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 June 30, 1998 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 August 13, 1998, 12,564,631 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. and Subsidiaries as of June 30, 1998 and December 31, 1997 Condensed Consolidated Statements of Operations of Alexandria Real Estate Equities, Inc. and Subsidiaries for the three months ended June 30, 1998 and 1997 and the six months ended June 30, 1998 and 1997 Condensed Consolidated Statement of Stockholders' Equity of Alexandria Real Estate Equities, Inc. and Subsidiaries for the six months ended June 30, 1998 Condensed Consolidated Statements of Cash Flows of Alexandria Real Estate Equities, Inc. and Subsidiaries for the six months ended June 30, 1998 and 1997 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 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
Alexandria Real Estate Equities, Inc. and Subsidiaries Condensed Consolidated Balance Sheets (Unaudited) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) <TABLE> <CAPTION> JUNE 30, DECEMBER 31, 1998 1997 ----------- ------------ <S> <C> <C> ASSETS Rental properties, net $376,195 $225,551 Land under development 14,281 4,419 Cash and cash equivalents 2,010 2,060 Tenant security deposits and other restricted cash 7,831 6,799 Secured note receivable 6,000 - Tenant receivables and deferred rent 5,751 3,630 Other assets 8,829 5,995 -------- -------- Total assets $420,897 $248,454 -------- -------- -------- -------- LIABILITIES AND STOCKHOLDERS' EQUITY Secured notes payable $ 96,409 $ 47,817 Unsecured line of credit 110,200 23,000 Accounts payable, accrued expenses and tenant security deposits 9,360 6,158 Dividends payable 5,022 4,562 -------- -------- Total liabilities 220,991 81,537 Stockholders' equity: Common stock, $0.01 par value per share, 100,000,000 shares authorized; 12,554,631 and 11,404,631 shares issued and outstanding at June 30, 1998 and December 31, 1997, respectively 126 114 Additional paid-in capital 199,780 173,735 Retained earnings (accumulated deficit) - (6,932) -------- -------- Total stockholders' equity 199,906 166,917 Total liabilities and stockholders' equity $420,897 $248,454 -------- -------- -------- -------- </TABLE> SEE ACCOMPANYING NOTES. 3
Alexandria Real Estate Equities, Inc. and Subsidiaries Condensed Consolidated Statements of Operations (Unaudited) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, 1998 1997 1998 1997 ----------- --------- ----------- ---------- <S> <C> <C> <C> <C> Revenues: Rental $ 11,903 $ 5,725 $ 21,043 $ 10,900 Tenant recoveries 2,949 1,806 5,312 3,703 Interest and other income 308 212 501 301 ----------- --------- ----------- ---------- 15,160 7,743 26,856 14,904 Expenses: Rental operations 3,620 2,003 6,124 3,833 General and administrative 882 593 1,633 1,176 Stock compensation - 3,768 - 4,162 Post retirement benefit - - - 632 Special bonus - - - 353 Interest 3,478 2,066 5,563 4,575 Acquisition LLC financing costs - 6,973 - 6,973 Write-off of unamortized loan costs - 2,146 - 2,146 Depreciation and amortization 2,456 1,106 4,177 2,109 ----------- --------- ----------- ---------- 10,436 18,655 17,497 25,959 ----------- --------- ----------- ---------- Net income (loss) $ 4,724 $ (10,912) $ 9,359 $ (11,055) ----------- --------- ----------- ---------- ----------- --------- ----------- ---------- Net income allocated to preferred stockholders $ - 1,459 $ - $ 3,036 ----------- --------- ----------- ---------- ----------- --------- ----------- ---------- Net income (loss) allocated to common stockholders $ 4,724 $ (12,371) $ 9,359 $ (14,091) ----------- --------- ----------- ---------- ----------- --------- ----------- ---------- Net income (loss) per share of common stock (pro forma for 1997): -Basic $ 0.40 $ (1.79) $ 0.81 $ (2.27) ----------- --------- ----------- ---------- ----------- --------- ----------- ---------- -Diluted $ 0.39 $ (1.79) $ 0.79 $ (2.27) ----------- --------- ----------- ---------- ----------- --------- ----------- ---------- Weighted average shares of common stock outstanding (pro forma for 1997): -Basic 11,821,664 6,098,381 11,614,300 4,870,256 ----------- --------- ----------- ---------- ----------- --------- ----------- ---------- -Diluted 12,053,983 6,098,381 11,854,843 4,870,256 ----------- --------- ----------- ---------- ----------- --------- ----------- ---------- </TABLE> SEE ACCOMPANYING NOTES. 4
Alexandria Real Estate Equities, Inc. and Subsidiaries Condensed Consolidated Statement of Stockholders' Equity Six months ended June 30, 1998 (Unaudited) (DOLLARS IN THOUSANDS) <TABLE> <CAPTION> RETAINED NUMBER OF ADDITIONAL EARNINGS COMMON COMMON PAID-IN (ACCUMULATED SHARES STOCK CAPITAL DEFICIT) TOTAL ------------ ------- ---------- ------------- ---------- <S> <C> <C> <C> <C> <C> Balance at December 31, 1997 11,404,631 $114 $173,735 $(6,932) $166,917 Issuance of common stock 1,150,000 12 33,202 - 33,214 Dividends declared on common stock - - (7,157) (2,427) (9,584) Net income - - - 9,359 9,359 ---------- ---- -------- ------- --------- Balance at June 30, 1998 12,554,631 $126 $199,780 $ - $199,906 ---------- ---- -------- ------- --------- ---------- ---- -------- ------- --------- </TABLE> SEE ACCOMPANYING NOTES. 5
Alexandria Real Estate Equities, Inc. and Subsidiaries Condensed Consolidated Statements of Cash Flows (Unaudited) (DOLLARS IN THOUSANDS) <TABLE> <CAPTION> SIX MONTHS ENDED JUNE 30, 1998 1997 --------- -------- <S> <C> <C> Net cash provided by (used in) operating activities $ 10,580 $ (662) INVESTING ACTIVITIES Purchase of rental properties (145,345) (52,102) Additions to rental properties (9,305) (1,720) Additions to land under development (9,862) - Note receivable (6,000) - --------- -------- Net cash used in investing activities (170,512) (53,822) FINANCING ACTIVITIES Proceeds from secured notes payable 49,132 15,360 Net borrowings on unsecured line of credit 87,200 2,500 Proceeds from issuance of common stock 33,214 139,185 Redemption of Series T preferred stock - (1) Decrease in due to Health Science Properties Holding Corporation - (2,525) Principal reductions of secured notes payable (540) (73,391) Common dividends paid (9,124) (2,785) Preferred dividends paid - (1,126) --------- -------- Net cash provided by financing activities 159,882 74,717 Net (decrease) increase in cash and cash equivalents (50) 20,233 Cash and cash equivalents at beginning of period 2,060 1,696 --------- -------- Cash and cash equivalents at end of period $ 2,010 $ 21,929 --------- -------- --------- -------- </TABLE> SEE ACCOMPANYING NOTES. 6
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., a Maryland corporation (the "Company"), was formed in October 1994 to acquire, manage, and selectively develop properties for lease principally to the life science industry ("Life Science Facilities"). As of June 30, 1998 and December 31, 1997, the Company owned 41 and 22 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, 1998. These financial statements should be read in conjunction with the financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 1997. BASIS OF PRESENTATION The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, which own, directly or indirectly, Life Science Facilities. All significant intercompany balances and transactions have been eliminated. RECLASSIFICATIONS Certain prior year amounts have been reclassified to conform to the current period presentation. 7
2. RENTAL PROPERTIES Rental properties consist of the following: <TABLE> <CAPTION> JUNE 30, DECEMBER 31, 1998 1997 ---------- ------------ (DOLLARS IN THOUSANDS) <S> <C> <C> Land $ 60,854 $ 41,970 Buildings and improvements 315,833 189,518 Tenant and other improvements 12,318 2,867 ---------- -------- 389,005 234,355 Less accumulated depreciation (12,810) (8,804) ---------- -------- $ 376,195 $225,551 ---------- -------- ---------- -------- </TABLE> During the six months ended June 30, 1998, the Company acquired 19 Life Science Facilities from various unrelated third parties for an aggregate purchase price (including closing and transaction costs) of $145,345,000. 3. SECURED NOTE RECEIVABLE In connection with the acquisition of a Life Science Facility in San Diego, California in March 1998, the Company 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, the Company may obtain title to the improvements that secure the loan, and, in such event, the Company may also require the sole tenant at the property to lease such improvements back from the Company for an additional rental amount. 4. UNSECURED LINE OF CREDIT The Company has an unsecured line of credit providing for borrowings of up to $150,000,000. Borrowings under the line of credit bear interest at a floating rate 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 one, two, three or six months. 8
4. 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. Accordingly, as the Company acquires additional unencumbered properties, borrowings available under the line of credit will increase. As of June 30, 1998, borrowings under the line of credit were limited to approximately $150,000,000, and $110,200,000 was outstanding (leaving $39,800,000 available) at a weighted average interest rate of 7.16%. The line of credit expires 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 August 1998, the Company amended its unsecured line of credit to provide for borrowings of up to $250 million. As under the original line, borrowings under the line of credit, as amended, bear interest at a floating rate 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%. However, under the line, as amended, the LIBOR based rate has been reduced, resulting in a rate of 6.91% as of August 5, 1998. Financial covenants for the line of credit, as amended, are substantially similar to those under the original line. The line, as amended, 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 June 30, 1998, the Company had five notes payable to certain banks and an insurance company, secured by first deeds of trust on eight Life Science Facilities. The notes bear interest at fixed rates ranging from 7.17% to 9.00% and are due at various dates through 2016. 6. STOCKHOLDERS EQUITY On May 29, 1998, the Company sold 1,150,000 shares of common stock to PaineWebber Incorporated for inclusion in the PaineWebber Equity Trust REIT Series I, a unit investment trust. The shares were issued at a price of $30.5625 per share (before discounts and commissions). The aggregate proceeds to the Company, net of offering costs of $1.9 million, were approximately $33.2 million. On June 1, 1998, the Company declared a cash dividend on its common stock of $5,022,000 ($ 0.40 per share) for the calendar quarter ended June 30, 1998. The dividend was paid on July 17, 1998. 9
7. COMMITMENTS The Company is committed to complete the construction of a building and certain improvements thereto in San Diego, California at a remaining cost of approximately $4.8 million under the terms of two leases. In addition, the Company is committed to complete the construction of a building and certain improvements thereto in Gaithersburg, Maryland at a remaining cost of between $9.1 million and $18.1 million (depending on the level of improvements to the facility elected by the tenant) under the terms of a lease. Under the terms of the lease, the tenant's rental rate will be adjusted depending on the ultimate cost of the improvements. The Company is also committed under the terms of various leases to construct improvements for certain tenants totaling approximately $11.9 million. Of this amount, approximately $5.3 million has been set aside in restricted cash accounts 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 and 3000/3018 Western Avenue. 8. NET INCOME (LOSS) PER SHARE The following table sets forth the computation of net income (loss) per pro forma share of common stock outstanding. <TABLE> <CAPTION> THREE MONTHS ENDED JUNE 30, 1998 1997 ------------------------------------------------ (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) <S> <C> <C> Net income (loss) $ 4,724 $ (10,912) ----------- ---------- ----------- ---------- Weighted average shares of common stock (pro forma for 1997) - basic 11,821,664 6,098,381 Add: dilutive effect of stock options 232,319 - ----------- ---------- Weighted average shares of common stock (pro forma for 1997) - diluted 12,053,983 6,098,381 ----------- ---------- ----------- ---------- Net income (loss) per share - basic $ 0.40 $ (1.79) ----------- ---------- ----------- ---------- Net income (loss) per share - diluted $ 0.39 $ (1.79) ----------- ---------- ----------- ---------- </TABLE> 10
8. NET INCOME (LOSS) PER SHARE (CONTINUED) <TABLE> <CAPTION> SIX MONTHS ENDED JUNE 30, 1998 1997 ------------------------------------------------ (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) <S> <C> <C> Net income (loss) $ 9,359 $ (11,055) ----------- ---------- ----------- ---------- Weighted average shares of common stock (pro forma for 1997) - basic 11,614,300 4,870,256 Add: dilutive effect of stock options 240,543 - ----------- ---------- Weighted average shares of common stock (pro forma for 1997) - diluted 11,854,843 4,870,256 ----------- ---------- ----------- ---------- Net income (loss) per share - basic $ 0.81 $ (2.27) ----------- ---------- ----------- ---------- Net income (loss) per share - diluted $ 0.79 $ (2.27) ----------- ---------- ----------- ---------- </TABLE> Historical per share data has not been presented for the three or six months ended June 30, 1997 because it is not meaningful due to the various changes in the Company's capital structure in connection with the Company's initial public offering on June 2, 1997 (the "Offering"). Pro forma shares of common stock outstanding for the three and six months ended June 30, 1997 include all shares of common stock outstanding after giving effect to a 1,765.923 to 1 stock split, the issuance of certain stock grants, the issuance and exercise of substitute stock options and conversions of preferred stock, each of which occurred in connection with the Offering. In addition, shares issued to the public in connection with the Offering have been weighted for the period of time they were outstanding. 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 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) initially filed with the Securities and Exchange Commission on March 18, 1997. The following discussion should be read in conjunction with the financial statements and notes appearing elsewhere in this report. 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 tenants in the life science industry in its target markets. The Company's primary source of income is rental revenue (including tenant recoveries) from its properties (the "Properties"). The Company has acquired its current portfolio since the beginning of 1994, with four of the Properties acquired in calendar year 1994, eight acquired in 1996, three acquired in 1997 in connection with the Offering, seven acquired in 1997 after the Offering (together, the "1997 Acquired Properties") and 19 acquired in 1998 (the "1998 Acquired Properties"). As a result of the Company's acquisition activities in 1997 and 1998, the financial data shows significant increases in total revenue and expenses for the 1998 periods compared to the 1997 periods. 12
RESULTS OF OPERATIONS COMPARISON OF THREE MONTHS ENDED JUNE 30, 1998 ("SECOND QUARTER 1998") TO THREE MONTHS ENDED JUNE 30, 1997 ("SECOND QUARTER 1997") Rental revenue increased by $6.2 million, or 109%, to $11.9 million for Second Quarter 1998 compared to $5.7 million for Second Quarter 1997. The increase resulted primarily from rental revenue from the 1997 Acquired Properties purchased after April 1, 1997 and from the 1998 Acquired Properties, which together added an additional $6.2 million of rental revenue. Of this amount, $155,000 represents the receipt of a rental termination payment associated with a lease at one of the Properties. Rental revenue from the Properties acquired before April 1, 1997 (the "Second Quarter Same Properties") increased by $28,000, or 1%, generally due to increases in rental rates. Results for the Second Quarter Same Properties for Second Quarter 1998 were impacted by the vacancy of approximately 68,000 square feet at 1102/1124 Columbia Street beginning May 31, 1998. The Company is currently negotiating with tenants for substantially all of this vacant space. Rental revenue for the Second Quarter Same Properties (excluding 1102/1124 Columbia Street) increased by $85,000, or 2%. Tenant recoveries increased by $1.1 million, or 61%, to $2.9 million for Second Quarter 1998 compared to $1.8 million for Second Quarter 1997. The increase resulted primarily from the 1997 Acquired Properties purchased after April 1, 1997 and the 1998 Acquired Properties, which together added an additional $1.0 million of tenant recoveries. Tenant recoveries from the Second Quarter Same Properties increased by $107,000, or 6%, primarily due to an increase in rental operating expenses, improved identification and recovery of costs at certain properties, and adjustments to tenant recoveries relating to operating expenses for prior periods. Tenant recoveries for the Second Quarter Same Properties (excluding 1102/1124 Columbia Street) increased by $287,000, or 24%. Interest and other income increased by $96,000, or 45%, to $308,000 for Second Quarter 1998 compared to $212,000 for Second Quarter 1997, resulting primarily from interest income from the secured note receivable. Rental operating expenses increased by $1.6 million, or 80%, to $3.6 million for Second Quarter 1998 compared to $2.0 million for Second Quarter 1997. The increase resulted primarily from the 1997 Acquired Properties purchased after April 1, 1997 and the 1998 Acquired Properties, which together added an additional $1.6 million of rental operating expenses. Operating expenses for the Second Quarter Same Properties increased by approximately $55,000, or 3%, primarily due to an increase in utility expenses (due to greater usage) that are passed through to the tenants. Rental operating expenses for the Second Quarter Same Properties (excluding 1102/1124 Columbia Street) increased by $37,000, or 3%. General and administrative expenses increased by $289,000, or 49%, to $882,000 for Second Quarter 1998 compared to $593,000 for Second Quarter 1997, due to the Company's larger scope of operations and increased costs incurred as a result of being a public company in 1998. 13
Stock compensation expense of $3.8 million was recorded for Second Quarter 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 $1.4 million, or 67%, to $3.5 million for Second Quarter 1998 compared to $2.1 million for Second Quarter 1997. The increase resulted primarily from the indebtedness incurred to acquire the 1997 Acquired Properties purchased after April 1, 1997 and the 1998 Acquired Properties, offset by the decrease in interest expense due to the indebtedness related to the Second Quarter Same Properties paid off in June 1997 with proceeds from the Offering. Acquisition LLC financing costs of $6,973,000 were expensed in Second Quarter 1997, representing the portion of the purchase price of ARE Acquisitions, LLC (the "Acquisition LLC") in excess of the cost incurred by it to acquire its three Life Science Facilities. Write-off of unamortized loan costs in Second Quarter 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 $1.4 million, or 127%, to $2.5 million for Second Quarter 1998 compared to $1.1 million for Second Quarter 1997. The increase resulted primarily from depreciation associated with the 1997 Acquired Properties purchased after April 1, 1997, and the addition of the 1998 Acquired Properties. As a result of the foregoing, there was net income of $4.7 million for Second Quarter 1998 compared to a net loss of $10.9 million for Second Quarter 1997. COMPARISON OF SIX MONTHS ENDED JUNE 30, 1998 ("SIX MONTHS 1998") TO SIX MONTHS ENDED JUNE 30, 1997 ("SIX MONTHS 1997") Rental revenue increased by $10.1 million, or 93%, to $21.0 million for Six Months 1998 compared to $10.9 million for Six Months 1997. The increase resulted primarily from the 1997 Acquired Properties purchased after January 1, 1997 and the 1998 Acquired Properties, which together added an additional $10.0 million of rental revenue. Of this amount, $277,000 represents the receipt of rental termination payments associated with leases at two of the Properties. Rental revenue from the Properties acquired before January 1, 1997 (the "Same Properties") increased by $115,000, or 1%, generally due to increases in rental rates. Results for the Same Properties for Six Months 1998 were impacted by the vacancy of approximately 68,000 square feet at 1102/1124 Columbia Street beginning May 31, 1998. The Company is currently negotiating with tenants for substantially all of this vacant space. Rental revenue for the Same Properties (excluding 1102/1124 Columbia Street) increased by $165,000, or 2%. 14
Tenant recoveries increased by $1.6 million, or 43%, to $5.3 million for Six Months 1998 compared to $3.7 for Six Months 1997. The increase resulted primarily from the 1997 Acquired Properties purchased after January 1, 1997 and the 1998 Acquired Properties, which together added an additional $1.5 million of tenant recoveries. Tenant recoveries for the Same Properties increased by $96,000, or 2.6%, generally due to an increase in rental operating expenses, improved identification and recovery of costs at certain properties, and adjustments to tenant recoveries relating to operating expenses for prior periods. Tenant recoveries for the Same Properties (excluding 1102/1124 Columbia Street) increased by $292,000, or 11%. Interest and other income increased by $200,000, or 66%, to $501,000 for Six Months 1998 compared to $301,000 for Six Months 1997, resulting primarily from interest income from the secured note receivable. Rental operating expenses increased by $2.3 million, or 61%, to $6.1 million for Six Months 1998 compared to $3.8 million for Six Months 1997. The increases resulted primarily from the 1997 Acquired Properties purchased after January 1, 1997 and the 1998 Acquired Properties, which together added an additional $2.2 million of rental operating expenses. Operating expenses for the Same Properties increased by $97,000, or 2.6%, primarily due to an increase in utility expenses (due to greater usage) that are passed through to the tenants. Rental operating expenses for the Same Properties (excluding 1102/1124 Columbia Street) increased by $141,000, or 5%. General and administrative expenses increased by $457,000, or 39%, to $1.6 million for Six Months 1998 compared to $1.2 million for Six Months 1997 due to the Company's larger scope of operations and increased costs incurred as a result of being a public company in 1998. The special bonus of $353,000 in Six Months 1997 was awarded to an officer of the Company in connection with the Offering and accrued for the period ended March 31, 1997. Post-retirement benefit expense of $632,000 in Six Months 1997 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 recorded in Six 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 $1.0 million, or 22%, to $5.6 million for Six Months 1998 compared to $4.6 million for Six Months 1997. The increase resulted primarily from indebtedness incurred to acquire the 1997 Acquired Properties purchased after January 1, 1997 and the 1998 Acquired Properties. Acquisition LLC financing costs of $6,973,000 were expensed in Six Months 1997, representing the portion of the purchase price of the Acquisition LLC in excess of the cost incurred by it to acquire its three Life Science Facilities. Write-off of unamortized loan costs in Six Months 1997 represents the write-off of loan costs associated with $72,698,000 of secured notes repaid with proceeds of the Offering. 15
Depreciation and amortization increased by $2.1 million, or 100%, to $4.2 million for Six Months 1998 compared to $2.1 million for Six Months 1997. The increase resulted primarily from depreciation associated with the 1997 Acquired Properties purchased after January 1, 1997 and the 1998 Acquired Properties. As a result of the foregoing, there was net income of $9.4 million for Six Months 1998 compared to a net loss of $11.1 million for Six Months 1997. LIQUIDITY AND CAPITAL RESOURCES CASH FLOWS Net cash provided by operating activities for Six Months 1998 increased by $11.2 million to $10.6 million compared to net cash used in operating activities of $662,000 for Six Months 1997. The increase resulted primarily from operating cash flows from the 1997 Acquired Properties purchased after January 1, 1997 and the 1998 Acquired Properties. Net cash used in investing activities increased by $116.7 million to $170.5 million for Six Months 1998 compared to net cash used in investing activities of $53.8 million for Six Months 1997. The increase resulted primarily from the costs associated with the acquisition of the 1998 Acquired Properties. Net cash provided by financing activities increased by $85.2 million to $159.9 million for Six Months 1998 compared to net cash provided by financing activities of $74.7 million for Six Months 1997. The increase resulted primarily from $49.1 million in proceeds from secured debt, $87.2 million in net borrowings under the unsecured line of credit and $33.2 million in net proceeds from the issuance of common stock, partially offset by payments of $9.1 million in dividends payable on common stock. CAPITAL COMMITMENTS The Company is committed to complete the construction of a building and certain improvements thereto in San Diego, California at a remaining cost of approximately $4.8 million under the terms of two leases. In addition, the Company is committed to complete the construction of a building and certain improvements thereto in Gaithersburg, Maryland at a remaining cost of between $9.1 million and $18.1 million (depending on the level of improvements to the facility elected by the tenant) under the terms of a lease. Under the terms of the lease, the tenant's rental rate will be adjusted depending on the ultimate cost of the improvements. 16
The Company is also committed under terms of various leases to construct improvements for tenants totaling approximately $11.9 million. Of this amount, approximately $5.3 million has been set aside in restricted cash accounts 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 and 3000/3018 Western Avenue. RESTRICTED CASH As of June 30, 1998, the Company had $9.8 million in cash and cash equivalents, including $7.8 million in restricted cash accounts. Of the $7.8 million in restricted cash accounts, approximately $5.3 million has been set aside to complete the conversions described under "--Capital Commitments", approximately $1.7 million is held in trust as additional security required under the terms of the Company's secured notes payable, and approximately $850,000 is held in security deposit reserve accounts based on the terms of certain lease agreements. SECURED DEBT As of June 30, 1998, the Company's secured debt is as follows: <TABLE> <CAPTION> PRINCIPAL BALANCE AT INTEREST MATURITY COLLATERAL JUNE 30, 1998 RATE DATE - -------------------------- --------------- --------- -------------- <S> <C> <C> <C> 3535/3565 General Atomics Court, San Diego, CA $17,819,000 9.00% December 2014 1431 Harbor Bay Parkway Alameda, CA 8,500,000 7.17% January 2014 1102/1124 Columbia Street Seattle, WA 21,003,000 7.75% May 2016 100/800/801 Capitola Drive, Durham, NC 12,608,000 8.68% December 2006 14225 Newbrook Drive, Chantilly, VA and 3000/3018 Western Avenue, Seattle, WA 36,479,000 7.22% May 2008 ----------- $96,409,000 ----------- ----------- </TABLE> UNSECURED LINE OF CREDIT The Company has an unsecured line of credit providing for borrowings of up to $150,000,000. Borrowings under the line of credit bear interest at a floating rate 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 one, two, three or six months. 17
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, borrowings available under the line of credit will increase. As of June 30, 1998, borrowings under the line of credit were limited to approximately $150,000,000, and $110,200,000 was outstanding (leaving $39,800,000 available) at a weighted average interest rate of 7.16%. The line of credit expires 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 August 1998, the Company amended its unsecured line of credit to provide for borrowings of up to $250 million. As under the original line, borrowings under the line of credit, as amended, bear interest at a floating rate 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%. However, under the line, as amended, the LIBOR based rate has been reduced, resulting in a rate of 6.91% as of August 5, 1998. Financial covenants for the line of credit, as amended, are substantially similar to those under the original line. The line, as amended, 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 bank. LIQUIDITY AND CAPITAL RESOURCES On May 29, 1998, the Company sold 1,150,000 shares of common stock to PaineWebber Incorporated for inclusion in the PaineWebber Equity Trust REIT Shares I, a unit investment trust. The shares were issued at a price of $30.5625 per share (before discounts and commissions). The aggregate proceeds to the Company, net of offering costs of $1.9 million, were approximately $33.2 million. The Company expects to continue meeting its short-term liquidity and capital requirements generally through its working capital and net cash provided by operating activities. The Company believes that the net cash provided by operating activities will continue to be sufficient to pay any distributions necessary to enable the Company to continue qualifying as a real estate investment trust. 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, property development activities, scheduled debt maturities, renovations, expansions and other non-recurring capital improvements, through long-term secured and unsecured indebtedness, including borrowings under the unsecured line of credit, and the issuance of additional debt and/or equity securities. 18
EXPOSURE TO ENVIRONMENTAL LIABILITIES In connection with the acquisition of all of the Properties, the Company has obtained Phase I environmental assessments to ascertain the existence of any environmental liabilities or other issues. 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. INFLATION More than 70% 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). In addition, a majority 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 unsecured line of credit. IMPACT OF 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 the Company's 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, or engage in similar normal business activities. 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 to date has not been material, and future impacts are not anticipated to be material. The Company relies in part on the computer systems of its vendors and other companies. If any such company failed to become Year 2000 compliant, the Company could be adversely affected thereby. The Company has surveyed several of its larger vendors, and all have responded that they either are currently Year 2000 compliant, or are actively taking steps to become Year 2000 compliant. 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 19
an understanding of the ability of the Company to incur and service debt, to make capital expenditures and to make distributions. 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, 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 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 on a historical basis (in thousands): <TABLE> <CAPTION> Three Months Ended June 30, 1998 1997 ------------ ------------ (Unaudited) <S> <C> <C> Net income (loss) $4,724 $(10,912) Add: Stock compensation - 3,768 Acquisition LLC financing costs - 6,973 Write off of unamortized loan fees - 2,146 Depreciation and amortization 2,456 1,106 ------ -------- FFO $7,180 $ 3,081 ------ -------- ------ -------- Six Months Ended June 30, 1998 1997 ----------- ----------- (Unaudited) <S> <C> <C> Net income (loss) $ 9,359 $(11,055) Add: Stock compensation - 4,162 Post retirement benefit - 632 Special bonus - 353 Acquisition LLC financing costs - 6,973 Write off of unamortized loan fees - 2,146 Depreciation and amortization 4,177 2,109 ------- -------- FFO $13,536 $ 5,320 ------- -------- ------- -------- </TABLE> 20
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Since early 1998, the Company and its President, Alan D. Gold, have engaged in discussions regarding the potential termination of Mr. Gold's full-time employment and his entering into a consulting arrangement with the Company. While these discussions were ongoing, the Company gave Mr. Gold written notice that it did not wish to extend the term of his employment agreement past its December 31, 1998 expiration date. On July 16, 1998, Mr. Gold gave the Company written notice that he intended to terminate his employment agreement, allegedly for "good reason," on or before August 16, 1998. The Company disputes Mr. Gold's contention that he has "good reason" to terminate his employment agreement and has submitted the disputes between the parties to binding arbitration pursuant to the terms of Mr. Gold's employment agreement. Mr. Gold has asserted claims against the Company that also will be considered in the arbitration. The Company currently anticipates that Mr. Gold will leave as of August 16, 1998 and that other executives of the Company will assume Mr. Gold's responsibilities. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS On May 27, 1998, the Company privately placed 1,150,000 shares of its common stock, par value $.01 per share (the "Shares"), with PaineWebber Incorporated at a price before discounts and commissions of $30.5625 per Share, resulting in aggregate proceeds to the Company of approximately $33.2 million. Such proceeds were used to repay borrowings under the Company's unesecured line of credit. PaineWebber deposited the Shares with the trustee of PaineWebber Equity Trust REIT Series I (A Unit Investment Trust) (the "Trust"), a registered unit investment trust under the Investment Company Act of 1940, as amended, for which PaineWebber acted as sponsor and depositor, in exchange for units in the Trust. The issuance of the Shares was effected in reliance upon an exemption from registration under Section 4(2) of the Securities Act as a transaction by an issuer not involving a public offering. On June 9, 1998, the Company filed a Registration Statement (File No. 333-56449) on Form S-3 with the Securities and Exchange Commission to register the Shares under the Securities Act of 1933, as amended. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On May 15, 1998, the Company held its Annual Meeting of Stockholders. At the meeting, eight directors were elected to serve for a one-year term and until their successors are duly elected and qualify. The directors elected were: Jerry M. Sudarsky, Joel S. Marcus, Alan D. Gold, Richard Jennings, Joseph Elmaleh, Viren Mehta, David M. Petrone and Anthony Solomon. There are no other directors of the Company. A total of 10,902,809 shares voted "for" each of the directors, 0 voted "against" and 16,180 shares abstained. 21
In addition, the stockholders voted to ratify the selection of Ernst & Young LLP as the Company's independent public accountants for the fiscal year ending December 31, 1998. A total of 10,906,149 shares voted "for" the ratification, 7,300 voted "against" and 5,540 shares abstained. The stockholders also voted to amend the Company's 1997 Stock Award and Incentive Plan (the "Plan") to increase the number of shares of common stock of the Company available for issuance thereunder from 900,000 shares to that number of shares equal to 10% of the number of shares of common stock outstanding at any time, PROVIDED, that in no event shall the number of shares available for issuance under the Plan exceed 3,000,000 shares of common stock. A total of 6,308,959 shares voted "for" the amendment, 3,803,380 voted "against" and 17,982 shares abstained. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10.20 Amended and Restated 1997 Stock Award and Incentive Plan 27.1 Financial Data Schedule (b) Reports on Form 8-K. On April 9, 1998, the Company filed a Current Report on Form 8-K, dated March 26, 1998, to report the acquisition of one Life Science Facility and certain vacant land in San Diego, California. On May 27, 1998, the Company filed a Current Report on Form 8-K, dated May 27, 1998, to report the acquisition of fourteen Life Science Facilities. On June 23, 1998, the Company filed a Current Report on Form 8-K, dated May 27, 1998, to report the sale of 1,150,000 shares of common stock to PaineWebber Incorporated for inclusion in the PaineWebber Equity Trust REIT Series I, a unit investment trust. 22
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 August 14, 1998. 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) 23