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    March 31, 2008

 

 

 

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

 

(IRS Employer

of Incorporation or Organization)

 

 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, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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 May 1, 2008

Common Stock, $.01 par value per share

 

146,686,438 shares

 

 



 

DUKE REALTY CORPORATION

 

INDEX

 

 

 

 

 

Page

Part I -  Financial Information

 

 

 

 

 

 

 

Item 1.  Financial Statements

 

 

 

 

 

 

 

 

 

Consolidated Balance Sheets as of March 31, 2008 (Unaudited) and December 31, 2007

 

2

 

 

 

 

 

 

 

Consolidated Statements of Operations (Unaudited) for the three months ended March 31, 2008 and 2007

 

3

 

 

 

 

 

 

 

Consolidated Statements of Cash Flows (Unaudited) for the three months ended March 31, 2008 and 2007

 

4

 

 

 

 

 

 

 

Consolidated Statement of Shareholders’ Equity (Unaudited) for the three months ended March 31, 2008

 

5

 

 

 

 

 

 

 

Notes to Consolidated Financial Statements (Unaudited)

 

6-14

 

 

 

 

 

Item 2.

 

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

 

14-25

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

25

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

26

 

Part II - Other Information

 

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

26

Item 1A.

 

Risk Factors

 

26

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

27

Item 3.

 

Defaults Upon Senior Securities

 

27

Item 4.

 

Submission of Matters to a Vote of Security Holders

 

27

Item 5.

 

Other Information

 

27

Item 6.

 

Exhibits

 

28-29

 



 

PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements

DUKE REALTY CORPORATION AND SUBSIDIARIES

Consolidated Balance Sheets

(in thousands, except per share amounts)

 

 

 

March 31,

 

December 31,

 

 

 

2008

 

2007

 

 

 

(Unaudited)

 

ASSETS

 

 

 

 

 

Real estate investments:

 

 

 

 

 

Land and improvements

 

$

938,764

 

$

872,372

 

Buildings and tenant improvements

 

4,849,556

 

4,600,408

 

Construction in progress

 

444,691

 

412,729

 

Investments in and advances to unconsolidated companies

 

665,572

 

601,801

 

Land held for development

 

836,245

 

912,448

 

 

 

7,734,828

 

7,399,758

 

Accumulated depreciation

 

(1,029,862

)

(951,375

)

Net real estate investments

 

6,704,966

 

6,448,383

 

Real estate investments and other assets held for sale

 

144,077

 

273,591

 

 

 

 

 

 

 

Cash and cash equivalents

 

15,529

 

48,012

 

Accounts receivable, net of allowance of $1,812 and $1,359

 

26,672

 

29,009

 

Straight-line rent receivable, net of allowance of $2,095 and $2,886

 

116,682

 

110,737

 

Receivables on construction contracts, including retentions

 

70,684

 

66,925

 

Deferred financing costs, net of accumulated amortization of $30,337 and $29,170

 

53,480

 

55,987

 

Deferred leasing and other costs, net of accumulated amortization of $163,576 and $150,702

 

377,253

 

374,635

 

Escrow deposits and other assets

 

250,900

 

254,702

 

 

 

$

7,760,243

 

$

7,661,981

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

Indebtedness:

 

 

 

 

 

Secured debt

 

$

506,071

 

$

524,393

 

Unsecured notes

 

3,121,000

 

3,246,000

 

Unsecured lines of credit

 

635,068

 

546,067

 

 

 

4,262,139

 

4,316,460

 

 

 

 

 

 

 

Liabilities of properties held for sale

 

3,813

 

8,954

 

 

 

 

 

 

 

Construction payables and amounts due subcontractors, including retentions

 

129,631

 

142,655

 

Accrued expenses:

 

 

 

 

 

Real estate taxes

 

72,559

 

63,796

 

Interest

 

38,490

 

54,631

 

Other

 

31,283

 

59,221

 

Other liabilities

 

127,971

 

148,013

 

Tenant security deposits and prepaid rents

 

38,085

 

34,535

 

Total liabilities

 

4,703,971

 

4,828,265

 

 

 

 

 

 

 

Minority interest

 

76,619

 

83,683

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Preferred shares ($.01 par value); 5,000 shares authorized; 4,176 and 2,976 shares issued and outstanding

 

1,044,000

 

744,000

 

Common shares ($.01 par value); 250,000 shares authorized; 146,670 and 146,175 shares issued and outstanding

 

1,467

 

1,462

 

Additional paid-in capital

 

2,637,099

 

2,632,615

 

Accumulated other comprehensive income (loss)

 

(9,719

)

(1,279

)

Distributions in excess of net income

 

(693,194

)

(626,765

)

Total shareholders’ equity

 

2,979,653

 

2,750,033

 

 

 

$

7,760,243

 

$

7,661,981

 

 

See accompanying Notes to Consolidated Financial Statements.

 

2



 

DUKE REALTY CORPORATION AND SUBSIDIARIES

Consolidated Statements of Operations

For the Three Months Ended March 31,

(in thousands, except per share amounts)

(Unaudited)

 

 

 

2008

 

2007

 

RENTAL OPERATIONS

 

 

 

 

 

Revenues:

 

 

 

 

 

Rental revenue from continuing operations

 

$

217,802

 

$

202,105

 

Equity in earnings of unconsolidated companies

 

10,099

 

7,691

 

 

 

227,901

 

209,796

 

Operating expenses:

 

 

 

 

 

Rental expenses

 

52,027

 

49,049

 

Real estate taxes

 

27,544

 

25,043

 

Interest expense

 

47,534

 

44,408

 

Depreciation and amortization

 

78,713

 

66,375

 

 

 

205,818

 

184,875

 

Earnings from continuing rental operations

 

22,083

 

24,921

 

 

 

 

 

 

 

SERVICE OPERATIONS

 

 

 

 

 

Revenues:

 

 

 

 

 

General contractor gross revenue

 

76,759

 

54,157

 

General contractor costs

 

(70,104

)

(48,688

)

Net general contractor revenue

 

6,655

 

5,469

 

Service fee revenue

 

7,524

 

6,397

 

Gain on sale of service operations properties

 

597

 

2,864

 

 

 

 

 

 

 

Total service operations revenue

 

14,776

 

14,730

 

 

 

 

 

 

 

Operating expenses

 

10,363

 

7,796

 

 

 

 

 

 

 

Earnings from service operations

 

4,413

 

6,934

 

 

 

 

 

 

 

General and administrative expense

 

(12,162

)

(13,460

)

 

 

 

 

 

 

Operating income

 

14,334

 

18,395

 

 

 

 

 

 

 

OTHER INCOME (EXPENSE)

 

 

 

 

 

Interest and other income, net

 

3,725

 

2,403

 

Earnings from sale of land, net

 

629

 

13,997

 

Minority interest in earnings of common unitholders

 

(214

)

(1,331

)

Income from continuing operations

 

18,474

 

33,464

 

 

 

 

 

 

 

Discontinued operations:

 

 

 

 

 

Income (loss) from discontinued operations, net of minority interest

 

(173

)

2,039

 

Gain on sale of depreciable property, net of minority interest

 

1,053

 

48,286

 

Income from discontinued operations

 

880

 

50,325

 

 

 

 

 

 

 

Net income

 

19,354

 

83,789

 

Dividends on preferred shares

 

(15,306

)

(15,226

)

Net income available for common shareholders

 

$

4,048

 

$

68,563

 

 

 

 

 

 

 

Basic net income per common share:

 

 

 

 

 

Continuing operations

 

$

.02

 

$

.13

 

Discontinued operations

 

.01

 

.37

 

Total

 

$

.03

 

$

.50

 

 

 

 

 

 

 

Diluted net income per common share:

 

 

 

 

 

Continuing operations

 

$

.02

 

$

.13

 

Discontinued operations

 

.01

 

.36

 

Total

 

$

.03

 

$

.49

 

 

 

 

 

 

 

Weighted average number of common shares outstanding

 

146,331

 

136,823

 

Weighted average number of common shares and potential dilutive securities

 

154,596

 

149,465

 

 

See accompanying Notes to Consolidated Financial Statements.

 

3



 

DUKE REALTY CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows

For the three months ended March 31,

(in thousands)

(Unaudited)

 

 

 

2008

 

2007

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

19,354

 

$

83,789

 

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

 

 

 

 

 

Depreciation of buildings and tenant improvements

 

60,850

 

52,143

 

Amortization of deferred leasing and other costs

 

18,271

 

15,596

 

Amortization of deferred financing costs

 

3,399

 

2,865

 

Minority interest in earnings

 

261

 

4,910

 

Straight-line rent adjustment

 

(4,638

)

(5,773

)

Earnings from land and depreciated property sales

 

(1,739

)

(65,717

)

Build-for-sale operations, net

 

(41,775

)

(49,989

)

Construction contracts, net

 

(14,418

)

6,764

 

Other accrued revenues and expenses, net

 

(35,300

)

(32,590

)

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

 

(2,042

)

137

 

Net cash provided by operating activities

 

2,223

 

12,135

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Development of real estate investments

 

(151,872

)

(96,588

)

Acquisition of real estate investments and related intangible assets

 

(8,701

)

(33,628

)

Acquisition of land held for development

 

(14,741

)

(34,738

)

Recurring tenant improvements

 

(10,803

)

(10,333

)

Recurring leasing costs

 

(6,098

)

(7,732

)

Recurring building improvements

 

(967

)

(974

)

Other deferred leasing costs

 

(5,939

)

(3,664

)

Other deferred costs and other assets

 

(298

)

(1,053

)

Proceeds from land and depreciated property sales, net

 

26,684

 

176,726

 

Capital distributions from unconsolidated companies

 

38,753

 

53,500

 

Capital contributions and advances to unconsolidated companies, net

 

(20,296

)

(33,140

)

Net cash provided by (used for) investing activities

 

(154,278

)

8,376

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of common shares

 

5,801

 

 

Proceeds (disbursements) from exercise of stock options

 

112

 

(12

)

Proceeds from issuance of preferred shares, net

 

290,445

 

 

Proceeds from unsecured debt issuance

 

 

5,812

 

Payments on unsecured debt

 

(125,000

)

 

Payments on secured indebtedness including principal amortization

 

(36,532

)

(12,007

)

Borrowings on lines of credit, net

 

89,001

 

13,000

 

Distributions to common shareholders

 

(70,211

)

(65,004

)

Distributions to preferred shareholders

 

(15,306

)

(15,226

)

Distributions to minority interest, net

 

(3,828

)

(4,662

)

Cash settlement of interest rate swaps

 

(14,625

)

 

Deferred financing costs

 

(285

)

(1,403

)

Net cash provided by (used for) financing activities

 

119,572

 

(79,502

)

Net decrease in cash and cash equivalents

 

(32,483

)

(58,991

)

Cash and cash equivalents at beginning of period

 

48,012

 

68,483

 

Cash and cash equivalents at end of period

 

$

15,529

 

$

9,492

 

 

 

 

 

 

 

Other non-cash items:

 

 

 

 

 

Conversion of Limited Partner Units to common shares

 

$

4,376

 

$

117,245

 

Issuance of Limited Partner Units for acquisition

 

$

 

$

11,020

 

Assumption of secured debt for real estate acquisitions

 

$

18,465

 

$

 

Contribution of property to unconsolidated company

 

$

77,158

 

$

 

 

See accompanying Notes to Consolidated Financial Statements

 

4



 

DUKE REALTY CORPORATION AND SUBSIDIARIES

Consolidated Statement of Shareholders’ Equity

For the three months ended March 31, 2008

(in thousands,  except per share data)

(Unaudited)

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Additional

 

Other

 

Distributions

 

 

 

 

 

Preferred

 

Common

 

Paid-in

 

Comprehensive

 

in Excess of

 

 

 

 

 

Shares

 

Shares

 

Capital

 

Income (Loss)

 

Net Income

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2007

 

$

744,000

 

$

1,462

 

$

2,632,615

 

$

(1,279

)

$

(626,765

)

$

2,750,033

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive Income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

19,354

 

19,354

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Losses on derivative instruments

 

 

 

 

(8,440

)

 

(8,440

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

 

 

 

 

 

10,914

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of preferred shares

 

300,000

 

 

(10,000

)

 

 

290,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of common shares

 

 

2

 

5,799

 

 

 

5,801

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock based compensation plan activity

 

 

1

 

4,311

 

 

(266

)

4,046

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Acquisition of minority interest

 

 

2

 

4,374

 

 

 

4,376

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Distributions to preferred shareholders

 

 

 

 

 

(15,306

)

(15,306

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Distributions to common shareholders ($.48 per share) 

 

 

 

 

 

(70,211

)

(70,211

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at March 31, 2008

 

$

1,044,000

 

$

1,467

 

$

2,637,099

 

$

(9,719

)

$

(693,194

)

$

2,979,653

 

 

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. The 2007 year-end consolidated balance sheet data included in this Form 10-Q was derived from the audited financial statements referenced above, but does not include all disclosures required by accounting principles generally accepted in the United States of America (“GAAP”).  The financial statements have been prepared in accordance with 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, 2007.

 

We believe we qualify as a  real estate investment trust (“REIT”) under the provisions of the internal revenue code. Substantially all of our Rental Operations (see Note 7) are conducted through Duke Realty Limited Partnership (“DRLP”). We owned approximately 95.0% of the common partnership interests of DRLP (“Units”) at March 31, 2008. The remaining Units are redeemable for shares of our common stock on a one-to-one basis and earn dividends at the same rates as shares of our common stock. We conduct our Service Operations (see Note 7) through Duke Realty Services LLC, Duke Realty Services Limited Partnership and Duke Construction Limited Partnership.  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.              New Accounting Pronouncement

 

Statement of Financial Accounting Standard (“SFAS”) No.157, Fair Value Measurements (“SFAS 157”) was effective for us on January 1, 2008. SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements; accordingly, the standard does not require any new fair value measurements of reported balances. Based on the guidance provided by FASB Staff Position No. 157-2, Effective Date of FASB Statement No. 157 (“FSP No. 157-2”), we have only partially implemented the guidance promulgated under SFAS 157 as of January 1, 2008, which in our circumstances only affects financial instruments. SFAS 157 will not be applied during 2008 to nonfinancial long lived asset groups that may be measured for an impairment assessment, reporting units measured at fair value in the first step of the goodwill impairment test, and nonfinancial assets and nonfinancial liabilities initially measured at fair value in a business combination. We will fully apply the provisions of SFAS 157 beginning January 1, 2009 and do not expect there to be a material impact to the financial statements.

 

6



 

SFAS 157 emphasized that fair value is a market-based measurement, not an entity-specific measurement.  Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability.  As a basis for considering market participant assumptions in fair value measurements, SFAS 157 establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).

 

Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities to which we have access.  Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates and yield curves that are observable at commonly quoted intervals.  Level 3 inputs are unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity.  In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety.  Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

 

3.              Reclassifications

 

Certain 2007 balances have been reclassified to conform to the 2008 presentation.

 

4.              Indebtedness

 

Our unsecured lines of credit as of March 31, 2008 are described as follows (in thousands):

 

 

 

Borrowing

 

Maturity

 

Outstanding Balance

 

Description

 

Capacity

 

Date

 

at March 31, 2008

 

Unsecured Line of Credit - DRLP

 

$

1,300,000

 

January 2010

 

$

631,000

 

Unsecured Line of Credit - Consolidated Subsidiary

 

$

30,000

 

July 2011

 

$

4,068

 

 

We use the DRLP unsecured 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 that may be lower than the stated interest rate, subject to certain restrictions. Interest rates on the amounts outstanding on the unsecured line of credit as of March 31, 2008 ranged from LIBOR plus .45% to LIBOR plus .525% (ranging from 3.135% to 3.61% as of March 31, 2008). 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 March 31, 2008, we were in compliance with all covenants under this line of credit.

 

The consolidated subsidiary’s unsecured line of credit allows for borrowings up to $30.0 million at a rate of LIBOR plus .85%  (equal to 3.456% for outstanding borrowings as of March 31, 2008).  The unsecured line of credit is used to fund development activities within the consolidated subsidiary.  The consolidated subsidiary’s unsecured line of credit matures in July 2011 with a 12-month extension option.

 

In January 2008, we repaid $125.0 million of senior unsecured notes with an effective interest rate of 3.36% on their scheduled maturity date.

 

 

7



 

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 three months ended March 31, 2008 and 2007, respectively, we earned from these companies management fees of $1.6 million and $1.3 million, leasing fees of $657,000 and $505,000 and construction and development fees of $2.8 million and $3.6 million. We recorded these fees based on contractual terms that 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 securities for the period.

 

The following table reconciles the components of basic and diluted net income per common share for the three months ended March 31, 2008 and 2007, respectively (in thousands):

 

 

 

2008

 

2007

 

Basic net income available for common shareholders

 

$

4,048

 

$

68,563

 

Joint venture partner convertible ownership net income (1)

 

 

452

 

Minority interest in earnings of common unitholders

 

220

 

4,910

 

Diluted net income available for common shareholders

 

$

4,268

 

$

73,925

 

 

 

 

 

 

 

Weighted average number of common shares outstanding

 

146,331

 

136,823

 

Weighted average partnership Units outstanding

 

7,858

 

9,729

 

Joint venture partner convertible ownership interest (1)

 

 

1,138

 

Dilutive shares for stock-based compensation plans (2)

 

407

 

1,775

 

Weighted average number of common shares and potential dilutive securities

 

154,596

 

149,465

 

 


(1)         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 our common shares.  The effect of this option on earnings per share was dilutive for the first quarter of 2007; therefore, conversion to common shares is included in weighted average potential dilutive securities for that quarter. This option was anti-dilutive for the first quarter of 2008.

 

(2)         Excludes (in thousands of shares) 6,575 and 420 of anti-dilutive shares as of March 31, 2008 and 2007, respectively. Also excludes the Exchangeable Senior Notes (“Exchangeable Notes”) issued in 2006, that have an anti-dilutive effect on earnings per share for the three-month periods ended March 31, 2008 and 2007.

 

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 operations of our office and industrial properties, along with our healthcare properties (our healthcare properties, and other property types which are not significant, are not separately presented as a reportable segment), are collectively referred to as “Rental Operations”. The third reportable segment consists of our build 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 (and is collectively referred to as “Service Operations”). Our reportable segments offer different products or services and are managed separately because each segment requires different operating strategies and management expertise.

 

8



 

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 revenues 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.

 

Other 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 a 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 measure 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 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 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 months ended March 31, 2008, and 2007, respectively (in thousands):

 

 

 

Three Months Ended March 31,

 

 

 

2008

 

2007

 

Revenues

 

 

 

 

 

Rental Operations:

 

 

 

 

 

Office

 

$

148,245

 

$

143,826

 

Industrial

 

61,316

 

54,214

 

Non-reportable Rental Operations segments

 

6,229

 

1,838

 

Service Operations

 

14,776

 

14,730

 

Total Segment Revenues

 

230,566

 

214,608

 

Other Revenue

 

12,111

 

9,918

 

Consolidated Revenue from continuing operations

 

242,677

 

224,526

 

Discontinued Operations

 

974

 

11,087

 

Consolidated Revenue

 

$

243,651

 

$

235,613

 

Funds From Operations

 

 

 

 

 

Rental Operations:

 

 

 

 

 

Office

 

$

89,833

 

$

86,100

 

Industrial

 

45,392

 

40,667

 

Non-reportable Rental Operations segments

 

3,683

 

1,353

 

Service Operations

 

4,413

 

6,934

 

Total Segment FFO

 

143,321

 

135,054

 

Non-Segment FFO:

 

 

 

 

 

Interest expense

 

(47,534

)

(44,408

)

Interest and other income, net

 

3,725

 

2,403

 

General and administrative expense

 

(12,162

)

(13,460

)

Gain on land sales, net

 

629

 

13,997

 

Other non-segment income (expense)

 

(677

)

(106

)

Minority interest

 

(214

)

(1,331

)

Minority interest share of FFO adjustments

 

(4,326

)

(1,263

)

Joint venture FFO

 

17,008

 

10,698

 

Dividends on preferred shares

 

(15,306

)

(15,226

)

Discontinued operations, net of minority interest

 

178

 

(31

)

Consolidated basic FFO

 

84,642

 

86,327

 

Depreciation and amortization on continuing operations

 

(78,713

)

(66,375

)

Depreciation and amortization on discontinued operations

 

(408

)

(1,364

)

Company’s share of joint venture adjustments

 

(6,928

)

(4,968

)

Earnings from depreciated property sales on discontinued operations

 

1,110

 

51,720

 

Earnings from depreciated property sales – share of joint venture

 

19

 

1,960

 

Minority interest share of FFO adjustments

 

4,326

 

1,263

 

Net income available for common shareholders

 

$

4,048

 

$

68,563

 

 

8.              Discontinued Operations and Assets Held for Sale

 

The operations of 34 buildings are currently classified as discontinued operations for the three-month periods ended March 31, 2008 and March 31, 2007. These 34 buildings consist of 17 industrial and 17 office properties. Of these properties, one was sold during the first quarter of 2008, 32 were sold during 2007 and one operating property is classified as held-for-sale at March 31, 2008.

 

10



 

The following table illustrates the operations of the buildings reflected in discontinued operations for the three months ended March 31, 2008 and 2007, respectively (in thousands):

 

 

 

Three Months Ended March 31,

 

 

 

2008

 

2007

 

 

 

 

 

 

 

Revenues

 

$

974

 

$

11,087

 

Expenses:

 

 

 

 

 

Operating

 

441

 

4,718

 

Interest

 

307

 

2,810

 

Depreciation and Amortization

 

408

 

1,364

 

General and Administrative

 

1

 

11

 

Operating Income (Loss)

 

(183

)

2,184

 

Minority interest expense

 

10

 

(145

)

Income (loss) from discontinued operations, before gain on sales

 

(173

)

2,039

 

Gain on sale of property

 

1,110

 

51,720

 

Minority interest expense – gain on sales

 

(57

)

(3,434

)

Gain on sale of property, net of minority interest

 

1,053

 

48,286

 

Income from discontinued operations

 

$

880

 

$

50,325

 

 

At March 31, 2008, we classified one property as held-for-sale and included in discontinued operations.  Additionally, we have classified seven in-service properties as held-for-sale, but have included the results of operations of these properties in continuing operations.  The following table illustrates the aggregate balance sheet information of the aforementioned property included in discontinued operations, as well as the seven held-for-sale properties whose results are included in continuing operations, at March 31, 2008 (in thousands):

 

 

 

Property

 

Properties

 

 

 

 

 

Included in

 

Included in

 

Total

 

 

 

Discontinued

 

Continuing

 

Held-for-Sale

 

 

 

Operations

 

Operations

 

Properties

 

 

 

 

 

 

 

 

 

Balance Sheet:

 

 

 

 

 

 

 

Real estate investments, net

 

$

11,693

 

$

122,344

 

$

134,037

 

Other assets

 

1,287

 

8,753

 

10,040

 

Total assets held-for-sale

 

$

12,980

 

$

131,097

 

$

144,077

 

 

 

 

 

 

 

 

 

Accrued expenses

 

$

462

 

$

577

 

$

1,039

 

Other liabilities

 

 

2,774

 

2,774

 

Total liabilities held-for-sale

 

$

462

 

$

3,351

 

$

3,813

 

 

We had entered into a preliminary agreement to sell a portfolio of 14 buildings in our Cleveland Office market and had accordingly ceased depreciation on those buildings in July 2007, as they met the criteria for held for sale accounting. As a result, we had also included the 14 buildings in discontinued operations. However, due to the potential buyer not being able to secure financing on acceptable terms, the sale agreement was cancelled and we have determined that this portfolio no longer meets the criteria for held for sale classification. As the result of this determination, the portfolio was reclassified from discontinued to continuing operations in the first quarter of 2008, resulting in an additional $5.3 million of depreciation expense.

 

11



 

We allocate interest expense to discontinued operations and have included such interest expense in computing income from discontinued operations. Interest expense allocable to discontinued operations includes interest on any secured debt on 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 unencumbered real estate assets included in discontinued operations  as it related to the total gross book value of our unencumbered real estate assets.

 

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 February 2008, we issued $300.0 million of 8.375% Series O Cumulative Redeemable Preferred Shares from which the net proceeds were used to reduce the outstanding balance on DRLP’s unsecured line of credit.  The Series O Cumulative Redeemable Preferred Shares have no stated maturity date although they may be redeemed, at our option, in February 2013.

 

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.

 

The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves.

 

To comply with the provisions of SFAS 157, to the extent it has been adopted for the period ending March 31, 2008 (see Note 2), we incorporate credit valuation adjustments to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of our derivative contracts for the effect of nonperformance risk, we have considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts and guarantees.

 

Although we have determined that the majority of the inputs used to value our derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with our derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by us and our counterparties. However, as of March 31, 2008, we have assessed the significance of the impact of the credit valuation adjustments on the overall valuations of our derivative positions and have determined that the credit valuation adjustments are not significant to the overall valuation of our derivatives. As a result, we have determined that our derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy. We do not have any fair value measurements using significant unobservable inputs (Level 3) as of March 31, 2008.

 

12



 

In November 2007, we entered into forward-starting interest rate swaps with notional amounts appropriate to hedge interest rates on $300.0 million of anticipated debt offerings in 2008. The forward-starting swaps were appropriately designated and tested for effectiveness as cash flow hedges. In March 2008, we settled the forward-starting swaps and made a cash payment of $14.6 million to the counterparties. An effectiveness test was performed as of the settlement date and it was concluded that a highly effective cash flow hedge is still in place for the expected debt offering. Of the amount paid in settlement, approximately $700,000 was immediately reclassified to interest expense, as the result of partial ineffectiveness calculated at the settlement date, while $13.9 million remains in Other Comprehensive income (“OCI”) and will be recognized through interest expense over the life of the hedged debt offering, which took place in May 2008 (Note 12).

 

In August 2005, we entered into forward-starting interest rate swaps with notional amounts appropriate to hedge interest rates on $300.0 million of anticipated debt offerings in 2007. The forward-starting swaps were appropriately designated and tested for effectiveness as cash flow hedges. In conjunction with the September 2007 issuance of $300.0 million of senior unsecured notes, we terminated these cash flow hedges as designated. The settlement amount received of $10.7 million is being recognized to earnings through a reduction of interest expense over the term of the hedged cash flows. The ineffective portion of the hedge was insignificant.

 

The effectiveness of our hedges is 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.             Recent Accounting Pronouncements

 

In December 2007, the FASB issued SFAS No. 141R, Business Combinations (“SFAS 141R”) and SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements an amendment to ARB No. 51 (“SFAS 160”). SFAS 141R and SFAS 160 require most identifiable assets, liabilities, noncontrolling interests and goodwill acquired in a business combination to be recorded at “full fair value” and require noncontrolling interests (previously referred to as minority interests) to be reported as a component of equity, which changes the accounting for transactions with noncontrolling interest holders. Both Statements are effective for periods beginning on or after December 15, 2008, and earlier adoption is prohibited. SFAS 141R will be applied to business combinations after the effective date. SFAS 160 will be applied prospectively to all noncontrolling interests, including any that arose before the effective date. We are currently evaluating the impact of adopting SFAS 141R and SFAS 160 on our results of operations and financial position.

 

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133 (“SFAS 161”). SFAS 161 requires enhanced disclosures for derivative instruments and hedging activities, specifically in regard to the purpose of the derivative and how the derivative and hedging activities affect an entity’s financial position, financial performance and cash flows. SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008 and early application is allowed.  We will apply SFAS 161 beginning in 2009.

 

13



 

12.          Subsequent Events

 

Declaration of Dividends

 

The Company’s board of directors declared the following dividends at its April 30, 2008, regularly scheduled board meeting:

 

 

 

Quarterly

 

 

 

 

 

Class

 

Amount/Share

 

Record Date

 

Payment Date

 

Common

 

$

0.48

 

May 14, 2008

 

May 30, 2008

 

Preferred (per depositary share):

 

 

 

 

 

 

 

Series J

 

$

0.414063

 

May 16, 2008

 

May 30, 2008

 

Series K

 

$

0.406250

 

May 16, 2008

 

May 30, 2008

 

Series L

 

$

0.412500

 

May 16, 2008

 

May 30, 2008

 

Series M

 

$

0.434375

 

June 16, 2008

 

June 30, 2008

 

Series N

 

$

0.453125

 

June 16, 2008

 

June 30, 2008

 

Series O

 

$

0.523438

 

June 16, 2008

 

June 30, 2008

 

 

Issuance of Unsecured Notes

 

In May 2008, we issued $325.0 million of 6.25% senior unsecured notes due in May 2013.

 

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

 

Cautionary Statement Regarding Forward Looking Statements

 

Certain statements contained in or incorporated by reference into 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 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;

 

·                 Volatility in our stock price and trading volume;

 

·                 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 be flexible in the development and operation of joint venture properties;

 

·                 Our ability to successfully dispose of properties on terms that are favorable to us;

 

14



 

·                 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 other public 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, 2007, which we filed with the SEC on February 29, 2008, 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.

 

Business Overview

 

We are a self-administered and self-managed REIT that began operations through a related entity in 1972. As of March 31, 2008, we:

 

·                 Owned or jointly controlled 730 industrial, office, healthcare and retail properties (including properties under development), consisting of more than 122 million square feet; and

 

·                 Owned or jointly controlled approximately 7,600 acres of land with an estimated future development potential of more than 111 million square feet of industrial, office, healthcare 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;

 

·                 Asset management;

 

·                 Construction;

 

·                 Development; and

 

·                 Other tenant-related services.

 

Key Performance Indicators

 

Our operating results depend primarily upon rental income from our industrial, office and healthcare 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.

 

15



 

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, which are referred to as “Build for Sale Properties”) as of March 31, 2008 and 2007, respectively (in thousands, except percentage data):

 

 

 

Total

 

Percent of

 

 

 

 

 

Square Feet

 

Total Square Feet

 

Percent Occupied

 

Type

 

2008

 

2007

 

2008

 

2007

 

2008

 

2007

 

Industrial

 

80,779

 

75,628

 

70.2

%

69.8

%

89.4

%

92.6

%

Office

 

32,757

 

31,862

 

28.4

%

29.4

%

88.6

%

91.9

%

Other

 

1,613

 

916

 

1.4

%

0.8

%

91.8

%

95.0

%

Total

 

115,149

 

108,406

 

100.0

%

100.0

%

89.2

%

92.4

%

 

The decrease in occupancy in the first quarter of 2008, as compared to the first quarter of 2007, is the result of a significant increase in developments placed in service between the two periods, with certain of the rental properties placed in service not yet being stabilized. There are not significant differences in occupancy between wholly owned properties and properties held by unconsolidated subsidiaries.

 

Lease Expiration and Renewal: Our ability to maintain and improve 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 March 31, 2008. The table indicates square footage and annualized net effective rents (based on March 2008 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

 

2008

 

7,157

 

$

39,518

 

5

%

5,502

 

$

20,741

 

1,622

 

$

18,238

 

33

 

$

539

 

2009

 

12,633

 

83,423

 

11

%

9,087

 

36,268

 

3,480

 

46,499

 

66

 

656

 

2010

 

13,645

 

99,750

 

14

%

9,427

 

40,614

 

4,205

 

58,949

 

13

 

187

 

2011

 

14,881

 

90,935

 

13

%

11,282

 

42,171

 

3,532

 

47,757

 

67

 

1,007

 

2012

 

10,840

 

75,951

 

11

%

7,390

 

29,285

 

3,404

 

45,777

 

46

 

889

 

2013

 

11,016

 

92,592

 

13

%

6,560

 

27,610

 

4,398

 

64,104

 

58

 

878

 

2014

 

6,476

 

39,609

 

6

%

4,890

 

18,226

 

1,558

 

20,918

 

28

 

465

 

2015

 

8,423

 

61,996

 

9

%

6,147

 

24,452

 

2,276

 

37,544

 

 

 

2016

 

4,170

 

28,310

 

4

%

3,000

 

10,836

 

959

 

15,031

 

211

 

2,443

 

2017

 

6,518

 

45,682

 

6

%

4,572

 

18,166

 

1,539

 

21,995

 

407

 

5,521

 

2018 and Thereafter

 

6,949

 

60,937

 

8

%

4,349

 

21,592

 

2,046

 

31,664

 

554

 

7,681

 

 

 

102,708

 

$

718,703

 

100

%

72,206

 

$

289,961

 

29,019

 

$

408,476

 

1,483

 

$

20,266

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Portfolio Square Feet

 

115,149

 

 

 

 

 

80,779

 

 

 

32,757

 

 

 

1,613

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Percent Occupied

 

89.2

%

 

 

 

 

89.4

%

 

 

88.6

%

 

 

91.8

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Note:  Excludes Build for Sale Properties.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

We renewed 70.6% and 81.6% of our leases up for renewal in the three months ended March 31, 2008 and 2007 totaling approximately 2.7 million and 1.9 million square feet, respectively, on which we attained 7% and 5% growth in net effective rents.

 

The average term of renewals decreased from 3.6 years in the three months ended March 31, 2007 to 3.2 years in the three months ended March 31, 2008.

 

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 income as they are placed in service. We had 13.6 million square feet of property under development with total estimated costs upon completion of $1.1 billion at March 31, 2008, compared to 9.1 million square feet with total costs of $1.0 billion, at March 31, 2007.

 

16



 

The following table summarizes our properties under development as of March 31, 2008 (in thousands, except percentage data):

 

 

 

 

 

 

 

Total

 

 

 

Anticipated

 

 

 

 

 

Estimated

 

Anticipated

 

In-Service

 

Square

 

Percent

 

Project

 

Stabilized

 

Date

 

Feet

 

Leased

 

Costs

 

Return (1)

 

Held for Rental Buildings:

 

 

 

 

 

 

 

 

 

2nd Quarter 2008

 

4,265

 

23

%

$

 234,422

 

8.65

%

3rd Quarter 2008

 

2,010

 

32

%

166,759

 

9.10

%

4th Quarter 2008

 

248

 

34

%

48,875

 

9.24

%

Thereafter

 

758

 

68

%

164,401

 

8.73

%

 

 

7,281

 

31

%

$

 614,457

 

8.84

%

Build for Sale Properties:

 

 

 

 

 

 

 

 

 

2nd Quarter 2008

 

1,044

 

100

%

86,654

 

8.30

%

3rd Quarter 2008

 

1,252

 

100

%

78,858

 

8.43

%

4th Quarter 2008

 

2,313

 

60

%

87,950

 

7.88

%

Thereafter

 

1,758

 

76

%

197,708

 

8.37

%

 

 

6,367

 

79

%

451,170

 

8.27

%

Total

 

13,648

 

53

%

$

 1,065,627

 

8.60

%

 


(1) Anticipated yield upon leasing 95% of the property.

 

Acquisition and Disposition Activity: Gross sales proceeds related to dispositions of wholly owned held for rental properties were $18.6 million for the three months ended March 31, 2008. Additionally, our share of proceeds from sales of properties within unconsolidated joint ventures, in which we have less than a 100% interest, totaled $25.5 million for the three months ended March 31, 2008. For the three months ended March 31, 2007, proceeds totaled $144.9 million for wholly owned held for rental properties and $5.1 million for our share of property sales from unconsolidated joint ventures. We had no dispositions of wholly owned properties developed for sale rather than rental for the three months ended March 31, 2008, but recognized gross proceeds of $25.9 million for such dispositions in the same period in 2007. Although the current credit environment has affected certain buyers’ ability to finance acquisitions, the timing of major transactions is the main reason for the decrease in disposition activity.

 

For the three months ended March 31, 2008, we acquired $27.3 million of income producing properties comprised of two industrial real estate properties in Savannah, Georgia. In the first quarter of 2007, we continued our expansion into the healthcare real estate market by completing the acquisition of Bremner Healthcare Real Estate, a national health care development and management firm. The initial consideration paid to the sellers totaled $47.1 million, and the sellers may be eligible for further contingent payments over three years following the acquisition date. We also acquired $15.4 million of undeveloped land in the three months ended March 31, 2008, compared to $34.0 million in the same period in 2007.

 

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 accounting principles generally accepted in the United States of America (“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 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 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 months ended March 31, 2008 and 2007, respectively (in thousands):

 

 

 

2008

 

2007

 

Net income available for common shareholders

 

$

4,048

 

$

68,563

 

Adjustments:

 

 

 

 

 

Depreciation and amortization

 

79,121

 

67,739

 

Company share of joint venture depreciation and amortization

 

6,928

 

4,968

 

Earnings from depreciable property sales – wholly owned

 

(1,110

)

(51,720

)

Earnings from depreciable property sales – share of joint venture

 

(19

)

(1,960

)

Minority interest share of adjustments

 

(4,326

)

(1,263

)

Funds From Operations

 

$

84,642

 

$

86,327

 

 

Results of Operations

 

A summary of our operating results and property statistics for the three months ended March 31, 2008 and 2007, respectively, is as follows (in thousands, except number of properties and per share data):

 

 

 

2008

 

2007

 

Rental Operations revenues from Continuing Operations

 

$

227,901

 

$

209,796

 

Service Operations revenues from Continuing Operations

 

14,776

 

14,730

 

Earnings from Continuing Rental Operations

 

22,083

 

24,921

 

Earnings from Continuing Service Operations

 

4,413

 

6,934

 

Operating income

 

14,334

 

18,395

 

Net income available for common shareholders

 

$

4,048

 

$

68,563

 

Weighted average common shares outstanding

 

146,331

 

136,823

 

Weighted average common shares and potential dilutive securities

 

154,596

 

149,465

 

Basic income per common share:

 

 

 

 

 

Continuing operations

 

$

.02

 

$

.13

 

Discontinued operations

 

$

.01

 

$

.37

 

Diluted income per common share:

 

 

 

 

 

Continuing operations

 

$

.02

 

$

.13

 

Discontinued operations

 

$

.01

 

$

.36

 

Number of in-service properties at end of period

 

698

 

691

 

In-service square footage at end of period

 

115,149

 

108,406

 

 

18



 

Comparison of Three Months Ended March 31, 2008 to Three Months Ended March 31, 2007

 

Rental Income From Continuing Operations

 

Overall, rental revenue from continuing operations increased from $202.1 million for the three months ended March 31, 2007, to $217.8 million for the same period in 2008. The following table reconciles rental revenue from continuing operations by reportable segment to our total reported rental revenue from continuing operations for the three months ended March 31, 2008 and 2007, respectively (in thousands):

 

 

 

2008

 

2007

 

 

 

 

 

 

 

Rental Revenue:

 

 

 

 

 

Office

 

$

148,245

 

$

143,826

 

Industrial

 

61,316

 

54,214

 

Non-reportable segments

 

8,241

 

4,065

 

Total

 

$

217,802

 

$

202,105

 

 

The following factors contributed to these results:

 

·

 

We acquired nine properties and placed 40 developments in service from April 1, 2007 to March 31, 2008 that provided incremental revenues of $12.6 million in the first quarter of 2008, as compared to the same period in 2007.

·

 

Lease termination fees increased from $3.4 million in the first quarter of 2007 to $7.6 million in the first quarter of 2008.

 

Rental Expenses and Real Estate Taxes

 

The following table reconciles rental expenses and real estate taxes by reportable segment to our total reported amounts in the statements of operations for the three months ended March 31, 2008 and 2007, respectively (in thousands):

 

 

 

2008

 

2007

 

Rental Expenses:

 

 

 

 

 

Office

 

$

40,969

 

$

40,488

 

Industrial

 

8,186

 

7,309

 

Non-reportable segments

 

2,872

 

1,252

 

Total

 

$

52,027

 

$

49,049

 

 

 

 

 

 

 

Real Estate Taxes:

 

 

 

 

 

Office

 

$

17,443

 

$

17,237

 

Industrial

 

7,738

 

6,239

 

Non-reportable segments

 

2,363

 

1,567

 

Total

 

$

27,544

 

$

25,043

 

 

Of the overall $3.0 million increase in rental expenses in the first quarter of 2008, compared to the same period in 2007, $1.5 million was attributable to properties acquired and developments placed in service from April 1, 2007 to March 31, 2008.

 

Of the overall $2.5 million increase in real estate taxes in the first quarter of 2008, compared to the same period in 2007, $1.2 million was attributable to properties acquired and developments placed in service from April 1, 2007 to March 31, 2008. The remaining increase in real estate taxes was driven by increases in assessments by municipal authorities in our different markets.

 

Interest Expense

 

Interest expense increased from $44.4 million in the first quarter of 2007 to $47.5 million in the first quarter of 2008 primarily due to carrying higher levels of borrowings under DRLP’s unsecured line of credit. The outstanding balance increased from $330.0 million at March 31, 2007 to $631.0 million at March 31, 2008. This was somewhat offset by a reduction in interest rates between the two periods.

 

19



 

Depreciation and Amortization

 

Depreciation and amortization expense increased from $66.4 million during the three months ended March 31, 2007 to $78.7 million for the same period in 2008 primarily due to the following:

 

·

 

We recorded $5.8 million of additional depreciation expense for a portfolio of properties that no longer meets the criteria for being classified as held for sale.

 

 

 

·

 

Our held-for-rental asset base increased from acquisitions and developments during 2007.

 

 

 

·

 

We accelerated depreciation for certain assets related to terminated leases.

 

Service Operations

 

Service Operations consists primarily of sales of properties developed or acquired with the intent to sell within a short period of time and the leasing, management, construction and development services for joint venture properties and properties owned by third parties. These operations are heavily influenced by the current state of the economy, as leasing and management fees are dependent upon occupancy while construction and development services rely on the expansion of business operations of third party property owners. Earnings from Service Operations decreased from $6.9 million for the three months ended March 31, 2007 to $4.4 million for the three months ended March 31, 2008, primarily as a result of gains on the sale of two properties totaling $2.9 million in the three months ended March 31, 2007 compared to no such sales during the three months ended March 31, 2008.

 

General and Administrative Expense

 

General and administrative expenses decreased from $13.5 million for the three months ended March 31, 2007 to $12.2 million for the same period in 2008. General and administrative expenses consist of two components. The first component is direct expenses that are not attributable to specific assets such as legal fees, audit fees, marketing costs, investor relations expenses and other corporate overhead. The second component is the unallocated indirect costs determined to be unrelated to the operation of our owned properties and Service Operations. Those indirect costs not allocated to these operations are charged to general and administrative expenses. While there was an increase in amount of indirect costs allocated to construction and leasing in 2008 compared to 2007 due to increases in wholly-owned and third-party activity in these areas, this was partially offset by an increase in the overall pool of overhead costs in 2008 necessitated by our overall growth.

 

Discontinued Operations

 

The results of operations for properties sold during the year or classified as held-for-sale to unrelated parties at the end of the period are required to be classified as discontinued operations. The property specific components of earnings that are classified as discontinued operations include rental revenues, rental expenses, real estate taxes, allocated interest expense, depreciation expense and minority interest, as well as the net gain or loss on the disposition of properties.

 

The operations of 34 buildings are currently classified as discontinued operations for the three months ended March 31, 2008 and March 31, 2007. These 34 buildings consist of 17 industrial and 17 office properties. As a result, we classified net income (loss) from operations, net of minority interest, of $(173,000) and $2.0 million in discontinued operations for the three months ended March 31, 2008 and 2007, respectively.

 

Of these properties, one was sold during the first quarter of 2008 and 10 properties were sold during the first quarter of 2007. The gains on disposal of these properties, net of minority interest, of $1.1 million and $48.3 million for the three months ended March 31, 2008 and 2007, respectively, are also reported in discontinued operations.

 

20



 

Liquidity and Capital Resources

 

Sources of Liquidity

 

We expect to meet our short-term liquidity requirements over the next twelve months, including payments of dividends and distributions, as well as recurring capital expenditures relating to maintaining our current real estate assets, primarily through working capital and proceeds received from real estate dispositions. Although we historically have not used any other sources of funds to pay for recurring capital expenditures on our current real estate investments, we may rely on the temporary use of borrowings needed to fund such expenditures during periods of high leasing volume.

 

We expect to meet long-term liquidity requirements, such as scheduled mortgage and unsecured debt maturities, property acquisitions, financing of development activities and other non-recurring capital improvements, primarily through the following sources:

 

·

issuance of additional equity, including common and preferred shares;

·

issuance of additional debt securities;

·

undistributed cash provided by operating activities; and

·

proceeds received from real estate dispositions.

 

In recognition of current economic conditions, we are constantly monitoring the state of the capital markets and accordingly managing our capital needs, specifically development expenditures and commitments.  We will continue to utilize DRLP’s $1.3 billion unsecured revolving line of credit to provide initial funding of new development expenditures and anticipate using multiple sources of capital including unsecured public debt, secured debt, preferred stock and private equity, as available, to meet our long term capital needs.

 

Rental Operations

 

We believe our principal source of liquidity, cash flows from Rental Operations, provides a stable source of cash to fund operational expenses. We believe that this cash-based revenue stream is substantially aligned with revenue recognition (except for periodic straight-line rental income accruals and amortization of above or below market rents) as cash receipts from the leasing of rental properties are generally received in advance of or a short time following the actual revenue recognition.

 

We are subject to risks of decreased occupancy through market conditions, as well as tenant defaults and bankruptcies, and potential reduction in rental rates upon renewal or re-letting of properties, each of which would result in reduced cash flow from operations. However, we believe that these risks may be mitigated by our relatively strong market presence in most of our markets and the fact that we perform in-house credit reviews and analyses on major tenants and all significant leases before they are executed.

 

Debt and Equity Securities

 

We use DRLP’s line of credit to fund development activities, acquire additional rental properties and provide working capital.

 

At March 31, 2008, we had on file with the SEC an automatic shelf registration statement on Form S-3 relating to the offer and sale, from time to time, of an indeterminate amount of debt securities (including guarantees thereof), common shares, preferred shares, depositary shares, warrants, stock purchase contracts and Units comprised of one or more of the securities described therein. From time to time, we expect to issue additional securities under this automatic shelf registration statement to fund development and acquisition of additional rental properties and to fund the repayment of the credit facility and other long-term debt upon maturity.

 

21



 

In May 2008, we issued $325.0 million of 6.25% senior unsecured notes due in May 2013.

 

The indentures (and related supplemental indentures) governing our outstanding series of notes also require us to comply with financial ratios and other covenants regarding our operations.  We were in compliance with all such covenants as of March 31, 2008.

 

Sale of Real Estate Assets

 

We utilize sales of real estate assets as an additional source of liquidity. We pursue opportunities to sell real estate assets at favorable prices to capture value created by us, as well as to improve the overall quality of our portfolio by recycling sales proceeds into new properties with greater value creation opportunities.

 

We had entered into a preliminary agreement to sell a portfolio of 14 buildings in our Cleveland Office market in mid-2007.  In the first quarter of 2008 the agreement was cancelled due to the potential buyer not being able to secure financing on acceptable terms.  It is our strategy to operate the buildings through our Rental Operations until we are able to sell the buildings at a favorable price.

 

Uses of Liquidity

 

Our principal uses of liquidity include the following:

 

·      property investments;

·      recurring leasing/capital costs;

·      dividends and distributions to shareholders and unitholders;

·      long-term debt maturities; and

·      other contractual obligations.

 

Property Investment

 

We evaluate development and acquisition opportunities based upon market outlook, supply and long-term growth potential.

 

Recurring Expenditures

 

One of our principal uses of our liquidity is to fund the recurring leasing/capital expenditures of our real estate investments. The following is a summary of our recurring capital expenditures for the three months ended March 31, 2008 and 2007, respectively (in thousands):

 

 

 

2008

 

2007

 

Recurring tenant improvements

 

$

10,803

 

$

10,333

 

Recurring leasing costs

 

6,098

 

7,732

 

Building improvements

 

967

 

974

 

Totals

 

$

17,868

 

$

19,039

 

 

Debt Maturities

 

Debt outstanding at March 31, 2008 totaled $4.3 billion with a weighted average interest rate of 5.48%, maturing at various dates through 2028. We had $3.1 billion of unsecured debt, $635.1 million outstanding on our unsecured lines of credit and $506.1 million of secured debt outstanding at March 31, 2008. Scheduled principal amortization and maturities of such debt totaled $161.8 million for the three months ended March 31, 2008.

 

22



 

The following is a summary of the scheduled future amortization and maturities of our indebtedness at March 31, 2008 (in thousands, except percentage data):

 

 

 

Future Repayments

 

Weighted Average

 

 

 

Scheduled

 

 

 

 

 

Interest Rate of

 

Year

 

Amortization

 

Maturities

 

Total

 

Future Repayments

 

 

 

 

 

 

 

 

 

 

 

2008

 

$

8,610

 

$

109,940

 

$

118,550

 

6.79

%

2009

 

11,099

 

275,000

 

286,099

 

7.36

%

2010

 

10,809

 

806,000

 

816,809

 

3.78

%

2011

 

10,781

 

1,037,207

 

1,047,988

 

5.11

%

2012

 

8,649

 

201,216

 

209,865

 

5.89

%

2013

 

8,571

 

150,000

 

158,571

 

4.71

%

2014

 

8,661

 

272,112

 

280,773

 

6.44

%

2015

 

6,774

 

 

6,774

 

6.05

%

2016

 

5,763

 

490,900

 

496,663

 

6.16

%

2017

 

4,517

 

457,761

 

462,278

 

5.94

%

2018

 

3,055

 

300,000

 

303,055

 

6.16

%

Thereafter

 

24,714

 

50,000

 

74,714

 

6.76

%

 

 

$

112,003

 

$

4,150,136

 

$

4,262,139

 

5.48

%

 

Historical Cash Flows

 

Cash and cash equivalents were $15.5 million and $9.5 million at March 31, 2008 and 2007, respectively. The following highlights significant changes in net cash associated with our operating, investing and financing activities (in millions):

 

 

 

Three Months Ended March 31,

 

 

 

2008

 

2007

 

Net Cash Provided by

 

 

 

 

 

Operating Activities

 

$

2.2

 

$

12.1