Business Context and Reporting Period
Company: Developers Diversified Realty Corporation (DDR)
Filing Type: Form 10-Q (Unaudited Quarterly Report)
Reporting Period: Three and nine months ended September 30, 2006
Business Overview: DDR is a real estate investment trust (REIT) engaged in acquiring, developing, owning, and managing shopping centers and business centers. As of September 30, 2006, the portfolio included 460 shopping centers (including joint ventures) and seven business centers across 44 states and Puerto Rico. The company recently announced a definitive merger agreement to acquire Inland Retail Real Estate Trust, Inc. (IRRETI) and formed a joint venture in Brazil.
Key Financial Metrics
| Metric (in thousands) | Three Months Ended Sep 30, 2006 | Nine Months Ended Sep 30, 2006 | Nine Months Ended Sep 30, 2005 |
|---|---|---|---|
| Total Revenues | $205,606 | $606,342 | $525,681 |
| Net Income | $62,812 | $191,275 | $233,782 |
| Net Income Applicable to Common Shareholders | $49,020 | $149,898 | $192,405 |
| Diluted EPS (Common) | $0.45 | $1.37 | $1.76 |
| Funds From Operations (FFO) to Common | $91,733 | $287,709 | $273,390 |
| Cash Flow from Operating Activities | N/A | $285,398 | $275,319 |
| Total Indebtedness | $4,078,284 | $4,078,284 | $3,891,001 |
| Cash and Cash Equivalents | $48,431 | $48,431 | $30,655 |
Material Changes vs. Prior Period
- Revenue Growth: Total revenues increased 14.6% for the three months and 15.3% for the nine months ended September 30, 2006, compared to the prior year. This was driven by acquisitions, development completions, and increased base rents.
- Net Income Decline: While quarterly net income rose slightly (4.2%), nine-month net income decreased 18.2% to $191.3 million. This decline was primarily due to a significant reduction in gains on the disposition of real estate assets ($24.9 million decrease) and increased interest expenses ($33.9 million increase), partially offset by higher operating revenues.
- FFO Growth: Funds From Operations (FFO) applicable to common shareholders increased 14.3% for the nine-month period to $287.7 million, reflecting strong operational performance despite the drop in GAAP net income.
- Debt Structure: Total indebtedness increased to $4.1 billion. The company reduced its exposure to variable rate debt by issuing $250 million in fixed-rate convertible notes and entering into $300 million of interest rate swaps, reducing the percentage of floating-rate debt to 6.6%.
- Portfolio Occupancy: Aggregate occupancy for shopping centers increased to 95.3% from 95.0% in the prior year. Average annualized base rent per occupied square foot rose to $11.19 from $10.69.
Guidance, Outlook, and Risks
- Strategic Transactions:
- IRRETI Merger: DDR announced a definitive agreement to acquire IRRETI for approximately $6.2 billion in enterprise value. The transaction is expected to close in Q1 2007.
- International Expansion: Acquired a 50% interest in Sonae Sierra Brazil (approx. $150 million investment) and formed a joint venture with TIAA-CREF to purchase a $3.0 billion portfolio from IRRETI.
- Development Pipeline: The company has eight wholly-owned projects under construction with a projected aggregate cost of $581.1 million and a pipeline of potential projects exceeding $700 million.
- Dividends: The quarterly dividend per common share was increased to $0.59 in 2006 from $0.54 in 2005. The payout ratio for the first nine months of 2006 was approximately 67.9% of FFO.
- Risks and Contingencies:
- Interest Rate Risk: While hedging has reduced exposure, the company remains sensitive to interest rate fluctuations on variable-rate debt.
- Tenant Concentration: Performance is dependent on major tenants (e.g., Wal-Mart, Target, Home Depot). Bankruptcy or closure of major tenants could impact occupancy and rent.
- International Risks: New operations in Brazil and Puerto Rico expose the company to foreign currency fluctuations, political instability, and differing legal environments.
- Accounting Changes: Adoption of SFAS 123(R) regarding share-based compensation increased expenses in 2006 compared to 2005.
Investor Verification Checklist
- Merger Completion: Verify the status of the IRRETI merger approval by shareholders and regulatory clearance, as this is a material future event.
- Debt Covenants: Confirm continued compliance with debt covenants, particularly fixed charge coverage ratios, given the increased debt load from acquisitions.
- Joint Venture Performance: Review the financial performance of the new Brazil joint venture and the TIAA-CREF joint venture, as these represent significant capital commitments.
- Gain on Sales Volatility: Assess the sustainability of earnings given the significant year-over-year decline in gains from real estate dispositions, which heavily impacted 2005 net income.
- Occupancy Trends: Monitor occupancy rates and rental spreads in the acquired IRRETI portfolio post-closing to ensure integration success.