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, 2007

 

 

 

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
Indianapolis, Indiana

 


46240

(Address of Principal Executive Offices)

 

(Zip Code)

 

Registrant’s 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 issuer’s classes of common stock, as of the latest practicable date:

 

Class

 

Outstanding at November 1, 2007

 

Common Stock, $.01 par value per share

 

145,598,641 shares

 

 

 



 

DUKE REALTY CORPORATION

 

INDEX

 

 

 

Page

Part I - Financial Information

 

 

 

 

 

Item 1.

 

  Financial Statements

 

 

 

 

 

 

 

 

 

Consolidated Balance Sheets as of September 30, 2007 (Unaudited) and December 31, 2006

 

2

 

 

 

 

 

 

 

Consolidated Statements of Operations (Unaudited) for the three and nine months ended September 30, 2007 and 2006

 

3

 

 

 

 

 

 

 

Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 30, 2007 and 2006

 

4

 

 

 

 

 

 

 

Consolidated Statement of Shareholders’ Equity (Unaudited) for the nine months ended September 30, 2007

 

5

 

 

 

 

 

 

 

Notes to Consolidated Financial Statements (Unaudited)

 

6-13

 

 

 

 

 

Item 2.

 

  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

14-29

 

 

 

 

 

Item 3.

 

  Quantitative and Qualitative Disclosures About Market Risk

 

30

 

 

 

 

 

Item 4.

 

  Controls and Procedures

 

30

 

 

 

 

 

Part II - Other Information

 

 

 

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

31

 

 

Item 1A.

Risk Factors

 

31

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

31-32

 

 

Item 3.

Defaults Upon Senior Securities

 

32

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

 

32

 

 

Item 5.

Other Information

 

32

 

 

Item 6.

Exhibits

 

33-34

 



 

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

DUKE REALTY CORPORATION AND SUBSIDIARIES

Consolidated Balance Sheets

(in thousands)

 

 

 

September 30,

 

December 31,

 

 

 

2007

 

2006

 

 

 

(Unaudited)

 

 

 

ASSETS

 

 

 

 

 

Real estate investments:

 

 

 

 

 

Land and improvements

 

$

822,436

 

$

844,091

 

Buildings and tenant improvements

 

4,493,009

 

4,211,602

 

Construction in progress

 

441,560

 

359,765

 

Investments in and advances to unconsolidated companies

 

551,193

 

628,323

 

Land held for development

 

800,737

 

737,752

 

 

 

7,108,935

 

6,781,533

 

Accumulated depreciation

 

(928,024

)

(867,079

)

 

 

 

 

 

 

Net real estate investments

 

6,180,911

 

5,914,454

 

 

 

 

 

 

 

Real estate investments and other assets held for sale

 

351,259

 

512,925

 

 

 

 

 

 

 

Cash and cash equivalents

 

18,424

 

68,483

 

Accounts receivable, net of allowance of $2,260 and $1,088

 

22,483

 

24,118

 

Straight-line rent receivable, net of allowance of $1,800 and $1,915

 

110,544

 

105,319

 

Receivables on construction contracts, including retentions

 

60,190

 

64,768

 

Deferred financing costs, net of accumulated amortization of $27,543 and $19,492

 

57,579

 

62,277

 

Deferred leasing and other costs, net of accumulated amortization of $146,472 and $127,155

 

367,729

 

311,553

 

Escrow deposits and other assets

 

247,723

 

174,698

 

 

 

$

7,416,842

 

$

7,238,595

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

Indebtedness:

 

 

 

 

 

Secured debt

 

$

492,538

 

$

515,192

 

Unsecured notes

 

3,368,920

 

3,129,653

 

Unsecured lines of credit

 

304,224

 

317,000

 

 

 

4,165,682

 

3,961,845

 

 

 

 

 

 

 

Liabilities of properties held for sale

 

37,926

 

155,185

 

 

 

 

 

 

 

Construction payables and amounts due subcontractors, including retentions

 

140,679

 

136,508

 

Accrued expenses:

 

 

 

 

 

Real estate taxes

 

88,182

 

59,276

 

Interest

 

37,603

 

52,106

 

Other

 

46,790

 

63,217

 

Other liabilities

 

134,126

 

118,901

 

Tenant security deposits and prepaid rents

 

28,251

 

31,121

 

Total liabilities

 

4,679,239

 

4,578,159

 

 

 

 

 

 

 

Minority interest

 

90,524

 

156,853

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Preferred shares ($.01 par value); 5,000 shares authorized;
3,241 shares issued and outstanding

 

876,250

 

876,250

 

Common shares ($.01 par value); 250,000 shares authorized;
138,570 and 133,921 shares issued and outstanding

 

1,386

 

1,339

 

Additional paid-in capital

 

2,378,590

 

2,196,388

 

Accumulated other comprehensive income

 

6,053

 

5,435

 

Distributions in excess of net income

 

(615,200

)

(575,829

)

Total shareholders’ equity

 

2,647,079

 

2,503,583

 

 

 

 

 

 

 

 

 

$

7,416,842

 

$

7,238,595

 

 

See accompanying Notes to Consolidated Financial Statements.

 

2



 

DUKE REALTY CORPORATION AND SUBSIDIARIES

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

 

 

 

2007

 

2006

 

2007

 

2006

 

RENTAL OPERATIONS:

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

Rental income from continuing operations

 

$

201,376

 

$

192,568

 

$

588,564

 

$

553,006

 

Equity in earnings of unconsolidated companies

 

1,838

 

3,492

 

17,478

 

21,447

 

 

 

203,214

 

196,060

 

606,042

 

574,453

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Rental expenses

 

44,833

 

41,993

 

133,417

 

124,256

 

Real estate taxes

 

24,750

 

21,321

 

73,223

 

64,128

 

Interest expense

 

42,390

 

46,825

 

124,924

 

124,757

 

Depreciation and amortization

 

71,981

 

59,432

 

202,854

 

173,623

 

 

 

183,954

 

169,571

 

534,418

 

486,764

 

Earnings from continuing rental operations

 

19,260

 

26,489

 

71,624

 

87,689

 

SERVICE OPERATIONS

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

General contractor gross revenue

 

77,996

 

100,314

 

195,714

 

223,924

 

General contractor costs

 

(66,696

)

(93,555

)

(171,374

)

(206,561

)

Net general contractor revenue

 

11,300

 

6,759

 

24,340

 

17,363

 

Service fee revenue

 

7,857

 

7,866

 

21,909

 

16,714

 

Gain on sale of service operations properties

 

1,116

 

7,849

 

10,793

 

8,121

 

Total revenue

 

20,273

 

22,474

 

57,042

 

42,198

 

Operating expenses

 

12,972

 

11,923

 

30,789

 

23,721

 

Earnings from service operations

 

7,301

 

10,551

 

26,253

 

18,477

 

General and administrative expense

 

(3,847

)

(6,760

)

(27,912

)

(27,642

)

Operating income

 

22,714

 

30,280

 

69,965

 

78,524

 

OTHER INCOME (EXPENSE)

 

 

 

 

 

 

 

 

 

Interest and other income, net

 

6,292

 

4,381

 

11,276

 

8,313

 

Earnings from sale of land, net of impairment adjustment

 

1,799

 

2,982

 

18,207

 

5,427

 

Other minority interest in earnings of subsidiaries

 

(38

)

(126

)

(89

)

(301

)

Minority interest in earnings of common unitholders

 

(1,078

)

(2,126

)

(3,634

)

(4,754

)

Income from continuing operations

 

29,689

 

35,391

 

95,725

 

87,209

 

Discontinued operations:

 

 

 

 

 

 

 

 

 

Net income from discontinued operations, net of minority interest

 

1,735

 

1,773

 

4,513

 

9,896

 

Gain on sale of properties, net of minority interest

 

37,190

 

39,796

 

104,467

 

41,620

 

Income from discontinued operations

 

38,925

 

41,569

 

108,980

 

51,516

 

Net income

 

68,614

 

76,960

 

204,705

 

138,725

 

Dividends on preferred shares

 

(15,227

)

(15,226

)

(45,679

)

(41,193

)

Adjustments for redemption of preferred shares

 

 

 

 

(2,633

)

Net income available for common shareholders

 

$

53,387

 

$

61,734

 

$

159,026

 

$

94,899

 

 

 

 

 

 

 

 

 

 

 

Basic net income per common share:

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

.11

 

$

.15

 

$

.36

 

$

.32

 

Discontinued operations

 

.28

 

.31

 

.80

 

.38

 

Total

 

$

.39

 

$

.46

 

$

1.16

 

$

.70

 

Diluted net income per common share:

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

.11

 

$

.15

 

$

.36

 

$

.32

 

Discontinued operations

 

.28

 

.30

 

.79

 

.38

 

Total

 

$

.39

 

$

.45

 

$

1.15

 

$

.70

 

Weighted average number of common shares outstanding

 

137,576

 

135,117

 

137,110

 

134,957

 

Weighted average number of common shares and potential dilutive common equivalents

 

147,651

 

150,947

 

147,986

 

149,472

 

 

See accompanying Notes to Consolidated Financial Statements

 

3



 

DUKE REALTY CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows

For the nine months ended September 30,

(in thousands)

(Unaudited)

 

 

 

2007

 

2006

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

204,705

 

$

138,725

 

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

 

 

 

 

 

Depreciation of buildings and tenant improvements

 

160,987

 

155,156

 

Amortization of deferred leasing and other costs

 

47,235

 

34,956

 

Amortization of deferred financing costs

 

8,518

 

6,093

 

Minority interest in earnings

 

11,323

 

10,153

 

Straight-line rent adjustment

 

(13,643

)

(15,263

)

Earnings from land and depreciated property sales

 

(129,958

)

(46,734

)

Build-for-sale operations, net

 

(167,640

)

(163,106

)

Construction contracts, net

 

720

 

(208

)

Other accrued revenues and expenses, net

 

8,901

 

(6,304

)

Operating distributions received in excess of (less than) equity in earnings from unconsolidated companies

 

4,166

 

(4,990

)

Net cash provided by operating activities

 

135,314

 

108,478

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Development of real estate investments

 

(324,317

)

(274,672

)

Acquisition of real estate investments and related intangible assets

 

(80,954

)

(735,294

)

Acquisition of land held for development

 

(155,556

)

(367,517

)

Recurring tenant improvements

 

(32,987

)

(36,300

)

Recurring leasing costs

 

(22,771

)

(12,338

)

Recurring building improvements

 

(4,894

)

(5,490

)

Other deferred leasing costs

 

(20,562

)

(30,918

)

Other deferred costs and other assets

 

(11,301

)

718

 

Proceeds from land and depreciated property sales, net

 

405,094

 

140,273

 

Capital distributions from unconsolidated companies

 

207,545

 

21,238

 

Repayments from (advances to) unconsolidated companies

 

(104,461

)

4,865

 

Net cash used for investing activities

 

(145,164

)

(1,295,435

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of common shares

 

2,186

 

 

Payments for repurchases of common shares

 

 

(11,883

)

Proceeds from exercise of stock options

 

703

 

6,336

 

Proceeds from issuance of preferred shares, net

 

 

283,994

 

Payments for redemption of preferred shares

 

 

(75,010

)

Proceeds from unsecured debt issuance

 

339,424

 

850,000

 

Payments on unsecured debt

 

(100,000

)

(100,000

)

Proceeds from issuance of secured debt

 

 

710,450

 

Payments on secured indebtedness including principal amortization

 

(22,617

)

(722,777

)

Borrowings (repayments) on lines of credit, net

 

(12,776

)

521,000

 

Distributions to common shareholders

 

(195,799

)

(191,256

)

Distributions to preferred shareholders

 

(45,679

)

(41,193

)

Distributions to minority interest, net

 

(11,637

)

(17,238

)

Cash settlement of interest rate swaps

 

10,746

 

732

 

Deferred financing costs

 

(4,760

)

(27,930

)

Net cash provided by (used for) financing activities

 

(40,209

)

1,185,225

 

Net decrease in cash and cash equivalents

 

(50,059

)

(1,732

)

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

68,483

 

26,732

 

Cash and cash equivalents at end of period

 

$

18,424

 

$

25,000

 

Other non-cash items:

 

 

 

 

 

Assumption of secured debt for real estate acquisitions

 

$

 

$

217,520

 

Conversion of Limited Partner Units to common shares

 

$

168,671

 

$

6,616

 

Contribution of real estate investments to, net of debt assumed by, unconsolidated companies

 

$

125,353

 

$

77,412

 

Issuance of Limited Partner Units for acquisition

 

$

11,020

 

$

 

 

See accompanying Notes to Consolidated Financial Statements

 

4



 

DUKE REALTY CORPORATION AND SUBSIDIARIES

Consolidated Statement of Shareholders’ Equity

For the nine months ended September 30, 2007

(in thousands, except per share data)

(Unaudited)

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Additional

 

Other

 

Distributions

 

 

 

 

 

Preferred

 

Common

 

Paid-in

 

Comprehensive

 

in Excess of

 

 

 

 

 

Stock

 

Stock

 

Capital

 

Income

 

Net Income

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2006

 

$

876,250

 

$

1,339

 

$

2,196,388

 

$

5,435

 

$

(575,829

)

$

2,503,583

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Effect of implementing new accounting principle

 

 

 

 

 

(1,717

)

(1,717

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at January 1, 2007

 

$

876,250

 

$

1,339

 

$

2,196,388

 

$

5,435

 

$

(577,546

)

$

2,501,866

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive Income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

204,705

 

204,705

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gains on derivative instruments

 

 

 

 

618

 

 

618

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

$

205,323

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of common shares

 

 

1

 

2,185

 

 

 

2,186

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock based compensation plan activity

 

 

2

 

11,390

 

 

(881

)

10,511

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Acquisition of minority interest

 

 

44

 

168,627

 

 

 

168,671

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Distributions to preferred shareholders

 

 

 

 

 

(45,679

)

(45,679

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Distributions to common shareholders ($1.43 per share)

 

 

 

 

 

(195,799

)

(195,799

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at September 30, 2007

 

$

876,250

 

$

1,386

 

$

2,378,590

 

$

6,053

 

$

(615,200

)

$

2,647,079

 

 

See accompanying Notes to Consolidated Financial Statements

 

5



 

DUKE REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.              General Basis of Presentation

 

The interim 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, 2006). The financial statements have been prepared in accordance with U.S. 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, as amended. 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. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and revenue and expenses during the reporting period. Our actual results could differ from those estimates and assumptions. These financial statements should be read in conjunction with Management’s 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, 2006.

 

Our Rental Operations (see Note 7) are conducted through Duke Realty Limited Partnership (“DRLP”). Approximately 94.4% of the common partnership interests of DRLP (“Units”) were owned by us at September 30, 2007. The remaining Units are redeemable for shares of our common stock on a one-to-one basis. We conduct our Service Operations (see Note 7) through Duke Realty Services LLC and Duke Realty Services Limited Partnership, and we are the sole general partner of both of those entities. We also conduct Service Operations through Duke Construction Limited Partnership, which is effectively 100% owned by DRLP. The consolidated financial statements include our accounts and our majority-owned or controlled subsidiaries. In this Quarterly Report on Form 10-Q (this “Report”), unless the context indicates otherwise, the terms “we,” “us” and “our” refer to the Company and those entities owned or controlled by the Company.

 

2.              Reclassifications

 

Certain 2006 balances have been reclassified to conform to the 2007 presentation.

 

3.              Acquisitions

 

In February 2007, we completed the acquisition of Bremner Healthcare Real Estate (“Bremner”), a national health care development and management firm. The primary reason for the acquisition was to expand our development capabilities within the health care real estate market.

 

The initial consideration paid to the sellers totaled $47.1 million, and the sellers may be eligible for further contingent payments over the next three years.

 

Approximately $39.1 million of the total purchase price was allocated to goodwill, which is attributable to the value of Bremner’s overall development capabilities and its in-place workforce. The results of operations for Bremner since the date of acquisition have been included in continuing operations in our consolidated financial statements.

 

6



 

4.              Indebtedness

 

We had one unsecured line of credit available as of September 30, 2007. Additionally, in July 2007, one of our consolidated majority owned subsidiaries entered into a lending agreement that included an additional unsecured line of credit. Our unsecured lines of credit as of September 30, 2007 are described as follows (dollars in thousands):

 

 

 

Borrowing

 

Maturity

 

Outstanding Balance

 

Description

 

Capacity

 

Date

 

at September 30, 2007

 

Unsecured Line of Credit

 

$

1,000,000

 

January 2010

 

$

302,000

 

Unsecured Line of Credit – Consolidated Subsidiary

 

$

30,000

 

July 2011

 

$

2,224

 

 

We use our line of credit to fund development activities, acquire additional rental properties and provide working capital. This 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, 2007 range from LIBOR +.16% to LIBOR +.525% (equal to 5.29% and 5.655% as of September 30, 2007). Our line of credit also contains financial covenants that require us to meet financial ratios and defined levels of performance, including those related to variable rate indebtedness, consolidated net worth and debt-to-market capitalization. As of September 30, 2007, we were in compliance with all covenants under our line of credit.

 

The consolidated subsidiary’s unsecured line of credit allows for borrowings up to $30.0 million at a rate of LIBOR + .85%. (equal to 6.04% as of September 30, 2007). The unsecured line of credit is used to fund development activities within the consolidated subsidiary. The consolidated subsidiary’s unsecured line of credit matures on July 27, 2011 with a 12-month extension option.

 

In August 2007, we repaid $100.0 million of 7.375% senior unsecured notes on their scheduled maturity date.

 

In September 2007, we issued $300.0 million of 6.50% senior unsecured notes due in January 2018. This issuance was hedged with an interest rate swap (Note 9) that reduced the effective interest rate to 6.16%. The net proceeds from that issuance were used to partially pay down the outstanding balance on our $1.0 billion unsecured line of credit.

 

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, 2007 and 2006, we received management fees of $5.1 million and $3.3 million, leasing fees of $2.7 million and $2.2 million and construction and development fees of $9.0 million and $16.8 million, respectively, from these companies. These fees approximate market rates for these types of services, and we have eliminated our ownership percentage of these fees in the 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 outstanding and minority Units outstanding, including any potential dilutive common equivalents for the period.

 

7



 

The following table reconciles the components of basic and diluted net income per common share for the three and nine months ended September 30, 2007 and 2006, respectively (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Basic net income available for common shareholders

 

$

53,387

 

$

61,734

 

$

159,026

 

$

94,899

 

Joint venture partner convertible ownership net income (2)

 

 

378

 

 

 

Minority interest in earnings of common unitholders

 

3,573

 

6,083

 

11,101

 

9,396

 

Diluted net income available for common shareholders

 

$

56,960

 

$

68,195

 

$

170,127

 

$

104,295

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of common shares outstanding

 

137,576

 

135,117

 

137,110

 

134,957

 

Weighted average partnership Units outstanding

 

9,176

 

13,211

 

9,560

 

13,302

 

Joint venture partner convertible ownership common share equivalents (2)

 

 

1,357

 

 

 

Dilutive shares for stock-based compensation plans (1)

 

899

 

1,262

 

1,316

 

1,213

 

Weighted average number of common shares and potential dilutive common equivalents

 

147,651

 

150,947

 

147,986

 

149,472

 

 


(1)          Excludes the effect of outstanding stock options, as well as Exchangeable Senior Notes (“Exchangeable Notes”) issued in 2006, that have an anti-dilutive effect on earnings per share for the three and nine-month periods ended September 30, 2007 and 2006.

 

(2)          One of our joint venture partners in one of our unconsolidated companies has the option to convert a portion of its ownership in the joint venture to common shares. The effect of this option on earnings per share is dilutive for the third quarter 2006; therefore, conversion to common shares is included in weighted average potential dilutive common equivalents for the quarter.

 

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 (collectively, “Rental Operations”). The third reportable segment consists of our build-to-suit for sale operations and providing of 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 or services and are managed separately because each segment requires different operating strategies and management expertise.

 

The assets of the Service Operations business segment generally include properties under development. During the period between the completion of development, rehabilitation or repositioning of a Service Operations property and the date the property is contributed to a property fund or sold to a third party, the property and its associated rental income and rental expenses are included in the applicable Rental Operations segment because the primary activity associated with the Service Operations property during that period is rental activities. Upon contribution or sale, the resulting gain or loss is part of the income of the Service Operations business segment.

 

Non-segment revenue consists mainly of equity in earnings of unconsolidated companies and other insignificant rental operations such as retail and medical office properties. 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.

 

8



 

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 analysts and investors 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 believes FFO is 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, 2007 and 2006, respectively (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Revenues

 

 

 

 

 

 

 

 

 

Rental Operations:

 

 

 

 

 

 

 

 

 

Office

 

$

140,858

 

$

139,260

 

$

409,886

 

$

399,938

 

Industrial

 

52,741

 

50,755

 

160,761

 

144,113

 

Service Operations

 

20,273

 

22,474

 

57,042

 

42,198

 

Total Segment Revenues

 

213,872

 

212,489

 

627,689

 

586,249

 

Non-Segment Revenue

 

9,615

 

6,045

 

35,395

 

30,402

 

Consolidated Revenue from continuing operations

 

$

223,487

 

$

218,534

 

$

663,084

 

$

616,651

 

Discontinued Operations

 

7,088

 

17,482

 

32,949

 

59,964

 

Consolidated Revenue

 

$

230,575

 

$

236,016

 

$

696,033

 

$

676,615

 

Funds From Operations

 

 

 

 

 

 

 

 

 

Rental Operations:

 

 

 

 

 

 

 

 

 

Office

 

$

87,742

 

$

88,494

 

$

251,862

 

$

249,786

 

Industrial

 

40,645

 

40,357

 

123,528

 

111,079

 

Services Operations

 

7,301

 

10,551

 

26,253

 

18,477

 

Total Segment FFO

 

135,688

 

139,402

 

401,643

 

379,342

 

Non-Segment FFO:

 

 

 

 

 

 

 

 

 

Interest expense

 

(42,390

)

(46,825

)

(124,924

)

(124,757

)

Interest and other income, net

 

6,292

 

4,381

 

11,276

 

8,313

 

General and administrative expense

 

(3,847

)

(6,760

)

(27,912

)

(27,642

)

Gain on land sales, net of impairment

 

1,799

 

2,982

 

18,207

 

5,427

 

Other non-segment income

 

3,407

 

169

 

6,535

 

3,492

 

Minority interest

 

(1,116

)

(2,252

)

(3,723

)

(5,055

)

Minority interest share of FFO adjustments

 

(2,697

)

(2,621

)

(7,539

)

(13,831

)

Joint venture FFO

 

12,414

 

8,341

 

36,801

 

27,060

 

Dividends on preferred shares

 

(15,227

)

(15,226

)

(45,679

)

(41,193

)

Adjustment for redemption of preferred shares

 

 

 

 

(2,633

)

Discontinued operations, net of minority interest

 

(650

)

7,196

 

2,597

 

26,697

 

Consolidated basic FFO

 

$

93,673

 

$

88,787

 

$

267,282

 

$

235,220

 

Depreciation and amortization on continuing operations

 

(71,981

)

(59,432

)

(202,854

)

(173,623

)

Depreciation and amortization on discontinued operations

 

(95

)

(4,931

)

(5,368

)

(16,489

)

Company’s share of joint venture adjustments

 

(10,574

)

(4,568

)

(21,152

)

(13,695

)

Earnings from depreciated property sales on discontinued operations

 

39,670

 

39,537

 

111,751

 

41,573

 

Earnings from depreciated property sales-share of joint venture

 

(3

)

(280

)

1,828

 

8,082

 

Minority interest share of FFO adjustments

 

2,697

 

2,621

 

7,539

 

13,831

 

  Net income available for common shareholders

 

$

53,387

 

$

61,734

 

$

159,026

 

$

94,899

 

 

10



 

The assets for each of the reportable segments as of September 30, 2007 and December 31, 2006, respectively, are as follows (in thousands):

 

 

 

September 30,

 

December 31,

 

 

 

2007

 

2006

 

Assets

 

 

 

 

 

Rental Operations:

 

 

 

 

 

Office

 

$

3,890,873

 

$

4,061,806

 

Industrial

 

2,099,009

 

1,942,992

 

Service Operations

 

349,163

 

301,886

 

Total Segment Assets

 

6,339,045

 

6,306,684

 

Non-Segment Assets

 

1,077,797

 

931,911

 

Consolidated Assets

 

$

7,416,842

 

$

7,238,595

 

 

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 vacant 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, 2007 and 2006, respectively  (in thousands):

 

 

 

Nine Months Ended

 

 

 

September 30,

 

 

 

2007

 

2006

 

Recurring Capital Expenditures

 

 

 

 

 

Office

 

$

50,079

 

$

42,035

 

Industrial

 

10,383

 

9,672

 

Non-segment

 

190

 

347

 

Total

 

$

60,652

 

$

52,054

 

 

8.     Discontinued Operations

 

We classified the operations of 67 buildings as discontinued operations as of September 30, 2007. These 67 buildings consist of 32 industrial and 35 office properties. Of these properties, 30 were sold during the first nine months of 2007, 21 were sold during 2006 and 16 operating properties are classified as held-for-sale at September 30, 2007.

 

The following table illustrates the operations of the buildings reflected in discontinued operations for the three and nine months ended September 30, 2007 and 2006, respectively (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Statement of Operations:

 

 

 

 

 

 

 

 

 

Revenues

 

$

7,088

 

$

17,482

 

$

32,949

 

$

59,964

 

Expenses:

 

 

 

 

 

 

 

 

 

Operating

 

3,080

 

6,780

 

14,022

 

21,645

 

Interest

 

2,045

 

3,776

 

8,690

 

10,858

 

Depreciation and Amortization

 

95

 

4,931

 

5,368

 

16,489

 

General and Administrative

 

17

 

46

 

41

 

97

 

Operating Income

 

1,851

 

1,949

 

4,828

 

10,875

 

Minority interest expense

 

(116

)

(176

)

(315

)

(979

)

Income from discontinued operations, before gain on sales

 

1,735

 

1,773

 

4,513

 

9,896

 

Gain on sale of property

 

39,670

 

43,735

 

111,751

 

45,739

 

Minority interest expense – gain on sales

 

(2,480

)

(3,939

)

(7,284

)

(4,119

)

Gain on sale of property, net of minority interest

 

37,190

 

39,796

 

104,467

 

41,620

 

Income from discontinued operations

 

$

38,925

 

$

41,569

 

$

108,980

 

$

 51,516

 

 

11



 

At September 30, 2007, we classified 16 properties as held-for-sale and included in discontinued operations. Additionally, we have classified 13 in-service properties as held-for-sale, but have included the results of operations of these properties in continuing operations, 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 properties included in discontinued operations, as well as the 13 held-for-sale properties whose results are included in continuing operations, at September 30, 2007 (in thousands):

 

 

 

Properties

 

Properties

 

 

 

 

 

Included in

 

Included in

 

Total

 

 

 

Discontinued

 

Continuing

 

Held-for-Sale

 

 

 

Operations

 

Operations

 

Properties

 

 

 

 

 

 

 

 

 

Balance Sheet:

 

 

 

 

 

 

 

Real estate investments, net

 

$

133,895

 

$

193,064

 

$

326,959

 

Other assets

 

9,810

 

14,490

 

24,300

 

Total assets

 

$

143,705

 

$

207,554

 

$

351,259

 

 

 

 

 

 

 

 

 

Accrued expenses

 

$

2,762

 

$

633

 

$

3,395

 

Other liabilities

 

1,021

 

7,759

 

8,780

 

Secured debt

 

 

25,751

 

25,751

 

Total liabilities held-for-sale

 

$

3,783

 

$

34,143

 

$

37,926

 

 

We allocate interest expense 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.

 

9.     Financial Instruments

 

We are exposed to capital market risk, such as changes in interest rates. In order to reduce 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 August 2005, we entered into $300.0 million of cash flow hedges through forward-starting interest rate swaps to hedge interest rates on $300.0 million of estimated debt offerings in 2007. The swaps qualified for hedge accounting, with any change in fair value recorded in Accumulated Other Comprehensive Income (“OCI”). In conjunction with the September 2007 issuance of $300.0 million of senior unsecured notes (Note 4), we terminated these cash flow hedges as designated. The settlement amount received of $10.7 million will be recognized to earnings through interest expense over the term of the hedged cash flows. The ineffective portion of the hedge was insignificant.

 

In July 2007, we entered into a $21.0 million cash flow hedge through an interest rate swap to fix the rate on $21.0 million of floating rate term debt, issued by one of our consolidated majority owned subsidiaries, which matures in July 2011. The swap qualifies for hedge accounting, with any changes in fair value recorded in OCI. At September 30, 2007 the fair value of this swap was approximately $585,000 in a liability position.

 

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.

 

12



 

10.  Recent Accounting Pronouncements

 

We adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109 (“FIN 48”), on January 1, 2007. The adoption of FIN 48 resulted in an additional tax exposure of approximately $1.7 million recorded as an adjustment to the opening balance of Distributions in Excess of Net Income. Our uncertain tax positions are immaterial both individually and in the aggregate primarily due to our tax status as a REIT.

 

In September 2006, the FASB issued Statement of Financial Accounting Standard (“SFAS”) No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with GAAP and expands disclosure about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. Management is currently evaluating the impact of adopting this statement.

 

In January 2007, the FASB issued SFAS No. 159, The Fair Value Options for Financial Assets and Financial Liabilities (“SFAS 159”). SFAS 159 provides a “Fair Value Option” under which a company may irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities. This Fair Value Option will be available on a contract-by-contract basis with changes in fair value recognized in earnings as those changes occur. The effective date for SFAS 159 is the beginning of each reporting entity’s first fiscal year end that begins after November 15, 2007. We do not expect to elect the Fair Value Option for any of our financial assets or liabilities.

 

11.  Subsequent Events

 

Declaration of Dividends

 

The Company’s board of directors declared the following dividends at its October 31, 2007, regularly scheduled board meeting:

 

 

 

Quarterly

 

 

 

 

 

Class

 

Amount/Share

 

Record Date

 

Payment Date

 

Common

 

$

0.48

 

November 14, 2007

 

November 30, 2007

 

Preferred (per depositary share):

 

 

 

 

 

 

 

Series J

 

$

0.414063

 

November 16, 2007

 

November 30, 2007

 

Series K

 

$

0.406250

 

November 16, 2007

 

November 30, 2007

 

Series L

 

$

0.412500

 

November 16, 2007

 

November 30, 2007

 

Series M

 

$

0.434375

 

December 17, 2007

 

December 31, 2007

 

Series N

 

$

0.453125

 

December 17, 2007

 

December 31, 2007

 

 

Issuance of Common Stock

 

In October 2007, we issued 7.0 million shares of our common stock for net proceeds of $232.7 million. The net proceeds of the offering were used to partially pay down our $1.0 billion unsecured line of credit.

 

Redemption of Series B Cumulative Redeemable Preferred Shares

 

In October 2007, we redeemed all of the outstanding shares of our 7.990% Series B Cumulative Redeemable Preferred Stock at a liquidation amount of $132.3 million.

 

13



 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Cautionary Statement Regarding Forward Looking Statements

 

Certain statements contained in this Report, including, without limitation, those related to our future operations, constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. 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 the performance of financial markets;

      Our continued qualification as a real estate investment trust, or “REIT”, for U.S. federal income tax purposes;

      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 raise funds on favorable terms 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, but not limited to, tenant defaults, potential liability relating to environmental matters and liquidity of real estate investments; and

      Other risks and uncertainties described herein, as well as those risks and uncertainties discussed from time to time in our other reports and filings with the Securities and Exchange Commission (“SEC”).

 

This list of risks and uncertainties, however, is only a summary of some of the most important factors and is not intended to be exhaustive. Additional information regarding risk factors that may affect us is included under the caption “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006, which we filed with the SEC on March 1, 2007, and is updated by us from time to time in Quarterly Reports on Form 10-Q and other public 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 subjective, uncertain and subject to change, 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, except as otherwise may be required by law.

 

14



 

Business Overview

 

We are a self-administered and self-managed REIT that began operations through a related entity in 1972. As of September 30, 2007, we:

 

      Owned or jointly controlled 723 industrial, office and retail properties (including properties under development), consisting of approximately 119.8 million square feet; and

      Owned or jointly controlled more than 7,600 acres of land with an estimated future development potential of more than 112 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 February 2007, we completed the acquisition of Bremner Healthcare Real Estate (“Bremner”), a national health care development and management firm. The primary reason for the acquisition was to expand our development capabilities within the health care real estate market.

 

The initial consideration paid to the sellers totaled $47.1 million, and the sellers may be eligible for further contingent payments over the next three years.

 

Approximately $39.1 million of the total purchase price is allocated to goodwill, which is attributable to the value of Bremner’s overall development capabilities and its in-place workforce.

 

Key Performance Indicators

 

Our operating results depend primarily upon rental income from our office and industrial 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 (excluding in-service properties developed or acquired with the intent to sell – “Service Operations Buildings”) as of September 30, 2007 and 2006, respectively (in thousands, except percentage data):

 

 

 

Total

 

Percent of

 

 

 

 

 

Square Feet

 

Total Square Feet

 

Percent Occupied

 

Type

 

2007

 

2006

 

2007

 

2006

 

2007

 

2006

 

Industrial

 

75,225

 

73,248

 

69.5

%

69.0

%

94.6

%

93.2

%

Office

 

31,688

 

32,170

 

29.2

%

30.3

%

91.0

%

91.0

%

Other

 

1,378

 

745

 

1.3

%

0.7

%

90.7

%

96.9

%

Total

 

108,291

 

106,163

 

100.0

%

100.0

%

93.5

%

92.5

%

 

15



 

Lease Expiration and Renewal: Our ability to maintain and grow occupancy rates primarily depends upon our continuing ability to re-lease expiring space. The following table reflects our in-service lease expiration schedule by property type as of September 30, 2007. The table indicates square footage and annualized net effective rents (based on September 2007 rental revenue) under expiring leases (in thousands, except percentage data):

 

 

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Portfolio

 

Industrial

 

Office

 

Other

 

Year of

 

Square

 

Ann. Rent

 

% of

 

Square

 

Ann. Rent

 

Square

 

Ann. Rent

 

Square

 

Ann. Rent

 

Expiration

 

Feet

 

Revenue

 

Revenue

 

Feet

 

Revenue

 

Feet

 

Revenue

 

Feet

 

Revenue

 

2007

 

2,580

 

$

13,597

 

2

%

2,130

 

$

8,075

 

405

 

$

4,953

 

45

 

$

569

 

2008

 

12,358

 

69,195

 

9

%

9,606

 

35,501

 

2,724

 

33,295

 

28

 

399

 

2009

 

11,524

 

74,835

 

11

%

8,287

 

33,313

 

3,177

 

40,931

 

60

 

591

 

2010

 

12,938

 

98,818

 

14

%

8,660

 

38,755

 

4,263

 

59,876

 

15

 

187

 

2011

 

13,538

 

85,246

 

12

%

10,107

 

38,743

 

3,364

 

45,442

 

67

 

1,061

 

2012

 

10,589

 

74,873

 

11

%

7,159

 

28,149

 

3,386

 

45,868

 

44

 

856

 

2013

 

8,589

 

74,965

 

11

%

4,752

 

20,335

 

3,785

 

53,812

 

52

 

818

 

2014

 

6,380

 

37,698

 

5

%

4,914

 

18,089

 

1,431

 

19,071

 

35

 

538

 

2015

 

7,353

 

55,841

 

8

%

5,165

 

19,811

 

2,188

 

36,030

 

 

 

2016

 

3,949

 

26,890

 

4

%

2,847

 

10,427

 

887

 

13,964

 

215

 

2,499

 

2017 and Thereafter

 

11,447

 

88,150

 

13

%

7,531

 

31,081

 

3,227

 

47,501

 

689

 

9,568

 

Total Leased

 

101,245

 

$

700,108

 

100

%

71,158

 

$

282,279

 

28,837

 

$

400,743

 

1,250

 

$

17,086

 

Total Portfolio Square Feet

 

108,291

 

 

 

 

 

75,225

 

 

 

31,688

 

 

 

1,378

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Percent Occupied

 

93.5

%

 

 

 

 

94.6

%

 

 

91.0

%

 

 

90.7

%

 

 

 

Note:  Excludes Service Operations Buildings.

 

We renewed 80.8% and 81.9% of our leases up for renewal in the three and nine months ended September 30, 2007, totaling approximately 2.9 million and 8.5 million square feet, respectively. This compares to renewals of 79.6% and 78.9% for the three and nine months ended September 30, 2006, totaling approximately 1.9 million and 5.7 million square feet, respectively. We attained 7.6% and 5.3% growth in net effective rents on these renewals in the three and nine months ended September 30, 2007, respectively.

 

The average term of renewals for the three and nine months ended September 30, 2007 was 3.0 and 3.9 years, respectively, compared to an average term of 4.7 and 3.9 years for the three and nine months ended September 30, 2006, respectively.

 

Future Development:  Another source of growth in earnings is the development of additional properties. These properties should provide future earnings through income upon sale or from Rental Operations growth as they are placed in service. We had 16.6 million square feet of property under development with total estimated costs of $1.3 billion at September 30, 2007, compared to 11.4 million square feet with total estimated costs of $1.1 billion at September 30, 2006.

 

16



 

The following table summarizes our properties under development as of September 30, 2007 (in thousands, except percentage data):

 

 

 

 

 

 

 

Total

 

 

 

Anticipated

 

 

 

 

 

 

Estimated

 

Anticipated

 

In-Service

 

 

Square

 

Percent

 

Project

 

Stabilized

 

Date

 

 

Feet

 

Leased

 

Costs

 

Return

 

Held-for-Rental Buildings:

 

 

 

 

 

 

 

 

 

4th Quarter 2007

 

3,917

 

16%

 

$

282,789

 

9.38%

 

1st Quarter 2008

 

5,493

 

14%

 

282,511

 

8.99%

 

2nd Quarter 2008

 

1,391

 

46%

 

97,798

 

8.93%

 

Thereafter

 

660

 

61%

 

109,714

 

9.44%

 

 

 

11,461

 

21%

 

$

772,812

 

9.19%

 

Service Operations Buildings:

 

 

 

 

 

 

 

 

 

4th Quarter 2007

 

1,469

 

49%

 

$

223,352

 

8.27%

 

1st Quarter 2008

 

585

 

31%

 

30,651

 

8.77%

 

2nd Quarter 2008

 

1,044

 

88%

 

86,925

 

8.08%

 

Thereafter

 

2,047

 

79%

 

209,502

 

8.51%

 

 

 

5,145

 

67%

 

$

550,430

 

8.36%

 

Total

 

16,606

 

35%

 

$

1,323,242

 

8.85%

 

 

Acquisition and Disposition Activity: We continued to selectively dispose of non-strategic properties during the nine months ended September 30, 2007. Gross sales proceeds related to the dispositions of wholly owned held-for-rental properties were $317.4 million for the nine months ended September 30, 2007, which included the disposition of a portfolio of eight office properties in the Cleveland market and a portfolio of twelve industrial properties in the St. Louis market. Our share of proceeds from sales of properties within unconsolidated joint ventures, in which we have a less than 100% interest, totaled $13.4 million for the nine months ended September 30, 2007. For the nine months ended September 30, 2006, proceeds totaled $126.5 million for the disposition of wholly owned held-for-rental properties and $72.6 million for our share of property sales from unconsolidated joint ventures. Dispositions of wholly owned properties developed for sale rather than rental resulted in $85.0 million in proceeds for the nine months ended September 30, 2007, compared to $39.0 million for the same period in 2006.

 

For the nine months ended September 30, 2007, in addition to the acquisition of Bremner, we acquired $47.4 million of income producing properties and also acquired $156.8 million of undeveloped land, compared to acquisitions of $963.9 million of income producing properties and $366.2 million of undeveloped land in the nine months ended September 30, 2006.

 

Funds From Operations

 

Funds From Operations (“FFO”) is used by industry analysts and investors as a supplemental operating performance measure of an equity 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 U.S. generally accepted accounting principles (“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 measure of other companies.

 

17



 

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 analysts and investors 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 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 believes FFO is 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.

 

The following table shows a reconciliation of net income available for common shareholders to the calculation of FFO for the three and nine months ended September 30, 2007 and 2006, respectively (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Net income available for common shareholders

 

$

53,387

 

$

61,734

 

$

159,026

 

$

94,899

 

Adjustments:

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

72,076

 

64,363

 

208,222

 

190,112

 

Company share of joint venture depreciation and amortization

 

10,574

 

4,568

 

21,152

 

13,695

 

Earnings from depreciable property sales - wholly owned

 

(39,670

)

(39,537

)

(111,751

)

(41,573

)

Earnings from depreciable property sales - share of joint venture

 

3

 

280

 

(1,828

)

(8,082

)

Minority interest share of adjustments

 

(2,697

)

(2,621

)

(7,539

)

(13,831

)

Funds From Operations

 

$

93,673

 

$

88,787

 

$

267,282

 

$

235,220

 

 

18



 

Results of Operations

 

A summary of our operating results and property statistics for the three and nine months ended September 30, 2007 and 2006, respectively, is as follows (in thousands, except number of properties and per share data):

 

 

 

Three Months Ended

 

Nine Months Ended