Table of Contents

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x                              QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2010

 

OR

 

o                                 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
incorporation or organization)

 

(I.R.S. Employer Identification Number)

 

385 East Colorado Boulevard, Suite 299, Pasadena, California 91101

(Address of principal executive offices)(Zip Code)

 

(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 o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes x     No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer or a smaller reporting company.  See the definitions of `“large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

 

Accelerated filer o

 

Non-accelerated filer o   (Do not check if a smaller reporting company)

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes o     No x

As of November 5, 2010, 55,339,406 shares of common stock, par value $.01 per share, were outstanding.

 



Table of Contents

 

TABLE OF CONTENTS

 

 

 

 

Page

PART I–FINANCIAL INFORMATION

 

 

 

 

 

Item 1.

FINANCIAL STATEMENTS (UNAUDITED)

3

 

 

 

 

Condensed Consolidated Balance Sheets–As of September 30, 2010 and December 31, 2009

4

 

 

 

 

Condensed Consolidated Income Statements–For the Three and Nine Months Ended September 30, 2010 and 2009

5

 

 

 

 

Condensed Consolidated Statement of Changes in Stockholders’ Equity and Noncontrolling Interests–For the Nine Months Ended September 30, 2010

6

 

 

 

 

Condensed Consolidated Statements of Cash Flows–For the Nine Months Ended September 30, 2010 and 2009

7

 

 

 

 

Notes to Condensed Consolidated Financial Statements

8

 

 

 

 

Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

24

 

 

 

Item 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

47

 

 

 

Item 4.

CONTROLS AND PROCEDURES

48

 

 

 

PART II–OTHER INFORMATION

48

 

 

 

Item 1A.

RISK FACTORS

48

 

 

 

Item 6.

EXHIBITS

49

 

 

 

Signatures

51

 



Table of Contents

 

PART I – FINANCIAL INFORMATION

 

Item 1.                             FINANCIAL STATEMENTS (UNAUDITED)

 

3



Table of Contents

 

Alexandria Real Estate Equities, Inc.
Condensed Consolidated Balance Sheets

(In thousands)
(Unaudited)

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

Assets

 

 

 

 

 

Investments in real estate:

 

 

 

 

 

Rental properties

 

$

4,162,394

 

$

3,903,955

 

Less: accumulated depreciation

 

(588,167

)

(520,647

)

Rental properties, net

 

3,574,227

 

3,383,308

 

Land held for future development

 

306,577

 

255,025

 

Construction in progress

 

1,356,905

 

1,400,795

 

Investment in unconsolidated real estate entity

 

35,940

 

 

Investments in real estate, net

 

5,273,649

 

5,039,128

 

Cash and cash equivalents

 

110,811

 

70,628

 

Restricted cash

 

35,295

 

47,291

 

Tenant receivables

 

4,929

 

3,902

 

Deferred rent

 

108,303

 

96,700

 

Investments

 

80,941

 

72,882

 

Other assets

 

134,697

 

126,696

 

Total assets

 

$

5,748,625

 

$

5,457,227

 

 

 

 

 

 

 

Liabilities and Equity

 

 

 

 

 

Secured notes payable

 

$

841,317

 

$

937,017

 

Unsecured line of credit and unsecured term loan

 

1,304,000

 

1,226,000

 

Unsecured convertible notes

 

374,146

 

583,929

 

Accounts payable, accrued expenses, and tenant security deposits

 

294,833

 

282,516

 

Dividends payable

 

25,554

 

21,686

 

Total liabilities

 

2,839,850

 

3,051,148

 

 

 

 

 

 

 

Redeemable noncontrolling interests

 

15,945

 

41,441

 

 

 

 

 

 

 

Alexandria Real Estate Equities, Inc. stockholders’ equity:

 

 

 

 

 

Series C preferred stock

 

129,638

 

129,638

 

Series D convertible preferred stock

 

250,000

 

250,000

 

Common stock

 

549

 

438

 

Additional paid-in capital

 

2,504,365

 

1,977,062

 

Accumulated other comprehensive loss

 

(33,348

)

(33,730

)

Total Alexandria Real Estate Equities, Inc. stockholders’ equity

 

2,851,204

 

2,323,408

 

Noncontrolling interests

 

41,626

 

41,230

 

Total equity

 

2,892,830

 

2,364,638

 

Total

 

$

5,748,625

 

$

5,457,227

 

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements

 

4



Table of Contents

 

Alexandria Real Estate Equities, Inc.
Condensed Consolidated Income Statements

(Dollars in thousands, except per share amounts)
(Unaudited)

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Revenues

 

 

 

 

 

 

 

 

 

Rental

 

$

90,395

 

$

88,419

 

$

268,765

 

$

279,891

 

Tenant recoveries

 

29,648

 

26,230

 

82,782

 

77,694

 

Other income

 

1,586

 

1,177

 

3,579

 

10,839

 

Total revenues

 

121,629

 

115,826

 

355,126

 

368,424

 

 

 

 

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

 

 

 

 

Rental operations

 

33,704

 

31,218

 

95,707

 

92,876

 

General and administrative

 

8,044

 

9,611

 

25,791

 

27,833

 

Interest

 

16,111

 

21,225

 

52,451

 

62,797

 

Depreciation and amortization

 

32,009

 

28,112

 

92,086

 

88,854

 

Total expenses

 

89,868

 

90,166

 

266,035

 

272,360

 

 

 

 

 

 

 

 

 

 

 

(Loss) gain on early extinguishment of debt

 

(1,300

)

 

(42,796

)

11,254

 

Income from continuing operations

 

30,461

 

25,660

 

46,295

 

107,318

 

 

 

 

 

 

 

 

 

 

 

Income from discontinued operations, net

 

 

718

 

727

 

4,425

 

 

 

 

 

 

 

 

 

 

 

Net income

 

30,461

 

26,378

 

47,022

 

111,743

 

 

 

 

 

 

 

 

 

 

 

Net income attributable to noncontrolling interests

 

920

 

886

 

2,785

 

6,123

 

Dividends on preferred stock

 

7,089

 

7,090

 

21,268

 

21,268

 

Net income attributable to unvested restricted stock awards

 

217

 

199

 

502

 

1,038

 

Net income attributable to Alexandria Real Estate Equities, Inc.’s common stockholders

 

$

22,235

 

$

18,203

 

$

22,467

 

$

83,314

 

 

 

 

 

 

 

 

 

 

 

Earnings per share attributable to Alexandria Real Estate Equities, Inc.’s common stockholders – basic

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.45

 

$

0.45

 

$

0.47

 

$

2.14

 

Discontinued operations, net

 

 

0.02

 

0.02

 

0.12

 

Earnings per share – basic

 

$

0.45

 

$

0.47

 

$

0.49

 

$

2.26

 

 

 

 

 

 

 

 

 

 

 

Earnings per share attributable to Alexandria Real Estate Equities, Inc.’s common stockholders – diluted

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.45

 

$

0.45

 

$

0.47

 

$

2.14

 

Discontinued operations, net

 

 

0.02

 

0.02

 

0.12

 

Earnings per share – diluted

 

$

0.45

 

$

0.47

 

$

0.49

 

$

2.26

 

 

 

 

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements

 

5



Table of Contents

 

Alexandria Real Estate Equities, Inc.

Condensed Consolidated Statement of Changes in Stockholders’ Equity and Noncontrolling Interests

(Dollars in thousands)

(Unaudited)

 

 

 

Alexandria Real Estate Equities, Inc. Stockholders

 

 

 

 

 

 

 

 

 

Series C
Preferred
Stock

 

Series D
Convertible
Preferred
Stock

 

Number of
Common
Shares

 

Common
Stock

 

Additional
Paid-In
Capital

 

Retained
Earnings

 

Accumulated
Other
Comprehensive
Loss

 

Noncontrolling
Interests

 

Total
Equity

 

Redeemable
Noncontrolling
Interests

 

Balance at December 31, 2009

 

$

129,638

 

$

250,000

 

43,846,050

 

$

438

 

$

1,977,062

 

$

-

 

$

(33,730

)

$

41,230

 

$

2,364,638

 

$

41,441

 

Net income

 

-

 

-

 

-

 

-

 

-

 

44,237

 

-

 

1,846

 

46,083

 

939

 

Unrealized loss on marketable securities

 

-

 

-

 

-

 

-

 

-

 

-

 

(1,419

)

-

 

(1,419

)

-

 

Unrealized (loss) gain on interest rate hedge agreements

 

-

 

-

 

-

 

-

 

-

 

-

 

(4,276

)

-

 

(4,276

)

80

 

Foreign currency translation

 

-

 

-

 

-

 

-

 

-

 

-

 

6,077

 

12

 

6,089

 

-

 

Contributions by noncontrolling interests

 

-

 

-

 

-

 

-

 

-

 

-

 

-

 

711

 

711

 

674

 

Distributions to noncontrolling interests

 

-

 

-

 

-

 

-

 

-

 

-

 

-

 

(2,173

)

(2,173

)

(1,017

)

Redemption of redeemable noncontrolling interests

 

-

 

-

 

-

 

-

 

(179

)

-

 

-

 

-

 

(179

)

(2,167

)

Deconsolidation of investment in real estate entity (see Note 3)

 

-

 

-

 

-

 

-

 

-

 

-

 

-

 

-

 

-

 

(24,005

)

Exchange of 8.00% unsecured convertible notes (see Note 6)

 

-

 

-

 

5,620,256

 

56

 

203,051

 

-

 

-

 

-

 

203,107

 

-

 

Equity component related to repurchase of 8.00% unsecured convertible notes (see Note 6)

 

-

 

-

 

-

 

-

 

(5,213

)

-

 

-

 

-

 

(5,213

)

-

 

Issuance of common stock, net of offering costs

 

-

 

-

 

5,175,000

 

52

 

342,290

 

-

 

-

 

-

 

342,342

 

-

 

Issuances pursuant to stock plan

 

-

 

-

 

250,332

 

3

 

16,756

 

-

 

-

 

-

 

16,759

 

-

 

Dividends declared on preferred stock

 

-

 

-

 

-

 

-

 

-

 

(21,268

)

-

 

-

 

(21,268

)

-

 

Dividends declared on common stock

 

-

 

-

 

-

 

-

 

-

 

(52,371

)

-

 

-

 

(52,371

)

-

 

Distributions in excess of earnings

 

-

 

-

 

-

 

-

 

(29,402

)

29,402

 

-

 

-

 

-

 

-

 

Balance at September 30, 2010

 

$

129,638

 

$

250,000

 

54,891,638

 

$

549

 

$

2,504,365

 

$

-

 

$

(33,348

)

$

41,626

 

$

2,892,830

 

$

15,945

 

 

 

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements

 

6



Table of Contents

 

Alexandria Real Estate Equities, Inc.
Condensed Consolidated Statements of Cash Flows

(In thousands) 
(Unaudited)

 

 

 

Nine Months Ended

 

 

 

September 30,

 

 

 

2010

 

2009

 

Operating Activities

 

 

 

 

 

Net income

 

$

47,022

 

$

111,743

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

92,089

 

89,504

 

Loss (gain) on early extinguishment of debt

 

42,796

 

(11,254

)

Amortization of loan fees and costs

 

5,893

 

5,877

 

Amortization of debt premiums/discount

 

7,967

 

7,790

 

Amortization of acquired above and below market leases

 

(5,504

)

(7,991

)

Deferred rent

 

(13,740

)

(7,315

)

Stock compensation expense

 

8,049

 

10,857

 

Equity in income related to investments

 

(48

)

(39

)

Gain on sales of investments

 

(1,263

)

(2,625

)

Loss on sales of investments

 

155

 

854

 

Gain on sales of property

 

(24

)

(2,234

)

Changes in operating assets and liabilities:

 

 

 

 

 

Restricted cash

 

2,258

 

(4,718

)

Tenant receivables

 

(776

)

2,664

 

Other assets

 

(27,972

)

(22,901

)

Accounts payable, accrued expenses, and tenant security deposits

 

5,053

 

954

 

Net cash provided by operating activities

 

161,955

 

171,166

 

 

 

 

 

 

 

Investing Activities

 

 

 

 

 

Additions to properties

 

(327,448

)

(341,410

)

Purchase of properties

 

(29,881

)

 

Proceeds from sales of properties

 

10,514

 

11,929

 

Change in restricted cash related to construction projects

 

15,032

 

(3,350

)

Contributions to unconsolidated real estate entity

 

(2,299

)

 

Transfer of cash to unconsolidated real estate entity upon deconsolidation

 

(154

)

 

Additions to investments

 

(11,849

)

(10,442

)

Proceeds from investments

 

3,527

 

3,979

 

Net cash used in investing activities

 

(342,558

)

(339,294

)

 

 

 

 

 

 

Financing Activities

 

 

 

 

 

Proceeds from secured notes payable

 

 

1,082

 

Principal reductions of secured notes payable

 

(63,868

)

(245,849

)

Change in restricted cash related to financings

 

(8,156

)

15,848

 

Principal borrowings from unsecured line of credit and term loan

 

455,000

 

583,000

 

Repayments of borrowings from unsecured line of credit

 

(377,000

)

(760,000

)

Proceeds from issuance of 8.00% unsecured convertible notes

 

 

232,950

 

Payment on exchange of 8.00% unsecured convertible notes

 

(43,528

)

 

Repurchase of unsecured convertible notes

 

(12,755

)

(59,204

)

Proceeds from issuance of common stock

 

342,342

 

488,163

 

Proceeds from exercise of stock options

 

2,673

 

302

 

Dividends paid on common stock

 

(48,503

)

(71,191

)

Dividends paid on preferred stock

 

(21,268

)

(21,268

)

Contributions by redeemable noncontrolling interests

 

674

 

5,003

 

Distributions to redeemable noncontrolling interests

 

(1,017

)

(1,046

)

Redemption of redeemable noncontrolling interests

 

(2,346

)

(1,052

)

Contributions by noncontrolling interests

 

711

 

300

 

Distributions to noncontrolling interests

 

(2,173

)

(1,791

)

Net cash provided by financing activities

 

220,786

 

165,247

 

Net increase (decrease) in cash and cash equivalents

 

40,183

 

(2,881

)

Cash and cash equivalents at beginning of period

 

70,628

 

71,161

 

Cash and cash equivalents at end of period

 

$

110,811

 

$

68,280

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements

 

7



Table of Contents

 

Alexandria Real Estate Equities, Inc.
Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

1.                 Background

 

As used in this quarterly report on Form 10-Q, references to the “Company,” “we,” “our,” and “us” refer to Alexandria Real Estate Equities, Inc. and its subsidiaries.

 

Alexandria Real Estate Equities, Inc., Landlord of Choice to the Life Science Industry®, is the largest owner and preeminent real estate investment trust (“REIT”) focused principally on cluster development through the ownership, operation, management, selective redevelopment, development, and acquisition of properties containing life science space.  We are the leading provider of high-quality, environmentally sustainable real estate, technical infrastructure, and services to the broad and diverse life science industry. Client tenants include institutional (universities and independent not-for-profit institutions), pharmaceutical, biotechnology, medical device, product, service, and government agencies. Our operating platform is based on the principle of “clustering,” with assets and operations located adjacent to life science entities driving growth and technological advances within each cluster.  Our asset base contains 164 properties approximating 12.9 million rentable square feet consisting of 159 properties approximating 12.3 million rentable square feet (including spaces undergoing active redevelopment) and five properties undergoing ground-up development approximating an additional 561,929 rentable square feet.

 

2.                 Basis of presentation

 

We have prepared the accompanying interim condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States (“GAAP”) and in conformity with the rules and regulations of the Securities and Exchange Commission (“SEC”).  In our opinion, the interim condensed consolidated financial statements presented herein reflect all adjustments, consisting solely of normal and recurring adjustments, which are necessary to fairly present the interim condensed consolidated financial statements.  The results of operations for the interim period are not necessarily indicative of the results that may be expected for the year ending December 31, 2010.  These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in our annual report on Form 10-K for the year ended December 31, 2009.

 

The accompanying condensed consolidated financial statements include the accounts of Alexandria Real Estate Equities, Inc. and its subsidiaries.  All significant intercompany balances and transactions have been eliminated.

 

We hold interests, together with certain third parties, in companies which we consolidate in our financial statements.  We consolidate the companies because we exercise significant control over major decisions by these entities, such as investing and financing activities.

 

Reclassifications

 

Certain prior period amounts have been reclassified to conform to the current period presentation.

 

International operations

 

The functional currency for our subsidiaries operating in the United States is the United States dollar.  We have four operating properties and one development parcel in Canada and development parcels in Asia.  The functional currencies for our foreign subsidiaries are the local currencies in each respective country.  The assets and liabilities of our foreign subsidiaries are translated into United States dollars at the exchange rate in effect as of the financial statement date.  Income statement accounts of our foreign subsidiaries are translated using the average exchange rate for the periods presented.  Gains or losses resulting from the translation are included in accumulated other comprehensive income (loss) as a separate component of total equity.

 

The appropriate amounts of foreign exchange rate gains or losses included in accumulated other comprehensive income (loss) will be reflected in income when there is a sale or partial sale of our investment in these operations or upon a complete or substantially complete liquidation of the investment.

 

8



Table of Contents

 

2.                 Basis of presentation (continued)

 

Rental properties, net, land held for future development, and construction in progress

 

We recognize assets acquired (including the intangible values to above or below market leases, acquired in-place leases, tenant relationships and other intangible assets or liabilities), liabilities assumed, and any noncontrolling interest in an acquired entity at their fair value as of the acquisition date.  The value of tangible assets acquired is based upon our estimation of value on an “as if vacant” basis.  The value of acquired in-place leases includes the estimated carrying costs during the hypothetical lease-up period and other costs that would have been incurred to execute similar leases, considering market conditions at the acquisition date of the acquired in-place lease.  The values of acquired in-place leases are classified as leasing costs, included in other assets in the accompanying condensed consolidated balance sheets and amortized over the remaining terms of the related leases.  We assess the fair value of tangible and intangible assets based on numerous factors, including estimated cash flow projections that utilize appropriate discount and capitalization rates and available market information.  Estimates of future cash flows are based on a number of factors including the historical operating results, known trends and market/economic conditions that may affect the property. We also recognize the fair values of assets acquired, the liabilities assumed, and any noncontrolling interests in acquisitions of less than a 100% interest when the acquisition constitutes a change in control of the acquired entity.  In addition, acquisition-related costs and restructuring costs are expensed as incurred.

 

We are required to capitalize construction, redevelopment, and development costs, including preconstruction costs, interest, property taxes, insurance, and other costs directly related and essential to the project while activities are ongoing to prepare an asset for its intended use.  Capitalization of interest and other direct project costs ceases after a project is substantially complete and ready for its intended use.  In addition, should activities necessary to prepare an asset for its intended use cease, interest, taxes, insurance, and certain other costs would be expensed as incurred.  Expenditures for repairs and maintenance are expensed as incurred.

 

Rental properties, net, land held for future development, construction in progress, and intangibles are individually evaluated for impairment when conditions exist that may indicate that it is probable that the sum of expected future undiscounted cash flows is less than the carrying amount.  Impairment indicators for our rental properties, land held for future development, and construction in progress are assessed by project and include, but are not limited to, significant fluctuations in estimated net operating income, occupancy changes, construction costs, estimated completion dates, rental rates, and other market factors.  We assess the expected undiscounted cash flows based upon numerous factors, including, but not limited to, construction costs, available market information, historical operating results, known trends, and market/economic conditions that may affect the property and our assumptions about the use of the asset, including, if necessary, a probability-weighted approach if multiple outcomes are under consideration.  Upon determination that an impairment has occurred, a write-down is recorded to reduce the carrying amount to its estimated fair value.  We did not incur impairment charges for the three and nine months ended September 30, 2010 and 2009.

 

Variable interest entity

 

In June 2009, the Financial Accounting Standards Board (the “FASB”) issued new accounting literature with respect to variable interest entities (“VIEs”).  The new guidance impacts the consolidation guidance applicable to VIEs and among other things requires a qualitative rather than a quantitative analysis to determine the primary beneficiary of a VIE, continuous assessments of whether a company is the primary beneficiary of a VIE, and enhanced disclosures about a company’s involvement with a VIE.  We prospectively adopted the new guidance on January 1, 2010.

 

We consolidate a VIE if it is determined that we are the primary beneficiary, an evaluation that we perform on an ongoing basis.  A VIE is broadly defined as an entity where either (i) the equity investors as a group, if any, do not have a controlling financial interest, or (ii) the equity investment at risk is insufficient to finance that entity’s activities without additional subordinated financial support.  We use qualitative analyses when determining whether or not we are the primary beneficiary of a VIE.  Consideration of various factors includes, but is not limited to, the purpose and design of the VIE, risks that the VIE was designed to create and pass through, the form of our ownership interest, our representation of the entity’s governing body, the size and seniority of our investment, our ability to participate in policy making decisions, and the rights of the other investors to participate in the decision making process, and to replace us as manager and/or liquidate the venture, if applicable.  Our ability to correctly assess our influence or control over an entity at the inception of our involvement with the entity or upon reevaluation of the entity’s continuing status as a VIE and determine the primary beneficiary of a VIE affects the presentation of these entities in our consolidated financial statements.  See Note 3, Investments in Real Estate, Net.

 

9



Table of Contents

 

2.     Basis of presentation (continued)

 

Interest rate hedge agreements

 

We utilize interest rate hedge agreements to hedge a portion of our exposure to variable interest rates primarily associated with our unsecured line of credit and unsecured term loan.  We recognize our interest rate hedge agreements as either assets or liabilities on the balance sheet at fair value.  The accounting for changes in fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship.  For those derivative instruments that are designated and qualify as hedging instruments, a company must designate the hedging instrument, based upon the hedged exposure, as a fair value hedge, cash flow hedge, or a hedge of a net investment in a foreign operation.  Our interest rate hedge agreements are considered cash flow hedges as they are designated and qualify as hedges of the exposure to variability in expected future cash flows.  Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the earnings effect of the hedged forecasted transactions in a cash flow hedge.

 

Accumulated other comprehensive loss

 

Accumulated other comprehensive loss attributable to Alexandria Real Estate Equities, Inc. consists of the following (in thousands):

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

Unrealized gain on marketable securities

 

$

5,861

 

$

7,280

 

Unrealized loss on interest rate hedge agreements

 

(54,319

)

(50,043

)

Unrealized gain on foreign currency translation

 

15,110

 

9,033

 

 

 

$

(33,348

)

$

(33,730

)

 

The following table provides a reconciliation of comprehensive income attributable to Alexandria Real Estate Equities, Inc. (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Net income

 

$

30,461

 

$

26,378

 

$

47,022

 

$

111,743

 

Unrealized gain (loss) on marketable securities

 

434

 

604

 

(1,419

)

946

 

Unrealized (loss) gain on interest rate hedge agreements

 

(2,115

)

(3,649

)

(4,196

)

23,540

 

Unrealized gain on foreign currency translation

 

8,718

 

11,869

 

6,089

 

18,525

 

Comprehensive income

 

37,498

 

35,202

 

47,496

 

154,754

 

Comprehensive income attributable to noncontrolling interests

 

928

 

859

 

2,877

 

6,055

 

Comprehensive income attributable to Alexandria Real Estate Equities, Inc.

 

$

36,570

 

$

34,343

 

$

44,619

 

$

148,699

 

 

Income Taxes

 

We are organized and qualify as a REIT pursuant to the Internal Revenue Code of 1986, as amended (the “Code”).  Under the Code, a REIT that distributes at least 90% of its REIT taxable income as a dividend to its shareholders each year and that meets certain other conditions is not subject to federal income taxes, but is subject to certain state and local taxes.  We generally distribute 100% or more of our taxable income.  Therefore, no provision for federal income taxes is required.  We file tax returns, including returns for our subsidiaries, with federal, state and local jurisdictions, including jurisdictions located in the United States, Canada, China, and other international locations.  Our tax returns are subject to examination in various jurisdictions for the calendar years 2005 through 2009.

 

10



Table of Contents

 

2.                 Basis of presentation (continued)

 

Income Taxes (continued)

 

We recognize tax benefits of uncertain tax positions only if it is more likely than not that the tax position will be sustained, based solely on its technical merits, with the taxing authority having full knowledge of all relevant information.  The measurement of a tax benefit for an uncertain tax position that meets the “more likely than not” threshold is based on a cumulative probability model under which the largest amount of tax benefit recognized is the amount with a greater than 50% likelihood of being realized upon ultimate settlement with the taxing authority having full knowledge of all the relevant information.  As of September 30, 2010, there were no unrecognized tax benefits.  We do not anticipate a significant change to the total amount of unrecognized tax benefits within the next 12 months.

 

Interest expense and penalties, if any, would be recognized in the first period the interest or penalty would begin accruing according to the provisions of the relevant tax law at the applicable statutory rate of interest.  We did not incur any tax related interest expense or penalties for the three and nine months ended September 30, 2010 and 2009.

 

Earnings per share and dividends declared

 

We account for unvested restricted stock awards which contain nonforfeitable rights to dividends as participating securities and include these securities in the computation of earnings per share using the two-class method.  Under the two-class method, we allocate net income after preferred stock dividends and amounts attributable to noncontrolling interests to common stockholders and unvested restricted stock awards based on their respective participation rights to dividends declared (or accumulated) and undistributed earnings.  Diluted earnings per share is computed using the weighted average shares of common stock outstanding determined for the basic earnings per share computation plus the effect of any dilutive securities, including the dilutive effect of stock options using the treasury stock method.  We use income from continuing operations attributable to Alexandria Real Estate Equities, Inc’s common stockholders as the “control number” in determining whether potential shares of common stock issuable upon exercise of outstanding stock options are dilutive or antidilutive to earnings per share.

 

The following table shows the computation of earnings per share and dividends declared per common share (dollars in thousands, except per share amounts):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

Numerator:

 

2010

 

2009

 

2010

 

2009

 

Net income attributable to Alexandria Real Estate Equities, Inc.’s common stockholders – numerator for basic earnings per share

 

$

22,235

 

$

18,203

 

$

22,467

 

$

83,314

 

Assumed conversion of 8.00% unsecured convertible notes

 

 

 

 

 

Effect of dilutive securities attributable to unvested restricted stock awards

 

 

 

 

 

Net income attributable to Alexandria Real Estate Equities, Inc.’s common stockholders assuming effect of dilutive securities and assumed conversion – numerator for diluted earnings per share

 

$

22,235

 

$

18,203

 

$

22,467

 

$

83,314

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted average shares of common stock outstanding – basic

 

49,807,241

 

39,094,018

 

46,188,308

 

36,858,606

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Stock options

 

23,098

 

11,932

 

31,813

 

8,207

 

8.00% unsecured convertible notes

 

 

 

 

 

Weighted average shares of common stock outstanding – diluted

 

49,830,339

 

39,105,950

 

46,220,121

 

36,866,813

 

Earnings per share attributable to Alexandria Real Estate Equities, Inc.’s common stockholders:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.45

 

$

0.47

 

$

0.49

 

$

2.26

 

Diluted

 

$

0.45

 

$

0.47

 

$

0.49

 

$

2.26

 

Dividends declared per common share

 

$

0.35

 

$

0.35

 

$

1.05

 

$

1.50

 

 

11



Table of Contents

 

2.                 Basis of presentation (continued)

 

Earnings per share and dividends declared (continued)

 

We apply the if-converted method of accounting for our 8.00% unsecured senior convertible notes (“8.00% Unsecured Convertible Notes”). In applying the if-converted method of accounting, conversion is assumed for purposes of calculating diluted earnings per share if the effect is dilutive to earnings per share.  If the assumed conversion pursuant to the if-converted method of accounting is dilutive, diluted earnings per share would be calculated by adding back interest charges applicable to our 8.00% Unsecured Convertible Notes to the numerator and our 8.00% Unsecured Convertible Notes would be assumed to have been converted at the beginning of the period presented (or from the date of issuance, if occurring on a date later than the date that the period begins) and the resulting incremental shares associated with the assumed conversion would be included in the denominator.  Furthermore, we assume that our 8.00% Unsecured Convertible Notes are converted for the period prior to any retirement or actual conversion if the effect of such assumed conversion is dilutive, and any shares of common stock issued upon retirement or actual conversion are included in the denominator for the period after the date of retirement or conversion. We use income from continuing operations attributable to Alexandria Real Estate Equities, Inc.’s common stockholders as the “control number” in determining whether potential shares of common stock issuable upon conversion of our 8.00% Unsecured Convertible Notes are dilutive or antidilutive to earnings per share.  For purposes of calculating diluted earnings per share, we did not assume conversion of our 8.00% Unsecured Convertible Notes for the three and nine months ended September 30, 2010 and 2009 since the impact was antidilutive to earnings per share from continuing operations during those periods.

 

We also apply the if-converted method of accounting to our series D cumulative convertible preferred stock (“Series D Convertible Preferred Stock”).  We use income from continuing operations attributable to Alexandria Real Estate Equities, Inc.’s common stockholders as the “control number” in determining whether potential shares of common stock issuable upon conversion of our Series D Convertible Preferred Stock are dilutive or antidilutive to earnings per share.  For purposes of calculating diluted earnings per share, we did not assume conversion of our Series D Convertible Preferred Stock for the three and nine months ended September 30, 2010 and 2009 since the impact was antidilutive to earnings per share from continuing operations during those periods.

 

Our calculation of weighted average diluted shares will include additional shares related to our 3.70% unsecured senior convertible notes (“3.70% Unsecured Convertible Notes”) when the average market price of our common stock is higher than the conversion price ($117.36 as of September 30, 2010). The number of additional shares that will be included in the weighted average diluted shares is equal to the number of shares that would be issued upon the settlement of the 3.70% Unsecured Convertible Notes assuming the settlement occurred at the end of the reporting period pursuant to the treasury stock method.  For the three and nine months ended September 30, 2010 and 2009, the weighted average shares of common stock related to our 3.70% Unsecured Convertible Notes have been excluded from diluted weighted average shares of common stock as the average market price of our common stock was lower than the conversion price of $117.36 as of September 30, 2010 related to our 3.70% Unsecured Convertible Notes and the impact of conversion would have been antidilutive.

 

Net income attributable to Alexandria Real Estate Equities, Inc.

 

The following table shows net income attributable to Alexandria Real Estate Equities, Inc. (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Net income attributable to Alexandria Real Estate Equities, Inc.:

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

29,541

 

$

24,774

 

$

43,510

 

$

101,195

 

Income from discontinued operations, net

 

 

718

 

727

 

4,425

 

Net income attributable to Alexandria Real Estate Equities, Inc.

 

$

29,541

 

$

25,492

 

$

44,237

 

$

105,620

 

 

12



Table of Contents

 

2.                 Basis of presentation (continued)

 

Stock-based compensation expense

 

We have historically issued two forms of stock-based compensation under our equity incentive plan: options to purchase common stock (“options”) and restricted stock awards.  We have not granted any options since 2002.  We recognize all stock-based compensation in the income statement based on the grant date fair value.  The fair value is based on the market value of the common stock on the grant date and such cost is then recognized on a straight-line basis over the period during which the employee is required to provide services in exchange for the award (the vesting period). We compute stock-based compensation based on awards that are ultimately expected to vest and as a result, future forfeitures of awards are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.  No compensation cost is recognized for equity instruments that are forfeited or are anticipated to be forfeited.

 

Fair value

 

We are required to disclose fair value information about all financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate fair value.  We measure and disclose the estimated fair value of financial assets and liabilities utilizing a fair value hierarchy that distinguishes between data obtained from sources independent of the reporting entity and the reporting entity’s own assumptions about market participant assumptions.  This hierarchy consists of three broad levels as follows: 1) using quoted prices in active markets for identical assets or liabilities, 2) “significant other observable inputs,” and 3) “significant unobservable inputs.”  “Significant other observable inputs” can include quoted prices for similar assets or liabilities in active markets, as well as inputs that are observable for the asset or liability, such as interest rates, foreign exchange rates, and yield curves that are observable at commonly quoted intervals.  “Significant unobservable inputs” are typically based on an entity’s own assumptions, since there is little, if any, related market activity. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

 

The carrying amounts of cash and cash equivalents, restricted cash, tenant receivables, other assets, accounts payable, accrued expenses, and tenant security deposits approximate fair value.  As described in Note 7, our interest rate hedge agreements have been recorded at fair value. The fair values of our secured notes payable, unsecured line of credit, unsecured term loan, and unsecured convertible notes were estimated using “significant other observable inputs” such as available market information and discounted cash flows analyses based on borrowing rates we believe we could obtain with similar terms and maturities.  Because the valuations of our financial instruments are based on these types of estimates, the actual fair values of our financial instruments may differ materially if our estimates do not prove to be accurate.  Additionally, the use of different market assumptions or estimation methods may have a material effect on the estimated fair value amounts.  As of September 30, 2010 and December 31, 2009, the book and fair values of our secured notes payable, unsecured line of credit, unsecured term loan, and unsecured convertible notes were as follows (in thousands):

 

 

 

September 30, 2010

 

December 31, 2009

 

 

 

Book Value

 

Fair Value

 

Book Value

 

Fair Value

 

Secured notes payable

 

$

841,317

 

$

927,219

 

$

937,017

 

$

909,367

 

Unsecured line of credit and unsecured term loan

 

1,304,000

 

1,277,595

 

1,226,000

 

1,175,512

 

Unsecured convertible notes

 

374,146

 

382,642

 

583,929

 

615,572

 

 

13



Table of Contents

 

2.                 Basis of presentation (continued)

 

Impact of recently issued accounting standards

 

In January 2010, the FASB issued an Accounting Standard Update to address implementation issues associated with the accounting for decreases in the ownership of a subsidiary. The new guidance clarified the scope of the entities covered by the guidance related to accounting for decreases in the ownership of a subsidiary and specifically excluded in-substance real estate or conveyances of oil and gas mineral rights from the scope.  Additionally, the new guidance expands the disclosures required for a business combination achieved in stages and deconsolidation of a business or nonprofit activity. The new guidance was effective for interim and annual periods ending on or after December 31, 2009 and must be applied on a retrospective basis to the first period that an entity adopted the new guidance related to noncontrolling interests.  The adoption of this new guidance did not have an impact on our consolidated financial statements.

 

3.                 Investments in real estate, net

 

Our real estate investments consisted of the following (in thousands):

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

Land

 

$

473,662

 

$

474,859

 

Buildings and building improvements

 

3,508,658

 

3,249,866

 

Other improvements

 

180,074

 

179,230

 

Gross book value of rental/operating properties

 

4,162,394

 

3,903,955

 

Less: accumulated depreciation

 

(588,167

)

(520,647

)

Rental properties, net

 

3,574,227

 

3,383,308

 

Land held for future development

 

306,577

 

255,025

 

Construction in progress

 

1,356,905

 

1,400,795

 

Investment in unconsolidated real estate entity

 

35,940

 

 

Investments in real estate, net

 

$

5,273,649

 

$

5,039,128

 

 

Rental properties, net, land held for future development, and construction in progress

 

As of September 30, 2010 and December 31, 2009, we had approximately $3.6 billion and $3.4 billion of rental properties, net aggregating 11.7 and 11.2 million rentable square feet as of the end of each respective period.  Additionally, as of September 30, 2010 and December 31, 2009, we had approximately $306.6 million and $255.0 million, respectively, of land held for future development aggregating 5.5 million and 4.8 million rentable square feet, respectively.  Land held for future development represents real estate we plan to develop in the future but as of each period presented, no construction activities were ongoing.  As a result, interest, property taxes, insurance, and other costs are expensed as incurred.

 

As of September 30, 2010 and December 31, 2009, we had approximately $1.4 billion in costs related to development, redevelopment, and other assets undergoing preconstruction and construction activities.  These projects are classified in the accompanying condensed consolidated balance sheets as construction in progress.  As of September 30, 2010 and December 31, 2009, we had 617,662 and 575,152 rentable square feet, respectively, undergoing active redevelopment through a permanent change in use to life science space, including conversion of single-tenancy space to multi-tenancy space or multi-tenancy space to single-tenancy space. As of September 30, 2010 and December 31, 2009, we had 561,929 and 980,000 rentable square feet, respectively, undergoing active ground-up development consisting of vertical aboveground construction of life science properties.  Additionally, as of September 30, 2010 and December 31, 2009, we had an aggregate of 5.8 million and 6.3 million rentable square feet, respectively, undergoing preconstruction activities (entitlements, permitting, design, and site work; activities prior to commencement of vertical construction of aboveground shell and core) as well as preconstruction and construction in new markets and other projects.  We are required to capitalize interest during the period an asset is undergoing activities to prepare it for its intended use.  Capitalization of interest ceases after a project is substantially complete and ready for its intended use.  In addition, should construction activity cease, interest would be expensed as incurred.  Total interest capitalized for the nine months ended September 30, 2010 and 2009, was approximately $58.2 million and $56.1 million, respectively.

 

14



Table of Contents

 

3.                 Investments in real estate, net (continued)

 

Investment in unconsolidated real estate entity

 

In 2007, we formed an entity with a development partner for the purpose of owning, developing, leasing, managing, and operating a development parcel supporting a future building aggregating 428,000 rentable square feet.  The development parcel serves as collateral for a non-recourse secured loan due in 2012 with an outstanding balance of $38.4 million as of September 30, 2010 and December 31, 2009.  In 2009, the entity entered into an interest rate cap agreement related to the secured note with a notional amount approximating $38.4 million effective May 15, 2009 and terminating on January 3, 2012.  The agreement sets a ceiling on one month LIBOR at 2.50% related to the secured note.  Prior to the adoption of the new VIE accounting literature, we determined that the entity qualified as a VIE for which we were also the entity’s primary beneficiary since we would absorb the majority of the entity’s expected losses and receive a majority of the entity’s expected residual returns.  As a result, we had consolidated the entity since its inception in 2007.  The new VIE accounting literature cites two criteria to determine the primary beneficiary of a VIE, both of which must be met to be deemed the primary beneficiary of a VIE.  Upon adoption of the new VIE accounting literature on January 1, 2010, we determined that we did not meet both criteria since we do not have the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance.  The decisions that most significantly impact the VIE’s economic performance require both our consent and that of our partner, including all major operating, investing, and financing decisions as well as decisions over major expenditures.  Because we share power over the decisions that most significantly impact the VIE’s economic performance, we determined that we are not the primary beneficiary of the VIE.  As of January 1, 2010, we prospectively deconsolidated the VIE at its carrying amounts, including a decrease of approximately $92.3 million of construction in progress, approximately $3.0 million of restricted cash, approximately $38.4 million of secured notes payable, and $24.0 million of redeemable noncontrolling interests, with a corresponding increase to investment in unconsolidated real estate entity pursuant to the equity method of approximately $33.7 million which is classified as investment in unconsolidated real estate entity on the condensed consolidated balance sheets.  There was no adjustment to retained earnings upon adoption.  As of September 30, 2010, our investment in the unconsolidated entity was approximately $35.9 million.

 

Our investment in the unconsolidated real estate entity is adjusted for additional contributions and distributions, the proportionate share of the net earnings or losses, and other comprehensive income or loss.  Distributions, profits, and losses related to this entity are allocated in accordance with the operating agreement.  When circumstances indicate there may have been a reduction in value of an equity investment, we evaluate the equity investment and any advances made for impairment by estimating our ability to recover our investment from future expected cash flows.  If we determine the loss in value is other than temporary, we recognize an impairment charge to reflect the equity investment and any advances made at fair value.  For the three and nine months ended September 30, 2010, there were no indications of a reduction in the value of our investment in the unconsolidated real estate entity.

 

4.                 Investments

 

We hold equity investments in certain publicly traded companies and privately held entities primarily involved in the life science industry. All of our investments in publicly traded companies are considered “available for sale” and are recorded at fair value.  Fair value of our investments in publicly traded companies has been determined based upon the closing price as of the balance sheet date, with unrealized gains and losses shown as a separate component of total equity.  The classification of each investment is determined at the time each investment is made, and such determination is reevaluated at each balance sheet date.  The cost of each investment sold is determined by the specific identification method, with net realized gains and losses included in other income.  Investments in privately held entities are generally accounted for under the cost method when our interest in the entity is so minor that we have virtually no influence over the entities’ operating and financial policies.  Additionally, we limit our ownership percentage in the voting stock of each individual entity to less than 10%.  As of September 30, 2010 and December 31, 2009, our ownership percentage in the voting stock of each individual entity was less than 10%.

 

15



Table of Contents

 

4.                 Investments (continued)

 

Individual investments are evaluated for impairment when changes in conditions exist that may indicate an impairment exists. The factors that we consider in making these assessments include, but are not limited to, market prices, market conditions, available financing, prospects for favorable or unfavorable clinical trial results, new product initiatives, and new collaborative agreements.  If there are no identified events or changes in circumstances that would have an adverse effect on our cost method investments, we do not estimate its fair value.  For all of our investments, if a decline in the fair value of an investment below the carrying value is determined to be other-than-temporary, such investment is written down to its estimated fair value with a non-cash charge to current earnings.  We use “significant other observable inputs” and “significant unobservable inputs” to determine the fair value of privately held entities.  We did not recognize impairment charges related to our investments for the three and nine months ended September 30, 2010 and 2009.

 

The following table summarizes our “available for sale” securities (in thousands):

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

Adjusted cost of “available for sale” securities

 

$

1,410

 

$

1,518

 

Gross unrealized gains

 

5,966

 

7,417

 

Gross unrealized losses

 

(106

)

(137

)

Fair value of “available for sale” securities

 

$

7,270

 

$

8,798

 

 

We believe that the gross unrealized losses related to our “available for sale” securities as of September 30, 2010 shown above are temporary.

 

Our investments in privately held entities as of September 30, 2010 and December 31, 2009 totaled approximately $73,671,000 and $64,084,000, respectively.  Of these totals, approximately $73,589,000 and $64,050,000, respectively, are accounted for under the cost method.  The remainder (approximately $82,000 and $34,000 as of September 30, 2010 and December 31, 2009, respectively) are accounted for under the equity method.   As of September 30, 2010 and December 31, 2009, there were no unrealized losses in our investments in privately held entities.

 

5.                 Unsecured line of credit and unsecured term loan

 

Our $1.9 billion in unsecured credit facilities consist of a $1.15 billion unsecured line of credit and a $750 million unsecured term loan. We may in the future elect to increase commitments under our unsecured credit facilities by up to an additional $500 million. As of September 30, 2010, we had borrowings of $554 million and $750 million outstanding under our unsecured line of credit and unsecured term loan, respectively, with a weighted average interest rate, including the impact of our interest rate hedge agreements, of approximately 3.4%.

 

Our unsecured line of credit and unsecured term loan, as amended, bear interest at a floating rate based on our election of either (1) a London Interbank Offered Rate (“LIBOR”) based rate plus 1.00% to 1.45% depending on our leverage or (2) the higher of a rate based upon Bank of America’s prime rate plus 0.0% to 0.25% depending on our leverage and the Federal Funds rate plus 0.50%.  For each LIBOR-based borrowing, we must elect a LIBOR period of one, two, three, or six months. In the third quarter of 2010, we exercised our option to extend the maturity date of our $1.15 billion unsecured line of credit from October 29, 2010 to October 29, 2011. We are currently reviewing a proposal for the amendment and extension of our unsecured line of credit with commitments equal to or approximating current commitments of $1.15 billion. We currently anticipate closing this transaction in the fourth quarter of 2010 or the first quarter of 2011.

 

Our unsecured line of credit and unsecured term loan contain financial covenants, including, among others, the following (as defined under the terms of the agreement):

 

·                  leverage ratio less than 65.0%;

·                  fixed charge coverage ratio greater than 1.40;

·                  minimum book value of $2.1 billion; and

·                  secured debt ratio less than 55.0%.

 

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Table of Contents

 

5.                 Unsecured line of credit and unsecured term loan (continued)

 

In addition, the terms of the unsecured line of credit and unsecured term loan restrict, among other things, certain investments, indebtedness, distributions, mergers, developments, land, and borrowings available under our unsecured line of credit and unsecured term loan for developments, land, encumbered, and unencumbered assets.  As of September 30, 2010, we were in compliance with all such covenants.

 

Aggregate unsecured borrowings may be limited to an amount based primarily on the net operating income derived from a pool of unencumbered properties and our cost basis of development assets and land.  Aggregate unsecured borrowings may increase as we complete the development, redevelopment, or acquisition of additional unencumbered properties.  As of September 30, 2010, aggregate unsecured borrowings were limited to approximately $2.8 billion.

 

6.                 Unsecured convertible notes

 

The following tables summarize the balances, significant terms, and components of interest cost recognized (excluding amortization of loan fees and before the impact of capitalized interest) on our unsecured convertible notes outstanding as of September 30, 2010 and December 31, 2009, and for the three and nine months ended September 30, 2010 and 2009 (dollars in thousands, except conversion rates):

 

 

 

8.00% Unsecured
Convertible Notes

 

3.70% Unsecured
Convertible Notes

 

 

 

September 30,

 

December 31,

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

2010

 

2009

 

Principal amount

 

$

250

 

$

240,000

 

$

384,700

 

$

384,700

 

Unamortized discount

 

22

 

24,098

 

10,782

 

16,673

 

Net carrying amount of liability component

 

$

228

 

$

215,902

 

$

373,918

 

$

368,027

 

 

 

 

 

 

 

 

 

 

 

Carrying amount of equity component

 

$

27

 

$

26,216

 

$

43,538

 

$

43,538

 

Number of shares on which the aggregate consideration to be delivered on conversion is determined

 

6,039

 

5,797,101

 

N/A

(1)

N/A

(1)

 

 

 

 

 

 

Issuance date

 

April 2009

 

January 2007

 

Stated coupon interest rate

 

8.00%

 

3.70%

 

Effective interest rate

 

11.0%

 

5.96%

 

Conversion rate per $1,000 principal value of unsecured convertible notes, as adjusted

 

$41.40

 

$117.36

 

 

 

 

 

 

 

 

 

 

 

 

 

8.00% Unsecured Convertible Notes

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Contractual interest coupon

 

$

28

 

$

4,800

 

$

8,801

 

$

8,213

 

Amortization of discount on liability component

 

7

 

1,057

 

2,080

 

1,809

 

Total interest cost

 

$

35

 

$

5,857

 

$

10,881

 

$

10,022

 

 

 

 

 

 

 

3.70% Unsecured Convertible Notes

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Contractual interest coupon

 

$

3,558

 

$

3,559

 

$

10,675

 

$

11,550

 

Amortization of discount on liability component

 

1,993

 

1,878

 

5,891

 

6,001

 

Total interest cost

 

$

5,551

 

$

5,437

 

$

16,566

 

$

17,551

 

 

(1)             Our 3.70% Unsecured Convertible Notes require that upon conversion, the entire principal amount is to be settled in cash, and any excess value above the principal amount, if applicable, is to be settled in shares of our common stock.  Based on the September 30, 2010 and December 31, 2009 closing stock prices of our common stock of $70.00 and $64.29, respectively, and the conversion price of our 3.70% Unsecured Convertible Notes of $117.36 as of September 30, 2010 and December 31, 2009, the if-converted value of the notes did not exceed the principal amount as of September 30, 2010 or December 31, 2009, and accordingly, no shares of our common stock would have been issued if the notes were settled on September 30, 2010 or December 31, 2009.

 

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6.                 Unsecured convertible notes (continued)

 

8.00% Unsecured Convertible Notes

 

In April 2009, we completed a private offering of $240 million principal amount of 8.00% Unsecured Convertible Notes.  At issuance, the 8.00% Unsecured Convertible Notes had an initial conversion rate of approximately 24.1546 shares of common stock per $1,000 principal amount of the 8.00% Unsecured Convertible Notes, representing a conversion price of approximately $41.40 per share of our common stock.

 

In June 2010, we completed an exchange of our 8.00% Unsecured Convertible Notes for shares of our common stock and cash (the “Exchange Offer”).  The terms of the Exchange Offer included an offer price per $1,000 principal amount of our outstanding unsecured convertible notes of an equivalent number of common shares per bond allowed for under the holder conversion option, or 24.1546 shares, plus a cash premium of $180.  Upon completion of the Exchange Offer, we retired approximately $232.7 million principal amount of our 8.00% Unsecured Convertible Notes (representing approximately 97% of the $240.0 million aggregate principal amount of our 8.00% Unsecured Convertible Notes outstanding prior to the Exchange Offer) in exchange for 5,620,256 shares of our common stock and cash payments of approximately $41.9 million.  Additionally, we paid approximately $3.1 million in accrued and unpaid interest on the retired portion of our 8.00% Unsecured Convertible Notes to, but excluding, the settlement date.

 

Upon completion of the Exchange Offer, the total value of the consideration of the Exchange Offer was allocated to the extinguishment of the liability component equal to the fair value of that component immediately prior to extinguishment, with the difference between this allocation and the net carrying amount of the liability component and unamortized debt issuance costs recognized as a loss on early extinguishment of debt.  The remaining settlement consideration was allocated to the reacquisition of the equity component and was recognized as a reduction of Alexandria Real Estate Equities, Inc.’s stockholders’ equity.  In connection with the Exchange Offer, we recognized a loss on early extinguishment of debt of approximately $41.5 million, including approximately $4.7 million in unamortized issuance costs.  The loss was classified as loss on early extinguishment of debt on the accompanying condensed consolidated income statements for the nine months ended September 30, 2010.

 

In July 2010, we repurchased, in a privately negotiated transaction, an additional $7.1 million principal amount of our 8.00% Unsecured Convertible Notes for an aggregate cash price of approximately $12.8 million (the “Repurchase”).  Upon completion of the Repurchase, the total value of the consideration of the Repurchase was allocated to the extinguishment of the liability component equal to the fair value of that component immediately prior to extinguishment, with the difference between this allocation and the net carrying amount of the liability component and unamortized debt issuance costs recognized as a loss on early extinguishment of debt.  The remaining settlement consideration of $5.2 million was allocated to the reacquisition of the equity component and was recognized as a reduction of Alexandria Real Estate Equities, Inc.’s stockholders’ equity.  As a result of the Repurchase, we recognized a loss on early extinguishment of debt of approximately $1.3 million, including approximately $140,000 in unamortized issuance costs.  The loss was classified as loss on early extinguishment of debt on the accompanying condensed consolidated income statements for the three and nine months ended September 30, 2010.

 

3.70% Unsecured Convertible Notes

 

In January 2007, we completed a private offering of $460 million principal amount of 3.70% Unsecured Convertible Notes.    Prior to January 15, 2012, we will not have the right to redeem the 3.70% Unsecured Convertible Notes, except to preserve our qualification as a REIT.  On and after that date, we have the right to redeem the 3.70% Unsecured Convertible Notes, in whole or in part, at any time and from time to time, for cash equal to 100% of the principal amount of the 3.70% Unsecured Convertible Notes to be redeemed, plus any accrued and unpaid interest to, but excluding, the redemption date.  Holders of the 3.70% Unsecured Convertible Notes may require us to repurchase their notes, in whole or in part, on January 15, 2012, 2017 and 2022 for cash equal to 100% of the principal amount of the notes to be purchased plus any accrued and unpaid interest to, but excluding, the repurchase date.  Holders of the 3.70% Unsecured Convertible Notes may require us to repurchase all or a portion of their notes upon the occurrence of specified corporate transactions (each, a “Fundamental Change”), including a change in control, certain merger or consolidation transactions or the liquidation of the Company, at a repurchase price in cash equal to 100% of the principal amount of the notes to be repurchased, plus any accrued and unpaid interest to, but excluding, the fundamental change repurchase date.

 

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6.                 Unsecured convertible notes (continued)

 

3.70% Unsecured Convertible Notes (continued)

 

At issuance, the 3.70% Unsecured Convertible Notes had an initial conversion rate of approximately 8.4774 shares of common stock per $1,000 principal amount of the 3.70% Unsecured Convertible Notes, representing a conversion price of approximately $117.96 per share of our common stock.  The conversion rate of the 3.70% Unsecured Convertible Notes is subject to adjustments for certain events, including, but not limited to, certain cash dividends on our common stock in excess of $0.74 per share per quarter and dividends on our common stock payable in shares of our common stock.  As of September 30, 2010, the 3.70% Unsecured Convertible Notes had a conversion rate of approximately 8.5207 shares of common stock per $1,000 principal amount of the 3.70% Unsecured Convertible Notes, which is equivalent to a conversion price of approximately $117.36 per share of our common stock.

 

Holders of the 3.70% Unsecured Convertible Notes may convert their notes into cash and, if applicable, shares of our common stock prior to the stated maturity of January 15, 2027 only under the following circumstances: (1) during any calendar quarter after the calendar quarter ending March 31, 2007, if the closing sale price of our common stock for each of 20 or more trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter exceeds 120% of the conversion price in effect on the last trading day of the immediately preceding calendar quarter; (2) during the five consecutive business days immediately after any five consecutive trading day period (the “3.70% Unsecured Convertible Note Measurement Period”) in which the average trading price per $1,000 principal amount of 3.70% Unsecured Convertible Notes was equal to or less than 98% of the average conversion value of the 3.70% Unsecured Convertible Notes during the 3.70% Unsecured Convertible Note Measurement Period; (3) upon the occurrence of a Fundamental Change; (4) if we call the 3.70% Unsecured Convertible Notes for redemption; and (5) at any time from, and including, December 15, 2026 until the close of business on the business day immediately preceding January 15, 2027 or earlier redemption or repurchase.

 

In April 2009, we repurchased, in privately negotiated transactions, certain of our 3.70% Unsecured Convertible Notes aggregating approximately $75 million (par value) at an aggregate cash price of approximately $59.2 million.  As a result of the repurchases, we recognized a gain on early extinguishment of debt of approximately $11.3 million, net of approximately $860,000 in unamortized issuance costs.  The gain was classified as gain on early extinguishment of debt on the accompanying condensed consolidated income statements for the nine months ended September 30, 2009.

 

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7.          Interest rate hedge agreements

 

We are exposed to certain risks arising from both our business operations and economic conditions.  We principally manage our exposures to a wide variety of business and operational risks through management of our core business activities. We manage economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of our debt funding and the use of interest rate hedge agreements.  Specifically, we enter into interest rate hedge agreements to manage exposures that arise from business activities that result in the payment of future known and uncertain cash amounts, the value of which are determined by interest rates.  Our interest rate hedge agreements are used to manage differences in the amount, timing, and duration of our known or expected cash payments principally related to our LIBOR-based borrowings.  We do not use derivatives for trading or speculative purposes and currently all of our derivatives are designated as hedges. Our objectives in using interest rate hedge agreements are to add stability to interest expense and to manage our exposure to interest rate movements in accordance with our interest rate risk management strategy.  Interest rate hedge agreements designated as cash flow hedges involve the receipt of variable rate amounts from a counterparty in exchange for the Company making fixed rate payments over the life of the interest rate hedge agreements without exchange of the underlying notional amount.  Interest rate cap agreements designated as cash flow hedges involve the receipt of variable rate amounts from a counterparty if interest rates rise above the strike rate on the contract in exchange for an up-front premium.

 

The effective portion of changes in the fair value of our interest rate hedge agreements designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income.  The amount is subsequently reclassified into earnings in the period that the hedged forecasted transactions affect earnings.  During the three and nine months ended September 30, 2010 and 2009, our interest rate hedge agreements were used primarily to hedge the variable cash flows associated with certain of our existing LIBOR-based variable rate debt, including our unsecured line of credit and unsecured term loan.  The ineffective portion of the change in fair value of our interest rate hedge agreements is recognized directly in earnings. During the three and nine months ended September 30, 2010 and 2009, our interest rate hedge agreements were 100% effective.  Accordingly, we did not recognize any of the change in fair value of our interest rate hedge agreements directly into earnings.

 

As of September 30, 2010 and December 31, 2009, our interest rate hedge agreements were classified in accounts payable, accrued expenses, and tenant security deposits based upon their respective fair values aggregating a liability balance of approximately $54.1 million and $49.9 million, respectively, which included accrued interest and adjustments for non-performance risk, with the offsetting adjustment reflected as unrealized gain (loss) in accumulated other comprehensive loss in total equity.  We have not posted any collateral related to our interest rate hedge agreements.

 

Balances in accumulated other comprehensive income are recognized in the periods that the forecasted hedge transactions affect earnings.  For the three months ended September 30, 2010 and 2009, approximately $7.0 million and $9.9 million, respectively, was reclassified from accumulated other comprehensive income to interest expense as an increase to interest expense.  For the nine months ended September 30, 2010 and 2009, approximately $23.6 million and $29.6 million, respectively, was reclassified from accumulated other comprehensive income to interest expense as an increase to interest expense.  During the next twelve months, we expect to reclassify approximately $23.0 million from accumulated other comprehensive loss to interest expense as an increase to interest expense.

 

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7.                 Interest rate hedge agreements (continued)

 

As of September 30, 2010, we had the following outstanding interest rate hedge agreements that were designated as cash flow hedges of interest rate risk (dollars in thousands):

 

Transaction
Date

 

Effective
Date

 

Termination
Date

 

Interest
Pay Rate

 

Notional Amount

 

Effective at
September 30,
2010

 

Fair
Value

 

December 2006

 

December 29, 2006

 

March 31, 2014

 

4.990

%

 

$

50,000

 

$

50,000

 

$

(6,961

)

December 2006

 

January 2, 2007

 

January 3, 2011

 

5.003

 

 

28,500

 

28,500

 

(463

)

October 2007

 

October 31, 2007

 

September 30, 2012

 

4.546

 

 

50,000

 

50,000

 

(4,036

)

October 2007

 

October 31, 2007

 

September 30, 2013

 

4.642

 

 

50,000

 

50,000

 

(5,738

)

December 2005

 

January 2, 2008

 

December 31, 2010

 

4.768

 

 

50,000

 

50,000

 

(572

)

October 2007

 

July 1, 2008

 

March 31, 2013

 

4.622

 

 

25,000

 

25,000

 

(2,470

)

October 2007

 

July 1, 2008

 

March 31, 2013

 

4.625

 

 

25,000

 

25,000

 

(2,472

)

June 2006

 

October 31, 2008

 

December 31, 2010

 

5.340

 

 

50,000

 

50,000

 

(646

)

June 2006

 

October 31, 2008

 

December 31, 2010

 

5.347

 

 

50,000

 

50,000

 

(646

)

October 2008

 

September 30, 2009

 

January 31, 2011

 

3.119

 

 

100,000

 

100,000

 

(965

)

December 2006

 

November 30, 2009

 

March 31, 2014

 

5.015

 

 

75,000

 

75,000

 

(10,505

)

December 2006

 

November 30, 2009

 

March 31, 2014

 

5.023

 

 

75,000

 

75,000

 

(10,525

)

December 2006

 

December 31, 2010

 

October 31, 2012

 

5.015

 

 

100,000

 

 

(8,137

)

Total

 

 

 

 

 

 

 

 

 

 

$

628,500

 

$

(54,136

)

 

The fair value of each interest rate hedge agreement is determined using widely accepted valuation techniques including discounted cash flow analyses on the expected cash flows of each derivative. These analyses reflect the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities (also referred to as “significant other observable inputs”).  The fair values of our interest rate hedge agreements are determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts.  The variable cash receipts are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves.  The fair value calculation also includes an amount for risk of non-performance using “significant unobservable inputs” such as estimates of current credit spreads to evaluate the likelihood of default, which we have determined to be insignificant to the overall fair value of our interest rate hedge agreements.

 

8.                 Alexandria Real Estate Equities, Inc. stockholders’ equity

 

In September 2010, we sold 5,175,000 shares of our common stock in a follow-on offering (including 675,000 shares issued upon full exercise of the underwriters’ over-allotment option).  The shares were issued at a price of $69.25 per share, resulting in aggregate proceeds of approximately $342.3 million (after deducting underwriters’ discounts and other offering costs).

 

In June 2010, we completed our Exchange Offer.  Pursuant to the terms of the Exchange Offer, we issued 5,620,256 shares of our common stock and paid approximately $41.9 million in cash, as consideration for the exchange of approximately $232.7 million of our 8.00% Unsecured Convertible Notes.  See Note 6, Unsecured Convertible Notes.

 

In September 2009, we sold 4,600,000 shares of our common stock in a follow-on offering (including shares issued upon exercise of the underwriters’ over-allotment option).  The shares were issued at a price of $53.25 per share, resulting in aggregate proceeds of approximately $233.5 million (after deducting underwriters’ discounts and other offering costs).

 

In March 2009, we sold 7,000,000 shares of our common stock in a follow-on offering.  The shares were issued at a price of $38.25 per share, resulting in aggregate proceeds of approximately $254.6 million (after deducting underwriters’ discounts and other offering costs).

 

In September 2010, we declared a cash dividend on our common stock aggregating $19,368,000 ($0.35 per share) for the calendar quarter ended September 30, 2010.  In September 2010, we also declared cash dividends on our 8.375% series C cumulative redeemable preferred stock (“Series C Preferred Stock”) aggregating $2,714,000 ($0.5234375 per share), for the period from July 15, 2010 through October 15, 2010.  Additionally, in September 2010, we declared cash dividends on our Series D Convertible Preferred Stock aggregating approximately $4,375,000 ($0.4375 per share), for the period from July 15, 2010 through October 15, 2010.

 

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9.                 Noncontrolling interests

 

Noncontrolling interests represent the third party interests in certain entities in which we have a controlling interest. These entities own eight properties and three development parcels as of September 30, 2010 and are included in our consolidated financial statements.  As of December 31, 2009, noncontrolling interests also included a third party interest in a VIE in which we had determined we were the primary beneficiary.  On January 1, 2010, we deconsolidated the VIE upon adoption of the new VIE accounting literature.  See “Variable Interest Entity” in Note 2 and “Investment in Unconsolidated Real Estate Entity” in Note 3 for further discussion on the VIE.  Noncontrolling interests are adjusted for additional contributions and distributions, the proportionate share of the net earnings or losses, and other comprehensive income or loss.  Distributions, profits, and losses related to these entities are allocated in accordance with the respective operating agreements.

 

Certain of our noncontrolling interests have the right to require us to redeem their ownership interests in the respective entities.  We classify these ownership interests in the entities as redeemable noncontrolling interests outside of total equity in the accompanying condensed consolidated balance sheets.  Redeemable noncontrolling interests are adjusted for additional contributions and distributions, the proportionate share of the net earnings or losses and other comprehensive income or loss. Distributions, profits, and losses related to these entities are allocated in accordance with the respective operating agreements.  If the carrying amount of a redeemable noncontrolling interest is less than the maximum redemption value at the balance sheet date, such amount is adjusted to the maximum redemption value.  Subsequent declines in the redemption value are recognized only to the extent previously recorded increases have been recorded pursuant to the preceding sentence.  As of September 30, 2010 and December 31, 2009, our redeemable noncontrolling interest balances were approximately $15.9 million and $41.4 million, respectively.  Our remaining noncontrolling interests aggregating approximately $41.6 million and $41.2 million as of September 30, 2010 and December 31, 2009, respectively, do not have rights to require us to purchase their ownership interests and are classified in total equity in the accompanying condensed consolidated balance sheets.

 

10.          Discontinued operations

 

We classify a property as “held for sale” when all of the following criteria for a plan of sale have been met: (1) management, having the authority to approve the action, commits to a plan to sell the property; (2) the property is available for immediate sale in its present condition, subject only to terms that are usual and customary; (3) an active program to locate a buyer and other actions required to complete the plan to sell, have been initiated; (4) the sale of the property is probable and is expected to be completed within one year; (5) the property is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and (6) actions necessary to complete the plan of sale indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn.  When all of these criteria have been met, the property is classified as “held for sale,” its operations, including any interest expense directly attributable to it, are classified as discontinued operations in our consolidated statements of income, and amounts for all prior periods presented are reclassified from continuing operations to discontinued operations.  A loss is recognized for any initial adjustment of the asset’s carrying amount to fair value less costs to sell in the period the asset qualifies as “held for sale.”  Depreciation of assets ceases upon designation of a property as “held for sale.”

 

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Table of Contents

 

10.          Discontinued operations (continued)

 

The following is a summary of income from discontinued operations, net and net assets of discontinued operations (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Total revenue

 

$

 

$

1,195

 

$

800

 

$

3,624

 

Operating expenses

 

 

252

 

94

 

759

 

Revenue less operating expenses

 

 

943

 

706

 

2,865

 

Interest expense

 

 

1

 

 

24

 

Depreciation expense

 

 

224

 

3

 

650

 

Subtotal

 

 

718

 

703

 

2,191

 

Gain on properties “held for sale” and sales of property, net

 

 

 

24

 

2,234

 

Income from discontinued operations, net

 

$

 

$

718

 

$

727

 

$

4,425

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30,
2010

 

December 31,
2009

 

 

 

 

 

Properties “held for sale,” net

 

$

 

$

10,260

 

 

 

 

 

Other assets

 

 

551

 

 

 

 

 

Total assets

 

$

 

$

10,811

 

 

 

 

 

Total liabilities

 

 

526

 

 

 

 

 

Net assets of discontinued operations

 

$

 

$

10,285

 

 

 

 

 

 

Income from discontinued operations, net for the three months ended September 30, 2009 includes the results of operations of one property that was sold during the first quarter of 2010, one property that was sold in the fourth quarter of 2009, and three properties that were sold in the first quarter of 2009.  Income from discontinued operations, net for the nine months ended September 30, 2010 includes the results of operations of one property that was sold during the first quarter of 2010.  Income from discontinued operations, net for the nine months ended September 30, 2009 includes the results of operations of one property that was sold during the first quarter of 2010, one property that was sold in the fourth quarter of 2009, and three properties that were sold in the first quarter of 2009.  During the nine months ended September 30, 2010, we sold one property located in the Seattle market that had been classified as “held for sale” as of December 31, 2009.  The total sales price for the property sold during the nine months ended September 30, 2010 was approximately $11.8 million.

 

11.          Subsequent Events

 

In October 2010, we acquired a life science campus in the San Diego market aggregating approximately 347,000 rentable square feet.  The purchase of this life science campus included land supporting the future development of additional life science buildings aggregating approximately 382,000 rentable square feet.  The purchase price was approximately $128 million and was funded with borrowings under our unsecured line of credit.  The property is fully leased through December 2011 to a credit life science entity.

 

In November 2010, we completed sales of land parcels in Mission Bay, San Francisco for an aggregate sales price of approximately $278 million at a gain of approximately $60 million. The sales of the land parcels resulted in a reduction of our preconstruction square footage by approximately 2.0 million square feet in the Mission Bay, San Francisco submarket.  The cash proceeds from these sales were used to repay outstanding borrowings under our unsecured line of credit.  These sales did not meet the criteria required for classification as held for sale until late October 2010.

 

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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,” “expects,” “may,” “will,” “should,” “seeks,” “approximately,” “intends,” “plans,” “estimates,” or “anticipates,” or the negative of these words or similar words, constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  Forward-looking statements involve inherent risks and uncertainties regarding events, conditions, and financial trends that may affect our future plans of operation, business strategy, results of operations, and financial position.  A number of important factors could cause actual results to differ materially from those included within or contemplated by the forward-looking statements, including, but not limited to the following:

 

·                  negative worldwide economic, financial, and banking conditions;

 

·                  worldwide economic recession and lack of confidence;

 

·                  financial, banking, and credit market conditions;

 

·                  the seizure or illiquidity of credit markets;

 

·                  our inability to obtain capital (debt, construction financing, and/or equity) or refinance debt maturities;

 

·                  inflation or deflation;

 

·                  prolonged period of stagnant growth;

 

·                  increased interest rates and operating costs;

 

·                  adverse economic or real estate developments in our markets;

 

·                  our failure to successfully complete and lease our existing space held for redevelopment and new properties acquired for that purpose and any properties undergoing development;

 

·                  significant decreases in our active development, active redevelopment, or preconstruction activities resulting in significant increases in our interest, operating, and payroll expenses;

 

·                  our failure to successfully operate or lease acquired properties;

 

·                  the financial condition of our insurance carriers;

 

·                  general and local economic conditions;

 

·                  decreased rental rates or increased vacancy rates/failure to renew or replace expiring leases;

 

·                  defaults on or non-renewal of leases by tenants;

 

·                  our failure to comply with laws or changes in law;

 

·                  compliance with environmental laws;

 

·                  our failure to maintain our status as a real estate investment trust (“REIT”);

 

·                  changes in laws, regulations, and financial accounting standards;

 

·                  certain ownership interests outside the United States may subject us to different or greater risks than those associated with our domestic operations; and

 

·                  fluctuations in foreign currency exchange rates.

 

This list of risks and uncertainties, however, is only a summary and is not intended to be exhaustive.  Additional information regarding risk factors that may affect us is included under the headings “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our annual report on Form 10-K for the fiscal year ended December 31, 2009.  Readers of this quarterly report on Form 10-Q should also read our Securities and Exchange Commission (“SEC”) and other publicly filed documents for further discussion regarding such factors.

 

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Table of Contents

 

The following discussion should be read in conjunction with the condensed consolidated financial statements and notes appearing elsewhere in this quarterly report on Form 10-Q.

 

Overview

 

We are a Maryland corporation formed in October 1994 that has elected to be taxed as a REIT for federal income tax purposes.  We are the largest owner and preeminent REIT focused principally on cluster development through the ownership, operation, management, selective redevelopment, development, and acquisition of properties containing life science space.  We are the leading provider of high-quality, environmentally sustainable real estate, technical infrastructure, and services to the broad and diverse life science industry.  Client tenants include institutional (universities and independent not-for-profit institutions), pharmaceutical, biotechnology, medical device, product, service, and government agencies. Our primary business objective is to maximize shareholder value by providing its shareholders and employees with the greatest possible total return based on a multi-faceted platform of internal and external growth. Our operating platform is based on the principle of “clustering,” with assets and operations located adjacent to life science entities driving growth and technological advances within each cluster.

 

As of September 30, 2010, we had 164 properties approximating 12.9 million rentable square feet consisting of 159 properties approximating 12.3 million rentable square feet (including spaces undergoing active redevelopment) and five properties undergoing ground-up development approximating an additional 561,929 rentable square feet.  As of that date, our properties were approximately 94.0% leased, excluding ground-up development and spaces at properties undergoing a permanent change in use to life science space through redevelopment, including the conversion of single-tenancy space to multi-tenancy space or multi-tenancy space to single-tenancy space.  Our primary sources of revenues are rental income and tenant recoveries from leases of our properties.  The comparability of financial data from period to period is affected by the timing of our property development, redevelopment, and acquisition activities.

 

For the nine months ended September 30, 2010, we:

 

·                executed 112 leases for 1,670,000 rentable square feet, including 437,000 rentable square feet of redevelopment and development space;

 

·                reported occupancy at 94.0%;

 

·                completed a follow-on common stock offering with net proceeds of $342 million;

 

·                retired substantially all $240 million of our 8.00% unsecured senior convertible notes (“8.00% Unsecured Convertible Notes”);

 

·                exercised our option to extend the maturity date of our $1.15 billion unsecured line of credit from October 29, 2010 to October 29, 2011;

 

·                repaid five secured loans aggregating $55.2 million;

 

·                completed the ground-up development of two properties aggregating approximately 245,000 rentable square feet pursuant to 10-year leases;

 

·                commenced the ground-up development of a single-tenant property in the Southeast market aggregating 97,000 rentable square feet pursuant to a 15-year lease;

 

·                sold one property aggregating 71,000 rentable square feet which was previously classified as “held for sale”;

 

·                obtained final zoning approval for Alexandria Center™ at Kendall Square located in East Cambridge, Massachusetts, which is an 11.3-acre development of 1.9 million rentable square feet of life science and other space;

 

·                acquired one property in the Suburban Washington, D.C. market aggregating approximately 49,000 rentable square feet for $13 million; and

 

·                entered into a definitive agreement to acquire three life science properties and other selected assets and interests of privately-held Veralliance Properties, Inc., for which we completed the acquisition of one property in the third quarter of 2010 and expect to complete the acquisition of the remaining two properties in the fourth quarter of 2010.

 

·                Additionally, Eli Lilly and Company occupied its space at Alexandria Center™ for Life Science – New York City.

 

We continue to demonstrate the strength and durability of our core operations providing life science space to the broad and diverse life science industry.  Our core operating results were steady for the nine months ended September 30, 2010.  We intend to continue to focus on the completion of our existing active redevelopment projects aggregating approximately 617,662 rentable square feet and our existing active development projects aggregating approximately an additional 561,929 rentable square feet. Additionally, we intend to continue with preconstruction activities for certain land parcels for future ground-up/vertical aboveground development in order to preserve and create value for these projects.  These important

 

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preconstruction activities add significant value to our land for future ground-up development and are required for the ultimate vertical construction of the buildings.  We also intend to be very careful and prudent with any future decisions to add new projects to our active ground-up/vertical developments.  Future ground-up/vertical development projects will likely require significant preleasing from high quality and/or creditworthy entities.  We also intend to selectively acquire properties that we believe provide long-term value to our stockholders. Our strategy for acquisitions will focus on quality of the submarket locations, improvements, tenancy, and overall return. We believe the life science industry will remain keenly focused on adjacency locations to key innovation drivers in each major life science submarket. As such, we will also focus on adjacency locations which will deliver high cash flows, stability, and returns as we work to deliver the highest value to our stockholders.  We intend to continue to reduce debt as a percentage of our overall capital structure over a multi-year period.  During this period, we may also extend and/or refinance certain debt maturities.  We expect sources of funds for construction activities and repayment of outstanding debt to be provided over several years by opportunistic sales of real estate, joint ventures, cash flows from operations, new secured or unsecured debt, and the issuance of additional equity securities, as appropriate.  During the nine months ended September 30, 2010, we sold one property for approximately $11.8 million.  In November 2010, we completed sales of land parcels in Mission Bay, San Francisco for an aggregate sales price of approximately $278 million.  The proceeds from these sales were used to repay outstanding debt.

 

Properties

 

The locations of our properties are diversified among a number of life science markets.  The following table sets forth the rentable square footage, number of properties, annualized base rent, and occupancy of our properties in each of our existing markets as of September 30, 2010 (dollars in thousands):

 

 

 

September 30, 2010

 

 

 

Rentable Square Feet

 

Number of

 

Annualized

 

Occupancy

 

Markets

 

Operating

 

Redevelopment

 

Development

 

Total

 

Properties

 

Base Rent (1)

 

Percentage (1)(2)

 

California – San Diego

 

1,538,430

 

193,289

 

 

1,731,719

 

33

 

$

42,685

 

88.5%

 

California – San Francisco Bay

 

1,823,217

 

 

308,744

 

2,131,961

 

22

 

63,293

 

96.8

 

Eastern Massachusetts

 

3,220,589

 

240,660

 

 

3,461,249

 

38

 

117,911

 

94.5

 

NYC/New Jersey/Suburban Philadelphia

 

612,107

 

 

156,185

 

768,292

 

9

 

18,482

 

87.6

 

Southeast

 

688,919

 

30,000

 

97,000

 

815,919

 

13

 

15,093

 

93.3

 

Suburban Washington, D.C.

 

2,387,587

 

153,713

 

 

2,541,300

 

32

 

49,707

 

94.3

 

Washington – Seattle

 

1,090,205

 

 

 

1,090,205

 

13

 

35,057

 

97.5

 

International

 

342,394

 

 

 

342,394

 

4

 

8,941

 

100.0

 

Total Properties (Continuing Operations)

 

11,703,448

 

617,662

 

561,929

 

12,883,039

 

164

 

$

351,169

 

94.0%

 

 

(1)          Annualized base rent means the annualized fixed base rental amount in effect as of September 30, 2010 (using rental revenue computed on a straight-line basis in accordance with accounting principles generally accepted in the United States (“GAAP”)).  Annualized base rent and occupancy percentages relate to our operating properties aggregating 11,703,448 rentable square feet.

(2)          Including spaces undergoing a permanent change in use to life science space through redevelopment, including the conversion of single-tenancy space to multi-tenancy space or multi-tenancy space to single-tenancy space, occupancy as of September 30, 2010 was 89.3%.

 

Our average occupancy rate of operating properties as of December 31 of each year from 1997 to 2009 and September 30, 2010 was approximately 95.2%.  Our average occupancy rate of operating and redevelopment properties as of December 31 of each year from 1997 to 2009 and September 30, 2010 was approximately 89.3%.

 

Leasing

 

As of September 30, 2010, approximately 97% of our leases (on a rentable square footage basis) recover a majority of operating expenses, including approximately 88% triple net leases, requiring tenants to pay substantially all real estate taxes, insurance, utilities, common area, and other operating expenses (including increases thereto) in addition to base rent, and approximately 9% of our leases requiring the tenants to pay a majority of operating expenses.  Additionally, approximately 92% of our leases (on a rentable square footage basis) provided for the recapture of certain capital expenditures, and approximately 94% of our leases (on a rentable square footage basis) contained effective annual rent escalations that were either fixed or indexed based on the consumer price index or another index.  Our leases also typically give us the right to review and approve tenant alterations to the property. Generally, tenant-installed improvements to the properties remain our property after termination of the lease at our election.  However, we are permitted under the terms of most of our leases to require that the tenant, at its expense, remove the improvements and restore the premises to their original condition.

 

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The following table provides information with respect to lease expirations at our properties as of September 30, 2010:

 

Year of Lease
Expiration

 

Number of
Leases Expiring

 

Rentable Square
Footage of
Expiring Leases

 

Percentage of
Aggregate
Total Rentable
Square Feet

 

Annualized Base Rent
of Expiring Leases
(per rentable
square foot)

 

2010

 

19

 (1)

 

427,928

 (1)

 

3.5

%

 

$25.32

 

2011

 

81

 

 

1,405,526

 

 

11.4

 

 

27.54

 

2012

 

76

 

 

1,348,502

 

 

10.9

 

 

32.06

 

2013

 

74

 

 

1,292,188

 

 

10.5

 

 

28.71

 

2014

 

54

 

 

1,191,121

 

 

9.7

 

 

28.71

 

2015

 

40

 

 

877,183

 

 

7.1

 

 

29.82

 

2016

 

23

 

 

1,159,697

 

 

9.4

 

 

32.29

 

2017

 

18

 

 

795,588

 

 

6.5

 

 

34.58

 

2018

 

12

 

 

834,738

 

 

6.8

 

 

40.16

 

2019

 

5

 

 

224,703

 

 

1.8

 

 

36.28

 

 

(1)          Excludes five month-to-month leases for approximately 13,000 rentable square feet.

 

Value-Added Activities

 

A key component of our business is our value-added redevelopment and development programs. These programs are focused on providing high quality generic life science space to meet the real estate requirements of various life science industry tenants. Redevelopment projects consist of the permanent change in use of office, warehouse, and shell space into generic life science space, including the conversion of single-tenancy space to multi-tenancy space or multi-tenancy space to single-tenancy space. Development projects consist of the ground-up development of generic life science facilities. Preconstruction projects include significant value added projects undergoing important and substantial activities to bring these assets to their intended use. These critical activities add significant value for future ground-up development (which are projected to yield substantial revenues and cash flows) and are required for the ultimate vertical construction of buildings. Amounts are classified as construction in progress as required under GAAP while construction activities are ongoing to bring the asset to its intended use. When construction activities cease, the asset is transferred out of construction in progress and classified as rental properties, net or land held for future development.

 

Land held for future development includes certain land parcels with improvements to the land, including, grading, piles, foundations, and other land improvements. Future redevelopment represents properties containing non-laboratory uses (office, industrial, or warehouse) for future conversion to life science laboratory space.

 

A key strategy for our value-added activities will include generation of significant cash flows through the ground-up development or redevelopment of life science properties and the lease or sale of land parcels.

 

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The following table summarizes the components of our total value-added square footage as of September 30, 2010:

 

 

 

Square Footage

 

 

 

Construction in Progress (“CIP”)

 

 

 

 

 

 

 

 

 

Markets

 

Redevelopment

 

Development

 

Preconstruction

 

New
Markets
and Other
Projects (1)

 

Total
CIP

 

Investment in
Unconsolidated
Real Estate
Entity

 

Land

 

Future
Redevelopment

 

Total Value-
Added
Square
Footage

 

California – San Diego

 

193,289

 

 

 

 

193,289

 

 

443,000

 

168,000

 

804,289

 

California – San Francisco Bay/ Mission Bay

 

 

146,744

 

2,030,000

(2)

 

2,176,744

 

 

290,000

(2)

 

2,466,744

 

California – San Francisco Bay/ So. San Francisco

 

 

162,000

 

144,000

 

 

306,000

 

 

1,051,000

 

46,000

 

1,403,000

 

Eastern Massachusetts

 

240,660

 

 

1,927,000

 

 

2,167,660

 

428,000

 

225,000

 

512,000

 

3,332,660

 

Suburban Washington, D.C.

 

153,713

 

 

 

 

153,713

 

 

1,035,000

 

394,000

 

1,582,713

 

Washington – Seattle

 

 

 

328,000

 

 

328,000

 

 

968,000

 

319,000

 

1,615,000

 

International and Other

 

30,000

 

253,185

 

260,000

 

1,091,000

 

1,634,185

 

 

1,438,000

 

226,000

 

3,298,185

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

617,662

 

561,929

 

4,689,000

 

1,091,000

 

6,959,591

 

428,000

(3)

5,450,000

(4)

1,665,000

(5)

14,502,591

 

 

(1)                    Includes site of future building approximating 410,000 rentable square feet related to our project in New York City and four buildings aggregating 547,000 rentable square feet related to two ground-up development projects in China.

(2)                    In November 2010, we completed the sales of land parcels in Mission Bay, San Francisco resulting in a reduction of our preconstruction and land square footage. Upon completion of the sale, we expect to have approximately 290,000 future developable square feet remaining in Mission Bay, San Francisco.

(3)                    Represents a land parcel supporting ground-up development of approximately 428,000 rentable square feet in the Longwood Medical Area of Boston.

(4)                    Our objective is to advance preconstruction efforts to reduce the time to deliver projects to prospective tenants.  Since all efforts have been advanced to appropriate stages and no further preconstruction activities are ongoing, interest, property taxes, insurance, and other costs are expensed as incurred.  Represents land and land improvements (site work and piles for foundation) related to land parcels that have been advanced through entitlement and certain levels of design.  Amounts exclude a parcel supporting ground-up development of approximately 442,000 rentable square feet in New York City that we have an option to ground lease for future development, and land parcels supporting ground-up development of 636,000 rentable square feet in Edinburgh, Scotland that we have a long-term right to purchase.

(5)                    Square footage related to future redevelopment is included in our operating asset base (rental properties, net).

 

San Francisco Bay – Mission Bay and South San Francisco Value-Added Preconstruction Activities

 

The value-added preconstruction activities in Mission Bay and South San Francisco will create high quality space in state-of-the-art environmentally sustainable facilities for our clients generating value and net operating income for the Company. The entitlement process includes a multitude of activities necessary for the vertical construction of these high quality facilities including, among other items, regulatory approval, mapping, conceptual design, schematic design, design development, permitting, construction drawings, and estimating. Our value-added projects in Mission Bay and South San Francisco, that have been completed or are now under construction, have attracted Merck & Co., Inc., Celgene Corporation, Pfizer Inc., Roche Holding Ltd, Bayer AG, Onyx Pharmaceuticals Inc., and the University of California, San Francisco (“UCSF”).

 

In addition to the opportunities located at Mission Bay, our asset base contains a broad pipeline of opportunities located in South San Francisco. This includes, among others, a high-quality facility with entitlements completed totaling over 275,000 rentable square feet and a four-building campus totaling an additional 405,000 rentable square feet located nearby existing well established and emerging life science companies in South San Francisco.

 

In November 2010, we completed the sale of approximately 2 million rentable square feet of entitlements in multiple transactions.  We will retain a dominant life science presence in Mission Bay and amongst our completed facilities, expect to have the opportunity to deliver 290,000 additional developable square feet ready for build-to-suit clients. At the heart of this intellectual center is UCSF, one of the nation’s top generators of life science commercial enterprises and the number two

 

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recipient of grants from the National Institutes of Health. At least 75 California life science companies, including two of the largest, Genentech, Inc. (now a subsidiary of Roche) and Chiron Corporation (now a subsidiary of Novartis AG), have been successfully launched by UCSF faculty or alumni. UCSF’s expansion of major research functions to its Mission Bay campus serves as a hub for basic scientific inquiry and a meeting place for academics from around the world. The wide range of UCSF’s sophisticated laboratories include the Center for Advanced Technology, as well as significant efforts in structural and chemical biology, molecular, cell and developmental biology, advanced microscopy, neurology, and cardiology. Finally, the UCSF Mission Bay hospital campus is in the design phase, and will initially offer 280 beds in an integrated facility to serve women, children, and cancer patients. Construction is expected to begin in late 2010 or early 2011. The overriding emphasis of this array of diverse life science entities is to translate research discoveries into viable commercial products to solve critical unmet medical needs.

 

Following the sale of the approximately 2 million rentable square feet of entitlements in November 2010, the Alexandria Center™ for Science and Technology at Mission Bay will consist of up to five high-quality facilities aggregating approximately 813,000 rentable square feet. We currently have three buildings aggregating approximately 523,000 rentable square feet leased to Merck & Co., Inc., Pfizer Inc., Bayer AG, and UCSF as well as other top tier life science companies.

 

Eastern Massachusetts Value-Added Preconstruction Activities

 

In June 2010, the Cambridge Planning Board granted final zoning approval for our life science development, known as the Alexandria Center™ at Kendall Square (the ‘‘Alexandria Center’’). The Alexandria Center is an 11.3-acre development with approximately 1.9 million square feet of life science and other spaces located in East Cambridge. It will include a mixed mode transportation center and more than two acres of public open space for the East Cambridge community. Once completed, the Alexandria Center will have five highly sustainable state-of-the-art life science facilities in addition to the preservation of existing historic buildings. All buildings will be LEED certifiable, employing state-of-the-art design and technology featuring sustainable operations including high-efficiency mechanical systems, rooftop storm water management and water-efficient landscaping. Located in the heart of the renowned Kendall Square innovation district, Alexandria Center tenants will enjoy convenient access to leading research and academic institutions including the Massachusetts Institute of Technology (“MIT”), Whitehead Institute for Biomedical Research, the Broad Institute, and Harvard University. With its crucial adjacency location near the Kendall Square T Station and the MIT campus, the Alexandria Center is positioned to be the epicenter of Cambridge’s life science industry.

 

Immediately adjacent to the Alexandria Center, we recently completed the conversion of an approximately 52,000 rentable square foot portion of an existing office building known as Athenaeum Center into life science space and expect to complete the conversion of an additional 33,000 rentable square foot portion of the Athenaeum Center into life science space in the fourth quarter of 2010. The remaining space in the Athenaeum Center, constituting approximately 281,000 rentable square feet of office space, is substantially leased.

 

Nearby in Cambridge, at our flagship Technology Square campus, design and engineering is underway for the conversion of an existing office building into an approximately 210,000 rentable square foot life science laboratory building. The design will include a dramatic new façade treatment on the building, along with substantial infrastructure and system upgrades needed to support laboratory use. Previously, an approximately 175,000 rentable square foot office building at Technology Square was converted to life science laboratory use and substantially leased to Sirtris Pharmaceuticals, Inc., a division of GlaxoSmithKline plc, the Novartis Institutes of Biomedical Research, and a unit of Pfizer Inc.

 

Elsewhere in the Eastern Massachusetts region, design activities are ongoing at Longwood Center, our approximately 428,000 rentable square foot life science development located on a 1.0 acre parcel in the heart of Boston’s Longwood Medical Area (“LMA”). This project, partnered with a local development/investment group, has been entitled under the City of Boston’s site plan review process. The LMA is a compact and vibrant district which is home to world-renowned medical and academic institutions such as Harvard Medical School, Brigham & Womens’ Hospital, Dana Farber Cancer Institute, Childrens’ Hospital Boston, Beth Israel Deaconess Medical Center, and Joslin Diabetes Center, among several others. Fully entitled land sites are extremely scarce in the LMA and we believe that Longwood Center is well-positioned to accommodate expected growth within the district.

 

New Markets and Other Projects

 

A component of our business model also includes ground-up development projects in new markets and other projects.  We have two development parcels in China. One development parcel is located in South China where a two-building project

 

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aggregating approximately 275,000 rentable square feet is under construction. The second development parcel is located in North China where a two-building project aggregating approximately 272,000 rentable square feet is under construction.

 

Additionally, other projects include construction related to site and improvements at the Alexandria CenterTM for Life Science – New York City, a state-of-the-art urban science park in the city and in the adjoining future building approximating 410,000 rentable square feet.

 

Redevelopment

 

A key component of our business model is redevelopment of existing office, warehouse, shell space, or newly acquired properties into generic life science space, including the conversion of single-tenancy space to multi-tenancy space or multi-tenancy space to single-tenancy space that can be leased at higher rental rates in our target life science cluster markets.  As of September 30, 2010, we had approximately 617,662 rentable square feet undergoing redevelopment at 13 projects.  In addition to properties undergoing redevelopment, as of September 30, 2010, our asset base contained embedded opportunities for a future permanent change of use to life science space through redevelopment aggregating approximately 1.7 million rentable square feet.

 

The following table summarizes our properties undergoing redevelopment as of September 30, 2010:

 

 

 

 

 

 

 

 

 

Redevelopment

 

 

 

Total

 

 

 

Estimated

 

 

&