Q1 D0C 2014

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, 2014
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) 0-20625 (Duke Realty Limited Partnership)
DUKE REALTY CORPORATION
DUKE REALTY LIMITED PARTNERSHIP
(Exact Name of Registrant as Specified in Its Charter)
Indiana (Duke Realty Corporation)
 
35-1740409 (Duke Realty Corporation)
Indiana (Duke Realty Limited Partnership)
 
35-1898425 (Duke Realty Limited Partnership)
(State or Other Jurisdiction
of Incorporation or Organization)
 
(I.R.S. Employer
Identification Number)
600 East 96thStreet, 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.
Duke Realty Corporation
Yes x
 No   o
 
Duke Realty Limited Partnership
Yes x
 No   o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Duke Realty Corporation
Yes x
No  o
 
Duke Realty Limited Partnership
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 the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Duke Realty Corporation:
Large accelerated filer  x
Accelerated filer  o
Non-accelerated filer  o
Smaller reporting company  o
Duke Realty Limited Partnership:
Large accelerated filer  o
Accelerated filer  o
Non-accelerated filer  x
Smaller reporting company  o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):
Duke Realty Corporation
Yes  o 
No  x
 
Duke Realty Limited Partnership
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 Common Shares of Duke Realty Corporation at May 2, 2014
Common Stock, $.01 par value per share
 
329,489,363



EXPLANATORY NOTE
This report combines the quarterly reports on Form 10-Q for the period ended March 31, 2014 of both Duke Realty Corporation and Duke Realty Limited Partnership. Unless stated otherwise or the context otherwise requires, references to "Duke Realty Corporation" or the "General Partner" mean Duke Realty Corporation and its consolidated subsidiaries; and references to the "Partnership" mean Duke Realty Limited Partnership and its consolidated subsidiaries. The terms the "Company," "we," "us" and "our" refer to the General Partner and the Partnership, collectively, and those entities owned or controlled by the General Partner and/or the Partnership.
Duke Realty Corporation is a self-administered and self-managed real estate investment trust ("REIT") and is the sole general partner of the Partnership, owning 98.7% of the common partnership interests of the Partnership ("General Partner Units") as of March 31, 2014. The remaining 1.3% of the common partnership interests ("Limited Partner Units" and, together with the General Partner Units, the "Common Units") are owned by limited partners. As the sole general partner of the Partnership, the General Partner has full, exclusive and complete responsibility and discretion in the day-to-day management and control of the Partnership. The General Partner also owns all of the issued and outstanding preferred partnership interests in the Partnership ("Preferred Units").
The General Partner and the Partnership are operated as one enterprise. The management of the General Partner consists of the same members as the management of the Partnership. As the sole general partner with control of the Partnership, the General Partner consolidates the Partnership for financial reporting purposes, and the General Partner does not have any significant assets other than its investment in the Partnership. Therefore, the assets and liabilities of the General Partner and the Partnership are substantially the same.
We believe combining the quarterly reports on Form 10-Q of the General Partner and the Partnership into this single report results in the following benefits:
•
enhances investors' understanding of the General Partner and the Partnership by enabling investors to view the business as a whole in the same manner as management views and operates the business;
•
eliminates duplicative disclosure and provides a more streamlined and readable presentation of information since a substantial portion of the Company's disclosure applies to both the General Partner and the Partnership; and
•
creates time and cost efficiencies through the preparation of one combined report instead of two separate reports.
 
We believe it is important to understand the few differences between the General Partner and the Partnership in the context of how we operate as an interrelated consolidated company. The General Partner's only material asset is its ownership of partnership interests in the Partnership. As a result, the General Partner does not conduct business itself, other than acting as the sole general partner of the Partnership and issuing public equity from time to time. The General Partner does not issue any indebtedness, but does guarantee the unsecured debt of the Partnership. The Partnership holds substantially all the assets of the business, directly or indirectly, and holds the ownership interests related to certain of the Company's investments. The Partnership conducts the operations of the business and has no publicly traded equity. Except for net proceeds from equity issuances by the General Partner, which are contributed to the Partnership in exchange for General Partner Units or Preferred Units, the Partnership generates the capital required by the business through its operations, its incurrence of indebtedness and the issuance of Limited Partner Units to third parties.
Noncontrolling interests, shareholders' equity and partners' capital are the main areas of difference between the consolidated financial statements of the General Partner and those of the Partnership. The noncontrolling interests in the Partnership's financial statements include the interests in consolidated investees not wholly owned by the Partnership. The noncontrolling interests in the General Partner's financial statements include the same noncontrolling interests at the Partnership level, as well as the common limited partnership interests in the Partnership, which are accounted for as partners' capital by the Partnership.
In order to highlight the differences between the General Partner and the Partnership, there are separate sections in this report, as applicable, that separately discuss the General Partner and the Partnership, including separate financial statements and separate Exhibit 31 and 32 certifications. In the sections that combine disclosure of the General Partner and the Partnership, this report refers to actions or holdings as being actions or holdings of the collective Company.



DUKE REALTY CORPORATION/DUKE REALTY LIMITED PARTNERSHIP
INDEX
 
 
 
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
Duke Realty Corporation:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Duke Realty Limited Partnership:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Duke Realty Corporation and Duke Realty Limited Partnership:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2

PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
DUKE REALTY CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except per share amounts)
 
March 31,
2014
 
December 31,
2013
 
(Unaudited)
 
 
 
 
 
 
ASSETS
 
 
 
Real estate investments:
 
 
 
Land and improvements
$
1,457,690

 
$
1,438,007

Buildings and tenant improvements
5,605,272

 
5,531,726

Construction in progress
277,398

 
256,895

Investments in and advances to unconsolidated companies
336,060

 
342,947

Undeveloped land
570,718

 
590,052

 
8,247,138

 
8,159,627

Accumulated depreciation
(1,419,088
)
 
(1,368,406
)
Net real estate investments
6,828,050

 
6,791,221

 
 
 
 
Real estate investments and other assets held-for-sale
34,826

 
57,466

 
 
 
 
Cash and cash equivalents
19,474

 
19,275

Accounts receivable, net of allowance of $1,888 and $1,576
34,763

 
26,173

Straight-line rent receivable, net of allowance of $6,404 and $9,350
126,286

 
118,251

Receivables on construction contracts, including retentions
27,833

 
19,209

Deferred financing costs, net of accumulated amortization of $39,553 and $37,016
33,764

 
36,250

Deferred leasing and other costs, net of accumulated amortization of $305,316 and $394,049
457,508

 
466,979

Escrow deposits and other assets
204,859

 
217,790

 
$
7,767,363

 
$
7,752,614

LIABILITIES AND EQUITY
 
 
 
Indebtedness:
 
 
 
Secured debt
$
1,077,468

 
$
1,100,124

Unsecured debt
3,065,742

 
3,066,252

Unsecured line of credit
180,000

 
88,000

 
4,323,210

 
4,254,376

 
 
 
 
Liabilities related to real estate investments held-for-sale
179

 
2,075

 
 
 
 
Construction payables and amounts due subcontractors, including retentions
72,695

 
69,380

Accrued real estate taxes
77,169

 
74,696

Accrued interest
36,468

 
52,824

Other accrued expenses
52,118

 
67,495

Other liabilities
138,598

 
142,589

Tenant security deposits and prepaid rents
50,264

 
44,550

Total liabilities
4,750,701

 
4,707,985

Shareholders' equity:
 
 
 
Preferred shares ($.01 par value); 5,000 shares authorized; 1,716 and 1,791 shares issued and outstanding
428,926

 
447,683

Common shares ($.01 par value); 400,000 shares authorized; 328,480 and 326,399 shares issued and outstanding
3,285

 
3,264

Additional paid-in capital
4,649,914

 
4,620,964

Accumulated other comprehensive income
3,832

 
4,119

Distributions in excess of net income
(2,100,245
)
 
(2,062,787
)
Total shareholders' equity
2,985,712

 
3,013,243

Noncontrolling interests
30,950

 
31,386

Total equity
3,016,662

 
3,044,629

 
$
7,767,363

 
$
7,752,614

See accompanying Notes to Consolidated Financial Statements

3

DUKE REALTY CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations and Comprehensive Income
For the three months ended March 31,
(in thousands, except per share amounts)
(Unaudited)
 
2014
 
2013
Revenues:
 
 
 
Rental and related revenue
$
237,350

 
$
209,879

General contractor and service fee revenue
55,820

 
47,404

 
293,170

 
257,283

Expenses:
 
 
 
Rental expenses
50,267

 
38,861

Real estate taxes
32,467

 
29,040

General contractor and other services expenses
47,271

 
38,341

Depreciation and amortization
98,059

 
92,993

 
228,064

 
199,235

Other operating activities:
 
 
 
Equity in earnings of unconsolidated companies
2,321

 
49,378

Gain on sale of properties
15,853

 
168

Gain on land sales
152

 
—

Undeveloped land carrying costs
(2,124
)
 
(2,198
)
Other operating expenses
(92
)
 
(68
)
General and administrative expenses
(14,694
)
 
(13,145
)
 
1,416

 
34,135

Operating income
66,522

 
92,183

Other income (expenses):
 
 
 
Interest and other income, net
351

 
153

Interest expense
(55,257
)
 
(57,181
)
Acquisition-related activity
(14
)
 
643

Income from continuing operations before income taxes
11,602

 
35,798

Income tax expense
(2,674
)
 
—

Income from continuing operations
8,928

 
35,798

Discontinued operations:
 
 
 
Loss before gain on sales
(132
)
 
(629
)
Gain on sale of depreciable properties, net of tax
16,775

 
8,954

Income from discontinued operations
16,643

 
8,325

Net income
25,571

 
44,123

Dividends on preferred shares
(7,037
)
 
(9,550
)
Adjustments for redemption/repurchase of preferred shares
483

 
(5,932
)
Net income attributable to noncontrolling interests
(334
)
 
(598
)
Net income attributable to common shareholders
$
18,683

 
$
28,043

Basic net income per common share:
 
 
 
Continuing operations attributable to common shareholders
$
0.01

 
$
0.06

Discontinued operations attributable to common shareholders
0.05

 
0.03

Total
$
0.06

 
$
0.09

Diluted net income per common share:
 
 
 
Continuing operations attributable to common shareholders
$
0.01

 
$
0.06

Discontinued operations attributable to common shareholders
0.05

 
0.03

Total
$
0.06

 
$
0.09

Weighted average number of common shares outstanding
327,106

 
314,936

Weighted average number of common shares and potential dilutive securities
331,716

 
319,571

 
 
 
 
Comprehensive income:
 
 
 
Net income
$
25,571

 
$
44,123

Other comprehensive income (loss):
 
 
 
Amortization of interest contracts
(287
)
 
457

Other
—

 
80

Total other comprehensive income (loss)
(287
)
 
537

Comprehensive income
$
25,284

 
$
44,660

See accompanying Notes to Consolidated Financial Statements

4

DUKE REALTY CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the three months ended March 31,
(in thousands)
(Unaudited)
 
2014
 
2013
Cash flows from operating activities:
 
 
 
Net income
$
25,571

 
$
44,123

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation of buildings and tenant improvements
71,393

 
70,548

Amortization of deferred leasing and other costs
26,871

 
29,232

Amortization of deferred financing costs
2,499

 
3,507

Straight-line rental income and expense, net
(5,974
)
 
(4,839
)
Gain on acquisitions
—

 
(962
)
Gains on land and depreciated property sales, net of tax
(30,106
)
 
(9,122
)
Third-party construction contracts, net
411

 
11,138

Other accrued revenues and expenses, net
(33,911
)
 
(26,261
)
Operating distributions received in excess of (less than) equity in earnings from unconsolidated companies
2,383

 
(43,930
)
Net cash provided by operating activities
59,137

 
73,434

Cash flows from investing activities:
 
 
 
Development of real estate investments
(105,413
)
 
(103,684
)
Acquisition of real estate investments and related intangible assets
(17,224
)
 
(35,495
)
Acquisition of undeveloped land
(2,270
)
 
(5,149
)
Second generation tenant improvements, leasing costs and building improvements
(19,631
)
 
(17,119
)
Other deferred leasing costs
(8,706
)
 
(11,079
)
Other assets
5,539

 
(5,124
)
Proceeds from land and depreciated property sales, net
70,673

 
61,931

Capital distributions from unconsolidated companies
2,546

 
89,237

Capital contributions and advances to unconsolidated companies
(420
)
 
(4,846
)
Net cash used for investing activities
(74,906
)
 
(31,328
)
Cash flows from financing activities:
 
 
 
Proceeds from issuance of common shares, net
23,783

 
574,685

Payments for redemption/repurchase of preferred shares
(17,656
)
 
(177,955
)
Proceeds from unsecured debt
—

 
250,000

Payments on unsecured debt
(511
)
 
(480
)
Proceeds from secured debt financings
—

 
1,933

Payments on secured indebtedness including principal amortization
(21,471
)
 
(17,486
)
Borrowings (payments) on line of credit, net
92,000

 
(285,000
)
Distributions to common shareholders
(55,596
)
 
(54,678
)
Distributions to preferred shareholders
(7,140
)
 
(9,550
)
Distributions to noncontrolling interests
(770
)
 
(961
)
Change in book overdrafts
3,629

 
(45,272
)
Deferred financing costs
(300
)
 
(4,064
)
Net cash provided by financing activities
15,968

 
231,172

Net increase in cash and cash equivalents
199

 
273,278

Cash and cash equivalents at beginning of period
19,275

 
33,889

Cash and cash equivalents at end of period
$
19,474

 
$
307,167

 
 
 
 
Non-cash investing and financing activities:
 
 
 
Assumption of other liabilities in real estate acquisitions
$
76

 
$
50

Carrying amount of pre-existing ownership interest in acquired property
$
—

 
$
630

Conversion of Limited Partner Units to common shares
$
—

 
$
337

See accompanying Notes to Consolidated Financial Statements


5

DUKE REALTY CORPORATION AND SUBSIDIARIES
Consolidated Statement of Changes in Equity
For the three months ended March 31, 2014
(in thousands, except per share data)
(Unaudited)
 
 
Common Shareholders
 
 
 
 
 
Preferred
Stock
 
Common
Stock
 
Additional
Paid-in
Capital
 
Accumulated
Other
Comprehensive
Income
 
Distributions
in Excess of
Net Income
 
Non-
Controlling
Interests
 
Total
Balance at December 31, 2013
$
447,683

 
$
3,264

 
$
4,620,964

 
$
4,119

 
$
(2,062,787
)
 
$
31,386

 
$
3,044,629

Net income
—

 
—

 
—

 
—

 
25,237

 
334

 
25,571

Other comprehensive income (loss)
—

 
—

 
—

 
(287
)
 
—

 
—

 
(287
)
Issuance of common shares
—

 
14

 
23,769

 
—

 
—

 
—

 
23,783

Stock-based compensation plan activity
—

 
7

 
4,563

 
—

 
(545
)
 
—

 
4,025

Distributions to preferred shareholders
—

 
—

 
—

 
—

 
(7,037
)
 
—

 
(7,037
)
Repurchase of preferred shares
(18,757
)
 
—

 
618

 
—

 
483

 
—

 
(17,656
)
Distributions to common shareholders ($0.17 per share)
—

 
—

 
—

 
—

 
(55,596
)
 
—

 
(55,596
)
Distributions to noncontrolling interests
—

 
—

 
—

 
—

 
—

 
(770
)
 
(770
)
Balance at March 31, 2014
$
428,926

 
$
3,285

 
$
4,649,914

 
$
3,832

 
$
(2,100,245
)
 
$
30,950

 
$
3,016,662

See accompanying Notes to Consolidated Financial Statements



6

DUKE REALTY LIMITED PARTNERSHIP AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands)

 
March 31, 2014
 
December 31, 2013
 
(Unaudited)
 
 
 
 
 
 
ASSETS
 
 
 
Real estate investments:
 
 
 
     Land and improvements
$
1,457,690

 
$
1,438,007

     Buildings and tenant improvements
5,605,272

 
5,531,726

     Construction in progress
277,398

 
256,895

     Investments in and advances to unconsolidated companies
336,060

 
342,947

     Undeveloped land
570,718

 
590,052

 
8,247,138

 
8,159,627

     Accumulated depreciation
(1,419,088
)
 
(1,368,406
)
              Net real estate investments
6,828,050

 
6,791,221

 
 
 
 
Real estate investments and other assets held-for-sale
34,826

 
57,466

 
 
 
 
Cash and cash equivalents
19,474

 
19,275

Accounts receivable, net of allowance of $1,888 and $1,576
34,763

 
26,173

Straight-line rent receivable, net of allowance of $6,404 and $9,350
126,286

 
118,251

Receivables on construction contracts, including retentions
27,833

 
19,209

Deferred financing costs, net of accumulated amortization of $39,553 and $37,016
33,764

 
36,250

Deferred leasing and other costs, net of accumulated amortization of $305,316 and $394,049
457,508

 
466,979

Escrow deposits and other assets
204,859

 
217,790

 
$
7,767,363

 
$
7,752,614

LIABILITIES AND EQUITY
 
 
 
Indebtedness:
 
 
 
     Secured debt
$
1,077,468

 
$
1,100,124

     Unsecured debt
3,065,742

 
3,066,252

     Unsecured line of credit
180,000

 
88,000

 
4,323,210

 
4,254,376

 
 
 
 
Liabilities related to real estate investments held-for-sale
179

 
2,075

 
 
 
 
Construction payables and amounts due subcontractors, including retentions
72,695

 
69,380

Accrued real estate taxes
77,169

 
74,696

Accrued interest
36,468

 
52,824

Other accrued expenses
52,362

 
67,739

Other liabilities
138,598

 
142,589

Tenant security deposits and prepaid rents
50,264

 
44,550

     Total liabilities
4,750,945

 
4,708,229

Partners' equity:
 
 
 
  General Partner:
 
 
 
     Common equity (328,480 and 326,399 General Partner Units issued and outstanding)
2,556,883

 
2,565,370

     Preferred equity (1,716 and 1,791 Preferred Units issued and outstanding)
428,926

 
447,683

 
2,985,809

 
3,013,053

     Limited Partners' common equity (4,387 and 4,387 Limited Partner Units issued and outstanding)
19,662

 
20,158

     Accumulated other comprehensive income
3,832

 
4,119

            Total partners' equity
3,009,303

 
3,037,330

Noncontrolling interests
7,115

 
7,055

     Total equity
3,016,418

 
3,044,385

 
$
7,767,363

 
$
7,752,614

See accompanying Notes to Consolidated Financial Statements

7

DUKE REALTY LIMITED PARTNERSHIP AND SUBSIDIARIES
Consolidated Statements of Operations and Comprehensive Income
For the three months ended March 31,
(in thousands, except per unit amounts)
(Unaudited)
 
 
2014
 
2013
Revenues:
 
 
 
 
     Rental and related revenue
 
$
237,350

 
$
209,879

     General contractor and service fee revenue
 
55,820

 
47,404

 
 
293,170

 
257,283

Expenses:
 
 
 
 
     Rental expenses
 
50,267

 
38,861

     Real estate taxes
 
32,467

 
29,040

     General contractor and other services expenses
 
47,271

 
38,341

     Depreciation and amortization
 
98,059

 
92,993

 
 
228,064

 
199,235

Other operating activities:
 
 
 
 
     Equity in earnings of unconsolidated companies
 
2,321

 
49,378

     Gain on sale of properties
 
15,853

 
168

Gain on land sales
 
152

 
—

     Undeveloped land carrying costs
 
(2,124
)
 
(2,198
)
     Other operating expenses
 
(92
)
 
(68
)
     General and administrative expenses
 
(14,694
)
 
(13,145
)
 
 
1,416

 
34,135

     Operating income
 
66,522

 
92,183

Other income (expenses):
 
 
 
 
     Interest and other income, net
 
351

 
153

     Interest expense
 
(55,257
)
 
(57,181
)
     Acquisition-related activity
 
(14
)
 
643

Income from continuing operations before income taxes
 
11,602

 
35,798

Income tax expense
 
(2,674
)
 
—

Income from continuing operations
 
8,928

 
35,798

Discontinued operations:
 
 
 
 
Loss before gain on sales
 
(132
)
 
(629
)
Gain on sale of depreciable properties, net of tax
 
16,775

 
8,954

           Income from discontinued operations
 
16,643

 
8,325

Net income
 
25,571

 
44,123

Distributions on Preferred Units
 
(7,037
)
 
(9,550
)
Adjustments for redemption/repurchase of Preferred Units
 
483

 
(5,932
)
Net income attributable to noncontrolling interests
 
(84
)
 
(206
)
     Net income attributable to common unitholders
 
$
18,933

 
$
28,435

Basic net income per Common Unit:
 
 
 
 
     Continuing operations attributable to common unitholders
 
$
0.01

 
$
0.06

     Discontinued operations attributable to common unitholders
 
0.05

 
0.03

           Total
 
$
0.06

 
$
0.09

Diluted net income per Common Unit:
 
 
 
 
     Continuing operations attributable to common unitholders
 
$
0.01

 
$
0.06

     Discontinued operations attributable to common unitholders
 
0.05

 
0.03

           Total
 
$
0.06

 
$
0.09

Weighted average number of Common Units outstanding
 
331,493

 
319,341

Weighted average number of Common Units and potential dilutive securities
 
331,716

 
319,571

 
 
 
 
 
Comprehensive income:
 
 
 
 
   Net income
 
$
25,571

 
$
44,123

   Other comprehensive income (loss):
 
 
 
 
Amortization of interest contracts
 
(287
)
 
457

Other
 
—

 
80

Total other comprehensive income (loss)
 
(287
)
 
537

Comprehensive income
 
$
25,284

 
$
44,660

See accompanying Notes to Consolidated Financial Statements

8

DUKE REALTY LIMITED PARTNERSHIP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the three months ended March 31,
(in thousands)
(Unaudited)
 
2014
 
2013
Cash flows from operating activities:
 
 
 
Net income
$
25,571

 
$
44,123

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation of buildings and tenant improvements
71,393

 
70,548

Amortization of deferred leasing and other costs
26,871

 
29,232

Amortization of deferred financing costs
2,499

 
3,507

Straight-line rental income and expense, net
(5,974
)
 
(4,839
)
Gain on acquisitions
—

 
(962
)
Gains on land and depreciated property sales, net of tax
(30,106
)
 
(9,122
)
Third-party construction contracts, net
411

 
11,138

Other accrued revenues and expenses, net
(33,911
)
 
(26,232
)
Operating distributions received in excess of (less than) equity in earnings from unconsolidated companies
2,383

 
(43,930
)
Net cash provided by operating activities
59,137

 
73,463

Cash flows from investing activities:
 
 
 
Development of real estate investments
(105,413
)
 
(103,684
)
Acquisition of real estate investments and related intangible assets
(17,224
)
 
(35,495
)
Acquisition of undeveloped land
(2,270
)
 
(5,149
)
Second generation tenant improvements, leasing costs and building improvements
(19,631
)
 
(17,119
)
Other deferred leasing costs
(8,706
)
 
(11,079
)
Other assets
5,539

 
(5,124
)
Proceeds from land and depreciated property sales, net
70,673

 
61,931

Capital distributions from unconsolidated companies
2,546

 
89,237

Capital contributions and advances to unconsolidated companies
(420
)
 
(4,846
)
Net cash used for investing activities
(74,906
)
 
(31,328
)
Cash flows from financing activities:
 
 
 
Contributions from the General Partner
23,783

 
574,685

Payments for redemption/repurchase of Preferred Units
(17,656
)
 
(177,955
)
Proceeds from unsecured debt
—

 
250,000

Payments on unsecured debt
(511
)
 
(480
)
Proceeds from secured debt financings
—

 
1,933

Payments on secured indebtedness including principal amortization
(21,471
)
 
(17,486
)
Borrowings (payments) on line of credit, net
92,000

 
(285,000
)
Distributions to common unitholders
(56,342
)
 
(55,458
)
Distributions to preferred unitholders
(7,140
)
 
(9,550
)
Distributions to noncontrolling interests
(24
)
 
(210
)
Change in book overdrafts
3,629

 
(45,272
)
Deferred financing costs
(300
)
 
(4,064
)
Net cash provided by financing activities
15,968

 
231,143

Net increase in cash and cash equivalents
199

 
273,278

Cash and cash equivalents at beginning of period
19,275

 
33,889

Cash and cash equivalents at end of period
$
19,474

 
$
307,167

 
 
 
 
Non-cash investing and financing activities:
 
 
 
Assumption of other liabilities in real estate acquisitions
$
76

 
$
50

Carrying amount of pre-existing ownership interest in acquired property
$
—

 
$
630

Conversion of Limited Partner Units to common shares of the General Partner
$
—

 
$
337

See accompanying Notes to Consolidated Financial Statements

9

DUKE REALTY LIMITED PARTNERSHIP AND SUBSIDIARIES
Consolidated Statement of Changes in Equity
For the three months ended March 31, 2014
(in thousands, except per unit data)
(Unaudited)
 
Common Unitholders
 
 
 
 
 
 
 
 
 
Limited
 
Accumulated
 
 
 
 
 
 
 
General Partner
 
Partners'
 
Other
 
Total
 
 
 
 
 
Common Equity
 
Preferred Equity
 
Common Equity
 
Comprehensive
Income
 
Partners' Equity
 
Noncontrolling
Interests
 
Total Equity
Balance at December 31, 2013
$
2,565,370

 
$
447,683

 
$
20,158

 
$
4,119

 
$
3,037,330

 
$
7,055

 
$
3,044,385

Net income
18,200

 
7,037

 
250

 
—

 
25,487

 
84

 
25,571

Other comprehensive income (loss)
—

 
—

 
—

 
(287
)
 
(287
)
 
—

 
(287
)
Capital contribution from the General Partner
23,783

 
—

 
—

 
—

 
23,783

 
—

 
23,783

Stock-based compensation plan activity
4,025

 
—

 
—

 
—

 
4,025

 
—

 
4,025

Distributions to Preferred Unitholders
—

 
(7,037
)
 
—

 
—

 
(7,037
)
 
—

 
(7,037
)
Repurchase of Preferred Units
1,101

 
(18,757
)
 
—

 
—

 
(17,656
)
 
—

 
(17,656
)
Distributions to Partners ($0.17 per Common Unit)
(55,596
)
 
—

 
(746
)
 
—

 
(56,342
)
 
—

 
(56,342
)
Distributions to noncontrolling interests
—

 
—

 
—

 
—

 
—

 
(24
)
 
(24
)
Balance at March 31, 2014
$
2,556,883

 
$
428,926

 
$
19,662

 
$
3,832

 
$
3,009,303

 
$
7,115

 
$
3,016,418


See accompanying Notes to Consolidated Financial Statements

10

DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
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 "General Partner") and Duke Realty Limited Partnership (the "Partnership"). In this Report, unless the context indicates otherwise, the terms "Company," "we," "us" and "our" refer to the General Partner and the Partnership, collectively, and those entities owned or controlled by the General Partner and/or the Partnership. The 2013 year-end consolidated balance sheet data included in this Quarterly Report on Form 10-Q (this "Report") was derived from the audited financial statements in the combined Annual Report on Form 10-K of the General Partner and the Partnership for the year ended December 31, 2013, 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 the combined Annual Report on Form 10-K of the General Partner and the Partnership for the year ended December 31, 2013.
The General Partner was formed in 1985, and we believe that it qualifies as a real estate investment trust ("REIT") under the provisions of the Internal Revenue Code of 1986, as amended (the "Code"). The Partnership was formed on October 4, 1993, when the General Partner contributed all of its properties and related assets and liabilities, together with the net proceeds from an offering of additional shares of its common stock, to the Partnership. Simultaneously, the Partnership completed the acquisition of Duke Associates, a full-service commercial real estate firm operating in the Midwest whose operations began in 1972.
The General Partner is the sole general partner of the Partnership, owning approximately 98.7% of the common partnership interests of the Partnership ("General Partner Units") at March 31, 2014. The remaining 1.3% of the common partnership interests ("Limited Partner Units" and, together with the General Partner Units, the "Common Units") are owned by limited partners. As the sole general partner of the Partnership, the General Partner has full, exclusive and complete responsibility and discretion in the day-to-day management and control of the Partnership. The General Partner and the Partnership are operated as one enterprise. The management of the General Partner consists of the same members as the management of the Partnership. As the sole general partner with control of the Partnership, the General Partner consolidates the Partnership for financial reporting purposes, and the General Partner does not have any significant assets other than its investment in the Partnership. Therefore, the assets and liabilities of the General Partner and the Partnership are substantially the same.
Limited Partners have the right to redeem their Limited Partner Units, subject to certain restrictions. Pursuant to the Fourth Amended and Restated Agreement of Limited Partnership, as amended (the "Partnership Agreement"), the General Partner is obligated to redeem the Limited Partner Units in shares of its common stock, unless it determines in its reasonable discretion that the issuance of shares of its common stock could cause it to fail to qualify as a REIT. Each Limited Partner Unit shall be redeemed for one share of the General Partner's common stock, or, in the event that the issuance of shares could cause the General Partner to fail to qualify as a REIT, cash equal to the fair market value of one share of the General Partner's common stock at the time of redemption, in each case, subject to certain adjustments described in the Partnership Agreement. The Limited Partner Units are not required, per the terms of the Partnership Agreement, to be redeemed in registered shares of the General Partner. The General Partner also owns preferred partnership interests in the Partnership ("Preferred Units").

11

We own and operate a portfolio primarily consisting of industrial, office and medical office properties and provide real estate services to third-party owners. Substantially all of our Rental Operations (see Note 10) are conducted through the Partnership. We conduct our Service Operations (see Note 10) through Duke Realty Services, LLC, Duke Realty Services Limited Partnership and Duke Construction Limited Partnership ("DCLP"), which are consolidated entities that are 100% owned by a combination of the General Partner and the Partnership. DCLP is owned through a taxable REIT subsidiary. The consolidated financial statements include our accounts and the accounts of our majority-owned or controlled subsidiaries.  
2.    New Accounting Pronouncement
In April 2014, the Financial Accounting Standards Board issued Accounting Standards Update No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity ("ASU 2014-08"). Under ASU 2014-08, only disposals representing a strategic shift in operations (for example, a disposal of a major geographic area or a major line of business) will be presented as discontinued operations, while significant continuing involvement with such dispositions will no longer preclude discontinued operations classification. As current GAAP generally requires companies that sell a single investment property to report the sale as a discontinued operation, the implementation of ASU 2014-08 will result in us reporting only sales that represent strategic shifts in operations as discontinued operations. ASU 2014-08 will also require additional disclosures for discontinued operations as well as for material property dispositions that do not meet the new criteria for discontinued operation classification.
ASU 2014-08 is effective for fiscal years beginning on or after December 15, 2014, with early adoption permitted only for disposals or classifications as held for sale that have not been reported in financial statements previously issued or available for issuance. It is our intention to adopt ASU 2014-08 during the three-month period ended June 30, 2014.
3.    Reclassifications
Certain amounts in the accompanying consolidated financial statements for 2013 have been reclassified to conform to the 2014 consolidated financial statement presentation.
4.    Variable Interest Entities

At March 31, 2014, there were two unconsolidated joint ventures that met the criteria to be considered variable interest entities ("VIEs"). These two unconsolidated joint ventures were formed with the sole purpose of developing, constructing, leasing, marketing and selling or operating properties. The business activities of these unconsolidated joint ventures have been financed through a combination of equity contributions, partner/member loans, and third-party debt that is guaranteed by a combination of us and the other partner/member of each entity. All significant decisions for these unconsolidated joint ventures, including those decisions that most significantly impact each venture's economic performance, require unanimous approval of each joint venture's partners or members. In certain cases, these decisions also require lender approval. Unanimous approval requirements for these unconsolidated joint ventures include entering into new leases, setting annual operating budgets, selling underlying properties, and incurring additional indebtedness. Because no single entity exercises control over the decisions that most significantly affect each joint venture's economic performance, we determined there to be no individual primary beneficiary and that the equity method of accounting is appropriate.
The following table provides a summary of the carrying value in our consolidated balance sheet, as well as our maximum loss exposure under guarantees for the two unconsolidated subsidiaries that we have determined to be VIEs at March 31, 2014 (in millions):
 
Carrying Value
 
Maximum Loss Exposure
Investment in unconsolidated companies
$
5.2

 
$
5.2

Guarantee obligations (1)
$
(18.4
)
 
$
(112.8
)

12

 
(1)
We are party to guarantees of the third-party debt of these joint ventures, and our maximum loss exposure is equal to the maximum monetary obligation pursuant to the guarantee agreements. We have also recorded a liability for our probable future obligation under a guarantee to the lender of one of these ventures, which is included within the carrying value of our guarantee obligations. Pursuant to an agreement with the lender, we may make partner loans to this joint venture that will reduce our maximum guarantee obligation on a dollar-for-dollar basis. The carrying value of our recorded guarantee obligations is included in other liabilities in our Consolidated Balance Sheets.
Our maximum loss exposure for guarantees of joint venture indebtedness, including guarantees of the debt of joint ventures that are not VIEs, totaled $196.4 million at March 31, 2014.
5.    Acquisitions and Dispositions
2014 Acquisitions
We acquired one operating property, an industrial building in Atlanta, Georgia, during the three months ended March 31, 2014. The following table summarizes the fair value of amounts recognized for each major class of asset and liability (in thousands) for this acquisition:
Real estate assets
$
15,972

Lease related intangible assets
1,578

Total acquired assets
17,550

Other liabilities
76

Total assumed liabilities
76

Fair value of acquired net assets
$
17,474

The lease in the acquired property had a remaining life at acquisition of approximately 3.8 years.
Acquisition-Related Activity
The acquisition-related activity in our Consolidated Statements of Operations and Comprehensive Income for the three months ended March 31, 2014 and 2013 consisted of transaction costs related to completed acquisitions, which are expensed as incurred, as well as gains or losses related to acquisitions where we had a pre-existing non-controlling ownership interest. We expensed $14,000 and $319,000, respectively, for acquisition-related transaction costs incurred in the three months ended March 31, 2014 and 2013. During the three months ended March 31, 2013, we also recognized a gain of $962,000 on the pre-existing ownership interest that we held in an industrial property we acquired in that period.
Dispositions
We disposed of certain consolidated income-producing real estate assets and undeveloped land and received net cash proceeds of $70.7 million and $61.9 million during the three months ended March 31, 2014 and 2013, respectively.
Income tax expense from continuing operations of $2.7 million was the result of the sale of a property that was partially owned by our taxable REIT subsidiary but, due to continuing involvement in managing the property, was not classified as a discontinued operation. Income tax expense included in discontinued operations of $3.0 million was also the result of the sale of a property that was partially owned by our taxable REIT subsidiary where we have no continuing involvement.
6.    Indebtedness
All debt is held directly or indirectly by the Partnership. The General Partner does not have any indebtedness, but does guarantee all of the unsecured debt of the Partnership. The following table summarizes the book value and changes in the fair value of our debt for the three months ended March 31, 2014 (in thousands):

13

 
Book Value
at 12/31/13
 
Book Value
at 3/31/14
 
Fair Value
at 12/31/13
 
Issuances and
Assumptions
 
Payments/Payoffs
 
Adjustments
to Fair Value
 
Fair Value
at 3/31/14
Fixed rate secured debt
$
1,081,035

 
$
1,058,485

 
$
1,145,717

 
$
—

 
$
(21,365
)
 
$
11,244

 
$
1,135,596

Variable rate secured debt
19,089

 
18,983

 
19,089

 
—

 
(106
)
 
—

 
18,983

Unsecured debt
3,066,252

 
3,065,742

 
3,250,518

 
—

 
(511
)
 
39,208

 
3,289,215

Unsecured line of credit
88,000

 
180,000

 
88,383

 
92,000

 
—

 
468

 
180,851

Total
$
4,254,376

 
$
4,323,210

 
$
4,503,707

 
$
92,000

 
$
(21,982
)
 
$
50,920

 
$
4,624,645


Secured Debt
Because our fixed rate secured debt is not actively traded in any marketplace, we utilized a discounted cash flow methodology to determine its fair value. Accordingly, we calculated fair value by applying an estimate of the current market rate to discount the debt's remaining contractual cash flows. Our estimate of a current market rate, which is the most significant input in the discounted cash flow calculation, is intended to replicate debt of similar maturity and loan-to-value relationship. The estimated rates ranged from 3.40% to 4.40%, depending on the attributes of the specific loans. The current market rates we utilized were internally estimated; therefore, we have concluded that our determination of fair value for our fixed rate secured debt was primarily based upon Level 3 inputs.
During the three months ended March 31, 2014, we repaid one secured loan, totaling $18.1 million. The loan had a stated interest rate of 5.14%.
Unsecured Debt
At March 31, 2014, with the exception of one variable rate term note that was issued in March 2013, all of our unsecured debt bore interest at fixed rates and primarily consisted of unsecured notes that are publicly traded. We utilized broker estimates in estimating the fair value of our fixed rate unsecured debt. Our unsecured notes are thinly traded and, in certain cases, the broker estimates were not based upon comparable transactions. The broker estimates took into account any recent trades within the same series of our fixed rate unsecured debt, comparisons to recent trades of other series of our fixed rate unsecured debt, trades of fixed rate unsecured debt from companies with profiles similar to ours, as well as overall economic conditions. We reviewed these broker estimates for reasonableness and accuracy, considering whether the estimates were based upon market participant assumptions within the principal and most advantageous market and whether any other observable inputs would be more accurate indicators of fair value than the broker estimates. We concluded that the broker estimates were representative of fair value. We have determined that our estimation of the fair value of our fixed rate unsecured debt was primarily based upon Level 3 inputs. The estimated trading values of our fixed rate unsecured debt, depending on the maturity and coupon rates, ranged from 96.00% to 124.00% of face value.
We utilize a discounted cash flow methodology in order to estimate the fair value of our $250.0 million variable rate term loan. The net present value of the difference between future contractual interest payments and future interest payments based on our estimate of a current market rate represents the difference between the book value and the fair value. Our estimate of a current market rate was based on estimated market spreads and the quoted yields on federal government treasury securities with similar maturity dates. Our estimate of the current market rate for our variable rate term loan was 1.36% and was based primarily upon Level 3 inputs.
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 at March 31, 2014.
Unsecured Line of Credit
Our unsecured line of credit at March 31, 2014 is described as follows (in thousands):
Description
Maximum
Capacity
 
Maturity Date
 
Outstanding
Balance at
March 31, 2014
Unsecured Line of Credit - Partnership
$
850,000

 
December 2015
 
$
180,000


14


The Partnership's unsecured line of credit has an interest rate on borrowings of LIBOR plus 1.25% (equal to 1.41% for outstanding borrowings at March 31, 2014) and a maturity date of December 2015. Subject to certain conditions, the terms also include an option to increase the facility by up to an additional $400.0 million, for a total of up to $1.25 billion. 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.
This line of credit contains financial covenants that require us to meet certain financial ratios and defined levels of performance, including those related to fixed charge coverage, unsecured interest expense coverage and debt-to-asset value (with asset value being defined in the Partnership's unsecured line of credit agreement). At March 31, 2014, we were in compliance with all covenants under this line of credit.
To the extent that there are outstanding borrowings, we utilize a discounted cash flow methodology in order to estimate the fair value of our unsecured line of credit. The net present value of the difference between future contractual interest payments and future interest payments based on our estimate of a current market rate represents the difference between the book value and the fair value. Our estimate of a current market rate is based upon the rate, considering current market conditions and our specific credit profile, at which we estimate we could obtain similar borrowings. The current market rate of 1.41% that we utilized was internally estimated; therefore, we have concluded that our determination of fair value for our unsecured line of credit was primarily based upon a Level 3 input.
7.    Shareholders' Equity of the General Partner and Partners' Capital of the Partnership
General Partner
In the first three months of 2014, pursuant to the share repurchase plan approved by our board of directors, the General Partner repurchased 750,243 preferred shares from among our three outstanding series. The preferred shares repurchased had a total redemption value of approximately $18.8 million and were repurchased for $17.7 million. In conjunction with the repurchases, approximately $618,000 of initial issuance costs, the ratable portion of such costs associated with the repurchased shares, were charged against income attributable to common shareholders. An adjustment of approximately $483,000 was included as an increase to income attributable to common shareholders.
During the three months ended March 31, 2014, the General Partner issued 1.4 million common shares pursuant to its at the market equity program, generating gross proceeds of approximately $24.1 million and, after deducting commissions and other costs, net proceeds of approximately $23.8 million. The proceeds from these offerings were used for general corporate purposes, which include the funding of development costs.
Partnership
For each common share or preferred share that the General Partner issues, the Partnership issues a corresponding General Partner Unit or Preferred Unit, as applicable, to the General Partner in exchange for the contribution of the proceeds from the stock issuance. Similarly, when the General Partner redeems or repurchases common shares or preferred shares, the Partnership redeems the corresponding Common Units or Preferred Units held by the General Partner at the same price.
8.    Related Party Transactions
We provide property management, asset management, leasing, construction and other tenant-related services to unconsolidated companies in which we have equity interests. We recorded the corresponding fees based on contractual terms that approximate market rates for these types of services and have eliminated our ownership percentage of these fees in the consolidated financial statements. The following table summarizes the fees earned from these companies, prior to elimination, for the three months ended March 31, 2014 and 2013, respectively (in thousands): 

15

 
 
Three Months Ended
 
 
March 31,
 
 
2014
 
2013
Management fees
 
$
2,219

 
$
2,456

Leasing fees
 
344

 
555

Construction and development fees
 
965

 
1,067


9.    Net Income (Loss) Per Common Share or Common Unit
Basic net income (loss) per common share or Common Unit is computed by dividing net income (loss) attributable to common shareholders or common unitholders, less dividends or distributions on share-based awards expected to vest (referred to as "participating securities" and primarily composed of unvested restricted stock units), by the weighted average number of common shares or Common Units outstanding for the period.
Diluted net income (loss) per common share is computed by dividing the sum of basic net income (loss) attributable to common shareholders and the noncontrolling interest in earnings allocable to Limited Partner Units (to the extent the Limited Partner Units are dilutive) by the sum of the weighted average number of common shares outstanding and, to the extent they are dilutive, Units outstanding and any potential dilutive securities for the period. Diluted net income (loss) per Common Unit is computed by dividing the basic net income (loss) attributable to common unitholders by the sum of the weighted average number of Common Units outstanding and any potential dilutive securities for the period. The following table reconciles the components of basic and diluted net income per common share or Common Unit for the three months ended March 31, 2014 and 2013, respectively (in thousands): 
 
 
Three Months Ended March 31,
 
 
2014
 
2013
General Partner
 
 
 
 
Net income attributable to common shareholders
 
$
18,683

 
$
28,043

Less: Dividends on participating securities
 
(645
)
 
(688
)
Basic net income attributable to common shareholders
 
18,038

 
27,355

Noncontrolling interest in earnings of common unitholders
 
250

 
392

Diluted net income attributable to common shareholders
 
$
18,288

 
$
27,747

Weighted average number of common shares outstanding
 
327,106

 
314,936

Weighted average Limited Partner Units outstanding
 
4,387

 
4,405

Other potential dilutive shares
 
223

 
230

Weighted average number of common shares and potential dilutive securities
 
331,716

 
319,571

 
 
 
 
 
Partnership
 
 
 
 
Net income attributable to common unitholders
 
$
18,933

 
$
28,435

Less: Distributions on participating securities
 
(645
)
 
(688
)
Basic and diluted net income attributable to common unitholders
 
$
18,288

 
$
27,747

Weighted average number of Common Units outstanding
 
331,493

 
319,341

Other potential dilutive units
 
223

 
230

Weighted average number of Common Units and potential dilutive securities
 
331,716

 
319,571

Substantially all potential shares related to our stock-based compensation plans are anti-dilutive for all periods presented. The following table summarizes the data that is excluded from the computation of net income per common share or Common Unit as a result of being anti-dilutive (in thousands): 

16

 
 
Three Months Ended March 31,
 
 
2014
 
2013
General Partner and Partnership
 
 
 
 
Potential dilutive shares or units:
 
 
 
 
Anti-dilutive outstanding potential shares or units under fixed stock option and other stock-based compensation plans
 
1,215

 
1,378

Outstanding participating securities
 
3,841

 
4,078

10.    Segment Reporting
Reportable Segments
We have four reportable operating segments at March 31, 2014, the first three of which consist of the ownership and rental of (i) industrial, (ii) office and (iii) medical office real estate investments. The operations of our industrial, office and medical office properties, along with our retail properties, are collectively referred to as "Rental Operations." Our retail properties, as well as any other properties not included in our reportable segments, do not by themselves meet the quantitative thresholds for separate presentation as a reportable segment and are referred to as non-reportable Rental Operations. The fourth reportable segment consists of various real estate services such as property management, asset management, maintenance, leasing, development, general contracting 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.
Revenues by Reportable Segment
The following table shows the revenues for each of the reportable segments, as well as a reconciliation to consolidated revenues, for the three months ended March 31, 2014 and 2013, respectively (in thousands): 
 
 
Three Months Ended March 31,
 
 
2014
 
2013
Revenues
 
 
 
 
Rental Operations:
 
 
 
 
Industrial
 
$
134,002

 
$
114,700

Office
 
66,972

 
61,197

Medical Office
 
33,310

 
30,484

Non-reportable Rental Operations
 
2,087

 
2,301

Service Operations
 
55,820

 
47,404

Total segment revenues
 
292,191

 
256,086

Other revenue
 
979

 
1,197

Consolidated revenue from continuing operations
 
293,170

 
257,283

Discontinued operations
 
1,368

 
16,404

Consolidated revenue
 
$
294,538

 
$
273,687

Supplemental Performance Measure
In prior periods, we evaluated the profitability of our reportable segments using net earnings excluding depreciation and other items that were not allocated to our operating segments. As the result of a recent shift in the focus of our executive management team on the metrics used to evaluate the performance of, and to allocate resources among, our reportable segments, we have elected to change our segment measurement of profitability beginning with the period ended March 31, 2014. We have also revised prior period information in order to provide period-over-period comparability. Property level net operating income, on a cash basis (“PNOI”) is the supplemental performance measure that we now use to evaluate the performance of, and to allocate resources among, the real estate investments in the reportable and operating segments that comprise our Rental Operations. PNOI excludes certain

17

items such as straight-line rental income and expense, lease buyout revenues, and the amortization of lease concessions and above and below market rents (collectively referred to as "Rental Operations revenues and expenses excluded from PNOI," as shown in the table below). Additionally, we do not allocate interest expense, depreciation expense and certain other non-property specific revenues and expenses (collectively referred to as "Non-Segment Items," as shown in the table below) to our individual operating segments.
We evaluate the performance of our Service Operations reportable segment using net income or loss, as allocated to that segment ("Earnings from Service Operations").
The following table shows a reconciliation of our segment-level measures of profitability to consolidated income from continuing operations before income taxes for the three months ended March 31, 2014 and 2013, respectively (in thousands and excluding discontinued operations): 
 
 
Three Months Ended March 31,
 
 
2014
 
2013
PNOI
 
 
 
 
Industrial
 
$
91,909

 
$
81,279

Office
 
36,264

 
36,816

Medical Office
 
20,577

 
16,502

Non-reportable Rental Operations
 
1,105

 
971

Total PNOI
 
149,855

 
135,568

 
 
 
 
 
Earnings from Service Operations
 
8,549

 
9,063

 
 

 

Rental Operations revenues and expenses excluded from PNOI:
Straight-line rental income and expense, net
 
6,463

 
4,270

Revenues related to lease buyouts
 
2,695

 
1,993

Amortization of lease concessions and above and below market rents
 
(2,467
)
 
(1,897
)
Intercompany rents and other adjusting items
 
(1,142
)
 
(1,034
)
PNOI from sold properties included in continuing operations
 
(96
)
 
2,767

Non-Segment Items:
 
 
 
 
Equity in earnings of unconsolidated companies
 
2,321

 
49,378

Interest expense
 
(55,257
)
 
(57,181
)
Depreciation expense
 
(98,059
)
 
(92,993
)
Gain on sale of properties
 
15,853

 
168

Interest and other income, net
 
351

 
153

Other operating expenses
 
(92
)
 
(68
)
General and administrative expenses
 
(14,694
)
 
(13,145
)
Gain on land sales
 
152

 
—

Undeveloped land carrying costs
 
(2,124
)
 
(2,198
)
Acquisition-related activity
 
(14
)
 
643

Other non-segment revenues and expenses, net
 
(692
)
 
311

Income from continuing operations before income taxes
 
$
11,602

 
$
35,798

The most comparable GAAP measure to PNOI is income from continuing operations before income taxes. PNOI excludes expenses that materially impact our overall results of operations and, therefore, should not be considered as a substitute for income from continuing operations before income taxes or any other measures derived in accordance with GAAP. Furthermore, PNOI may not be comparable to other similarly titled measures of other companies.



18

Assets by Reportable Segment
The assets for each of the reportable segments at March 31, 2014 and December 31, 2013 were as follows (in thousands): 
 
March 31,
2014
 
December 31,
2013
Assets
 
 
 
Rental Operations:
 
 
 
Industrial
$
4,438,376

 
$
4,414,740

Office
1,527,997

 
1,524,501

Medical Office
1,155,112

 
1,170,420

Non-reportable Rental Operations
79,899

 
81,056

Service Operations
151,724

 
145,222

Total segment assets
7,353,108

 
7,335,939

Non-segment assets
414,255

 
416,675

Consolidated assets
$
7,767,363

 
$
7,752,614


11.    Discontinued Operations and Assets Held for Sale
The following table illustrates the number of sold or held-for-sale properties included in, or excluded from, discontinued operations:
 
 
Held for Sale at March 31, 2014
 
Sold in 2014
 
Sold in 2013
 
Total
 
 
 
 
 
 
 
 
Industrial
2
 
9
 
6
 
17
Office
0
 
0
 
12
 
12
Medical Office
1
 
1
 
6
 
8
Retail
0
 
0
 
1
 
1
Total properties included in discontinued operations
3
 
10
 
25
 
38
Properties excluded from discontinued operations
0
 
1
 
13
 
14
Total properties sold or classified as held-for-sale
3
 
11
 
38
 
52
    
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 for 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.
The following table illustrates the operations of the buildings reflected in discontinued operations for the three months ended March 31, 2014 and 2013, respectively (in thousands):  

19

 
Three Months Ended March 31,
 
2014
 
2013
Revenues
$
1,368

 
$
16,404

Operating expenses
(913
)
 
(5,986
)
Depreciation and amortization
(205
)
 
(6,787
)
Operating income
250

 
3,631

Interest expense
(382
)
 
(4,260
)
Loss before gain on sales
(132
)
 
(629
)
Gain on sale of depreciable properties
19,752

 
8,954

Income from discontinued operations before income taxes
19,620

 
8,325

Income tax expense
(2,977
)
 
—

Income from discontinued operations
$
16,643

 
$
8,325

The income tax expense included in discontinued operations during the three months ended March 31, 2014 was triggered by the sale of a property that was partially owned by our taxable REIT subsidiary.
The income tax expense from continuing operations of $2.7 million for the three months ended March 31, 2014, as presented in the Consolidated Statements of Operations and Comprehensive Income, was related to the sale of another property that was partially owned by our taxable REIT subsidiary but, due to continuing involvement in managing the property, was not classified as a discontinued operation.
Dividends or distributions on preferred shares or Preferred Units and adjustments for the redemption or repurchase of preferred shares or Preferred Units are allocated entirely to continuing operations for both the General Partner and the Partnership.
Allocation of Noncontrolling Interests - General Partner
The following table illustrates the General Partner's share of the income (loss) attributable to common shareholders from continuing operations and discontinued operations, reduced by the allocation of income or loss between continuing and discontinued operations to the Limited Partner Units, for the three months ended March 31, 2014 and 2013, respectively (in thousands):
 
 
Three Months Ended March 31,
 
 
2014
 
2013
Income from continuing operations attributable to common shareholders
 
$
2,260

 
$
19,833

Income from discontinued operations attributable to common shareholders
 
16,423

 
8,210

Net income attributable to common shareholders
 
$
18,683

 
$
28,043

Allocation of Noncontrolling Interests - Partnership
Substantially all of the income from discontinued operations for all periods presented in the Partnership's Consolidated Statements of Operations and Comprehensive Income is attributable to the common unitholders.
Properties Held for Sale
At March 31, 2014, we classified three in-service properties as held-for-sale, which were included in discontinued operations, due to our intention and ability to sell these properties in the second quarter of 2014. The following table illustrates aggregate balance sheet information of these properties at March 31, 2014 (in thousands):

20

 
March 31, 2014
Real estate investment, net
$
29,316

Other assets
5,510

Total assets held-for-sale
$
34,826

 
 
Accrued expenses
$
132

Other liabilities
47

Total liabilities held-for-sale
$
179

12.    Subsequent Events
Declaration of Dividends/Distributions
The General Partner's board of directors declared the following dividends/distributions at its regularly scheduled board meeting held on April 30, 2014:
Class of stock/units
Quarterly Amount per Share or Unit
 
Record Date
 
Payment Date
Common
$0.17
 
May 15, 2014
 
May 30, 2014
Preferred (per depositary share or unit):

 

 

Series J
$0.414063
 
May 15, 2014
 
May 30, 2014
Series K
$0.406250
 
May 15, 2014
 
May 30, 2014
Series L
$0.412500
 
May 15, 2014
 
May 30, 2014
Amendments to Articles of Incorporation - General Partner
At the annual meeting of the General Partner’s shareholders, held on April 30, 2014, the shareholders approved an increase in the number of authorized shares of the General Partner’s common stock from 400 million to 600 million and the establishment of certain detailed stock ownership and transfer restrictions intended to enable the General Partner to better protect its status as a REIT.


21

Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations
The following Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to help the reader understand our operations and our present business environment. Management's Discussion and Analysis is provided as a supplement to and should be read in conjunction with our consolidated financial statements and the notes thereto, contained in Part I, Item I of this Quarterly Report on Form 10-Q (this "Report") and the consolidated financial statements and notes thereto, contained in Part IV, Item 15 of our combined Annual Report on Form 10-K for the year ended December 31, 2013, as filed with the Securities and Exchange Commission (the "SEC") on February 21, 2014 for Duke Realty Corporation (the "General Partner") and Duke Realty Limited Partnership (the "Partnership"). As used herein, the terms the "Company," "we," "us" and "our" refer to the General Partner and the Partnership, collectively, and those entities owned or controlled by the General Partner and/or the Partnership.
Cautionary Notice 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," "could" and similar expressions or statements regarding future periods are intended to identify forward-looking statements, although not all forward-looking statements contain such words.
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 financial condition of our tenants and the value of our real estate assets;
•
The General Partner's continued qualification as a real estate investment trust ("REIT") for U.S. federal income tax purposes;
•
Heightened competition for tenants and potential decreases in property occupancy;
•
Potential changes in the financial markets and interest rates;
•
Volatility in the General Partner's stock price and trading volume;
•
Our continuing ability to raise funds on favorable terms;
•
Our ability to successfully identify, acquire, develop and/or manage properties on terms that are favorable to us;
•
Potential increases in real estate construction costs;
•
Our ability to successfully dispose of properties on terms that are favorable to us, including, without limitation, through one or more transactions that are consistent with our previously disclosed strategic plans;
•
Our ability to retain our current credit ratings;
•
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 SEC.
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, including those 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.


22

The above list of risks and uncertainties 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 in our combined Annual Report on Form 10-K for the fiscal year ended December 31, 2013, which we filed with the SEC on February 21, 2014 for the General Partner and the Partnership. The risk factors contained in our Annual Report are updated by us from time to time in Quarterly Reports on Form 10-Q and other public filings. 
Business Overview
The General Partner is a self-administered and self-managed REIT that began operations in 1986 and is the sole general partner of the Partnership. The Partnership is a limited partnership formed in 1993, at which time all of the properties and related assets and liabilities of the General Partner, as well as proceeds from a secondary offering of the General Partner's common shares, were contributed to the Partnership. Simultaneously, the Partnership completed the acquisition of Duke Associates, a full-service commercial real estate firm operating in the Midwest whose operations began in 1972. We operate the General Partner and the Partnership as one enterprise, and therefore, our discussion and analysis refers to the General Partner and its consolidated subsidiaries, including the Partnership, collectively. A more complete description of our business, and of management's philosophy and priorities, is included in our 2013 Annual Report on Form 10-K.
At March 31, 2014, we:
•
Owned or jointly controlled 747 industrial, office, medical office and other properties, of which 722 properties with approximately 146.6 million square feet were in service and 25 properties with more than 7.5 million square feet were under development. The 722 in-service properties were comprised of 616 consolidated properties with more than 124.1 million square feet and 106 jointly controlled unconsolidated properties with more than 22.4 million square feet. The 25 properties under development consisted of 23 consolidated properties with approximately 5.8 million square feet and two jointly controlled unconsolidated properties with approximately 1.8 million square feet.
•
Owned, including through ownership interests in unconsolidated joint ventures, more than 4,000 acres of land and controlled more than 1,600 acres through purchase options.
A key component of our overall strategy is to increase our investment in quality industrial properties in both existing and select new markets and to reduce our investment in suburban office properties and other non-strategic assets.
We have four reportable operating segments at March 31, 2014, the first three of which consist of the ownership and rental of (i) industrial, (ii) office and (iii) medical office real estate investments. The operations of our industrial, office and medical office properties, along with our retail properties, are collectively referred to as "Rental Operations." Our retail properties, as well as any other properties not included in our reportable segments, do not by themselves meet the quantitative thresholds for separate presentation as a reportable segment. The fourth reportable segment consists of various real estate services such as property management, asset management, maintenance, leasing, development, general contractor 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. Our Service Operations segment also includes our taxable REIT subsidiary, a legal entity through which certain of the segment's operations are conducted.
Key Performance Indicators
Our operating results depend primarily upon rental income from our Rental Operations. The following discussion highlights the areas of Rental Operations that we consider critical drivers of future revenues.



23

Occupancy Analysis
Our ability to maintain high occupancy rates is a principal driver of maintaining and increasing rental revenue. The following table sets forth percent leased and average net effective rent information regarding our in-service portfolio of rental properties, including properties classified within both continuing and discontinued operations, at March 31, 2014 and 2013, respectively (in thousands, except percentage data):
 
 
Total Square Feet
 
Percent of
Total Square Feet
 
Percent Leased*
 
Average Annual Net Effective Rent**
Type
2014
 
2013
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
Industrial
104,590
 
94,859
 
84.2
%
 
81.7
%
 
94.9
%
 
93.1
%
 
$3.93
 
$3.85
Office
14,628
 
15,574
 
11.8
%
 
13.4
%
 
87.9
%
 
84.2
%
 
$13.45
 
$13.32
Medical Office
4,580
 
5,011
 
3.7
%
 
4.3
%
 
93.2
%
 
90.6
%
 
$22.93
 
$21.70
Other
348
 
739
 
0.3
%
 
0.6
%
 
85.7
%
 
85.8
%
 
$19.75
 
$24.12
Total Consolidated
124,146
 
116,183
 
100.0
%
 
100.0
%
 
94.0
%
 
91.8
%
 
$5.72
 
$5.90
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unconsolidated Joint Ventures
22,413
 
21,624
 
 
 
 
 
94.1
%
 
93.9
%
 
$8.15
 
$7.29
Total Including Unconsolidated Joint Ventures
146,559
 
137,807
 
 
 
 
 
94.0
%
 
92.1
%
 
$5.85
 
$5.99
 *Represents the percentage of total square feet leased based on executed leases and without regard to whether the leases have commenced.
**Represents average annual base rental payments per leased square foot, on a straight-line basis for the term of each lease, from space leased to tenants at the end of the most recent reporting period. This amount excludes additional amounts paid by tenants as reimbursement for operating expenses.
Leasing activity within our existing portfolio of properties as well as, to a lesser extent, acquisitions of fully leased industrial properties through the course of 2013 drove the increase in our total percent leased from March 31, 2013.
Vacancy Activity
The following table sets forth vacancy activity, shown in square feet, regarding our in-service rental properties, including properties classified within both continuing and discontinued operations, at March 31, 2014, (in thousands):

 
Consolidated Properties
 
Unconsolidated Joint Venture Properties
 
Total Including Unconsolidated Joint Venture Properties
Vacant square feet at December 31, 2013
7,368

 
1,165

 
8,533

  Dispositions
(22
)
 
(30
)
 
(52
)
  Expirations
2,212

 
298

 
2,510

  Early lease terminations
1,280

 
64

 
1,344

  Property structural changes/other
6

 
—

 
6

  Leasing of previously vacant space
(3,379
)
 
(179
)
 
(3,558
)
Vacant square feet at March 31, 2014
7,465

 
1,318

 
8,783


Total Leasing Activity

The initial leasing of development projects or vacant space in acquired properties is referred to as first generation lease activity. The leasing of such space that we have previously held under lease is referred to as second generation lease activity. The total leasing activity for our consolidated rental properties, expressed in square feet of leases

24

signed during the period, is as follows for the three months ended March 31, 2014 and 2013, respectively (in thousands):
 
Three Months Ended March 31,
 
2014
 
2013
New Leasing Activity - First Generation
1,439
 
1,359
New Leasing Activity - Second Generation
2,544
 
2,266
Renewal Leasing Activity
1,677
 
1,992
Total Consolidated Leasing Activity
5,660
 
5,617
Unconsolidated Joint Venture Leasing Activity
370
 
735
Total Including Unconsolidated Joint Venture Leasing Activity
6,030
 
6,352
New leasing activity, for second generation leases, increased in part due to back-filling vacant industrial space within our Atlanta and Savannah, Georgia, properties. The lower volume of renewal leases executed during the three months ended March 31, 2014, for consolidated rental properties, was mainly the result of approximately 1.8 million less square feet being up for renewal than during the three months ended March 31, 2013.
New Second Generation Leases
The following table sets forth the estimated costs of tenant improvements and leasing commissions, on a per square foot basis, that we are obligated to fulfill under the new second generation leases signed for our rental properties during the three months ended March 31, 2014 and 2013, respectively (square feet data in thousands):
 
Square Feet of New Second Generation Leases Signed
 
Average Term in Years
 
Estimated Tenant Improvement Cost per Square Foot
 
Leasing Commissions per Square Foot
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
Three Months