Alexandria Real Estate Equities Inc (ARE) 2003 Q2 法說會逐字稿

Thank you for standing by. Welcome everyone to the Alexandria Real Estate Equities second-quarter 2003 conference call. Today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn the conference over to Miss Rhonda Chiger. Ms. Chiger, please go ahead.

Thank you. Good afternoon and thank you for joining us today. This conference call contains forward-looking statements within the meaning of the Federal Securities Laws. The Company's actual results may differ materially from those projected in the forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in the Company's form 10-K annual report and other periodic reports filed with the Securities and Exchange Commission.

With that out of the way, I would like to turn the call over to Joel Marcus, Chief Executive Officer. Please go ahead.

Thank you, Rhonda. Good morning everybody. Welcome to our second-quarter '03 conference call. A few macro observations before we get into a review of the quarter. Our current economic sluggishness, we believe, is likely to continue through '04 and probably '05, based on what we think to be the Fed's thinking. It appears that a future recovery may be spurred by a confidence level to move cash from the sidelines into the sector, but probably buoyed by external events. Otherwise, there doesn't seem to be any likely visible stimulus ahead.

Our particular markets have been characterized basically as an anemic but stable, which isn't necessarily a bad thing in this environment. But our 2000 -- or our second-quarter was one of our quietest leasing quarters. We continue to place a significant amount of emphasis on our existing tenant relationships and existing relationships with non-tenants, were we can move those people into properties. And that's really where we're focused as you'll hear throughout the conference call today. Area is -- certainly is a good place to be in a tough market with a well-diversified geographic and life-science sector base, both assets and tenants.

On the pharmaceutical industry front, good news continues at the FDA under Commissioner McClelland. As I said during the first quarter conference call, key products approvals were very buoyant in the first quarter, including drugs for psoriasis -- an HIV drug can being marketed by Roche with a different mechanism of action than those currently existing which is going to prove very, very helpful from those suffering from HIV. A new cancer drug, a new asthma drug, and a new influenza drug among others.

The FDA's announced commitment to reduce the review time by 10 percent or more will clearly help reduce costs, make regulatory rules less onerous, and certainly I think loosen information aimed at consumers. And that's all I think macro good for the broad sector of pharmaceutical type products.

Moving specifically to the quarter and earnings guidance and dividend policy, we are certainly pleased with our $1.05 per share diluted for the second quarter. Approximately 8 percent growth in this very tough environment. EPS at 54 cents a share diluted, up 15 percent. In giving guidance for 2003, as we have in the press release, I want to highlight that we have zeroed in at the bottom of the range. Last quarter, we gave 4.23 to 4.27 and we would like to update and revised that to 4.23. But, certainly back-end loaded to the fourth quarter because of a pending significant sale to be completed this quarter, meaning Q3. That would be about 7.5 plus percent growth rate for the year which is still is one of the best in the office sector, again, in a continuing tough market environment.

You may see, over coming quarters, additional future selected dispositions as well. And we will keep you posted on that. EPS -- we have focused in at 224 per share diluted about a 27 percent increase over last year. Updating and revising our 2004 guidance again, we focused at the bottom end of the range at 455 per share diluted, again, back and loaded. Again, about a 7.5 plus percent growth rate in EPS at 271 per share diluted. So we feel very, very good about these numbers and, again, in a really tough environment.

As I mentioned last quarter the Board has increased the dividend -- did increase the dividend from 50 to 53 cents in the first quarter, a 6 percent increase. And it's pretty clear they are going to consider a mid-year increase in September. We believe this may be appropriate, given Alexandria's continuing strong free cash flow, conservatively estimated at about $30 million for this year. And this would certainly emphasize a continuing strong management policy toward maximizing our free cash flow, which we have tried to do every quarter since we came public. Generally speaking, the second-quarter -- revenue is up about 15 percent. FFO up about 21 percent. EPS, as I said, up about 15 percent.

And our diluted FFO per share of $1.05 -- about 8 percent growth rate. This, again, I think validates the core operating strength of the Company and the validity of our business model, which continues to pay off in rather sluggish times. Pete is going to detail same-store growth in some detail. But, again, GAAP and cash came in at about 1.9 percent. Key factors and trends here -- the numbers are stable. They're not negative. Rental rates and occupancy are continuing to grow, although slowly but steadily. He'll also talk about kind of the run rate for same-store growth.

Turning to leasing -- key factors and trends. This was a relatively slow leasing quarter. We did have 18 month-to-month leases during the quarter. Don't read anything into that number materially. It's really case-by-case. We have one significant lease in the Bay Area, where we have a non life-science tenant that is really renewing month-to-month, based on its future move and our re-development of that property. Another key lease in Massachusetts is rolling to a permanent lease, but is on month-to-month until that lease negotiation is finalized. That's true of a couple of leases in the Seattle market, pending re-development.

So, again, don't read anything necessarily macro-wise or materially into the month-to-month leases. We did have four renewed and releasable leases -- four leases for renewed or releasable space. You may notice that it was kind of a short-term number on that in the leasing schedule. That really was skewed by one lease of a tenant that renewed through year-end, but is moving to another location and then our moving up a current tenant who is expanding into that space. So, again, I wouldn't read anything necessarily fundamental into those numbers. We also had nine leases for re-developed or vacant space -- 31,000 for re-developed, 17,000 for vacant. And again, the key to growth in our whole leasing program is existing relationships and relationships that our tenants and relationships that we have that are non-tenants that we look to move into the portfolio over the next quarter or two -- which we have, I think, a pretty good feeling about.

Current vacancies -- about 6 percent have now been leased post-second -- end of second-quarter. About one-third of the total vacancies are under negotiation. About six, we're currently targeting for specific tenants or -- an amount of which that space is could comprise of office, simply sits vacant, were we don't have much activity. The remaining 2003 rolls about 8 percent of the portfolio -- about 423,000 feet -- about 275,000 feet roll in this third quarter. About 20 percent-plus is committed. About another 25 percent, we anticipate. About 14 percent we'll roll into the re-development pipeline. And about 41 percent is too early.

But of the too early, 90 percent of that amount is office. So, it will likely be kind of a sluggish time in trying to find tenants for that space, much like the rest of the office sector. The fourth quarter, we expect to have about a 148,000 square feet. About 55 or 56 percent of that is either committed or anticipated, with the balance of about 44 or 45 percent either too early to tell or part of that will go into the re-development pipeline. Minimal office space coming up in the fourth quarter. We still are guiding the street to maybe somewhere around 5 percent mark-to-market. But that's very lease and space specific.

Moving onto the redevelopment program. It did pop up a little bit this quarter to 417,000 feet -- about 7 percent of our total square footage. But below the historical average of about 8 to 12 percent. And it was up from about 383,000 feet in the first quarter, but below the end of the fourth quarter of 429,000 feet. I think you will see that trail down over the next few quarters. We did deliver one property in the suburban DC market for about 21,000 feet of re-developed space this quarter and look to deliver one or two properties and converted spaces next quarter, as well.

The additions were one Bay area redevelopment added when a non life-science tenant moved out and one recent acquisition in the Massachusetts market that will be re-developed and purchased for that purpose, with a specific tenant or potential tenant in mind. Q3 '03 deliveries will likely deliver one or two properties in the third quarter. Again to re-emphasize, we're targeting existing tenant relationships and existing high-quality relationships which are not tenants, but who we have on-going, very detailed discussions with.

On the development side, the developments held steady at about 477,000 square feet. About 8 percent of our total portfolio. Again, these should trend-down over the next few quarters. And our strategy is the same as the re-development -- expanding existing high-quality tenant relationships that we have or maximizing our relationships with existing relationships that are non-tenants.

On the acquisition and disposition side, people have some comments on the disposition which will likely close here in the third quarter. And we continue to see a variety of interesting opportunities on the acquisition side. Although, we have not made any specific movement and we will continue our very judicious and, I think, very disciplined approach toward our deployment of capital and our return on invested capital which we have always done since the day we came public.

Moving to the balance sheet -- our debt to total market cap ended up the quarter about 41.4 percent. So, it's strong and de-levered. We certainly have the ability to take advantage of low, long-term interest rates which, again, Pete will talk about. We are and we have and will continue to do that. You may see some increase in leverage over time, if we see significant external opportunities that make sense. We continue our aggressive strategy in this environment to fix long-term, fixed-rate debt in this favorable environment. We closed last week on a $30 million fixed-rate, ten-year loan, which you can see from the press release. And we expect more activity during the balance of 2003.

Our margins continue to be stable and -- at about 79 percent, which is kind of within the historic norm. Our ratios continue. Other financial metrics -- very strong. Our interest coverage ratio is over four-times -- fixed-charge, about 3.3 times. We have no current reserve for bad debts. And our accounts receivable as a percentage of rents and recoveries are at a very low point of about 6 percent. So, that is good news.

Before I turn it over to Pete for variety of comments, I would like to comment generally on the Company's disclosure. It's important to remember that Alexandria is a very unique company with a unique niche. It's a non-commodity premium product. And its focus in business model have proven to be a safe haven and a growth engine, even in very challenging times for the over six years since we came public. We'll continue to preserve our value, both for shareholders and, I think, our important franchise. And we will guide our disclosure according to those important precepts.

So, why don't I turn it over to Pete Nelson for a few minutes, on a variety of other quarter highlights.

Thanks Joel. I'm going to comment on a number of matters of financial concern, starting with the same property results which are found on page 10 of our press release. As Joel mentioned, during the second quarter of '03, GAAP-basis NOI for the same property pool was up 1.9 percent. Also up 1.9 percent on a cash basis. Cash basis is usually up a little more than that. And indeed it would have been up 4.6 percent without a single prepayment in the second quarter period of '02 for a one property in the Bay area, which kind of held down the comparison on a cash basis -- prepayment of rent.

About half of the increase in NOI is from an increase in rental rates in the same property pool. About half is from an increase in occupancies. The same property pool occupancy, as of June 30 '03, was 97.1 percent compared to 96.7 percent last year. My guidance for 2003 for the same property pool is 2 percent, which is about the same as I said last quarter. And for the six-month, you'll see it's up 2.2 percent. So, we're still in that set targeted range.

I'm commenting a little bit on operating expenses which have moved around a little bit for the same property pool. Remember that 88 percent of our properties are fully triple-net leases -- actually we call them quadruple-net. And another 7 percent, we recover about 7 percent -- a majority of the operating expenses from another 7 percent of the property. So, 95 percent of the properties, we have operating expense protection. Just commenting a little bit. Operating expense for the quarter were up 10 percent, compared to the same period last year.

This quarter, the increase was due to property taxes, HVAC expenses, certain properties, and property insurance expense. Property insurance, as you would guess, is up this year, compared to last year, due to the extremely high cost of property insurance and terrorism insurance. We're a June 1 renewal and just went through our renewal, where we experienced a decline in -- significant decline in property insurance. So, overall, we expect property and liability to decline -- property and liability insurance to decline about 22 percent, on a go-forward basis.

Operating expenses compared to second quarter of '03, compared to the first quarter of '03 are also down. The first quarter was an unusual quarter, due to the harsh winter in the Northeast. And so we had high utility costs and snow removal costs at our properties in the Northeast region of the US. As always, no termination fees are included in our same-property results. So they are not skewing that. Operating margins, as Joel mentioned, for the second quarter are back in the 79 percent range.

This is a good run-rate on a go-forward basis. And for the full year 2002, our operating margins were at 79 percent. Looking back at the first quarter, you might recall there was a slight seasonal decline in the margins during the first quarter. Not really in the bottom-line. But just in the margins, due to the recoverable costs for utilities and snow removals at some of the same-store properties.

Turning to the pay-out ratio, I'll just make a couple of brief comments, and since Joel mentioned, some things about the dividend. We are not up against any tax requirements to distribute more of our taxable income. We do not expect this for another couple of years. Our current pay-out ratio is right at about 50 percent -- 50.5 percent. So it's quite low. Now, turning to our property and discontinued operations. Looking back at what it has been and what it is on a go-forward basis. We continue to apply the provisions of FAS 144 in reporting our discontinued operations. We have one property in our discontinued operations portfolio in the second quarter. We sold one property in the Bay area, in the first quarter, for a $6.8 million sales price.

The remaining property designated as held for sale should be sold this quarter, in the third quarter. The property will be sold for approximately $45 million, at a gain of about $8.8 million. The proceeds will be used to pay down the line, as well as -- there's a piece of debt associated with it, that will be assumed by the buyer. The average debt -- the average rate on those two debt transactions will be 4.75 percent. So, you can kind of use that in your modeling. The lost NOI from this asset will be about $1 million a quarter. As I said, the first full quarter for that will be the fourth quarter. But some of it will be this quarter. And from a tax standpoint we'll be using a combination of reversed and forward 1031 exchange to defer the gain on this transaction, from a tax standpoint.

Turning now to our secured-loan program -- our view of debt and our swap program. As mentioned in our press release and referred to by Joel, we did close on a $30 million loan last week. A 6.36 percent interest rate, fixed-rate. It's a ten-year loan, based on a 30-year amortization schedule. This loan is consistent with our program that consists -- to convert some of our variable-rate borrowings to fixed-rate debt. Approximately balance the fixed and variable-rate components of our debt over the long-term.

We continue to be recognized by lenders for our corporate quality and our premier assets and tenants. So we've not had any issues in financing our assets. Looking at our swap schedule which is an our -- near the end of our press release, we have $200 million of our variable-rate debt hedged at rates from about 3.1 percent to 5.3 percent at latter maturities through June of 2006. Represents about 59 percent of our line of credit balance, adjusted for this week's financing. With the closing of the loan, last week -- $30 million loan, and the anticipated pay down in the variable-rate line from the sales proceeds of the sale transaction, the unhedged or unswapped portion of our floating-rate debt will be reduced to this 17 to 18 percent level of total debt.

I also want to comment on our accounting for our re-development assets. Sometimes I am asked about that, from time to time. We do our accounting for re-development and related costs in accordance with applicable GAAP, which is generally FAS number 34 and FAS number 67. Interest and operating expenses are capitalized for only that portion of the property undergoing re-development. In other words, if you look at our re-development schedule, we show the total property as well as the portion undergoing re-development -- we do it on a pro rata basis for only that portion undergoing re-development.

Capitalization of these types of costs continue, only while re-development activities are ongoing. And certainly, no later than one year after cessation of major re-development activity. Capitalized about 1.2 million of interest during -- associated with re-developments during the second-quarter of '03. And then, just one last reminder regarding FAS 141, since it's of interest in the real estate world. We have no impact for FAS 141 for any periods that we have disclosed.

Ok, I'd like to ask the Operator to open up for Q&A.

Thank you. Kent Green, Boston American. (ph)

Yes. Good quarter fellas. My quick question pertains to where you stand on the pay-out percentage, versus the 95 percent rule, which I think is still in existence, of earnings?

Okay. Thank you Kent, this is Pete. We are paying out about 50 -- 50.5 percent of our cash flow or of our FFO, I should say. With respect to taxable income, we are not bumping up against that 95 percent. And based on our projections, looking out a couple of years, we don't see that becoming a factor for at least two years -- at least until '06, I would say.

And then, you said that you're considering a mid-year dividend increase. Is this normal, to say you would consider dividend increases twice a year?

Kent, let me answer that. It has not necessarily been normal for us. But given the fact that, historically, our dividend and our pay-out ratio have been at the low end of the spectrum -- and in light of today's environment -- the Board is going to consider a mid-year -- my guess is -- a modest mid-year raise. That would still be for the year, probably on average, less than the growth of -- potentially less or approximating the growth in FFO.

Tony Pallone, J.P. Morgan. (ph)

Hi. Good morning, just a few items here. Can you talk about the expiration schedule for 2004 -- what percentage of those or how much in terms of square feet you anticipate taking out for re-development?

About 15 or 16 percent total. So, it's pretty small.

Okay. In terms of looking at the rents --

I'm sorry, if you look at -- you're looking at 2004 total? Yes, I would say it's closer to about -- less than 10 percent -- total for 2004.

Less than 10 percent. Okay. And then, in terms of looking at those rent rolls, how would you characterize market versus those expiring rents, right now?

For 2004?

Yeah, I think they were about $21?

Yes, it's so market-specific. And so property-specific. But I would say the guidance would be somewhere in the 5 -- maybe at the upper-end 10 percent. But I think 5 would be probably pretty good. That's the guidance we have given for this year. I think, again, given the sluggish nature of the economy in all sectors, it would be probably imprudent to speak a number above that amount.

Okay. In terms of your properties under development -- the two properties expected to come into service in the balance of 2003 -- can you talk about leasing prospects at each of those and how you see those penciling out?

Yes, let me just give you kind of a -- say, the best framework, as best I can. The 95,000 square-foot development in the suburban DC market, which we are hoping to deliver over the next -- this quarter or so. And when you develop in this area, development is always complex because the design, the programming, the development, oftentimes track a lease negotiation. And it is very rare to actually sign a lease ahead of time, generally speaking. We're hoping to tenant that space with existing tenant relationship to for a full-building user. And that's what we're hoping for. But we certainly have nothing to announce at this point. The remaining development in the San Diego market is very similar. And it would be a relationship that's not currently a tenant. But one we've had a long-term relationship with. And we're hoping to end up with a full-building user there. Although, that's about a quarter behind the one in the suburban D.C. market.

In terms of the guidance that you talked about -- what do you assume in those numbers?

We assume that the one in D.C. does get done in the fourth quarter of '03. But we have assumed no further leasing on the development. As per my normal conservative nature, we've left those about.

Just a couple of small items. The straight-line rents in the second-quarter. Do you have that number?

I do. Approximately 1.3 million.

Pete, you mentioned 1.2 million in capitalized interest. Is that just strictly for the re-development properties.

That is correct. I should point that out. Let me give it as a total. I just wanted to comment a little on our activity on the re-developments. But, it's about 3.6 million for the quarter overall. It did tick-up this quarter, compared to last quarter, due to the acquisition of the development assets in the first quarter of '03. That was in Seattle -- on-stream there.

Okay, great. Thank you.

Brian Lake, Merrill Lynch. (ph)

Hey Joel, can you just give us little color on the pace of leasing activity. Clearly, it flowed from the first to the second quarter. And also, if you look year-over-year, leasing is down. Can you just give an idea of what is going on? Is it a factor of -- that the amount of lease rollover exposure we have in this quarter? Or is it just tenants are pushing off -- (technical difficulty)

I think it's pretty clear, as I tried to allude to in my opening, Brian, that leasing, certainly across the board in all sectors, is down and sluggish. I think the lab market is, in a sense, no difference. It tends not to have the swings that office does, either on the upside or, certainly, on the down side. It operates historically in a much narrower band. I think that is good. But I think it's pretty clear that I characterize the markets as pretty anemic. And I think that is true. Across the board East and West.

And I think that the key to our success, as you will likely see over the next few quarters, will be really maximizing existing relationships where we have the ability to expand tenants that we believe are high-quality and that have opportunities for growth. As opposed to just people walking in the door. We almost never do business like that. But nonetheless, I think that's where the core growth will come from over the next few quarters. But, we expected it to be relatively sluggish for the foreseeable future.

If you look at the stock prices, which have done reasonably well since the beginning of the year -- pretty darn well. You would expect that there might be some re-igniting of demand as they have more capital. And it sounds like, from a global overview of looking at what is going on with the FDA, it sounds like things are getting faster-track. So, these should all be positive. I'm wondering why you think tenants are pushing back decisions? Part of it -- are you seeing an increase in supply in certain markets, which makes the competition more difficult?

Well, a couple of hard questions. Let me speak to the markets. As you know, I you looked at the biotech sector which is only a sector that we focus on, not the sector -- yeah, stock prices were up. The markets were pretty bland in the first half. But that really belies the underlying weakness of the sector. Really the stocks -- a lot of stocks went up. But most of it is really focused on the high-end companies with product approvals -- Genentech, Amgen, etc. But it is not -- I wouldn't read into that kind of stock blip, any fundamental change in the depressed nature of the sector. It continues to be pretty depressed.

And I don't see a change in that for the foreseeable future. But that is a sector that we focus on, just one of a number. So, I think you can't read much into that. I think the product approvals again are mostly at the larger-company level. And so those companies continue to grow and prosper. But broadly speaking, a lot of companies are withholding any decisions for the future, pending much more focus on product approval. And there is a big pipeline at the FDA. And even though it's getting faster and a little bit easier under Mark McClellan's leadership, it is going to take time for a lot of the companies in that particular sector, whether it be Farmer or even the biotech sector, to get their products through. There's just a big, big logjam there.

So I think two fundamental things are impacting the sector. One is the macroeconomic markets, which just are poor and sluggish and no change in-sight. And two, I think it's very company-specific. And where companies do have product approvals, they can kind of give the green light to expansion. Where they don't, they would be foolish to do so. By the way, we are cautious. People who have come to us through third parties where we don't believe it's prudent to expand with that client, we have declined to enter into lease negotiations. We've done that actually quite a bit. They can go off to somebody else and make a decision. But we don't believe, either we think the risk of product approval is too high, or we think the time is not within the -- I had a discussion with the CEO of a company back east last week. They thought they were going to get an approval very quickly. And I was just saying I didn't believe it.

And I think we have to manage our portfolio and our risk within the Company very carefully. And I think that has been a hallmark of this Company in working with high-quality tenants. I think the other thing is supply. I would say there is certainly more supply, due to just available space and some subleases based in different markets. But, overall, I would say broadly speaking, nationwide, if you took an average of the markets -- probably don't have more than -- you know it varies a little bit -- more than either high-single-digits or low-double-digit vacancy rates, compared to maybe 1.5, 2.5 times that in the office sector. So I don't think that's the factor, primarily.

How about space that could be -- you're talking about just the low leasing. But are people -- are you seeing more people market space that could be converted, that they don't plan to convert it unless somebody comes to them -- (multiple speakers)?

No, because that's not real space. Because, if you need to deliver, you need to deliver it pretty quickly. And somebody who's just got to sign up -- you know, there's a famous case. If you have some telecom building somewhere that you want to convert -- just to put a sign up is meaningless for almost everybody. It sounds impressive. But it's, frankly, not very impressive. And usually, most of those locations are either secondary or tertiary locations that most people wouldn't really -- high-quality companies wouldn't generally consider -- maybe poor or weaker companies would. And those are ones we don't really care to do business with.

With the sluggish environment, are you feeling any pressure on rents? Or are rents pretty much sticking? It's just a matter -- (multiple speakers)

I think is some pressure on rents in some submarkets. But I think, overall, things are relatively stable. They weren't as strong as they were a year or so ago. But I think, certainly, you aren't seeing what's happened in the office markets across the country. As I said, the ups are not the ups of the office market and the downs are not the downs of the office market.

Turning to some of your low -- your relatively low occupancy markets in Raleigh and Eastern Massachusetts. You've talked in the past about having a couple of really non-core assets, either being warehouse or lab offices -- really in the non-core marketing in eastern Massachusetts. Could you just give us the update on those properties?

I think if you look at the press release, the occupancy is skewed a little bit by a little vacancy in Pasadena, where we have a single asset. But I wouldn't read much into that. That will probably be filled fairly soon. I think Eastern Massachusetts -- the 10 percent big vacancy or 9 percent vacancy there, primarily due to a weaker outer suburban market for lab space. And one specific asset we have south of Boston, which is a tough market. And we are looking to probably sell that asset or lease it. But that is a sluggish submarket. So that kind of weighs down the number. Although, the square footage and the rental rates are not very significant.

So they don't really have -- although the occupancy seems low, the actual impact to the Company is pretty minor. In the southeast we do have one significant office building with a fair amount of vacancy which weights down that number. But, again, it's not a huge amount of space and the rental rates are actually quite small. So, the percentages, at 95.5 this quarter, are lower than they have been historically. But I think the number that probably is more important is the number Pete gave, on same-store property, which was over 97 percent. And that is probably more indicative of where we are, realistically.

Last couple of questions. You talked about a portion of the 565,000 square feet. 10 percent will go into the re-development pipeline. Do you have any of that 565,000 square feet, either signed or in a letter of intent, right now?

We would categorize it either committed or we anticipate commitment at about 35 percent. So that's pretty good. That's for '04, are you asking?

Yes.

And then, the re-development actually comes in at just below 9 percent. So, it's actually fairly low. And then there is hard-core amount of office that we'll just have to wait to see.

How much of the '04 rollovers is office?

Let me see. I am not sure I can give you that exact number. But I can find it out and we can let you know.

Last question. You said the size of the mid-year dividend increase would be modest. Would there be -- normally you raise in the first quarter. Would you expect another modest raise in the first quarter of '04?

Assuming nothing changes, I would think the Board would give due consideration to that, yes.

Ralph Block, Bay Isle Financial. (ph)

Hi guys. Just following up for a second, on Brian's question. Do you see any kind of shift, either now or perhaps over the next few quarters, in terms of where the incremental demand for space is going to come from among the various types of tenants you now serve?

I think I do. But I'm not sure I would publicly announce that. I think what I would like to say is, I think it's better to think, in terms of us, of coming from existing tenants who are growing, that have near-term product approvals and that are growing at relatively fast rates, would be a I think one way to characterize that, Ralph. As opposed to a sector in general.

Of course, I assume there is a lot of variances among each sector, as well?

Absolutely.

Are you seeing any kind of fallout at all? Or reluctance to lease space from any tenants because of the California budget problems?

That's a good question. We have not seen it yet. We don't have big vacancies in California. But it is something to think about. There is, I guess, a proposal to even repeal Prop 13. But so far, I think it's way too early to see any fallout yet. But I think it's pretty clear that the Bay area continues to be -- again, we have pretty minimal vacancy in that market. So we don't have much exposure. But I think it's pretty clear that that's the one market in California that I think is probably at risk, more than any other market. Just -- I think that's broadly true of all sectors. Not only the lab market, but I think the office sector. And we are certainly seeing -- I mean, Pfizer announced this past quarter that they were not going to do business in San Francisco. They had made an acquisition there and they have announced that they are closing down that operation and either firing people or transferring them either back east or down to San Diego. So, that's not a good sign.

Okay. Just, if you could refresh my memory a little bit. I think you've talked about this before. But how do you think about property sales? When do you decide to sell? Is it typically a vanilla variety office that doesn't really have much prospects for the kind of properties you like to own?

Well, I think that's the easiest category -- where if we have non-core assets, either in submarkets we've decided not to pursue additional clustering in, that would certainly be true. That was true of the first quarter sale. Although, we were frustrated by local approvals in that situation. The third quarter sale is an important asset. But we decided for variety of reasons -- we'll make known next quarter why it was sold. I think we would consider a variety of sales in a variety of ways, really to maximize our invested capital.

And if we saw opportunities where we see the future, either the future value being maximized. Or for some reason we had an opportunity to redeploy the capital in a more accretive fashion, I think we would try to be creative. There are a variety of assets we simply probably wouldn't sell, unless the offer was so compelling, we had to take a second breath. But I think we're pretty flexible about how we think about that. The real key is how best to replace that invested capital. Or if not to consider, again, further dividend payments to shareholders.

Keith Mills, UBS. (ph)

How are you? Joel, could you give us an update, in terms of what type of trends you're seeing for leasing from European-based pharmaceutical companies, versus maybe what you're seeing from U.S. companies or U.S. organizations, for your space?

I don't think you can generalize on trends for European companies. You really have to look at each company case-specific. I think, if you look at the top 10 pharmaceutical companies, it's pretty clear there will be further consolidation. I think companies like Schering-Plough, etc. probably -- maybe even Bristol -- are probably companies that will not be stand-alone companies for the future, whether they're bought by European companies or U.S. companies, who knows. I think Novartis is probably the one dominant European company. I think the rest are pretty far back, as far as their impact on the States. So, I don't think you can make a generalization.

You're not seeing increased demand from European pharmaceutical companies for space here in the U.S., relative to maybe what you're seeing from the U.S. companies?

I would say no. Again, it's a highly case-specific submarket building need. So it's not like -- these are not trends you could track. They're really very specific company types of situations.

My second question for Joel is, how is technology changing kind of R&D development in either pharmaceutical or biotechnology research? And what impact do you think that may have on the leasing space over the next several years?

That a pretty good question. That's a many, many part question. I think it's pretty clear though, that's technology is having an important impact. But I think, when you get down to it, especially -- a number of the heretofore what used to be considered kind of unique technologies, now have been embedded into the drug discovery process, whether it be high-throughput screening or a variety of other techniques and mechanisms -- the whole chip market, etc. Years ago, those were looked at as kind of unique situations. Today you can't really do drug discovery without those techniques.

But I think it's fair to say basic chemistry and basic biology and basic informatics will continue to be the hallmarks of successful drug discovery. And those companies or entities or whatever that are able to successfully integrate and utilize those three base technologies and have the brain-power to move those ahead, I think, will be the ultimate winners. It's not like you are going to eliminate lots of technicians, lots of Ph.D.s -- you can't skip chemistry. You can't skip the whole fundamental world of systems biology, just to get to a drug. It just is not going to work that way. Certainly, in the short to medium-term. Maybe someday that will happen. But I don't think in my immediate future here.

Then just finally. Have you noticed of your tenants, that they have cut back on CapEx spending, related to technology as maybe companies in other sectors have over last several years? And maybe they're due to kind of step-up their technology spending?

That's another really good question. I would say that the bigger and more successful companies -- the companies with products that that is not true of, they've actually continued to invest in CapEx -- a whole variety of things. I think it's -- the companies that may be more marginable -- more margin -- on the margins, if you will, have kind of either cut it or reduced it -- eliminated it. And I think those are the people that, whether the economy comes back or not, the gross impact of what they may do is fairly insignificant or weak. So, I'd say this sector operates pretty fundamentally differently than the high-tech sector. You can't look at those items. I mean, if you looked at what Pfizer's investments are or you look at some of the other companies -- Lilly's another one -- that trend certainly is not true.

I appreciate the feedback, thank you.

David Comp, RBC capital. (ph)

Could you talk a bit about what you believe the market opportunity in Pasadena is? When you entered that market, at least my assumption was that we would see a couple of acquisitions in pretty short order. Now, it's been a good year and a half and I haven't seen anything there. What are your views on that market. It sounds like, from your comments, Joel, that you're pretty comfortable with the lease-up of your asset there. What can we expect next, in that market?

As I think we said from the beginning, the market is certainly a pretty small one. Actually, it's not even a market. We're really creating the market here. We're based here. And it makes sense to have some presence here. We have an exceedingly strong network in the L.A. Basin. And you may see other property situations emerge over time. I'm not sure I could predict that. It really is so dependent on, really, the strength of the economy.

I think Pasadena as a location has a lot to learn from some of the other markets. Because if you don't have a historically important cluster, where you have layers of management, both scientific and business, who have been there and done it, it's hard to start companies. It's not an institutional market. There are no big pharmas here. There is some non-profit here. But it's really a beginning market. So we look at our efforts here, really, more in the 5 to 10-year time-frame. But I think you will see some further activity here. But it's not really material to the Company.

Are the rents that you are getting there pretty much in-line with what you pro formaed when you made that acquisition?

I would say they're probably ahead of that. But again, we're setting the market. Because there really is nothing -- there are no other real -- you know, there is really not a market here. But the answer is, yes.

Okay. It didn't sound like you were ready to talk about it yet. But what was the motivation for the sale that we're looking for in the third-quarter?

Yeah, I think, until it closes, we're under strict confidentiality. So we won't be able to talk about that until it happens.

This does conclude today's question-and-answer session. At this time, I would like to turn the conference back to Joel Marcus for a closing remark.

I want to thank you for attending the second-quarter '03 conference call. And we look forward to reporting '03 results. And again, many thanks and good afternoon.