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, 2006
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: 1-9044
DUKE REALTY CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
Indiana |
35-1740409 |
(State or Other Jurisdiction of Incorporation or Organization) |
(I.R.S. Employer Identification Number) |
|
|
600 East 96th Street, Suite 100 |
46240 |
(Address of Principal Executive Offices) |
(Zip Code) |
|
|
Registrants Telephone Number, Including Area Code: (317) 808-6000 |
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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.
Large accelerated filer x Accelerated filer o Non-accelerated filer 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
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date:
Class |
|
Outstanding at November 1, 2006 |
Common Stock, $.01 par value per share |
|
135,225,177 shares |
DUKE REALTY CORPORATION
INDEX
PART I - FINANCIAL INFORMATION
DUKE REALTY CORPORATION
AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(in thousands, except per share data)
|
|
September 30, |
|
December 31, |
|
||
|
|
2006 |
|
2005 |
|
||
|
|
(Unaudited) |
|
|
|
||
ASSETS |
|
|
|
|
|
||
Real estate investments: |
|
|
|
|
|
||
Land and improvements |
|
$ |
751,529 |
|
$ |
675,050 |
|
Buildings and tenant improvements |
|
4,378,929 |
|
4,156,456 |
|
||
Construction in progress |
|
332,857 |
|
227,066 |
|
||
Investments in unconsolidated companies |
|
453,484 |
|
301,322 |
|
||
Land held for development |
|
696,551 |
|
429,270 |
|
||
|
|
6,613,350 |
|
5,789,164 |
|
||
Accumulated depreciation |
|
(860,504 |
) |
(754,742 |
) |
||
|
|
|
|
|
|
||
Net real estate investments |
|
5,752,846 |
|
5,034,422 |
|
||
|
|
|
|
|
|
||
Real estate investments and other assets held-for-sale (see Note 8) |
|
838,556 |
|
|
|
||
|
|
|
|
|
|
||
Cash and cash equivalents |
|
25,000 |
|
26,732 |
|
||
Accounts receivable, net of allowance of $1,078 and $1,093 |
|
21,758 |
|
31,342 |
|
||
Straight-line rent receivable, net of allowance of $1,693 and $1,538 |
|
105,245 |
|
95,948 |
|
||
Receivables on construction contracts, including retentions |
|
62,955 |
|
50,035 |
|
||
Deferred financing costs, net of accumulated amortization of $18,194 and $14,113 |
|
50,916 |
|
27,118 |
|
||
Deferred leasing and other costs, net of accumulated amortization of $125,843 and $112,245 |
|
251,538 |
|
227,648 |
|
||
Escrow deposits and other assets |
|
164,728 |
|
154,315 |
|
||
|
|
$ |
7,273,542 |
|
$ |
5,647,560 |
|
|
|
|
|
|
|
||
LIABILITIES AND SHAREHOLDERS EQUITY |
|
|
|
|
|
||
|
|
|
|
|
|
||
Indebtedness: |
|
$ |
371,465 |
|
$ |
167,255 |
|
Secured debt |
|
2,800,218 |
|
2,050,396 |
|
||
Unsecured notes |
|
904,000 |
|
383,000 |
|
||
Unsecured line of credit |
|
4,075,683 |
|
2,600,651 |
|
||
Construction payables and amounts due subcontractors, including retentions |
|
125,299 |
|
93,137 |
|
||
Accounts payable |
|
82 |
|
781 |
|
||
Accrued expenses: |
|
|
|
|
|
||
Real estate taxes |
|
78,255 |
|
60,883 |
|
||
Interest |
|
31,976 |
|
33,022 |
|
||
Other |
|
47,833 |
|
54,878 |
|
||
Other liabilities |
|
111,419 |
|
133,920 |
|
||
Tenant security deposits and prepaid rents |
|
32,309 |
|
34,924 |
|
||
Total liabilities |
|
4,502,856 |
|
3,012,196 |
|
||
Minority interest |
|
172,230 |
|
182,566 |
|
||
|
|
|
|
|
|
||
Shareholders equity: |
|
|
|
|
|
||
Preferred shares ($.01 par value); 5,000 shares authorized; 3,241 and 2,365 shares issued and outstanding |
|
876,250 |
|
657,250 |
|
||
Common shares ($.01 par value); 250,000 shares authorized; 135,160 and 134,697 shares issued and outstanding |
|
1,352 |
|
1,347 |
|
||
Additional paid-in capital |
|
2,277,650 |
|
2,266,204 |
|
||
Accumulated other comprehensive income (loss) |
|
4,840 |
|
(7,118 |
) |
||
Distributions in excess of net income |
|
(561,636 |
) |
(464,885 |
) |
||
Total shareholders equity |
|
2,598,456 |
|
2,452,798 |
|
||
|
|
$ |
7,273,542 |
|
$ |
5,647,560 |
|
See accompanying Notes to Condensed Consolidated Financial Statements.
2
DUKE
REALTY CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
For the three and nine months ended September 30,
(in thousands, except per share data)
(Unaudited)
|
|
Three Months Ended |
|
Nine months Ended |
|
||||||||
|
|
2006 |
|
2005 |
|
2006 |
|
2005 |
|
||||
RENTAL OPERATIONS: |
|
|
|
|
|
|
|
|
|
||||
Revenues: |
|
|
|
|
|
|
|
|
|
||||
Rental income from continuing operations |
|
$ |
208,253 |
|
$ |
170,022 |
|
$ |
599,175 |
|
$ |
486,534 |
|
Equity in earnings of unconsolidated companies |
|
3,492 |
|
4,143 |
|
21,447 |
|
25,033 |
|
||||
|
|
211,745 |
|
174,165 |
|
620,622 |
|
511,567 |
|
||||
Operating expenses: |
|
|
|
|
|
|
|
|
|
||||
Rental expenses |
|
46,073 |
|
40,502 |
|
136,498 |
|
115,885 |
|
||||
Real estate taxes |
|
23,086 |
|
21,684 |
|
69,752 |
|
59,403 |
|
||||
Interest expense |
|
50,173 |
|
30,523 |
|
133,288 |
|
86,123 |
|
||||
Depreciation and amortization |
|
63,892 |
|
59,494 |
|
187,099 |
|
164,239 |
|
||||
|
|
183,224 |
|
152,203 |
|
526,637 |
|
425,650 |
|
||||
Earnings from continuing rental operations |
|
28,521 |
|
21,962 |
|
93,985 |
|
85,917 |
|
||||
SERVICE OPERATIONS |
|
|
|
|
|
|
|
|
|
||||
Revenues: |
|
|
|
|
|
|
|
|
|
||||
General contractor gross revenue |
|
100,314 |
|
103,879 |
|
223,924 |
|
292,303 |
|
||||
General contractor costs |
|
(93,555 |
) |
(93,750 |
) |
(206,561 |
) |
(267,906 |
) |
||||
Net general contractor revenue |
|
6,759 |
|
10,129 |
|
17,363 |
|
24,397 |
|
||||
Property management, maintenance and leasing fees |
|
3,335 |
|
4,092 |
|
10,626 |
|
12,124 |
|
||||
Construction management and development activity income |
|
11,665 |
|
8,092 |
|
12,948 |
|
28,124 |
|
||||
Other income |
|
715 |
|
271 |
|
1,261 |
|
3,382 |
|
||||
Total revenue |
|
22,474 |
|
22,584 |
|
42,198 |
|
68,027 |
|
||||
Operating expenses |
|
11,923 |
|
10,025 |
|
23,721 |
|
30,584 |
|
||||
Earnings from service operations |
|
10,551 |
|
12,559 |
|
18,477 |
|
37,443 |
|
||||
General and administrative expense |
|
(6,804 |
) |
(5,803 |
) |
(27,715 |
) |
(21,308 |
) |
||||
Operating income |
|
32,268 |
|
28,718 |
|
84,747 |
|
102,052 |
|
||||
OTHER INCOME (EXPENSE) |
|
|
|
|
|
|
|
|
|
||||
Interest and other income, net |
|
4,381 |
|
1,517 |
|
8,313 |
|
3,676 |
|
||||
Earnings from sale of land, net of impairment adjustments |
|
2,982 |
|
2,371 |
|
5,427 |
|
5,779 |
|
||||
Other minority interest in earnings of subsidiaries |
|
(126 |
) |
(1,396 |
) |
(301 |
) |
(1,462 |
) |
||||
Minority interest in earnings of common unitholders |
|
(2,306 |
) |
(1,897 |
) |
(5,314 |
) |
(6,934 |
) |
||||
Income from continuing operations |
|
37,199 |
|
29,313 |
|
92,872 |
|
103,111 |
|
||||
Discontinued operations: |
|
|
|
|
|
|
|
|
|
||||
Net income (loss) from discontinued operations, net of minority interest |
|
(35 |
) |
3,042 |
|
4,233 |
|
10,344 |
|
||||
Gain on sale of discontinued operations, net of impairment adjustment and minority interest |
|
39,796 |
|
192,612 |
|
41,620 |
|
200,532 |
|
||||
Income from discontinued operations |
|
39,761 |
|
195,654 |
|
45,853 |
|
210,876 |
|
||||
Net income |
|
76,960 |
|
224,967 |
|
138,725 |
|
313,987 |
|
||||
Dividends on preferred shares |
|
(15,226 |
) |
(11,619 |
) |
(41,193 |
) |
(34,859 |
) |
||||
Adjustments for redemption of preferred shares |
|
|
|
|
|
(2,633 |
) |
|
|
||||
Net income available for common shareholders |
|
$ |
61,734 |
|
$ |
213,348 |
|
$ |
94,899 |
|
$ |
279,128 |
|
Basic net income per common share: |
|
|
|
|
|
|
|
|
|
||||
Continuing operations |
|
$ |
.16 |
|
$ |
.13 |
|
$ |
.36 |
|
$ |
.48 |
|
Discontinued operations |
|
.30 |
|
1.37 |
|
.34 |
|
1.47 |
|
||||
Total |
|
$ |
.46 |
|
$ |
1.50 |
|
$ |
.70 |
|
$ |
1.95 |
|
Diluted net income per common share: |
|
|
|
|
|
|
|
|
|
||||
Continuing operations |
|
$ |
.16 |
|
$ |
.12 |
|
$ |
.36 |
|
$ |
.47 |
|
Discontinued operations |
|
.29 |
|
1.36 |
|
.34 |
|
1.47 |
|
||||
Total |
|
$ |
.45 |
|
$ |
1.48 |
|
$ |
.70 |
|
$ |
1.94 |
|
Weighted average number of common shares outstanding |
|
135,117 |
|
142,663 |
|
134,957 |
|
143,076 |
|
||||
Weighted average number of common and dilutive potential common shares |
|
150,947 |
|
158,468 |
|
149,472 |
|
157,453 |
|
See accompanying Notes to Condensed Consolidated Financial Statements
3
DUKE
REALTY CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
For the nine months ended September 30,
(in thousands)
(Unaudited)
|
|
2006 |
|
2005 |
|
||
Cash flows from operating activities: |
|
|
|
|
|
||
Net income |
|
$ |
138,725 |
|
$ |
313,987 |
|
Adjustments to reconcile net income to net cash provided by operating activities: |
|
|
|
|
|
||
Depreciation of buildings and tenant improvements |
|
155,156 |
|
157,260 |
|
||
Amortization of deferred leasing and other costs |
|
34,956 |
|
37,713 |
|
||
Amortization of deferred financing costs |
|
6,093 |
|
4,687 |
|
||
Minority interest in earnings |
|
10,153 |
|
28,439 |
|
||
Straight-line rent adjustment |
|
(15,263 |
) |
(16,887 |
) |
||
Earnings from land and depreciated property sales |
|
(46,734 |
) |
(225,371 |
) |
||
Build-for-sale operations, net |
|
(163,106 |
) |
12,783 |
|
||
Construction contracts, net |
|
(208 |
) |
4,542 |
|
||
Other accrued revenues and expenses, net |
|
(10,117 |
) |
7,643 |
|
||
Operating distributions received in excess of (less than) equity in earnings from unconsolidated companies |
|
(4,990 |
) |
(894 |
) |
||
Net cash provided by operating activities |
|
104,665 |
|
323,902 |
|
||
Cash flows from investing activities: |
|
|
|
|
|
||
Development of real estate investments |
|
(274,672 |
) |
(130,825 |
) |
||
Acquisition of in-service real estate investments |
|
(735,294 |
) |
(285,342 |
) |
||
Acquisition of land held for development and infrastructure costs |
|
(367,517 |
) |
(93,230 |
) |
||
Recurring tenant improvements |
|
(36,300 |
) |
(44,108 |
) |
||
Recurring leasing costs |
|
(12,338 |
) |
(24,618 |
) |
||
Recurring building improvements |
|
(5,490 |
) |
(10,370 |
) |
||
Other deferred leasing costs |
|
(30,918 |
) |
(11,073 |
) |
||
Other deferred costs and other assets |
|
4,531 |
|
(18,491 |
) |
||
Tax deferred exchange escrow, net |
|
|
|
(12,890 |
) |
||
Proceeds from land and depreciated property sales, net |
|
140,273 |
|
1,095,416 |
|
||
Distributions received from unconsolidated companies for land and depreciated property sales |
|
21,238 |
|
|
|
||
Repayments from (advances to) unconsolidated companies |
|
4,865 |
|
(9,206 |
) |
||
Net cash provided by (used for) investing activities |
|
(1,291,622 |
) |
455,263 |
|
||
Cash flows from financing activities: |
|
|
|
|
|
||
Payments for repurchases of common shares |
|
(11,883 |
) |
(95,167 |
) |
||
Proceeds from exercise of stock options, including tax benefit of $419 |
|
6,336 |
|
2,814 |
|
||
Proceeds from issuance of preferred shares, net |
|
283,994 |
|
|
|
||
Payments for redemption of preferred shares |
|
(75,010 |
) |
|
|
||
Redemption of limited partner units |
|
|
|
(2,129 |
) |
||
Proceeds from unsecured debt issuance |
|
850,000 |
|
400,000 |
|
||
Payments on unsecured debt |
|
(100,000 |
) |
(665,000 |
) |
||
Proceeds from issuance of secured debt |
|
710,450 |
|
|
|
||
Payments on secured indebtedness including principal amortization |
|
(722,777 |
) |
(45,281 |
) |
||
Borrowings on line of credit, net |
|
521,000 |
|
|
|
||
Distributions to common shareholders |
|
(191,256 |
) |
(200,595 |
) |
||
Distributions to preferred shareholders |
|
(41,193 |
) |
(34,859 |
) |
||
|
|
|
|
|
|
||
Distributions to minority interest |
|
(17,238 |
) |
(19,141 |
) |
||
Deferred financing costs |
|
(27,198 |
) |
(529 |
) |
||
Net cash provided by (used for) financing activities |
|
1,185,225 |
|
(659,887 |
) |
||
Net increase (decrease) in cash and cash equivalents |
|
(1,732 |
) |
119,278 |
|
||
Cash and cash equivalents at beginning of period |
|
26,732 |
|
5,589 |
|
||
Cash and cash equivalents at end of period |
|
$ |
25,000 |
|
$ |
124,867 |
|
Other non-cash items: |
|
|
|
|
|
||
Conversion of Limited Partner Units to common shares |
|
$ |
6,616 |
|
$ |
18,049 |
|
Issuance of Limited Partner Units for acquisition of minority interest |
|
$ |
|
|
$ |
15,000 |
|
Assumption of debt for real estate acquisitions |
|
$ |
217,520 |
|
$ |
11,743 |
|
Transfer of construction in process to investment in unconsolidated joint venture |
|
$ |
96,634 |
|
$ |
11,743 |
|
Contribution of real estate investments to unconsolidated companies |
|
$ |
77,412 |
|
$ |
|
|
See accompanying Notes to Condensed Consolidated Financial Statements
4
DUKE
REALTY CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statement of Shareholders Equity
For the nine months ended September 30, 2006
(in thousands, except per share data)
(Unaudited)
|
|
Preferred |
|
Common |
|
Additional |
|
Accumulated |
|
Distributions |
|
Total |
|
||||||
Balance at December 31, 2005 |
|
$ |
657,250 |
|
$ |
1,347 |
|
$ |
2,266,204 |
|
$ |
(7,118 |
) |
$ |
(464,885 |
) |
$ |
2,452,798 |
|
Comprehensive Income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
Net income |
|
|
|
|
|
|
|
|
|
138,725 |
|
138,725 |
|
||||||
Distributions to preferred shareholders |
|
|
|
|
|
|
|
|
|
(41,193 |
) |
(41,193 |
) |
||||||
Adjustment for carrying value of preferred stock redemption |
|
|
|
|
|
2,633 |
|
|
|
(2,633 |
) |
|
|
||||||
Gains on derivative instruments |
|
|
|
|
|
|
|
11,958 |
|
|
|
11,958 |
|
||||||
Comprehensive income available for common shareholders |
|
|
|
|
|
|
|
|
|
|
|
$ |
109,490 |
|
|||||
Issuance of common shares |
|
|
|
3 |
|
6,004 |
|
|
|
|
|
6,007 |
|
||||||
Redemption of Preferred Series I shares |
|
(75,000 |
) |
|
|
(10 |
) |
|
|
|
|
(75,010 |
) |
||||||
Issuance of Preferred Series M shares |
|
184,000 |
|
|
|
(6,266 |
) |
|
|
|
|
177,734 |
|
||||||
Issuance of Preferred Series N shares |
|
110,000 |
|
|
|
(3,740 |
) |
|
|
|
|
106,260 |
|
||||||
Acquisition of minority interest |
|
|
|
2 |
|
6,614 |
|
|
|
|
|
6,616 |
|
||||||
Tax benefits from employee stock plans |
|
|
|
|
|
419 |
|
|
|
|
|
419 |
|
||||||
Stock based compensation expense |
|
|
|
|
|
7,612 |
|
|
|
|
|
7,612 |
|
||||||
Dividends on long-term compensation plans |
|
|
|
|
|
706 |
|
|
|
(706 |
) |
|
|
||||||
Retirement of common shares |
|
|
|
|
|
(2,526 |
) |
|
|
|
|
(2,526 |
) |
||||||
Distributions to common shareholders ($1.415 per share) |
|
|
|
|
|
|
|
|
|
(190,944 |
) |
(190,944 |
) |
||||||
Balance at September 30, 2006 |
|
$ |
876,250 |
|
$ |
1,352 |
|
$ |
2,277,650 |
|
$ |
4,840 |
|
$ |
(561,636 |
) |
$ |
2,598,456 |
|
See accompanying Notes to Condensed Consolidated Financial Statements
5
DUKE
REALTY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. General Basis of Presentation
The interim condensed consolidated financial statements included herein have been prepared by Duke Realty Corporation (the Company) without audit (except for the Balance Sheet as of December 31, 2005). The financial statements have been prepared in accordance with United States generally accepted accounting principles (GAAP) for interim financial information and in accordance with Rule 10-01 of Regulation S-X of the Securities Exchange Act of 1934. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. These financial statements should be read in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations included herein and the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2005.
Our rental operations are conducted through Duke Realty Limited Partnership (DRLP). Approximately 91.1% of the common partnership interests of DRLP (Units) were owned by us at September 30, 2006. The remaining Units in DRLP are redeemable for shares of our common stock on a one-to-one basis. We conduct our Service Operations through Duke Realty Services LLC and Duke Realty Services Limited Partnership, both of which we are the sole general partner. We also conduct our Service Operations through Duke Construction Limited Partnership, which is effectively 100% owned by DRLP. The condensed consolidated financial statements include our accounts and our majority-owned or controlled subsidiaries. In this Quarterly Report on Form 10-Q (this Report), the terms we, us and our refer to the Company and those entities owned or controlled by the Company.
2. Reclassifications
Certain 2005 balances have been reclassified to conform to the 2006 presentation.
3. Acquisitions
In 2006, we completed the acquisition of a Washington D.C. metropolitan area portfolio of suburban office and light industrial properties (the Mark Winkler Portfolio). The assets acquired for a purchase price of approximately $865.2 million are comprised of 32 properties with approximately 2.9 million square feet for rental, 166 acres of undeveloped land, as well as certain related assets of the Mark Winkler Company, a real estate management company. The acquisition was financed primarily through assumed mortgage loans and new borrowings (see Note 4). The assets of the Mark Winkler Portfolio related to the 32 in-service properties, consisting of $695.9 million of real estate investments and acquired lease related intangible assets, are classified and accounted for as held-for-sale based on meeting the applicable criteria of Statement of Financial Accounting Standards No. 144, Accounting For the Impairment or Disposal of Long-Lived Assets (SFAS 144). As required by SFAS 144, the results of operations of the acquired properties since the date of acquisition have been included in continuing operations, rather than discontinued operations, based on our present intention to sell the majority of our ownership interest in the properties to an entity in which we will retain a minority equity ownership interest. The allocation of purchase price based on the fair value of assets acquired is preliminary.
In the third quarter of 2006, we completed the purchase of a portfolio of industrial real estate properties in
6
Savannah, Georgia with the purpose of expanding our industrial real estate holdings near major port facilities. We completed a majority of the purchase in January 2006. The assets acquired for a purchase price of approximately $196.2 million are comprised of 18 buildings with approximately 5.1 million square feet for rental as well as over 60 acres of undeveloped land. The acquisition was financed in part through assumed mortgage loans (see Note 4). The results of operations for the acquired properties since the date of acquisition have been included in continuing rental operations in our consolidated financial statements.
4. Indebtedness
We had one unsecured line of credit available as of September 30, 2006, described as follows (dollars in thousands):
|
|
Borrowing |
|
Maturity |
|
Interest |
|
Outstanding Balance |
|
||
Description |
|
Capacity |
|
Date |
|
Rate |
|
at September 30, 2006 |
|
||
Unsecured Line of Credit |
|
$ |
1,000,000 |
|
January 2010 |
|
LIBOR + .525 |
% |
$ |
904,000 |
|
We use this line of credit to fund development activities, acquire additional rental properties and provide working capital.
The line of credit provides us with an option to obtain borrowings from financial institutions that participate in the line, at rates lower than the stated interest rate, subject to certain restrictions. Interest rates on the amounts outstanding on the unsecured line of credit as of September 30, 2006 ranged from LIBOR + .15% to LIBOR + .525% (equal to 5.48% to 5.86% as of September 30, 2006).
The line of credit also contains financial covenants that require us to meet financial ratios and defined levels of performance, including those related to variable interest indebtedness, consolidated net worth and debt-to-market capitalization. As of September 30, 2006, we were in compliance with all covenants under our line of credit.
We took the following actions during the nine-month period ended September 30, 2006, relevant to our indebtedness:
· In January 2006, we renewed our unsecured line of credit. The new facility provides borrowing capacity up to $1.0 billion and, subject to certain conditions, may be increased to $1.3 billion. Under the new facility, which replaced the previous unsecured line of credit agreement, the interest rate was reduced, the borrowing capacity was increased by $500.0 million and the maturity date was extended to January 25, 2010.
· To finance the acquisition of the Mark Winkler Portfolio (see Note 3), we obtained a $700.0 million term loan with an interest rate of LIBOR +.525%, secured by certain of the acquired real estate properties. This term loan was paid in full in August 2006 with proceeds from the issuance of senior unsecured debt as described below.
· In conjunction with our real estate acquisitions (see Note 3), we assumed $221.6 million of mortgage loans, of which we received $10.5 million of proceeds directly. The assumed mortgage loans bear interest at rates ranging between 5.55% and 8.50% and have maturities ranging between 2011 and 2026. An adjustment of $6.3 million was recorded to increase the assumed loans to fair value.
· In March 2006, we issued $150.0 million of 5.50% senior unsecured notes due in 2016. A portion of the proceeds were used to retire our $100.0 million 6.72% unsecured notes. The remaining cash proceeds were used to fund costs associated with the issuance of the debt and to repay amounts outstanding under our line of credit.
7
· In August 2006, we issued $450.0 million of 5.95% senior unsecured notes due in 2017 and $250.0 million of 5.625% senior unsecured notes due in 2011. The proceeds from these issuances were used to pay off the $700.0 million secured term loan that was obtained to finance the purchase of the Mark Winkler Portfolio (see Note 3).
5. Related Party Transactions
We provide property management, leasing, construction and other tenant related services to unconsolidated companies in which we have equity interests. For the nine months ended September 30, 2006 and 2005, we received management fees of $3.3 million and $3.6 million, leasing fees of $2.2 million and $3.4 million and construction and development fees of $16.8 million and $1.6 million, respectively, from these companies. These fees approximate market rates and we eliminated our ownership percentage of these fees in the condensed consolidated financial statements.
6. Net Income Per Common Share
Basic net income per common share is computed by dividing net income available for common shareholders by the weighted average number of common shares outstanding for the period. Diluted net income per common share is computed by dividing the sum of net income available for common shareholders and the minority interest in earnings allocable to Units not owned by us, by the sum of the weighted average number of common shares and minority Units outstanding, including any dilutive potential common shares for the period.
The following table reconciles the components of basic and diluted net income per common share for the three and nine months ended September 30, 2006 and 2005, respectively (in thousands):
|
Three Months Ended |
|
Nine Months Ended |
|
|||||||||
|
|
September 30, |
|
September 30, |
|
||||||||
|
|
2006 |
|
2005 |
|
2006 |
|
2005 |
|
||||
Basic net income available for common shareholders |
|
$ |
61,734 |
|
$ |
213,348 |
|
$ |
94,899 |
|
$ |
279,128 |
|
Joint venture partner convertible ownership net income (1) |
|
378 |
|
498 |
|
|
|
|
|
||||
Minority interest in earnings of common unitholders |
|
6,083 |
|
20,255 |
|
9,396 |
|
26,571 |
|
||||
Diluted net income available for common shareholders |
|
$ |
68,195 |
|
$ |
234,101 |
|
$ |
104,295 |
|
$ |
305,699 |
|
|
|
|
|
|
|
|
|
|
|
||||
Weighted average number of common shares outstanding |
|
135,117 |
|
142,663 |
|
134,957 |
|
143,076 |
|
||||
Weighted average partnership units outstanding |
|
13,211 |
|
13,447 |
|
13,302 |
|
13,602 |
|
||||
Joint venture
partner convertible ownership common share |
|
1,357 |
|
1,525 |
|
|
|
|
|
||||
Dilutive shares for stock-based compensation plans |
|
1,262 |
|
833 |
|
1,213 |
|
775 |
|
||||
Weighted average number
of common shares and dilutive |
|
150,947 |
|
158,468 |
|
149,472 |
|
157,453 |
|
(1) One of our joint venture partners in one of our unconsolidated companies has the option to convert a portion of its ownership to common shares. The effect of this option on earnings per share is dilutive for the third quarters 2005 and 2006; therefore, conversion to common shares is included in weighted average dilutive potential common shares for both quarters.
7. Segment Reporting
We are engaged in three reportable operating segments, the first two of which consist of the ownership and rental of office and industrial real estate investments. The third segment consists of our build-to-suit for sale operations and providing various real estate services such as property management, maintenance, leasing, development and construction management to third party property owners and joint ventures (Service Operations). Our reportable segments offer different products and services and are managed separately because each segment requires different operating strategies and management expertise.
8
Non-segment revenue consists mainly of equity in earnings of unconsolidated companies. Segment FFO information (FFO is defined below) is calculated by subtracting operating expenses attributable to the applicable segment from segment revenues. Non-segment assets consist of corporate assets including cash, deferred financing costs and investments in unconsolidated companies. Interest expense and other non-property specific revenues and expenses are not allocated to individual segments in determining our performance measure.
We assess and measure segment operating results based upon an industry performance measure referred to as Funds From Operations (FFO), which management believes is a useful indicator of our operating performance. FFO is used by industry analysts and investors as a supplemental operating performance measure of an equity real estate investment trust (REIT) like Duke. FFO is calculated in accordance with the definition that was adopted by the Board of Governors of the National Association of Real Estate Investment Trusts (NAREIT). NAREIT created FFO as a supplemental measure of REIT operating performance that excludes historical cost depreciation, among other items, from net income determined in accordance with GAAP. FFO is a non-GAAP financial measure developed by NAREIT to compare the operating performance of REITs. The most comparable GAAP measure is net income (loss). FFO should not be considered as a substitute for net income or any other measures derived in accordance with GAAP and may not be comparable to other similarly titled measures of other companies.
Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen or fallen with market conditions, many industry investors and analysts have considered presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves. FFO, as defined by NAREIT, represents GAAP net income (loss), excluding extraordinary items as defined under GAAP and gains or losses from sales of previously depreciated operating real estate assets, plus certain non-cash items such as real estate asset depreciation and amortization, and after similar adjustments for unconsolidated partnerships and joint ventures.
Management believes that the use of FFO, combined with the required primary GAAP presentations, improves the understanding of operating results of REITs among the investing public and makes comparisons of REIT operating results more meaningful. Management considers FFO to be a useful measure for reviewing comparative operating and financial performance (although FFO should be reviewed in conjunction with net income which remains the primary measure of performance) because by excluding gains or losses related to sales of previously depreciated operating real estate assets and excluding real estate asset depreciation and amortization, FFO provides a useful comparison of the operating performance of our real estate between periods or as compared to different companies.
9
The following table shows (i) the revenues and FFO for each of the reportable segments and (ii) a reconciliation of net income available for common shareholders to the calculation of FFO for the three and nine months ended September 30, 2006 and 2005, respectively (in thousands):
|
|
Three Months Ended |
|
Nine Months Ended |
|
||||||||
|
|
September 30, |
|
September 30, |
|
||||||||
|
|
2006 |
|
2005 |
|
2006 |
|
2005 |
|
||||
Revenues |
|
|
|
|
|
|
|
|
|
||||
Rental Operations: |
|
|
|
|
|
|
|
|
|
||||
Office |
|
$ |
158,036 |
|
$ |
125,278 |
|
$ |
440,244 |
|
$ |
356,520 |
|
Industrial |
|
47,664 |
|
42,240 |
|
149,976 |
|
122,879 |
|
||||
Service Operations |
|
22,474 |
|
22,584 |
|
42,198 |
|
68,027 |
|
||||
Total Segment Revenues |
|
228,174 |
|
190,102 |
|
632,418 |
|
547,426 |
|
||||
Non-Segment Revenue |
|
6,045 |
|
6,647 |
|
30,402 |
|
32,168 |
|
||||
Consolidated Revenue from continuing operations |
|
$ |
234,219 |
|
$ |
196,749 |
|
$ |
662,820 |
|
$ |
579,594 |
|
Discontinued Operations |
|
1,797 |
|
31,536 |
|
13,795 |
|
99,352 |
|
||||
Consolidated Revenue |
|
$ |
236,016 |
|
$ |
228,285 |
|
$ |
676,615 |
|
$ |
678,946 |
|
|
|
|
|
|
|
|
|
|
|
||||
Funds From Operations |
|
|
|
|
|
|
|
|
|
||||
Rental Operations: |
|
|
|
|
|
|
|
|
|
||||
Office |
|
$ |
100,567 |
|
$ |
75,153 |
|
$ |
273,731 |
|
$ |
217,404 |
|
Industrial |
|
38,127 |
|
32,001 |
|
115,436 |
|
91,625 |
|
||||
Services Operations |
|
10,551 |
|
12,559 |
|
18,477 |
|
37,443 |
|
||||
Total Segment FFO |
|
149,245 |
|
119,713 |
|
407,644 |
|
346,472 |
|
||||
Non-Segment FFO: |
|
|
|
|
|
|
|
|
|
||||
Interest expense |
|
(50,173 |
) |
(30,523 |
) |
(133,288 |
) |
(86,123 |
) |
||||
Interest and other income |
|
4,381 |
|
1,517 |
|
8,313 |
|
3,676 |
|
||||
General and administrative expense |
|
(6,804 |
) |
(5,803 |
) |
(27,715 |
) |
(21,308 |
) |
||||
Gain on land sales, net of impairment |
|
2,982 |
|
2,371 |
|
5,427 |
|
5,779 |
|
||||
Impairment adjustments on depreciable property |
|
(235 |
) |
(79 |
) |
(266 |
) |
(3,643 |
) |
||||
Other income on non-segment FFO |
|
401 |
|
683 |
|
3,759 |
|
2,215 |
|
||||
Minority interest in earnings of subsidiaries |
|
(126 |
) |
(1,396 |
) |
(301 |
) |
(1,462 |
) |
||||
Minority interest in earnings of common unitholders |
|
(2,306 |
) |
(1,897 |
) |
(5,314 |
) |
(6,934 |
) |
||||
Minority interest share of FFO adjustments |
|
(2,621 |
) |
12,038 |
|
(13,831 |
) |
2,138 |
|
||||
Joint venture FFO |
|
8,341 |
|
9,146 |
|
27,060 |
|
28,671 |
|
||||
Dividends on preferred shares |
|
(15,226 |
) |
(11,619 |
) |
(41,193 |
) |
(34,859 |
) |
||||
Adjustment for redemption of preferred shares |
|
|
|
|
|
(2,633 |
) |
|
|
||||
Discontinued operations, net of minority interest |
|
928 |
|
(6,976 |
) |
7,558 |
|
22,019 |
|
||||
Consolidated basic FFO |
|
$ |
88,787 |
|
$ |
87,175 |
|
$ |
235,220 |
|
$ |
256,641 |
|
Depreciation and amortization on continuing operations |
|
(63,892 |
) |
(59,494 |
) |
(187,099 |
) |
(164,239 |
) |
||||
Depreciation and amortization on discontinued operations |
|
(471 |
) |
(8,129 |
) |
(3,013 |
) |
(30,734 |
) |
||||
Companys share of joint venture adjustments |
|
(4,568 |
) |
(5,003 |
) |
(13,695 |
) |
(14,811 |
) |
||||
Earnings from depreciated property sales on discontinued operations |
|
39,537 |
|
210,837 |
|
41,573 |
|
223,235 |
|
||||
Earnings from depreciated property sales-share of joint venture |
|
(280 |
) |
|
|
8,082 |
|
11,174 |
|
||||
Minority interest share of FFO adjustments |
|
2,621 |
|
(12,038 |
) |
13,831 |
|
(2,138 |
) |
||||
Net income available for common shareholders |
|
$ |
61,734 |
|
$ |
213,348 |
|
$ |
94,899 |
|
$ |
279,128 |
|
10
The assets for each of the reportable segments as of September 30, 2006 and December 31, 2005, respectively, are as follows (in thousands):
|
|
September 30, |
|
December 31, |
|
||
|
|
2006 |
|
2005 |
|
||
Assets |
|
|
|
|
|
||
Rental Operations: |
|
|
|
|
|
||
Office |
|
$ |
4,401,853 |
|
$ |
3,396,985 |
|
Industrial |
|
1,939,724 |
|
1,577,631 |
|
||
Service Operations |
|
216,546 |
|
177,463 |
|
||
Total Segment Assets |
|
6,558,123 |
|
5,152,079 |
|
||
Non-Segment Assets |
|
715,419 |
|
495,481 |
|
||
Consolidated Assets |
|
$ |
7,273,542 |
|
$ |
5,647,560 |
|
In addition to revenues and FFO, we also review our recurring capital expenditures in measuring the performance of our individual Rental Operations segments. These recurring capital expenditures consist of tenant improvements, leasing commissions and building improvements. We review these expenditures to determine the costs associated with re-leasing space and maintaining the condition of our properties. Our recurring capital expenditures by segment are summarized as follows for the nine months ended September 30, 2006 and 2005, respectively (in thousands):
|
|
2006 |
|
2005 |
|
||
Recurring Capital Expenditures |
|
|
|
|
|
||
Office |
|
$ |
42,035 |
|
$ |
44,838 |
|
Industrial |
|
9,672 |
|
37,794 |
|
||
Non-segment |
|
347 |
|
28 |
|
||
Total |
|
$ |
52,054 |
|
$ |
82,660 |
|
8. Discontinued Operations
We classified the operations of 257 buildings as discontinued operations in the condensed consolidated statements of operations for the three and nine months ended September 30, 2006 and 2005. These 257 buildings consist of 239 industrial properties, 17 office properties and one retail property. Of these properties, 18 were sold during the first nine months of 2006, 234 were sold during 2005 and five operating properties were classified as held-for-sale at September 30, 2006.
The following table illustrates the operations of the 257 buildings reflected in discontinued operations for the three and nine months ended September 30, 2006 and 2005, respectively (in thousands):
|
|
Three Months Ended |
|
Nine Months Ended |
|
||||||||
|
|
September 30, |
|
September 30, |
|
||||||||
|
|
2006 |
|
2005 |
|
2006 |
|
2005 |
|
||||
Statement of Operations: |
|
|
|
|
|
|
|
|
|
||||
Revenues |
|
$ |
1,797 |
|
$ |
31,536 |
|
$ |
13,795 |
|
$ |
99,352 |
|
Expenses: |
|
|
|
|
|
|
|
|
|
||||
Operating |
|
935 |
|
10,162 |
|
3,779 |
|
31,019 |
|
||||
Interest |
|
428 |
|
9,851 |
|
2,327 |
|
26,142 |
|
||||
Depreciation and Amortization |
|
471 |
|
8,129 |
|
3,013 |
|
30,734 |
|
||||
General and Administrative |
|
2 |
|
65 |
|
24 |
|
130 |
|
||||
Operating Income (loss) |
|
(39 |
) |
3,329 |
|
4,652 |
|
11,327 |
|
||||
Minority interest expense - operating and other income |
|
4 |
|
(287 |
) |
(419 |
) |
(983 |
) |
||||
Income (loss) from discontinued operations, before gain on sales |
|
(35 |
) |
3,042 |
|
4,233 |
|
10,344 |
|
||||
Gain on sale of property, net of impairment adjustments |
|
43,735 |
|
210,758 |
|
45,739 |
|
219,592 |
|
||||
Minority interest expense gain on sales |
|
(3,939 |
) |
(18,146 |
) |
(4,119 |
) |
(19,060 |
) |
||||
Gain on sale of discontinued operations, net of impairment adjustments and minority interest |
|
39,796 |
|
192,612 |
|
41,620 |
|
200,532 |
|
||||
Income from discontinued operations |
|
$ |
39,761 |
|
$ |
195,654 |
|
$ |
45,853 |
|
$ |
210,876 |
|
11
At September 30, 2006, we classified as held-for-sale, and included in discontinued operations, four industrial properties and one office property comprising approximately 852,000 square feet. Additionally, we have classified the 32 in-service properties from the Mark Winkler Portfolio (see Note 3), as well as six additional properties, as held-for-sale. However, the results of these 38 properties are included in continuing operations, as required by SFAS 144, either based on our present intention to sell the majority of our ownership interest in the properties to entities in which we will retain a minority equity ownership interest or because the results of operations for the properties are immaterial. The following table illustrates the aggregate balance sheet of the aforementioned five properties included in discontinued operations, as well as the 38 held-for-sale properties whose results are included in continuing operations at September 30, 2006 (in thousands):
|
|
Held-for-Sale and Included in |
|
Held-for-Sale and Included in |
|
Total |
|
|||
Real estate investments, net |
|
$ |
29,662 |
|
$ |
698,734 |
|
$ |
728,396 |
|
Other assets |
|
1,112 |
|
109,048 |
|
110,160 |
|
|||
Assets held-for-sale |
|
30,774 |
|
807,782 |
|
838,556 |
|
|||
|
|
|
|
|
|
|
|
|||
Accrued expenses |
|
$ |
779 |
|
$ |
3,856 |
|
$ |
4,635 |
|
Other liabilities |
|
179 |
|
5,885 |
|
6,064 |
|
|||
Secured debt |
|
|
|
144,423 |
|
144,423 |
|
|||
Liabilities held-for-sale |
|
$ |
958 |
|
$ |
154,164 |
|
$ |
155,122 |
|
We allocate interest expense to discontinued operations as permitted under Emerging Issues Task Force (EITF) Issue No. 87-24, Allocation of Interest to Discontinued Operations, and have included such interest expense in computing net income from discontinued operations. Interest expense allocable to discontinued operations includes interest on any debt on secured properties included in discontinued operations and an allocable share of our consolidated unsecured interest expense for unencumbered properties. The allocation of unsecured interest expense to discontinued operations was based upon the gross book value of the discontinued operations unencumbered population as it related to our entire unencumbered population.
For the nine months ended September 30, 2006 and 2005, we recorded impairment adjustments of $576,000 and $3.8 million, respectively. The $576,000 impairment adjustment recorded in the nine months ended September 30, 2006 reflects the write-down of the carrying value of one industrial building, one office building and one land parcel sold in the nine months ended September 30, 2006, in addition to one industrial building that is held for sale as of September 30, 2006. The $3.8 million impairment adjustment recorded in the nine months ended September 30, 2005 reflects the write-down of the carrying value of three office buildings, three industrial buildings and four land parcels sold at various times in 2005 and 2006.
9. Shareholders Equity
We periodically access the public equity markets to fund the development and acquisition of additional rental properties or to pay down debt. The proceeds of these offerings are contributed to DRLP in exchange for an additional interest in DRLP. In January 2006, we issued $184 million of 6.95% Series M Cumulative Redeemable Preferred Shares, from which a portion of the net proceeds were used to redeem our $75 million of outstanding 8.45% Series I Cumulative Redeemable Preferred Shares. Offering costs of $2.6 million were charged against net income available to common shareholders in conjunction with the redemption of the Series I Cumulative Redeemable Preferred Shares. In June 2006, we issued $110 million of 7.25% Series N Cumulative Redeemable Preferred Shares.
12
The following series of preferred shares were outstanding as of September 30, 2006 (in thousands, except percentage data):
|
|
Shares |
|
Dividend |
|
Redemption |
|
Liquidation |
|
|
Description |
|
Outstanding |
|
Rate |
|
Date |
|
Preference |
|
|
Series B Preferred |
|
265 |
|
7.990 |
% |
September 30, 2007 |
|
$ |
132,250 |
|
Series J Preferred |
|
400 |
|
6.625 |
% |
August 29, 2008 |
|
100,000 |
|
|
Series K Preferred |
|
600 |
|
6.500 |
% |
February 13, 2009 |
|
150,000 |
|
|
Series L Preferred |
|
800 |
|
6.600 |
% |
November 30, 2009 |
|
200,000 |
|
|
Series M Preferred |
|
736 |
|
6.950 |
% |
January 31, 2011 |
|
184,000 |
|
|
Series N Preferred |
|
440 |
|
7.250 |
% |
June 30, 2011 |
|
110,000 |
|
|
The dividend rate on the Series B preferred shares increases to 9.99% after September 12, 2012.
All series of preferred shares require cumulative distributions and have no stated maturity date (although we may redeem all such preferred shares on or following their optional redemption dates at our option, in whole or in part).
10. Financial Instruments
We are exposed to capital market risk, such as changes in interest rates. In order to manage the volatility relating to interest rate risk, we may enter into interest rate hedging arrangements from time to time. We do not utilize derivative financial instruments for trading or speculative purposes.
In March 2005, we entered into $300 million of cash flow hedges through forward-starting interest rate swaps to hedge interest rates on $300 million of estimated debt offerings in 2006. The swaps qualified for hedge accounting under SFAS 133 with any changes in fair value recorded in Accumulated Other Comprehensive Income (OCI). The market value of these interest rate swaps is dependent upon existing market interest rates, which change over time. In March 2006, we issued $150 million of 5.5% senior unsecured notes due 2016 (see Note 4) and terminated a corresponding amount of the cash flow hedges designated for this transaction. The settlement amount paid of approximately $1 million will be recognized to earnings through interest expense ratably over the life of the senior notes and the ineffective portion of the hedge was insignificant. In August 2006, we issued $450 million of 5.95% senior unsecured notes due 2017 and $250 million of 5.69% senior unsecured notes due 2011 (see Note 4) and terminated the remaining $150 million of cash flow hedges. The settlement amount received of approximately $1.6 million will be recognized to earnings through interest expense ratably over the lives of the senior unsecured notes. The ineffective portion of the hedge was insignificant.
In August 2005, we entered into $300 million of cash flow hedges through forward-starting interest rate swaps to hedge interest rates on $300 million of estimated debt offerings in 2007. The swaps qualify for hedge accounting under SFAS 133 with any changes in fair value recorded in OCI. At September 30, 2006, the fair value of these swaps was approximately $9.6 million in an asset position as the effective rates of the swaps were lower than current interest rates at September 30, 2006.
In June 2006, we entered into a $250 million cash flow hedge through an interest rate swap to fix the rate on $250 million of previously floating rate debt which matures in December 2006. The swap qualifies for hedge accounting under SFAS 133 with any changes in fair value recorded in OCI. At September 30, 2006, the fair value of this swap was approximately $78,000 in a liability position and there was no ineffectiveness.
13
The effectiveness of our hedges will be evaluated throughout their lives using the hypothetical derivative method under which the change in fair value of the actual swap designated as the hedging instrument is compared to the change in fair value of a hypothetical swap.
11. Stock Based Compensation
Our stock based employee and non-employee compensation plans are described more fully below. We are authorized to issue up to 11,320,552 shares of our common stock under these compensation plans. New shares of common stock are issued to employees upon exercise of share-based awards that are settled in company stock.
For all issuances of stock-based awards prior to 2002, we applied the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and related interpretations, in accounting for our stock-based compensation.
Accordingly, for stock options granted prior to 2002, no compensation expense is reflected in net income as all options granted had an exercise price equal to the market value of the underlying common shares on the date of the grant.
Effective January 1, 2002, we prospectively adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123), and applied SFAS 123 to all awards granted after January 1, 2002.
Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123(R), Share Based Payment, (SFAS 123(R)), using the modified prospective application method. Under this method, as of January 1, 2006, we applied the provisions of SFAS 123(R) to new and modified awards, as well as to the nonvested portion of awards granted before the required effective date and outstanding at such time.
Some of our stock-based compensation awards, including both stock options and restricted stock units, have a retirement eligible provision, whereby awards granted to an employee who has reached certain age and service criteria, automatically vest upon such employees retirement. We have previously accounted for this type of arrangement by recognizing compensation cost (for both pro forma and expense recognition purposes) over the full stated vesting period of the award and, if the employee retired before the end of the vesting period, recognizing any remaining unrecognized compensation cost at the date of retirement. Upon adoption of SFAS 123(R), new awards granted to retirement eligible employees are subject to accelerated vesting over a period when the employees retention of the award is no longer contingent on providing additional service. Had we applied accelerated vesting to all existing unvested awards issued to retirement eligible employees prior to January 1, 2006, we would have recognized an additional $969,000 in stock-based employee compensation expense for the nine months ended September 30, 2006.
An additional requirement of SFAS 123(R) is that estimated forfeitures be considered in determining compensation expense. As previously permitted, we recorded forfeitures when they occurred. The effect of this accounting change on existing nonvested stock compensation was insignificant.
As a result of adopting SFAS 123(R) on January 1, 2006, our net income available for common shareholders for the nine-months ended September 30, 2006, was $437,000 higher than if we had continued to account for share-based compensation under SFAS 123 and APB 25. There was no effect on basic and diluted earnings per share from continuing operations as a result of the adoption of SFAS 123(R).
Cash flows resulting from tax deductions in excess of recognized compensation cost from the exercise of stock options (excess tax benefits) were not significant in either period presented.
14
The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS 123 to all stock-based employee compensation for the three and nine month periods ended September 30, 2005 (in thousands, except per share data):
|
|
Three Months Ended |
|
Nine months Ended |
|
||
|
|
September 30, 2005 |
|
September 30, 2005 |
|
||
Net income available for common shareholders, as reported |
|
$ |
213,348 |
|
$ |
279,128 |
|
Add: Stock-based employee compensation expense included in net income determined under fair value method |
|
547 |
|
1,477 |
|
||
|
|
|
|
|
|
||
Deduct: Total stock-based compensation expense determined under fair value method for all awards |
|
(603 |
) |
(1,642 |
) |
||
Pro forma net income available for common shareholders |
|
$ |
213,292 |
|
$ |
278,963 |
|
|
|
|
|
|
|
||
Basic net income per common share |
|
|
|
|
|
||
As reported |
|
$ |
1.50 |
|
$ |
1.95 |
|
Pro forma |
|
$ |
1.50 |
|
$ |
1.95 |
|
|
|
|
|
|
|
||
Diluted net income per common share |
|
|
|
|
|
||
As reported |
|
$ |
1.48 |
|
$ |
1.94 |
|
Pro forma |
|
$ |
1.48 |
|
$ |
1.94 |
|
Fixed Stock Option Plans
We had options outstanding under six fixed option plans as of September 30, 2006. Additional grants may be made under one of those plans. Stock option awards granted under our stock based employee and non-employee compensation plans generally vest over five years at 20% per year and have contractual lives of ten years. The exercise price for stock option grants is set at the fair value of our common stock on the day of grant.
The following table summarizes transactions under our stock option plans for the nine months ended September 30, 2006:
|
|
Shares |
|
Weighted |
|
Weighted |
|
Aggregate |
|
||
Outstanding, beginning of year |
|
3,828,157 |
|
$ |
25.50 |
|
|
|
|
|
|
Granted |
|
857,667 |
|
$ |
34.16 |
|
|
|
|
|
|
Exercised |
|
(401,764 |
) |
$ |
22.03 |
|
|
|
|
|
|
Forfeited |
|
(80,259 |
) |
$ |
29.66 |
|
|
|
|
|
|
Outstanding at September 30, 2006 |
|
4,203,801 |
|
$ |
27.52 |
|
6.36 |
|
$ |
41.3 |
|
Options exercisable at September 30, 2006 |
|
2,297,473 |
|
$ |
24.07 |
|
4.68 |
|
$ |
30.5 |
|
(1) The aggregate intrinsic value represents the total pre-tax intrinsic value, based on the closing stock price of $37.35 at September 30, 2006, which would have been received by the option holders had all option holders exercised their options as of that date. This amount changes continuously based on the fair value of the stock.
15
Options granted in the nine-month periods ended September 30, 2006 and 2005, respectively, had a weighted average fair value of $3.60 and $3.04. As of September 30, 2006, there was $4.1 million of total unrecognized compensation expense related to stock options granted under the plans, which is expected to be recognized over a weighted average remaining period of 3.23 years. The total intrinsic value of options exercised during the nine-month periods ended September 30, 2006 and 2005, respectively, was $5.8 million and $2.1 million. Compensation expense recognized for fixed stock option plans was $1.4 million and $837,000 in the first nine months of 2006 and 2005, respectively. The fair value of options vested during the nine month periods ending September 30, 2006 and 2005 was $1.3 million and $1.1 million.
The fair values of the options for the nine months ended September 30, 2006 and 2005, were determined using the Black-Scholes option-pricing model with the following assumptions:
|
|
2006 |
|
2005 |
|
Dividend yield |
|
6.25 |
% |
6.25 |
% |
Volatility |
|
20.0 |
% |
20.0 |
% |
Risk-free interest rate |
|
4.5 |
% |
3.8 |
% |
Expected life |
|
6 years |
|
6 years |
|
The risk free interest rate assumption is based upon observed interest rates appropriate for the term of our employee stock options. The dividend yield assumption is based on the history of and our present expectation of future dividend payouts. Our computation of expected volatility for the valuation of stock options granted in the quarters ended September 30, 2006 and 2005 is based on historic volatility over a period of time equal to the expected term. The expected life of employee stock options represents the weighted average period the stock options are expected to remain outstanding.
Performance Share Plans
Performance shares were granted under the 2000 Performance Share Plan, with each performance share economically equivalent to one share of our common stock.
The performance shares vest over a five-year period with the vesting percentage for a year dependent upon our attainment of certain predefined levels of earnings growth for such year. The performance shares have a contractual life of five years.
In April 2006, the 2000 Performance Share Plan was amended to provide that awards would be settled in shares of common stock rather than cash. The fair value of existing awards was fixed at the date of the amendment and the fair value of subsequent awards will be fixed at the fair value of our common stock at the date of grant. Under our 2005 Long-Term Incentive Plan, additional performance shares may be granted on such terms and conditions as may be selected by our compensation committee, including whether payment will be made in cash, shares of our common stock, DRLP Units or other property.
The following table summarizes transactions for our performance shares for the first nine months of 2006:
2000 Performance Share Plan |
|
Vested |
|
Unvested |
|
Total |
|
|
|
|
|
|
|
|
|
Performance Share Plan units at December 31, 2005 |
|
84,466 |
|
99,001 |
|
183,467 |
|
Granted |
|
|
|
|
|
|
|
Vested |
|
25,487 |
|
(25,487 |
) |
|
|
Forfeited |
|
|
|
(3,746 |
) |
(3,746 |
) |
Dividend reinvestments |
|
6,599 |
|
|
|
6,599 |
|
Disbursements |
|
(13,744 |
) |
|
|
(13,744 |
) |
Total Performance Share Plan units outstanding at September 30, 2006 |
|
102,808 |
|
69,768 |
|
172,576 |
|
16
Compensation expense recognized for Performance Share Plan units was $787,000 and $860,000 for the nine-month periods ended September 30, 2006 and 2005, respectively. As of September 30, 2006, there was $201,000 of total unrecognized compensation expense related to nonvested performance shares granted under the Plan, which will be recognized based on the Companys actual performance. The total vest date fair value of shares vesting during the nine-month period ended September 30, 2006 was $918,000.
Shareholder Value Plan Awards
Our 2005 Shareholder Value Plan (2005 SVP Plan), a sub-plan of our 2005 Long-Term Incentive Plan, was approved by our shareholders in April 2005. Upon vesting, payout of the 2005 Shareholder Value Plan awards will be made in shares of our common stock. Under the 2005 SVP Plan, shareholder value awards fully vest three years after the date of grant. The number of common shares to be issued may range from 0%-300% of the target shares awarded and will be based upon our total shareholder return for such three-year period as compared to the S & P 500 Index and the NAREIT Real Estate 50 Index. Each index is weighted at 50%.
Awards made under the 2005 SVP Plan are measured at fair value, which is determined using a Monte Carlo simulation model that was developed to accommodate the unique features of the 2005 SVP Plan. Compensation cost recognized under the 2005 SVP Plan was $531,000 and $395,000 for the nine-month periods ended September 30, 2006 and 2005, respectively.
The following table summarizes transactions for our awards under the 2005 SVP Plan for the first nine months of 2006:
2005 Shareholder Value Plan Awards |
|
Number of |
|
Weighted |
|
|
SVP awards at December 31, 2005 |
|
75,678 |
|
$ |
30.64 |
|
Granted |
|
90,356 |
|
$ |
34.13 |
|
Forfeited |
|
(3,829 |
) |
$ |
31.23 |
|
SVP awards at September 30, 2006 |
|
162,205 |
|
$ |
32.57 |
|
As of September 30, 2006, there was $2.1 million of total unrecognized compensation expense related to nonvested SVP Plan awards granted under the 2005 SVP Plan, which will be recognized over a weighted average period of two years. All 2005 SVP Plan awards have a contractual life of three years.
Restricted Stock Units
Under our 2005 Long-Term Incentive Plan and our 2005 Non-Employee Directors Compensation Plan approved by our shareholders in April 2005, restricted stock units (RSUs) may be granted to non-employee directors, executive officers and selected management employees. An RSU is economically equivalent to one share of our common stock. RSUs granted prior to January 1, 2006 vest 20% per year over five years, have contractual lives of five years and are payable in shares of our common stock. RSUs granted to existing non-employee directors subsequent to January 1, 2006 vest 100% over one year, and have contractual lives of one year. We recognize the value of the granted RSUs over this vesting period as expense.
17
The following table summarizes transactions for our RSUs, excluding dividend equivalents, for the first nine months of 2006:
Restricted Stock Units |
|
Number of |
|
Weighted |
|
|
RSUs at December 31, 2005 |
|
172,095 |
|
$ |
32.19 |
|
Granted |
|
108,118 |
|
$ |
34.16 |
|
Vested |
|
(16,548 |
) |
$ |
30.76 |
|
Forfeited |
|
(7,563 |
) |
$ |
32.62 |
|
RSUs at September 30, 2006 |
|
256,102 |
|
$ |
33.65 |
|
Compensation cost recognized for RSUs totaled $1.7 million and $245,000 for the nine-month periods ended September 30, 2006 and 2005, respectively.
As of September 30, 2006, there was $6.0 million of total unrecognized compensation expense related to nonvested RSUs granted under the Plan, which is expected to be recognized over a weighted average period of 4 years.
In addition, all RSUs earn dividend equivalents that are deemed to be reinvested in additional RSUs. Dividend equivalents vest immediately and will be paid in shares of our common stock when the corresponding portion of the original RSU award vests or upon termination of the participant. Dividend equivalents of 10,732 RSUs were earned in the first nine months of 2006, and 14,814 dividend equivalents were outstanding as of September 30, 2006. A charge to retained earnings of $706,000 was recorded for the value of these dividend equivalents during the first nine months of 2006.
12. Recent Accounting Pronouncements
In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109 (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a companys financial statements and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Interpretation also provides guidance on description, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 becomes effective on January 1, 2007. We are currently evaluating the effect that the adoption of FIN 48 will have on our financial statements.
In September 2006, the Securities Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Qualifying Misstatements in Current Year Financial Statements (SAB 108). SAB 108 provides guidance regarding the process of qualifying financial statement misstatements. We will adopt SAB 108 in the fourth quarter of 2006 and do not believe that the adoption of SAB 108 will have a material effect on our financial statements.
13. Subsequent Events
Declaration of Dividends
The Companys Board of Directors declared the following dividends at its October 25, 2006, regularly scheduled Board me
Class |
|
Quarterly |
|
Record Date |
|
Payment Date |
|
|
Common |
|
$ |
0.4750 |
|
November 14, 2006 |
|
November 30, 2006 |
|
Preferred (per depositary share): |
|
|
|
|
|
|
|
|
Series B |
|
$ |
0.998750 |
|
December 15, 2006 |
|
December 29, 2006 |
|
Series J |
|
$ |
0.414063 |
|
November 16, 2006 |
|
November 30, 2006 |
|
Series K |
|
$ |
0.406250 |
|
November 16, 2006 |
|
November 30, 2006 |
|
Series L |
|
$ |
0.412500 |
|
November 16, 2006 |
|
November 30, 2006 |
|
Series M |
|
$ |
0.434375 |
|
December 15, 2006 |
|
December 29, 2006 |
|
Series N |
|
$ |
0.453125 |
|
December 15, 2006 |
|
December 29, 2006 |
|
18
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Cautionary Statement Regarding Forward Looking Statements
Certain statements in this quarterly report, including those related to our future operations, constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act) and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). The words believe, estimate, expect, anticipate, intend, plan, seek, may, and similar expressions or statements regarding future periods are intended to identify forward-looking statements. These forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause our actual results, performance or achievements, or industry results, to differ materially from any predictions of future results, performance or achievements that we express or imply in this Report. Some of the risks, uncertainties and other important factors that may affect future results include, among others:
· Changes in general economic and business conditions, including performance of financial markets;
· Our continued qualification as a real estate investment trust, or REIT;
· Heightened competition for tenants and potential decreases in property occupancy;
· Potential increases in real estate construction costs;
· Potential changes in the financial markets and interest rates;
· Our continuing ability to favorably raise funds through the issuance of debt and equity in the capital markets;
· Our ability to successfully identify, acquire, develop and/or manage properties on terms that are favorable to us;
· Our ability to successfully dispose of properties on terms that are favorable to us;
· Inherent risks in the real estate business including tenant defaults, potential liability relating to environmental matters and liquidity of real estate investments; and
· Other risks and uncertainties described herein, including, without limitation, under the caption Item 1A. Risk Factors, and in our other reports and other filings with the Securities and Exchange Commission (SEC).
This list of risks and uncertainties, however, is not intended to be exhaustive. Additional risk factor information is included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005, which we filed with the SEC on March 7, 2006, and is updated by us from time to time in Quarterly Reports on Form 10-Q and other future filings.
Although we presently believe that the plans, expectations and results expressed in or suggested by the forward-looking statements are reasonable, all forward-looking statements are inherently uncertain as they involve substantial risks and uncertainties beyond our control. New factors emerge from time to time, and it is not possible for us to predict the nature or assess the potential impact of each new factor on our business. Given these uncertainties, we caution you not to place undue reliance on these forward-looking statements. We undertake no obligation to update or revise any of our forward-looking statements for events or circumstances that arise after the statement is made.
19
Business Overview
We are a self-administered and self-managed REIT that began operations through a related entity in 1972. As of September 30, 2006, we:
· Owned or controlled 733 industrial, office and retail properties (including properties under development), consisting of approximately 112.9 million square feet; and
· Owned or controlled more than 6,500 acres of land with an estimated future development potential of more than 94 million square feet of industrial, office and retail properties.
We provide the following services for our properties and for certain properties owned by third parties and joint ventures:
· Property leasing;
· Property management;
· Construction;
· Development; and
· Other tenant-related services
Acquisitions
In the first quarter of 2006, we completed the majority of the acquisition of a Washington D.C. metropolitan area portfolio of suburban office and light industrial properties (the Mark Winkler Portfolio). The assets acquired for a purchase price of approximately $865.2 million are comprised of 32 properties with approximately 2.9 million square feet for rental, 166 acres of undeveloped land, as well as certain related assets of the Mark Winkler Company, a real estate management company. The acquisition was financed primarily through assumed mortgage loans and new borrowings.
In the third quarter of 2006, we completed the purchase of a portfolio of industrial real estate properties in Savannah, Georgia with the purpose of expanding our industrial real estate holdings near major port facilities. We completed a majority of the purchase in January 2006. The assets acquired for a purchase price of approximately $196.2 million are comprised of 18 buildings with approximately 5.1 million square feet for rental as well as over 60 acres of undeveloped land. The acquisition was financed in part through assumed mortgage loans.
Key Performance Indicators
Our operating results depend primarily upon rental income from our office, industrial and retail properties (Rental Operations). The following highlights the areas of Rental Operations that we consider critical for future revenue growth. (All square footage totals and occupancy percentages reflect both wholly owned properties and properties in joint ventures).
Occupancy Analysis: Our ability to maintain favorable occupancy rates is a principal driver of our results of operations. The following table sets forth occupancy information regarding our in-service portfolio of rental properties as of September 30, 2006 and 2005, respectively (in thousands, except percentage data):
|
|
Total |
|
Percent of |
|
Percent Occupied |
|
||||||
Type |
|
2006 |
|
2005 |
|
2006 |
|
2005 |
|
2006 |
|
2005 |
|
Industrial |
|
|
|
|
|
|
|
|
|
|
|
|
|
Service Centers |
|
4,724 |
|
4,724 |
|
4.4 |
% |
4.9 |
% |
91.9 |
% |
90.2 |
% |
Bulk |
|
69,515 |
|
61,723 |
|
64.9 |
% |
63.5 |
% |
93.2 |
% |
92.5 |
% |
Office |
|
32,182 |
|
30,074 |
|
30.1 |
% |
31.0 |
% |
90.9 |
% |
88.7 |
% |
Retail |
|
611 |
|
611 |
|
0.6 |
% |
0.6 |
% |
99.7 |
% |
95.6 |
% |
Total |
|
107,032 |
|
97,132 |
|
100.0 |
% |
100.0 |
% |
92.5 |
% |
91.2 |
% |
20
Lease Expiration and Renewal: Our ability to maintain and increase occupancy rates primarily depends upon our continuing ability to re-lease expiring space. The following table reflects our in-service portfolio lease expiration schedule by property type as of September 30, 2006. The following table indicates square footage and annualized net effective rents (based on September 2006 rental revenue) under expiring leases (in thousands, except percentage data):
|
|
Total Portfolio |
|
Industrial |
|
Office |
|
Retail |
|
||||||||||||||
Year of Expiration |
|
Square |
|
Ann. Rent |
|
Percent of |
|
Square |
|
Ann. Rent |
|
Square |
|
Ann. Rent |
|
Square |
|
Ann. Rent |
|
||||
2006 |
|
1,967 |
|
$ |
10,974 |
|
2 |
% |
1,582 |
|
$ |
6,172 |
|
385 |
|
$ |
4,802 |
|
|
|
$ |
|
|
2007 |
|
9,972 |
|
61,009 |
|
9 |
% |
7,550 |
|
29,483 |
|
2,413 |
|
31,403 |
|
9 |
|
123 |
|
||||
2008 |
|
13,686 |
|
84,441 |
|
12 |
% |
10,121 |
|
40,252 |
|
3,546 |
|
43,854 |
|
19 |
|
335 |
|
||||
2009 |
|
12,636 |
|
82,605 |
|
12 |
% |
9,031 |
|
35,574 |
|
3,601 |
|
46,953 |
|
4 |
|
78 |
|
||||
2010 |
|
11,426 |
|
92,737 |
|
14 |
% |
7,102 |
|
31,659 |
|
4,317 |
|
60,973 |
|
7 |
|
105 |
|
||||
2011 |
|
13,015 |
|
81,942 |
|
12 |
% |
9,608 |
|
36,783 |
|
3,363 |
|
44,340 |
|
44 |
|
819 |
|
||||
2012 |
|
8,416 |
|
57,427 |
|
8 |
% |
5,696 |
|
20,772 |
|
2,713 |
|
36,322 |
|
7 |
|
333 |
|
||||
2013 |
|
6,385 |
|
59,114 |
|
9 |
% |
3,325 |
|
14,521 |
|
3,026 |
|
44,014 |
|
34 |
|
579 |
|
||||
2014 |
|
4,990 |
|
28,212 |
|
4 |
% |
3,859 |
|
13,306 |
|
1,131 |
|
14,906 |
|
|
|
|
|
||||
2015 |
|
6,807 |
|
52,393 |
|
8 |
% |
4,729 |
|
18,693 |
|
2,078 |
|
33,700 |
|
|
|
|
|
||||
2016 and Thereafter |
|
9,711 |
|
70,978 |
|
10 |
% |
6,554 |
|
26,341 |
|
2,673 |
|
41,338 |
|
484 |
|
3,299 |
|
||||
Total Leased |
|
99,011 |
|
$ |
681,832 |
|
100 |
% |
69,157 |
|
$ |
273,556 |
|
29,246 |
|
$ |
402,605 |
|
608 |
|
$ |
5,671 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
Total Portfolio |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
Square Feet |
|
107,032 |
|
|
|
|
|
74,239 |
|
|
|
32,182 |
|
|
|
611 |
|
|
|
||||
Percent Occupied |
|
92.5 |
% |
|
|
|
|
93.2 |
% |
|
|
90.9 |
% |
|
|
99.7 |
% |
|
|
Lease Renewals: We renewed 79.6% and 78.9% of leases up for renewal in the three and nine months ended September 30, 2006, totaling 1.9 million and 5.7 million square feet, respectively. This compared to renewals of 78.8% and 74.2% for the three and nine months ended September 30, 2005 totaling 2.7 million and 7.6 million square feet, respectively.
The average term of renewals for the three and nine months ended September 30, 2006, was 4.7 and 3.9 years, respectively, compared to an average term of 5.3 and 4.4 years for the three and nine months ended September 30, 2005, respectively.
Future Development: Another source of growth in earnings is the development of additional properties. These properties should provide future earnings through Service Operations income upon sale or from Rental Operations growth as they are placed in service. As of September 30, 2006, we had 11.4 million square feet of property under development with total estimated costs upon completion of $1.1 billion, which were 39% pre-leased as of September 30, 2006. This compares to 6.9 million square feet with total estimated costs of $480.8 million, which were 34% pre-leased as of September 30, 2005.
21
A summary of properties under development as of September 30, 2006, follows (in thousands, except percentage data):
Anticipated In-Service Date |
|
Square |
|
Percent |
|
Total |
|
Anticipated |
|
|
Held for Rental: |
|
|
|
|
|
|
|
|
|
|
4th Quarter 2006 |
|
3,811 |
|
32 |
% |
$ |
189,574 |
|
9.02 |
% |
1st Quarter 2007 |
|
891 |
|
23 |
% |
93,522 |
|
9.95 |
% |
|
2nd Quarter 2007 |
|
372 |
|
18 |
% |
49,812 |
|
9.50 |
% |
|
Thereafter |
|
752 |
|
8 |
% |
115,680 |
|
9.51 |
% |
|
|
|
5,826 |
|
26 |
% |
$ |
448,588 |
|
9.39 |
% |
Service Segment: |
|
|
|
|
|
|
|
|