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 March 31, 1999 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) 135 North Los Robles Avenue, Suite 250, 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 May 14, 1999, 13,598,822 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. and Subsidiaries as of March 31, 1999 and December 31, 1998 Condensed Consolidated Income Statements of Alexandria Real Estate Equities, Inc. and Subsidiaries for the three months ended March 31, 1999 and 1998 Condensed Consolidated Statement of Stockholders' Equity of Alexandria Real Estate Equities, Inc. and Subsidiaries for the three months ended March 31, 1999 Condensed Consolidated Statements of Cash Flows of Alexandria Real Estate Equities, Inc. and Subsidiaries for the three months ended March 31, 1999 and 1998 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 2
PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS 3
Alexandria Real Estate Equities, Inc. and Subsidiaries Condensed Consolidated Balance Sheets (Unaudited) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) <TABLE> <CAPTION> MARCH 31, DECEMBER 31, 1999 1998 -------------------------------- <S> <C> <C> ASSETS Rental properties, net $489,976 $471,907 Property under development 25,363 21,839 Cash and cash equivalents 1,450 1,554 Tenant security deposits and other restricted cash 4,559 7,491 Secured note receivable 6,000 6,000 Tenant receivables 2,915 2,884 Deferred rent 6,329 5,595 Other assets 13,291 13,026 -------------------------------- Total assets $549,883 $530,296 -------------------------------- -------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Secured notes payable $127,220 $115,829 Unsecured line of credit 172,000 194,000 Accounts payable, accrued expenses and tenant security deposits 19,140 15,663 Dividends payable 5,440 5,035 -------------------------------- Total liabilities 323,800 330,527 Stockholders' equity: Common stock, $0.01 par value per share, 100,000,000 shares authorized; 13,598,822 and 12,586,263 shares issued and outstanding at March 31, 1999 and 136 126 December 31, 1998, respectively Additional paid-in capital 225,947 199,643 Retained earnings -- -- -------------------------------- Total stockholders' equity 226,083 199,769 -------------------------------- Total liabilities and stockholders' equity $549,883 $530,296 -------------------------------- -------------------------------- </TABLE> SEE ACCOMPANYING NOTES 4
Alexandria Real Estate Equities, Inc. and Subsidiaries Condensed Consolidated Income Statements (Unaudited) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) <TABLE> <CAPTION> THREE MONTHS ENDED MARCH 31, 1999 1998 ---------------------------------- <S> <C> <C> Revenues: Rental $15,748 $9,140 Tenant recoveries 3,424 2,363 Interest and other income 367 193 ---------------------------------- 19,539 11,696 Expenses: Rental operations 4,383 2,504 General and administrative 1,301 751 Interest 4,963 2,085 Depreciation and amortization 3,594 1,721 ---------------------------------- 14,241 7,061 ---------------------------------- Net income $5,298 $4,635 ---------------------------------- ---------------------------------- Net income per share of common stock: -Basic $0.41 $0.41 ---------------------------------- ---------------------------------- -Diluted $0.40 $0.40 ---------------------------------- ---------------------------------- Weighted average shares of common stock outstanding: -Basic 13,025,303 11,404,631 ---------------------------------- ---------------------------------- -Diluted 13,163,695 11,652,772 ---------------------------------- ---------------------------------- </TABLE> SEE ACCOMPANYING NOTES
Alexandria Real Estate Equities, Inc. and Subsidiaries Condensed Consolidated Statement of Stockholders' Equity Three months ended March 31, 1999 (Unaudited) (DOLLARS IN THOUSANDS) <TABLE> <CAPTION> NUMBER OF ADDITIONAL COMMON COMMON PAID-IN RETAINED SHARES STOCK CAPITAL EARNINGS TOTAL --------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> Balance at December 31, 1998 12,586,263 $126 $199,643 $ -- $199,769 Issuance of common stock, net of offering costs 1,150,000 11 29,819 -- 29,830 Redemption and retirement of common stock (3,420) (145,343) (1) (3,419) -- Exercise of stock options, net 7,902 -- 46 -- 46 Dividends declared on common stock -- -- (142) (5,298) (5,440) Net income -- -- -- 5,298 5,298 --------------------------------------------------------------------------------- Balance at March 31, 1999 13,598,822 $136 $225,947 $ -- $226,083 --------------------------------------------------------------------------------- </TABLE> SEE ACCOMPANYING NOTES. 6
Alexandria Real Estate Equities, Inc. and Subsidiaries Condensed Consolidated Statements of Cash Flows (Unaudited) (DOLLARS IN THOUSANDS) <TABLE> <CAPTION> THREE MONTHS ENDED MARCH 31, 1999 1998 -------------------------------- <S> <C> <C> Net cash provided by operating activities $14,003 $8,682 INVESTING ACTIVITIES Purchase of rental properties (5,161) (117,517) Additions to rental properties (4,177) (547) Additions to property under development (3,524) (2,538) Issuance of note receivable -- (6,000) -------------------------------- Net cash used in investing activities (12,862) (126,602) FINANCING ACTIVITIES Proceeds from secured notes payable 624 12,641 Net proceeds from issuance of common stock 29,830 -- Redemption and retirement of common stock (3,420) -- Proceeds from exercise of stock options 46 -- Net (principal reductions) borrowings on unsecured line of credit (22,000) 109,500 Principal reductions of secured notes payable (1,290) (254) Dividends paid on common stock (5,035) (4,562) -------------------------------- Net cash (used in) provided by financing activities (1,245) 117,325 Net decrease in cash and cash equivalents (104) (595) Cash and cash equivalents at beginning of period 1,554 2,060 -------------------------------- Cash and cash equivalents at end of period $ 1,450 $ 1,465 -------------------------------- -------------------------------- </TABLE> SEE ACCOMPANYING NOTES. 7
Alexandria Real Estate Equities, Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) 1. BACKGROUND AND BASIS OF PRESENTATION BACKGROUND Alexandria Real Estate Equities, Inc. is a real estate investment trust ("REIT") formed in 1994. We are engaged primarily in the acquisition, management, and selective development of properties for lease principally to participants in the life science industry (we refer to these properties as "Life Science Facilities"). As of March 31, 1999, our portfolio consisted of 52 properties with approximately 3,704,000 rentable square feet. We have prepared the accompanying interim financial statements in accordance with generally accepted accounting principles and in conformity with the rules and regulations of the Securities and Exchange Commission. In our opinion, 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, 1999. These financial statements should be read in conjunction with the financial statements included in our Annual Report on Form 10-K for the year ended December 31, 1998. BASIS OF PRESENTATION The accompanying condensed consolidated financial statements include the accounts of Alexandria and its subsidiaries. All significant intercompany balances and transactions have been eliminated. RECLASSIFICATIONS Certain prior year amounts have been reclassified to conform to the current period presentation. 8
2. RENTAL PROPERTIES Rental properties consist of the following (in thousands): <TABLE> <CAPTION> MARCH 31, DECEMBER 31, 1999 1998 ------------------------------ <S> <C> <C> Land $ 78,988 $ 76,254 Buildings and improvements 409,258 393,728 Tenant and other improvements 23,743 20,536 ------------------------------ 511,989 490,518 Less accumulated depreciation (22,013) (18,611) ------------------------------ ------------------------------ $ 489,976 $ 471,907 ------------------------------ ------------------------------ </TABLE> During the three months ended March 31, 1999, we acquired a property containing approximately 114,000 rentable square feet from an unrelated third party for an aggregate purchase price (including closing and transaction costs) of $16.6 million. 3. SECURED NOTE RECEIVABLE In connection with the acquisition of a Life Science Facility in San Diego, California in March 1998, we made a $6,000,000 loan to the sole tenant of the property, fully secured by a first deed of trust on certain improvements at the property. The loan bears interest at a rate of 11% per year, payable monthly, and matures in March 2002. The loan is cross-defaulted to the lease with the sole tenant. Under certain circumstances, we may obtain title to the improvements that secure the loan, and, in such event, we may also require the sole tenant at the property to lease such improvements back from us for an additional rental amount. 4. UNSECURED LINE OF CREDIT We have an unsecured line of credit that provides for borrowings of up to $250 million. Borrowings under the line of credit 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 to fix the rate for a period of one, two, three or six months. 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 we acquire additional unencumbered properties, borrowings available under the line of credit will increase, but may not exceed $250 million. As of March 31, 1999, borrowings under the line of credit were limited to approximately $200,000,000, and carried a weighted average interest rate of 6.36%. 9
4. UNSECURED LINE OF CREDIT (CONTINUED) The line of credit expires May 31, 2000 and provides for annual extensions (provided there is no default) for two additional one-year periods upon notice by the company and consent of the participating banks. 5. SECURED NOTES PAYABLE As of March 31, 1999, we had seven notes payable to certain banks and an insurance company, secured by first deeds of trust on 10 of our Life Science Facilities. The notes bear interest at fixed rates ranging from 7.17% to 9.125% and are due at various dates through 2016. 6. STOCKHOLDERS' EQUITY On February 23, 1999, we completed a public offering of 1,150,000 shares of common stock (including the shares issued upon exercise of the underwriters' over-allotment option). The shares were issued at a price of $28.125 per share, resulting in aggregate proceeds of approximately $29.8 million, net of underwriters' discount and commissions, advisory fees and offering costs. On March 16, 1999, we declared a cash dividend on our common stock aggregating $5,440,000 ($ 0.40 per share) for the calendar quarter ended March 31, 1999. We paid the dividend on April 12, 1999. In March 1999, we completed a transaction with Health Science Properties Holding Corporation ("Holdings"), one of our significant stockholders. In connection with the transaction, Holdings delivered to us all of the 1,765,923 shares of our common stock it owned in exchange for (i) the assumption by us of a $3,136,000 obligation of Holdings and (ii) the issuance by us to Holdings of 1,620,580 new shares of our common stock. The number of new shares we issued was computed by subtracting from the 1,765,923 shares owned by Holdings prior to the transaction, a number of shares with an aggregate market value equal to 2% of the value of the 1,765,923 shares, plus the amount of the $3,136,000 loan. The new shares issued were not registered under the Securities Act of 1933, as amended; however, we have granted registration rights to the holders of new shares. In connection with the issuance of the new shares, stockholders of Holdings have agreed to certain limitations on transfer of any of the shares of our common stock received by them upon the redemption or liquidation of Holdings, which occurred in March 1999. 10
7. COMMITMENTS In March 1999, we acquired an 85% tenancy-in-common interest in a 4.9 acre parcel of land in Worcester, Massachusetts for $425,000. The seller retained the remaining 15% tenancy-in-common interest. The site will be developed as a life science facility (the "Facility"). We are committed to complete the construction of a 94,000 square foot building and certain related improvements at a remaining cost of approximately $14,840,000 under the terms of a lease with a third party that will cover 45,000 square feet of the completed Facility. The seller of the property has provided us with a $2,625,000 loan for use in the construction of the Facility. The loan bears interest at a rate of 9% and is due on the earlier of (i) twenty days after a certificate of occupancy is issued for the Facility, or (ii) June 30, 2000. Upon completion of the Facility, the ownership of the Facility will be converted into a condominium structure and, concurrently, the seller may convert its 15% tenancy-in-common interest into a condominium interest in 13,000 square feet of the completed Facility. We have the right to purchase the seller's 15% tenancy-in-common interest at any time prior to such conversion for $300,000. 8. NON-CASH TRANSACTIONS As described in Note 6, we redeemed common stock in part in exchange for the assumption of a $3,136,000 obligation. We repaid this obligation with funds borrowed under our line of credit. In addition, we assumed a $11,297,000 secured note payable in connection with our acquisition of the property described in Note 2. 9. NET INCOME (LOSS) PER SHARE The following table shows the computation of net income per share of common stock outstanding (dollars in thousands, except per share amounts): <TABLE> <CAPTION> THREE MONTHS THREE MONTHS ENDED ENDED MARCH 31, 1999 MARCH 31, 1998 ------------------------------ <S> <C> <C> Net income $ 5,298 $ 4,635 ------------------------------ ------------------------------ Weighted average shares of common stock outstanding - basic 13,025,303 11,404,631 Add: dilutive effect of stock options 138,392 248,141 ------------------------------ Weighted average shares of common stock outstanding - diluted 13,163,695 11,652,772 ------------------------------ ------------------------------ Net income per share: - Basic $ 0.41 $ 0.41 ------------------------------ ------------------------------ - Diluted $ 0.40 $ 0.40 ------------------------------ ------------------------------ </TABLE> 11
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 that involve known and unknown risks and uncertainties. Given these uncertainties, prospective and current investors are cautioned not to place undue reliance on such forward-looking statements. Our actual results, performance or achievements, or industry results, may be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements as a result of many factors. We disclaim any obligation to update any such factors or to publicly announce the result of any revisions to any of the forward-looking statements contained in this or any other document. Readers of this Form 10-Q should also read our other publicly filed documents for further discussion regarding such factors. The following discussion should be read in conjunction with the financial statements and notes appearing elsewhere in this report. OVERVIEW Since our formation in October 1994, we have continued to devote substantially all of our resources to the acquisition, selective development and management of high quality, strategically located Life Science Facilities in our target markets. Our primary source of revenue is rental income and tenant recoveries from leases at the properties we own. Of the 52 properties we owned as of March 31, 1999, four were acquired in calendar year 1994, eight in 1996, 10 in 1997, 29 in 1998 (the "1998 Acquired Properties") and one in 1999 (the "1999 Acquired Property"). As a result of our acquisition activities, the financial data shows significant increases in total revenue and expenses for the three months ended March 31, 1999 compared to the three months ended March 31, 1998. 12
RESULTS OF OPERATIONS COMPARISON OF THREE MONTHS ENDED MARCH 31, 1999 ("FIRST QUARTER 1999") TO THREE MONTHS ENDED MARCH 31, 1998 ("FIRST QUARTER 1998") Rental revenue increased by $6.6 million, or 73%, to $15.7 million for First Quarter 1999 compared to $9.1 million for First Quarter 1998. The increase resulted primarily from rental revenue from the 1998 Acquired Properties purchased after January 1, 1998 and from the 1999 Acquired Property. Rental revenue from the Properties acquired before January 1, 1998 (the "First Quarter Same Properties") increased by $185,000, or 2.8%, primarily due to increases in rental rates. Tenant recoveries increased by $1.0 million, or 42%, to $3.4 million for First Quarter 1999 compared to $2.4 million for First Quarter 1998. The increase resulted primarily from tenant recoveries from the 1998 Acquired Properties purchased after January 1, 1998 and the 1999 Acquired Property. Tenant recoveries from the First Quarter Same Properties increased by $18,000, or 1.1%, generally due to the improved identification and recovery of costs at certain properties. Interest and other income increased by $174,000, or 90%, to $367,000 for First Quarter 1999 compared to $193,000 for First Quarter 1998, resulting primarily from interest income from the secured note receivable. Rental operating expenses increased by $1.9 million, or 76%, to $4.4 million for First Quarter 1999 compared to $2.5 million for First Quarter 1998. The increase resulted primarily from the 1998 Acquired Properties purchased after January 1, 1998 and the 1999 Acquired Property. Operating expenses for the First Quarter Same Properties decreased by $30,000, or 1.8%, generally due to lower premiums on our blanket property and liability insurance policies. The following is a comparison of property operating data computed under generally accepted accounting principles ("GAAP Basis") and under generally accepted accounting principles, adjusted to exclude the effect of straight line rent adjustments required by GAAP ("Cash Basis") for the First Quarter Same Properties (in thousands, except percentage data): <TABLE> <CAPTION> FOR THE THREE MONTHS ENDED MARCH 31, ----------------------- 1999 1998 CHANGE ------------------------------------- <S> <C> <C> <C> GAAP BASIS: Revenue $8,325 $8,107 2.7% Rental operating expenses 1,679 1,709 -1.8% ------------------------------------- Net operating income $6,646 $6,398 3.9% ------------------------------------- ------------------------------------- CASH BASIS (1): Revenue $7,746 $7,464 3.8% Rental operating expenses 1,522 1,572 -3.2% ------------------------------------- Net operating income $6,224 $5,892 5.6% ------------------------------------- ------------------------------------- </TABLE> 13
- --------- (1)Revenue and operating expenses are computed in accordance with GAAP, except that revenue excludes the effect of straight line rent adjustments. In addition, the cash basis same property comparison excludes the results for 1431 Harbor Bay Parkway, a property located in Alameda, California. The lease for this property (which was in place when the property was acquired by the company) contains significant step-down provisions which affected the cash rent paid by the tenant beginning in January 1999. As a result, cash rent paid was reduced from $737,000 per quarter in 1998 to $538,000 for First Quarter 1999. The lease, which expires in January 2014, requires another step-down in rent beginning in January 2004 to $188,000 per quarter. If this property were included in the cash basis same property comparison for the three months ended March 31, 1999, the comparison would show that revenue increased 1.1%, rental operating expenses decreased 1.8% and net operating income increased 1.9%. On a GAAP basis, rental income from this property throughout 1998 and for the three months ended March 31, 1999 was $353,000 per quarter. General and administrative expenses increased by $550,000, or 73%, to $1.3 million for First Quarter 1999 compared to $751,000 for First Quarter 1998. The increase was primarily due to the continued increase in the scope of our operations. A portion of this increase was due to $67,000 in abandoned projects expense in First Quarter 1999. Interest expense increased by $2.9 million, or 138%, to $5.0 million for First Quarter 1999 compared to $2.1 million for First Quarter 1998. The increase resulted primarily from the indebtedness incurred to acquire the 1998 Acquired Properties purchased after January 1, 1998 and the 1999 Acquired Property. Depreciation and amortization increased by $1.9 million, or 112%, to $3.6 million for First Quarter 1999 compared to $1.7 million for First Quarter 1998. The increase resulted primarily from depreciation associated with the 1998 Acquired Properties purchased after January 1, 1998, and the addition of the 1999 Acquired Property. As a result of the foregoing, net income was $5.3 million for First Quarter 1999 compared to $4.6 million for First Quarter 1998. LIQUIDITY AND CAPITAL RESOURCES CASH FLOWS Net cash provided by operating activities for First Quarter 1999 increased by $6.1 million to $14.8 million compared to $8.7 million for First Quarter 1998. The increase resulted primarily from operating cash flows from the addition of the 1998 Acquired Properties purchased after January 1, 1998 and the 1999 Acquired Property. Net cash used in investing activities decreased by $112.9 million to $13.7 million for First Quarter 1999 compared to $126.6 million for First Quarter 1998. The decrease was primarily due to a lower level of property acquisitions during First Quarter 1999 compared to First Quarter 1998. 14
Net cash provided by financing activities decreased by $118.5 million to $1.2 million used in financing activities for First Quarter 1999 compared to $117.3 million provided by financing activities for First Quarter 1998. Cash used in financing activities for First Quarter 1999 consisted of principal payments on our unsecured line of credit, principal payments on our secured debt and distributions to stockholders, partially offset by net proceeds from the issuance/redemption of our common stock, exercise of stock options and secured debt. Cash provided by financing activities for First Quarter 1998 consisted of net proceeds from our unsecured line of credit and secured debt, partially offset by distributions to stockholders. COMMITMENTS We are committed to complete the construction of buildings and certain related improvements in San Diego, California and Gaithersburg, Maryland at a remaining cost of between $10.2 million and $19.2 million under the terms of certain leases (depending on the level of improvements to one of the facilities elected by the tenant at that facility). Under the terms of this lease, the tenant's rental rate will be adjusted depending on the ultimate cost of the improvements. In March 1999, we acquired an 85% tenancy-in-common interest in a 4.9 acre parcel of land in Worcester, Massachusetts for $425,000. The seller retained the remaining 15% tenancy-in-common interest. The site will be developed as a life science facility (the "Facility"). We are committed to complete the construction of a 94,000 square foot building and certain related improvements at a remaining cost of approximately $14,840,000 under the terms of a lease with a third party that will cover 45,000 square feet of the completed Facility. The seller of the property has provided us with a $2,625,000 loan for use in the construction of the Facility. The loan bears interest at a rate of 9% and is due on the earlier of (i) twenty days after a certificate of occupancy is issued for the Facility, or (ii) June 30, 2000. Upon completion of the Facility, the ownership of the Facility will be converted into a condominium structure and, concurrently, the seller may convert its 15% tenancy-in-common interest into a condominium interest in 13,000 square feet of the completed Facility. We have the right to purchase the seller's 15% tenancy-in-common interest at any time prior to such conversion for $300,000. We are also committed to fund approximately $8.8 million for investments in limited partnerships and rental properties, including the construction of tenant improvements under the terms of various leases. RESTRICTED CASH As of March 31, 1999, we had $6.0 million in cash and cash equivalents, including $4.6 million in restricted cash accounts. Of the $4.6 million in restricted cash accounts, approximately $456,000 has been set aside to complete the conversion of existing space into higher rent generic laboratory space (as well as certain related improvements) at 1102/1124 Columbia Street, approximately $3.2 million is held in trust as additional security required under the terms of our secured notes payable and approximately $916,000 is held in security deposit reserve accounts based on the terms of certain lease agreements. 15
SECURED DEBT Secured debt as of March 31, 1999 consists of the following (dollars in thousands): <TABLE> <CAPTION> STATED BALANCE AT INTEREST COLLATERAL MARCH 31, 1999 RATE MATURITY DATE - ----------------------------------------------------------------------------------------------- <S> <C> <C> <C> 3535/3565 General Atomics Court, San Diego, CA $ 17,454 9.00% December 2014 1431 Harbor Bay Parkway, Alameda, CA 7,682 7.165% January 2014 1102/1124 Columbia Street, Seattle, WA 20,588 7.75% May 2016 100/800/801 Capitola Drive, Durham, NC 12,529 8.68% December 2006 14225 Newbrook Drive, Chantilly, VA and 3000/3018 Western Avenue, Seattle, WA 36,236 7.22% May 2008 620 Memorial Drive, Cambridge, MA (1) 20,074 9.125% Oct 2007 One Innovation Drive, Worcester, MA (2) 12,033 8.75% January 2006 Five Biotech, development project Worcester, MA (3) 624 9.0% June 2000 --------- $ 127,220 --------- --------- </TABLE> - --------- (1) The balance shown includes an unamortized premium of $2,213,000 so that the effective rate of the loan is 7.25%. (2) The balance shown includes an unamortized premium of $809,000 so that the effective rate of the loan is 7.25%. (3) The balance shown represents the amount drawn on the construction loan provided by the seller in connection with the acquisition of the 85% tenancy-in-common interest in the parcel of land. The loan provides for borrowings of up to $2,625,000. The following is a summary of the scheduled principal payments for our secured debt as of March 31, 1999 (in thousands): <TABLE> <CAPTION> YEAR AMOUNT ------------------------------------------- <S> <C> 1999 $ 2,013 2000 3,861 2001 3,505 2002 3,788 2003 4,095 Thereafter 106,936 ------------- Subtotal 124,198 Unamortized premium 3,022 ------------- $ 127,220 ------------- ------------- </TABLE> 16
UNSECURED LINE OF CREDIT We have an unsecured line of credit that provides for borrowings of up to $250 million. Borrowings under the line of credit 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 to fix the rate for a period of one, two, three or six months. 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 we acquire additional unencumbered properties, borrowings available under the line of credit will increase, but may not exceed $250 million. As of March 31, 1999, borrowings under the line of credit were limited to approximately $200,000,000, and carried a weighted average interest rate of 6.36%. The line of credit expires May 31, 2000 and provides for annual extensions (provided there is no default) for two additional one-year periods upon notice by the company and consent of the participating banks. In September 1998, we entered into an interest rate swap agreement with BankBoston, N.A. (the "Bank") to hedge our exposure to variable interest rates associated with our line of credit. Interest paid is calculated at a fixed interest rate of 5.43% through May 31, 2000 on a notional amount of $50 million, and interest received is calculated at one month LIBOR. The net difference between the interest paid and the interest received is reflected as an adjustment to interest expense. The fair value of the swap agreement and changes in the fair value as a result of changes in market interest rates are not recognized in the financial statements. We are exposed to loss in the event the Bank is unable to perform under the swap agreement or in the event one month LIBOR is less than 5.43%. OTHER RESOURCES AND LIQUIDITY REQUIREMENTS On February 23, 1999, we completed a public offering of 1,150,000 shares of common stock (including the shares issued upon exercise of the underwriters' over-allotment option). The shares were issued at a price of $28.125 per share, resulting in aggregate proceeds of approximately $29.8 million, net of underwriters' discount and commissions, advisory fees and offering costs. 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 make distributions necessary to enable us to continue qualifying as a real estate investment trust. We also believe that net cash provided by operations will be sufficient to fund our recurring non-revenue enhancing capital expenditures, tenant improvements and leasing commissions. 17
We expect to meet certain long-term liquidity requirements, such as property acquisitions, property development activities, scheduled debt maturities, renovations, expansions and other non-recurring capital improvements, through long-term secured and unsecured indebtedness, including borrowings under our line of credit 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 such material environmental liabilities. INFLATION More than 79% of our 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). In addition, a majority of our 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, we do not believe that our earnings or cash flow are subject to any significant risk of inflation. An increase in inflation, however, could result in an increase in our variable rate borrowing cost, including borrowings under the unsecured line of credit. IMPACT OF THE YEAR 2000 The year 2000 issue is the result of computer programs being written using two digits rather than four digits to define the applicable year. Any of our computer programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send tenant invoices, provide building services or engage in similar normal business activities. We rely on computer technologies to operate our business. In October 1998, we formed an internal task force to identify, assess and evaluate our critical systems to determine which year 2000 related problems may cause system errors or failures. We have identified three major areas as critical systems: (i) internal accounting systems, (ii) systems of significant tenants, vendors and financial institutions; and (iii) internal building systems at our properties. We have engaged consulting professionals from a nationally recognized accounting firm to review our plans and assist us with our solutions. The following discussion of our year 2000 project contains numerous forward-looking statements based on inherently uncertain information. The cost of our evaluation and the date on which we plan to complete our internal evaluation and related remediation projects are based on our best estimates. We derived these estimates using a number of assumptions of future events, including the continued availability of internal and external resources, third-party modifications and other factors. However, there can be no guarantee that these estimates will be achieved, and actual results may be materially different from those anticipated. Moreover, although we believe that 18
we will be operating in a year 2000 compliant manner prior to December 31, 1999, there can be no assurance that any failure to modify a critical system would not have a material adverse effect on our operations. READINESS Our year 2000 project is designed to ensure that all critical systems have been evaluated and will be suitable for continued use into and beyond the year 2000. We completed our identification and initial evaluation of critical systems in the first quarter of 1999, and we expect to implement substantially all of the necessary remedial actions by mid-1999. We have completed our review of our internal accounting systems. Our most significant accounting systems, our general ledger system and our accounts payable system, are currently year 2000 compliant. Our billing system is currently not year 2000 compliant. We have been notified by the vendor that they will be distributing the year 2000 compliant upgrade to the software at no additional cost by June 1999. Once we receive this upgrade, all software will be tested for compatibility and year 2000 compliance. We place a high degree of reliance on computer systems of third parties, such as tenants, vendors and financial institutions. Although we are assessing the readiness of these third parties, there can be no guarantee that the failure of these third parties to modify their systems in advance of December 31, 1999 would not have a material adverse effect on our operations. We have surveyed our most significant third-party vendors and financial institutions, and all surveyed indicated that they have implemented year 2000 programs. In addition, we are in the process of surveying our significant tenants for their year 2000 readiness. Approximately 40% of our tenants have returned their surveys. Most have indicated that they have a year 2000 program in place and expect to be year 2000 compliant by the end of 1999. A few have indicated that they have some concerns regarding their systems. We intend to monitor their status in this regard. We are in the process of contacting those tenants who have not returned their surveys. We anticipate that this process will be completed by mid-1999. We are continually participating in surveys with new tenants, vendors and other third-party suppliers. If future risk assessments of third-party suppliers or tenants indicate significant exposure from a supplier's year 2000 problem, the supplier or tenant will be asked to demonstrate how the problems will be addressed. We believe that we have viable alternatives for each of our major vendors. The task force has completed its evaluation of internal systems in our properties that may have embedded microprocessors with potential year 2000 problems, mainly building systems, including heating, ventilation and air conditioning systems, elevators and security systems. Based on the results of our review, seven of our properties have certain critical systems that must be upgraded for year 2000 readiness. All upgrades are in progress. We anticipate completion of these upgrades by mid-1999. We anticipate using the services of outside experts to test and review our findings and to reconfirm that our building systems are year 2000 compliant. We expect to complete this part of the project in the third quarter of 1999. 19
COST We do not expect our year 2000 project costs, including the costs of any remedial activities and outside experts, to be material. The aggregate cost of purchasing conversion packages for the accounting systems and the cost to survey tenants, vendors and financial institutions are not expected to be material. In addition, any costs incurred to review the building systems and to replace or upgrade them as appropriate constitute property maintenance costs, and are therefore generally recoverable from the tenants pursuant to the terms of their existing leases. RISKS We believe that the principal risks associated with the year 2000 issue include the risk of disruption of our operations due to operational failures of third parties, including tenants, vendors and financial institutions, and the risk of business interruption due to building system failures. We do not believe that the risk of disruptions due to operational failures of vendors or financial institutions is significant, because our major vendors and financial institutions are currently year 2000 compliant, and we believe we have viable alternatives for such suppliers. If any of our major tenants do not become year 2000 compliant on schedule, such tenant's operations and financial condition could be adversely affected, which may impact the tenant's ability to meet its rent obligations. Similarly, if our building systems failed due to year 2000 problems, services to our properties and tenants, such as mechanical and security services, could be interrupted, resulting in potential rent disputes with the tenants. We believe, however, that our early involvement in identifying, assessing and evaluating our critical systems should minimize the risk of year 2000 problems to our operations. CONTINGENCY PLANS We believe that development of contingency plans for significant exposures to potential year 2000 problems are integral to our planning process. Once we have completed our evaluation of critical systems and have completed the subsequent remedial action phase, we will again assess our exposure to year 2000 problems. Based on this assessment, we intend to develop appropriate contingency plans for the systems. Because we anticipate being substantially year 2000 compliant by mid-1999, we believe that adequate time exists to ensure that alternatives can be developed, assessed and implemented prior to the end of 1999. Based on our assessment of the success or adequacy of these alternatives, we intend to develop contingency plans. We cannot give assurance, however, that failure to develop an alternative or an appropriate contingency plan would not have a material adverse effect on our operations. FUNDS FROM OPERATIONS We believe 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, FFO provides investors with an understanding of our ability to incur and service debt, to make capital expenditures and to make distributions. We compute 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 used by other equity REITs, and, accordingly, may not be comparable to such other REITs. Further, FFO does not represent amounts available for our discretionary use because of needed capital replacement or expansion, debt service obligations, or other 20
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, sales of property and unusual items, plus real estate related depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures. FFO should not be considered as an alternative to net income (determined in accordance with GAAP) as an indication of our 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. The following table presents our FFO for the three months ended March 31, 1999 and 1998 on a historical basis (in thousands): <TABLE> <CAPTION> THREE MONTHS ENDED THREE MONTHS ENDED MARCH 31, 1999 MARCH 31, 1998 ------------------------------------------ <S> <C> <C> Net income $ 5,298 $ 4,635 Add: Depreciation and amortization 3,594 1,721 ------- ------- FFO $ 8,892 $ 6,356 ------- ------- ------- ------- </TABLE> PROPERTY AND LEASE INFORMATION The following table is a summary of our property portfolio as of March 31, 1999 (dollars in thousands): <TABLE> <CAPTION> NUMBER OF RENTABLE ANNUALIZED OCCUPANCY PROPERTIES SQUARE FEET BASE RENT PERCENTAGE ------------------------------------------------------------ <S> <C> <C> <C> <C> REGION: Suburban Washington D.C. 17 1,537,338 $ 20,807 96.1% (1) California - San Diego 7 428,955 11,794 98.9% California - San Francisco Bay 6 355,398 5,275 89.4% (1) Southeast 4 254,230 3,672 100% New Jersey/Suburban Philadelphia 5 273,048 3,481 100% Eastern Massachusetts 6 392,888 10,031 100% Washington - Seattle 3 328,556 8,666 94.8% ------------------------------------------------------------ Subtotal 48 3,570,413 63,726 96.6% Renovation/Repositioning Properties 4 133,460 37 2.8% ------------------------------------------------------------ Total 52 3,703,873 $ 63,763 93.3% ------------------------------------------------------------ ------------------------------------------------------------ </TABLE> - --------- (1) All, or substantially all, of the vacant space is office or warehouse space. 21
The following table shows certain information with respect to the lease expirations of our properties as of March 31, 1999: <TABLE> <CAPTION> SQUARE PERCENTAGE OF ANNUALIZED BASE YEAR OF NUMBER OF FOOTAGE OF AGGREGATE RENT OF EXPIRING LEASE EXPIRING EXPIRING PORTFOLIO LEASE LEASES (PER EXPIRATION LEASES LEASES SQUARE FOOT SQUARE FOOT) ---------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> 1999 (1) 45 314,441 9.1% $ 18.78 2000 29 386,570 11.2% $ 17.02 2001 26 479,895 13.9% $ 19.14 2002 13 156,868 4.5% $ 13.21 2003 16 342,803 9.9% $ 15.86 Thereafter 36 1,773,378 51.4% $ 19.50 </TABLE> - --------- (1) Represents leases expiring between April 1, 1999 to December 31, 1999. The following table is a summary of our lease activity for the quarter ended March 31, 1999 computed under generally accepted accounting principles ("GAAP Basis") and under generally accepted accounting principles, adjusted to exclude the effect of straight line rent adjustments required by GAAP ("Cash Basis"): <TABLE> <CAPTION> CASH BASIS GAAP BASIS -------------------------------------- <S> <C> <C> EXPIRED LEASES Square footage 113,731 113,731 Rental rate $14.03 $14.03 RENEWED/RELEASED SPACE Square footage 96,018 96,018 Rental rate $13.73 $13.73 New rate $17.04 $18.69 Rental rate increase 24.1% 36.1% </TABLE> 22
The following table shows the breakdown of the renewed and released space for the quarter ended March 31, 1999 computed under generally accepted accounting principles ("GAAP Basis") and under generally accepted accounting principles, adjusted to exclude the effect of straight line rent adjustments required by GAAP ("Cash Basis"): <TABLE> <CAPTION> CASH BASIS GAAP BASIS ---------------------------------------- <S> <C> <C> NEW LEASES Square footage 64,111 64,111 Expiring rate $10.82 $10.82 New rate $13.92 $16.31 Rental rate increase 28.7% 50.7% RENEWAL LEASES Square footage 25,070 25,070 Rental rate $20.26 $20.26 New rate $25.01 $25.22 Rental rate increase 23.4% 24.5% MONTH-TO-MONTH LEASES Square footage 6,837 6,837 Rental rate $17.06 $17.06 New rate $17.06 $17.06 Rental rate increase 0.0% 0.0% </TABLE> 23
ITEM 3. 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 are exposed is interest rate risk, which is sensitive to 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 characteristics of our outstanding debt and limit the effects of interest rates 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 our exposure to changes in interest rates carries additional risks such as counter-party credit risk and legal enforceability of hedging contracts. Our future earnings, cash flows and fair values relating to financial instruments are primarily dependent upon prevalent market rates of interest, such as LIBOR. However, due to the purchase of our interest rate swap agreement, the effects of interest rate changes are reduced. Based on interest rates at March 31, 1999, a 1% increase in interest rates on our line of credit would decrease annual future earnings and cash flows, after considering the effect of our interest rate swap agreement, by approximately $1.2 million. A 1% decrease in interest rates on our line of credit would increase annual future earnings and cash flows, after considering the effect of our interest rate swap agreement, by approximately $1.2 million. A 1% increase interest rates on our secured debt and interest rate swap agreement would decrease their fair value by approximately $8.4 million. A 1% decrease in interest rates on our secured debt and interest rate swap agreement would increase their fair value by approximately $9.5 million. A 1% increase or decrease in interest rates on our secured note receivable would not have a material impact on its fair value. These amounts are determined by considering the impact of the hypothetical interest rates on our borrowing cost and interest rate swap agreement. 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. 24
PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On August 10, 1998, we filed for arbitration against Mr. Alan Gold, our former President, alleging various claims from his employment relationship and seeking declaratory relief. On October 8, 1998, Mr. Gold filed a response and alleged claims against us, arising from his employment relationship. The arbitration took place April 19, 1999 to April 23, 1999. The Arbitrator found in our favor with respect to all of Mr. Gold's claims against us. To our knowledge, no other litigation is pending against us, other than routine actions and administrative proceedings, substantially all of which are expected to be covered by liability insurance or which, in the aggregate, are not expected to have a material adverse effect on our financial condition, results of operations or cash flows. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS In March 1999, we completed a transaction with Health Science Properties Holding Corporation ("Holdings"), one of our significant stockholders. In connection with the transaction, Holdings delivered to us all of the 1,765,923 shares of our common stock it owned in exchange for (i) the assumption by us of a $3,136,000 obligation of Holdings and (ii) the issuance by us to Holdings of 1,620,580 new shares of our common stock. The number of new shares we issued was computed by subtracting from the 1,765,923 shares owned by Holdings prior to the transaction, a number of shares with an aggregate market value equal to 2% of the value of the 1,765,923 shares, plus the amount of the $3,136,000 loan. The new shares issued were not registered under the Securities Act of 1933, as amended; however, we have granted registration rights to the holders of new shares. In connection with the issuance of the new shares, stockholders of Holdings have agreed to certain limitations on transfer of any of the shares of our common stock received by them upon the redemption or liquidation of Holdings, which occurred in March 1999 The issuance of the new shares was effected in reliance upon an exemption from registration under Section 3(a)(9) of the Securities Act as an exchange by the issuer with existing stockholders where no commission was paid for soliciting the exchange. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. 25
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 10.15 Share Exchange Agreement, dated as of February 26, 1999, between Alexandria Real Estate Equities, Inc. and Health Science Properties Holding Corporation 10.16 First Amendment to Share Exchange Agreement, dated as of March 10, 1999, by and between Alexandria Real Estate Equities, Inc. and Health Science Properties Holding Corporation 10.17 Second Amendment to Share Exchange Agreement, dated as of March 11, 1999, by and between Alexandria Real Estate Equities, Inc. and Health Science Properties Holding Corporation 10.18 Escrow and Security Agreement, dated as of March 11, 1999, among Alexandria Real Estate Equities, Inc., Health Science Properties Holding Corporation and Cedars Bank 10.19 Registration Rights Agreement, dated as of March 11, 1999, by and among Alexandria Real Estate Equities, Inc. and Health Science Properties Holding Corporation (together with its permitted assigns) 12.1 Computation of Consolidated Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends 27.1 Financial Data Schedule (b) Reports on Form 8-K. On February 18, 1999, the Company filed a Current Report on Form 8-K, dated February 18, 1999, to report the sale of 1,150,000 shares of common stock to Goldman, Sachs & Co. 26
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 May 17, 1999. ALEXANDRIA REAL ESTATE EQUITIES, INC. /s/ Joel. S. Marcus ------------------------------------------------- Joel S. Marcus Chief Executive Officer (Principal Executive Officer) /s/ Peter J. Nelson ------------------------------------------------- Peter J. Nelson Chief Financial Officer, Treasurer and Secretary (Principal Financial and Accounting Officer) 27