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DDR > SEC Filings for DDR > Form 10-K on 28-Feb-2014All Recent SEC Filings

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Form 10-K for DDR CORP


28-Feb-2014

Annual Report


Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Executive Summary

The Company is a self-administered and self-managed Real Estate Investment Trust ("REIT") in the business of acquiring, owning, developing, redeveloping, expanding, leasing and managing shopping centers. In addition, the Company engages in the origination and acquisition of loans and debt securities collateralized directly or indirectly by shopping centers. As of December 31, 2013, the Company's portfolio consisted of 416 shopping centers (including 173 shopping centers owned through joint ventures) in which the Company had an economic interest. These properties consist of shopping centers and enclosed malls owned in the United States, Puerto Rico and Brazil. At December 31, 2013, the Company owned and managed more than 115 million total square feet of gross leasable area ("GLA"), which includes all of the aforementioned properties. These amounts do not include 25 assets that the Company has a nominal interest in and has not managed since January 1, 2012. The Company also owns more than 1,300 acres of undeveloped land, including an interest in land in Canada and Russia. At December 31, 2013, the aggregate occupancy of the Company's operating shopping center portfolio in which the Company has an economic interest was 92.2%, as compared to 91.5% at December 31, 2012. The Company owned 452 shopping centers (including 209 shopping centers owned through joint ventures) at December 31, 2012. The average annualized base rent per occupied square foot was $14.18 at December 31, 2013, as compared to $13.66 at December 31, 2012.

Current Strategy

The Company has positioned itself for growth after considerable progress in recent years recycling capital, enhancing the quality of the portfolio and improving the balance sheet. The Company issued $827.3 million of common equity in 2013 to selectively acquire prime assets (i.e., market-dominant shopping centers with high-quality tenants located in attractive markets with strong demographic profiles, which are referred to as "Prime Portfolio" or "Prime Assets"). The Company seeks to acquire Prime Assets that will improve portfolio quality, credit quality of cash flows and property-level operating results. The Company will also seek to simplify its structure by selectively acquiring its partners' economic interest in prime power centers currently held in joint ventures. To advance these initiatives and further upgrade portfolio quality, the Company recently created a portfolio management department to identify asset-level opportunities, risks, competition and trends.

In addition to transactional activity, growth opportunities include continued lease-up of the portfolio, selective ground-up development and a redevelopment pipeline with over $500 million of identified strategic opportunities. These strategic opportunities include small shop consolidation to accommodate high credit quality national and regional tenants, as well as downsizing of junior anchors in order to enhance the merchandising mix of the assets, provide retailers with the preferred footprint and generate higher blended rents.

The following set of core competencies is expected to continue to benefit the Company:

Strong tenant relationships with the nation's leading retailers, maintained through a national tenant account program;

An internal anchor store leasing department solely dedicated to aggressively identifying opportunities to re-tenant vacant anchor space;

A retail partnership group to optimize portfolio management by enhancing communication between retailers, the leasing department and other areas of the Company;

An investment group focused on selectively acquiring well-located, quality shopping centers that have leases at below-market rental rates or other cash flow growth or capital appreciation


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potential where the Company's financial strength, relationships with retailers and management capabilities can enhance value and sourcing these acquisitions through identifying buyers for non-core assets;

A portfolio management department tasked with constructing the optimal portfolio to achieve long-term growth and value creation after capital expenditures;

A redevelopment department focused on identifying viable projects with attractive returns;

A capital markets department with broad and diverse relationships with capital providers to facilitate access to secured and unsecured, public and private capital;

An experienced funds management team dedicated to generating consistent returns and disclosure for institutional partners;

A development department adhering to disciplined standards for development and redevelopment and

A focus on growth and value creation within the Prime Portfolio, from which approximately 92% of the Company's net operating income (defined as property-level revenues less property-level operating expenses) is generated.

Transaction and Capital Markets Highlights

During 2013, the Company completed approximately $2.8 billion of transactions and financing activity, including the following:

Completed $2.33 billion of prime shopping center acquisitions and $433.2 million of non-Prime Asset dispositions. DDR's share of these acquisitions and dispositions was $1.92 billion and $296.0 million, respectively;

Acquired the remaining 95% interest in 30 Prime Assets from its existing joint venture with affiliates of The Blackstone Group L.P. (collectively "Blackstone") for $1.46 billion, not including working capital, (the "Blackstone Acquisition"), included in the acquisition amounts above;

Issued $827.3 million of common equity at an average price of $18.76 per share to fund the net investment in Prime Assets;

Issued $150 million, 6.25% Class K Cumulative Redeemable Preferred Shares to redeem $150 million, 7.375% Class H Cumulative Redeemable Preferred Shares;

Issued $300 million, 10-year, 3.375% senior unsecured notes, with net proceeds used to fund the Blackstone Acquisition;

Issued $300 million, 7-year, 3.50% senior unsecured notes, with net proceeds used to repay debt under its unsecured revolving credit facility;

Opportunistically accessed attractively priced long-term debt with the proactive refinancing of the Company's credit facilities and secured term loan in advance of maturity. The new $815 million unsecured revolving credit facilities and $400 million secured term loan mature in 2018 and pricing was reduced by 20 basis points on average and

Paid an annual cash dividend of $0.54 per common share, an increase of 12.5% from 2012.

Operational Accomplishments

The Company accomplished the following in 2013 to improve cash flow and the quality of its portfolio:

Increased the percentage of net operating income generated from the Prime Portfolio to over 90%;


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Signed over 1,700 leases and renewals for the third consecutive year;

Achieved blended leasing spreads for new deals and renewals greater than 8%;

Transitioned premier tenants such as Nordstrom Rack, Whole Foods, L.A. Fitness and Five Below into the Company's top 50 tenants by annual base rent;

Acquired 46 Prime Assets and disposed of 80 non-Prime Assets and non-income producing assets;

Increased the amount of unencumbered net operating income by 17% since year-end 2012;

Achieved consensus investment grade ratings;

Increased the portfolio occupancy rate to 92.2% at year-end 2013 from 91.5% at year-end 2012 and

Increased the Company's total portfolio average annualized base rent per square foot to $14.18 at December 31, 2013 from $13.66 at December 31, 2012.

Retail Environment

Retailers continue to open stores to meet their store opening plans. With demand exceeding supply, retailers also continue to be flexible with their design and prototype requirements, in some cases reducing square footage requirements.

Value-oriented retailers are taking market share from conventional and national chain department stores. The Company's largest tenants, including Walmart/Sam's Club, Target, TJX Companies and Kohl's, have taken market share from the department stores, remaining well-capitalized and outperforming other retail categories on a relative basis. In addition, the Company continues to increase exposure to specialty grocers, which are gaining market share over non-traditional grocers.

Company Fundamentals

The following table lists the Company's 10 largest tenants based on total
annualized rental revenues of the wholly-owned properties and the Company's
proportionate share of unconsolidated joint venture properties combined as of
December 31, 2013:



                                             % of Total
                                           Shopping Center        % of Company-
                                             Base Rental          Owned Shopping
      Tenant                                  Revenues              Center GLA
        1.     Walmart(1)                               3.4 %                 6.5 %
        2.     TJX Companies(2)                         3.1 %                 3.6 %
        3.     Bed Bath & Beyond(3)                     2.7 %                 2.6 %
        4.     PetSmart                                 2.6 %                 2.2 %
        5.     Kohl's                                   2.2 %                 3.7 %
        6.     Best Buy                                 1.8 %                 1.6 %
        7.     Office Depot(4)                          1.8 %                 1.8 %
        8.     Dick's Sporting Goods(5)                 1.7 %                 1.8 %
        9.     Michaels                                 1.7 %                 1.7 %
       10.     Ross Stores(6)                           1.6 %                 1.8 %

(1) Includes Walmart, Sam's Club and Neighborhood Market

(2) Includes T.J. Maxx, Marshalls and HomeGoods

(3) Includes Bed Bath & Beyond, Cost Plus World Market, buybuy BABY and Christmas Tree Shops

(4) Includes Office Depot and OfficeMax

(5) Includes Dick's Sporting Goods and Golf Galaxy

(6) Includes Ross Dress for Less and dd's Discounts


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The following table lists the Company's 10 largest tenants based on total annualized rental revenues of the wholly-owned properties and of the unconsolidated joint venture properties as of December 31, 2013:

                                         Wholly-Owned Properties                           Joint Venture Properties
                                     % of                       % of                    % of                       % of
                                   Shopping                   Company-                Shopping                   Company-
                                  Center Base                  Owned                Center Base                   Owned
                                    Rental                    Shopping                 Rental                    Shopping
Tenant                             Revenues                  Center GLA               Revenues                  Center GLA
Walmart(1)                                 3.7 %                      7.0 %                   1.2 %                      2.4 %
TJX Companies(2)                           3.4 %                      3.8 %                   1.1 %                      1.7 %
Bed Bath & Beyond(3)                       2.9 %                      2.7 %                   1.5 %                      1.9 %
PetSmart                                   2.8 %                      2.3 %                   1.2 %                      1.3 %
Kohl's                                     2.3 %                      3.8 %                   1.2 %                      2.4 %
Best Buy                                   2.0 %                      1.8 %                   0.6 %                      0.5 %
Office Depot(4)                            1.9 %                      1.8 %                   0.7 %                      0.9 %
Dick's Sporting Goods(5)                   1.8 %                      1.9 %                   1.0 %                      1.2 %
Michaels                                   1.7 %                      1.7 %                   1.2 %                      1.4 %
Ross Stores(6)                             1.6 %                      1.7 %                   1.7 %                      2.4 %
AMC Theatres                               1.5 %                      0.8 %                   1.3 %                      1.0 %
Kroger(7)                                  0.7 %                      0.9 %                   2.3 %                      4.2 %
Tops Markets                               0.5 %                      0.5 %                   1.2 %                      1.6 %
Publix                                     0.2 %                      0.3 %                   3.3 %                      5.2 %

(1) Includes Walmart, Sam's Club and Neighborhood Market

(2) Includes T.J. Maxx, Marshalls and HomeGoods

(3) Includes Bed Bath & Beyond, Cost Plus World Market, buybuy BABY and Christmas Tree Shops

(4) Includes Office Depot and OfficeMax

(5) Includes Dick's Sporting Goods and Golf Galaxy

(6) Includes Ross Dress for Less and dd's Discounts

(7) Includes Kroger, Harris Teeter and King Soopers

Occupancy was 92.2% at December 31, 2013, an improvement of 70 basis points from the end of 2012. During 2013, the Company continued to sign a large number of new leases with over 10 million square feet leased as reflected below:

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The Company leased approximately 10.3 million square feet, including 778 new leases and 941 renewals, for a total of 1,719 leases. The Company continued to execute both new leases and renewals at positive rental spreads. At December 31, 2013, the Company had 1,467 leases expiring in 2014 with an average base rent per square foot of $16.81. For the comparable leases executed in 2013, the Company generated positive leasing spreads on a pro rata basis of 14.9% for new leases and 7.6% for renewals. The Company's leasing spread calculation includes only those deals that were executed within one year of the date the prior tenant vacated and, as a result, is a good benchmark to compare the average annualized base rent of expiring leases with the comparable executed market rental rates.

For new leases executed during 2013, the Company expended a weighted-average cost of tenant improvements and lease commissions estimated at $3.68 per rentable square foot over the lease term. The Company generally does not expend a significant amount of capital on lease renewals.

Year in Review - 2013 Financial Results

For the year ended December 31, 2013, net loss attributable to common shareholders decreased as compared to 2012 primarily due to organic growth and net shopping center acquisition activity, a reduction in impairment charges and the loss on debt retirement related to the Company's repurchase of senior unsecured notes in 2012. The following provides an overview of the key financial metrics (see Funds From Operations described later in this section) (in thousands):

                                                                Year Ended December 31,
                                                                 2013               2012
Net loss attributable to common shareholders                 $    (43,142 )       $ (60,271 )

Funds From Operations ("FFO") attributable to common
shareholders                                                 $    372,521         $ 312,380

Operating FFO                                                $    366,667         $ 305,318

Earnings per share - Diluted                                 $      (0.14 )       $   (0.21 )

During 2013, the Company continued to pursue opportunities to position itself for long-term growth while also lowering the Company's risk profile and cost of capital. The Company continued making progress on its balance sheet initiatives, strengthening the operations of its Prime Portfolio and recycling capital from non-Prime Asset sales into the acquisition of Prime Assets to improve portfolio quality. The Company continues to carefully consider opportunities that fit its selective acquisition requirements and remains prudent in its underwriting and bidding practices.

The following discussion of the Company's financial condition and results of operations provides information that will assist in the understanding of the Company's financial statements, the changes in certain key items and the factors that accounted for changes in the financial statements, as well as critical accounting policies that affected these financial statements.

CRITICAL ACCOUNTING POLICIES

The consolidated financial statements of the Company include the accounts of the Company and all subsidiaries where the Company has financial or operating control. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying consolidated financial statements and related notes. In preparing these financial statements, management has used available information, including the Company's history, industry standards and the current economic environment, among other factors, in forming its estimates and judgments of certain amounts included in the consolidated financial statements, giving due


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consideration to materiality. It is possible that the ultimate outcome as anticipated by management in formulating its estimates inherent in these financial statements might not materialize. Application of the critical accounting policies described below involves the exercise of judgment and the use of assumptions as to future uncertainties. As a result, actual results could differ from these estimates. In addition, other companies may use different estimates that may affect the comparability of the Company's results of operations to those of companies in similar businesses.

Revenue Recognition and Accounts Receivable

Rental revenue is recognized on a straight-line basis that averages minimum rents over the current term of the leases. Certain of these leases provide for percentage and overage rents based upon the level of sales achieved by the tenant. Percentage and overage rents are recognized after a tenant's reported sales have exceeded the applicable sales breakpoint set forth in the applicable lease. The leases also typically provide for tenant reimbursements of common area maintenance and other operating expenses and real estate taxes. Accordingly, revenues associated with tenant reimbursements are recognized in the period in which the expenses are incurred based upon the tenant lease provision. Management fees are recorded in the period earned. Fee income derived from the Company's unconsolidated joint venture investments is recognized to the extent attributable to the unaffiliated ownership interest. Ancillary and other property-related income, which includes the leasing of vacant space to temporary tenants, is recognized in the period earned. Lease termination fees are included in other revenue and recognized and earned upon termination of a tenant's lease and relinquishment of space in which the Company has no further obligation to the tenant.

The Company makes estimates of the collectability of its accounts receivable related to base rents, including straight-line rentals, expense reimbursements and other revenue or income. The Company analyzes accounts receivable, tenant credit worthiness and current economic trends when evaluating the adequacy of the allowance for doubtful accounts. In addition, with respect to tenants in bankruptcy, the Company makes estimates of the expected recovery of pre-petition and post-petition claims in assessing the estimated collectability of the related receivable. The time to resolve these claims may exceed one year. These estimates have a direct impact on the Company's earnings because a higher bad debt reserve and/or a subsequent write-off in excess of an estimated reserve results in reduced earnings.

Notes Receivable

Notes receivable include certain loans that are held for investment and are generally collateralized by real estate-related investments and may be subordinate to other senior loans. Loan receivables are recorded at stated principal amounts or at initial investment plus accretable yield for loans purchased at a discount. The related discounts on mortgages and other loans purchased are accreted over the life of the related loan receivable. The Company defers loan origination and commitment fees, net of origination costs, and amortizes them over the term of the related loan. The Company evaluates the collectability of both principal and interest on each loan based on an assessment of the underlying collateral value to determine whether it is impaired, and not by the use of internal risk ratings. A loan is considered to be impaired when, based upon current information and events, it is probable that the Company will be unable to collect all amounts due according to the existing contractual terms, and the amount of loss can be reasonably estimated. When a loan is considered to be impaired, the amount of loss is calculated by comparing the recorded investment to the value of the underlying collateral. As the underlying collateral for a majority of the notes receivable is real estate-related investments, the same valuation techniques are used to value the collateral as those used to determine the fair value of real estate investments for impairment purposes. Given the small number of loans outstanding, the Company does not provide for an additional allowance for loan losses based on the grouping of loans, as the Company believes the characteristics of the loans are not sufficiently similar to allow an evaluation of these loans as a group. As such, all of the Company's loans are evaluated individually for this


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purpose. Interest income on performing loans is accrued as earned. A loan is placed on non-accrual status when, based upon current information and events, it is probable that the Company will not be able to collect all amounts due according to the existing contractual terms. Interest income on non-performing loans is generally recognized on a cash basis. Recognition of interest income on an accrual basis on non-performing loans is resumed when it is probable that the Company will be able to collect amounts due according to the contractual terms.

Consolidation

The Company has a number of joint venture arrangements with varying structures. The Company consolidates entities in which it owns less than a 100% equity interest if it is determined that it is a variable interest entity ("VIE") and the Company has a controlling financial interest in that VIE, or is the controlling general partner. The analysis to identify whether the Company is the primary beneficiary of a VIE is based upon which party has (a) the power to direct activities of the VIE that most significantly affect the VIE's economic performance and (b) the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE. In determining whether it has the power to direct the activities of the VIE that most significantly affect the VIE's performance, the Company is required to assess whether it has an implicit financial responsibility to ensure that a VIE operates as designed. This qualitative assessment has a direct impact on the Company's financial statements, as the detailed activity of off-balance sheet joint ventures is not presented within the Company's consolidated financial statements.

Real Estate and Long-Lived Assets

Properties are depreciated using the straight-line method over the estimated useful lives of the assets. The Company is required to make subjective assessments as to the useful lives of its properties to determine the amount of depreciation to reflect on an annual basis with respect to those properties. These assessments have a direct impact on the Company's net income. If the Company were to extend the expected useful life of a particular asset, it would be depreciated over more years and result in less depreciation expense and higher annual net income.

On a periodic basis, management assesses whether there are any indicators that the value of real estate assets, including land held for development and construction in progress, and intangibles may be impaired. A property's value is impaired only if management's estimate of the aggregate future cash flows (undiscounted and without interest charges) to be generated by the property are less than the carrying value of the property. The determination of undiscounted cash flows requires significant estimates by management. In management's estimate of cash flows, it considers factors such as expected future operating income (loss), trends and prospects, the effects of demand, competition and other factors. If the Company is evaluating the potential sale of an asset or development alternatives, the undiscounted future cash flows analysis is probability-weighted based upon management's best estimate of the likelihood of the alternative courses of action. Subsequent changes in estimated undiscounted cash flows arising from changes in anticipated actions could affect the determination of whether an impairment exists and whether the effects could have a material impact on the Company's net income. To the extent an impairment has occurred, the loss will be measured as the excess of the carrying amount of the property over the fair value of the property.

The Company is required to make subjective assessments as to whether there are impairments in the value of its real estate properties and other investments. These assessments have a direct impact on the Company's net income because recording an impairment charge results in an immediate negative adjustment to net income.


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The Company allocates the purchase price to assets acquired and liabilities assumed at the date of acquisition. In estimating the fair value of the tangible and intangible assets and liabilities acquired, the Company considers information obtained about each property as a result of its due diligence, marketing and leasing activities. It applies various valuation methods, such as estimated cash flow projections using appropriate discount and capitalization rates, estimates of replacement costs net of depreciation and available market information. If the Company determines that an event has occurred after the initial allocation of the asset or liability that would change the estimated useful life of the asset, the Company will reassess the depreciation and amortization of the asset. The Company is required to make subjective estimates in connection with these valuations and allocations.

Off-Balance Sheet Arrangements - Impairment Assessment

The Company has a number of off-balance sheet joint ventures and other unconsolidated arrangements with varying structures. On a periodic basis, . . .

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