Business Context and Reporting Period
Company: Developers Diversified Realty Corporation (DDR), a real estate investment trust (REIT) engaged in acquiring, developing, and operating shopping centers and business centers.
Reporting Period: Quarterly report (Form 10-Q) for the period ended September 30, 2002.
Portfolio Overview: As of September 30, 2002, the Company owned or managed approximately 192 shopping centers and 38 business centers across 38 and 11 states, respectively. The portfolio includes significant joint venture interests, including a 25% stake in a joint venture holding asset designation rights for the bankrupt estate of Service Merchandise Corporation.
Key Financial Metrics
| Metric (in thousands) | Three Months Ended Sep 30, 2002 | Nine Months Ended Sep 30, 2002 |
|---|---|---|
| Total Revenues | $92,509 | $264,037 |
| Net Income | $25,177 | $72,352 |
| Net Income Applicable to Common Shareholders | $18,687 | $51,785 |
| Diluted EPS (Common) | $0.28 | $0.80 |
| Funds From Operations (FFO) | $40,603 | $121,931 |
| Cash Flow from Operating Activities | N/A | $158,001 |
| Total Indebtedness | $1,500,386 | $1,500,386 |
| Cash and Cash Equivalents | $9,227 | $9,227 |
Liquidity: The Company had $9.2 million in cash and $168.7 million available under revolving credit facilities as of September 30, 2002.
Material Changes vs. Prior Period
- Revenue Growth: Total revenues increased 12.4% ($10.2 million) for the three months and 13.3% ($30.9 million) for the nine months ended September 30, 2002, compared to 2001. This was driven by acquisitions (11 shopping centers), the merger with American Industrial Properties (AIP), and new leasing.
- Net Income: Net income increased 23.7% ($4.8 million) for the quarter but remained relatively flat (0.2% increase) for the nine-month period. The nine-month stability was due to higher operating revenues and lower interest rates offset by a significant decrease in gains on property dispositions and a loss from discontinued operations.
- Debt Structure: Total indebtedness increased to $1.5 billion from $1.3 billion at year-end 2001. The Company issued $100 million in fixed-rate senior notes and $150 million in Preferred F shares, while redeeming $150 million of older preferred shares. Interest expense decreased 5.7% for the nine months due to lower interest rates.
- Discontinued Operations: The Company adopted SFAS No. 144, classifying sales of individual properties as discontinued operations. This resulted in a $3.1 million loss for the nine months ended September 30, 2002, primarily due to a $4.7 million impairment charge on an Orlando, Florida property.
Guidance, Outlook, and Risks
- Strategic Merger: On October 4, 2002, DDR entered a definitive merger agreement with JDN Realty Corporation. The transaction values JDN at approximately $1.1 billion and is expected to close in Q1 2003. Post-merger, the combined entity would own or manage ~400 retail properties with a market capitalization over $5.0 billion.
- Dividends: The quarterly common dividend was increased to $0.38 per share. The payout ratio for the first nine months of 2002 was approximately 61.4% of FFO.
- Legal Contingencies:
- Movie Theater Litigation: A $9.0 million judgment (plus fees) was entered against the Company in September 2001. The Company has appealed and deposited an $8.0 million letter of credit. Management believes the verdict will likely be reversed and has not recorded a provision.
- Merger Litigation: Two shareholder lawsuits were filed in October 2002 challenging the JDN merger. Management intends to defend vigorously but acknowledges the risk of delay or interference.
- Economic Risks: The Company notes exposure to the Kmart bankruptcy (2.2% of base rental revenue) and general economic recession, though it believes its portfolio of necessity-based retailers mitigates significant risk.
Investor Verification Checklist
- Merger Consummation: Verify the status of the JDN Realty merger, including shareholder approval and resolution of pending litigation.
- Legal Exposure: Monitor the appeal of the $9.0 million movie theater judgment and the potential impact of the $8.0 million letter of credit deposit.
- Discontinued Operations: Confirm the closing of the Orlando, Florida property sale and the finalization of the $4.7 million impairment charge.
- Debt Covenants: Review the impact of the increased debt load ($1.5 billion) on credit ratings (currently Baa3/BBB with negative outlook) and compliance with covenants.
- FFO vs. Net Income: Analyze the divergence between Net Income and Funds From Operations (FFO) to understand the impact of non-cash depreciation and property sales on reported earnings.