UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE --- SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1997 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE --- SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to ____________ Commission file number 1-12993 ALEXANDRIA REAL ESTATE EQUITIES, INC. (Exact name of registrant as specified in its charter) Maryland 95-4502084 (State or other jurisdiction of (I.R.S. Employer Identification Number) incorporation or organization) 251 South Lake Avenue, Suite 700, Pasadena, California 91101 (Address of principal executive offices) (626) 578-0777 (Registrant's telephone number, including area code) N/A - - - - - - - - - - - - - - - - - - - - (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes X No --------- ---------- As of November 13, 1997, 11,404,631 shares of common stock, par value $.01 per share, were outstanding.
TABLE OF CONTENTS PART I - FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS (UNAUDITED) Condensed Consolidated Balance Sheets of Alexandria Real Estate Equities, Inc. as of September 30, 1997 and December 31, 1996 Condensed Consolidated Statements of Operations of Alexandria Real Estate Equities, Inc. for the three months ended September 30, 1997 and 1996 and the nine months ended September 30, 1997 and 1996 Condensed Consolidated Statement of Stockholders' Equity of Alexandria Real Estate Equities, Inc. for the nine months ended September 30, 1997 Condensed Consolidated Statements of Cash Flows of Alexandria Real Estate Equities, Inc. for the nine months ended September 30, 1997 and 1996 Notes to Condensed Consolidated Financial Statements Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK PART II - OTHER INFORMATION Item 1. LEGAL PROCEEDINGS Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS Item 3. DEFAULTS UPON SENIOR SECURITIES Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Item 5. OTHER INFORMATION Item 6. EXHIBITS AND REPORTS ON FORM 8-K 1
Alexandria Real Estate Equities, Inc. Condensed Consolidated Balance Sheets (Unaudited) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) SEPTEMBER 30, DECEMBER 31, 1997 1996 ---------------------------- ASSETS Rental properties, net $214,922 $146,960 Cash and cash equivalents 6,789 1,696 Tenant security deposit funds and other restricted cash 4,655 5,585 Tenant receivables and deferred rent 1,153 1,244 Loan fees and costs (net of accumulated amortization of $184 and $131, respectively) 1,602 2,502 Other assets 2,403 2,405 -------------------------- Total assets $231,524 $160,392 -------------------------- ------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Secured notes payable and line of credit $ 54,727 $113,182 Accounts payable, accrued expenses and tenant security deposits 4,965 3,562 Dividends payable 4,562 1,550 Due to Health Science Properties Holding Corporation -- 2,525 -------------------------- Total liabilities 64,254 120,819 Manditorily redeemable Series V cumulative convertible preferred stock, $0.01 par value per share -- 25,042 Stockholders' equity: Preferred stock, $0.01 par value per share -- 111 Common stock, $0.01 par value per share, 100,000,000 shares authorized; 11,404,631 and 1,000 shares issued and outstanding at September 30, 1997 and December 31, 1996, respectively 114 -- Additional paid-in capital 178,297 16,195 Accumulated deficit (11,141) (1,775) -------------------------- Total stockholders' equity 167,270 14,531 -------------------------- Total liabilities and stockholders' equity $231,524 $160,392 -------------------------- -------------------------- SEE ACCOMPANYING NOTES. 2
Alexandria Real Estate Equities, Inc. Condensed Consolidated Statements of Operations (Unaudited) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) <TABLE> <CAPTION> THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, 1997 1996 1997 1996 --------------------------------------------------------- <S> <C> <C> <C> <C> Revenues: Rental $ 7,062 $ 3,752 $ 17,963 $ 8,303 Tenant recoveries and other income 2,615 1,659 6,619 2,881 --------------------------------------------------------- 9,677 5,411 24,582 11,184 Expenses: Rental operations 2,383 1,374 6,216 2,599 General and administrative 629 310 1,805 1,080 Interest 1,214 1,924 5,789 4,042 Stock compensation -- -- 4,239 -- Post retirement benefit -- 438 632 438 Special bonus -- -- 353 -- Acquisition LLC financing costs -- -- 6,973 -- Write-off of unamortized loan costs -- -- 2,147 -- Depreciation and amortization 1,325 674 3,434 1,567 --------------------------------------------------------- 5,551 4,720 31,588 9,726 --------------------------------------------------------- Net (loss) income $ 4,126 $ 691 $ (7,006) $ 1,458 --------------------------------------------------------- --------------------------------------------------------- Net income allocated to preferred stockholders $ -- 255 $ 3,038 255 --------------------------------------------------------- --------------------------------------------------------- Net (loss) income allocated to common stockholders $ 4,126 436 $ (10,044) 1,203 --------------------------------------------------------- --------------------------------------------------------- Net (loss) per pro forma share of common stock $ 0.36 $ (0.99) ------------- ------------- ------------- ------------- Pro forma weighted average shares of common stock outstanding 11,404,631 7,048,381 ------------- ------------- ------------- ------------- </TABLE> SEE ACCOMPANYING NOTES. 3
Alexandria Real Estate Equities, Inc. Condensed Consolidated Statements of Stockholders' Equity Nine months ended September 30, 1997 (Unaudited) (DOLLARS IN THOUSANDS) <TABLE> <CAPTION> NUMBER OF NUMBER OF SERIES T SERIES T SERIES U SERIES U NUMBER OF PREFERRED PREFERRED PREFERRED PREFERRED COMMON SHARES STOCK SHARES STOCK SHARES ------------------------------------------------------------- <S> <C> <C> <C> <C> <C> Balance at December 31, 1996 12 $ 1 220 $ 110 1,000 Accretion on Series V preferred stock -- -- -- -- -- Cash dividends on Series T, U and V preferred stock -- -- -- -- -- Exercise of compensatory stock options and issuance of stock grants (including compensation expense of $4,161) -- -- -- -- 209,615 Stock split -- -- -- -- 1,764,923 Issuance of common stock in connection with initial public offering, net of offering costs -- -- -- -- 7,762,500 Conversion of Series U preferred stock -- -- (220) (110) 7,354 Conversion of Series V preferred stock -- -- -- -- 1,659,239 Redemption of Series T preferred stock (12) (1) -- -- -- Cash dividends on common stock -- -- -- -- -- Dividends declared on common stock -- -- -- -- -- Net loss -- -- -- -- -- ------------------------------------------------------------- Balance at September 30, 1997 -- $-- -- $ -- 11,404,631 ------------------------------------------------------------- ------------------------------------------------------------- <CAPTION> ADDITIONAL COMMON PAID-IN ACCUMULATED STOCK CAPITAL DEFICIT TOTAL ----------------------------------------- <S> <C> <C> <C> <C> Balance at December 31, 1996 $ -- $ 16,195 $ (1,775) $ 14,531 Accretion on Series V preferred stock -- (1,911) -- (1,911) Cash dividends on Series T, U and V preferred stock -- -- (1,127) (1,127) Exercise of compensatory stock options and issuance of stock grants (including compensation expense of $4,161) 2 4,190 -- 4,192 Stock split 18 (18) -- -- Issuance of common stock in connection with initial public offering, net of offering costs 78 138,812 -- 138,890 Conversion of Series U preferred stock -- 109 -- (1) Conversion of Series V preferred stock 16 26,936 -- 26,952 Redemption of Series T preferred stock -- -- -- (1) Cash dividends on common stock -- (1,454) (1,233) (2,687) Dividends declared on common stock -- (4,562) -- (4,562) Net loss -- -- (7,006) (7,006) ----------------------------------------- Balance at September 30, 1997 $114 $178,297 $(11,141) $167,270 ----------------------------------------- ----------------------------------------- </TABLE> SEE ACCOMPANYING NOTES. 4
Alexandria Real Estate Equities, Inc. Condensed Consolidated Statements of Cash Flows (Unaudited) (IN THOUSANDS) NINE MONTHS ENDED SEPTEMBER 30, 1997 1996 --------------------- Net cash provided by (used in) operating activities $ 3,710 $ (2,573) INVESTING ACTIVITIES Purchase of rental properties (68,555) (55,941) Improvements to rental properties (2,635) (878) --------------------- Net cash used in investing activities (71,190) (56,819) FINANCING ACTIVITIES Proceeds from secured notes payable 15,360 68,060 Proceeds from unsecured line of credit 2,500 -- Proceeds from issuance of common stock 138,919 -- Redemption of Series T preferred stock (1) -- Issuance of Series U preferred stock -- 110 Issuance of Series V preferred stock -- 13,270 (Decrease) increase in due to Health Science Properties Holding Corporation (2,525) 2,400 Principal reductions of secured notes payable (73,815) (16,424) Principal reductions of unsecured line of credit (2,500) (4,000) Common dividends paid (4,237) (939) Preferred dividends paid (1,127) (98) --------------------- Net cash provided by financing activities 72,573 62,379 Net increase in cash and cash equivalents 5,093 2,987 Cash and cash equivalents at beginning of period 1,696 919 --------------------- Cash and cash equivalents at end of period $ 6,789 $ 3,906 --------------------- --------------------- SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during the period year for interest $ 12,753 $ 3,898 --------------------- --------------------- SEE ACCOMPANYING NOTES. 5
Alexandria Real Estate Equities, Inc. Notes to Condensed Consolidated Financial Statements (Unaudited) 1. BACKGROUND, BASIS OF PRESENTATION AND THE INITIAL PUBLIC OFFERING BACKGROUND Alexandria Real Estate Equities, Inc. (formerly known as Health Science Properties, Inc.), a Maryland corporation (the "Company"), is a Real Estate Investment Trust ("REIT") formed in October 1994 to acquire, manage, and selectively develop properties for lease principally to participants in the life science industry ("Life Science Facilities"). As of September 30, 1997 and December 31, 1996, the Company owned 18 and 12 Life Science Facilities, respectively. The accompanying interim financial statements have been prepared by the Company's management in accordance with generally accepted accounting principles and in conformity with the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the interim financial statements presented herein reflect all adjustments of a normal and recurring nature that are necessary to fairly state the interim financial statements. The results of operations for the interim period are not necessarily indicative of the results that may be expected for the year ended December 31, 1997. These financial statements should be read in conjunction with the financial statements included in the Company's prospectus dated May 27, 1997. BASIS OF PRESENTATION The accompanying condensed consolidated financial statements include the accounts of Alexandria Real Estate Equities, Inc. and all of its subsidiaries. All significant intercompany balances and transactions have been eliminated. THE INITIAL PUBLIC OFFERING AND RELATED TRANSACTIONS On June 2, 1997, the Company completed an initial public offering (the "Offering") of 6,750,000 shares of common stock, $.01 par value per share. The Offering price was $20.00 per share, resulting in gross proceeds of $135,000,000. On June 26, 1997, the underwriters exercised their over-allotment option in connection with the Offering and the Company issued an additional 1,012,500 shares of common stock, resulting in additional gross proceeds of $20,250,000. The aggregate net proceeds of the Offering (including exercise of the over-allotment option), net of underwriting discounts and commissions, advisory fees and offering costs, were approximately $ 138,890,000. 6
Alexandria Real Estate Equities, Inc. Notes to Condensed Consolidated Financial Statements (continued) (Unaudited) 1. BACKGROUND, BASIS OF PRESENTATION AND THE INITIAL PUBLIC OFFERING (CONTINUED) THE INITIAL PUBLIC OFFERING AND RELATED TRANSACTIONS (CONTINUED) The following transactions also occurred in June 1997 in connection with the Offering: - The Company paid off debt of approximately $77,698,000, including (i) mortgage debt of $72,698,000, (ii) debt of $2,500,000 outstanding under its prior unsecured line of credit, and (iii) debt of $2,500,000 to Health Science Properties Holding Corporation ("Holdings"). Holdings owned all of the Company's common stock prior to the Offering and 15.5% of the common stock of the Company as of September 30, 1997. - The Company obtained two new mortgage loans totaling $15,360,000. - The Company acquired an entity that owns three Life Science Facilities from affiliates of PaineWebber Incorporated, the lead managing underwriter for the Offering, for an aggregate of $58,844,000 ($51,871,000 of which has been recorded as the purchase price of the properties and $6,973,000 of which has been recorded as a financing cost (see Note 6)). - Each previously outstanding share of the Company's common stock was split into 1,765.923 shares of common stock. - All of the previously outstanding Series T preferred stock was redeemed at its stated value ($1,200 in the aggregate). - All of the previously outstanding shares of the Company's Series U preferred stock and Series V preferred stock were converted into shares of common stock (7,354 shares in the aggregate for Series U and 1,659,239 shares in the aggregate for Series V). - Officers, directors and certain employees of the Company were granted an aggregate of 152,615 shares of the Company's common stock. In addition, officers, directors and certain employees of the Company were granted options to purchase 57,000 shares of the Company's common stock in substitution for stock options previously issued by Holdings (see Note 5). These options were exercised in connection with the Offering. 7
Alexandria Real Estate Equities, Inc. Notes to Condensed Consolidated Financial Statements (continued) (Unaudited) 1. BACKGROUND, BASIS OF PRESENTATION AND THE INITIAL PUBLIC OFFERING (CONTINUED) THE INITIAL PUBLIC OFFERING AND RELATED TRANSACTIONS (CONTINUED) - Officers, directors and employees of the Company were granted options to purchase an aggregate of 600,000 shares of the Company's common stock of the Company at the Offering price under the Company's 1997 stock option plan. 2. RENTAL PROPERTIES, NET Rental properties, net consist of the following: SEPTEMBER 30, DECEMBER 31, 1997 1996 ---------------------------- (IN THOUSANDS) Land $ 43,245 $ 28,383 Buildings and improvements 179,079 122,771 ----------------------- 222,324 151,154 Less accumulated depreciation (7,402) (4,194) ----------------------- $214,922 $146,960 ----------------------- ----------------------- During the three months ended September 30, 1997, the Company acquired three Life Science Facilities and a parcel of land to be developed as a Life Science Facility for an aggregate purchase price of $16,046,000. 3. UNSECURED LINE OF CREDIT In connection with the Offering, the Company obtained an unsecured line of credit providing for borrowings of up to $150,000,000, consisting of a $100,000,000 activated portion and a $50,000,000 portion that may be activated at the Company's discretion (upon the payment of an activation fee), provided no default exists under the line of credit. Borrowings under the line of credit bear interest at a floating rate which is based on the Company's 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, the Company must elect to fix the rate for a period of time of one, two, three or six month period. 8
Alexandria Real Estate Equities, Inc. Notes to Condensed Consolidated Financial Statements (continued) (Unaudited) 3. UNSECURED LINE OF CREDIT (CONTINUED) The line of credit contains financial covenants, including, among other things, maintenance of minimum market net worth, a total liabilities to gross asset value ratio, and a fixed charge coverage ratio. In addition, the terms of the line of credit restrict, among other things, certain investments, indebtedness, distributions and mergers. Borrowings under the line of credit are limited to an amount based on a pool of unencumbered assets. As of September 30, 1997, borrowings under the line of credit were limited to approximately $84 million. No borrowings were outstanding under the line of credit at September 30, 1997. The line of credit expires on May 31, 2000 and provides for annual extensions (provided there is no default) for one-year periods upon notice by the Company and consent of the participating banks. In addition, at the Company's election, the line of credit may be converted at any time to a term loan with principal installments over two years from the date of such conversion. In connection with obtaining the line of credit, the Company incurred $695,000 in fees and costs, which are being amortized over the initial term of the line of credit. In addition, the Company is required to continue to pay certain periodic fees for the line of credit, depending on the usage of the facility. In June 1997, the Company paid off its prior unsecured line of credit of $2,500,000 with proceeds from the Offering (see Note 1). 4. SECURED NOTES PAYABLE Secured notes payable as of September 30, 1997 are as follows: Notes payable secured by first deeds of trust on four rental properties bearing interest at annual rates between 7.17% and 9.00%, payable in installments through 2016 $48,056,000 Note payable to the City of Seattle secured by a second deed of trust on 1102/1124 Columbia Street, bearing interest at a variable annual rate (approximately 6% at September 30, 1997), payable in annual installments through 2016 6,671,000 ----------- $54,727,000 ----------- ----------- 9
Alexandria Real Estate Equities, Inc. Notes to Condensed Consolidated Financial Statements (continued) (Unaudited) 4. SECURED NOTES PAYABLE (CONTINUED) In September 1997, the City of Seattle notified the Company that, in accordance with the terms of the loan, the Company's note in favor of the City would be pooled with other notes (unrelated to the Company), and the interest rate on the note would be fixed at approximately 7.1% in October 1997. Thereafter, the Company and the City of Seattle agreed that: (i) the note will not be pooled, (ii) the Company will prepay the note, and (iii) the interest rate will remain variable (approximately 6% at September 30, 1997) until the prepayment is made. The Company intends to prepay the note during the fourth quarter of 1997. In connection with the prepayment, $1,833,000 in restricted cash held in trust as additional security on the loan will be returned to the Company. In June 1997, the Company paid off secured notes with a principal balance of $72,698,000 with proceeds from the Offering and related transactions (see Note 1). In connection with the retirement of these loans, the Company wrote off $2,146,000 of unamortized loan costs, including the cost of certain interest rate cap agreements. 5. NON-CASH TRANSACTIONS Stock compensation expense represents non-cash compensation expense associated with stock grants and stock options issued to officers, directors and certain employees of the Company in connection with the Offering (see Note 1). Stock compensation expense for the nine months ended September 30, 1997 includes (i) $394,000 recognized with respect to stock options issued during the three months ended March 31, 1997, and (ii) $3,845,000 recognized with respect to stock grants and the issuance and exercise of the substitute options during the three months ended June 30, 1997 (including $77,000 not previously recognized in the financial statements included in the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1997). In connection with the Offering, outstanding shares of the Company's Series U preferred stock and Series V preferred stock were converted into shares of common stock (see Note 1). The common stock issued was recorded at the book value of the Series U preferred stock and the Series V preferred stock (an aggregate of $27,061,000). 6. PURCHASE OF ACQUISITION LLC In connection with the Offering, the Company acquired 100% of the membership interests in ARE Acquisitions, LLC (formerly PW Acquisitions I, LLC) (the "Acquisition LLC") from affiliates of PaineWebber Incorporated, the lead managing underwriter of the 10
Alexandria Real Estate Equities, Inc. Notes to Condensed Consolidated Financial Statements (continued) (Unaudited) Offering. Acquisition LLC owns three Life Science Facilities which it acquired in January 1997 from unaffiliated sellers. The Company's purchase price for the membership interests (approximately $58,844,000) exceeded the cost incurred by the Acquisition LLC to acquire the properties (approximately $51,871,000). The Company's acquisition of the membership interests in the Acquisition LLC has been recorded as a financing transaction, with the excess of the purchase price of such membership interests over the cost of the Acquisition LLC over its cost to acquire the properties ($6,973,000) being reflected as a financing cost in the accompanying condensed consolidated statement of operations. 7. DIVIDEND On September 26, 1997, the Company declared a cash dividend on its common stock of $4,562,000 ($ 0.40 per share) for the calendar quarter ended September 30, 1997. The dividend was paid on October 17, 1997. 8. NET LOSS PER SHARE Historical per share data has not been presented because it is not meaningful due to the various changes in the Company's capital structure in connection with the Offering. Pro forma shares of common stock outstanding on a historical basis include all shares of common stock outstanding after giving effect to the 1,765.923 to 1 stock split, the issuance of the stock grants, the issuance and exercise of the substitute stock options and the conversion of the Series U and Series V preferred stock (see Note 1). In addition, shares issued to the public in connection with the Offering have been weighted for the period of time they were outstanding. 11
Alexandria Real Estate Equities, Inc. Notes to Condensed Consolidated Financial Statements (continued) (Unaudited) 8. NET LOSS PER SHARE (CONTINUED) The following table sets forth the computation of net loss per pro forma share of common stock outstanding. THREE MONTHS NINE MONTHS ENDED ENDED SEPTEMBER 30, SEPTEMBER 30, 1997 1997 ------------------------------- Net loss $(4,126,000) $(7,006,000) ------------------------------- ------------------------------- Pro forma shares of common stock on a historical basis 11,404,631 3,642,131 Shares issued in the Offering, weighted for period outstanding -- 3,406,250 ------------------------------- 11,404,631 7,048,381 ------------------------------- ------------------------------- Net loss per share $ (0.36) $ (0.99) ------------------------------- ------------------------------- In February 1997, the Financing Accounting Standards Board (FASB), issued Statement of Financial Accounting Standards No. 128 "Earnings Per Share" which is required to be adopted on December 31, 1997. At that time the Company will be required to change the method currently used to compute earnings per share and to restate all prior periods. Under the new requirements for calculating primary earnings per share, the dilutive effect of stock options will be excluded. The methodology required by this pronouncement would not have a material impact on net loss per share information presented by the Company for the three months or nine months ended September 30, 1997. 9. PURCHASE AGREEMENTS As of November 13, 1997, the Company has entered into agreements to purchase three Life Science Facilities for an aggregate purchase price of $19,100,000 and approximately 18 acres of land suitable for the development of Life Science Facilities for a purchase price of $5,375,000. Subject to the Company's due diligence review and customary closing conditions, the Company anticipates that these acquisitions will close during the fourth quarter of 1997. The Company anticipates using its line of credit to fund the cost of these acquisitions. 12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Certain information and statements included in this Quarterly Report on Form 10-Q, including, without limitation, statements containing the words "believes," "anticipates," "expects" and words of similar import, constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 and involve known and unknown risks and uncertainties that could result in actual results of the Company differing materially from expected results expressed or implied by such forward-looking information and statements. In the context of forward-looking information and statements provided in this Form 10-Q and in other reports, please refer to the discussion of risk factors detailed in, as well as the other information contained in, the Company's filings with the Securities and Exchange Commission, including but not limited to, those risk factors set forth under the caption "Risk Factors" in the Company's Registration Statement on Form S-11 (File No. 333-23545) (the "Registration Statement"). The following discussion should be read in conjunction with the financial statements and notes appearing elsewhere in this report and in the Registration Statement. OVERVIEW Since its formation in October 1994, the Company has devoted substantially all of its resources to the acquisition and management of high quality, strategically located Life Science Facilities leased principally to Life Science Industry tenants in the life science industry in its target markets. The Company receives income from rental revenue (including tenant recoveries) from its properties. Of the Company's 18 properties, four were acquired in calendar year 1994, eight in 1996 (the "1996 Acquired Properties"), three in 1997 in connection with the Offering and three in 1997 subsequent to the Offering (together, the "1997 Acquired Properties"). As a result of the Company's acquisition strategy, the financial data shows significant increases in total revenue and expenses for the 1997 periods compared to the 1996 periods, largely attributable to the acquisitions in 1996 and 1997 and the recognition of a full period of revenues for the 1996 Acquired Properties. For the foregoing reasons, and due to the effects of the Offering and related transactions, the Company does not believe its period-to-period historical financial data are comparable. Accordingly, the Company also has included pro forma financial information, which gives effect to the Offering and the acquisitions made in 1996 and in 1997 in connection with the Offering. 13
RESULTS OF OPERATIONS COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 1997 ("THIRD QUARTER 1997") TO THREE MONTHS ENDED SEPTEMBER 30, 1996 ("THIRD QUARTER 1996") Rental revenue increased by $3.3 million, or 87%, to $7.1 million for Third Quarter 1997 compared to $3.8 million for Third Quarter 1996. The increase resulted primarily from the 1996 Acquired Properties acquired after July 1, 1996 being owned for a full period and the 1997 Acquired Properties, which together added $3.2 million of rental revenue in Third Quarter 1997. Rental revenue from the Properties owned since July 1, 1996 (the "Third Quarter Same Properties") increased by $96,000 or 3%. This increase resulted primarily from the conversion and lease of 19,310 square feet of storage space at 10933 North Torrey Pines Road to higher rent laboratory space in October 1996. Tenant recoveries and other income increased by $956,000, or 58%, to $2.6 million for Third Quarter 1997 compared to $1.7 million for Third Quarter 1996. The increase resulted primarily from the 1996 Acquired Properties acquired after July 1, 1996 being owned for a full period and the 1997 Acquired Properties, which together added $644,000 million of tenant recoveries. Tenant recoveries from the Third Quarter Same Properties increased by $255,000, or 24%, due to an increase in operating expenses (particularly utilities) being passed through to the tenants and due to the improved measurement and recovery of certain tenant utility expenses. Other income increased by $57,000 for Third Quarter 1997 compared to Third Quarter 1996, resulting from an increase in interest income due to the investment of excess funds from the Offering and increased amounts in capital improvement reserve accounts. Rental operating expenses increased by $1.0 million, or 73%, to $2.4 million for Third Quarter 1997 compared to $1.4 million for Third Quarter 1996. The increases resulted primarily from the 1996 Acquired Properties acquired after July 1, 1996 being owned for a full period and the 1997 Acquired Properties, which together added $868,000 of rental operating expenses. Operating expenses for the Third Quarter Same Properties increased by $263,000, or 25%, primarily due to increased utility expenses (due to greater usage) that are passed through to the tenants. General and administrative expenses increased by $319,000, or 103%, to $629,000 for Third Quarter 1997 compared to $310,000 for Third Quarter 1996, due to the Company's larger scope of operations and increased costs incurred as a result of being a public company. Post retirement benefit for Third Quarter 1996 relates to the non-cash accrual associated with a one-time post-retirement benefit for an officer of the Company. Interest expense decreased by $710,000, or 37%, to $1.2 million for Third Quarter 1997 compared to $1.9 million for Third Quarter 1996. The decrease resulted from lower interest expense in Third Quarter 1997 due to the repayment of indebtedness paid off in June 1997 in connection with the Offering. 14
Depreciation and amortization increased by $651,000, or 97%, to $1.3 million for Third Quarter 1997 compared to $674,000 for Third Quarter 1996. The increase resulted primarily from depreciation associated with the 1996 Acquired Properties acquired after July 1, 1996 being owned for a full period and the 1997 Acquired Properties. As a result of the foregoing, net income was $4.1 million for Third Quarter 1997 compared to $691,000 for Third Quarter 1996. COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 1997 ("NINE MONTHS 1997") TO NINE MONTHS ENDED SEPTEMBER 30, 1996 ("NINE MONTHS 1996") Rental revenue increased by $9.7 million, or 117%, to $18.0 million for Nine Months 1997 compared to $8.3 million for Nine Months 1996. The increase resulted primarily from the 1996 Acquired Properties being owned for a full period and the 1997 Acquired Properties, which together added $9.5 million of rental revenue in Nine Months 1997. Rental revenue from the properties owned since January 1, 1996 (the "Same Properties") increased by $174,000, or 3%. This increase resulted primarily from the conversion and lease of 19,310 square feet of storage space at 10933 North Torrey Pines Road to higher rent laboratory space in October 1996. Tenant recoveries and other income increased by $3.7 million, or 128%, to $6.6 million for Nine Months 1997 compared to $2.9 million for Nine Months 1996. The increase resulted primarily from the 1996 Acquired Properties being owned for a full period and the 1997 Acquired Properties, which together added $3.1 million of tenant recoveries. Tenant recoveries for the Same Properties increased by $224,000, or 13%, due to an increase in operating expenses (particularly utilities) being passed through to the tenants. Other income increased by $246,000 for Nine Months 1997 compared to Nine Months 1996, resulting from an increase in interest income due to the investment of excess funds from the Offering and increased amounts in capital improvement reserve accounts. Rental operating expenses increased by $3.6 million, or 139%, to $6.2 million for Nine Months 1997 compared to $2.6 million for Nine Months 1996. The increase resulted almost entirely from the 1996 Acquired Properties being owned for a full period and the 1997 Acquired Properties, which together added $3.4 million in operating expenses. Operating expenses for the Same Properties increased by $225,000, or 12%, primarily due to increased utility expenses (due to greater usage) that are passed through to the tenants. General and administrative expenses increased by $725,000, or 67%, to $1.8 million for Nine Months 1997 compared to $1.1 million for Nine Months 1996 due to the Company's larger scope of operations and increased costs incurred as a result of being a public company. Special bonus of $353,000 in Nine Months 1997 reflects a bonus awarded to an officer of the Company in connection with the Offering. Post retirement benefit expense of $632,000 and $438,000 in Nine Months 1997 and Nine Months 1996, respectively, reflects an adjustment for the non-cash accrual associated with a one-time post retirement benefit for an officer of the Company. Stock compensation expense of $4.2 million was 15
recorded in Nine Months 1997 for the non-recurring, non-cash expense related to the issuance of stock grants and options to officers, directors and certain employees of the Company principally in connection with the Offering. Interest expense increased by $1.8 million, or 43%, to $5.8 million for Nine Months 1997 compared to $4.0 million for Nine Months 1996. The increase resulted from indebtedness incurred to acquire the 1996 Acquired Properties, offset by a reduction in ongoing interest expense due to the payoff of $72,698,000 in secured notes payable in June 1997 in connection with the Offering Acquisition LLC financing costs of $6,973,000 in Nine Months 1997, represent the portion of the purchase price of the membership interests in the Acquisition LLC in excess of the cost incurred by Acquisition LLC to acquire its three Life Science Facilities (see Note 6 to condensed financial statements). Write-off of unamortized loan costs in Nine Months 1997 represents the write-off of loan costs associated with $72,698,000 of secured notes repaid with proceeds of the Offering. Depreciation and amortization increased by $1.8 million, or 119%, to $3.4 million for Nine Months 1997 compared to $1.6 million for Nine Months 1996. The increase resulted primarily from depreciation associated with the 1996 Acquired Properties being owned for a full period and the 1997 Acquired Properties. As a result of the foregoing, net loss was $7.0 million for Nine Months 1997 compared to net income of $1.5 million for Nine Months 1996. 16
LIQUIDITY AND CAPITAL RESOURCES Aggregate net proceeds of the Offering (including exercise of the over-allotment option), net of underwriting discounts and commissions, advisory fees, and offering costs, were approximately $138,890,000. The Company used net proceeds from the Offering, as well as $15,360,000 in proceeds from two new mortgage loans, to repay debt of approximately $77,698,000. As a result, total secured debt was reduced during the nine months ended September 30, 1997 to the following: PRINCIPAL BALANCE AT INTEREST MATURITY COLLATERAL SEPTEMBER 30, RATE DATE 1997 - ------------------------------------------------------------------------------- 3535/3565 General Atomics Court, San Diego, CA $18,161,000 9.00% December 2014 1431 Harbor Bay Parkway Alameda, CA 8,500,000 7.17% January 2014 1102/1124 Columbia Street Seattle, WA (first deed of trust) 21,395,000 7.75% May 2016 1102/1124 Columbia Street Seattle, WA (second deed of trust) 6,671,000 (1) July 2016 ----------- $54,727,000 ----------- ----------- (1) At September 30, 1997, the loan bore interest at a variable annual rate (approximately 6%). The lender notified the Company in September 1997, that, in accordance with the terms of the note, interest would become fixed at approximately 7.1% in October 1997. Thereafter, the Company and the lender agreed that the Company will prepay the loan, and the interest rate will remain variable until the date of prepayment. The Company expects to prepay the loan during the fourth quarter of 1997. In connection with the prepayment of the second mortgage loan on 1102/1124 Columbia Street, $1,833,000 in restricted cash held in trust as additional security on the loan will be returned to the Company. As of September 30, 1997, approximately $3.5 million had been set aside in a restricted cash account to complete the conversion of existing space into higher rent generic laboratory space (as well as certain related improvements to the property) at 1102/1124 Columbia Street pursuant to an agreement between the Company and a tenant. The Company also holds approximately $758,000 in security deposit reserve accounts based on the terms of certain lease agreements. Although cash from operations required to fund interest expense has decreased substantially as a result of the Company's reduction in overall debt following the Offering, 17
such reduction has been offset by an increased requirement to use cash from operations to meet annual REIT distribution requirements. The Company expects to make distributions and to pay amortization of principal and interest on its debt from cash available for distribution, which is expected to exceed cash historically available for distribution as a result of the reduction in debt described above. Initially, cash accumulated will be invested by the Company primarily in interest-bearing accounts and other short-term, interest-bearing securities that are consistent with the Company's qualification for taxation as a REIT. After the Company begins utilizing its line of credit facility to fund the cost of acquisitions, amounts accumulated may also be utilized to reduce borrowings outstanding under the line of credit. The Company expects to meet its short-term liquidity requirements generally through net cash provided by operations. The Company believes that its net cash provided by operations will be sufficient to allow the Company to make distributions necessary to enable the Company to continue to qualify as a REIT. The Company also believes that net cash provided by operations will be sufficient to fund its recurring non-revenue enhancing capital expenditures, tenant improvements and leasing commissions. The Company expects to meet certain long-term liquidity requirements, such as property acquisitions, scheduled debt maturities, renovations, expansions and other non-recurring capital improvements, through long-term secured and unsecured indebtedness, including borrowings under the line of credit, and the issuance of additional equity securities. In connection with the Offering, the Company obtained an unsecured line of credit providing for borrowings of up to $150,000,000, consisting of a $100,000,000 activated portion and a $50,000,000 portion that may be activated at the Company's discretion (upon payment of an activation fee), provided no default exists under the line of credit. The line of credit provides for borrowings bearing interest at a floating rate which is based on the Company's 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 the Company must elect to fix the rate for a one, two, three or six month period. The line of credit contains financial covenants, including, among other things, maintenance of minimum market net worth, a total liabilities to gross asset value ratio, and a fixed charge coverage ratio. In addition, the terms of the line of credit restrict, among other things, certain investments, indebtedness, distributions and mergers. Borrowings under the line of credit are limited to an amount based on a pool of unencumbered assets. Accordingly, as the Company acquires additional unencumbered properties, the borrowing limitation under the line of credit will be increased. As of September 30, 1997, borrowings under the line of credit were limited to approximately $84 million. The line of credit will be used primarily to finance acquisitions and capital improvements. As of September 30, 1997 and November 13, 1997, no borrowings were outstanding under the line of credit. The line of credit expires on May 31, 2000 and provides for annual extensions (provided there is no default) for one-year periods upon notice by the Company and consent of the 18
participating banks. In addition, at the Company's election, the line of credit may be converted at any time to a term loan with principal installments over two years from the date of such conversion. The Phase I environmental assessments of the properties have not revealed any environmental liabilities that the Company believes would have a material adverse effect on the Company's financial condition or results of operations taken as a whole, nor is the Company aware of any such material environmental liabilities. HISTORICAL CASH FLOWS Historically, the Company's principal sources of funding for operations and capital expenditures have been the proceeds from the Offering, cash flows from operating activities, private stock offerings and debt financings. Net cash provided by operating activities for Nine Months 1997 increased by $6.4 million to $3.7 million compared to net cash used by operating activities of $2.6 million for Nine Months 1996. The increase resulted primarily from operating cash flows from the 1996 Acquired Properties and the 1997 Acquired Properties. Net cash used in investing activities increased by $14.4 million to $71.2 million for Nine Months 1997 compared to net cash used in investing activities of $56.8 million for Nine Months 1996. The increase resulted primarily from the costs associated with the acquisition of the 1997 Acquired Properties. Cash provided by financing activities increased by $10.2 million to $72.6 million for Nine Months 1997 compared to $62.4 million for Nine Months 1996. The increase resulted primarily from $138.8 million in net proceeds from the Offering and $15.4 million in proceeds from secured debt, offset by $78.8 million of principal reductions in debt, retired principally with proceeds from the Offering. In addition, the Company paid dividends on common stock of $4.2 million and dividends on preferred stock of $1.1 million during Nine Months 1997. INFLATION Approximately 78% of the Company's leases (on a square footage basis) are triple net leases, requiring tenants to pay substantially all real estate taxes and insurance, common area and other operating expenses (including increases thereto). An additional 17% of the Company's leases (on a square footage basis) require the tenants to pay a majority of operating expenses. In addition, approximately 65% of the Company's leases (on a square footage basis) contain effective annual rent escalations that are either fixed (ranging from 2.5% to 4.0%) or indexed based on a CPI or other index. Accordingly, the Company does not believe that its earnings or cash flow are subject to any significant risk of inflation. An increase in inflation, however, could result in an increase in the Company's variable rate borrowing cost, including borrowings under the line of credit. 19
COMPUTER SYSTEM IN THE YEAR 2000 The Company has evaluated the significance of the change from the year 1999 to the year 2000 on its existing computer system and has taken steps to ensure that its computer system will not be adversely affected thereby. The financial impact of steps taken to accommodate the change for the year 2000 is not anticipated to be material. PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION Due to the impact of the Offering and related transactions and the acquisitions by the Company in 1996 and 1997, the historical results of operations are not indicative of the Company's future results of operations. The following pro forma condensed consolidated financial information presents the results of operations of the Company as if the Offering (including the exercise of the over-allotment option) and related transactions occurred on January 1, 1996. As described in the pro forma financial statements included in the Company's prospectus dated May 27, 1997, pro forma results for the nine months ended September 30, 1997 do not include the operations of two of the Company's properties (14225 Newbrook Drive and 1330 Piccard Drive) for the period prior to their acquisition by Acquisition LLC (on January 13, 1997 and January 15, 1997, respectively). These properties were owner-occupied prior to purchase and, as a result, there were no historical operating results as rental properties. The adjusted pro forma financial information presented below assumes that the new leases entered into with the sellers of such properties were in effect for the entire period presented. The pro forma and adjusted pro forma financial information presented below is based upon historical information and does not purport to present the actual results that would have occurred had the offering and related transactions occurred on January 1, 1996, nor to project the Company's results of operations for any future period. 20
CONDENSED CONSOLIDATED PRO FORMA FINANCIAL INFORMATION (UNAUDITED) NINE MONTHS ENDED SEPTEMBER 30 ADJUSTED PRO FORMA PRO FORMA 1997 1996 1997 ----------- ----------- ----------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) Total revenues $ 27,839 18,774 $ 28,110 Expenses: Rental operations 6,307 3,679 6,314 General and administrative 1,992 2,100 1,992 Interest 3,564 2,549 3,564 Special bonus 353 -- 353 Stock compensation 4,239 -- 4,239 Post retirement benefit 632 438 632 Depreciation and amortization 3,836 2,545 3,877 ----------- ----------- ----------- 20,923 11,311 20,971 ----------- ----------- ----------- Net income $ 6,916 7,463 $ 7,139 ----------- ----------- ----------- ----------- ----------- ----------- Pro forma shares of common stock outstanding 11,404,631 11,404,631 11,404,631 ----------- ----------- ----------- ----------- ----------- ----------- Net income per pro forma share of common stock outstanding $ 0.61 $ 0.65 $ 0.63 ----------- ----------- ----------- ----------- ----------- ----------- FUNDS FROM OPERATIONS Management believes that funds from operations (FFO) is helpful to investors as a measure of the performance of an equity REIT because, along with cash flows from operating activities, financing activities and investing activities, it provides investors with an understanding of the ability of the Company to incur and service debt and to make capital expenditures. The Company computes FFO in accordance with standards established by the Board of Governors of NAREIT in its March 1995 White Paper (the "White Paper"), which may differ from the methodology for calculating FFO utilized by other equity REITs, and, accordingly, may not be comparable to such other REITs. Further, FFO does not represent amounts available for management's discretionary use because of needed capital replacement or expansion, debt service obligations, or other commitments and uncertainties. The White Paper defines FFO as net income (loss) (computed in accordance with generally accepted accounting principles ("GAAP")), excluding gains (or losses) from debt restructuring and sales of property, plus real estate related depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures and significant non-recurring events. FFO should not be considered as an alternative to net income (determined in accordance with GAAP) as an indication of the Company's financial performance or to cash flows from operating activities (determined in accordance with GAAP) as a measure of the Company's liquidity, nor is it indicative of funds available to fund the Company's cash needs, including its ability to make distributions. The following tables present the Company's FFO for the three months ended September 30, 1997 on an historical basis, and for the nine months ended September 30, 1997 on an historical, pro forma and adjusted pro forma basis. The adjusted pro forma information for the nine months ended September 21
30, 1997 assumes that leases entered into with sellers of previously owner-occupied properties were in effect for the entire period presented: (UNAUDITED) THREE MONTHS ENDED SEPTEMBER 30, 1997 HISTORICAL -------------- (IN THOUSANDS) Net income $ 4,126 Add: Depreciation and amortization 1,325 -------------- FFO $ 5,451 -------------- -------------- (UNAUDITED) NINE MONTHS ENDED SEPTEMBER 30, 1997 ADJUSTED HISTORICAL PRO FORMA PRO FORMA ----------------------------------- (IN THOUSANDS) Net income (loss) $ (7,006) $ 6,916 $ 7,139 Add: Special bonus 353 353 353 Stock compensation 4,239 4,239 4,239 Post-retirement benefit 632 632 632 Acquisition LLC financing costs 6,973 -- -- Write-off of unamortized loan costs 2,147 -- -- Depreciation and amortization 3,434 3,836 3,877 ----------------------------------- FFO $ 10,772 $ 15,976 $ 16,240 ----------------------------------- ----------------------------------- 22
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS During the three months ended September 30, 1997, no legal proceedings were initiated against the Company, the adverse determination of which would have a material adverse effect upon the financial condition and results of operations of the Company. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS Use of Proceeds. The Company consummated its initial public offering (the "Offering") of Common Stock in June 1997. The Company's Registration Statement on Form S-11 (Registration No. 333-23545), as amended, with respect to the Offering was declared effective by the Securities and Exchange Commission on May 27, 1997. The Offering commenced on May 28, 1997, and has since terminated, resulting in the sale by the Company of (i) 6,750,000 shares of Common Stock on June 2, 1997 and (ii) 1,012,500 shares of Common Stock on June 26, 1997 pursuant to the exercise of the underwriters' over-allotment option, for an aggregate offering price of $155,250,000. The shares of Common Stock sold constitute all of the shares of Common Stock covered by the Registration Statement. The managing underwriters of the Offering were PaineWebber Incorporated, Lehman Brothers Inc., Smith Barney Inc. and EVEREN Securities, Inc. During the period from May 27, 1997 through September 30, 1997, the Company paid a total of $16,360,000 in expenses in connection with the Offering, including $10,091,000 for underwriters' commissions and discounts, $1,553,000 for the underwriters' advisory fee, and $4,716,000 for other expenses. None of these expenses were direct or indirect payments to directors or officers of the Company or their associates, to persons owning ten percent or more of any class of equity securities of the Company or to affiliates of the Company. The net proceeds to the Company from the Offering were approximately $138,890,000. During the period from May 27, 1997 through September 30, 1997, the Company used such net proceeds, as well as $15,360,000 in proceeds from two mortgage loans obtained in connection with the Offering, as follows: (i) $77,698,000 to repay mortgage and other indebtedness (including the repayment of $2,500,000 of indebtedness advanced to the Company from Health Science Properties Holding Corporation, the sole holder of the Common Stock prior to the Offering); (ii) $58,844,000_to acquire the membership interests in ARE Acquisitions, LLC, thereby acquiring three Life Science Facilities; and (iii) an 23
aggregate of $16,046,000 to acquire three additional Life Science Facilities and one parcel of land suitable for the development of a Life Science Facility. Except as set forth in clause (i) above, none of such uses were direct or indirect payments to directors or officers of the Company or their associates, to persons owning ten percent or more of any class of equity securities of the Company or to affiliates of the Company. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 3.1 Articles of Amendment and Restatement of the Registrant (incorporated by reference to Exhibit 3.1 of the Registrant's Quarterly Report on Form 10-Q for the Period Ended June 30, 1997) 3.2 Certification of Correction of the Registrant (incorporated by reference to Exhibit 3.2 of the Registrant's Quarterly Report on Form 10-Q for the Period Ended June 30, 1997) 3.3 Amended and Restated Bylaws of the Registrant (incorporated by reference to Exhibit 3.3 of the Registrant's Quarterly Report on Form 10-Q for the Period Ended June 30, 1997) 4.1 Specimen certificate representing shares of Common Stock (incorporated by reference from Exhibit 4.1 of the Registrant's Registration Statement on Form S-11 (File No. 333-23545)) 10.41 Executive Employment Agreement by and between the Company and James H. Richardson, dated July 30, 1997 27.1 Financial Data Schedule (b) Reports on Form 8-K. None. 24
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on November 13, 1997. ALEXANDRIA REAL ESTATE EQUITIES, INC. ------------------------------------------------- Joel S. Marcus Chief Executive Officer (Principal Executive Officer) ------------------------------------------------- Peter J. Nelson Chief Financial Officer, Treasurer and Secretary (Principal Financial and Accounting Officer) 25