SITC

Business Context and Reporting Period

Company: Developers Diversified Realty Corporation (DDR)
Filing Type: Form 10-Q (Unaudited)
Period Ended: June 30, 2008
Business Overview: DDR is a self-administered REIT engaged in acquiring, developing, owning, and operating shopping centers and enclosed malls. As of June 30, 2008, the portfolio consisted of 708 shopping centers and seven business centers across 45 states, Puerto Rico, and Brazil, with an aggregate occupancy rate of 94.2%.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Total revenues decreased 7.7% year-over-year for the three-month period ($232.7M vs. $252.1M) primarily due to the disposition of assets in 2007 and a reduction in transactional income. For the six-month period, revenues were relatively flat, increasing 0.7% ($474.1M vs. $470.8M).
• Significant Earnings Drop: Net income applicable to common shareholders fell 73.6% for the three-month period and 61.2% for the six-month period compared to 2007. This decline is largely attributed to the absence of significant gains on real estate dispositions and promoted income from joint ventures that occurred in 2007, as well as a one-time tax benefit recognized in Q1 2007.
• FFO Decrease: FFO applicable to common shareholders decreased 37.8% for the quarter and 25.1% for the six-month period, reflecting the same factors impacting net income.
• Expense Increases: Operating and maintenance expenses increased 15.9% for the six-month period, driven by higher bad debt provisions (1.4% of revenue vs. 0.7% in 2007) and the impact of the IRRETI merger.
• Interest Expense: Interest expense decreased 8.0% for the six-month period due to lower short-term interest rates and the sale of assets in 2007, despite increased borrowing related to the IRRETI merger.

Guidance, Outlook, and Risks

• Market Conditions: Management notes a challenging retail environment with consumers "trading down" to value retailers. While the portfolio is anchored by value-oriented tenants (e.g., Wal-Mart, Target), the company anticipates continued distress among full-priced specialty stores over the next 18 months.
• Liquidity Strategy: The company is prioritizing balance sheet strength amidst credit market disruptions. It maintains $441 million in availability under revolving credit facilities and $47.8 million in cash. Management expects to be a net seller of assets in 2008 to fund development and debt maturities.
• Debt Maturities: The company has $115.9 million in consolidated debt and $492.2 million in unconsolidated joint venture debt maturing in 2008. Management believes it has viable refinancing alternatives.
• Development Pipeline: The company is committing less capital to early-stage domestic developments, adjusting underwriting assumptions to meet stricter return requirements. Significant development projects are underway in the U.S., Canada, and Brazil.
• Accounting Changes: The company is assessing the impact of new accounting standards (SFAS 141(R), SFAS 160, FSP APB 14-a) which may negatively impact future results by requiring the expensing of acquisition costs and altering the treatment of convertible debt.

Investor Verification Checklist

• Asset Dispositions: Verify the extent of asset sales in 2007 versus 2008 to understand the baseline for revenue and earnings comparisons.
• Tenant Distress: Review the $15.6 million in tenant improvements recorded for tenants in financial distress (e.g., Goody's, Mervyns) and assess the risk of future write-offs.
• Debt Refinancing: Monitor the company's ability to refinance the $608 million in debt maturing in 2008 and 2009, particularly given the constrained credit market.
• FFO vs. Net Income: Analyze the divergence between GAAP net income and FFO, noting the significant impact of non-cash depreciation and the exclusion of gains on dispositions from FFO.
• Joint Venture Exposure: Evaluate the $5.7 billion in unconsolidated joint venture debt and the company's exposure to partner defaults or differing strategic goals.