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DDR > SEC Filings for DDR > Form 10-Q on 8-Aug-2014All Recent SEC Filings

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Form 10-Q for DDR CORP


8-Aug-2014

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") provides readers with a perspective from management on the Company's financial condition, results of operations, liquidity and other factors that may affect the Company's future results. The Company believes it is important to read the MD&A in conjunction with its Annual Report on Form 10-K for the year ended December 31, 2013, as amended, as well as other publicly available information.

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 June 30, 2014, the Company's portfolio consisted of 390 shopping centers (including 155 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 and Puerto Rico. At June 30, 2014, the Company owned approximately 108 million total square feet of gross leasable area ("GLA"), which includes all of the aforementioned properties. These amounts do not include 22 assets that the Company has a nominal interest in and has not managed since January 1, 2012.

The following provides an overview of the Company's key financial metrics (see Funds From Operations described later in this section) (in thousands, except per share amounts):

                                           Three-Month Periods           Six-Month Periods
                                              Ended June 30,              Ended June 30,
                                            2014          2013          2014          2013
Net income (loss) attributable to common
shareholders                             $   67,815     $ (36,034 )   $  44,567     $ (36,761 )
Funds From Operations ("FFO")            $   82,126     $  79,964     $ 167,938     $ 162,480
Operating FFO                            $  101,263     $  86,094     $ 201,973     $ 172,146
Earnings per share - Diluted             $     0.19     $   (0.11 )   $    0.12     $   (0.12 )

The increase in FFO for the three and six-month periods ended June 30, 2014, primarily is due to organic growth, the impact of prime shopping center acquisitions, as well as the reduction of the write-off of the original issuance costs from the redemption of the Company's 7.375% Class H cumulative redeemable preferred shares ("Class H Preferred Shares") and impairment charges on non-depreciable assets as compared to 2013, partially offset by non-Prime asset dispositions and the sale of DDR's entire interest in Sonae Sierra Brazil BV Sarl ("SSB"). The increase in net income primarily is due to the same factors impacting FFO as well as the gain on sale and change in control of interests related to SSB.

Second Quarter 2014 Operating Results

During the second quarter of 2014, the Company continued to pursue opportunities to position itself for long-term growth. The Company continued strengthening the operations of its prime portfolio and recycling capital from non-prime asset sales into the acquisition of prime assets (i.e., market-dominant prime power centers located in large and supply-constrained markets occupied by high credit quality retailers that cater to the consumer's desire for value and convenience, which are referred to as "Prime," "Prime Portfolio" or "Prime Assets") to improve portfolio quality. The Company continues to carefully consider opportunities that meet its selective acquisition requirements and remains prudent in its underwriting and bidding practices.

Significant second quarter 2014 transactional activity included the following:

- Acquired four wholly-owned Prime power centers for $264.8 million;

- Completed the disposition of $78.6 million of non-Prime assets, of which DDR's pro-rata share of the proceeds was $50.9 million;

- Sold its entire ownership interest in SSB for gross proceeds of $343.6 million;

- Closed on a $75.0 million, seven-year non-recourse mortgage loan secured by a shopping center in Puerto Rico with an interest rate of 3.59%;

- Redeemed the remaining $55.0 million of Class H Preferred shares and



- Formed a new unconsolidated joint venture between consolidated affiliates of the Company and Blackstone Real Estate Partners VII ("Blackstone"), which executed a purchase and sale agreement to acquire 76 shopping centers in a transaction valued at $1.975 billion which is expected to close in the third quarter of 2014.

The Company also continued its trend of consistent internal growth and strong operating performance in the first half of 2014 as evidenced by the number of leases executed during the second quarter, the increase in the occupancy rate and the upward trend in the average annualized base rental rates. All prior period metrics noted below have been adjusted to exclude the SSB assets.

- The Company leased approximately 3.1 million square feet in the second quarter of 2014, including 153 new leases and 211 renewals for a total of 364 leases. For the six months ended June 30, 2014, the Company leased approximately 6.1 million square feet, for a total of 742 leases, addressing a significant percentage of its 2014 lease expirations. At December 31, 2013, the Company had 982 leases expiring in 2014, totaling 5.8 million square feet of GLA. As of June 30, 2014, approximately 1.9 million square feet of total GLA leases expiring in 2014 (or 35.5% of total average annualized base rent) remained.

- The aggregate occupancy of the Company's operating shopping center portfolio increased to 92.8% at June 30, 2014, as compared to 92.6% at December 31, 2013, and 91.7% at June 30, 2013. In addition, the Company's total portfolio average annualized base rent per square foot was $13.50 at June 30, 2014, as compared to $13.35 at December 31, 2013, and $12.92 at June 30, 2013.

The Company continued to execute both new leases and renewals at positive rental spreads which contributed to the increase in the average annualized base rent per square foot. At December 31, 2013, the Company had 982 leases expiring in 2014, with an average base rent per square foot of $13.53. For the comparable leases executed in the second quarter of 2014, the Company generated positive leasing spreads on a pro rata basis of 18.8% for new leases and 7.5% for renewals. The Company's leasing spread calculation only includes deals that were executed within one year of the date the prior tenant vacated. As a result, the Company believes its calculation 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 the second quarter of 2014, the Company expended a weighted-average cost of tenant improvements and lease commissions estimated at $4.48 per rentable square foot over the lease term. The Company generally does not expend a significant amount of capital on lease renewals.

RESULTS OF OPERATIONS

Continuing Operations

Shopping center properties owned as of January 1, 2013, but excluding properties under development or redevelopment and those classified in discontinued operations, are referred to herein as the "Comparable Portfolio Properties."

Revenues from Operations (in thousands)



                                               Three-Month Periods
                                                  Ended June 30,
                                                2014          2013        $ Change
      Base and percentage rental revenues    $  178,783     $ 140,458     $  38,325
      Recoveries from tenants                    58,264        44,742        13,522
      Fee and other income                       16,613        22,500        (5,887 )
      Total revenues                         $  253,660     $ 207,700     $  45,960


                                                Six-Month Periods
                                                  Ended June 30,
                                                2014          2013        $ Change
      Base and percentage rental revenues(A) $  355,365     $ 278,035     $  77,330
      Recoveries from tenants(B)                118,324        89,437        28,887
      Fee and other income(C)                    33,068        39,455        (6,387 )
      Total revenues                         $  506,757     $ 406,927     $  99,830


(A) The increase is due to the following (in millions):

                                                    Increase (Decrease)
         Acquisition of shopping centers           $                67.6
         Comparable Portfolio Properties                             9.3
         Development or redevelopment properties                     1.0
         Straight-line rents                                        (0.6 )
         Total revenues                            $                77.3

The following tables present the statistics for the Company's operating shopping center portfolio affecting base and percentage rental revenues summarized by the following portfolios: combined shopping center portfolio, wholly-owned shopping center portfolio and joint venture shopping center portfolio:

                          Combined Shopping               Wholly-Owned                  Joint Venture
                          Center Portfolio            Shopping Centers (1)            Shopping Centers
                              June 30,                      June 30,                      June 30,
                         2014           2013           2014            2013          2014           2013
Centers owned              390             435             235            233           155            202
Aggregate occupancy
rate                       92.8 %         91.7 %          93.0 %         92.1 %        92.3 %         91.3 %
Average annualized
base rent per
occupied square foot   $ 13.50  (2)    $ 13.77      $   13.79  (3)    $ 13.05      $ 12.90  (2)    $ 14.69

(1) For the six months ended June 30, 2014 and 2013, the Comparable Portfolio Properties' aggregate occupancy rate was 93.1% for both periods, and the average annualized base rent per occupied square foot was $13.73 and $12.84, respectively.

(2) Decrease primarily as a result of the Company's sale of its entire interest in SSB in April 2014. The combined shopping center portfolio and joint venture shopping center rates excluding the SSB assets at June 30, 2013, were $12.92 and $12.73, respectively.

(3) Increase primarily due to the Company's strategic portfolio realignment achieved through the recycling of capital from non-Prime Asset sales into the acquisition of Prime Assets, as well as continued leasing of the existing portfolio at positive rental spreads.

(B) The increase in recoveries from tenants primarily was driven by the impact of acquisition properties with higher recovery rates. Recoveries from tenants for all properties on a blended basis were approximately 90.4% and 89.4% of reimbursable operating expenses and real estate taxes for the six-month periods ended June 30, 2014 and 2013, respectively.

(C) Composed of the following (in millions):

                                                  Six-Month Periods
                                                    Ended June 30,
                                                  2014           2013       $ Change
   Management, development and other fee income $    16.1       $ 20.9     $     (4.8 )
   Ancillary and other property income               12.5         13.1           (0.6 )
   Lease termination fees                             3.3          5.2           (1.9 )
   Other                                              1.2          0.3            0.9
                                                $    33.1       $ 39.5     $     (6.4 )

The decrease in management, development and other fee income for the six-month period ended June 30, 2014, compared to the comparable period in 2013, largely is the result of a decrease in the number of properties held through unconsolidated joint ventures, which was 154 at June 30, 2014, as compared to 199 at June 30, 2013.


Expenses from Operations (in thousands)



                                            Three-Month Periods
                                               Ended June 30,
                                             2014          2013        $ Change
         Operating and maintenance        $   35,436     $  32,871     $   2,565
         Real estate taxes                    36,578        26,258        10,320
         Impairment charges                   14,342        13,642           700
         General and administrative           19,085        20,117        (1,032 )
         Depreciation and amortization        99,826        67,047        32,779
                                          $  205,267     $ 159,935     $  45,332


                                             Six-Month Periods
                                               Ended June 30,
                                             2014          2013        $ Change
         Operating and maintenance(A)     $   73,583     $  64,535     $   9,048
         Real estate taxes(A)                 72,042        52,318        19,724
         Impairment charges(B)                24,615        13,642        10,973
         General and administrative(C)        39,338        39,877          (539 )
         Depreciation and amortization(A)    208,295       132,671        75,624
                                          $  417,873     $ 303,043     $ 114,830

(A) The changes for the six-month period ended June 30, 2014, compared to the comparable period in 2013, are due to the following (in millions):

                                             Operating                          Depreciation
                                                and           Real Estate           and
                                            Maintenance          Taxes          Amortization
Acquisition of shopping centers            $        10.8     $        18.5     $         68.0
Comparable Portfolio Properties                     (1.0 )             1.0                6.8
Development or redevelopment properties             (0.8 )             0.2                0.8
                                           $         9.0     $        19.7     $         75.6

The increase in depreciation expense for the Comparable Portfolio Properties and the development or redevelopment properties is attributable to a combination of accelerated depreciation charges related to changes in the estimated useful life of certain assets that are expected to be redeveloped in future periods and assets placed in service in 2013.

(B) The Company recorded impairment charges during the three- and six-month periods ended June 30, 2014 and 2013, related to its shopping center assets marketed for sale. These impairments are more fully described in Note 12, "Impairment Charges and Impairment of Joint Venture Investments," in the notes to the condensed consolidated financial statements included herein.

(C) General and administrative expenses were approximately 5.0% and 4.9% of total revenues, including total revenues of unconsolidated joint ventures and discontinued operations, for the six-month periods ended June 30, 2014 and 2013, respectively. The Company continues to expense certain internal leasing salaries, legal salaries and related expenses associated with leasing and re-leasing of existing space.


Other Income and Expenses (in thousands)



                                           Three-Month Periods
                                             Ended June 30,
                                           2014           2013        $ Change
         Interest income                $    3,158     $    5,797     $  (2,639 )
         Interest expense                  (62,573 )      (53,626 )      (8,947 )
         Other income (expense), net        (4,510 )        1,895        (6,405 )
                                        $  (63,925 )   $  (45,934 )   $ (17,991 )


                                            Six-Month Periods
                                             Ended June 30,
                                           2014           2013        $ Change
         Interest income(A)             $    6,285     $   13,674     $  (7,389 )
         Interest expense(B)              (125,207 )     (105,835 )     (19,372 )
         Other income (expense), net(C)     (9,124 )       (1,005 )      (8,119 )
                                        $ (128,046 )   $  (93,166 )   $ (34,880 )

(A) The weighted-average interest rate of loan receivables, including loans to affiliates, was 8.2% and 9.0% at June 30, 2014 and 2013, respectively. The decrease in the amount of interest income recognized in the first six months of 2014 primarily is due to the repayment of a portion of a preferred equity investment in the fourth quarter of 2013.

(B) The weighted-average debt outstanding and related weighted-average interest rates, including amounts allocated to discontinued operations, are as follows:

                                                          Six-Month Periods
                                                            Ended June 30,
                                                          2014           2013
      Weighted-average debt outstanding (in billions)   $    5.3         $ 4.4
      Weighted-average interest rate                         5.0  %        5.1 %

The weighted-average interest rate (based on contractual rates and excluding convertible debt accretion and deferred financing costs) was 4.7% at both June 30, 2014 and 2013. The increase in the weighted-average debt outstanding is a result of the acquisition of Prime Assets in 2013 and 2014.

Interest costs capitalized in conjunction with development and redevelopment projects and unconsolidated development and redevelopment joint venture interests were $2.2 million and $4.0 million for the three- and six-month periods ended June 30, 2014, respectively, as compared to $2.1 million and $4.8 million for the respective periods in 2013. The Company ceases the capitalization of interest as assets are placed in service or upon the suspension of construction activities.

(C) Other income (expense) was composed of the following (in millions):

                                                     Six-Month Periods
                                                       Ended June 30,
                                                     2014           2013
            Transaction and other expenses, net(1) $    (8.1 )     $ (0.6 )
            Litigation-related expenses                 (1.0 )       (0.7 )
            Debt extinguishment costs, net                 -          0.3
                                                   $    (9.1 )     $ (1.0 )

(1) The Company recorded a $7.3 million charge as a result of a termination fee paid to a major tenant in connection with a redevelopment.


Other Items (in thousands)



                                                    Three-Month Periods
                                                       Ended June 30,
                                                    2014            2013         $ Change
Equity in net income (loss) of joint ventures    $     1,131     $   (1,191 )   $     2,322
Gain on sale and change in control of interests,
net                                                   83,830          1,066          82,764
Tax expense of taxable REIT subsidiaries and
state franchise and income
  taxes                                                 (649 )       (1,703 )         1,054


                                                     Six-Month Periods
                                                       Ended June 30,
                                                    2014            2013         $ Change
Equity in net income of joint ventures(A)        $     6,621     $    1,763     $     4,858
Impairment of joint venture investments(B)            (9,100 )            -          (9,100 )
Gain on sale and change in control of interests,
net(C)                                                83,830          1,066          82,764
Tax expense of taxable REIT subsidiaries and
state franchise and income
  taxes                                               (1,335 )       (2,063 )           728

(A) The increase in equity in net income of joint ventures for the six-month period ended June 30, 2014, compared to the comparable prior-year period, primarily is a result of gains recognized in 2014 from the sale of assets held in joint ventures and lower impairments recorded in 2014 as compared to 2013, partially offset by lower net income from the Company's investment in SSB in 2014 related to the impact of foreign currency translation, as well as the sale of its interest in the joint venture. On April 28, 2014, the Company sold its entire investment in SSB (see 2014 Strategic Transaction Activity).

Through April 28, 2014, the Company had a 50% interest in SSB, which owned an approximate 66% interest in a publicly traded company headquartered in Sao Paulo, Brazil, Sonae Sierra Brasil S.A. ("Sonae Sierra Brasil"), and an indirect interest in the Parque Dom Pedro shopping center. The Company's effective economic ownership in Sonae Sierra Brasil was 33%. SSB uses the functional currency of Brazilian real. The operating cash flow generated by this investment was generally retained by the joint venture and reinvested in the operation of the joint venture including ground-up developments and expansions in Brazil. The weighted-average exchange rates used for recording the equity in net income into U.S. dollars were 2.26 for the Company's ownership period in 2014 and 2.02 for the six-month period ended June 30, 2013.

(B) The other than temporary impairment charges of the joint venture investments are more fully described in Note 12 "Impairment Charges and Impairment of Joint Venture Investments," in the notes to the condensed consolidated financial statements included herein.

(C) Represents the gain associated with the Company's sale of its 50% interest in SSB in the second quarter of 2014. This gain excludes the release of $19.7 million of foreign currency translation from accumulated other comprehensive income.

Discontinued Operations (in thousands)



                                                         Three-Month Periods
                                                            Ended June 30,
                                                         2014            2013         $ Change
Income (loss) from discontinued operations            $       156     $  (19,533 )   $    19,689
Gain (loss) on disposition of real estate, net of tax       6,487         (2,063 )         8,550
                                                      $     6,643     $  (21,596 )   $    28,239


                                                          Six-Month Periods
                                                            Ended June 30,
                                                         2014            2013         $ Change
Income (loss) from discontinued operations            $        98     $  (25,064 )   $    25,162
Gain (loss) on disposition of real estate, net of tax      17,182         (1,462 )        18,644
                                                      $    17,280     $  (26,526 )   $    43,806

The Company sold 16 shopping center properties, including two properties held for sale at December 31, 2013, during the six-month period ended June 30, 2014, aggregating 1.7 million square feet. In addition, the Company sold 39 properties in 2013, aggregating 2.9 million square feet. Included in the reported loss from discontinued operations for the six-month period ended June 30, 2014 and 2013, is $0.6 million and $29.0 million, respectively, of impairment charges.


Disposition of Real Estate, Non-Controlling Interests and Net Income (Loss) (in thousands)

                                                    Three-Month Periods
                                                       Ended June 30,
                                                     2014          2013        $ Change
Gain (loss) on disposition of real estate, net    $    1,472     $  (1,525 )   $   2,997
Non-controlling interests                               (878 )        (195 )        (683 )
Net income (loss) attributable to DDR                 76,017       (23,313 )      99,330


                                                     Six-Month Periods
                                                       Ended June 30,
                                                     2014          2013        $ Change
Gain (loss) on disposition of real estate, net(A) $      383     $  (1,582 )   $   1,965
Non-controlling interests(B)                             860          (386 )       1,246
Net income (loss) attributable to DDR(C)              59,377       (17,010 )      76,387

(A) Amounts are generally attributable to the sale of land. The sales of land did not meet the criteria for discontinued operations because the land did not have any significant operations prior to disposition.

(B) Change in non-controlling interests primarily is the result of the sale of one asset in the first quarter of 2014.

(C) The increase in net income (loss) attributable to DDR for the three- and six-month periods ended June 30, 2014, compared to the prior year comparable periods, primarily is due to the gain on sale of interests recorded as a result of the sale of the Company's interest in SSB, organic growth, net acquisition activity and lower impairment charges.

NON-GAAP FINANCIAL MEASURES

Definition and Basis of Presentation

The Company believes that FFO and Operating FFO, both non-GAAP financial measures, provide additional and useful means to assess the financial performance of REITs. FFO and Operating FFO are frequently used by securities analysts, investors and other interested parties to evaluate the performance of REITs.

FFO excludes GAAP historical cost depreciation and amortization of real estate and real estate investments, which assume that the value of real estate assets diminishes ratably over time. Historically, however, real estate values have risen or fallen with market conditions, and many companies use different depreciable lives and methods. Because FFO excludes depreciation and amortization unique to real estate, gains and losses from depreciable property . . .

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