DDR CORP 10-K 2007
Documents found in this filing:
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
(Amendment No. 2)
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006
For the transition period from to
Commission file number 1-11690
DEVELOPERS DIVERSIFIED REALTY CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
3300 Enterprise Parkway, Beachwood, Ohio 44122
(Address of Principal Executive Offices Zip Code)
(Registrants telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act:
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ
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 þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ Accelerated filer o Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
The aggregate market value of the voting stock held by non-affiliates of the registrant at June 30, 2006 was $5.5 billion.
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
Indicate the number of shares outstanding of each of the registrants classes of common stock as of the latest practicable date.
109,452,823 common shares outstanding as of February 5, 2007
DOCUMENTS INCORPORATED BY REFERENCE
This Form 10-K/A (Amendment No. 2) (this Amendment) amends the Annual Report on Form 10-K of Developers Diversified Realty Corporation (the Company) for the year ended December 31, 2006, which was filed on February 21, 2007 and was amended on March 6, 2007 to incorporate by reference into Part III portions of the Companys definitive proxy statement for its 2007 Annual Shareholders Meeting (the Form 10-K as previously amended, the Original Report).
The Company is amending the Original Report to include as Exhibit 99.2 the financial statements of DDR Macquarie Fund LLC for its fiscal years ended June 30, 2006 and 2005 and the period November 21, 2003 (date of inception) to June 30, 2004. The Company is also including additional footnote disclosure in the Companys consolidated financial statements related to DDR MDT PS LLC, in addition to the existing footnote disclosure which presents combined financial information about the Companys joint ventures. The Company has determined that these additional financial statements and disclosures are appropriate based on the application of Rules 3.09 and 4.08(g) of Regulation S-X. These additional financial statements and disclosures do not have any affect on the Companys previously reported consolidated results of operations, financial condition or cash flows.
This Amendment also includes a signature page, the certifications required by Rule 13a-14(a) of the Securities Exchange Act of 1934 which have been reexecuted and refiled, the Exhibit Index which has been amended and restated in its entirety to reflect the inclusion of the certifications, the financial statements of DDR Macquarie LLC and the consents of PricewaterhouseCoopers LLP to the inclusion of the financial statements in subsequent filings under the Securities Act of 1933. Item 9A (Controls and Procedures) is included in this Amendment, but it has not been modified or updated from the Original Report.
All other items of the Original Report remain unchanged, and no attempt has been made to update matters in the Original Report, except to the extent expressly provided above. Refer to the Companys quarterly reports on Form 10-Q for periods subsequent to December 31, 2006.
Based on their evaluation as required by Securities Exchange Act Rules 13a-15(b) and 15d-15(b), the Companys Chief Executive Officer (CEO) and Chief Financial Officer (CFO) have concluded that the Companys disclosure controls and procedures (as defined in Securities Exchange Act Rules 13a-15(e) and 15d-15(e)) are effective as of December 31, 2006, to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and were effective as of December 31, 2006, to ensure that information required to be disclosed by the Company issuer in the reports that it files or submits under the Securities Exchange Act is accumulated and communicated to the Companys management, including its CEO and CFO, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
The Companys management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Exchange Act Rule 13a-15(f). Management assessed the effectiveness of its internal control over financial reporting based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control Integrated Framework. Based on those criteria, management concluded that the Companys internal control over financial reporting was effective as of December 31, 2006.
Managements assessment of the effectiveness of the Companys internal control over financial reporting as of December 31, 2006, has been audited by PricewaterhouseCoopers, LLP, an independent registered public accounting firm, as stated in their report, which is included in Part IV; Item 15 of this Annual Report on Form 10-K.
During the three-month period ended December 31, 2006, there were no changes in the Companys internal control over financial reporting that materially affected or are reasonably likely to materially affect the Companys internal control over financial reporting.
The following documents are filed as a part of this report:
Report of Independent Registered Public Accounting Firm.
Consolidated Balance Sheets as of December 31, 2006 and 2005.
Consolidated Statements of Operations for the three years ended December 31, 2006.
Consolidated Statements of Shareholders Equity for the three years ended December 31, 2006.
Consolidated Statements of Cash Flows for the three years ended December 31, 2006.
Notes to the Consolidated Financial Statements.
The following financial statement schedules were filed as part of the Annual Report on Form 10-K filed with the SEC on February 21, 2007 and should be read in conjunction with the Consolidated Financial Statements of the registrant:
II Valuation and Qualifying Accounts and Reserves for the three years ended December 31, 2006.
Schedules not listed above have been omitted because they are not applicable or because the information required to be set forth therein is included in the Consolidated Financial Statements or notes thereto.
b.) Exhibits The following exhibits are filed as part of, or incorporated by reference into, this report:
DEVELOPERS DIVERSIFIED REALTY CORPORATION
Financial statements of the Companys unconsolidated joint venture companies, except for DDR Macquarie Fund LLC, have been omitted because they do not meet the significant subsidiary definition of S-X 210.1-02(w).
To the Board of Directors and Shareholders of
Developers Diversified Realty Corporation:
We have completed integrated audits of Developers Diversified Realty Corporations consolidated financial statements and of its internal control over financial reporting as of December 31, 2006, in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Developers Diversified Realty Corporation and its subsidiaries (the Company) at December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 15(a)(2) present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Notes 1 and 2 to the consolidated financial statements, the Company, on April 1, 2004, adopted FIN 46R, Consolidation of Variable Interest Entities an interpretation of ARB 51, as interpreted.
Also, in our opinion, managements assessment, included Managements Report on Internal Control over Financial Reporting appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control Integrated Framework issued by the COSO. The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on managements assessment and on the effectiveness of the Companys internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PRICEWATERHOUSECOOPERS LLP
February 21, 2007
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
Developers Diversified Realty Corporation and its subsidiaries (the Company or DDR) are primarily engaged in the business of acquiring, expanding, owning, developing, managing and operating shopping centers and enclosed malls. The Companys shopping centers are typically anchored by two or more national tenant anchors (Wal-Mart and Target), home improvement stores (Home Depot, Lowes Home Improvement) and two or more junior tenants (Bed Bath & Beyond, Kohls, Circuit City, T.J. Maxx or PETsMART). At December 31, 2006, the Company owned or had interests in 467 shopping centers in 44 states plus Puerto Rico and Brazil and seven business centers in five states. The Company has an interest in 206 of these shopping centers through equity method investments. The tenant base primarily includes national and regional retail chains and local retailers. Consequently, the Companys credit risk is concentrated in the retail industry.
Consolidated revenues derived from the Companys largest tenant, Wal-Mart, aggregated 4.7%, 5.1% and 4.0% of total revenues for the years ended December 31, 2006, 2005 and 2004, respectively. The total percentage of Company-owned gross leasable area (GLA unaudited) attributed to Wal-Mart was 8.7% at December 31, 2006. The Companys ten largest tenants comprised 17.7%, 20.0% and 19.4% of total revenues for the years ended December 31, 2006, 2005 and 2004, respectively, including revenues reported within discontinued operations. Management believes the Companys portfolio is diversified in terms of the location of its shopping centers and its tenant profile. Adverse changes in general or local economic conditions could result in the inability of some existing tenants to meet their lease obligations and could otherwise adversely affect the Companys ability to attract or retain tenants. During the three-year period ended December 31, 2006, 2005 and 2004, certain national and regional retailers experienced financial difficulties, and several filed for protection under bankruptcy laws. The Company does not believe that these bankruptcies will have a material impact on the Companys financial position, results of operations or cash flows.
The Company consolidates certain entities if it is deemed to be the primary beneficiary in a variable interest entity (VIE), as defined in FIN No. 46(R), Consolidation of Variable Interest Entities (FIN 46). For those entities that are not VIEs, the Company also consolidates entities in which it has financial and operating control. All significant inter-company balances and transactions have been eliminated in consolidation. Investments in real estate joint ventures and companies in which the Company has the ability to exercise significant influence, but does not have financial or operating control, are accounted for using the equity method of accounting. Accordingly, the Companys share of the earnings (or loss) of these joint ventures and companies is included in consolidated net income.
In 2005, the Company formed a joint venture (the Mervyns Joint Venture) with an Australia-based Listed Property Trust, MDT, that acquired the underlying real estate of 36 operating Mervyns stores. The Company holds a 50% economic interest in the Mervyns Joint Venture, which is considered a VIE, and the Company was determined to be the primary beneficiary. The Company earns property management, acquisition and financing fees from this VIE, which are eliminated in consolidation. The VIE has total real estate assets and total non-recourse mortgage debt of approximately $405.8 million and $258.5 million, respectively, at December 31, 2006, and is consolidated in the results of the Company.
In 2003, the Company formed a joint venture (the MDT Joint Venture) with Macquarie Bank Limited, that focuses on acquiring community center properties in the United States. The Company maintains an interest in the MDT Joint Venture, a VIE in which the Company has an approximate 12% economic interest. The Company was not determined to be the primary beneficiary. The Company earns asset management and performance fees from a joint venture that serves as the manager of the MDT Joint Venture (MDT Manager). The Company has a 50% ownership and serves as the managing member, accounted for under the equity method of accounting. The MDT Joint Venture has total real estate assets and total non-recourse mortgage debt of approximately $1.7 billion and $1.1 billion and $1.7 billion and $1.0 billion, respectively, at December 31, 2006 and 2005, respectively. The Companys maximum exposure to loss associated with this joint venture is primarily limited to the Companys aggregate capital investment, which was approximately $63.6 million at December 31, 2006. The financial
statements of the MDT Joint Venture are included as part of the combined joint ventures financial statements in Note 2.
Non-cash investing and financing activities are summarized as follows (in millions):
The transactions above did not provide or use cash in the years presented and, accordingly, are not reflected in the consolidated statements of cash flows.
Real estate assets held for investment are stated at cost less accumulated depreciation, which, in the opinion of management, is not in excess of the individual propertys estimated undiscounted future cash flows, including estimated proceeds from disposition.
Depreciation and amortization are provided on a straight-line basis over the estimated useful lives of the assets as follows:
Expenditures for maintenance and repairs are charged to operations as incurred. Significant renovations that improve or extend the life of the assets are capitalized. Included in land at December 31, 2006, was undeveloped real estate, generally outlots or expansion pads adjacent to shopping centers owned by the Company (excluding shopping centers owned through joint ventures) and excess land of approximately 1,000 acres.
Construction in progress includes shopping center developments and significant expansions and redevelopments. The Company capitalizes interest on funds used for the construction, expansion or redevelopment of shopping centers, including funds invested in or advanced to joint ventures with qualifying development activities. Capitalization of interest ceases when construction activities are substantially completed and the property is available for occupancy by tenants. In addition, the Company capitalized certain direct and incremental internal construction and software development and implementation costs of $10.0 million, $6.2 million and $5.7 million in 2006, 2005 and 2004, respectively.
Upon acquisition of properties, the Company estimates the fair value of acquired tangible assets, consisting of land, building and improvements, and, if determined to be material, identifies intangible assets generally consisting
of the fair value of (i) above- and below-market leases, (ii) in-place leases and (iii) tenant relationships. The Company allocates the purchase price to assets acquired and liabilities assumed based on their relative fair values at the date of acquisition pursuant to the provisions of Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations. In estimating the fair value of the tangible and intangible assets acquired, the Company considers information obtained about each property as a result of its due diligence, marketing and leasing activities, and utilizes various valuation methods, such as estimated cash flow projections using appropriate discount and capitalization rates, estimates of replacement costs net of depreciation, and available market information. Depending upon the size of the acquisition, the Company may engage an outside appraiser to perform a valuation of the tangible and intangible assets acquired. The fair value of the tangible assets of an acquired property considers the value of the property as if it were vacant.
Above- and below-market lease values for acquired properties are recorded based on the present value (using a discount rate that reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to each in-place lease and (ii) managements estimate of fair market lease rates for each corresponding in-place lease, measured over a period equal to the remaining term of the lease for above-market leases and the initial term plus the term of any below-market fixed-rate renewal options for below-market leases. The capitalized above-market lease values are amortized as a reduction of base rental revenue over the remaining term of the respective leases, and the capitalized below-market lease values are amortized as an increase to base rental revenue over the remaining initial terms plus the terms of any below-market fixed-rate renewal options of the respective leases. At December 31, 2006 and 2005, the below-market leases aggregated $22.9 million and $11.5 million, respectively. At December 31, 2006 and 2005, the above-market leases aggregated $2.3 million and $1.4 million, respectively.
The total amount allocated to in-place lease values and tenant relationship values is based upon managements evaluation of the specific characteristics of the acquired lease portfolio and the Companys overall relationship with anchor tenants. Factors considered in the allocation of these values include the nature of the existing relationship with the tenant, the expectation of lease renewals, the estimated carrying costs of the property during a hypothetical, expected lease-up period, current market conditions and costs to execute similar leases. Estimated carrying costs include real estate taxes, insurance, other property operating costs and estimates of lost rentals at market rates during the hypothetical, expected lease-up periods, based upon managements assessment of specific market conditions.
The value of in-place leases including origination costs is amortized to expense over the estimated weighted average remaining initial term of the acquired lease portfolio. The value of tenant relationship intangibles is amortized to expense over the estimated initial and renewal terms of the lease portfolio; however, no amortization period for intangible assets will exceed the remaining depreciable life of the building.
Intangible assets associated with property acquisitions are included in other assets and other liabilities, with respect to the below-market leases, in the Companys consolidated balance sheets.
The Company follows the provisions of SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144). If an asset is held for sale, it is stated at the lower of its carrying value or fair value, less cost to sell. The determination of undiscounted cash flows requires significant estimates made by management and considers the expected course of action at the balance sheet date. Subsequent changes in estimated undiscounted cash flows arising from changes in anticipated actions could affect the determination of whether an impairment exists.
The Company reviews its long-lived assets used in operations for impairment when there is an event or change in circumstances that indicates an impairment in value. An asset is considered impaired when the undiscounted future cash flows are not sufficient to recover the assets carrying value. If such impairment is present, an impairment loss is recognized based on the excess of the carrying amount of the asset over its fair value. The Company records impairment losses and reduces the carrying amounts of assets held for sale when the carrying amounts exceed the estimated selling proceeds, less the costs to sell.
Costs incurred in obtaining indebtedness are included in deferred charges in the accompanying consolidated balance sheets and are amortized on a straight-line basis over the terms of the related debt agreements, which approximates the effective interest method. Such amortization is reflected as interest expense in the consolidated statements of operations.
Minimum rents from tenants are recognized using the straight-line method over the lease term of the respective leases. Percentage and overage rents are recognized after a tenants reported sales have exceeded the applicable sales breakpoint set forth in the applicable lease. Revenues associated with tenant reimbursements are recognized in the period that the expenses are incurred based upon the tenant lease provision. Management fees are recorded in the period earned based on a percentage of collected rent at the properties under management. Ancillary and other property-related income, which includes the leasing of vacant space to temporary tenants, is recognized in the period earned. Lease termination fees are included in other income and recognized upon the effective termination of a tenants lease when the Company has no further obligations with the lease. Fee income derived from the Companys joint venture investments is recognized to the extent attributable to the unaffiliated ownership interest.
The Company makes estimates of the uncollectability of its accounts receivable related to base rents, expense reimbursements and other revenues. The Company analyzes accounts receivable and historical bad debt levels, customer credit worthiness and current economic trends when evaluating the adequacy of the allowance for doubtful accounts. In addition, tenants in bankruptcy are analyzed and estimates are made in connection with the expected recovery of pre-petition and post-petition claims. The Companys reported net income is directly affected by managements estimate of the collectability of accounts receivable.
Accounts receivable, other than straight-line rents receivable, are expected to be collected within one year and are net of estimated unrecoverable amounts of approximately $14.5 million and $19.0 million at December 31, 2006 and 2005, respectively. At December 31, 2006 and 2005, straight-line rents receivable, net of a provision for uncollectable amounts of $3.5 million and $2.4 million, aggregated $54.7 million and $38.5 million, respectively.
Disposition of real estate relates to the sale of outlots and land adjacent to existing shopping centers, shopping center properties and real estate investments. Gains from dispositions are recognized using the full accrual or partial sale methods, as applicable, in accordance with the provisions of SFAS No. 66, Accounting for Real Estate Sales, (SFAS 66) provided that various criteria relating to the terms of sale and any subsequent involvement by the Company with the properties sold are met.
SFAS 144 retains the basic provisions for presenting discontinued operations in the income statement but broadens the scope to include a component of an entity rather than a segment of a business. Pursuant to the definition of a component of an entity in SFAS 144, assuming no significant continuing involvement, the sale of a retail or industrial operating property is considered discontinued operations. In addition, properties classified as held for sale are also considered a discontinued operation. Accordingly, the results of operations of properties disposed of, or classified as held for sale, for which the Company has no significant continuing involvement, are reflected as discontinued operations. Interest expense, which is specifically identifiable to the property, is used in the computation of interest expense attributable to discontinued operations. Consolidated interest at the corporate level is allocated to discontinued operations pursuant to the methods prescribed under Emerging Issues Task Force (EITF) 87-24, Allocation of Interest to Discontinued Operations, based on the proportion of net assets disposed.
The Company generally considers assets to be held for sale when the transaction has been approved by the appropriate level of management and there are no known significant contingencies relating to the sale such that the
property sale within one year is considered probable. The Company evaluates the held for sale classification of its owned real estate each quarter. Assets that are classified as held for sale are recorded at the lower of their carrying amount or fair value less cost to sell. The results of operations of these shopping centers are reflected as discontinued operations in all periods presented.
On occasion, the Company will receive unsolicited offers from third parties to buy individual shopping centers. The Company will generally classify the properties as held for sale when a sales contract is executed with no contingencies and the prospective buyer has significant funds at risk to ensure performance.
General and administrative expenses include certain internal leasing and legal salaries and related expenses directly associated with the re-leasing of existing space, which are charged to operations as incurred.
Prior to January 1, 2006, the Company followed Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. Accordingly, the Company did not recognize compensation cost for stock options when the option exercise price equaled or exceeded the market value on the date of the grant. Prior to January 1, 2006, no stock-based employee compensation cost for stock options was reflected in net income, as all options granted under those plans had an exercise price equal to or in excess of the market value of the underlying common stock on the date of grant. The Company recorded compensation expense related to its restricted stock plan and its performance unit awards.
In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123(R), Share-Based Payment (SFAS 123(R)). SFAS 123(R) is an amendment of SFAS 123 and requires that the compensation cost relating to share-based payment transactions be recognized in the financial statements based upon the grant date fair value. The grant date fair value of the portion of the restricted stock and performance unit awards issued prior to the adoption of SFAS 123(R) that is ultimately expected to vest is recognized as expense on a straight-line attribution basis over the requisite service periods in the Companys consolidated financial statements. SFAS 123(R) requires forfeitures to be estimated at the time of grant in order to estimate the amount of share-based awards that will ultimately vest. The forfeiture rate is based on historical rates.
The Company adopted SFAS 123(R) as required on January 1, 2006, using the modified prospective method. The Companys consolidated financial statements as of and for the year ended December 31, 2006, reflect the impact of SFAS 123(R). In accordance with the modified prospective method, the Companys consolidated financial statements for prior periods have not been restated to reflect the impact of SFAS 123(R). Share-based compensation expense recognized in the Companys consolidated financial statements for the year ended December 31, 2006, includes (i) compensation expense for share-based payment awards granted prior to, but not yet vested, as of December 31, 2005, based on the grant-date fair value and (ii) compensation expense for the share-based payment awards granted subsequent to December 31, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R).
The adoption of this standard changed the balance sheet and resulted in decreasing other liabilities and increasing shareholders equity by $11.6 million. In addition, unearned compensation restricted stock (included in shareholders equity) of $13.1 million was eliminated and reclassed to paid in capital. These balance sheet changes relate to deferred compensation under the performance unit plans and unvested restricted stock awards. Under SFAS 123(R), deferred compensation is no longer recorded at the time unvested shares are issued. Share-based compensation expense is recognized over the requisite service period with an offsetting credit to equity.
The compensation cost recognized under SFAS 123(R) was $8.3 million for the year ended December 31, 2006. There were no significant capitalized stock-based compensation costs at December 31, 2006. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS 148, Accounting for Stock-Based Compensation Transition and Disclosure an amendment of SFAS No. 123, for the years ended December 31, 2005 and 2004 (in thousands, except per share amounts):
See Note 18, Benefit Plans, for additional information.
Interest and real estate taxes incurred during the development and significant expansion of real estate assets are capitalized and depreciated over the estimated useful life of the building. Interest paid during the years ended December 31, 2006, 2005 and 2004, aggregated $239.3 million, $190.0 million and $133.8 million, respectively, of which $20.0 million, $12.7 million and $9.9 million, respectively, was capitalized.
SFAS 142, Goodwill and Other Intangible Assets, requires that intangible assets not subject to amortization and goodwill be tested for impairment annually, or more frequently if events or changes in circumstances indicate that the carrying value may not be recoverable. Amortization of goodwill, including such assets associated with joint ventures acquired in past business combinations, ceased upon adoption of SFAS 142. Goodwill is included in the balance sheet caption Investments in and Advances to Joint Ventures in the amount of $5.4 million as of December 31, 2006 and 2005. The Company evaluated the goodwill related to its joint venture investments for impairment and determined that it was not impaired as of December 31, 2006 and 2005.
In addition to the intangibles discussed above in purchase price accounting, the Company has finite-lived intangible assets, comprised of management contracts associated with the Companys acquisition of a joint venture, stated at cost less amortization calculated on a straight-line basis over 15 years. Intangible assets, net, are included in the balance sheet caption Investments in and Advances to Joint Ventures in the amount of $4.3 million and $4.4 million as of December 31, 2006 and 2005, respectively. The 15-year life approximates the expected turnover rate of the original management contracts acquired. The estimated amortization expense associated with this intangible asset for each of the five succeeding fiscal years is approximately $0.3 million per year.
To the extent that the Company contributes assets to a joint venture, the Companys investment in the joint venture is recorded at the Companys cost basis in the assets that were contributed to the joint venture. To the extent that the Companys cost basis is different from the basis reflected at the joint venture level, the basis difference is amortized over the life of the related assets and included in the Companys share of equity in net income of the joint venture. In accordance with the provisions of SFAS No. 66 and Statement of Position 78-9, Accounting for Investments in Real Estate Ventures, paragraph 30, the Company recognizes gains on the contribution of real estate to joint ventures, relating solely to the outside partners interest, to the extent the economic substance of the transaction is a sale. The Company continually evaluates its investments in and advances to joint ventures for other than temporary declines in market value. The Company records impairment charges based on these evaluations. The Company has determined that these investments are not impaired as of December 31, 2006.
The financial statements of Sonae Sierra Brazil, an equity method investment, are translated into U.S. dollars using the exchange rate at each balance sheet date for assets and liabilities and a weighted average exchange rate for each period for revenues, expenses, gains and losses, with the Companys proportionate share of the resulting translation adjustments recorded as Accumulated Other Comprehensive Income (Loss). Foreign currency gains or losses from changes in exchange rates are not material to the consolidated operating results.
The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. The Company maintains cash deposits with a major financial institution, which from time to time may exceed federally insured limits. The Company periodically assesses the financial condition of the institution and believes that the risk of loss is minimal. Cash flows associated with items intended as hedges of identifiable transactions or events are classified in the same category as the cash flows from the items being hedged.
The Company has made an election to qualify, and believes it is operating so as to qualify, as a REIT for federal income tax purposes. Accordingly, the Company generally will not be subject to federal income tax, provided that distributions to its stockholders equal at least the amount of its REIT taxable income as defined under Section 856 through 860 of the Code.
In connection with the REIT Modernization Act, which became effective January 1, 2001, the Company is now permitted to participate in certain activities which it was previously precluded from in order to maintain its qualification as a REIT, so long as these activities are conducted in entities which elect to be treated as taxable subsidiaries under the Code. As such, the Company is subject to federal and state income taxes on the income from these activities.
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled.
The Companys share repurchases are reflected as treasury stock utilizing the cost method of accounting and are presented as a reduction to consolidated shareholders equity.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities, the
disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses during the year. Actual results could differ from those estimates.
New Accounting Standards
Investors Accounting for an Investment in a Limited Partnership When the Investor is the Sole General Partner and the Limited Partners Have Certain Rights EITF 04-05
In June 2005, the FASB ratified the consensus reached by the EITF regarding EITF 04-05, Investors Accounting for an Investment in a Limited Partnership When the Investor is the Sole General Partner and the Limited Partners Have Certain Rights. The conclusion provides a framework for addressing the question of when a sole general partner, as defined in EITF 04-05, should consolidate a limited partnership. The EITF has concluded that the general partner of a limited partnership should consolidate a limited partnership unless the limited partners have the substantive right to remove the general partner, liquidate the limited partnership or substantive participating rights (veto rights decisions made in the ordinary course of business). This EITF is effective for all new limited partnerships formed and, for existing limited partnerships for which the partnership agreements are modified after June 29, 2005 and, as of January 1, 2006, for existing limited partnership agreements. As a result of the adoption of this EITF, the Company consolidated one limited partnership with total assets and liabilities of $24.4 million and $17.7 million, respectively, which were consolidated into the Companys financial statements at January 1, 2006.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (SFAS 154), which replaces APB Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements An Amendment of APB Opinion No. 28. SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application, on the latest practicable date, as the required method for reporting a change in accounting principle and the reporting of a correction of an error. SFAS 154 was effective for the Company in the first quarter of 2006. The adoption of this standard did not have a material impact on the Companys financial position, results of operations or cash flows.
In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes An Interpretation of SFAS No. 109 (FIN 48). FIN 48 prescribes a comprehensive model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that a company has taken or expects to take on a tax return (including a decision whether to file or not to file a return in a particular jurisdiction). Under FIN 48, the financial statements will reflect expected future tax consequences of such positions presuming the taxing authorities full knowledge of the position and all relevant facts, but without considering time values. FIN 48 also revises disclosure requirements and introduces a prescriptive, annual, tabular roll-forward of the unrecognized tax benefits. FIN 48 is effective for fiscal years beginning after December 15, 2006 (i.e., fiscal year ending December 31, 2007 for the Company). The Company is currently evaluating the impact that FIN 48 will have on its financial statements.
Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements SAB 108
In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements, to address the observed diversity in quantification practices with respect to annual financial statements. This bulletin was adopted by the Company in the fourth quarter of 2006. This bulletin did not have a material impact on the Companys results of operations, cash flows or financial position.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This Statement defines fair value and establishes a framework for measuring fair value in generally accepted accounting principles. The key changes to current practice are (1) the definition of fair value, which focuses on an exit price rather than an entry price; (2) the methods used to measure fair value, such as emphasis that fair value is a market-based measurement, not an entity-specific measurement, as well as the inclusion of an adjustment for risk, restrictions and credit standing and (3) the expanded disclosures about fair value measurements. This Statement does not require any new fair value measurements.
This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company is required to adopt SFAS 157 in the first quarter of 2008. The Company is currently evaluating the impact that this Statement will have on its financial statements.
The Companys substantial unconsolidated joint ventures at December 31, 2006, are as follows:
Combined condensed unconsolidated financial information of the Companys unconsolidated joint venture investments is summarized as follows (in thousands):
Investments in and advances to joint ventures include the following items, which represent the difference between the Companys investment and its proportionate share of all of the joint ventures underlying net assets (in millions):
The Company has made advances to several partnerships in the form of notes receivable and fixed-rate loans that accrue interest at rates ranging from 6.3% to 12%. Maturity dates range from payment on demand to June 2020. Included in the Companys accounts receivable is approximately $1.1 million and $1.2 million at December 31, 2006 and 2005, respectively, due from affiliates related to construction receivables.
Service fees earned by the Company through management, leasing, development and financing activities performed related to all of the Companys joint ventures are as follows (in millions):
The Companys joint venture agreements generally include provisions whereby each partner has the right to trigger a purchase or sale of its interest in the joint venture (Reciprocal Purchase Rights), to initiate a purchase or
sale of the properties (Property Purchase Rights) after a certain number of years, or if either party is in default of the joint venture agreements. Under these provisions, the Company is not obligated to purchase the interest of its outside joint venture partners.
Joint Venture Interests
The Company owns an interest in Macquarie DDR Trust, an Australia-based Listed Property Trust (MDT), with Macquarie Bank Limited (ASX: MBL), an international investment bank, advisor and manager of specialized real estate funds in Australia (MDT Joint Venture). MDT focuses on acquiring ownership interests in institutional-quality community center properties in the United States.
At December 31, 2006, MDT, which listed on the Australian Stock Exchange in November 2003, owns an approximate 83% interest in the portfolio of assets. The Company retained an effective 14.5% ownership interest in the assets, with MBL primarily owning the remaining 2.5%. The Company has been engaged to provide day-to-day operations of the properties and will receive fees at prevailing rates for property management, leasing, construction management, acquisitions, due diligence, dispositions (including outparcel sales) and financing. Through their joint venture, the Company and MBL receives base asset management fees and incentive fees based on the performance of MDT. The Company recorded fees aggregating $0.4 million, $2.4 million and $3.0 million in 2006, 2005 and 2004, respectively, in connection with the acquisition, structuring, formation and operation of the MDT Joint Venture.
In 2006, the Company sold four additional expansion areas in Birmingham, Alabama; McDonough, Georgia; Coon Rapids, Minnesota and Monaca, Pennsylvania to the MDT Joint Venture for approximately $24.7 million. These expansion areas are adjacent to shopping centers currently owned by the MDT Joint Venture. The Company recognized an aggregate merchant build gain of $9.2 million, and deferred gains of approximately $1.6 million relating to the Companys effective 14.5% ownership interest in the venture.
In October 2006, the Company acquired a 50% joint venture interest in Sonae Sierra Brazil, a fully integrated retail real estate company based in Sao Paulo, Brazil, for approximately $147.5 million. Sonae Sierra Brazil is a subsidiary of Sonae Sierra, an international owner, developer and manager of shopping centers based in Portugal. Sonae Sierra Brazil is the managing partner of a partnership that owns direct and indirect interests in nine retail assets aggregating 3.5 million square feet and a property management company in Sao Paulo, Brazil that oversees the leasing and management operations of the portfolio. Sonae Sierra Brazil owns approximately 93% of the joint venture and Enplanta Engenharia, a third party, owns approximately 7%.
In 2003, the Company and Coventry Real Estate Advisors (CREA) announced the formation of Coventry Real Estate Fund II (the Fund). The Fund was formed with several institutional investors and CREA as the investment manager. Neither the Company nor any of its officers owns a common equity interest in this Fund or has any incentive compensation tied to this Fund. The Fund and the Company have agreed to jointly acquire value-added retail properties in the United States. The Funds strategy is to invest in a variety of retail properties that present opportunities for value creation, such as retenanting, market repositioning, redevelopment or expansion.
The Company co-invested 20% in each joint venture and is responsible for day-to-day management of the properties. Pursuant to the terms of the joint venture, the Company will earn fees for property management, leasing
and construction management. The Company also will earn a promoted interest, along with CREA, above a 10% preferred return after return of capital, to fund investors. The retail properties at December 31, 2006, are as follows:
In February 1998, the Company and an equity affiliate of the Company entered into an agreement with Prudential Real Estate Investors (PREI) and formed the Retail Value Fund (the PREI Fund). The PREI Funds ownership interests in each of the projects, unless discussed otherwise, are generally structured with the Company owning (directly or through its interest in the management service company) a 24.75% limited partnership interest, PREI owning a 74.25% limited partnership interest and Coventry Real Estate Partners (Coventry), which was 75% owned by a consolidated entity of the Company, owning (directly or through its interest in the management service company) (Note 22) a 1% general partnership interest. The PREI Fund invests in retail properties within the United States that are in need of substantial re-tenanting and market repositioning and may also make equity and debt investments in companies owning or managing retail properties as well as in third party development projects that provide significant growth opportunities. The retail property investments may include enclosed malls, neighborhood and community centers or other potential retail commercial development and redevelopment opportunities.
The PREI Fund owned the following shopping center investments at December 31, 2006:
In 2006, four shopping centers in Kansas City, Kansas, and Kansas City, Missouri, aggregating 0.4 million square feet, were sold for approximately $20.0 million. The joint venture recognized a loss of approximately $1.8 million, of which the Companys proportionate share was approximately $0.5 million.
In addition, in 2000 the PREI Fund entered into an agreement to acquire ten properties located in western states from Burnham Pacific Properties, Inc. (Burnham), with PREI owning a 79% interest, the Company owning a 20% interest and Coventry owning a 1% interest. The Company earns fees for managing and leasing the properties. At
December 31, 2006, the joint venture owned two of these properties. The properties sold in 2006, 2005 and 2004 are summarized as follows:
As discussed above, Coventry generally owns a 1% interest in each of the PREI Funds investments. Coventry is entitled to receive an annual asset management fee equal to 0.5% of total assets for the Kansas City properties and the property in Deer Park, Illinois. Except for the PREI Funds investment associated with properties acquired from Burnham, Coventry is entitled to one-third of all profits (as defined), after the limited partners have received a 10% preferred return and previously advanced capital. The remaining two-thirds of the profits (as defined) in excess of the 10% preferred return are split proportionately among the limited partners.
With regard to the PREI Funds investment associated with the acquisition of shopping centers from Burnham, Coventry has a 1% general partnership interest. Coventry also receives annual asset management fees equal to 0.8% of total revenue collected from these assets, plus a minimum of 25% of all amounts in excess of an 11% annual preferred return to the limited partners, that could increase to 35% if returns to the limited partners exceed 20%.
The Company owns a 50% equity ownership interest in a management and development company in St. Louis, Missouri.
The Company entered into a joint venture in 2002 with Lubert-Adler Real Estate Funds and Klaff Realty, L.P. (Note 17), that was awarded asset designation rights for all of the retail real estate interests of the bankrupt estate of Service Merchandise Corporation for approximately $242 million. The Company had an approximate 25% interest in the joint venture (KLA/SM). In addition, the Company earned fees for the management, leasing, development and disposition of the real estate portfolio. The designation rights enabled the joint venture to determine the ultimate disposition of the real estate interests held by the bankrupt estate.
In August 2006, the Company purchased its then partners approximately 75% interest in the remaining 52 assets formerly occupied by Service Merchandise owned by the KLA/SM Joint Venture at a gross purchase price of approximately $138 million relating to the partners approximate 75% ownership interest, based on a total valuation of approximately $185 million for all remaining assets, including outstanding indebtedness.
In September 2006, the Company sold 51 of these assets to the Service Holdings LLC at a gross purchase price of approximately $185 million and assumed debt of approximately $29 million. The Company has a 20% interest in the newly formed joint venture. The Company recorded a gain of approximately $6.1 million.
The Service Merchandise site dispositions by the KLA/SM Joint Venture are summarized as follows:
The Company also earned disposition, development, management, leasing fees and interest income aggregating $5.7 million, $6.4 million and $2.6 million in 2006, 2005 and 2004, respectively, relating to this investment.
In 2006, as a result of the adoption of EITF 04-5, the Company consolidated one limited partnership with total assets and liabilities of $24.4 million and $17.7 million, respectively, which were consolidated into the Companys financial statements.
In 2004, the Company recorded a charge of $3.0 million as a cumulative effect of adoption of a new accounting standard attributable to the consolidation of a 50% owned shopping center in Martinsville, Virginia. This amount represents the minority partners share of cumulative losses in excess of its cost basis in the partnership.
The Company purchased its joint venture partners interest in the following shopping centers in 2006, 2005 and 2004:
The MDT Joint Venture acquired the interest in one shopping center owned through other joint venture interests in 2004.
Included in discontinued operations in the combined statements of operations for the joint ventures are the following properties sold subsequent to December 31, 2003:
During the second quarter of 2006, the Company sold six properties, aggregating 0.8 million owned square feet, to a newly formed joint venture with MDT (MDT Preferred Joint Venture or DDR MDT PS LLC), for approximately $122.7 million and recognized gains of approximately $38.9 million.
Under the terms of the new MDT Preferred Joint Venture, MDT receives a 9% preferred return on its preferred equity investment of approximately $12.2 million and then receives a 10% return on its common equity investment of approximately $20.8 million before the Company receives a 10% return on an agreed upon common equity investment of $3.5 million that has not been recognized in the consolidated balance sheet due to the terms of its subordination. The Company is then entitled to a 20% promoted interest in any cash flow achieved above a 10% leveraged internal rate of return on all common equity. The Company recognizes its proportionate share of equity in earnings of the MDT Preferred Joint Venture at an amount equal to increases in its common equity investment, based upon an assumed liquidation, including consideration of cash received, of the joint venture at its depreciated book value as of the end of each reporting period. The Company has not recorded any equity in earnings from the MDT Preferred Joint Venture as of December 31, 2006.
The Company has been engaged to perform all day-to-day operations of the properties and earns and/or may be entitled to receive ongoing fees for property management, leasing and construction management, in addition to a promoted interest, along with other periodic fees such as financing fees.
At December 31, 2006, the Companys investment in DDR MDT PS LLC was considered a significant subsidiary pursuant to the applicable Regulation S-X rules. During the year ended December 31, 2006, the Company recognized a gain, net of tax, of approximately $38.9 million relating to the contribution of the assets to the joint venture. Condensed financial information of DDR MDT PS LLC is as follows (in thousands):
4. Acquisitions and Pro Forma Financial Information
In 2005, the Mervyns Joint Venture acquired the underlying real estate of 36 operating Mervyns stores for approximately $396.2 million. The assets were acquired from several funds, one of which was managed by Lubert-Adler Real Estate Funds (Note 16). The Mervyns Joint Venture, owned approximately 50% by the Company and 50% by MDT, obtained approximately $258.5 million of debt, of which $212.6 million is a five-year secured non-recourse financing at a fixed rate of approximately 5.2%, and $45.9 million is at LIBOR plus 72 basis points for two
years. In 2006, the Mervyns Joint Venture purchased one additional site for approximately $11.0 million and the Company purchased one additional site for approximately $12.4 million. The Company is responsible for the day-to-day management of the assets and receives fees in accordance with the same fee schedule as the MDT Joint Venture for property management services.
During 2005, the Company received approximately $2.5 million of acquisition and financing fees in connection with the acquisition of the Mervyns assets. Pursuant to FIN 46(R), the Company is required to consolidate the Mervyns Joint Venture and, therefore, the $2.5 million of fees has been eliminated in consolidation and has been reflected as an adjustment in basis and is not reflected in net income.
In 2005, the Company completed the acquisition of 15 retail real estate assets located in Puerto Rico from Caribbean Property Group, LLC and related entities (CPG) for approximately $1.2 billion (CPG Properties). The financing for the transaction was provided by the assumption of approximately $660 million of existing debt and line of credit borrowings on the Companys senior unsecured credit facility and the application of a $30 million deposit funded in 2004. Included in the assets acquired are the land, building and tenant improvements associated with the underlying real estate. The other assets allocation of $12.6 million relates primarily to in-place leases, leasing commissions, tenant relationships and tenant improvements of the properties (Note 7). There was a separate allocation in the purchase price of $8.1 million for above-market leases and $1.4 million for below-market leases. The Company entered into this transaction to obtain a shopping center portfolio in Puerto Rico, a market where the Company previously did not have any assets.
In 2004, the Company entered into an agreement to purchase interests in 110 retail real estate assets, with approximately 18.8 million square feet of GLA, from Benderson Development Company and related entities (Benderson). The purchase price of the assets, including associated expenses, was approximately $2.3 billion, less assumed debt and the value of a 2% equity interest in certain assets valued at approximately $16.2 million at December 31, 2005, that Benderson converted its interest into the Companys common shares in 2006 (Note 13). Benderson transferred a 100% ownership in certain assets or entities owning certain assets. The remaining assets were held by a joint venture in which the Company held a 98.0% interest and Benderson held a 2.0% interest. Bendersons minority interest was classified as operating partnership minority interests on the Companys consolidated balance sheet at December 31, 2005.
The Company completed the purchase of 107 properties from Benderson, including 14 purchased directly by the MDT Joint Venture (Note 2) and 52 held by a consolidated joint venture with Benderson at various dates commencing May 14, 2004, through December 21, 2004. The remaining three properties were not acquired.
The Company funded the transaction through a combination of new debt financing of approximately $450 million, net proceeds of approximately $164.2 million from the issuance of 6.8 million cumulative preferred shares, net proceeds of approximately $491 million from the issuance of 15.0 million common shares, asset transfers to the MDT Joint Venture that generated net proceeds of approximately $194.3 million (Note 2), line of credit borrowings and assumed debt. With respect to the assumed debt, the fair value was approximately $400 million, which included an adjustment of approximately $30 million to increase its stated principal balance, based on rates for debt with similar terms and remaining maturities as of May 2004. Included in the assets acquired were the land, building and tenant improvements associated with the underlying real estate. The other assets allocation of $30.9 million relates primarily to in-place leases, leasing commissions, tenant relationships and tenant improvements of the properties (Note 7). There was a separate allocation in the purchase price of $4.7 million for certain below-market leases. The Company entered into this transaction to acquire the largest privately owned retail shopping center portfolio in markets where the Company previously did not have a strong presence.
Pro Forma Financial Information
The following unaudited supplemental pro forma operating data is presented for the year ended December 31, 2005, as if the acquisition of the CPG Properties were completed on January 1, 2005. The following unaudited supplemental pro forma operating data is presented for the year ended December 31, 2004, as if the acquisition of the CPG Properties, the common share offering completed in December 2004 and the acquisition of the properties from Benderson and related financing activity, including the sale of eight wholly-owned assets to the MDT Joint Venture, were completed on January 1, 2004.
These acquisitions were accounted for using the purchase method of accounting. The revenues and expenses related to assets and interests acquired are included in the Companys historical results of operations from the date of purchase.
The pro forma financial information is presented for informational purposes only and may not be indicative of what actual results of operations would have been had the acquisitions occurred as indicated, nor does it purport to represent the results of the operations for future periods (in thousands, except per share data):
The supplemental pro forma financial information does not present the acquisitions described below or the disposition of real estate assets.
During the year ended December 31, 2006, the Company acquired its partners interests, at an initial aggregate investment of approximately $94.1 million, net of mortgages assumed, in the following joint venture properties:
Additionally, the Company acquired one Mervyns site for approximately $12.4 million (Note 17).
During the year ended December 31, 2005, the Company acquired its partners 20% interest in one joint venture. This property aggregates approximately 0.4 million square feet of Company-owned GLA at an initial
aggregate investment of approximately $3.2 million. Additionally, the Company acquired one Mervyns site for approximately $14.4 million (Note 17).
During the year ended December 31, 2004, the Company acquired a 20% interest in two shopping centers and an effective 10% interest in a shopping center and its partners 50% interest in a joint venture. These four properties aggregate approximately 2.4 million square feet of Company-owned GLA at an initial aggregate investment of approximately $180 million.
The Company owns notes receivables aggregating $18.2 million and $25.0 million, including accrued interest, at December 31, 2006 and 2005, respectively, which are classified as held to maturity. The notes are secured by certain rights in future development projects and partnership interests. The notes bear interest ranging from 6.9% to 12.0% with maturity dates ranging from payment on demand through July 2026.
Included in notes receivable are $16.5 million and $23.2 million of tax incremental financing bonds or notes (TIF Bonds), plus accrued interest at December 31, 2006 and 2005, respectively, from the Town of Plainville, Connecticut (the Plainville Bonds), the City of Merriam, Kansas (the Merriam Bonds), and the City of St. Louis, Missouri (the Southtown Notes). The Plainville Bonds, with a principal balance of $7.1 million and $7.2 million at December 31, 2006 and 2005, respectively, mature in April 2021 and bear interest at 7.125%. The Merriam Bonds, with a principal balance of $7.1 million and $8.0 million at December 31, 2006 and 2005, respectively, mature in February 2016 and bear interest at 6.9%. The Southtown Notes, with a principal balance of $2.3 million and $8.0 million at December 31, 2006 and 2005, respectively, mature in July 2026 and bear interest ranging from 7.13% to 8.50%. Interest and principal are payable solely from the incremental real estate taxes, if any, generated by the respective shopping center and development project pursuant to the terms of the financing agreement.
Deferred charges consist of the following (in thousands):
The Company incurred deferred financing costs aggregating $9.6 million and $13.1 million in 2006 and 2005, respectively. Deferred financing costs paid in 2006 primarily relate to the modification of the Companys unsecured credit agreements and expansion of term loans (Note 8) and issuance of convertible notes (Note 9). Deferred financing costs paid in 2005 primarily relate to the modification of the Companys unsecured revolving credit agreements and term loan (Note 8), issuance of medium term notes (Note 9) and mortgages payable (Note 10) obtained in connection with the Mervyns Joint Venture. Amortization of deferred charges was $7.1 million, $6.1 million and $5.6 million for the years ended December 2006, 2005 and 2004, respectively.
Other assets consist of the following (in thousands):
The amortization period of the in-place leases and tenant relations is approximately two to 31 years and ten years, respectively. The Company recorded amortization expense of approximately $5.5 million, $6.1 million and $4.0 million for the years ended December 31, 2006, 2005 and 2004, respectively. The estimated amortization expense associated with the Companys intangible assets is $3.0 million, $2.9 million, $2.9 million, $2.9 million and $2.0 million for the years ending December 31, 2007, 2008, 2009, 2010 and 2011, respectively. Other assets consist primarily of deposits, land options and other prepaid expenses.
The Company maintains its primary unsecured revolving credit facility with a syndicate of financial institutions, for which JP Morgan serves as the administrative agent (the Unsecured Credit Facility). The Unsecured Credit Facility was amended in June 2006. As a result of the amendment, the borrowing capacity on the Unsecured Credit Facility increased from $1.0 billion to $1.2 billion, provided for an accordion feature of a future expansion to $1.4 billion, extended the maturity date to June 2010, with a one-year extension option, and amended the pricing. The Unsecured Credit Facility includes a competitive bid option on periodic interest rates for up to 50% of the facility. The Companys borrowings under the Unsecured Credit Facility bear interest at variable rates at the Companys election, based on the prime rate as defined in the facility or LIBOR, plus a specified spread (0.60% at December 31, 2006). The specified spread over LIBOR varies depending on the Companys long-term senior unsecured debt rating from Standard and Poors and Moodys Investors Service. The Company is required to comply with certain covenants relating to total outstanding indebtedness, secured indebtedness, maintenance of unencumbered real estate assets and fixed charge coverage. The Unsecured Credit Facility is used to finance the acquisition, development and expansion of shopping center properties, to provide working capital and for general corporate purposes. At December 31, 2006 and 2005, total borrowings under the Unsecured Credit Facility aggregated $297.5 million and $150.0 million, respectively, with a weighted average interest rate of 5.6% and 4.6%, respectively.
The Company also maintains a $60 million unsecured revolving credit facility with National City Bank (together with the $1.2 billion Unsecured Credit Facility, the Revolving Credit Facilities). This facility was also amended in June 2006 to extend the maturity date to June 2010 and to reflect terms consistent with those contained in the Unsecured Credit Facility. Borrowings under the facility bear interest at variable rates based on the prime rate as defined in the facility or LIBOR plus a specified spread (0.60% at December 31, 2006). The specified spread over LIBOR is dependent on the Companys long-term senior unsecured debt rating from Standard and Poors and Moodys Investors Service. The Company is required to comply with certain covenants relating to total outstanding indebtedness, secured indebtedness, maintenance of unencumbered real estate assets and fixed charge coverage. At December 31, 2006 and 2005, there were no borrowings outstanding.
The Company also maintains term loan facilities (collectively the Term Loans) with various lenders. These loans are summarized as follows:
For each of the Term Loans, the spread is dependent on the Companys corporate credit ratings from Standard & Poors and Moodys Investors Service. The Term Loans are subject to the same covenants associated with the Unsecured Credit Facility.
Total fees paid by the Company on its Revolving Credit Facilities and Term Loans in 2006, 2005 and 2004 aggregated approximately $1.7 million, $2.0 million and $1.7 million, respectively. At December 31, 2006 and 2005, the Company was in compliance with all of the financial and other covenant requirements.
The Company had outstanding unsecured notes of approximately $2.2 billion and $2.0 billion at December 31, 2006 and 2005, respectively. Several of the notes were issued at a discount aggregating $3.9 million and $6.0 million at December 31, 2006 and 2005, respectively. The effective interest rates of the unsecured notes range from 3.9% to 8.4% per annum.
In August 2006, the Company issued $250 million of Senior Convertible Notes due 2011 (the Senior Convertible Notes). The Senior Convertible Notes have an initial conversion price of $65.11 per share into the Companys common shares or cash, at the option of the Company. In connection with the issuance of these notes, the Company entered into a registration rights agreement for the common shares that may be issuable upon conversion of the Senior Convertible Notes.
Concurrent with the issuance of the Senior Convertible Notes, the Company purchased an option on its common stock in a private transaction, effectively increasing the conversion price of the notes to $74.41 per common share. This option allows the Company to receive shares of the Companys common stock (up to a maximum of approximately 480,000 shares) from counterparties equal to the amounts of common stock and/or cash related to the excess conversion value that the Company would pay to the holders of the Senior Convertible Notes upon conversion. The option will terminate upon the earlier of the maturity dates of the related Senior Convertible Notes or the first day all of the related Senior Convertible Notes are no longer outstanding due to conversion or otherwise. The option, which cost $10.3 million, was recorded as a reduction of shareholders equity.
The fixed-rate notes have maturities ranging from March 2007 to July 2018. Interest coupon rates ranged from approximately 3.5% to 7.5% (averaging 5.1% and 5.3% at December 31, 2006 and 2005, respectively). Notes issued prior to December 31, 2001, aggregating $212.0 million, may not be redeemed by the Company prior to maturity and will not be subject to any sinking fund requirements. Notes issued subsequent to 2001 and the notes assumed with the JDN merger, aggregating $1.4 billion at December 31, 2006, may be redeemed based upon a yield maintenance calculation. The notes issued in October 2005 (aggregating $348.6 million) are redeemable prior to maturity at par value plus a make-whole premium. If the notes issued in October 2005 are redeemed within 90 days of the maturity date, no make-whole premium will be paid. The Senior Convertible Notes aggregating $250 million may be converted prior to maturity into cash equal to the lesser of the principal amount of the note or the conversion value and, to the extent the conversion value exceeds the principal amount of the note, shares of the Companys
common stock. The fixed-rate senior notes and Senior Convertible Notes were issued pursuant to an indenture dated May 1, 1994, as amended, which contains certain covenants including limitation on incurrence of debt, maintenance of unencumbered real estate assets and debt service coverage. Interest is paid semi-annually in arrears.
At December 31, 2006, mortgages payable, collateralized by investments and real estate with a net book value of approximately $2.5 billion and related tenant leases, are generally due in monthly installments of principal and/or interest and mature at various dates through 2028. Fixed-rate debt obligations included in mortgages payable at December 31, 2006 and 2005, aggregated approximately $1,140.9 million and $1,173.3 million, respectively. Fixed interest rates ranged from approximately 4.4% to 10.2% (averaging 6.6% at both December 31, 2006 and 2005). Variable- rate debt obligations totaled approximately $192.4 million and $181.4 million at December 31, 2006 and 2005, respectively. Interest rates on the variable-rate debt averaged 6.2% and 5.3% at December 31, 2006 and 2005, respectively.
Included in mortgage debt are $14.1 million and $15.1 million of tax-exempt certificates with a weighted average fixed interest rate of 7.0% at December 31, 2006 and 2005, respectively. As of December 31, 2006, the scheduled principal payments of the Revolving Credit Facilities, Term Loans, fixed-rate senior notes and mortgages payable for the next five years and thereafter are as follows (in thousands):
Included in principal payments are $400 million in the year 2008 and $297.5 million in the year 2010, associated with the maturing of the Term Loans and the Revolving Credit Facilities, respectively.
11. Financial Instruments
The following methods and assumptions were used by the Company in estimating fair value disclosures of financial instruments:
The carrying amounts reported in the balance sheet for these financial instruments approximated fair value because of their short-term maturities. The carrying amount of straight-line rents receivable does not materially differ from its fair market value.
The fair value is estimated by discounting the current rates at which management believes similar loans would be made. The fair value of these notes was approximately $29.0 million and $129.9 million at December 31, 2006 and 2005, respectively, as compared to the carrying amounts of $28.4 million and $127.7 million, respectively. The carrying value of the TIF Bonds (Note 5) approximated its fair value at December 31, 2006 and 2005. The fair value of loans to affiliates is not readily determinable and has been estimated by management based upon its assessment of the interest rate and credit risk.
The carrying amounts of the Companys borrowings under its Revolving Credit Facilities and Term Loans approximate fair value because such borrowings are at variable rates and the spreads are typically adjusted to reflect changes in the Companys credit rating. The fair value of the fixed-rate senior notes is based on borrowings with a similar remaining maturity based on the Companys estimated interest rate spread over the applicable treasury rate or quoted market price. Fair value of the mortgages payable is estimated using a discounted cash flow analysis, based on the Companys incremental borrowing rates for similar types of borrowing arrangements with the same remaining maturities.
Considerable judgment is necessary to develop estimated fair values of financial instruments. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize on disposition of the financial instruments.
Financial instruments at December 31, 2006 and 2005, with carrying values that are different than estimated fair values, are summarized as follows (in thousands):
All derivatives are recognized on the balance sheet at their fair value. On the date that the Company enters into a derivative, it designates the derivative as a hedge against the variability of cash flows that are to be paid in connection with a recognized liability or forecasted transaction. Subsequent changes in the fair value of a derivative designated as a cash flow hedge that is determined to be highly effective are recorded in other comprehensive income (loss), until earnings are affected by the variability of cash flows of the hedged transaction. Any hedge ineffectiveness is reported in current earnings.
From time to time, the Company enters into interest rate swaps to convert certain fixed-rate debt obligations to a floating rate (a fair value hedge). This is consistent with the Companys overall interest rate risk management strategy to maintain an appropriate balance of fixed-rate and variable-rate borrowings. Changes in the fair value of derivatives that are highly effective and that are designated and qualify as a fair value hedge, along with changes in the fair value of the hedged liability that are attributable to the hedged risk, are recorded in current-period earnings. If hedge accounting is discontinued due to the Companys determination that the relationship no longer qualified as an effective fair value hedge, the Company will continue to carry the derivative on the balance sheet at its fair value but cease to adjust the hedged liability for changes in fair value.
The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. The Company formally assesses (both at the hedges inception and on an ongoing basis) whether the derivatives that are used in hedging transactions have been highly effective in offsetting changes in the cash flows of the hedged items and whether those derivatives may be expected to remain highly effective in future periods. Should it be determined that a derivative is not (or has ceased to be) highly effective as a hedge, the Company will discontinue hedge accounting on a prospective basis.
The Company enters into derivative contracts to minimize significant unplanned fluctuations in earnings that are caused by interest rate volatility or in the case of a fair value hedge to minimize the impacts of changes in the fair value of the debt. The Company does not typically utilize these arrangements for trading or speculative purposes.
The principal risk to the Company through its interest rate hedging strategy is the potential inability of the financial institutions, from which the interest rate swaps were purchased, to cover all of their obligations. To mitigate this exposure, the Company purchases its interest rate swaps from major financial institutions.
In 2006, the Company entered into five interest rate swaps with notional amounts aggregating $500 million ($200 million for a three-year term and $300 million for a four-year term). Interest rate swaps aggregating $400 million effectively convert Term Loan floating rate debt into a fixed rate of approximately 5.9%. Interest rate swaps aggregating $100 million effectively convert Revolving Credit Facilities floating rate debt into a fixed rate of approximately 5.25%. As of December 31, 2006, the aggregate fair value of the Companys interest rate swaps was a liability of $1.1 million, which is included in other liabilities in the consolidated balance sheets. For the year ended December 31, 2006, the amount of hedge ineffectiveness was not material.
All components of the interest rate swaps were included in the assessment of hedge effectiveness. The Company expects that within the next 12 months it will reflect as an increase to earnings $0.9 million of the amount recorded in accumulated other comprehensive income. The fair value of the interest rate swaps is based upon the estimated amounts the Company would receive or pay to terminate the contracts at the reporting date and is determined using interest rate market pricing models.
In March 2002, the Company entered into an interest rate swap agreement, with a notional amount of $60 million for a five-year term, effectively converting a portion of the outstanding fixed-rate debt under a fixed-rate senior note to a variable rate of six-month LIBOR.
In anticipation of the joint venture with TIAA-CREF (Note 22), an affiliate of the Company purchased two interest rate swaption agreements during 2006 that economically limits the benchmark interest rate component of future interest rates on $500 million of forecasted five-year borrowings at 5.72% and $750 million of forecasted ten-year borrowings at 5.78%. These swaptions were not designated for hedge accounting, and accordingly, gains or losses are reported in earnings as a component of interest expense, which approximated $1.2 million of additional expense for the year ended December 31, 2006. The fair value was calculated based upon expected changes in forward interest rates. TIAA-CREF will be obligated to fund its proportionate share of the cost and be entitled to the economic benefits, if any, of the swaptions upon formation of the joint venture.
At December 31, 2006 and 2005, certain of the Companys joint ventures had interest rate swaps with notional amounts aggregating $557 million and $150 million, respectively, converting LIBOR to a weighted average fixed rate of approximately 5.28% and 4.36%, respectively. The aggregate fair value of these instruments at December 31, 2006 and 2005, was a liability of $5.0 million and an asset of $1.0 million, respectively.
12. Commitments and Contingencies
The Company is engaged in the operation of shopping centers, which are either owned or, with respect to certain shopping centers, operated under long-term ground leases that expire at various dates through 2070, with renewal options. Space in the shopping centers is leased to tenants pursuant to agreements that provide for terms ranging generally from one month to 30 years and, in some cases, for annual rentals subject to upward adjustments based on operating expense levels, sales volume, or contractual increases as defined in the lease agreements.
The scheduled future minimum revenues from rental properties under the terms of all non-cancelable tenant leases, assuming no new or renegotiated leases or option extensions for such premises for the subsequent five years ending December 31, are as follows for continuing operations (in thousands):
Scheduled minimum rental payments under the terms of all capital and non-cancelable operating leases in which the Company is the lessee, principally for office space and ground leases, for the subsequent five years ending December 31, are as follows for continuing operations (in thousands):
In conjunction with the development and expansion of various shopping centers, the Company has entered into agreements with general contractors for the construction of shopping centers aggregating approximately $63.7 million as of December 31, 2006.
At December 31, 2006, the Company had letters of credit outstanding of approximately $20.6 million. The Company has not recorded any obligation associated with these letters of credit. The majority of letters of credit are collateral for existing indebtedness and other obligations of the Company.
As discussed in Note 2, the Company and certain equity affiliates entered into several joint ventures with various third-party developers. In conjunction with certain joint venture agreements, the Company and/or its equity affiliate has agreed to fund the required capital associated with approved development projects, comprised principally of outstanding construction contracts, aggregating approximately $6.8 million as of December 31, 2006. The Company and/or its equity affiliate are entitled to receive a priority return on these capital advances at rates ranging from 10.0% to 11.0%.
In connection with certain of the Companys joint ventures, the Company agreed to fund any amounts due the joint ventures lender if such amounts are not paid by the joint venture based on the Companys pro rata share of such amount, aggregating $61.1 million at December 31, 2006. The Company and its joint venture partner provided a $33.0 million payment and performance guarantee on behalf of the Mervyns Joint Venture to the joint ventures lender in certain events such as the bankruptcy of Mervyns. The Companys maximum obligation is equal to its effective 50% ownership percentage, or $16.5 million.
In 2003, the Company entered into an agreement with DRA Advisors, one of its joint venture partners, to pay a $0.8 million annual consulting fee for ten years for ongoing services relating to the assessment of financing and strategic investment alternatives.
In connection with the transfer of one of the properties to the MDT Joint Venture, the Company deferred the recognition of approximately $2.8 million and $2.9 million at December 31, 2006 and 2005, respectively, of the gain on sale of real estate related to a shortfall agreement guarantee maintained by the Company. The MDT Joint Venture is obligated to fund any shortfall amount caused by the failure of the landlord or tenant to pay taxes on the shopping center when due and payable. The Company is obligated to pay any shortfall to the extent that the shortfall is not caused by the failure of the landlord or tenant to pay taxes on the shopping center when due and payable. No shortfall payments have been made on this property since the completion of construction in 1997.
The Company entered into master lease agreements during 2003 through 2006 with the transfer of properties to certain joint ventures, which are recorded as a liability and reduction of its related gain. The Company is responsible for the monthly base rent, all operating and maintenance expenses and certain tenant improvements and leasing commissions for units not yet leased at closing for a three-year period. At December 31, 2006, the Companys material master lease obligations, included in accounts payable and other expenses, in the following amounts, were incurred with the properties transferred to the following joint ventures (in millions):
In connection with the Service Holdings LLC joint venture, the Company guaranteed the base rental income from one to three years for various affiliates of the Service Holdings LLC joint venture in the aggregate amount of $2.8 million. The Company has not recorded a liability for the guarantee, as the subtenants of the Service Holdings LLC affiliates are paying rent as due. The Company has recourse against the other parties in the partnership in the event of default. No assets of the Company are currently held as collateral to pay this guarantee.
In the event of any loss or the reduction in the historic tax credit allocated or to be allocated to a joint venture partner in connection with a historic commercial parcel acquired in 2002, the Company guaranteed payment in the maximum amount of $0.7 million to the other joint venture partner. The Company has a liability recorded as of December 31, 2006, related to this guarantee. The Company does not have recourse against any other party in the event of default. No assets of the Company are currently held as collateral to pay this guarantee.
Related to one of the Companys developments in Long Beach, California, the Company guaranteed the payment of any special taxes levied on the property within the City of Long Beach Community Facilities District No. 6 and attributable to the payment of debt service on the bonds for periods prior to the completion of certain improvements related to this project. In addition, an affiliate of the Company has agreed to make an annual payment of approximately $0.6 million to defray a portion of the operating expenses of a parking garage through the earlier of October 2032 or until the Citys parking garage bonds are repaid. There are no assets held as collateral or liabilities recorded related to these obligations.
Related to the development of a shopping center in San Antonio, Texas, the Company guaranteed the payment of certain road improvements expected to be funded by the City of San Antonio, Texas, of approximately $1.5 million. These road improvements are expected to be completed in 2007. There are no assets held as collateral or liabilities recorded related to this guarantee.
The Company continually monitors obligations and commitments entered into on its behalf. There have been no other material items entered into by the Company since December 31, 2003, through December 31, 2006, other than as described above.
The Company and its subsidiaries are subject to various legal proceedings, which, taken together, are not expected to have a material adverse effect on the Company. The Company is also subject to a variety of legal actions for personal injury or property damage arising in the ordinary course of its business, most of which are covered by
insurance. While the resolution of all matters cannot be predicted with certainty, management believes that the final outcome of such legal proceedings and claims will not have a material adverse effect on the Companys liquidity, financial position or results of operations.
Minority equity interests consist of the following (in millions):
At December 31, 2006 and 2005, the Company had 872,373 and 1,349,822 OP Units outstanding, respectively. These OP Units, issued to different partnerships, are exchangeable, by the election of the OP Unit holder, and under certain circumstances at the option of the Company, into an equivalent number of the Companys common shares or for the equivalent amount of cash. Most of these OP Units have registration rights agreements equivalent to the amount of OP Units held by the holder if the Company elects to settle in its common shares. The liability for the OP Units is classified on the Companys balance sheet as operating partnership minority interests.
The OP Unit holders are entitled to receive distributions, per OP Unit, generally equal to the per share distributions on the Companys common shares.
In 2004, the Company issued 0.5 million OP Units in conjunction with the purchase of assets from Benderson. In December 2005, Benderson exercised its option to convert its remaining 0.4 million OP Units (Note 4), effective February 2006. The Company agreed to issue an equivalent number of common shares of the Company. In 2004 the Company exchanged 284,304 OP Units for common shares of the Company including 60,260 OP Units issued to Benderson. Also in 2006, the Company purchased 32,274 OP Units for cash of $2.1 million. These transactions were treated as a purchase of minority interest.
The Companys preferred shares outstanding at December 31 are as follows (in thousands):
In May 2004, the Company issued $170.0 million, 7.5% Preferred I Depositary shares and received net proceeds of approximately $164.2 million.
The Class F and G depositary shares represent 1/10 of a share of their respective preferred class of shares and have a stated value of $250 per share. The Class H and I depositary shares represent 1/20 of a share of a preferred share and have a stated value of $500 per share. The Class F, Class G, Class H and Class I depositary shares are not redeemable by the Company prior to March 27, 2007, March 28, 2008, July 28, 2008, and May 7, 2009, respectively, except in certain circumstances relating to the preservation of the Companys status as a REIT.
The Companys authorized preferred shares consist of the following:
The Companys common shares have a $0.10 per share stated value.
In December 2006, the Company entered into forward sale agreements in anticipation of a merger (Note 22). Pursuant to the terms of the forward sale agreements, and subject to the Companys right to elect cash settlement, the Company agreed to sell, upon physical settlement of such forward sale agreements, an aggregate of 11,599,134 of its common shares for approximately $750 million. The forward sale contract expires September 2007 and will
be reflected in shareholders equity as the contract does not include any provision that could require the Company to net cash settle the contract. The Company will not receive any proceeds from the sale of its common shares until settlement of the forward sale agreements, which is expected to occur on or before September 2007.
Common share issuances over the three-year period ended December 31, 2006, are as follows (in millions):
In August 2006, the Companys Board of Directors authorized the Company to repurchase 909,000 common shares of the Companys common stock at a cost of $53.15 per share in connection with the convertible debt financing (Note 8).
In 2006, 2005 and 2004, certain officers and a director of the Company completed a stock for stock option exercise and received approximately 0.3 million, 0.1 million and 1.0 million common shares, respectively, in exchange for 0.2 million, 0.1 million and 0.6 million common shares of the Company. In addition, vesting of restricted stock grants approximating less than 0.1 million, 0.1 million and 0.1 million shares in 2006, 2005 and 2004, respectively, of common stock of the Company was deferred. The Company recorded $0.8 million, $1.4 million and $1.9 million in 2006, 2005 and 2004, respectively, in shareholders equity as deferred obligations for the vested restricted stock deferred into the Companys non-qualified deferred compensation plans.
Other income from continuing operations was comprised of the following (in thousands):
15. Comprehensive Income
Comprehensive income is as follows (in thousands):
16. Discontinued Operations and Disposition of Real Estate and Real Estate Investments
During the year ended December 31, 2006, the Company sold six properties and one property was classified as held for sale at December 31, 2006, which were classified as discontinued operations for the years ended