tenants to pay a majority of operating expenses. Additionally, as of December 31, 2005, approximately 89% of our leases (on a square footage basis) provided for the recapture of certain capital expenditures and approximately 90% of our leases (on a square footage basis) contained effective annual rent escalations that are either fixed or indexed based on the consumer price index or another index. The information provided in this paragraph is unaudited.
2. Basis of Presentation and Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements include the accounts of Alexandria Real Estate Equities, Inc. and its subsidiaries. All significant intercompany balances and transactions have been eliminated.
The Company holds interests, together with certain third parties, in a limited partnership and in a limited liability company which we consolidate in our financial statements. Such interests are subject to provisions of FASB Interpretation No. 46R, "Consolidation of Variable Interest Entities", FASB Emerging Issues Task Force Issue No. 96-16, "Investor's Accounting for an Investee When the Investor Has a Majority of the Voting Interest but the Minority Shareholder or Shareholders Have Certain Approval or Veto Rights", and AICPA Statement of Position 78-9, "Accounting for Investments in Real Estate Ventures". Based on the provisions set forth in these rules, we consolidate the limited partnership and limited liability company because we exercise significant control over major decisions by these entities, such as investment activity and changes in financing.
Use of Estimates
The preparation of financial statements in conformity with United States generally accepted accounting principles requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current year presentation.
Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents, tenant receivables, unsecured line of credit and unsecured term loan, and accounts payable, accrued expenses and tenant security deposits approximate fair value.
The fair value of our secured notes payable was estimated using discounted cash flows analyses based on borrowing rates we believe we could obtain with similar terms and maturities. As of December 31, 2005 and 2004, the fair values of our secured notes payable were approximately $682,835,000 and $652,100,000, respectively.
Operating Segments
We view our operations as principally one segment and the financial information disclosed herein represents all of the financial information related to our principal operating segment.
International Operations
The functional currency for our subsidiaries operating in the United States is the U.S. dollar. During 2005, we acquired three operating properties in Canada through wholly-owned Canadian subsidiaries. The functional currency for our foreign subsidiaries operating in Canada is the local currency, the Canadian dollar. The assets and liabilities of our foreign subsidiaries are translated into U.S. dollars at the exchange rate in effect as of the financial statement date. Income statement accounts of our foreign subsidiaries are translated using the average exchange rate for the period presented. Gains resulting from the translation are included in accumulated other comprehensive income as a separate component of stockholders' equity.
The appropriate amounts of exchange gains or losses included in accumulated other comprehensive income are reflected in income when there is a sale or partial sale of the Company's investment in these operations or upon a complete or substantially complete liquidation of the investment.
The values allocated to land improvements, buildings, building improvements, tenant improvements and equipment are depreciated on a straight-line basis using an estimated life of 20 years for land improvements, 40 years for buildings and building improvements, the respective lease term for tenant improvements and the estimated useful life for equipment. The values of above and below market leases are amortized over the life of the related lease and recorded as either an increase (for below market leases) or a decrease (for above market leases) to rental income. The values of at-market leases and origination costs are classified as leasing costs, included in other assets in the accompanying consolidated balance sheets and amortized over the remaining life of the lease.
In accordance with Statement of Financial Accounting Standards No. 34, "Capitalization of Interest Cost" ("SFAS 34") and Statement of Financial Accounting Standards No. 67, "Accounting for Costs and Initial Rental Operations of Real Estate Projects" ("SFAS 67"), we capitalize direct construction and development costs, including predevelopment costs, interest, property taxes, insurance and other costs directly related and essential to the acquisition, development or construction of a project. Pursuant to SFAS 34 and SFAS 67, capitalization of construction and development costs is required while activities are ongoing to prepare an asset for its intended use. Costs incurred after a project is substantially complete and ready for its intended use are expensed as incurred. Costs previously capitalized related to abandoned acquisition or development opportunities are written off. Should development activity cease, a portion of interest, property taxes, insurance and certain costs would no longer be eligible for capitalization, and would be expensed as incurred. Expenditures for repairs and maintenance are expensed as incurred.
In accordance with Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), we classify a property as "held for sale" when all of the following criteria for a plan of sale have been met: (1) management, having the authority to approve the action, commits to a plan to sell the property; (2) the property is available for immediate sale in its present condition, subject only to the terms that are usual and customary; (3) an active program to locate a buyer, and other actions required to complete the plan to sell, have been initiated; (4) the sale of the property is probable and is expected to be completed within one year; (5) the property is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and (6) actions necessary to complete the plan of sale indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. When the property is classified as "held for sale", its operations are classified as discontinued operations in our consolidated statements of income. When a property is designated as "held for sale", amounts for all prior periods presented are reclassified from continuing operations to discontinued operations. A loss is recognized for any initial adjustment of the asset's carrying amount to fair value less costs to sell in the period the asset qualifies as "held for sale". Depreciation of assets is discontinued commencing on the date they are designated as "held for sale".
Cash Equivalents
We consider all highly liquid investments with original maturities of three months or less when purchased to be cash equivalents.
December 31, -------------------------- 2005 2004 ----------- ------------- Funds held in trust under the terms of certain secured notes payable $ 13,838 $ 11,241 Security deposit funds based on the terms of certain lease agreement 2,047 2,045 Other funds held in escrow 5,128 4,383 ----------- ------------- $ 21,013 $ 17,669 =========== =============
Investments
We hold equity investments in certain publicly-traded companies and privately held entities primarily involved in the life science industry. All of our investments in publicly-traded companies are considered "available for sale" in accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"), and are recorded at fair value. Fair value has been determined as the closing trading price at the balance sheet date, with unrealized gains and losses shown as a separate component of stockholders' equity. The classification of investments under SFAS 115 is determined at the time each investment is made, and such determination is reevaluated at each balance sheet date. The cost of investments sold is determined by the specific identification method, with realized gains and losses included in other income in the accompanying consolidated statements of income.
Investments in privately held entities are generally accounted for under the cost method because we do not influence any operating or financial policies of the entities in which we invest. Certain investments are accounted for under the equity method in accordance with Accounting Principles Board Opinion No. 18, "The Equity Method of Accounting for Investments in Common Stock" ("APB 18") and Emerging Issues Task Force Topic D-46, "Accounting for Limited Partnership Investments" ("EITF Topic D-46"). Under the equity method we record our investment initially at cost and adjust the carrying amount of the investment to recognize our share of the earnings or losses of the investee subsequent to the date of our investment.
For all of our investments, if a decline in the fair value of an investment below its carrying value is determined to be other than temporary, such investment is written down to its estimated fair value with a non-cash charge to current earnings. The factors that we consider in making these assessments include, but are not limited to, market prices, market conditions, prospects for favorable or unfavorable clinical trial results, new product initiatives and new collaborative agreements.
Leasing Costs
Costs directly related and essential to our leasing activities are capitalized and amortized on a straight-line basis over the term of the related lease. Costs that were previously capitalized and which related to unsuccessful leasing opportunities are written off. Leasing costs, net of related amortization, totaled $32,924,000 and $29,747,000 as of December 31, 2005 and 2004, respectively, and are included in other assets in the accompanying consolidated balance sheets.
Loan Fees and Costs
Fees and costs incurred in obtaining long-term financing are amortized over the terms of the related loans and included in interest expense in the accompanying consolidated statements of income. Loan fees and costs, net of related amortization, totaled $14,789,000 and $14,075,000 as of December 31, 2005 and 2004, respectively, and are included in other assets in the accompanying consolidated balance sheets.
Statement of Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging Activities", as amended by Statement of Financial Accounting Standards No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities" establishes accounting and reporting standards for derivative financial instruments such as our interest rate swap agreements. All of our interest rate swap agreements meet the criteria to be deemed "highly effective" under SFAS 133 in reducing our exposure to variable interest rates. In accordance with SFAS 133, we formally document all relationships between interest rate swap agreements and hedged items, including the method for evaluating effectiveness and the risk strategy. Accordingly, we have categorized these instruments as cash flow hedges. We make an assessment at the inception of each interest rate swap agreement and on an on-going basis to determine whether these instruments are highly effective in offsetting changes in cash flows associated with the hedged items. The ineffective portion of each interest rate swap agreement is immediately recognized in earnings. While we intend to continue to meet the conditions for such hedge accounting, if hedges did not qualify as "highly effective", the changes in the fair values of the derivatives used as hedges would be reflected in earnings.
Pursuant to SFAS 133, interest rate swaps are reflected at their estimated fair values in the accompanying consolidated balance sheets. We use a variety of methods and assumptions based on market conditions and risks existing at each balance sheet date to determine the fair values of our interest rate swap agreements. These methods of assessing fair value result in a general approximation of value.
Accumulated Other Comprehensive Income
Accumulated other comprehensive income consisted of the following (in thousands):
December 31, ----------------------- 2005 2004 ----------- ----------- Unrealized gain on marketable securities $ 28,373 $ 15,934 Unrealized gain (loss) on interest rate swap agreements 4,867 (2,090) Unrealized foreign currency translation gain 1,793 -- ----------- ----------- $ 35,033 $ 13,844 =========== ===========
Rental Income and Tenant Recoveries
Rental income from leases with scheduled rent increases, free rent, incentives and other rent adjustments are recognized on a straight-line basis over the respective lease terms. We include amounts currently recognized as income, and expected to be received in later years, in deferred rent in the accompanying consolidated balance sheets. Amounts received currently, but recognized as income in future years, are included as unearned rent in accounts payable, accrued expenses and tenant security deposits in the accompanying consolidated balance sheets. We commence recognition of rental income at the date the tenant takes possession of or controls the physical use of the property.
We maintain an allowance for estimated losses that may result from the inability of our tenants to make required payments. If a tenant fails to make contractual payments beyond any allowance, we may recognize additional bad debt expense in future periods equal to the amount of unpaid rent and unrealized deferred rent. As of December 31, 2005 and 2004, we had no allowance for doubtful accounts.
Interest Income
Interest income was $578,000, $181,000 and $108,000 in 2005, 2004 and 2003, respectively, and is included in other income in the accompanying consolidated statements of income.
Income Taxes
As a REIT, we are not subject to federal income taxation as long as we meet a number of organizational and operational requirements and make distributions greater than or equal to 100% of our taxable income to our stockholders. Since we believe we have met these requirements and our distributions exceeded taxable income, no federal income tax provision has been reflected in the accompanying consolidated financial statements for the years ended December 31, 2005, 2004 and 2003. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate tax rates.
During 2005, 2004 and 2003, we declared dividends on our common stock of $2.72, $2.52 and $2.20 per share, respectively. During 2004 and 2003, we declared dividends on our Series A cumulative redeemable preferred stock of $1.72847 and $2.375 per share, respectively. During 2005, 2004 and 2003, we declared dividends on our Series B cumulative redeemable preferred stock of $2.275, $2.275 and $2.275, respectively. During 2005 and 2004, we declared dividends on our Series C cumulative redeemable preferred stock of $2.09375 and $0.61649 per share, respectively. See Note 11, Preferred Stock and Excess Stock.
The tax treatment of distributions on common stock paid in 2005 is as follows: (1) 71.8% ordinary dividend, (2) 24.1% return of capital, (3) 3.9% capital gain at 15%, and (4) 0.2% Section 1250 capital gain at 25%. The tax treatment of distributions paid in 2004 is as follows: (1) 76.8% ordinary dividend, (2) 19.8% return of capital, (3) 2.4% capital gain at 15%, and (4) 1.0% Section 1250 capital gain at 25%. The information provided in this paragraph is unaudited.
Earnings Per Share, Dividends Declared and Preferred Stock Redemption Cost
The following table shows the computation of earnings per share, and dividends declared per common share:
Year Ended December 31, ------------------------------------------ 2005 2004 2003 ------------ ------------- ------------- (Dollars in thousands, except per share amounts) Net income available to common stockholders $ 47,343 $ 45,724 $ 50,745 ============ ============= ============= Weighted average shares of common stock outstanding - basic 20,948,915 19,315,364 18,993,856 Add: dilutive effect of stock options and stock grants 367,971 343,395 253,934 ------------ ------------- ------------- Weighted average shares of common stock outstanding - diluted 21,316,886 19,658,759 19,247,790 ============ ============= ============= Earnings per share - basic $ 2.26 $ 2.37 $ 2.67 ============ ============= ============= Earnings per share - diluted $ 2.22 $ 2.33 $ 2.64 ============ ============= ============= Dividends declared per common share $ 2.72 $ 2.52 $ 2.20 ============ ============= =============
Emerging Issues Task Force Topic D-42, "The Effect on the Calculation of Earnings Per Share for the Redemption or Induced Conversion of Preferred Stock" ("EITF Topic D-42") provides, among other things, that any excess of (1) the fair value of the consideration transferred to the holders of preferred stock redeemed over (2) the carrying amount of the preferred stock, should be subtracted from net earnings to determine net income available to common stockholders in the calculation of earnings per share. The cost to issue our preferred stock was recorded as a reduction to additional paid-in capital in the years that the preferred stock was issued. Upon any redemption of our preferred stock, the respective offering costs, representing the excess of the fair value of the consideration transferred to the holders over the carrying amount of the preferred stock, will be recognized as a dividend to preferred stockholders. During 2004, we recorded a charge of approximately $1,876,000 to net income available to common stockholders for costs related to the redemption of our 9.5% Series A cumulative redeemable preferred stock. Dividends on preferred stock are deducted from net income to arrive at net income allocable to common stockholders.
Stock-Based Compensation Expense
For 2002 and all prior years, we have elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related Interpretations in accounting for our employee and non-employee director stock options, stock grants and stock appreciation rights. Effective January 1, 2003, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), prospectively to all employee awards granted, modified or settled after January 1, 2003. We have not granted any stock options since 2002. Under APB 25, because the exercise price of the options we granted equals the market price of the underlying stock on the date of grant, no compensation expense has been recognized. Although we have elected to follow APB 25 for previously granted options, pro forma information regarding net income available to common stockholders and earnings per share is required by SFAS 123. This information has been determined as if we had accounted for our stock options under the fair value method under SFAS 123.
For purposes of the following pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting periods (in thousands, except per share information):
Year Ended December 31, ------------------------------------------ 2005 2004 2003 ------------ ------------- ------------- Net income available to common stockholders, as reported $ 47,343 $ 45,724 $ 50,745 Fair value of stock-based compensation cost (152) (733) (1,323) ------------ ------------- ------------- Pro forma net income available to common stockholders $ 47,191 $ 44,991 $ 49,422 ============ ============= ============= Earnings per share: Basic - as reported $ 2.26 $ 2.37 $ 2.67 Basic - pro forma $ 2.25 $ 2.33 $ 2.60 Diluted - as reported $ $2.22 $ $2.33 $ 2.64 Diluted - pro forma $ $2.21 $ $2.29 $ 2.57
Impact of Recently Issued Accounting Standards
In March 2004, the Emerging Issues Task Force ("EITF") of the Financial Accounting Standards Board ("FASB") reached a consensus on Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" ("EITF 03-1"). EITF 03-1 provides guidance on other-than-temporary impairment of marketable debt and equity securities accounted for under Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115") and Statement of Financial Accounting Standards No. 124, "Accounting for Certain Investments Held by Not-for-Profit Organizations" ("SFAS 124"), and non-marketable equity securities accounted for under the cost method. EITF 03-1 provides a three-step model to determine (1) when an investment is considered impaired; (2) whether the impairment is other-than-temporary; and (3) the measurement of the impairment loss. The guidance also requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. In addition, EITF 03-1 provides that a company does not have to estimate the fair value of an investment accounted for under the cost method if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value of the investment. In September 2004, the FASB issued FASB Staff Position ("FSP") No. EITF Issue 03-1-1, "Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments", which delays the effective date of the recognition and measurement provisions of EITF 03-1 until certain implementation issues are addressed and a final FSP providing implementation guidance is issued. In November 2005, the FASB issued FSP 115-1 and FSP 124-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" ("FSP 115-1 and FSP 124-1") which replaces the guidance set forth in paragraphs 10-18 of EITF 03-1 with reference to existing guidance including SFAS 115, SEC Staff Accounting Bulletin No. 59, "Accounting for Noncurrent Marketable Equity Securities" and Accounting Principles Board Opinion No. 18, "The Equity Method of Accounting for Investments in Common Stock". FSP 115-1 and FSP 124-1 is effective for other-than-temporary impairment analysis conducted in periods beginning after December 15, 2005. The Company adopted FSP 115-1 and FSP 124-1 in December 2005. The adoption of FSP 115-1 and FSP 124-1 did not have a material impact on our financial statements.
In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment" ("SFAS 123R"). SFAS 123R requires measurement of all employee stock-based compensation awards using a fair value method and the recording of such expense in the financial statements. This eliminates the accounting for such awards using the intrinsic method pursuant to Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). In April 2005, the Securities and Exchange Commission amended the compliance date for SFAS 123R to no later than the beginning of the registrant's first fiscal year beginning after June 15, 2005. Accordingly, we plan to adopt SFAS 123R on January 1, 2006. Upon adoption of SFAS 123R, we intend to use the modified-prospective transition method whereby compensation expense will be recognized relating to the remaining unvested portion of outstanding stock options at the time of adoption, and the expense will be recognized over the remaining service period. We do not expect the adoption of SFAS 123R to have a material impact on our financial statements since all awards accounted for under APB 25 were fully vested on December 31, 2005.
In December 2004, the FASB issued Statement of Financial Accounting Standards No. 153, "Exchanges of Nonmonetary Assets" ("SFAS 153"), which amends Accounting Principles Board Opinion No. 29, "Accounting for Nonmonetary Transactions" ("APB 29"). SFAS 153 addresses the measurement of exchanges of nonmonetary assets and redefines the scope of transactions that should be measured based on the fair values of the assets exchanged. SFAS 153 is effective for nonmonetary asset exchanges beginning in our third quarter of 2005. The adoption of SFAS 153 did not have a material impact on our financial statements.
In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, "Accounting Changes and Error Corrections" ("SFAS 154"), which replaces Accounting Principles Board Opinion No. 20, "Accounting Changes" and Statement of Financial Accounting Standards No. 3, "Reporting Accounting Changes in Interim Financial Statements". SFAS 154 requires retrospective application to prior periods' financial statements of voluntary changes in accounting principles, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. We do not expect the adoption of SFAS 154 to have an impact on our financial statements.
3. Rental Properties, Net, Properties Under Development and Land Held For Development
Rental properties, net consisted of the following (in thousands):
December 31, --------------------------- 2005 2004 ------------ ------------- Land $ 296,841 $ 217,201 Buildings and improvements 1,559,385 1,246,888 Tenant and other improvements 153,482 139,823 ------------ ------------- 2,009,708 1,603,912 Less accumulated depreciation (220,890) (176,059) ------------ ------------- $ 1,788,818 $ 1,427,853 ============ =============
As of December 31, 2005 and 2004, certain of our rental properties were encumbered by deeds of trust and assignments of rents and leases associated with the properties. See Note 5, Secured Notes Payable. The net book values of encumbered properties including land parcels as of December 31, 2005 and 2004 were $848,286,000 and $776,342,000, respectively.
We lease space under noncancelable leases with remaining terms of one to 18 years.
Included in rental properties, net as of December 31, 2005 and 2004 were 15 and 17 properties, respectively, in our redevelopment program. The allocated net book values of the portion of these properties undergoing redevelopment as of December 31, 2005 and 2004 were approximately $139,661,000 and $150,627,000, respectively. Depreciation ceases on the portion of a property undergoing redevelopment during the period of redevelopment.
In accordance with SFAS 34, we are required to capitalize interest on construction, development and redevelopment projects during the period an asset is undergoing activities to prepare it for its intended use. Capitalization of interest ceases after a project is substantially complete and ready for its intended use. In addition, should construction, development or redevelopment activity cease, interest would be expensed as incurred. Total interest capitalized for the years ended December 31, 2005, 2004 and 2003 was $27,490,000, $17,902,000 and $13,941,000, respectively. Total interest incurred for the years ended December 31, 2005, 2004 and 2003 was $77,695,000, $46,733,000 and $41,571,000, respectively.
Minimum lease payments to be received under the terms of the operating lease agreements, excluding expense reimbursements, as of December 31, 2005 are as follows (in thousands):
Year Amount - --------------------------------------- ------------ 2006 $ 182,666 2007 164,884 2008 153,116 2009 139,673 2010 130,859 Thereafter 478,638 ------------ $ 1,249,836 ============
4. Investments
We hold equity investments in certain publicly-traded companies and privately held entities primarily involved in the life science industry. All of our investments in publicly-traded companies are considered "available for sale" in accordance with SFAS 115, and are recorded at fair value. Investments in privately held entities are generally accounted for under the cost method because we do not influence any operating or financial policies of the entities in which we invest. Certain investments are accounted for under the equity method in accordance with APB 18 and EITF Topic D-46. For all of our investments, if a decline in the fair value of an investment below its carrying value is determined to be other than temporary, such investment is written down to its estimated fair value with a non-cash charge to current earnings. The factors that we consider in making these assessments include, but are not limited to, market prices, market conditions, prospects for favorable or unfavorable clinical trial results, new product initiatives and new collaborative agreements. For additional discussion of our accounting policies with respect to investments, see Note 2, Basis of Presentation and Summary of Significant Accounting Policies.
The following table summarizes our available-for-sale securities (in thousands):
December 31, -------------------- 2005 2004 --------- --------- Adjusted cost of available-for-sale securities $ 4,740 $ 3,190 Gross unrealized gains 29,135 16,110 Gross unrealized losses (762) (176) --------- --------- Fair value of available-for-sale securities $ 33,113 $ 19,124 ========= =========
Investments in available-for-sale securities with gross unrealized losses as of December 31, 2005 and 2004 have been in a continuous unrealized loss position for less than twelve months. We believe that these unrealized losses are temporary and accordingly we have not recognized an other-than-temporary impairment related to available-for-sale securities as of December 31, 2005 and 2004.
Our investments in privately held entities as of December 31, 2005 and 2004 totaled $48,897,000 and $48,295,000, respectively. Of these totals, $47,164,000 and $47,433,000 are accounted for under the cost method. The remainder ($1,733,000 and $862,000 for 2005 and 2004, respectively) are accounted for under the equity method in accordance with APB 18 and EITF Topic D-46. As of December 31, 2005 and 2004, there were no unrealized losses in our investments in privately held entities.
Net investment income of $2,294,000, $2,436,000 and $536,000 was recognized in 2005, 2004 and 2003, respectively, and is included in other income in the accompanying consolidated statements of income. Net investment income in 2005 consisted of equity in income of $483,000 related to investments in privately held entities accounted for under the equity method, gross realized gains of $2,433,000, and gross realized losses of $622,000. Net investment income in 2004 consisted of equity in income of $208,000 related to investments in privately held entities accounted for under the equity method, gross realized gains of $2,508,000, and gross realized losses of $280,000. Net investment income in 2003 consisted of equity in income of $306,000 related to investments in privately held entities accounted for under the equity method, gross realized gains of $532,000, and gross realized losses of $302,000.
5. Secured Notes Payable
Our secured notes payable generally require monthly payments of principal and interest. The total net book values of properties securing debt were $848,286,000 and $776,342,000 at December 31, 2005 and 2004, respectively. At December 31, 2005, our secured notes payable were comprised of $595.9 million and $70.8 million of fixed and variable rate debt, respectively, compared to $437.2 million and $201.7 million of fixed and variable rate debt, respectively, at December 31, 2004.
Future principal payments due on secured notes payable as of December 31, 2005, are as follows (in thousands):
Weighted Average Year Amount Interest Rate (1) - ---------------------------------- ------------ ------------- 2006 $ 44,552 6.32% 2007 83,623 6.26% 2008 123,190 6.16% 2009 42,084 6.52% 2010 88,553 6.48% Thereafter 280,145 6.24% ------------ Subtotal 662,147 Unamortized premiums 4,519 Total secured notes payable ------------ $ 666,666 ============
6. Unsecured Line of Credit and Unsecured Term Loan
Borrowings under our unsecured line of credit, as amended, bear interest at a floating rate based on our election of either a LIBOR-based rate or the higher of the bank's reference rate and the Federal Funds rate, plus 0.5%. For each LIBOR-based advance, we must elect a LIBOR period of one, two, three or six months. The unsecured line of credit matures in December 2007 and may be extended at our sole option for an additional one-year period. As of December 31, 2005, we had borrowings of $240 million outstanding on the unsecured line of credit with a weighted average interest rate of 5.69%.
7. Interest Rate Swaps
Statement of Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging Activities", as amended by Statement of Financial Accounting Standards No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities" establishes accounting and reporting standards for derivative financial instruments such as our interest rate swap agreements. All of our interest rate swap agreements meet the criteria to be deemed "highly effective" under SFAS 133 in reducing our exposure to variable interest rates. In accordance with SFAS 133, we formally document all relationships between interest rate swap agreements and hedged items, including the method for evaluating effectiveness and the risk strategy. Accordingly, we have categorized these instruments as cash flow hedges. We make an assessment at the inception of each interest rate swap agreement and on an on-going basis to determine whether these instruments are highly effective in offsetting changes in cash flows associated with the hedged items. While we intend to continue to meet the conditions for such hedge accounting, if hedges did not qualify as "highly effective", the changes in the fair values of the derivatives used as hedges would be reflected in earnings.
8. Commitments and Contingencies
Employee Retirement Savings Plan
We have a retirement savings plan pursuant to Section 401(k) of the Internal Revenue Code whereby our employees may contribute a portion of their compensation to their respective retirement accounts, in an amount not to exceed the maximum allowed under the Internal Revenue Code. In addition to employee contributions, we have elected to provide discretionary profit sharing contributions (subject to statutory limitations), which amounted to $552,000, $515,000 and $461,000, respectively, for the years ended December 31, 2005, 2004 and 2003. Employees who participate in the plan are immediately vested in their contributions and in the contributions of the company.
Concentration of Credit Risk
We maintain our cash and cash equivalents at insured financial institutions. The combined account balances at each institution periodically exceed FDIC insurance coverage, and, as a result, there is a concentration of credit risk related to amounts in excess of FDIC insurance coverage. We believe that the risk is not significant.
We are dependent on rental income from relatively few tenants in the life science industry. The inability of any single tenant to make its lease payments could adversely affect our operations. As of December 31, 2005, we held 283 leases with a total of 237 tenants and 73 of our 134 properties were each leased to a single tenant. At December 31, 2005, our three largest tenants accounted for approximately 11.6% of our aggregate annualized base rent.
We generally do not require collateral or other security from our tenants, other than security deposits. In addition to security deposits held in cash, we held $35.1 million in irrevocable letters of credit available from certain tenants as security deposits for 86 leases as of December 31, 2005.
Commitments
As of December 31, 2005, we were committed under the terms of contracts to complete the construction of properties under development at a remaining aggregate cost of approximately $46.4 million.
As of December 31, 2005, we were committed under the terms of eight ground leases. These lease obligations totaling approximately $62.8 million have remaining lease terms of 27 to 50 years, exclusive of extension options. In addition, as of December 31, 2005, we were committed under the terms of certain operating leases for our headquarters and field offices. These lease obligations totaling approximately $6.2 million have remaining lease terms of two to seven years, exclusive of extension options.
9. Minority Interest
Minority interest represents the interests in a limited partnership and in a limited liability company held by certain third parties, which own two properties and are included in our consolidated financial statements. We recognize minority interest in these entities in which we have a controlling interest. Minority interest is adjusted for additional contributions, distributions to minority holders and the minority holders' proportionate share of the net earnings or losses of each respective entity. Distributions, profits and losses related to these entities are allocated in accordance with the respective operating agreements. As of December 31, 2005 the aggregate minority interest balance related to these entities was approximately $20.1 million and is classified as minority interest in the accompanying consolidated balance sheet.
10. Issuances of Common Stock
In March 2005, we sold 1,437,500 shares of our common stock in an underwritten offering (including the shares issued upon exercise of the underwriter's over-allotment option). The shares were issued at a price of $62.51 per share, resulting in net proceeds of approximately $89.1 million (after deducting underwriting discounts and other offering costs).
11. Preferred Stock and Excess Stock
Series A Cumulative Redeemable Preferred Stock
In July 2004, we redeemed all 1,543,500 outstanding shares of our 9.50% Series A cumulative redeemable preferred stock ("Series A preferred stock") at a redemption price of $25.00 per share plus $0.5409722 per share representing accumulated and unpaid dividends to the redemption date. In accordance with EITF Topic D-42, we recorded a charge of approximately $1,876,000 to net income available to common stockholders during the second quarter of 2004 for costs related to the redemption of the Series A preferred stock. We redeemed our Series A preferred stock with proceeds from the Series C preferred stock offering.
Series B Cumulative Redeemable Preferred Stock
In January 2002, we completed a public offering of 2,300,000 shares of our 9.10% Series B cumulative redeemable preferred stock ("Series B preferred stock") (including the shares issued upon exercise of the underwriters' over-allotment option). The shares were issued at a price of $25.00 per share, resulting in aggregate proceeds of approximately $55.1 million (after deducting underwriters' discounts and other offering costs). The dividends on our Series B preferred stock are cumulative and accrue from the date of original issuance. We pay dividends quarterly in arrears at an annual rate of $2.275 per share. Our Series B preferred stock has no stated maturity, is not subject to any sinking fund or mandatory redemption and is not redeemable prior to January 22, 2007, except in order to preserve our status as a REIT. Investors in our Series B preferred stock generally have no voting rights. On or after January 22, 2007, we may, at our option, redeem our Series B preferred stock, in whole or in part, at any time with proceeds from the sale of equity securities at a redemption price of $25.00 per share, plus accrued and unpaid dividends.
Series C Cumulative Redeemable Preferred Stock
In June 2004, we completed a public offering of 5,185,500 shares of our 8.375% Series C cumulative redeemable preferred stock ("Series C preferred stock") (including the shares issued upon exercise of the underwriters' over-allotment option). The shares were issued at a price of $25.00 per share, resulting in aggregate proceeds of approximately $124.0 million (after deducting underwriters' discounts and other offering costs). The proceeds were used to redeem our Series A preferred stock with the remaining portion used to pay down our unsecured line of credit. The dividends on our Series C preferred stock are cumulative and accrue from the date of original issuance. We pay dividends quarterly in arrears at an annual rate of $2.09375 per share. Our Series C preferred stock has no stated maturity, is not subject to any sinking fund or mandatory redemption and is not redeemable prior to June 29, 2009, except in order to preserve our status as a REIT. Investors in our Series C preferred stock generally have no voting rights. On or after June 29, 2009, we may, at our option, redeem our Series C preferred stock, in whole or in part, at any time for cash at a redemption price of $25.00 per share, plus accrued and unpaid dividends.
Preferred Stock and Excess Stock Authorizations
Our charter authorizes the issuance of up to 100,000,000 shares of preferred stock, of which 7,485,500 shares were issued and outstanding as of December 31, 2005. In addition, 200,000,000 shares of "excess stock" (as defined) are authorized, none of which were issued and outstanding at December 31, 2005.
12. Stock Option Plans and Stock Grants
1997 Stock Plan
In 1997, we adopted a stock option and incentive plan (the "Stock Plan") for the purpose of attracting and retaining the highest quality personnel, providing for additional incentives and promoting the success of the company by providing employees the opportunity to acquire common stock pursuant to (i) options to purchase common stock; and (ii) share awards. As of December 31, 2005, a total of 413,501 shares were reserved for the granting of future options and share awards under the Stock Plan.
Options under our plan have been granted at prices that are equal to the market value of the stock on the date of grant and expire ten years after the date of grant. Employee options vest ratably in three annual installments from the date of grant. Non-employee director options vest immediately on the date of grant. The options outstanding under the Stock Plan expire at various dates through October 2012.
In addition, the Stock Plan permits us to issue share awards to our employees and non-employee directors. A share award is an award of common stock, which (i) may be fully vested upon issuance or (ii) may be subject to the risk of forfeiture under Section 83 of the Internal Revenue Code. Shares issued generally vest over a one to three year period from the date of issuance and the sale of the shares is restricted prior to the date of vesting. During 2005, we awarded 162,387 shares of common stock. The unearned portion of these awards is amortized as stock compensation expense on a straight-line basis over the vesting period.
The fair values of the options issued under the Stock Plan were estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for 2005, 2004 and 2003:
Year Ended December 31, ------------------------------------------ 2005 2004 2003 ------------ ------------- ------------- Risk-free interest rate 4.34% 3.94% 3.65% Dividend yield 3.19% 3.79% 3.95% Volatility factor of the expected market price 21.14% 21.50% 21.20% Weighted average expected life of the options 5.2 years 6.7 years 7.0 years
A summary of the stock option activity under our Stock Plan and related information for the years ended December 31, 2005, 2004 and 2003 follows:
2005 2004 2003 ---------------------- ---------------------- ----------------------- Weighted Weighted Weighted Average Average Average Stock Exercise Stock Exercise Stock Exercise Options Price Options Price Options Price ---------- ---------- ---------- ---------- ---------- ---------- Outstanding-beginning of year 607,331 $ 35.36 809,583 $ 35.39 1,011,166 $ 34.39 Granted -- -- -- -- -- -- Exercised (115,315) 37.22 (200,252) 35.44 (197,583) 30.08 Forfeited -- -- (2,000) 42.15 (4,000) 43.23 ---------- ---------- ---------- ---------- ---------- ---------- Outstanding-end of year 492,016 $ 34.92 607,331 $ 35.36 809,583 $ 35.39 ========== ========== ========== ========== ========== ========== Exercisable at end of year 492,016 $ 34.92 500,000 $ 33.38 533,420 $ 31.35 ========== ========== ========== ========== ========== ========== Weighted average fair value of options granted $ - $ - $ - ========== ========== ==========
The following table summarizes information about stock options outstanding at December 31, 2005:
Options Outstanding Options Exercisable ----------------------------------- ---------------------- Weighted Average Weighted Weighted Range of Number Remaining Average Number Average Exercise Outstanding Contractual Exercise Exercisable Exercise Prices at 12/31/05 Life Price at 12/31/05 Price - --------------- ------------ ------------ --------- ------------ --------- $20.00-$30.88 166,400 1.66 $22.19 166,400 $22.19 $31.88-$43.50 222,616 5.00 $38.55 222,616 $38.55 $44.99-$47.69 103,000 6.47 $47.65 103,000 $47.65 ------------ ------------ $20.00-$47.69 492,016 4.18 $34.92 492,016 $34.92 ============ ============
13. Non-Cash Transactions
During the twelve months ended December 31, 2005, we assumed seven secured notes payable in connection with the acquisitions of seven properties, in seven separate transactions, located in the San Francisco Bay, Suburban Washington D.C., Eastern Massachusetts, Seattle and Canada markets. During the twelve months ended December 31, 2004, we assumed six secured note payables in connection with the acquisitions of ten properties, in six separate transactions, located in the Eastern Massachusetts, Southeast, Suburban Washington D.C. and San Diego markets. The following table summarizes these transactions (in thousands):
2005 2004 2003 ------------ ------------- ------------- Aggregate purchase price $ 55,400 $ 185,912 $ 6,900 Secured notes payable assumed 31,853 127,653 3,384 ------------ ------------- ------------- Cash paid for the properties $ 23,547 $ 58,259 $ 3,516 ============ ============= =============
In connection with the sale of a property in the Eastern Massachusetts market in August 2003, the buyer assumed a secured note payable totaling $17.3 million.
In 2005, 2004 and 2003, we incurred $5,136,000, $3,157,000 and $3,354,000, respectively, in non-cash stock compensation expense.
14. Discontinued Operations
The following is a summary of operations and net assets of the properties included in discontinued operations presented in compliance with SFAS 144 (in thousands):
Year Ended December 31, ------------------------------------------ 2005 2004 2003 ------------ ------------- ------------- Total revenue $ 127 $ 217 $ 5,653 Operating expenses 14 38 1,428 ------------ ------------- ------------- Revenue less operating expenses 113 179 4,225 Interest -- -- 924 Depreciation 17 47 303 ------------ ------------- ------------- Income before gain/loss on sales of property 96 132 2,998 Gain/loss on sales of property 36 1,627 8,286 ------------ ------------- ------------- Income from discontinued operations, net $ 132 $ 1,759 $ 11,284 ============ ============= ============= December 31, --------------------------- 2005 2004 ------------ ------------- Properties held for sale, net $ -- $ 1,016 Other assets -- 142 ------------ ------------- Total assets $ -- $ 1,158 ============ ============= Total liabilities -- 50 ------------ ------------- Net assets of discontinued operations $ -- $ 1,108 ============ =============
Income from discontinued operations, net includes the results of operations of one property we sold during 2005, one property we sold during 2004 and three properties we sold during 2003 in accordance with the provisions of SFAS 144. See Note 2, Basis of Presentation and Summary of Significant Accounting Policies.
As of December 31, 2005 and 2004, we had no properties designated as "held for sale" in accordance with SFAS 144. During the third quarter of 2005, we sold one property located in the Southeast market that had been designated as "held for sale" as of June 30, 2005. The total sale price for the property was approximately $1.3 million. In connection with this sale, we recorded a gain on sale of property of approximately $36,000. During the first quarter of 2004, we sold one property located in the Suburban Washington D.C. market that had been designated as "held for sale" as of December 31, 2003. The total sale price for the property was approximately $5.7 million. In connection with the sale, we recorded a gain on sale of property of approximately $1.6 million. During the fourth quarter of 2003, we sold one property located in the Suburban Washington D.C. market that had been designated as "held for sale" during the fourth quarter of 2003. The total sale price for the property was approximately $9.0 million. In connection with the sale, we recorded a loss on sale of property of approximately $36,000. During the third quarter of 2003, we sold one property located in the Eastern Massachusetts market that had been previously designated as "held for sale" as of December 31, 2002. The total sale price for the property was approximately $46.5 million. In connection with this sale, we recorded a gain on sale of property of approximately $8.8 million. Interest expense included in discontinued operations represents interest related to a secured note payable, which was assumed by the buyer in connection with the sale of this property. During the first quarter of 2003, we sold one property located in the San Francisco Bay market which could not be redeveloped pursuant to our original strategic objectives and that had been designated as "held for sale" as of December 31, 2002. The total sale price for the property was approximately $6.8 million. In connection with this sale, we recorded a loss on sale of property of approximately $455,000 in 2003. Gains and losses on sales of these properties are included in the income statement in income from discontinued operations, net.
15. Quarterly Financial Data (Unaudited)
The following is a summary of consolidated financial information on a quarterly basis for 2005 and 2004:
Quarter ---------------------------------------------------------- First Second Third Fourth ------------- ------------- ------------- ------------- (In thousands, except per share amounts) 2005 - ---- Revenues $ 56,039 $ 58,217 $ 63,752 $ 66,076 Net income available to common stockholders $ 10,967 $ 12,250 $ 11,969 $ 12,157 Earnings per share: Basic $ 0.56 $ 0.59 $ 0.57 $ 0.55 Diluted $ 0.55 $ 0.58 $ 0.56 $ 0.54 Quarter ---------------------------------------------------------- First Second Third Fourth ------------- ------------- ------------- ------------- (In thousands, except per share amounts) 2004 - ---- Revenues $ 42,724 $ 43,472 $ 46,459 $ 50,426 Net income available to common stockholders $ 13,115 $ 9,757 $ 11,370 $ 11,482 Earnings per share: Basic $ 0.68 $ 0.51 $ 0.59 $ 0.59 Diluted $ 0.67 $ 0.50 $ 0.58 $ 0.58
Alexandria Real Estate Equities, Inc. and SubsidiariesSchedule IIIConsolidated Financial Statement Schedule of Rental Propertiesand Accumulated DepreciationDecember 31, 2005 (Unaudited) (In thousands, except square foot data)
Initial Costs Costs Total Costs Square ----------------------- Capitalized ---------------------- Footage Buildings and Subsequent to Buildings and Accumulated Year Built/ Property Name (unaudited) Land Improvements Acquisition Land Improvements Total Depreciation (1) Encumbrances (27) Renovated ------------- ---------- -------- ------------- ------------- -------- ------------ ----------- ---------------- ---------------- ------------------- North Torrey Pines Road #1 107,710 $ 1,321 $ 5,960 $ 6,719 $ 1,321 $ 12,679 $ 14,000 $ 2,915 $ - 1971/2003 Science Park Road 74,557 1,013 - 16,767 1,013 16,767 17,780 4,673 - 2000 North Torrey Pines Road #3 44,733 620 9,531 9,052 620 18,583 19,203 201 - 1962/2005 North Torrey Pines Road #2 86,962 2,663 10,649 5,203 2,663 15,852 18,515 5,362 - 1986/1996 General Atomics Court #1 76,084 2,651 18,046 1,447 2,651 19,493 22,144 6,888 37,928 (2) 1986/2000 General Atomics Court #2 43,600 1,227 9,554 30 1,227 9,584 10,811 3,466 - (2) 1991 Roselle Street #1 18,173 463 1,840 2,774 463 4,614 5,077 1,109 - (3) 1983/1998 Nexus Centre Drive 67,050 2,548 13,638 45 2,548 13,683 16,231 4,324 32,296 (4) 1989 Nancy Ridge Drive #1 29,333 733 2,273 1,878 733 4,151 4,884 1,655 - (5) 1997 Roselle Street #2 17,603 444 1,699 1,842 444 3,541 3,985 1,111 - late 1970's/1999 Tansy Street 15,410 651 1,375 1,899 651 3,274 3,925 1,422 - 1978/1999 John Hopkins Court #1 34,723 1,122 - 3,881 1,122 3,881 5,003 560 - (2) 2000 John Hopkins Court #2 55,200 1,683 - 5,647 1,683 5,647 7,330 1,084 - (2) 1999 Towne Centre Drive #1 45,030 275 8,621 3,661 275 12,282 12,557 1,754 89,580 (18) 1987/2003 Towne Centre Drive #2 52,228 320 10,070 2,948 320 13,018 13,338 2,342 - (18) 1987/2000 Towne Centre Drive #3 41,780 258 8,170 7,903 258 16,073 16,331 2,696 - (18) 1987/2000 Roselle Street #3 17,590 455 2,581 1,019 455 3,600 4,055 178 23,175 (3) 1981 Roselle Street #4 30,147 754 4,288 341 754 4,629 5,383 525 - (3) 1981/1998 Roselle Street #5 22,577 564 3,224 43 564 3,267 3,831 497 - (3) 1981/1995 Roselle Street #6 17,433 436 2,480 81 436 2,561 2,997 349 - (3) 1981/1999 Roselle Street #7 24,208 605 3,459 42 605 3,501 4,106 533 - (3) 1981/1995 Nancy Ridge Drive #2 21,940 515 1,566 2,502 515 4,068 4,583 750 - early 1980's/2001 Campus Point Drive 71,510 4,246 16,165 9,290 4,246 25,455 29,701 1,191 10,673 1986/1998 Nancy Ridge Drive #3 56,698 1,984 10,397 43 1,984 10,440 12,424 522 - (18) 1987/2001 Torreyana Road 87,140 9,980 9,448 1,975 9,980 11,423 21,403 112 - 1980 Nancy Ridge Drive #4 87,298 3,492 18,285 199 3,492 18,484 21,976 469 15,627 (17) 1999/2000 North Hill Avenue 31,343 2,172 812 9,848 2,172 10,660 12,832 1,697 - 1940's/2002 Harbor Bay Parkway #1 61,015 1,506 5,357 3,670 1,506 9,027 10,533 3,066 - (4) 1983/1999 Harbor Bay Parkway #2 27,745 775 1,917 1,632 775 3,549 4,324 1,141 - (4) 1984/2000 Harbor Bay Parkway #3 47,777 1,200 3,880 448 1,200 4,328 5,528 1,094 - (4) 1986/1994 Harbor Bay Parkway #4 68,711 1,800 9,731 743 1,800 10,474 12,274 2,336 1,230 1985/1994 Mitten Road & Malcolm Road 153,837 4,751 12,612 14,283 4,751 26,895 31,646 4,838 - 1962/2002 Hanover Street 32,074 - 6,628 7,840 - 14,468 14,468 4,029 - 1968/2000 Garcia Avenue & Bayshore Parkway 98,964 - 21,323 20,571 - 41,894 41,894 5,771 - 1980/2003 Oyster Point Boulevard #1 53,980 3,519 - 12,942 3,519 12,942 16,461 3,307 32,750 (6) 2001 Oyster Point Boulevard #2 53,980 3,519 - 7,671 3,519 7,671 11,190 1,433 - (6) 2001 Gateway Boulevard #1 110,428 7,730 24,397 24 7,730 24,421 32,151 2,290 - 2000 Gateway Boulevard #2 59,816 4,187 14,020 25 4,187 14,045 18,232 2,004 - 2002 Harbor Bay Parkway #5 67,482 1,349 9,915 59 1,349 9,974 11,323 529 - 1984/2001 Porter Drive 91,644 - 19,154 1,074 - 20,228 20,228 1,004 - (18) 1962/2002 Shoreline Court 140,143 7,038 39,704 2,407 7,038 42,111 49,149 1,289 - 2001 Bayshore Road 60,000 4,800 6,693 2,871 4,800 9,564 14,364 76 6,886 (19) 1982 Grand Avenue 116,284 28,276 - - 28,276 - 28,276 - - 1985 Bernardo Avenue 58,400 3,504 5,255 - 3,504 5,255 8,759 - - 1982/1999 Columbia Street #1 162,394 5,654 22,916 15,518 5,654 38,434 44,088 9,960 15,539 (7) 1975/1997 Columbia Street #2 46,303 912 612 2,688 912 3,300 4,212 32 - (7) 1975/1997 Western Avenue 47,746 1,432 7,497 3,096 1,432 10,593 12,025 2,863 33,430 (8) 1929/2000 First Avenue 70,647 2,119 11,275 4,703 2,119 15,978 18,097 4,747 - 1980/2000 Eastlake Avenue #1 106,003 4,240 31,232 25 4,240 31,257 35,497 2,539 - 1997 Eastlake Avenue #2 97,366 1,570 15,917 14,929 1,570 30,846 32,416 1,966 - 1997 Eastlake Avenue #3 125,066 5,245 - 38,866 5,245 38,866 44,111 1,058 - 2004 Harrison Street 32,279 2,097 1,645 5,352 2,097 6,997 9,094 124 - 1962 Elliot Avenue West 2,896 1,700 344 103 1,700 447 2,147 17 - 1951 Eastlake Avenue #5 121,790 8,525 20,064 164 8,525 20,228 28,753 505 13,000 1962/2000 Fairview Avenue 27,633 2,212 6,788 22 2,212 6,810 9,022 85 4,056 (20) 1998 Professional Drive #1 47,558 871 5,362 3,095 871 8,457 9,328 2,807 - 1989/1999 Professional Drive #2 62,739 1,129 6,940 48 1,129 6,988 8,117 1,666 - 1987 West Watkins Mill Road #1 138,938 3,281 14,416 189 3,281 14,605 17,886 3,508 23,690 (9) 1989/1997 Quince Orchard Road #1 49,225 1,267 3,031 5,168 1,267 8,199 9,466 4,706 - (9) 1982/1997 Clopper Road #1 44,464 900 2,732 1,576 900 4,308 5,208 1,804 - (10) 1989 East Gude Drive #1 45,989 748 3,609 1,608 748 5,217 5,965 1,292 - (11) 1981/2003 Research Boulevard 105,000 1,733 9,611 3,598 1,733 13,209 14,942 2,601 - 1967/2000 East Gude Drive #2 44,500 775 4,122 329 775 4,451 5,226 990 - (11) 1981/1995 Piccard Drive 131,415 2,800 11,533 19,527 2,800 31,060 33,860 2,086 - 1994/2005 Newbrook Drive 248,186 4,800 27,639 390 4,800 28,029 32,829 6,188 - (8) 1992 Virginia Manor Road 191,884 - 13,679 1,484 - 15,163 15,163 3,303 29,234 (11) 1990/2003 Old Columbia Road 75,500 1,510 5,210 1,627 1,510 6,837 8,347 2,197 - 1983/1997 West Watkins Mill Road #4 102,815 1,783 18,946 20 1,783 18,966 20,749 221 - 2005 Firstfield Road #1 25,175 376 3,192 2,114 376 5,306 5,682 902 - 1974/2000 West Watkins Mill Road #2 57,410 859 4,149 2,482 859 6,631 7,490 1,420 - 1988/2000 Clopper Road #2 143,585 2,463 493 17,893 2,463 18,386 20,849 6,738 27,219 (10) 2000 Firstfield Road #2 53,464 971 5,141 6,410 971 11,551 12,522 2,220 - (12) 1980/2001 Firstfield Road #3 54,000 947 5,092 4,560 947 9,652 10,599 1,090 - (12) 1980/2003 Quince Orchard Road #2 54,874 970 5,138 1,053 970 6,191 7,161 831 9,458 (12) 1981/2003 Clopper Road #3 59,838 983 6,638 90 983 6,728 7,711 1,105 - (10) 1989/1992 Research Place 58,632 1,466 5,708 4,182 1,466 9,890 11,356 984 - 1972/2003 West Watkins Mill Road #3 92,449 2,773 23,906 2,630 2,773 26,536 29,309 439 - 1999 Parklawn Drive 49,185 1,476 7,267 37 1,476 7,304 8,780 243 - 1963/1979 Broschart Road 37,861 2,576 5,661 46 2,576 5,707 8,283 190 - 1999 Medical Center Drive #1 58,733 - 8,070 268 - 8,338 8,338 259 - 1998 Research Court 54,906 1,647 13,258 734 1,647 13,992 15,639 387 - 1970/1992 Clopper Road #4 180,650 5,527 26,365 1,394 5,527 27,759 33,286 768 15,498 1982 Medical Center Drive #2 41,887 1,480 14,532 590 1,480 15,122 16,602 375 77,208 (14) 1996/2002 Medical Center Drive #3 60,485 2,138 20,868 5,768 2,138 26,636 28,774 538 - (14) 1996/2002 Medical Center Drive #4 125,008 4,419 43,110 1,338 4,419 44,448 48,867 1,111 - (14) 1996/2002 Medical Center Drive #5 56,987 2,015 19,660 1,049 2,015 20,709 22,724 516 - (14) 1996/2002 Professional Drive #3 26,127 784 4,705 85 784 4,790 5,574 99 3,398 (21) 2000/2003 Industrial Drive 83,541 2,924 19,664 86 2,924 19,750 22,674 123 - 1972/1983 Charlestown Navy Yard 24,940 - 6,247 397 - 6,644 6,644 1,335 - (15) 1880/1991 Pond Street 24,867 622 3,053 59 622 3,112 3,734 353 - 1965/1990 Westview Street 40,200 960 3,032 8,194 960 11,226 12,186 845 - 1975 Plantation Street #1 92,711 2,352 14,173 1,098 2,352 15,271 17,623 2,981 18,067 (5) 1993 Innovation Drive 115,179 2,734 14,567 3,966 2,734 18,533 21,267 3,468 8,505 1991 Plantation Street #2 92,423 651 - 15,749 651 15,749 16,400 6,651 - 2000 Arsenal Street #1 92,500 3,360 7,316 14,729 3,360 22,045 25,405 5,334 - 1978/2001 Hartwell Avenue #1 59,000 1,475 7,194 11,399 1,475 18,593 20,068 3,040 37,068 (15) 1972/2002 Arsenal Street #2 96,150 6,413 5,457 28,939 6,413 34,396 40,809 1,408 - 1980/2003 Memorial Drive #1 51,000 6,507 - 21,759 6,507 21,759 28,266 3,135 - 2002 Memorial Drive #2 47,497 6,058 - 21,285 6,058 21,285 27,343 1,885 - 2002 Hartwell Avenue #2 46,700 2,567 4,522 9,763 2,567 14,285 16,852 489 - (18) 1972 Belmont Street 78,916 1,578 10,195 29 1,578 10,224 11,802 426 9,298 (16) 1929/2003 Plantation Street #3 11,774 228 1,501 151 228 1,652 1,880 45 - (16) 1940/2003 Wiggins Avenue 48,640 876 5,033 17 876 5,050 5,926 147 - 1975/1997 Bearfoot Road 60,759 1,220 22,375 44 1,220 22,419 23,639 467 - 1977 Beaver Street 81,456 1,466 9,046 482 1,466 9,528 10,994 178 7,400 1982/1997 Hartwell Avenue #3 26,828 1,341 8,448 36 1,341 8,484 9,825 141 5,857 (22) 1975/2000 Presidential Way 128,325 12,833 27,333 53 12,833 27,386 40,219 456 - 1999 DeAngelo Drive 30,000 750 3,312 37 750 3,349 4,099 56 2,739 (23) 1972/2001 First Street 45,820 2,749 7,679 332 2,749 8,011 10,760 80 - 1907/1982 Fortune Boulevard 36,000 1,440 5,238 14 1,440 5,252 6,692 66 - 1985/1996 Wiggins Avenue #2 38,000 893 4,000 67 893 4,067 4,960 25 1,909 (24) 1975/2004 Sidney Street 26,589 1,595 3,554 - 1,595 3,554 5,149 - - 1920 Preston Court 54,391 1,278 7,057 - 1,278 7,057 8,335 29 - 1973/2000 Canada #1 68,000 2,924 17,735 856 2,924 18,591 21,515 387 - 2004 Canada #2 162,362 6,982 20,651 1 6,982 20,652 27,634 43 - 1999 Canada #3 66,000 2,276 8,612 - 2,276 8,612 10,888 - 6,387 (25) 1969/2003 College Road 107,874 1,943 9,764 1,550 1,943 11,314 13,257 2,527 - 1968/1984 Williams Drive 37,000 740 4,506 1,264 740 5,770 6,510 877 - 1982/1994 Phillips Parkway 78,501 1,840 2,298 14,546 1,840 16,844 18,684 4,146 - (15) late 1960's/1999 Campus Drive 42,782 654 4,234 402 654 4,636 5,290 993 - (15) 1989 Electronic Drive 40,000 600 3,110 3,289 600 6,399 6,999 2,950 - 1983/1998 Princeton Road 42,600 1,075 1,438 4,179 1,075 5,617 6,692 2,327 - 1984/1999 Welsh Pool Road 41,015 621 4,258 31 621 4,289 4,910 151 - 1968 Lawrence Road 111,451 1,289 12,039 70 1,289 12,109 13,398 433 - 1997/2004 Capitola Drive #1 65,114 337 5,795 845 337 6,640 6,977 1,499 - (13) 1986 Capitola Drive #2 59,397 288 5,789 5,611 288 11,400 11,688 3,891 11,522 (13) 1985 Capitola Drive #3 60,519 289 5,899 6,951 289 12,850 13,139 1,978 - (13) 1985 Technology Parkway 20,580 214 3,802 - 214 3,802 4,016 678 - 1976/1993 Triangle Drive 32,120 161 3,410 224 161 3,634 3,795 740 - 1981 Alexander Road 86,239 - 376 11,609 - 11,985 11,985 1,947 - 2000 Kit Creek Road #1 38,861 339 3,383 7,164 339 10,547 10,886 1,656 - 1995/2003 Kit Creek Road #2 48,236 364 8,734 3,789 364 12,523 12,887 - - 2005 State Highway 54 81,580 713 12,827 168 713 12,995 13,708 432 8,449 1995 ---------- -------- ------------- ------------- -------- ------------ ----------- ---------------- ---------------- 8,824,369 $296,841 $ 1,161,446 $ 551,421 $296,841 $ 1,712,867 $ 2,009,708 $ 220,890 $ 619,076 ========== ======== ============= ============= ======== ============ =========== ================ ================
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A summary of activity of consolidated rental properties and accumulated depreciation is as follows (in thousands):
Rental Properties Year Ended December 31, ------------------------------------------ 2005 2004 2003 ------------ ------------- ------------- Balance at beginning of period $ 1,603,912 $ 1,123,857 $ 1,089,899 Purchase of rental properties 272,532 383,350 48,729 Sale of properties (1,237) (4,084) (56,741) Additions 94,210 70,248 48,264 Transfer of costs from (to) properties under development 40,291 30,541 (6,294) ------------ ------------- ------------- Balance at end of period $ 2,009,708 $ 1,603,912 $ 1,123,857 ============ ============= ============= Accumulated Depreciation December 31, ------------------------------------------ 2005 2004 2003 ------------ ------------- ------------- Balance at beginning of period $176,059 $141,560 $113,477 Depreciation expense on rental properties 45,066 35,052 32,786 Accumulated depreciation on properties sold (235) (553) (4,703) ------------ ------------- ------------- Balance at end of period $220,890 $176,059 $141,560 ============ ============= =============