UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
| [X] | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2004
OR
| [ ] | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from ________ to ________
DEVELOPERS DIVERSIFIED REALTY CORPORATION
| Ohio (State or other jurisdiction of incorporation or organization) |
34-1723097 (I.R.S. Employer Identification No.) |
3300 Enterprise Parkway, Beachwood, Ohio 44122
(216) 755-5500
Indicated 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 [ ]
Indicated by check mark whether the registrant is an accelerated filer (as defined in Rule 12 b-2 of the Exchange Act) Yes þ No [ ]
As of November 3, 2004, the registrant had 102,366,264 outstanding common shares, without par value.
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PART I
FINANCIAL INFORMATION
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DEVELOPERS DIVERSIFIED REALTY CORPORATION
| September 30, | December 31, | |||||||
| 2004 |
2003 |
|||||||
Assets |
||||||||
Real estate rental property: |
||||||||
Land |
$ | 1,363,066 | $ | 821,893 | ||||
Buildings |
4,182,158 | 2,719,764 | ||||||
Fixtures and tenant improvements |
119,240 | 90,384 | ||||||
Construction in progress |
270,252 | 252,870 | ||||||
| 5,934,716 | 3,884,911 | |||||||
Less accumulated depreciation |
(552,095 | ) | (458,213 | ) | ||||
Real estate, net |
5,382,621 | 3,426,698 | ||||||
Cash and cash equivalents |
23,697 | 11,693 | ||||||
Restricted cash |
— | 99,340 | ||||||
Investments in and advances to joint ventures |
256,343 | 260,143 | ||||||
Notes receivable |
17,176 | 11,741 | ||||||
Real estate property held for sale, net |
4,330 | — | ||||||
Other assets |
189,623 | 131,536 | ||||||
| $ | 5,873,790 | $ | 3,941,151 | |||||
Liabilities and Shareholders’ Equity |
||||||||
Unsecured indebtedness: |
||||||||
Fixed rate notes |
$ | 1,269,151 | $ | 838,996 | ||||
Variable rate term debt |
350,000 | 300,000 | ||||||
Revolving credit facility |
550,000 | 171,000 | ||||||
| 2,169,151 | 1,309,996 | |||||||
Secured indebtedness: |
||||||||
Revolving credit facility |
20,500 | 15,500 | ||||||
Mortgage and other secured indebtedness |
1,090,603 | 757,635 | ||||||
| 1,111,103 | 773,135 | |||||||
Total indebtedness |
3,280,254 | 2,083,131 | ||||||
Accounts payable and accrued expenses |
103,621 | 98,046 | ||||||
Dividends payable |
59,148 | 43,520 | ||||||
Other liabilities |
85,785 | 54,946 | ||||||
| 3,528,808 | 2,279,643 | |||||||
Minority equity interest |
23,298 | 24,543 | ||||||
Operating partnership minority interests |
34,197 | 22,895 | ||||||
| 3,586,303 | 2,327,081 | |||||||
Commitments and contingencies |
||||||||
Shareholders’ equity: |
||||||||
Class F – 8.60% cumulative redeemable preferred shares, without par value, $250 liquidation
value;
750,000 shares authorized; 600,000 shares issued and outstanding at September 30, 2004 and
December 31, 2003 |
150,000 | 150,000 | ||||||
Class G – 8.0% cumulative redeemable preferred shares, without par value, $250 liquidation value;
750,000 shares authorized; 720,000 shares issued and outstanding at September 30, 2004 and
December 31, 2003 |
180,000 | 180,000 | ||||||
Class H – 7.375% cumulative redeemable preferred shares, without par value, $500 liquidation
value;
410,000 shares authorized; 410,000 shares issued and outstanding at September 30, 2004 and
December 31, 2003 |
205,000 | 205,000 | ||||||
Class I – 7.5% cumulative redeemable preferred shares, without par value, $500 liquidation value;
340,000 shares authorized; 340,000 shares issued and outstanding at September 30, 2004 |
170,000 | — | ||||||
Common shares, without par value, $.10 stated value; 200,000,000 shares authorized;
109,152,268 and 93,792,948 shares issued at September 30, 2004 and December 31, 2003,
respectively |
10,915 | 9,379 | ||||||
Paid-in-capital |
1,795,030 | 1,301,232 | ||||||
Accumulated distributions in excess of net income |
(111,224 | ) | (116,737 | ) | ||||
Deferred obligation |
10,234 | 8,336 | ||||||
Accumulated other comprehensive income (loss) |
173 | (541 | ) | |||||
Less: Unearned compensation – restricted stock |
(5,414 | ) | (3,892 | ) | ||||
Common stock in treasury at cost: 6,832,038 and 7,359,747 shares at September 30,
2004 and December 31, 2003, respectively |
(117,227 | ) | (118,707 | ) | ||||
| 2,287,487 | 1,614,070 | |||||||
| $ | 5,873,790 | $ | 3,941,151 | |||||
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
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DEVELOPERS DIVERSIFIED REALTY CORPORATION
| 2004 |
2003 |
|||||||
Revenues from operations: |
||||||||
Minimum rents |
$ | 122,013 | $ | 89,037 | ||||
Percentage and overage rents |
1,565 | 769 | ||||||
Recoveries from tenants |
32,415 | 24,760 | ||||||
Ancillary income |
897 | 535 | ||||||
Other property related income |
1,329 | 358 | ||||||
Management fee income |
3,761 | 2,601 | ||||||
Development fee income |
930 | 303 | ||||||
Other |
2,189 | 3,832 | ||||||
| 165,099 | 122,195 | |||||||
Rental operation expenses: |
||||||||
Operating and maintenance |
17,054 | 14,792 | ||||||
Real estate taxes |
21,875 | 15,787 | ||||||
General and administrative |
11,486 | 9,088 | ||||||
Other expense |
2,013 | 233 | ||||||
Depreciation and amortization |
37,561 | 24,480 | ||||||
| 89,989 | 64,380 | |||||||
Other income (expense): |
||||||||
Interest income |
812 | 1,132 | ||||||
Interest expense |
(37,142 | ) | (23,308 | ) | ||||
| (36,330 | ) | (22,176 | ) | |||||
Income before equity in net income of joint ventures, minority interests, income tax of taxable
REIT
subsidiaries and franchise taxes, discontinued operations and gain on disposition of real
estate |
38,780 | 35,639 | ||||||
Equity in net income of joint ventures |
5,322 | 6,852 | ||||||
Income before minority interests, income tax of taxable REIT subsidiaries and franchise taxes,
discontinued operations and gain on disposition of real estate |
44,102 | 42,491 | ||||||
Minority interests: |
||||||||
Minority equity interests |
(465 | ) | (420 | ) | ||||
Operating partnership minority interests |
(719 | ) | (444 | ) | ||||
| (1,184 | ) | (864 | ) | |||||
Income tax of taxable REIT subsidiaries and franchise taxes |
(1,365 | ) | (799 | ) | ||||
Income from continuing operations |
41,553 | 40,828 | ||||||
Discontinued operations: |
||||||||
Income from discontinued operations |
328 | 263 | ||||||
Gain on sale of real estate |
1,320 | — | ||||||
Income from discontinued operations |
1,648 | 263 | ||||||
Income before gain on disposition of real estate |
43,201 | 41,091 | ||||||
Gain on
disposition of real estate, net of tax |
1,115 | 897 | ||||||
Net income |
$ | 44,316 | $ | 41,988 | ||||
Net income applicable to common shareholders |
$ | 30,524 | $ | 24,525 | ||||
Per share data: |
||||||||
Basic earnings per share data: |
||||||||
Income from continuing operations applicable to common shareholders |
$ | 0.28 | $ | 0.29 | ||||
Income from discontinued operations |
0.02 | — | ||||||
Net income applicable to common shareholders |
$ | 0.30 | $ | 0.29 | ||||
Diluted earnings per share data: |
||||||||
Income from continuing operations applicable to common shareholders |
$ | 0.28 | $ | 0.28 | ||||
Income from discontinued operations |
0.02 | — | ||||||
Net income applicable to common shareholders |
$ | 0.30 | $ | 0.28 | ||||
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
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DEVELOPERS DIVERSIFIED REALTY CORPORATION
| 2004 |
2003 |
|||||||
Revenues from operations: |
||||||||
Minimum rents |
$ | 314,600 | $ | 252,847 | ||||
Percentage and overage rents |
4,693 | 3,247 | ||||||
Recoveries from tenants |
87,995 | 67,368 | ||||||
Ancillary income |
2,280 | 1,314 | ||||||
Other property related income |
3,391 | 665 | ||||||
Management fee income |
10,463 | 7,733 | ||||||
Development fee income |
1,724 | 976 | ||||||
Other |
12,244 | 10,003 | ||||||
| 437,390 | 344,153 | |||||||
Rental operation expenses: |
||||||||
Operating and maintenance |
49,134 | 42,380 | ||||||
Real estate taxes |
57,518 | 42,090 | ||||||
General and administrative |
32,980 | 28,001 | ||||||
Other expense |
2,045 | 483 | ||||||
Depreciation and amortization |
94,336 | 68,016 | ||||||
| 236,013 | 180,970 | |||||||
Other income (expense): |
||||||||
Interest income |
3,169 | 3,892 | ||||||
Interest expense |
(92,663 | ) | (65,121 | ) | ||||
| (89,494 | ) | (61,229 | ) | |||||
Income before equity in net income of joint ventures, minority interests, income tax of
taxable REIT
subsidiaries and franchise taxes, discontinued operations, gain on disposition of real
estate and cumulative effect of adoption of a new accounting standard |
111,883 | 101,954 | ||||||
Equity in net income of joint ventures |
30,486 | 23,749 | ||||||
Income before minority interests, income tax of taxable REIT subsidiaries and franchise taxes,
discontinued operations, gain on disposition of real estate and
cumulative effect of adoption of a new accounting standard |
142,369 | 125,703 | ||||||
Minority interests: |
||||||||
Minority equity interests |
(1,379 | ) | (1,263 | ) | ||||
Preferred operating partnership minority interests |
— | (2,236 | ) | |||||
Operating partnership minority interests |
(1,916 | ) | (1,303 | ) | ||||
| (3,295 | ) | (4,802 | ) | |||||
Income tax of taxable REIT subsidiaries and franchise taxes |
(2,257 | ) | (1,234 | ) | ||||
Income from continuing operations |
136,817 | 119,667 | ||||||
Discontinued operations: |
||||||||
Income (loss) income from discontinued operations |
987 | (1,240 | ) | |||||
Gain on the sale of real estate |
619 | 1,206 | ||||||
Income (loss) from discontinued operations |
1,606 | (34 | ) | |||||
Income before gain on disposition of real estate and cumulative
effect of
adoption of a new accounting standard |
138,423 | 119,633 | ||||||
Gain on disposition of real estate, net of tax |
46,492 | 29,142 | ||||||
Income before cumulative effect of adoption of a new accounting standard |
184,915 | 148,775 | ||||||
Cumulative effect of adoption of a new accounting standard |
(3,001 | ) | — | |||||
Net income |
$ | 181,914 | $ | 148,775 | ||||
Net income applicable to common shareholders |
$ | 145,000 | $ | 108,175 | ||||
Per share data: |
||||||||
Basic earnings per share data: |
||||||||
Income from continuing operations applicable to common shareholders |
$ | 1.54 | $ | 1.34 | ||||
Income from discontinued operations |
0.02 | — | ||||||
Cumulative effect of adoption of a new accounting standard |
(0.03 | ) | — | |||||
Net income applicable to common shareholders |
$ | 1.53 | $ | 1.34 | ||||
Diluted earnings per share data: |
||||||||
Income from continuing operations applicable to common shareholders |
$ | 1.53 | $ | 1.32 | ||||
Income discontinued operations |
0.02 | — | ||||||
Cumulative effect of adoption of a new accounting standard |
(0.03 | ) | — | |||||
Net income applicable to common shareholders |
$ | 1.52 | $ | 1.32 | ||||
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
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DEVELOPERS DIVERSIFIED REALTY CORPORATION
| 2004 |
2003 |
|||||||
Net cash flow provided by operating activities |
$ | 230,830 | $ | 187,449 | ||||
Cash flow from investing activities: |
||||||||
Real estate developed or acquired, net of liabilities assumed |
(1,829,916 | ) | (171,314 | ) | ||||
Decrease in restricted cash |
99,340 | — | ||||||
Proceeds from sale and refinancing of joint venture interests |
32,483 | 21,759 | ||||||
Investments in and advances to joint ventures, net |
(43,676 | ) | (83,885 | ) | ||||
Repayment of notes receivable |
3,065 | 8,436 | ||||||
Advances to affiliates |
(3,080 | ) | (12,223 | ) | ||||
Proceeds from disposition of real estate |
265,553 | 219,768 | ||||||
Net cash flow used for investing activities |
(1,476,231 | ) | (17,459 | ) | ||||
Cash flow from financing activities: |
||||||||
Proceeds from (repayment of) revolving credit facilities, net |
384,000 | (526,500 | ) | |||||
Proceeds
from borrowings from term loans |
50,000 | 300,000 | ||||||
Proceeds from construction loans and mortgages |
80,560 | 219,676 | ||||||
Proceeds from issuance of medium term notes, net of underwriting
commissions
$421 and $226 of offering expenses in 2004 and 2003, respectively |
520,003 | 297,204 | ||||||
Repayment of senior notes |
(90,000 | ) | (100,000 | ) | ||||
Principal payments on rental property debt |
(183,101 | ) | (230,828 | ) | ||||
Payment of deferred finance costs |
(4,046 | ) | (4,669 | ) | ||||
Proceeds from issuance of common shares, net of underwriting
commissions and $538 of offering expenses paid |
490,863 | — | ||||||
Proceeds from issuance of preferred shares, net of underwriting commissions
and $598 and $1,412 of offering expenses paid in 2004 and 2003,
respectively |
164,047 | 371,460 | ||||||
Redemption of preferred shares |
— | (204,000 | ) | |||||
Redemption of preferred operating partnership units |
— | (180,000 | ) | |||||
Proceeds from issuance of common shares in conjunction with the exercise
of stock options, dividend reinvestment plan and restricted stock plan |
7,406 | 19,027 | ||||||
Distributions to preferred and operating partnership minority interests |
(1,553 | ) | (6,790 | ) | ||||
Dividends paid |
(160,774 | ) | (122,467 | ) | ||||
Net cash flow provided by (used for) financing activities |
1,257,405 | (167,887 | ) | |||||
Increase in cash and cash equivalents |
12,004 | 2,103 | ||||||
Cash and cash equivalents, beginning of period |
11,693 | 16,371 | ||||||
Cash and cash equivalents, end of period |
$ | 23,697 | $ | 18,474 | ||||
Supplemental disclosure of non-cash investing and financing activities:
For the nine months ended September 30, 2004, in conjunction with the acquisition of 92 assets, the Company assumed mortgage debt at a fair value of approximately $475.0 and other liabilities of approximately $17.4 million. In conjunction with the acquisition of it’s partners 50% interest in a shopping center in March 2004, the Company acquired a property with a book value of $63.6 million and assumed debt of $47.0 million. In connection with the adoption of FIN 46 effective January 1, 2004, the Company consolidated real estate assets of $26.4 million and a mortgage payable of $20.0 million. At September 30, 2004, dividends payable were $59.1 million. In 2004, in conjunction with stock for stock option exercises, the Company recorded $1.9 million to treasury stock and $1.9 million to deferred obligation. The deferred obligation represents the portion of the common shares issuable upon exercise that were not currently issued but rather deferred pursuant to a deferral plan for which the Company maintains a separate trust. For the nine months ended September 30, 2004, minority interests with a book value of approximately $4.9 million were converted into approximately 224,000 common shares of the Company. Other assets include approximately $0.2 million, which represents the fair value of the Company’s fixed rate interest rate swaps at September 30, 2004. Included in other assets and debt is approximately $1.7 million, which represents the fair value of the Company’s reverse interest rate swaps at September 30, 2004. The foregoing transactions did not provide for or require the use of cash for the nine month period ended September 30, 2004.
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DEVELOPERS DIVERSIFIED REALTY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTH PERIODS ENDED SEPTEMBER 30,
(Dollars in thousands)
(Unaudited)
For the nine months ended September 30, 2003, in conjunction with the acquisition of a shopping center, the Company assumed liabilities of approximately $8.4 million. In connection with the merger of JDN Realty Corporation, the Company issued approximately 18.0 million common shares at an aggregate value of $381.8 million, $50.0 million of preferred shares, assumed mortgage and unsecured debt at a fair value of approximately $606.2 million and other liabilities of approximately $22.0 million. At September 30, 2003, dividends payable were $38.7 million. In 2003, in conjunction with stock for stock option exercises, the Company recorded $20.9 million to common stock and paid in capital, $29.5 million to treasury stock and $8.3 million to deferred obligation. The deferred obligation represents the portion of the common shares issued upon exercise that were not currently issued but rather deferred pursuant to a deferral plan for which the company maintains a separate trust. Other liabilities include approximately $0.8 million, which represents the fair value of the Company’s fixed rate interest rate swaps. Included in other assets and debt is approximately $6.7 million, which represents the fair value of the Company’s reverse interest rate swaps. The foregoing transactions did not provide for or require the use of cash.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
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DEVELOPERS DIVERSIFIED REALTY CORPORATION
Notes to Condensed Consolidated Financial Statements
1. NATURE OF BUSINESS AND FINANCIAL STATEMENT PRESENTATION
Developers Diversified Realty Corporation, related real estate joint ventures and subsidiaries (collectively the “Company” or “DDR”), are engaged in the business of acquiring, expanding, owning, developing, redeveloping, leasing, managing and operating shopping centers and business centers.
Reclassifications
Certain reclassifications have been made to the 2003 financial statements to conform to the 2004 presentation.
Use of Estimates
The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
Unaudited Interim Financial Statements
The Company consolidates certain entities in which it owns less than a 100% equity interest if it is deemed to be the primary beneficiary in a variable interest entity, as defined in FIN No. 46 “Consolidation of Variable Interest Entities” (“Fin 46.”) The Company also consolidates entities in which it has a controlling direct or indirect voting interest. The equity method of accounting is applied to entities in which the Company does not have a controlling direct or indirect voting interest, but can exercise influence over the entity with respect to its operations and major decisions.
These financial statements have been prepared by the Company in accordance with generally accepted accounting principles for interim financial information and the applicable rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all information and footnotes required by generally accepted accounting principles for complete financial statements. However, in the opinion of management, the interim financial statements include all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the results of the periods presented. The results of the operations for the three and nine months ended September 30, 2004 and 2003 are not necessarily indicative of the results that may be expected for the full year. These condensed consolidated financial statements should be read in conjunction with the Company’s audited financial statements and notes thereto included in the Company’s Form 8-K dated June 22, 2004 and filed on June 24, 2004 which reflects the impact of property sales as discontinued operations pursuant to the provisions of Statement of Financial Accounting Standard (“SFAS”) 144 – “Accounting for the Impairment or Disposal of Long-Lived Assets” for the year ended December 31, 2003.
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New Accounting Standards
FIN 46
In January 2003, the FASB issued FIN 46. This Interpretation was revised in December 2003. The objective of this Interpretation is to provide guidance on how to identify a variable interest entity (“VIE”) and determine when the assets, liabilities, non-controlling interests, and results of operations of a VIE need to be included in a company’s consolidated financial statements. A company that holds a variable interest in an entity will need to consolidate the entity if the company’s interest in the VIE is such that the company will absorb a majority of the VIEs expected losses and/or receive a majority of the entity’s expected residual returns, if they occur. FIN 46 also requires additional disclosure by primary beneficiaries and other significant variable interest holders. The disclosure provisions of this Interpretation became effective upon issuance in January 2003. The consolidation requirements of this Interpretation applied immediately to VIEs created after January 31, 2003 and no later than the end of the first fiscal year or interim period ending after March 15, 2004 for public companies with non-special purpose entities that were created prior to February 1, 2003. The consolidation requirements of this Interpretation were applicable to special purpose entities no later than the end of the first fiscal year or interim period ending after December 15, 2003.
The Company evaluated all of its pre-existing joint venture relationships in order to determine whether the entities are VIEs and whether the Company is considered to be the primary beneficiary or whether it holds a significant variable interest. Effective January 1, 2004, the Company consolidated five entities that were previously accounted for under the equity method. Four of these entities represent investments in undeveloped land located in Round Rock, Texas; Opelika, Alabama; Jackson, Mississippi; and Monroe, Louisiana, with combined real estate balances of $6.1 million as of September 30, 2004, and liabilities of $0.8 million of which $0.7 million is owed to the Company. The other entity consolidated is an operating shopping center property located in Martinsville, Virginia, in which DDR has a 50% interest. At September 30, 2004, this joint venture had advances payable to DDR of approximately $9.0 million with total real estate of $32.0 million and total debt of approximately $19.9 million, which is secured by the real estate assets of this entity and is non-recourse to the Company. The Company recorded a charge of $3.0 million in the first quarter of 2004 as a result of the adoption of this standard relating to the minority partner’s cumulative losses in excess of its cost basis in the Martinsville, Virginia joint venture (Note 2).
In May of 2004, the Company assumed all of the rights and obligations related to an independent trust (the “Grantor Trust”) from one of the Company’s joint venture entities in which the Company held a 50% interest. The Grantor Trust, a special purpose entity, owns tax exempt floating rate bonds which are serviced from incremental tax revenue generated on a shopping center development in Merriam, Kansas. The Company was determined to be the primary beneficiary of the Grantor Trust and consolidated the Grantor Trust’s assets and obligations assumed. As of September 30, 2004, the Grantor Trust has outstanding obligations totaling approximately $8.6 million and a receivable from the city of Merriam, Kansas of approximately $8.4 million. The Grantor Trust obligation is secured by a letter of credit guaranteed by the Company.
-9-
Service Merchandise Joint Venture
The Company holds a 25% economic interest in a VIE, in which the Company was not determined to be the primary beneficiary. In March 2002, this VIE acquired the designation rights to real estate assets owned and controlled by Service Merchandise Company, Inc. At September 30, 2004 this joint venture currently holds 66 fee simple, leasehold and ground lease interests previously owned by the Service Merchandise Company, Inc., including designation rights to 4 assets for which it has not obtained final title through the bankruptcy court. In total, these assets are located in 26 states across the United States. The VIE has total assets and total mortgage debt of approximately $174.9 million and $67.3 million, respectively, at September 30, 2004 and a note payable to DDR of approximately $14.0 million. In the unlikely event that all of the underlying assets of this entity had no value and all other owners failed to meet their obligations, the Company estimates that its maximum exposure to loss would approximate $24.3 million, primarily representing the net carrying value of the Company’s investment in and advances to this entity as of September 30, 2004. However, the Company expects to recover the recorded amount of its investment in this entity.
MDT Joint Venture and Related Entities
The Company earns property management, acquisition and financing fees from a VIE in which the Company has an 11.75% economic interest. The Company earns asset management and performance fees from a related joint venture (“VIE Manager”), in which the Company has a 50% ownership, and serves as the managing member for the VIE. The VIE, formed in November 2003, originally acquired four shopping centers from the Company and seven shopping centers held through joint ventures of the Company. At the date of formation, the entity was not determined to be a VIE and the Company accounted for its interest in this joint venture using the equity method of accounting.
In May 2004, the joint venture acquired an additional 22 retail properties, eight of which were purchased from the Company, which required a reconsideration of the entity’s VIE status. Upon reconsideration, the entity was determined to be a VIE as a result of material master lease agreements for vacant spaces held with the acquired properties’ former owners. However, the Company was not determined to be the primary beneficiary of the VIE and the Company continues to account for its investment in the VIE using the equity method of accounting.
The financial statements of the VIE as of September 30, 2004 and for the period ended September 30, 2004 are included as part of the combined financial statements in Note 2. In the unlikely event that all of the underlying assets of this entity had no value and all other owners failed to meet their obligations, the Company estimates that its maximum exposure to loss would approximate $89.3 million, primarily representing the aggregate net carrying value of the Company’s investments in and advances to the VIE and the VIE Manager as of September 30, 2004. However, the Company expects to recover the recorded amount of its investment in these entities.
-10-
SAB 104
In December 2003, the Staff of the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 104 (“SAB 104”), “Revenue Recognition”, which supercedes SAB 101, Revenue Recognition in Financial Statements.” SAB 104’s primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superceded as a result of the issuance of EITF 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” Additionally, SAB 104 rescinds the SEC’s Revenue Recognition in Financial Statements Frequently Asked Questions and Answers (the “FAQ”) issued with SAB 101 that had been codified in SEC Topic 13, “Revenue Recognition.” Selected portions of the FAQ have been incorporated into SAB 104. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. The adoption of this bulletin did not have a material impact on the Company’s financial position, results of operations or cash flows.
EITF Issue 03-06
In March 2004, the Emerging Issues Task Force (“EITF”) reached a final consensus regarding Issue 03-6, “Participating Securities and the Two-Class Method under SFAS 128”. The issue addresses a number of questions regarding the computation of earnings per share (“EPS”) by companies that have issued securities other than common stock that participate in dividends and earnings of the issuing entity. Such securities are contractually entitled to receive dividends when and if the entity declares dividends on common stock. The issue also provides further guidance in applying the two-class method of calculating EPS once it is determined that a security is participating. The two-class method is an earnings allocation formula that determines earnings per share for each class of common stock and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings. This consensus is effective for the period ended June 30, 2004 and should be applied by restating previously reported EPS. The adoption of this consensus did not have a material impact on the Company’s financial position, results of operations or cash flows.
Stock Based Compensation
In October 2004, the FASB delayed the effective date of its proposed standard, “Share-Based Payment.” Public companies with calendar year-ends would be required to adopt the provisions of the standard effective for periods beginning after June 15, 2005, rather than January 1, 2005 as originally proposed. The delay comes at the request of several constituents, including the staff of the Securities and Exchange Commission. The Company is currently evaluating the effects of this proposed new standard.
Comprehensive Income
Comprehensive income (in thousands) for the three month periods ended September 30, 2004 and 2003 was $44,170 and $42,179, respectively. Comprehensive income (in thousands) for the nine month periods ended September 30, 2004 and 2003 was $182,628 and $148,427, respectively.
Stock Based Compensation
The Company applies APB 25, “Accounting for Stock Issued to Employees” in accounting for its plans. Accordingly, the Company does not recognize compensation cost for stock options when the option exercise price equals or exceeds the market value on the date of the grant. Assuming application of the fair value method pursuant to SFAS 123, the compensation cost, which is required to be charged against income for all plans, was $1.5 million for the three months ended September 30, 2004 and 2003, and $4.4 million and $4.0 million for the nine months ended September 30, 2004 and 2003, respectively (in thousands, except per share amounts).
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| Three Month Periods | Nine Month Periods | |||||||||||||||
| Ended September 30, |
Ended September 30, |
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| 2004 |
2003 |
2004 |
2003 |
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Net income, as reported |
$ | 44,316 | $ | 41,988 | $ | 181,914 | $ | 148,775 | ||||||||
Add: Stock-based employee compensation
included in reported net income |
1,496 | 571 | 3,748 | 3,558 | ||||||||||||
Deduct: Stock-based employee
compensation expense determined under
fair value based method for all awards |
(1,503 | ) | (1,502 | ) | (4,393 | ) | (3,998 | ) | ||||||||
| $ | 44,309 | $ | 41,057 | $ | 181,269 | $ | 148,335 | |||||||||
Earnings Per Share: |
||||||||||||||||
Basic – as reported |
$ | 0.30 | $ | 0.29 | $ | 1.53 | $ | 1.34 | ||||||||
Basic – pro forma |
$ | 0.30 | $ | 0.27 | $ | 1.53 | $ | 1.34 | ||||||||
Diluted – as reported |
$ | 0.30 | $ | 0.28 | $ | 1.52 | $ | 1.32 | ||||||||
Diluted – pro forma |
$ | 0.30 | $ | 0.27 | $ | 1.51 | $ | 1.32 | ||||||||
2. EQUITY INVESTMENTS IN JOINT VENTURES
At September 30, 2004 and December 31, 2003, the Company had ownership interests in various joint ventures, which owned 74 and 52 operating shopping center properties, respectively, and 66 and 75 shopping center sites, respectively, formerly owned by Service Merchandise Company, Inc.
Combined condensed financial information of the Company’s joint venture investments is as follows (in thousands):
| September 30, | December 31, | |||||||
| 2004 |
2003 |
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