SITC

Business Context and Reporting Period

Company: Developers Diversified Realty Corporation (DDR)

Filing Type: Form 10-Q (Quarterly Report)

Period Ended: June 30, 2004

Business Overview: DDR is a real estate investment trust (REIT) engaged in acquiring, developing, and operating shopping centers and business centers. The reporting period was significantly impacted by the adoption of new accounting standards (FIN 46) and a major strategic acquisition of assets from Benderson Development Company.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 21.5% ($26.5 million) for the three months and 22.3% ($50.4 million) for the six months ended June 30, 2004, compared to 2003. This growth is primarily driven by the acquisition of assets from Benderson and the prior merger with JDN Realty Corporation.
• Net Income Increase: Net income rose 26.9% for the quarter and 28.9% for the six-month period. Significant contributors include gains on the disposition of real estate ($41.0 million for the quarter; $45.4 million for six months) and increased equity in net income of joint ventures.
• Expense Increases: Interest expense increased 33.4% for the quarter and 32.7% for the six months due to higher debt levels associated with acquisitions. Depreciation and amortization increased 33.2% and 30.4%, respectively, reflecting the expanded asset base.
• Accounting Standard Adoption: The adoption of FIN 46 resulted in the consolidation of five entities previously accounted for under the equity method, including a $3.0 million charge recorded in the first quarter related to minority partner losses in a Virginia joint venture.

Guidance, Outlook, and Risks

• Strategic Acquisitions: The company is in the process of acquiring approximately 109 retail assets from Benderson for roughly $2.3 billion. As of June 30, 101 properties had been closed. The portfolio is heavily concentrated in New York and New Jersey (over 80% of GLA).
• Joint Ventures: DDR announced new joint ventures with Kuwait Financial Centre and Prudential Real Estate Investors to divest neighborhood grocery-anchored assets, aiming to sharpen focus on community centers and reduce exposure to specific tenants like Royal Ahold.
• Dividends: The Board declared a third-quarter dividend of $0.51 per share, an increase from the previous $0.46. The payout ratio for the first six months of 2004 was approximately 60.9% of FFO.
• Liquidity: The company expanded its unsecured revolving credit facility from $650 million to $1.0 billion in July 2004. Management anticipates operating cash flow and available credit will fund future growth and dividend requirements.
• Risks: Key risks include general real estate market conditions, tenant bankruptcies, interest rate volatility, and the successful integration of the Benderson portfolio. The company also faces potential environmental liabilities and legal proceedings, including a settled $8.0 million judgment regarding a movie theater property.

Investor Verification Checklist

• Benderson Integration: Verify the final purchase price allocation and the performance of the newly acquired Benderson assets, particularly the 94.6% occupancy rate and master lease arrangements.
• Debt Structure: Review the mix of fixed vs. variable rate debt ($2.3 billion fixed, $951.5 million variable) and the effectiveness of interest rate swaps in mitigating rate risk.
• FFO vs. Net Income: Analyze the reconciliation between GAAP Net Income and Funds From Operations (FFO), noting the significant impact of depreciation and gains on property dispositions.
• Joint Venture Exposure: Assess the financial health of unconsolidated joint ventures, specifically the Service Merchandise joint venture and the MDT Joint Venture, which hold significant assets and debt.
• Legal Contingencies: Monitor the status of the settled Regal Cinemas litigation and any remaining attorney fee obligations.